Summary:
- CVP analysis helps to determine the impact of cost and volume on profit
- Used for many purposes:
- Analysis of impact of cost/volume on profit
- Calculating breakeven point (BEP), in terms of sales revenue or in terms of sales units, for single product or multiproducts.
- In CPA Canada cases, the requirement for which the CVP analysis is made is specified
- Once the requirement is specified then the calculation process is initiated.
- For calculating CVP, the following information is used:
- Sales price (SP)
- Variable cost (VC)
- Contribution margin (CM) (= SP – VC)
- Fixed cost (FC)
- Target Profit
CVP
CVP analysis is tested often in CPA Canada cases and exams. It’s part of Management Accounting (MA) competency, which is tested in-depth in Core 2, Performance Management (PM), Finance and the CFE.
CVP analysis helps to determine the impact of cost and volume on profit. It helps managers understand how the profit changes, based on changes in other variables, such as selling price, variable cost, and fixed costs.
CVP is an umbrella topic that includes several different calculations. The most commonly tested are:
- Contribution margin (CM) analysis
- Break-even point (BEP) analysis.
Contribution Margin (CM) analysis
CM analysis is used to determine the profitability of a product, before considering any fixed costs. The best way to understand CM is through the profit equation of MA:
Selling price (SP) – Variable Costs (VC) – Fixed Costs (FX) per unit = Profit
The above formula is per unit. To calculate for total, the formula is:
(Selling price (SP) – Variable Costs (VC)) x Qty of Units – Fixed Costs (FX) = Profit
CM is the result of deducting VC from the SP. The formula for CM is:
Selling price (SP) – Variable Costs (VC) = Contribution Margin (CM).
In CPA cases, you’ll be provided with either total amounts or per unit amounts. Put these numbers in Excel, apply the above formula, and calculate the CM.
The most common AOs that will test you on CM are:
- New product launch
- Outsource decision (known as Make or Buy)
- Keep or add or drop (product, service, department, customer)
- Special order
- Cost-benefit analysis
Break-even point (BEP) analysis
BEP analysis can be done for a single product or multiple products. I’ll discuss both below:
BEP for single product
BEP determines the number of units, or the selling price, at which point the profit is 0. The formula for BEP is terms of units is:
BEP in units = (Fixed Cost + Target profit (if any)) / CM per unit
Formula for BEP is terms of selling price is:
BEP in selling dollars = (Fixed Cost + Target profit (if any) + Variable Costs x Qty) / Qty
In CPA Canada eBook, the formula uses the term “contribution margin ratio” and the formula is Fixed costs / CM ratio, however I find the broken-out formula I put above easier to understand.
BEP for multiple products
Similar to above, we’re trying to determine the number of units, or the selling price, at which point the profit is 0. Since there are now multiple products, the formula changes.
BEP in units = (Fixed Cost + Target profit (if any)) / Weighted Average CM (WACM) per unit
The WACM is calculated using the sales mix. The sales mix tells you the % of each product that is normally sold at the company. CPA cases usually give this number. If it’s not provided, calculate using the sales (revenue) figures for each product.
BEP in selling dollars = (Fixed Cost + Target profit (if any) + Total Variable Costs x Qty) / Qty
Exam focus
Here are some ways you are tested on CPA exams:
- (1) The FC and target profit (if any) will be given in CPA cases in most cases while you may be asked to calculate SP, CM, WACM etc.
- (2) The exam might complicate the FC and say “fixed cost will increase if the sales activity exceeds this limit.” In this case, you have to provide two calculations, first for the sales activity below the limit and second for above the limit.
- (3) The sales may be fixed. In this case, you will need to treat the sales like fixed costs. This testing scenario is covered in my Core 2 case pack.
