What is Break-Even Point in Accounting?
In accounting, the term “break-even point” refers to the level of production or sales at which a particular company neither incurs any loss nor generates any profit. In other words, a company generates just enough revenue such that all its expenses are met, and as such the company doesn’t earn any profit. Mostly it is expressed in terms of the number of units.
Explanation of B.E.P in Accounting
Accounting is primarily used for determining the level of production or sales which should be achieved in order to avoid any losses due to core business operations. The break-even analysis is very important from the perspective of the start of planned capacity expansion or the launch of a new product line. Basically, the analysis indicates what level of production is necessary to justify the capacity expansion or new product line.
How to Calculate Break Even Point in Accounting?
Accounting can be calculated by dividing the total fixed costs of production by the difference of selling price and variable cost for each unit. Mathematically it is represented as,
Accounting Break-Even Point = Total Fixed Costs / (Selling Price – Variable Cost)
Examples of B.E.P in Accounting
Following examples are given below:
Example #1
Let us take the example of ASD Inc. to illustrate the computation of the B.E.P in accounting. It is an office stationery manufacturing company and currently, it is in the process of setting up a new unit for the manufacturing card holder. The annual fixed cost is expected to be $160,000, while the variable cost per unit will be $0.90, which includes raw material costs and direct labor expenses. Determine at what level of production the cardholder manufacturing unit will start booking profit if the selling price of each cardholder is$2.50.
Solution:
- Given, Selling price = $2.50
- Variable cost = $0.90
- Total fixed costs= $160,000
Accounting Break-Even Point is calculated as
Accounting Break-Even Point = Total Fixed Costs / (Selling Price – Variable Cost)
- Accounting Break-Even Point = $160,000 / ($2.50 – $0.90)
- Accounting Break-Even Point = 100,000
Therefore, ASD Inc.’s new unit will have to produce a minimum of 100,000 card holders in order to avoid operational losses. Any increase of production from this level will result in profit.
Example #2
Let us take another example to explain how to calculate accounting. SDF Inc. is a pizza manufacturing company and it has started a brand new store two months back. The new unit is yet to start booking any profit and as such the store manager intends to ascertain of the new unit. Help the store manager determine the break-even concept based on the given information:
- Average selling price of each pizza: $17
- Average variable cost of each pizza: $7
- Total fixed costs: $10 million
Solution:
- Given, Selling price = $17
- Variable cost = $7
- Total fixed costs= $10,000,000
Accounting Break-Even Point is calculated as
Accounting Break-Even Point = Total Fixed Costs / (Selling Price – Variable Cost)
- Accounting Break-Even Point = $10,000,000 / ($17 – $7)
- Accounting Break-Even Point = 1,000,000
Therefore, the new store has to achieve sales of 1,000,000 pizzas before its starts booking profit.
Break-Even Point in Accounting with Graph
In the above graph, green represents total revenue while the orange line represents total cost, which is the combination of fixed costs (blue dotted line) and variable costs (yellow dotted line). Now, it can be seen that the line for total cost remains above the total revenue before the break-even point and as such, it is the loss zone. However, after the break-even point, the line for total revenue goes above that of the total cost, and as such this the profit zone.
How to Reduce Break-Even Point in Accounting?
As can be seen from the formula, the break-even point can be reduced by:
- Decreasing fixed costs of production
- Increasing selling price per unit
- Decreasing variable costs of production per unit
Difference Between Accounting Break-Even Point and Financial Break-Even Point
Some of the major differences between accounting break-even point and financial break-even point are as follows:
- The accounting B.EP determines the level of output required to cover all costs, while the financial break-even point ascertains the earnings level at which EPS is zero.
- An accounting B.EP calculates zero operating margins, while the financial break-even point is based on zero net income.
- The financial B.EP is applicable to personal purposes, while the accounting B.EP is primarily applicable to companies and organizations only.
Advantages
Some of the advantages of B.E.P in accounting are as follows:
- It helps in measuring the amount of profit and losses that will be made at different levels of sales or production.
- It also facilitates forecasting the probable impact of changes in the selling price of an item.
- It helps in understanding the relationship between fixed costs and variable costs.
- It can be used to ascertain the effect of change in cost and efficiency on the overall profitability.
Disadvantages
Some of the disadvantages of B.E.P in accounting are as follows:
- It is based on an unrealistic assumption that the selling price remains constant at all levels of output.
- It assumes that sales and production remain at the same level, which is again not a very practical assumption.
- It takes a significant amount to prepare a break-even chart.
- This concept is only applicable for a single product or a single mix of products.
Conclusion
So, it can be seen that a seasoned businessman can use the concept of accounting break-even point and charts to determine the profitability at any given level of production. However, it has its own limitations in terms of impractical assumptions.
Recommended Articles
This is a guide to Break-Even Point in Accounting. Here we also discuss the introduction and how to calculate the B.E.P in accounting along with advantages and disadvantages. You may also have a look at the following articles to learn more –
