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Cost-Volume-Profit

Question1

Companiesin the same industry generally have about the same break-even point.Do you agree? Explain.

InCVP analysis, “an organization’s break-even point is the saleslevel where the net income equals zero”[ CITATION Atr14 l 1033 ].

S=TVC+TFC,CM=FC

Itis also the point where, “the sales revenues equate to the totalvariable costs plus the total fixed costs, and the contributionmargin (CM) equals fixed costs (FC)”[ CITATION Atr14 l 1033 ].Inmy opinion, firms in a similar business industry will tend to have anequivalent break-even point because they face similar costs ofproduction. For instance, CVP analysis can be applied in the serviceindustry to determine the price of goods and services being producedin the market. Employees in the service industry must be present attheir workstations irrespective of large queues or absence ofcustomers. Wages for this personnel are taken to be fixed costs andvital for the production process, regardless of the actual demand.Typically, the primary aim is to reduce the fixed costs and lower thebreak-even point. Therefore, it is evident that companies that fallwithin the same industry have a similar break-even point.

Question2

Whatare the components of (CVP) analysis? How does aCVP income statement help management make decisions?

TheCVP analysis is a method used in managerial accounting to determinethe impact of products costs and sales volume on the organization’soperating profit. The CVP analysis focuses on: “the variable costs,fixed costs, selling price, and the sales mix of two or moreproducts”[ CITATION Atr14 l 1033 ].The CVP analysis derives its roots from the profit equation.

P=ContributionMargin – TFC

WhereContribution margin = SP(x) – VC (x)

SPrepresents the selling price

VCrepresents the variable cost

TFCrepresents the total fixed cost

xrepresents the units produced and sold

ContributionMargin (CM), Sales-Variable Cost, is the amount by which the totalsales surpass the variable costs. The Contribution Margin Ratio is,therefore, obtained by dividing the CM by the total sales. Themanagement uses the CVP income statement in making pricing decisionsin a business organization. The CVP analysis is widely used inmanagerial accounting to help managers make informed decisionsregarding cost-effective moves and calculated sales projections toensure the company makes profits. For instance, a low contributionmargin exhibits non-profitable product line or businessfunctionality. On the other hand, contribution margin helps in theanalysis of sales level impact on the operating income. Thecalculations of contribution margin play a vital role in determiningthe type of profitable project the firm would pursue. Therefore, themanagement could use the CVP analysis to direct scarce resources tothe most profitable item.

Question3

Itis essential to choose the right CVP method – equation, contributionmargin, or graphical. If you pick the wrong one, your analysis willbe faulty. Do you agree? Explain

Iagree that it is vital to identify the appropriate CVP tactic eitherthe equation, contribution, or graphic because it is the analysis ofproduct cost, sales volume, and profit and if one of the variablesis misinterpreted, the whole study is deemed to fail. In my opinion,a wrong CVP method results in faulty results and a falserepresentation of the business’s operating income. The wrongequation of the CVP analysis would lead to wrong calculations of theprofit, cost, and volume[ CITATION Atr14 l 1033 ].A wrong computation of the firms’ CVP income statement could haveadverse impacts on the general performance. On the other hand, theuse of wrong contribution margin would lead to a wrong break-evenpoint, thus wrong graphical representations and misrepresentation ofa company’s CVP projections. The analysis of cost-volume-profit isa significant aspect of the managerial accounting the wrong methodcould present partial accounting statements. Therefore, managers havethe primary role in selecting the suitable CVP method within thefirm’s resources to prevent faulty results.

Reference

Atrill, P., McLaney, E., &amp Harvey, D. (2015). Accounting: An Introduction, 6/E. Melbourne: Pearson Higher Education AU.