Strategic Cost Management Handout 2‒Cost Volume Profit Analysis

Strategic Cost Management Handout #02 ‒ Cost Volume Profit Analysis

1) What is Cost – Volume – Profit Analysis? Answer: a. It analyzes the effect of changes in product cost, selling price, and volume or number of outputs, and its effect to the overall operating profit of the firm. CVP analysis enable the firm to determine how many units of a new product must be sold to break-even or how many units of a product must be sold to achieve a target or planned profit. b. It is useful for profit planning by way of a systematic analysis of the profit’s relationship with various costs and volume of sales. 2) What are the factors affecting profit and what will be the effect? Answer: There are four important factors that will affect the operating profit of the company, namely: a. Selling Price – the selling price will have a direct (same) effect on the profit. (i.e., increase in selling price = increase in profit, decrease in selling price = decrease in profit) b. Variable Cost Per Unit – the variable cost per unit will have an inverse (opposite) effect on the profit. (i.e., increase in variable cost/unit = decrease in profit, decrease in variable cost/unit = increase in profit) c. Total Fixed Cost – the total fixed cost will have an inverse (opposite) effect on the profit. (i.e., increase in total fixed cost = decrease in profit, decrease in total fixed cost = increase in profit) d. Volume (a.k.a. units sold) – the volume will have a direct (same) effect on the profit. (i.e., increase in volume = increase in profit, decrease in volume = decrease in profit) 3) What is the approach that will be used by the company in CVP analysis? Answer: The approach or the statement that the company will be using is the contribution margin income statement approach. This approach is for internal decision making purposes only and cannot be used for preparation of financial statement because it is not compliant with PFRS and PAS. In this approach we segregate costs according to their behavior (variable or fixed) instead of whether they are product costs or period costs (cost of goods sold vs. selling and general and administrative expenses). This contribution margin income statement is helpful in aiding sensitivity (“What if?”) analysis. Sensitivity analysis refers to estimating the operating profit if one of the four factors change. CONTRIBUTION MARGIN INCOME STATEMENT Sales XX Less: Variable cost (variable product cost + variable period cost) XX Contribution margin XX Less: Fixed cost (fixed product cost + fixed period cost) XX Operating income (profit) XX TRADITIONAL INCOME STATEMENT Sales XX Less: Cost of goods sold (variable product cost + fixed product cost) XX Gross profit XX Less: Operating expenses (variable period cost + fixed period cost)