Cost behaviour can be described as the indicator of how costs will adjust in whole when there is a variation in some activity. Several costs are incurred during production, including the variable and fixed expenses. A variety of cost behaviours are observed concerning changes in volume. To begin with, total fixed costs remain constant to changes in production activity. Moreover, fixed costs per unit change inversely to changes in volume; when volume increases, the price per unit decreases, and when the former decreases, the latter grows. In contrast, variable costs per unit remain constant to changes in size. Furthermore, the total variable costs change proportionately to changes in volume; when the volume rises, they increase, and when the amount decreases, they reduce.
Contribution margin (CM) denotes the incremental change created for each unit or product sold after subtracting the variable share of the company’s costs. It, thus, calculated as the selling price of a product minus all variable costs that cause the incremental profit earned for each unit sold. Primarily, the total contribution margin created by an organization signifies the total incomes available to pay for fixed expenses and to produce a profit. The CM concept is, therefore, useful for determining whether to permit a lower value in special pricing conditions. Moreover, If the CM at a specific price is disproportionately negative or low, it would be risky to continue marketing a commodity at that price (Miller, 2017). CM is also beneficial for defining the profits that will ascend from several sales levels. Furthermore, the model can be utilized to select which of various products to trade if they use a common pool resource. Consequently, the item with the highest CM value is given more preference. Additionally, the CM concept is applied in various sectors of business, including product lines, individual products, distribution channels, and in profit centres. CM makes it easier to calculate the operating income of the company. After calculating the CM, one can calculate the operating income by deducting the fixed costs from the contribution margin.
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Cost-Volume-Profit-Analysis, also referred to as break-even analysis, is used as a technique in cost accounting. Predominantly, it is used to aid managers in knowing how fluctuating levels of costs and volume have an effect on the value of a business. Prices have different behaviours when there is a variation in the number of sales. The primary assumptions utilized in this model include that the price is constant to changes in volume, costs are only classified as fixed, variable or mixed, volume affects total costs, inventory levels remain static, and fixed expenses are constant (Miller, 2017). Moreover, it is imperative and necessary to isolate diverse values to fixed and variable expenses so that managers in planning and decision control can use the information.
Cost-volume-profit analysis is essential in decision making as it helps managers to make informed judgements. It is, thus, more important in management accounting than in financial accounts. It helps managers understand how the costs incurred during production determine profits. Moreover, they can use the information to minimize costs thus maximizing the company’s profitability. The changes in cost and volume aid companies in determining how it affects their operating expenses in general. It is done when the costs are broken down into fixed versus variable cost, and thus, the companies realize the keen insight into the profitability of their products or services they sell. Primarily, CVP analysis is used to assess the amount of sales required to attain the break-even point, which indicates that the company earns neither a loss nor a profit as the operating income becomes zero.
Reference
Miller-Nobles, T. L., Norwood, P. R., Matsumura, E. M., Johnston, J.-A. L., Mattison, B., & Meissner, C. A. (2017). Horngren's accounting .
