PART II ACCOUNTING INFORMATION FOR

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© Pearson Education Limited 2012
C HAP TE R 8
Cost–volume–profit relationships
Teaching tips and points to stress
Terminology and abbreviations
Management accounting research has shown that volume, while not the only cost driver, is usually a major cost driver.
The breakeven point
The equation method has two advantages. First, if students can remember the income statement format, they can reconstruct the equation. Memorisation is unnecessary. Second, the equation form is more general and so is easier to apply with multiple products (see product mix discussion later in this chapter, with multiple cost and revenue drivers, and with changes in the cost structure (e.g. following annotation. In the Do-All example, what would be the breakeven point (BEP) if Mary had paid the wholesaler €20 per unit for the first 10 units and then €100 per unit for additional units All order data remain unchanged. There are two relevant ranges, and each should be examined fora BEP.
0–10 units

€200Q − €120Q − €2,000 = €0
Q
= 25 units → not a valid BEP, since 25 is outside the relevant range (0–10) in which this cost structure is valid. Over 10 units
€200Q − [(€120
×10) − €100 (Q − 10)] − €2,000 = € 0
Q
= 22 units → valid BEP, since 22 is within the relevant range (over ten units. In contrast to the linear model depicted in Exhibit 8.1, economists usually specify curvilinear TR and TC functions. Within the relevant range (RR, a linear approximation is acceptable, but projections outside the RR will be misleading. At higher volumes, this linear approximation overstates TR (since prices must be cut to increase volume) and understates TC (since ever higher output increases costs such as overtime premiums. Overstating revenues and understating costs yields a bad combination in which the linear model overestimates profit at high volume levels beyond the RR. In economics, the slope of the TR function equals marginal revenue (MR. Since the TR function in Exhibit 8.1 is linear, its slope – MR – is a price per unit. The slope of the TC function is marginal cost (also a constant in Exhibit 8.1), which equals variable cost (VC) per

Bhimani, Horngren, Datar and Rajan, Management and Cost Accounting, 5
th
Edition, Instructor’s Manual
© Pearson Education Limited 2012 unit. Note that selling price and VC per unit are constant across a wide range of volumes only if there is perfect competition in input and output markets. Under imperfect competition, selling price must be reduced to increase unit sales. Linear CAP analysis is most appropriate under perfect competition. Even if TR and TC are not linear functions across abroad range of quantities (i.e. if CVP assumptions 1 and 2 are violated, a linear approximation may still be acceptable within a relevant range of, say, 15–40 units. In this case, an alternative (to Exhibit 8.1) presentation is as follows. This format clearly conveys the limitations of the data and suggests that interferences outside the 15–40 unit range are potentially dangerous explorations.

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