Question

Horngren's Cost Accounting ; How can CVP analysis be adapted to meet the circumstance of multiple cost drivers

Answer 1

Cost-volume-profit (CVP) analysis is a method of cost accounting that looks at the impact that varying levels of costs and volume have on operating profit. The cost-volume-profit analysis, also commonly known as break-even analysis, looks to determine the break-even point for different sales volumes and cost structures, which can be useful for managers making short-term economic decisions.

Cost-Volume-Profit (CVP) Assumptions:

1 Changes in the level of revenues and costs arise only because of changes in the number of product units produced and sold.

2 Total costs can be divided into a fixed component and a component that is variable with respect to the level of output.

3 When graphed, the behavior of total revenues and total costs is linear in relation to output units within the relevant range and time period.

4 The unit selling price, unit variable costs, and fixed costs are assumed and constant.

5 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.

6 All revenues and costs are added and compared without taking into account the time value of money.

Now,

A cost driver triggers a change in the cost of an activity. The concept is most commonly used to assign overhead costs to the number of produced units. It can also be used in activity-based costing analysis to determine the causes of overhead, which can be used to minimize overhead costs. Examples of cost drivers are Direct labor hours worked, Number of customer contacts, Number of engineering change orders issued, Number of machine hours used, Number of product returns from customers.

Recognizing the existence of multiple or several cost drivers and then incorporating this into the equation formulation of the model, more realistic results can be obtained. The process can be, a separate variable cost needs to be calculated for each driver. Variable costs may arise from multiple cost drivers or activities. Examples include - Customer or patient count, Passenger miles, Patient days, Student credit-hours. Afterward, In a graph plot a line for total revenues and plot multiple line for diffrent total costs (diffrent variable cost + Fixed Cost). The breakeven point for each cost line is the point at which the total revenue line intersects the each total cost line. The area between the two lines i.e. revenue line and each total cost line to the right of the breakeven point is the operating income area for each total cost line. Alternatively, we can calculate operating profit for different cost drivers and compare them.