Accounting•Chapter 6•4 min read

Inventory and Cost Accounting — CVP Analysis and the Fundamentals of Cost Calculation

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OIYO EditorialContributor
6/12

What Is Inventory?

Inventory: Assets held for sale in the ordinary course of business, or in the process of being produced for such sale.

Types of Inventory:

  • Merchandise: Finished goods purchased for resale (retail/wholesale)
  • Finished Goods: Products manufactured by the company (manufacturing)
  • Work-in-Progress (WIP): Goods partially through the production process
  • Raw Materials: Materials to be used in production

Inventory Valuation Methods

The method used to allocate inventory costs affects both cost of goods sold (COGS) and ending inventory balances.

First-In, First-Out (FIFO)

Assumes the oldest inventory is sold first.

Example: Purchased 100 units at $10 each in January, 100 units at $12 each in February.
         Sold 150 units in March.

COGS = 100 units × $10 + 50 units × $12 = $1,600
Ending Inventory = 50 units × $12 = $600

During periods of rising prices: Ending inventory value ↑, COGS ↓, Net Income ↑

Weighted Average Cost

Allocates costs based on an average unit cost calculated across all purchases.

Average Unit Cost=Total Cost of PurchasesTotal Units Purchased\text{Average Unit Cost} = \frac{\text{Total Cost of Purchases}}{\text{Total Units Purchased}}

Method Not Permitted Under IFRS

Last-In, First-Out (LIFO): Assumes the most recently purchased goods are sold first. Prohibited under IFRS (though still permitted under US GAAP).

Components of Manufacturing Cost

Manufacturing Cost:

  • Direct Materials → Raw materials directly incorporated into the product
    • Direct Labor → Wages of production workers
    • Manufacturing Overhead → Factory rent, depreciation, indirect materials
  • = Total Manufacturing Cost

Period Costs: Selling and administrative expenses not directly tied to production (expensed in the current period)

CVP Analysis (Cost-Volume-Profit Analysis)

Analysis of how changes in costs and volume (output) affect profit.

Core concepts:

Contribution Margin=Revenue−Variable CostsContribution Margin Ratio=Contribution MarginRevenueOperating Income=Contribution Margin−Fixed Costs\begin{aligned} \text{Contribution Margin} &= \text{Revenue} − \text{Variable Costs} \\ \text{Contribution Margin Ratio} &= \frac{\text{Contribution Margin}}{\text{Revenue}} \\ \text{Operating Income} &= \text{Contribution Margin} − \text{Fixed Costs} \end{aligned}

Break-Even Point (BEP)

The level of sales at which operating income equals zero.

BEP in Units=Fixed CostsContribution Margin Per UnitBEP in Revenue=Fixed CostsContribution Margin RatioExample:Fixed costs$100,000,Selling price$10unit,Variable cost$6unitContribution margin per unit=10−6=$4BEP in units=100,0004=25,000unitsBEP in revenue=25,000×$10=$250,000\begin{aligned} \text{BEP in Units} &= \frac{\text{Fixed Costs}}{\text{Contribution Margin Per Unit}} \\ \text{BEP in Revenue} &= \frac{\text{Fixed Costs}}{\text{Contribution Margin Ratio}} \\ &\text{Example}: \text{Fixed costs} \$100,000, \text{Selling price} \$\frac{10}{\text{unit}}, \text{Variable cost} \$\frac{6}{\text{unit}} \\ \text{Contribution margin per unit} &= 10 − 6 = \$4 \\ \text{BEP in units} &= \frac{100,000}{4} = 25,000 \text{units} \\ \text{BEP in revenue} &= 25,000 \times \$10 = \$250,000 \end{aligned}

Target Profit Sales Volume

Target Sales Volume=(Fixed Costs+Target Profit)/Contribution Margin Per Unit\text{Target Sales Volume} = (\text{Fixed Costs} + \text{Target Profit}) / \text{Contribution Margin Per Unit}

Try It Yourself

Adjust price, variable cost, and fixed cost to see how the break-even point shifts.

CVP 손익분기점 라보

핵심 지표
단위당 공헌이익500원
공헌이익률41.7%
손익분기 판매량1,000 units
손익분기점 시각화

CVP 분석 시각화: 매출과 총원가의 교차

* 파란색 선(매출)과 주황색 선(원가)이 만나는 지점이 손익분기점(BEP)입니다.

Margin of Safety

Margin of Safety=Actual Revenue−BEP RevenueMargin of Safety Ratio=Margin of SafetyActual Revenue×100%\begin{aligned} \text{Margin of Safety} &= \text{Actual Revenue} − \text{BEP Revenue} \\ \text{Margin of Safety Ratio} &= \frac{\text{Margin of Safety}}{\text{Actual Revenue}} \times 100\% \end{aligned}

The higher the margin of safety ratio, the more comfortable the buffer above the break-even point.

Key Concept Cards

FIFO ★★★★★ : Assumes the oldest inventory is sold first. During periods of rising prices, ending inventory carries higher value and net income is reported higher. Memory tip: FIFO = oldest goods sold first

Contribution Margin ★★★★★ : Revenue minus variable costs. The amount that contributes to covering fixed costs and generating profit. Memory tip: Contribution margin = the portion that “contributes” to covering fixed costs

Break-Even Point (BEP) ★★★★★ : The sales volume or revenue level at which profit is zero. BEP = Fixed Costs ÷ Contribution Margin Ratio. Any sales above this level generate profit. Memory tip: BEP = Fixed Costs ÷ (Selling Price − Variable Cost per unit)

Practice Quiz

Q. Between FIFO and weighted average, which method reports higher profit during a period of rising prices?

FIFO. The older (cheaper) inventory is recognized as COGS first, resulting in lower COGS and higher reported profit.

Q. Fixed costs are $20,000; selling price is $5/unit; variable cost is $3/unit. What is the break-even point in units?

Contribution margin per unit = $5 − $3 = $2. BEP = $20,000 ÷ $2 = 10,000 units.

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