Profit-Cost-Volume relationship-Article Summary
(Ghandour, 2017) defines profit-cost volume analysis as the cost accounting method which considers the impacts which varying levels of volume as well as costs have on operating profit. This relationship sets to find out the break-even point for varying cost structures, and sales volumes which are important for management looking to make short terms economic decisions. Further, (Ghandour, 2017) states that the profit cost volume analysis considers various assumptions such as the variable cost per unit, fixed cost and sales price are constant. Running such an analysis involves the use of several equations for cost, price and other variables and then plotting them on economic graphs. According to (Drury, 1992), companies make use of profit-cost volume analysis to establish what influences changes in their volume, costs and prices. An accurate and careful profit cost volume analysis requires cost knowledge as well as their variables and fixed behaviors as the volume changes.
In addition, according to (Layne, 2004), profit-cost-volume analysis is inclusive of the analysis of number of goods sold, variable costs, fixed costs and sales prices and how it affects business profitability. He goes ahead to state that the main intention of businesses is earning profits and this profit depend much on various factors among them, the volume of sales and costs of manufacturing, both of which are largely interdependent. The sales volume depends on volume of production which is in turn related to costs, affected by production methods used, internal business efficiency, product mix and production volume. Thus, (Layne, 2004), concludes by stating that the profit cost volume analysis helps management to establish the relationship that exists between revenue and cost to generate profits.
Importance of Profit-cost-volume in planning
The profit cost volume defines an analytical tool used to study the relationship that exists between profits, prices, costs and volume. To an extent, the profit cost volume analysis is a part of, and to an extent it can even be expressed as an extension of marginal costing (Ghandour, 2017). It is a crucial part of the profit-planning of a company. Whereas the formal profit control and planning makes use of forecasts such as budget, the profit cost volume approach provides only the profit planning process overview. In addition, the approach assists in the evaluation of the reasonableness and purpose of these forecast and budgets (Layne, 2004). The profit cost volume analysis is useful as a managerial tool because it offers an insight into the interrelationships as well as effects of factors influencing the firms profits. The relationship among the profit, volume, and cost makes up the profit model of a firm. Thus, the profit-cost volume relationship becomes crucial in profit planning and budgeting.
As it is involved principally in profit planning, it assists in determining the maximum volume of sales so as to avoid losses (Ghandour, 2017). Further, it can be used to find the volume of sales under which the organizational profit goals have to be accomplished. Further, as an ultimate objective it assists in helping the management to come up with the most profitable combination of volume and costs. As a dynamic management tool, therefore, the profit cost volume is used to evaluate and predict the consequences of a firms short run decisions with regard to the selling price, sales volume, marginal cost and fixed costs for the continuous profit plans. In general, the profit cost volume analysis offers answers to the following questions which can be termed as the pillars of profit making and planning;
· Which is the most profitable product and which product should be discontinued
· What are the minimum volumes of sales have to be affected so as to avoid losses and
· What will be the effects of changes in volume, cost and prices on profits
Variable Costing -Article summary
This a term that defines the methodology which only assigns variable costs to inventories. Variable costing translates to the fact that all the overhead costs, in the period incurred are charged to the expenses while the variable overheads costs as well as the direct materials are assigned to the inventory. According to (Kristensen, 2020), in financial reporting, there are no applications of variable costing because the accounting frameworks for example the GAAP and the IFRS, expect that overheads be allocated onto the inventory. Variable costing has its only one application in internal reporting purposes. In the internal reporting purposes, the variable costs are used in;
· Formulating the internal financial statements into a format of contribution margin
· Establishing the lowest possible prices within which the products can be sold
· Conducting breakeven analysis in order to establish the sales levels within which an enterprise will earn zero profits.
Further, (King, 2006) outlines that when the variable costing is applied, the reported gross margin from revenue generating transactions are higher compared to the absorption costing systems. This is because the overhead allocations are charged to the sales. Even though this doesnt mean that the gross margin reported is higher, it doesnt mean that there are higher net profits. In essence, (King, 2006) states that its because the overhead is charged in the income statement to the expense lower, instead. However, (Drury, 1992) goes on to state that its only in cases where the production levels matches the sales. Thus, if sales fall below production, the absorption costing will lead to higher profitability levels because several of the allocated overhead resides in inventory asset as opposed to being charged in the period expense. Thus (Drury, 1992), states that the reverse situation will only occur once sales have exceeded production.
Use of Variable Costing in managerial decisions
As already analyzed, variable costing is the decision making tool in accounting which managers make use for internal reporting purposes. Variable costing can be used in various managerial decisions such as;
· Increasing profitability -the fixed production costs as well as sales stay the same for some time. A manager who considers using variable costing as a way of selling any added unit during a particular time-frame will add to the bottom-line profits as well as the sales of the company (King, 2006). This is since the units dont cost the firm more capital in production. Since variable costing does not consider absorption or fixed costs, there is higher chance of profits increasing through the additional items
· Product offerings-variable costing is used by the management to establish which product to discontinue and which ones to offer (Kristensen, 2020). As opposed to discontinuation of a product which is linked to the negligible profits, the management may use variable costing to establish the general costs of maintaining any additional units, in production. For instance, if an organization currently offers three product and decides to discontinue one of them, the remaining two products will have to absorb higher overhead expenses
· Cost control-the use of variable costing system will help simplify customer and product profitability (Kristensen, 2020). As opposed to analyzing cost hidden data which would otherwise exist if a unit is produced or not, the variable costing will allow a manager to analyze data based entirely on actual production cost. The comprehension of every units actual costs will allow the manager to reduce variances between budgeted and actual amounts .This translates to higher revenues and controlled costs for the company.
Drury, C. (1992). Cost-volume-profit analysis. Management and Cost Accounting, 205-235. doi:10.1007/978-1-4899-6828-9_9
Drury, C. (1992). Absorption costing and variable costing. Management and Cost Accounting, 182-202. doi:10.1007/978-1-4899-6828-9_8
Ghandour, G. F. (2017). The relationship between cost-volume profit management and profitability in private organizations. International Journal of Advanced Engineering Research and Science, 4(4), 281-288. doi:10.22161/ijaers.4.4.43
King, B. (2006). Absorption costing and variable costing income differences: Exceptions to the general expectations. SSRN Electronic Journal. doi:10.2139/ssrn.921283
Kristensen, T. B. (2020). Enabling use of standard variable costing in lean production. Production Planning & Control, 1-16. doi:10.1080/09537287.2020.1717662
Layne, W. A. (2004). CostVolumeProfit (CVP) analysis. Cost Accounting, 150-168. doi:10.1007/978-1-349-17691-5_10
Cost-Volume-Profit (CVP) Analysis
According to Lulaj (2018), the study of CVP has become an essential tool that looks at adjustments in the level of income, sales volume, expenses, and prices. CVP analysis may be a useful method for defining the nature and aspects of economic challenges posed by the organization. CVP analysis ensures strategy and decision-making relevant information, which includes: the identification of issues in preparing goods for export, extension or decrease of the manufacturing line, manufacturing capability usage through nation growth or recession. The analysis demonstrated that CVP analysis is taken into consideration and plays an important role throughout decision-taking in the manufacturing context, affecting managerial decisions on the good or service, costs, and profits to be made. This research has become a significant part of service companies as well as tends to affect strategic decisions for the goods to be provided, the items to be procured by processing firms, and the needs of the company (Lulaj, 2018).
The authors stated that the primary goal of virtually all companies is to gain full benefit. The key element affecting benefit income is production rates (i.e., sales volume). CVP analyses the cost-benefit-to-business partnership to optimize income. The amount of output can vary because of several factors, including the rivalry, new product development, trade slump or boom, rise in commodity demand, insufficient capital, market adjustments in goods, Production rates can shift, and so on. Management needs to examine the impact on income in these situations because of increasing output rates. Management assistance can be used in this way through a variety of techniques. The cost-to-benefit study is one such methodology. In both limited and wider words, the term CVP analysis can be understood. The Break-even point (B.E.P) used in its limited context is the amount of production where the net expense is equal to the total value of the revenue (Abdullahi, Sulaimon, Mukhtar, & Musa, 2017).
Ihemeje et al. (2015) mentioned that CVP research is being used by management to schedule as well as track the interaction between sales, expenses, quantity adjustments, taxes, and earnings more effectively. The CVP analysis is measured interdependently and integrated into the variable cost estimation method. Indeed, the program estimation of variable costs relies on a principle to allocation to market performance, and the approach requires a good mix of costs and revenue amount to maximize financial results. The CVP calculation is often carried out through the crucial B.E.P of productivity. For other constraints, B.E.P may be analysed quantitatively and graphically displayed. CVP research is a widely used method for making actions with valuable knowledge. CVP analyses are often used to take important and fair actions whether an organization is confronted with management issues that have consequences for costs and income. Such an issue involves income preparation, demand development, decision-making or purchasing, commodity expansion or reduction, manufacturing capability use in periods of economic boom, or downturn (Ihemeje, Okereafor, & Ogungbangbe, 2015).
As a manager in a company, I can use the CVP model to consider how earnings are influenced by shifts in market costs, Volume, and prices. Cost applies to the company’s fixed and variable expenses. The number of items produced corresponds to the Volume. Profit applies to the amount of revenue the company earns provided the sales price of the goods, the sale value, and fixed and variable expenses for the corporation. This is an important method in financial and accounting operations. It is one of the most popular methods of strategic accounting for effective decision-making by managers. I would also use the relationship of CVP graphically in order to clearly show the connection between the number of revenue and income.
A company sells an item for $100 per piece.
The variable cost of the company is $50 per unit.
The fixed costs of the company are $10,000.
The total costs of the company are $10,050 if it sells one unit, which shows that the company suffers from ($10,050 – $100) $9,050 loss.
Through CVP calculation, the company’s B.E.P calculation is the following:
Revenue (Unit of Sales x $100) = variable (Unit of Sales x $50) + fixed ($10,000) cost).
Thus, 200 unit sales had to make to reach B.E.P.
Hasan stated that currently, the variable costing method has emerged from a period of time and are an increasingly valuable method in so many large manufacturing organizations for managing and regulating activities. However, it still does not function as extensively as absorption does, but it is increasingly common. Material costs in variable pricing are restricted to manufacturing costs, which are specifically connected to the material and differ with the amount of output. Both processing expenses, direct and indirect, are counted as expenses of the processed materials at the expense of absorption. This paper addresses variable costs, which are used mostly for internal data analysis and reporting and their usefulness throughout the network. Not necessarily limited to contingent and absorption costing. Accountants believe that variable costing satisfies internal criteria more efficiently, giving further transparency into expense interactions when the consumption costing follows public monitoring standards (Hasan, 2015).
As mention by Dyhdalewicz (2015), Cost management and the declaration of donation income are known as essential elements of an organizational Information Program. The method of variable costing has evolved as a consequence of the vital absorption expense strategy, which is mandatory for contemporary financial statements. This system reflects on the requirements of current managers and is used to compile performance reviews on the effectiveness of the operation carried out. These reports provide financial information about the company’s revenues, costs, and financial statements. The annual statements of sales are calculated in the traditional type by the company’s internal operational divisions and the goods delivered. The operating costs are listed according to their response to adjustments in the nature of the company’s operations in variable costs. The expense is split into two groups: fixed as well as a variable cost. A company’s profitability is measured according to the investment margin. The net investment margin would reflect the company operating costs and the anticipated benefit, i.e., a deviation between the gross income and the marginal costs of the goods produced (Dyhdalewicz, 2015).
As stated by the authors, just the part of the expense, which differs from the operation level, is taken into account in variable costing. It comes in the form of direct material, labour as well as variable overhead production costs. Fixed expenses of variable costing are not deemed part of the product expense. Fixed operating expenses, including overhead and distribution costs, therefore do not include such fixed costs of output throughout the variable costing of the inventory as well as the cost of the products produced. There are a variety of drawbacks of flexible pricing. CVP analysis may take details directly out of the variable costing. But it is not readily accessible in absorption costing. Variable expenses are explicitly displayed in the income statement by the operating cost; in this sense, fixed costs may be stressed and become fully competitive. Variable costing offers a clearer estimate of income because there is no arbitrary fixed cost distribution (Aleem, Khan, & Hamad, 2016).
As a manager, I would use variable costing to decide which goods to sell and which to avoid. The manager may use variable costing to assess the total costs of maintaining a unit in service instead of discontinuing a commodity-based on marginal earnings. In comparison, variable prices require managers to evaluate data depending on the real cost of manufacturing, instead of evaluating data embedded in prices, irrespective of whether a unit is generated or not. Comprehension of increasing unit’s real expenses helps management to minimize variances between the present level and the target, thus contributing to managed costs and better sales for the business.
A.B.C. makes clothing for the wealthy that stay in the modern town. The managing accountant offers the following details, which the financial director of the group has evaluated:
Cloth raw material = $10 PU
Cloth labour cost = $6 PU
Total Fixed cost = $500,000 (redundant)
Sales team Salary = $250,000 (redundant)
Cloth related other direct costs (variable overhead) = $4 PU
Thus, Variable costing = $10 + $6 + $4
Per unit of cloth = $20
Abdullahi, S. R., Sulaimon, B. A., Mukhtar, I. S., & Musa, M. H. (2017). Cost-Volume-Profit Analysis as a management tool for decision making in small business enterprise within Bayero University, Kano. IOSR Journal of Business and Management, 19(2), 40-45. Retrieved from http://iosrjournals.org/iosr-jbm/papers/Vol19-issu…
Aleem, M., Khan, A. H., & Hamad, W. (2016). A comparative study of the different costing techniques and their application in the pharmaceutical companies. Audit financia, 11(143), 1253-1263. Retrieved from http://revista.cafr.ro/temp/Article_9514.pdf
Dyhdalewicz, A. (2015). The implementation of variable costing in the management of profitability of sales in trade companies. e-Finanse, 11(3), 116 – 127. doi: 10.14636/1734-039X_11_3_009
Hasan, M. (2015). Variable costing and its applications in manufacturing company. International Scholar Journal of Accounting and Finance, 5(1), 1-12. Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_i…
Ihemeje, J. C., Okereafor, G., & Ogungbangbe, B. M. (2015). Cost-volume-profit analysis and decision making in the manufacturing industries of Nigeria. Journal of International Business Research and Marketing, 1(1), 1-9. Retrieved from http://researchleap.com/wp-content/uploads/2015/12…
Lulaj, E. (2018). Role of analysis CVP (Cost-Volume-Profit) as important indicator for planning and making decisions in the business environment. European Journal of Economics and Business Studies, 4(2), 99-114. Retrieved from http://journals.euser.org/files/articles/ejes_v4_i…
Cost Volume-profit (CVP) is an accounting management way that describes the connection between net revenue, total costs, & income. Cost Volume-Profit Relationship is one of the key cost-management & accounting methods. It is a valuable device that gives the complete picture of the market structure & supports in the planning of business (Rahmayuni & Masmuddin, 2019). It can also answer what-if questions are kind, by telling the volume needed to generate. That definition is significant in each area of decision-making, particularly in the short term. The CVP analysis is very useful for management as it gives insight into the consequences and interrelationship of variables that affect the companys earnings (Mansour, 2016). The relation between cost, volume, and profit make up an enterprise’s benefit structure. Thus, the relationships with the CVP are important for budgeting and benefits planning. It helps to assess the optimal selling level to prevent losses, and the level of revenue at which the company’s income target is reached (Lulaj & Iseni, 2018).
For example, Business A will realize that in a given year, the selling price of commodity X will be in the area of dollar fifty & its variable costs will be about $ thirty. And with a degree of confidence, one may state that the allocation per unit (sales price minus variable costs) is $20. Business A could also have a fixed cost of dollar 200,000 a year, which may be estimated again very quickly.
Variable costing, similarly recognized as direct costing, is an accounting method applied to assign the cost of manufacture to the commodity being manufactured. This system assigns all the variable-manufacturing costs throughout the commodity. Companies follow two common costing methods: variable costing, similarly recognized as marginal costing, primarily applied for internal reporting, and full costing, similarly recognized as absorption costing, typically applied for external environment reports of a company (de Oliveira, Baqueta, Neumann, & Ribeiro, 2018). Direct costing views the total overhead cost of production as expensed during the time in which it is sustained. Such costs accompany the commodity before it is delivered, and as the cost of the products sold, they are expensed on the income statement. On the contrary, absorption costs allow revenue to rise as production increases (Puspitasari, Nuringwahyu, & Krisdianto, 2019). Under variable pricing, businesses only view the variable cost of production as the cost of the goods. The reasoning behind this burden of fixed manufacturing costs is that if a factory is in service or idle, the company will bear these costs. Those operating costs are also not unique to the manufacturing of goods (Gersil & Kayal, 2016).
For example, Let’s suppose the XYZ Business has issued an order for 5,000 widgets for a total sales price of dollar 5,000 & wishes to calculate the gross profit made by fulfilling the order. Second, it has to evaluate the variable cost per gadget. Let us accept the following:
Raw Materials Costs: $10,000
Annual Widgets Produced: 100,000
Direct Labor Costs: $50,000
From this detail, they may infer that each widget costs ten cents in raw materials ($10,000/100,000 widgets) and fifty cents indirect labor costs ($50,000/100,000 widgets). Using the formula above them may determine that the overall variable cost of the order for XYZ Business is:
5,000 x ($0.10 + $0.50) = $3,000
The company will now fairly hope to receive a gross income of $2,000 ($5,000-$ 3,000) from the order.
de Oliveira, N. C., Baqueta, A. C., Neumann, M., & Ribeiro, R. R. (2018). Application of variable costing to the decision-making process in agricultural production: the case of Surinan Farm. Custos E Agronegocio On Line, 14(3), 37-60.
Gersil, A., & Kayal, C. (2016). A comparative analysis of normal costing method with full costing and variable costing in internal reporting. International Journal of Management (IJM), 7(3), 7992.
Lulaj, E., & Iseni, E. (2018). Role of analysis cvp (cost-volume-profit) as important indicator for planning and making decisions in the business environment. European Journal of Economics and Business Studies, 4(2), 99-114.
Mansour, M. (2016). Quantifying the intangible costs related to non-ergonomic work conditions and work injuries based on the stress level among employees. Safety science, 82, 283-288.
Puspitasari, R., Nuringwahyu, S., & Krisdianto, D. (2019). Penerapan metode variable costing dalam menentukan harga jual produk sosis (studi pada rumah sosis di kota batu jawa timur). JIAGABI, 8(2), 75-80.
Rahmayuni, S., & Masmuddin, R. (2019). Analisis cost volume profit dalam meningkatkan pendapatan pada ukm balikpapan. Sebatik, 23(1), 15-19.
Explanation & Answer: 3 Responses 150 Words Each
Tags: Managerial accounting variable costing Profit Cost Volume relationship
User generated content is uploaded by users for the purposes of learning and should be used following Studypool’s honor code & terms of service.