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The McGraw-Hill Companies, I nc., 2007

Cost-Volume-
Profit Analysis
Chapter
14
100 Shares
$1 par value
CVP Analysis???

Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
The McGraw-Hill Companies, I nc., 2007
Describe different types of cost
behavior in relation to
production and sales volume.
Determine cost estimates using
three different methods.
Compute the break-even point
for a single product company.
Graphs costs and sales for a
single product company.

Learning Objectives
Identify assumptions in cost
volume profit analysis and
explain their impact.
Describe several applications
of cost-volumeprofit analysis.
Compute break-even point
for a multiproduct company.
Analyze changes in sales
using the degree of operating
leverage.
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The McGraw-Hill Companies, I nc., 2007
CVP analysis is used to answer questions
such as:
How much must I sell to earn my desired
income?
How will income be affected if I reduce
selling prices to increase sales volume?
How will income be affected if I change the
sales mix of my products?
Questions Addressed by
Cost-Volume-Profit Analysis
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Refers to the manner in which a cost changes as
a related activity changes.

3 common classifications:
Fixed Cost
Variable Cost
Mixed Cost
Identifying Cost Behavior
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Volume (units produced)
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(
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Total fixed costs remain unchanged when activity
changes.
Eg: Factory Insurance, Factory Rent
Your monthly rent for a
factory buildings does not
change at any level of
production.
Total Fixed Cost
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Volume (units produced)
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$
)

Fixed costs per unit decline as activity increases.
Your average cost per
unit decreases as
production increases.
Fixed Cost Per Unit
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Volume (units produced)
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(
$
)

Total variable costs change when activity changes.
Eg: Direct materials, Direct labor
Your direct materials cost
changes with the level of
productions
Total Variable Cost
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Volume (units produced)
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(
$
)

Variable costs per unit do not change as activity
increases.
Variable Cost Per Unit
Your average cost per
unit doest not change at
any level of production.
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
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Mixed Cost
Mixed cost includes both fixed and variable cost
components. It is greater than zero when volume is
zero, but increases when production is increased.
Eg: Utility charge
Facility costs is incurred even
when facility is unused, and
increases with usage.
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Variable
Utility Charge
Volume (units produced)
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Fixed Monthly
Utility Charge
Total Mixed Costs
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Volume (unit produced)
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Total cost remains
constant within a
narrow range of
activity.
Step-Wise Costs
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Total cost increases to a
new higher cost for the next
higher range of activity.
Step-Wise Costs
Volume (unit produced)
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Costs that increase when production increases,
but in a nonlinear manner.
Volume (units produced)
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Curvilinear Costs
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The objective is to classify all costs as either
fixed or variable.
Analysis of past cost behavior is required in
order to identify costs.
3 different methods can be used to determine
cost estimates:
1. Scatter Diagram
2. High-Low Method
3. Least-Squares Regression

Measuring Cost Behavior
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Plot the data points on a graph
(total cost vs. activity).
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Volume, 1,000s of Units Produced
Scatter Diagram
The Scatter Diagram Method estimates costs on
a visual fit on the cost line.
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
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Draw a line through the plotted data points so that about
equal numbers of points fall above and below the line.
Estimated fixed cost = 10,000
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Volume, 1,000s of Units Produced
Scatter Diagram
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
The McGraw-Hill Companies, I nc., 2007
Vertical
distance
is the
change
in cost.
Horizontal distance is
the change in activity.
Unit Variable Cost = Slope =
in cost
in units
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Volume, 1,000s of Units Produced
Scatter Diagram
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The McGraw-Hill Companies, I nc., 2007
High-Low Method
The High-Low Method cost estimates from the
high-low method are based only on costs
corresponding to the lowest and highest sales.
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Volume, 1,000s of Units Produced
High-Low line of cost behavior
Estimated fixed cost
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The following relationships between sales
and costs are observed:






Using these two levels of activity, compute:
the variable cost per unit.
the total fixed cost.
Sales Cost
High activity level 67,500 $ 29,000 $
Low activity level 17,500 20,500
Change 50,000 $ 8,500 $
High-Low Method
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Unit variable cost = = = $0.17 per unit
in cost
in units
$8,500
$50,000
Sales Cost
High activity level 67,500 $ 29,000 $
Low activity level 17,500 20,500
Change 50,000 $ 8,500 $
The High-Low Method
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Sales Cost
High activity level 67,500 $ 29,000 $
Low activity level 17,500 20,500
Change 50,000 $ 8,500 $
Unit variable cost = = =$0.17 per unit
Fixed cost = Total cost Total variable
in cost
in units
$8,500
$50,000
The High-Low Method
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
The McGraw-Hill Companies, I nc., 2007
Sales Cost
High activity level 67,500 $ 29,000 $
Low activity level 17,500 20,500
Change 50,000 $ 8,500 $
Unit variable cost = = = $0.17 per unit
Fixed cost = Total cost Total variable cost
Fixed cost = $29,000 ($0.17 per sales $ $67,500)
Fixed cost = $29,000 $11,475 = $17,525
in cost
in units
$8,500
$50,000
The High-Low Method
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The McGraw-Hill Companies, I nc., 2007
Least-Squares Regression
The least-squares regression method is a statistical
technique and uses all data points.
It is commonly used with computer software because
of the large number of calculations required.
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Volume, 1,000s of Units Produced
Regression Line of Cost Behavior
Estimated fixed cost
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The break-even point (expressed in units of
product or dollars of sales) is the unique sales
level at which a company earns neither a profit
nor incurs a loss which total revenues equal to
total costs.
To compute a break even point in terms of sales
unit, we divide total fixed costs by the contribution
margin per unit.
To compute a break even point in terms of sales
dollars, we divide total fixed costs by the
contribution margin ratio.
Break Even Analysis
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Contribution margin is amount by which revenue
exceeds the variable costs of producing the
revenue.
Contribution margin can be expressed in 3 ways:
1. Total contribution margin in dollars.
2. Unit contribution margin (dollars per unit)
3. Contribution margin ratio (%)
Contribution Margin
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Contribution Margin Per Unit
Selling price per unit less unit variable cost.
Dollar from each unit of sales available to cover
fixed cost and income from operation.
Useful when increase / decrease in sales volume
is measured in sales unit (quantity)
Contribution Margin per Unit = Selling price per unit
Variable cost per unit.
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Contribution Margin Ratio
Contribution margin per unit divide by selling price
per unit.
It measures the effect on income from operations
of an increase or a decrease in sales volume.
Useful when sales volume is measured in sales
dollars.

Contribution Margin = Unit Selling price Variable cost per unit.
Ratio Selling price per unit
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Computing Break-Even Point
We have just seen one of the basic CVP
relationships the break-even computation.
Break-even point in units =
Fixed costs
Contribution margin per unit
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The break-even formula may also be expressed
sales dollars.
Computing Break-Even Point
Break-even point in dollars =
Fixed costs
Contribution margin ratio
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Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) 100,000 $ 50 $
Variable costs (60,000) (30)
Contribution margin 40,000 $ 20 $
Fixed costs (30,000)
Profit for the period 10,000 $
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How much contribution margin must this company
have to cover its fixed costs (break even)?

Answer: $30,000
Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) 100,000 $ 50 $
Variable costs (60,000) (30)
Contribution margin 40,000 $ 20 $
Fixed costs (30,000)
Profit for the period 10,000 $
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How many units must this company sell to cover its
fixed costs (break even)?

Answer: $30,000 $20 per unit = 1,500 units
Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) 100,000 $ 50 $
Variable costs (60,000) (30)
Contribution margin 40,000 $ 20 $
Fixed costs (30,000)
Profit for the period 10,000 $
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
The McGraw-Hill Companies, I nc., 2007
ABC Co. sells product XYZ at $5.00 per unit. If
fixed costs are $200,000 and variable costs are
$3.00 per unit, how many units must be sold to
break even?

a. 100,000 units
b. 40,000 units
c. 200,000 units
d. 66,667 units
Computing Break-Even Point
Illustration 1
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ABC Co. sells product XYZ at $5.00 per unit. If
fixed costs are $200,000 and variable costs are
$3.00 per unit, how many units must be sold to
break even?

a. 100,000 units
b. 40,000 units
c. 200,000 units
d. 66,667 units
Unit contribution = $5.00 - $3.00 = $2.00
Fixed costs
Unit contribution
=
$200,000
$2.00 per unit
= 100,000 units
Computing Break-Even Point
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Use the contribution margin ratio formula to determine
the amount of sales revenue ABC must have to break
even. All information remains unchanged: fixed costs
are $200,000; Selling price per unit is $5.00; and unit
variable cost is $3.00.

a. $200,000
b. $300,000
c. $400,000
d. $500,000
Computing Break-Even Point
Illustration 2
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Use the contribution margin ratio formula to determine
the amount of sales revenue ABC must have to break
even. All information remains unchanged: fixed costs
are $200,000; Selling price per unit is $5.00; and unit
variable cost is $3.00.

a. $200,000
b. $300,000
c. $400,000
d. $500,000
Unit contribution
= $5.00 - $3.00 = $2.00
Contribution margin ratio
= $2.00 $5.00 = .40
Break-even revenue =
$200,000 .4 = $500,000
Computing Break-Even Point
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Volume in Units
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Total fixed costs
Total costs
Draw the total cost line with a slope
equal to the unit variable cost.
Plot total fixed costs on the vertical axis.
Preparing a CVP Chart
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Sales
Volume in Units
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Starting at the origin, draw the sales line
with a slope equal to the Selling price per unit.
Preparing a CVP Chart
Break-
even
Point
Total costs
Total fixed costs
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A limited range of activity called the relevant
range, where CVP relationships are linear.
Selling price per unit remains constant.
Variable costs per unit remain constant.
Total fixed costs remain constant.
Production = sales (no inventory changes).
Assumptions of CVP Analysis
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Profit (pretax) = Sales Variable costs Fixed costs
Sensitivity Analysis
Cost-Volume-Profit Analysis can be used to predict
what can happen under alternatives strategies
concerning sales volume, selling prices, variable
costs or fixed costs.
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Rydell expects to sell 1,500 units at $100 each
next month. Fixed costs are $24,000 per month
and the unit variable cost is $70. What amount
of income should Rydell expect?
Profit (pretax) = Sales Variable costs Fixed costs
= [1,500 units $100] [1,500 units $70] $24,000
= $21,000
Computing Profit
from Expected Sales Illustration 1
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Unit sales =
Fixed costs + Target profit
Contribution margin per unit
Dollar sales =
Fixed costs + Target profit
Contribution margin ratio
Computing Sales for a Target Profit
Break-even formulas may be adjusted to show
the sales volume needed to earn
any amount of income.
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ABC Co. sells product XYZ at $5.00 per unit. If
fixed costs are $200,000 and variable costs are
$3.00 per unit, how many units must be sold to
earn income of $40,000?

a. 100,000 units
b. 120,000 units
c. 80,000 units
d. 200,000 units
Computing Sales for a Target Profit
Illustration2
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The McGraw-Hill Companies, I nc., 2007
ABC Co. sells product XYZ at $5.00 per unit. If
fixed costs are $200,000 and variable costs are
$3.00 per unit, how many units must be sold to
earn income of $40,000?

a. 100,000 units
b. 120,000 units
c. 80,000 units
d. 200,000 units
= 120,000 units
Unit contribution = $5.00 - $3.00
= $2.00
Fixed costs + Target profit
Unit contribution
$200,000 + $40,000
$2.00 per unit
Computing Sales for a Target Profit
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Dollar sales =
Fixed Target Income
costs profit taxes
Contribution margin ratio
+ +
Computing Sales (Dollars) for a
Target Profit
Target profit is income after income tax.

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To convert target profit to before-tax profit, use the
following formula:
Before-tax profit =
Target profit
1 - tax rate
Computing Sales (Dollars) for a
Target Profit
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Rydell has a monthly target profit of $18,000. The
unit selling price is $100. Monthly fixed costs are
$24,000, the unit variable cost is $70, and the tax rate
is 25 percent.

What is Rydells before-tax profit and
income tax expense?
Computing Sales (Dollars) for a
Target Profit Illustration 1
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Before-tax profit =
Target profit
1 - tax rate
Before-tax profit = = $24,000
$18,000
1 - .25
Income tax = .25 $24,000 = $6,000
Rydell has a monthly target profit of $18,000. The
unit selling price is $100. Monthly fixed costs are
$24,000, the unit variable cost is $70, and the tax rate
is 25 percent.
What is Rydells before-tax profit and
income tax expense?
Computing Sales (Dollars) for a
Target Profit
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Rydell has a monthly target profit of $18,000. The
unit selling price is $100. Monthly fixed costs are
$24,000, the unit variable cost is $70, and the tax rate
is 25 percent.

What monthly sales revenue will Rydell
need to earn the target profit?
Computing Sales (Dollars) for a
Target Profit Illustration 2
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Dollar sales =
Fixed Target Income
costs profit taxes
Contribution margin ratio
+ +
Dollar sales = = $160,000
$24,000 + $18,000 + $6,000
30%
Rydell has a monthly target profit of $18,000. The
unit selling price is $100. Monthly fixed costs are
$24,000, the unit variable cost is $70, and the tax rate
is 25 percent.
What monthly sales revenue will Rydell
need to earn the target profit?
Computing Sales (Dollars) for a
Target Profit
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The formula for computing dollar sales may be used
to compute unit sales by substituting contribution per
unit in the denominator.
Contribution margin per unit
Unit sales =
Fixed Target Income
costs profit taxes
+ +
Unit sales = = 1,600 units
$24,000 + $18,000 + $6,000
$30 per unit
Formula for Computing Sales (Units)
for a Target Profit
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Margin of safety is the amount by which sales
may decline before reaching break-even sales.
Margin of safety may be expressed as a
percentage of expected sales.
Computing the Margin of Safety
Margin of safety Expected sales - Break-even sales
percentage Expected sales
=
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Margin of safety Expected sales - Break-even sales
percentage Expected sales
=
If Rydells sales are $100,000 and break-even
sales are $80,000, what is the margin of safety
in dollars and as a percentage?
Computing the Margin of Safety
Illustration
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If Rydells sales are $100,000 and break-even
sales are $80,000, what is the margin of safety
in dollars and as a percentage?
Margin of safety = $100,000 - $80,000 = $20,000
Margin of safety Expected sales - Break-even sales
percentage Expected sales
=
Margin of safety $100,000 - $80,000
percentage $100,000
= = 20%
Computing the Margin of Safety
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The CVP formulas may be modified for use when
a company sells more than one product.
The unit contribution margin is replaced with the
contribution margin for a composite unit.
A composite unit is composed of specific numbers of
each product in proportion to the product sales mix.
Sales mix is the ratio of the volumes of the various
products.
Computing Multiproduct
Break-Even Point
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The resulting break-even formula for composite
unit sales is:
Break-even point
in composite units
Fixed costs
Contribution margin
per composite unit
=
Consider the following example:
Computing Multiproduct
Break-Even Point
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Hair-Today offers three cuts as shown below. Annual
fixed costs are $96,000. Compute the break-even
point in composite units and in number of units for
each haircut at the given sales mix.
Haircuts
Basic Ultra Budget
Selling Price 10.00 $ 16.00 $ 8.00 $
Variable Cost (6.50) (9.00) (4.00)
Unit Contribution 3.50 $ 7.00 $ 4.00 $
Sales Mix Ratio 4 2 1
Computing Multiproduct
Break-Even Point - Illustration
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Hair-Today offers three cuts as shown below. Annual
fixed costs are $96,000. Compute the break-even
point in composite units and in number of units for
each haircut at the given sales mix.
Haircuts
Basic Ultra Budget
Selling Price 10.00 $ 16.00 $ 8.00 $
Variable Cost (6.50) (9.00) (4.00)
Unit Contribution 3.50 $ 7.00 $ 4.00 $
Sales Mix Ratio 4 2 1
A 4:2:1 sales mix means that if there are 500
budget cuts, then there will be 1,000 ultra cuts,
and 2,000 basic cuts.
Computing Multiproduct
Break-Even Point
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Haircuts
Basic Ultra Budget
Selling Price $10.00 $16.00 $8.00
Variable Cost (6.50) (9.00) (4.00)
Unit Contribution $3.50 $7.00 $4.00
Sales Mix Ratio 4 2 1
14.00 $ 14.00 $ 4.00 $
Step 1: Compute contribution margin per composite
unit.
Computing Multiproduct
Break-Even Point
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
The McGraw-Hill Companies, I nc., 2007
Haircuts
Basic Ultra Budget
Selling Price $10.00 $16.00 $8.00
Variable Cost (6.50) (9.00) (4.00)
Unit Contribution $3.50 $7.00 $4.00
Sales Mix Ratio 4 2 1
Weighted Contribution 14.00 $ + 14.00 $ + 4.00 $ = 32.00 $
Contribution margin per composite unit
Step 1: Compute contribution margin per composite
unit.
Computing Multiproduct
Break-Even Point
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
The McGraw-Hill Companies, I nc., 2007
Break-even point
in composite units
Fixed costs
Contribution margin
per composite unit
=
Step 2: Compute break-even point in composite units.
Computing Multiproduct
Break-Even Point
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
The McGraw-Hill Companies, I nc., 2007
Break-even point
in composite units
Fixed costs
Contribution margin
per composite unit
=
Step 2: Compute break-even point in composite
units.
Break-even point
in composite units
$96,000
$32.00 per
composite unit
=
Break-even point
in composite units
= 3,000 composite units
Computing Multiproduct
Break-Even Point
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
The McGraw-Hill Companies, I nc., 2007
Sales Composite
Product Mix Cuts Haircuts
Basic 4 3,000 = 12,000
Ultra 2 3,000 = 6,000
Budget 1 3,000 = 3,000
Step 3: Determine the number of each haircut
that must be sold to break even.
Computing Multiproduct
Break-Even Point
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
The McGraw-Hill Companies, I nc., 2007
Step 4: Verify the results.
Multiproduct Break-Even
Income Statement
Haircuts
Basic Ultra Budget Combined
Selling Price 10.00 $ 16.00 $ 8.00 $
Variable Cost (6.50) (9.00) (4.00)
Unit Contribution 3.50 $ 7.00 $ 4.00 $
Sales Volume 12,000 6,000 3,000
Total Contribution 42,000 $ 42,000 $ 12,000 $ 96,000 $
Fixed Costs 96,000
Profit $ 0
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
The McGraw-Hill Companies, I nc., 2007
Contribution margin ($)
Pretax profit
= Degree of operating leverage
Degree of Operating Leverage
A measure of the extent to which fixed costs
are being used in an organization.
Also used to measure the impact of changes in
sales on income from operation.
A high operating leverage indicates that a small
increase in sales will yield a large percentage
increase in income
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
The McGraw-Hill Companies, I nc., 2007
$48,000
$24,000
= 2.0
Contribution margin
Profit
= Degree of operating leverage
If Rydell increases sales by 10
percent, what will the percentage
increase in income be?
Operating Leverage - Illustration
Rydell Company
Sales (1,600 units) 160,000 $
Variable expenses (112,000)
Contribution margin 48,000
Fixed expenses (24,000)
Profit for the period 24,000 $
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
The McGraw-Hill Companies, I nc., 2007
Percent increase in sales 10%
Degree of operating leverage 2
Percent increase in income 20%
Operating Leverage
Rydell Company
Sales (1,600 units) 160,000 $
Variable expenses (112,000)
Contribution margin 48,000
Fixed expenses (24,000)
Profit for the period 24,000 $
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana
The McGraw-Hill Companies, I nc., 2007
End of Chapter 14