Kwame Nkrumah University of

Science & Technology, Kumasi, Ghana

ACC 657 Management Accounting

Unit 2
DECISION MAKING TECHNIQUES
Breakeven Analysis
(Cost-Volume-Profit Analysis)
Clement Oppong (PhD)
Department of Accounting and Finance

FF 34, Ayim Complex, KSB

[email protected]
 Learning Objectives

After completing this topic you should be able to:

1. Explain the assumptions, uses and limitations
of break-even analysis
2. Determine the break-even point using the
equation or graphical method
3. Undertake break-even analysis for a single
products
4. Undertake break-even analysis for multiple
products
 Introduction

• This unit examines one of the most basic planning

tools available to managers: cost–volume–profit
(CVP) analysis.
• Cost–volume–profit analysis examines the
behaviour of total revenues, total costs and
operating profit as changes occur in the output
level, selling price, variable costs per unit or fixed
costs.
 Uses of C-V-P Analysis

C-V-P Analysis is useful for decision making

 Short-term planning
 Explore the relationship which exists between costs,
revenue, output levels and profit
 Choice of sales mix
 Pricing policies
 Profit planning
 Sensitivity analysis
 Special order acceptance
 Assumptions of CVP Analysis

1) Total costs can be divided into a fixed component

and a component that is variable with respect to
the level of output.
2) Fixed costs will remain constant and variable costs
vary proportionately with activity within a
relevant range.
3) Changes in the level of revenues and costs arise
only because of changes in the number of
product (or service) units produced and sold.
4) The unit selling price, unit variable costs and fixed
costs are known and constant.
 Assumptions of CVP Analysis

5) When graphed, the behaviour of total revenues and total costs

is linear (straight-line) in relation to output units within the
relevant range (and time period)

6) All revenues and costs can be added and compared without

taking into account the time value of money.
7) The analysis either covers a single product or assumes that the
sales mix when multiple products are sold will remain constant
as the level of total units sold changes.

8) That technology, production methods and efficiency remain

unchanged

6
 Assumptions of CVP Analysis
• It is apparent that these are over simplifying
assumptions for many practical problems
• It is because of this that CVP analysis can only be an
approximate guide for decision making.

• Nevertheless, by highlighting the interaction of costs,

volume, revenue and profits, useful guidance can be
provided for managers making short run, tactical
decisions.

•NOTE: find out the limitations of BEA

7
 Types of Inputs for Calculation of Cost

 CVP analysis utilizes two types of inputs for

calculation of costs as:
• fixed costs and
• variable costs

Total Cost and Total Revenue

Total cost is the sum of the fixed and total variable
costs for any production or construction.

Total revenue is the product of expected unit sales and

the unit price of each unit.
 Breakeven Point
• Breakeven Point(BEP) is the sales level at which
operating profit is zero.
• The BEP is the point at which a business neither
makes a profit nor loss. At that point total revenue
equals total cost.
• At the breakeven point, sales minus variable
expenses equals fixed expenses.
• Total revenues = Total costs

• The dynamics of the computation of the BEP are

explained:
 Break-Even Point

Determining the Break-Even Point

3 Methods

1. The Mathematical Method

2. The Contribution Method

3. The Chart Method

 Break-Even Point

Mathematical Approach

The formula for break-even point is:

TR = TC Where;

TR = Total Revenues

TC = Total Cost
 Break-Even Point
 Expansion of Formula TR = TC, where
TR = Expected Unit Sales (Q) X Unit Price (P)
TC = Fixed Cost (FC) + Total Variable Cost (VC)
Therefore
Q x P = FC +Variable cost per Unit(V) X Expected Unit Sales(Q)
Q x P = FC + (V x Q)
(Q x P) – (V x Q) = FC
• Here, Q (expected unit sales) is break-even
Q(P-V) = FC point in sales.

Q = FC • As seen from the formulation, BEP analysis

depends on fixed costs, variable costs, unit
P-V price of a product and expected unit sales
(volume of sales).
 Break-Even Point
Contribution Approach
 C-V-P analysis can be undertaken by a graphical means
which are dealt with later or by simple formulae which are
listed below and illustrated by examples.

• BEP (in units) =

• BEP (sales) =

=
 Break-Even Point

• C/S ratio =

• Level of sales to result in target profit (units)

=
 Break-Even Point

Level of sales to result in target profit after tax

(units)
=

 Level of sales to result in target profit (sales) =

Note
The above formulae relates to a single product
firm or one with an unvarying mix of sales.
 Break-Even Point
Activity 1
Nyameye Ltd makes and sells a single product with a sales price of
GHC12 and a variable cost of GHC9. Fixed costs are GHC120,000 per
month. Nyameye budget to sell 90,000 units of the product a month.

Required
Calculate
a) Number of units to break even
b) Sales value at break-even point
c) Contribution to sales ratio
d) What the budgeted profit per month
e) What number of units will need to be sold to achieve a profit of
GHC20,000 per month?
f) What level of sales will achieve a profit of GHC20,000 per month?
g) If the taxation rate is 40% how many units will need to be sold to
make a profit after tax is GHC20,000 per month?
 Break-Even Point
Activity2
KSB wants to run a new programme. Estimated fees to be paid
by a student is GH¢7,500. Fixed cost for the programme is
expected to be GH¢135,000 per annum while variable cost per
student is estimated at GH¢3,000.

You are required to calculate and advise KSB on:

• the number of students to enroll to break even
• the enrolment fees value at break-even point
• the margin of safety, if the expected enrolment is 90 students
• If the taxation rate is 20% how many students need to enroll
on the programme to make a profit after tax of GH¢45,000
p.a.?
 Break-Even Point

The Chart Approach (Break-Even Charts)

The break-even chart is a graphical representation

of costs at various levels of activity shown on the
same chart as the variation of income (or sales,
revenue) with the same variation in activity.

The point at which neither profit nor loss is made

is known as the "break-even point" and is
represented on the chart below by the intersection
of the two lines:
Break-Even Point
 Break-Even Point
Preparing a Breakeven Chart
• You can prepare a breakeven chart by
plotting sales revenue against total cost.

• The breakeven point will be where the sales

revenue line and total cost line intersect.
 Break-Even Point
Activity 3
A new product has the following sales and cost
data.
Selling price GH¢60 per unit
Variable cost GH¢40 per unit
Fixed costs GH¢25,000 per month
Forecast sales 1,800 units per month

Required
Prepare a breakeven chart using the above data.
 Break-Even Point
Solution
 Step 1 Draw the axes and label them.
 The highest value on the vertical axis will be the monthly sales
revenue.
1,800 units x GH¢60 = GH¢108,000
NOTE: Your graph should fill as much of the page as possible, this will
make it clearer and easier to read.

 Step 2 Draw the fixed cost line and label it. This will be a straight
line parallel to the horizontal axis at the GH¢25,000 level.

 Step 3 Draw the total cost line and label it. The best way to do this
is to calculate the total costs for the maximum sales level (1,800
units). Mark this point on the graph and join it to the cost incurred
at zero activity, that is, GH¢25,000.
 Break-Even Point
GH¢
Variable costs for 1,800 units
(1,800 x GH¢40) 72,000
Fixed costs 25,000
Total cost for 1,800 units 97,000

 Step 4 Draw the revenue line and label it. Once again,
start by plotting the revenue at the maximum activity
level. 1,800 units x GH¢60 = GH¢108,000.
 This point can be joined to the origin, since at zero
activity there will be no sales revenue.
 Break-Even Point

 Step 5 Mark any required information on the chart and

read off solutions as required.

• Check that your chart is accurate by reading off the

measures that we have already covered in this session:
the breakeven point, the margin of safety, the profit for
sales of 1,800 units.

 Step 6 Check the accuracy of your readings using

arithmetic.
 Break-Even Point

GH¢’000
 Break-Even Point
Margin of safety
The margin of safety indicates by how much sales may
decrease before a loss occurs.

 Where unit selling price and variable cost of tickets are GHC20
and GHC10 respectively and fixed costs are GHC60,000,
 we will have a break-even point of 6,000 tickets or GHC120,000 sales
value.

If sales are expected to be 8,000 tickets or GHC160,000, the

margin of safety will be 2,000 tickets or 40,000.

Alternatively, we can express the margin of safety in a

percentage form based on the following ratio:
 Break-Even Point

• Percentage margin of safety

= 25%
 Break-Even Point

Sensitivity Analysis

It is one approach for coping with changes in

the values of the variables.

Sensitivity analysis focuses on how a result

will be changed if the original estimates or the
underlying assumptions change.
 Multi Product Approach
Firms typically produce and sell a variety of products and services.

To perform breakeven analysis in a multi-product firm, then a constant

product sales mix must be assumed.

We have to assume that whenever x units of product A are sold, y units of
product B and z units of product C are also sold.

 Such an assumption allows us to calculate a weighted average

contribution per mix.

 The weighting being on the basis of the quantities of each product in the
constant mix.

 The unit contribution of the product that makes up the largest proportion
of the mix has the greatest impact on the average contribution per mix.
Breakeven Point(BEP) for Multiple Products
The breakeven point (in number of mixes) for a standard mix of
products is calculated as fixed costs/contribution per mix.

Activity 4
Beacon Ltd produces and sells two products (Mani & Nani). The
Mani sells for GHS7 per unit and has a total variable cost of
GHS2.94 per unit, while the Nani sells for GHS15 per unit and has a
total variable cost of GHS4.40 per unit. The marketing department
has estimated that for every five units of Mani sold, one unit of
Nani will be sold. The organization's fixed costs total GHS123,600.

Required:
Calculate the breakeven point for Beacon.
 BEP for Multiple Products

Solution
We calculate the breakeven point as follows.
• Step 1 Calculate contribution per unit
• Step 2 Calculate contribution per mix
• Step 3 Calculate the weighted average
contribution
• Step 4 Calculate the breakeven point in units
• Step 5 Calculate the breakeven point in sales
revenue
 BEP for Multiple Products

 Step 1 Calculate contribution per unit

= Selling Price/unit - vc/unit

 Step 2 Calculate contribution per mix

= (Mix of Product Mani * Contribution of product Mani) + (Mix
of Product N * Contribution of product Nani)

 Step 3 Calculate the weighted average contribution

Contribution per mix

total mix (i.e mix of M + mix of N)
 BEP for Multiple Products
 Step 4 Calculate the breakeven point in units

• Fixed cost/ weighted average contribution per unit

• Then each product unit is ascertained by using the mix as

proportion
Mix of Mani/total mix *BEP in units
Mix of Nani/total mix *BEP in units

 Step 5 Calculate the breakeven point in sales revenue

• (BEP in Units for Mani * Selling Price/unit of Mani) +

• (BEP in Unit for Nani * Selling Price/unit of Nani)
 BEP for Multiple Products

 It is important to note that the breakeven point is not

GHS200,000 regardless of the sales mix of products.

 The breakeven point is GHS200,000 provided that the sales

mix remains 5:1.

 Likewise the breakeven point is not at a production/sales

level of 24,000 units regardless of the sales mix.

 Rather, it is when 20,000 units of Mani and 4000 Nani are

sold, assuming a sales mix of 5:1.
 BEP for Multiple Products
Activity 5
Alpha manufactures and sells three products, the Beta, the Gama and
the Delta. Relevant information is as follows:
BETA GAMMA DELTA
GHS/UNIT GHS/UNIT GHS/UNIT
Selling price 135 165 220
Variable cost 72.80 57.90 146.20

Total fixed cost are GHS1,025,000.

Analysis of past trading patterns indicates that the products Beta,
Gamma and Delta are sold in the ratio 3:4:5 respectively.
Required:

Calculate the breakeven point in units and sales value.

 BEP for Multiple Products

Contribution to Sales (C/S) ratio for multiple products

 The breakeven point in terms of sales revenue can be

calculated as
(fixed costs)/(weighted average C/S ratio).

 Any change in the proportions of products in the mix

will change the contribution per mix and the average
C/S ratio and hence the breakeven point.
 BEP for Multiple Products

STEPS
• Step 1 Calculate revenue/sales per mix
• Step 2 Calculate contribution per mix
• Step 3 Calculate average C/S ratio = Step2/step1
• Step 4 Calculate breakeven point (total) = FC/Step3
• Step 5 Calculate breakeven sales value based on revenue
mix ratio
• Step 6 Calculate breakeven in units
 BEP for Multiple Products

 Alternatively you might be provided with the individual C/S

ratios of a number of products.

For example if an organisation sells two products (A and B) in the

ratio 2:5 and if the C/S ratio of A is 10% whereas that of B is 50%,
the average C/S ratio is calculated as follows.

• Average C/S ratio

= (wa * c/sa + wb * c/sb)/ (wa+wb)

Sales revenue at the breakeven point

= (FC)/(Average C/S ratio)
 BEP for Multiple Products
Activity 6

TIM produces and sells two products, the MK and the KL.
The organisation expects to sell 1 MK for every 2 KLs and
have monthly sales revenue of $150,000. The MK has a
C/S ratio of 20% whereas the KL has a C/S ratio of 40%.
Budgeted monthly fixed costs are $30,000.

Required
• What is the budgeted breakeven sales revenue?
 BEP for Multiple Products

The C/S ratio is a measure of how much

contribution is earned from each $1 of sales of the
standard mix.

The C/S ratio of 33⅓% in the question above means

that for every $1 of sales of the standard mix of
products, a contribution of 33.33c is earned.

To earn a total contribution of, say, $20,000, sales

revenue from the standard mix must therefore be
•1/0.3333 × 20,000 = $60,006
 BEP for Multiple Products
Points to Bear In Mind
Any change in the proportions of products in the
mix will change the contribution per mix and the
average C/S ratio and hence the breakeven point.

(a) If the mix shifts towards products with lower

contribution margins, the breakeven point (in
units) will increase and profits will fall unless
there is a corresponding increase in total
revenue.
 BEP for Multiple Products

(b) A shift towards products with higher

contribution margins without a corresponding
decrease in revenues will cause an increase in
profits and a lower breakeven point.

(c) If sales are at the specified level but not in

the specified mix, there will be either a profit
or a loss depending on whether the mix shifts
towards products with higher or lower
contribution margins.
 BEP for Multiple Products

Margin of safety for multiple products

 The margin of safety for a multi-product firm is equal to
the budgeted sales in the standard mix less the breakeven
sales in the standard mix.

 It may be expressed as a percentage of the budgeted sales.

 It should not surprise you to learn that the calculation of the

margin of safety for multiple products is exactly the same as
for single products, but we use the standard mix.

 The easiest way to see how it's done is to look at an

example which we do in this section.
 BEP for Multiple Products
Activity 7
Margin of safety for multiple products
• BA produces and sells two products. The W sells for $8 per unit and
has a total variable cost of $3.80 per unit, while the R sells for $14
per unit and has a total variable cost of $4.20. For every five units
of W sold, six units of R are sold. BA's fixed costs are $43,890 per
period.

• Budgeted sales revenue for next period is $74,400, in the standard

mix.

Required
• Calculate the margin of safety in terms of sales revenue and also as
a percentage of budgeted sales revenue.
 BEP for Multiple Products
Target profits for multiple products

The number of mixes of products required to be

sold to achieve a target profit is calculated as
(fixed costs+ required profit)/weighted average
contribution per units.

You should already be familiar with the problem

of target profits for single products in a CVP
context from our earlier slides.
 BEP for Multiple Products
Activity 7
Target profits for multiple products
An organisation makes and sells three products, F, G and H.
The products are sold in the proportions F:G:H = 2:1:3. The
organization's fixed costs are $80,000 per month and details
of the products are as follows.
Selling price Variable cost
Product $ per unit $ per unit
F 22 16
G 15 12
H 19 13
 BEP for Multiple Products

The organisation wishes to earn a profit of $52,000 next month.

Calculate the required sales value of each product in order to
achieve this target profit.

Solution
We calculate the breakeven point as follows.
• Step 1 Calculate contribution per unit
• Step 2 Calculate contribution per mix
• Step 3 Calculate the weighted average contribution
• Step 4 Calculate the required number of sales in units
(FC+Profit)/step 3
• Step 5 Calculate the breakeven point in sales revenue
 BEP for Multiple Products

The sales revenue of $464,000 will generate a

profit of $52,000 if the products are sold in the
mix 2:1:3.

• Alternatively the C/S ratio could be used to

determine the required sales revenue for a profit
of $52,000.

• The method is again similar to that demonstrated

earlier when calculating the breakeven point.
 BEP for Multiple Products

Using the C/S ratio to determine the required sales

We'll use the data from the example above.

• Step 1 Calculate revenue per mix
• Step 2 Calculate contribution per mix
• Step 3 Calculate average C/S ratio
• Step 4 Calculate required total revenue
• Step 5 Calculate revenue ratio of mix
• Step 6 Calculate required sales
 End
Thank you
Bibliography

Alnoor, B., Horngren, C.T., Datar, S.M., and Madhav,V.R. (2019). Management
and Cost Accounting (Seventh Edition) Pearson Education Limited.

Atrill, P., and McLaney, E. (2019). Management Accounting for Decision

Makers (Ninth edition) Pearson Education Limited.

Emile Wolf (2019). Paper 2.2: Management Accounting, ICAG.

www.knust.edu.gh

ACC 557