Accounting Business Reporting for Decision Making

432 Accounting: Business Reporting for Decision Making

(continued)

The break-even level of sales will be equal to:

$9 000 000

= $15 873 015

0.567

At this level of sales revenue, the contribution margin will be equal to the fixed costs.

We can use the contribution margin ratio data to consider the impact on profit of, say, a 5 per cent

increase in sales revenue. Using the example above, a 5 per cent increase in sales revenue would be

(30 000 000 × 0.05) = $1 500 000. With an average contribution margin of 0.567, the additional con-

tribution margin (and profit) would be ($1 500 000 × 0.567) or $850 500.

10.4 CVP assumptions

LEARNING OBJECTIVE 10.4 Explain the key assumptions underlying CVP analysis.

CVP analysis and break-even analysis are underpinned by a range of important assumptions. Key

assumptions include the following.

• The behaviour of costs can be neatly classified as fixed or variable.


• Cost behaviour is linear (see figures 10.1 and 10.2).


• Fixed costs remain ‘fixed’ over the time period and/or a given range of activity (often referred to as

the relevant range).

• Unit price and cost data remain constant over the time period and relevant range.


• For multi-product entities, the sales mix between the products is constant.

If the conditions and environment for the entity fall outside the assumptions (e.g. not all costs can

easily be classified as fixed or variable), then such analysis is of little benefit.

10.5 Using break-even data

LEARNING OBJECTIVE 10.5 Discuss the uses of break-even data.

Break-even data can be used to assist with a variety of decision situations, including:

• identifying the number of products or services required to be sold to meet break-even or profit targets


• allocating resources, by focusing on those products that contribute more to profits


• determining the impact on profit of changes in the mix of fixed and variable costs


• pricing products.
  In the reality check ‘What happened to my groceries’ we see how increasing costs, including the high

price of inputs, means that entities are turning to creative initiatives such as changing product sizing to

maintain or increase profitability.

REALITY CHECK

What happened to my groceries?

It’s not always possible to increase selling prices when costs rise in order to maintain or improve profit-

ability. One action that is becoming more popular is to reduce (or maintain at existing levels) variable

costs per unit by reducing the size of the packaging. A number of examples exist.

1. Some cans of tuna now have less weight.


2. Doritos, Tostitos and Fritos now have 20 per cent less in quantity compared to a few years ago.


3. Cadbury dairy milk chocolate blocks have been reduced in size from 220 grams to 200 grams.
   Of course, companies argue that rising costs are the reason for the changes. This may well be the
   case. For many companies, adjusting the size of the product in order to maintain margins is preferable
   to increasing the price. Consumers may agree!
   Sources: Ma, Wen Lei 2015, ‘Cadbury reduces block sizes from 220g back down to 200g’, 3 February, News.com.au,
   http://www.news.com.au/finance/money/cadbury-reduces-block-sizes-from-220g-back-down-to-200g/story-fnagkbpv-
   1227206014592; Clifford, S & Rampell, C 2011, ‘Honey, who shrank the groceries?’, The Sydney Morning Herald, 30 March.