Accounting Business Reporting for Decision Making

CHAPTER 10 Cost–volume–profit analysis 435

VALUE TO BUSINESS

•   CVP analysis is an important part of the planning process and serves as a useful decision-making

tool.

•   An understanding of fixed, variable and mixed costs is necessary to execute break-even analysis.

•   Break-even analysis can be conducted for single-product/service entities and multi-product/service

entities.

•   CVP analysis is underpinned by a set of important assumptions.

•   The concepts of margin of safety and operating leverage provide entities with useful extensions to

the basic CVP analysis and break-even calculations.

DECISION-MAKING EXAMPLE

Improving the break-even level of sales

SITUATION Prior to the opening of EastLink in Melbourne in 2008, it was forecast that 258 000

vehicles would use the tollway daily. However, in 2008, fewer than 150 000 trips were being made

and at the time industrial analysts advised that at least 156 000 trips a day were needed to cover

the monthly interest bill. By 2011, daily trips were on average 186 332, still well below the original

forecasts. Using CVP concepts, how do you think management responded to this situation?

DECISION Connect East management focused on cost efficiencies and, as a result, the cost per

trip dropped from $1.72 in 2009 to $1.28 in 2010. Cost efficiencies were gained by upgrading the

image processing system, which led to a reduction in manual processing, and through technical

improvements to the web and contact centre channels with the expectation that customers would

elect to use self-service options. However, the actions taken were not sufficient and in 2011 the

tollway was sold to foreign investors.

10.7 Contribution margin per limiting factor

LEARNING OBJECTIVE 10.7 Assess the profitability of output when there are resource limitations.

For some businesses sales are not limited by market demand, but by production/operational limitations.

For example, limited production can be caused by a shortage of labour, materials, space or equipment,

or any combination of these. In such cases, if the entity offers more than one product or service to cus-

tomers, it would need to determine which product/service provides the most profitable use of the limited

resource. In order to calculate the most profitable mix of products/services, it is necessary to calculate

the contribution margin per limiting factor. We will use an earlier example, Coconut Plantations Pty

Ltd, to illustrate this situation. The following table provides financial data on the company’s three prod-

ucts and the amount of machine time (machine hours) required to produce each.

Products

Candles Soaps Detergents

Budgeted sales next year

Selling price per unit

Variable costs per unit

Contribution margin per unit

Machine hours per unit

Total machine hours required

are 370 000 hours

60 000

$25

$15

$10

1 hour

60 000 hrs

40 000

$40

$22

$18

4 hours

160 000 hrs

100 000

$20

$15

$5

1.5 hours

150 000 hrs