Chapter Three

Chapter Four
Cost-VolumeProfit Analysis
McGraw-Hill/Irwin
Copyright 2008 by The McGraw-Hill Companies, Inc. All
Learning
Objective
1
McGraw-Hill/Irwin
Cost-volume-profit (CVP)
analysis
Cost-volume-profit (CVP) analysis

examines the behavior of total revenues,
total costs, and operating income as
changes occur in the units sold, the selling
price, the variable cost per unit, or the fixed
costs of a product
A Five-Step Decision Making

Process in Planning & Control
Revisited
1.
2.
3.
4.
Identify the problem and uncertainties

Obtain information
Make predictions about the future
Make decisions by choosing between
alternatives, using Cost-Volume-Profit
(CVP) analysis
5. Implement the decision, evaluate
performance, and learn
Assumptions of Cost-Volume-Profit Analysis

The reliability of cost-volume-profit analysis
depends upon several assumptions.
1. Total sales and total costs can be represented by
straight lines.
2. Within the relevant range of operating activity, the
efficiency of operations does not change.
3. Costs can be accurately divided into fixed and
variable components.
4. The sales mix is constant.
5. There is no change in the inventory quantities
during the period.
Assumptions Underlying
CVP Analysis
Selling price is constant throughout
the entire relevant range.
Costs are linear over the relevant
range.
In multi-product companies, the sales
mix is constant.
In manufacturing firms, inventories do
not change (units produced = units
sold).
Foundational Assumptions in
CVP
Changes in production/sales volume are the sole
cause for cost and revenue changes
Total costs consist of fixed costs and variable
costs
Revenue and costs behave and can be graphed as
a linear function (a straight line)
Selling price, variable cost per unit and fixed costs
are all known and constant
In many cases only a single product will be
analyzed. If multiple products are studied, their
relative sales proportions are known and constant
The time value of money (interest) is ignored
2009 Pearson Prentice Hall. All rights reserved.
Basic Formulae
CVP: Contribution Margin

Manipulation of the basic equations yields an
extremely important and powerful tool

extensively used in Cost Accounting: the
Contribution Margin
Contribution Margin equals sales less variable
costs
CM = S VC
Contribution Margin per Unit equals unit
selling price less variable cost per unit

CMu = SP VCu
Contribution Margin,
continued
Contribution Margin also equals contribution
margin per unit multiplied by the number of

units sold (Q)
CM = CMu x Q
Contribution Margin Ratio (percentage) equals
contribution margin per unit divided by Selling

Price
CMR = CMu SP
Interpretation: how many cents out of every sales
dollar are represented by Contribution Margin

Basic Formula Derivations

The Basic Formula may be further rearranged
and decomposed as follows:

Sales VC FC = Operating Income
(OI)
(SP x Q) (VCu x Q) FC = OI
Q (SP VCu) FC = OI
Q (CMu) FC = OI
Remember this last equation, it will be used
again in a moment
Breakeven Point
Recall the last equation in an earlier slide:
Q (CMu) FC = OI
A simple manipulation of this formula, and setting
OI to zero will result in the Breakeven Point

(quantity):
BEQ = FC CMu
At this point, a firm has no profit or loss at the
given sales level

If per-unit values are not available, the Breakeven
Point may be restated in its alternate format:
BE Sales = FC CMR
Breakeven Point, extended:

Profit Planning
With a simple adjustment, the Breakeven
Point formula can be modified to become a

Profit Planning tool.
Profit is now reinstated to the BE formula,
changing it to a simple sales volume equation

Q = (FC + OI)
CM
Contribution Margin Income Statement
Total
Sales (50,000 units) $1,000,000
Variable costs
600,000
Contribution margin
$400,000
Fixed costs
300,000
Income from operations$100,000
Variable
Variablecosts
costs
Sales
Sales
Fixed
Fixedcosts
costs
Income
Incomefrom
fromoperations
operations
The
The
contribution
contribution
margin
marginis
is
available
availableto
to
cover
coverthe
thefixed
fixed
costs
costsand
and
income
incomefrom
from
operations.
operations.
Total Per Unit

Sales (50,000 units)
$1,000,000 $20
Variable costs
600,000
12
Contribution margin
$400,000 $ 8
Fixed costs
300,000
Income from operations $100,000
Percent
100%
60%
40%
The
Thestatement
statementcan
canbe
beextended
extended
to
toinclude
includeper
perunit
unitdollars
dollarsand
and
percentage
percentagenumbers.
numbers.
Total Per Unit

$1,000,000 $20
Variable costs
600,000
12
Contribution margin
$400,000 $ 8
Fixed costs
300,000
Sales
Sales
Variable
costs
Variable
costs
Percent
100%
60%
40%
Income
from
operations
Fixed
+
costs
Contribution
margin
Total Per Unit

$1,000,000 $20
Variable costs
600,000
12
Contribution margin
$400,000 $ 8
Fixed costs
300,000
Percent
100%
60%
40%
Unit
UnitContribution
ContributionMargin
Margin
Contribution
ContributionMargin
MarginRatio
Ratio
The
Thecontribution
contributionmargin
margincan
canbe
beexpressed
expressedthree
threeways:
ways:
1.
1.Total
Totalcontribution
contributionmargin
marginin
indollars.
dollars.
2.
2.Unit
Unitcontribution
contributionmargin
margin(dollars
(dollarsper
perunit).
unit).
3.
3.Contribution
Contributionmargin
marginratio
ratio(percentage).
(percentage).
Calculating the Break-Even Point
Total Per Unit

?
$20
Variable costs
?
12
Contribution margin
$300,000 $ 8
Fixed costs
300,000
Income from operations $
0
Percent
100%
60%
40%
At
Atthe
thebreak-even
break-even
point,
point,fixed
fixedcosts
costs
and
andthe
thecontribution
contribution
margin
marginare
areequal.
equal.
Total
?
Per Unit Percent

$20
100%
Variable costs
?
12
60%
Contribution margin
$ 300,000 / $ 8 or 40%
Fixed costs
300,000
Divide by either:
0
$8 per unit or 40%
Break-even
sales
Fixed
costs
Contribution
margin
Total Per Unit Percent

?
$20
100%
Variable costs
?
12
60%
Contribution margin
$ 300,000 $ 8 or 40%
Fixed costs
300,000
0
Break-even
sales
Fixed
costs
Contribution
margin
What
Whatis
isthe
thebreak-even
break-evensales
salesin
inunits?
units?

?
$20
100%
Variable costs
?
12
60%
Contribution margin
$ 300,000 / $ 8 or 40%
Fixed costs
300,000
0
Break-even
sales
Fixed
costs
Contribution
margin
Break-even
Break-evensales
sales==$300,000
$300,000//$8
$8==37,500
37,500units
units
What
Whatis
isthe
thebreak-even
break-evensales
salesin
indollars?
dollars?

?
$20
100%
Variable costs
?
12
60%
Contribution margin
$ 300,000 / $ 8 or 40%
Fixed costs
300,000
0
Break-even
sales
Fixed
costs
Contribution
margin
Break-even
Break-evensales
sales==$300,000
$300,000//$8
$8==37,500
37,500units
units
Break-even
Break-evensales
sales==$300,000
$300,000//40%
40%==$750,000
$750,000
The Break-Even Point

The break-even point is the point in the
volume of activity where the organizations
revenues and expenses are equal.
Sales
Sales
Less:
Less: variable
variable expenses
expenses
Contribution
Contribution margin
margin
Less:
Less: fixed
fixed expenses
expenses
Net
Net income
income
$$250,000
250,000
150,000
150,000
100,000
100,000
100,000
100,000
$$
--
Equation Approach
Sales revenue Variable expenses Fixed expenses = Profit
Unit
Sales
sales volume
price in units
Unit
Sales
variable volume
expense in units
($500 X)
($300 X)
$80,000 = $0
($200X) $80,000 = $0
X = 400 surf boards
Contribution-Margin Approach
Consider the following information
developed by the accountant at Curl, Inc.:
Sales
Sales(500
(500surf
surfboards)
boards)
Less:
Less: variable
variableexpenses
expenses
Contribution
Contributionmargin
margin
Less:
Less: fixed
fixedexpenses
expenses
Net
Net income
income
Total
Total
$$250,000
250,000
150,000
150,000
$$100,000
100,000
80,000
80,000
$$ 20,000
20,000
Per
Per Unit
Unit
$$ 500
500
300
300
$$ 200
200
Percent
Percent
100%
100%
60%
60%
40%
40%
For each additional surf board sold, Curl
generates $200 in contribution margin.
Sales
Sales(500
(500surf
surfboards)
boards)
Less:
Less: variable
variableexpenses
expenses
Contribution
Contributionmargin
margin
Less:
Less: fixed
fixedexpenses
expenses
Net
Net income
income
Total
Total
$$250,000
250,000
150,000
150,000
$$100,000
100,000
80,000
80,000
$$ 20,000
20,000
Per
Per Unit
Unit
$$ 500
500
300
300
$$ 200
200
Percent
Percent
100%
100%
60%
60%
40%
40%
Fixed expenses
Break-even point
=
Unit contribution margin
(in units)
Sales
Sales(500
(500surf
surfboards)
boards)
Less:
variable
expenses
Less: variable expenses
Contribution
Contributionmargin
margin
Less:
Less:fixed
fixedexpenses
expenses
Net
Netincome
income
$80,000
$200
Total
Total
$$250,000
250,000
150,000
150,000
$$100,000
100,000
80,000
80,000
$$ 20,000
20,000
Per
PerUnit
Unit
$$ 500
500
300
300
$$ 200
200
= 400 surf boards
Percent
Percent
100%
100%
60%
60%
40%
40%
Contribution Margin Ratio

Calculate the break-even point in sales dollars rather
than units by using the contribution margin ratio.
Contribution margin
Sales
Fixed expense
CM Ratio
= CM
Ratio
Break-even point
=
(in sales dollars)
Sales
Sales(400
(400surf
surfboards)
boards)
Less:
Less: variable
variableexpenses
expenses
Contribution
Contributionmargin
margin
Less:
Less: fixed
fixedexpenses
expenses
Net
Net income
income
$80,000
40%
Total
Total
$$200,000
200,000
120,000
120,000
$$ 80,000
80,000
80,000
80,000
$$
--
Per
Per Unit
Unit
$$ 500
500
300
300
$$ 200
200
= $200,000 sales
Percent
Percent
100%
100%
60%
60%
40%
40%
Learning
Objective
2
McGraw-Hill/Irwin
Learning
Objective
3
McGraw-Hill/Irwin
Sales and Costs ($000)
Cost-Volume-Profit Chart
$500
$450
$400
$350
$300
$250
$200
$150
$100
$ 50
0
Total Sales
3 4 5 6 7
Units of Sales (000)
Unit
$$50
Unitselling
sellingprice
price
50
Unit
30
Unitvariable
variablecost
cost
30
Unit
Unitcontribution
contributionmargin
margin $$20
20
Total
$100,000
Totalfixed
fixedcosts
costs
$100,000
9 10
$500
$450
$400
$350
$300
$250
$200
$150
$100
$ 50
0
Total Sales
Variable Costs
60%
3 4 5 6 7
Unit
$$50
Unitselling
sellingprice
price
50
Unit
30
Unitvariable
variablecost
cost
30
Unit
$$
Unitcontribution
contributionmargin
margin
20
20
Total
$100,000
Totalfixed
fixedcosts
costs
$100,000
9 10
$500
$450
$400
$350
$300
$250
$200
$150
$100
$ 50
0
Total Sales
3 4 5 6 7
Unit
$$50
Unitselling
sellingprice
price
50
Unit
30
Unitvariable
variablecost
cost
30
Unit
Unitcontribution
contributionmargin
margin $$20
20
Total
$100,000
Totalfixed
fixedcosts
costs
$100,000
40%
Contribution
Margin
60%
Variable Costs
9 10
100%
100%
60%
60%
40%
40%
$500
$450
$400
$350
$300
$250
$200
$150
$100
$ 50
0
Total Sales
Total Costs
Fixed Costs
Variable Costs
3 4 5 6 7
Unit
$$50
Unitselling
sellingprice
price
50
Unit
30
Unitvariable
variablecost
cost
30
Unit
Unitcontribution
contributionmargin
margin $$20
20
Total
$100,000
Totalfixed
fixedcosts
costs
$100,000
9 10
$500
$450
$400
$350
$300
$250
$200
$150
$100
$ 50
0
Total Sales
Total Costs
3 4 5 6 7
Unit
$$50
Unitselling
sellingprice
price
50
Unit
30
Unitvariable
variablecost
cost
30
Unit
Unitcontribution
contributionmargin
margin $$20
20
Total
$100,000
Totalfixed
fixedcosts
costs
$100,000
9 10
$500
$450
$400
$350
$300
$250
$200
$150
$100
$ 50
0
Total Sales
Operating Profit Area
Total Costs
Operating Loss Area

1
3 4 5 6 7
Unit
$$50
Unitselling
sellingprice
price
50
Unit
30
Unitvariable
variablecost
cost
30
Unit
Unitcontribution
contributionmargin
margin $$20
20
Total
$100,000
Totalfixed
fixedcosts
costs
$100,000
9 10
$500
$450
$400
$350
$300
$250
$200
$150
$100
$ 50
0
Total Sales
Total Costs
Break-Even Point
3 4 5 6 7
Unit
$$50
Unitselling
sellingprice
price
50
Unit
30
Unitvariable
variablecost
cost
30
Unit
Unitcontribution
contributionmargin
margin $$20
20
Total
$100,000
Totalfixed
fixedcosts
costs
$100,000
9 10
$500
$450
$400
$350
$300
$250
$200
$150
$100
$ 50
0
Total Sales
Total Costs
Break-Even Point
3 4 5 6 7
Unit
$$50
Unitselling
sellingprice
price
50
Unit
30
Unitvariable
variablecost
cost
30
Unit
Unitcontribution
contributionmargin
margin $20
$20
Total
$100,000
Totalfixed
fixedcosts
costs
$100,000
9 10
$100,000
= 5,000 units
$20
Cost-Volume-Profit Chart (Break-Even)

$500
$450
$400
$350
$300
$250
$200
$150
$100
$ 50
0
Total Sales
Total Costs
Break-Even Point
Operating Loss Area
1
3 4 5 6 7
Unit
$$50
Unitselling
sellingprice
price
50
Unit
30
Unitvariable
variablecost
cost
30
Unit
Unitcontribution
contributionmargin
margin $$20
20
Total
$100,000
Totalfixed
fixedcosts
costs
$100,000
9 10
$100,000
= 5,000 units
$20
CVP: Graphically
Revised Cost-Volume-Profit Chart

$500
$450
$400
$350
$300
$250
$200
$150
$100
$ 50
0
Total Sales
Total Costs
Operating Loss Area

1
Revised BreakEven Point
3 4 5 6 7
Unit
$$50
Unitselling
sellingprice
price
50
Unit
30
Unitvariable
variablecost
cost
30
Unit
Unitcontribution
contributionmargin
margin $$20
20
Total
$80,000
Totalfixed
fixedcosts
costs
$80,000
9 10
$80,000
$20
= 4,000 units
Operating Profit
(Loss) $000s
Profit-Volume Chart
$100
$75
$50
$25
$ 0
$(25)
$(50)
$(75)
$(100)
Relevant
Relevantrange
range
is
is10,000
10,000units.
units.
1
9 10
Units of Sales (000s)
Sales
$500,000
Sales(10,000
(10,000units
unitsxx$50)
$50)
$500,000
Variable
300,000
Variablecosts
costs(10,000
(10,000units
unitsxx$30)
$30)
300,000
Contribution
Contributionmargin
margin(10,000
(10,000units
unitsxx$20)
$20) $200,000
$200,000
Fixed
100,000
Fixedcosts
costs
100,000
Operating
$100,000
Operatingprofit
profit
$100,000
Operating Profit
(Loss) $000s
Profit-Volume Chart
$100
$75
$50
$25
$ 0
$(25)
$(50)
$(75)
$(100)
Maximum
Maximumprofit
profit
within
withinthe
the
relevant
relevantrange.
range.
1
9 10

Maximum
Maximumloss
lossis
is
equal
the
equalto
to
thetotal
total
Sales
(10,000
$500,000
Sales
(10,000units
unitsxx$50)
$50)
$500,000
fixed
costs.
fixed costs.
Variable
300,000
Variablecosts
costs(10,000
(10,000units
unitsxx$30)
$30)
300,000
Contribution
Contributionmargin
margin(10,000
(10,000units
unitsxx$20)
$20) $200,000
$200,000
Fixed
100,000
Fixedcosts
costs
100,000
Operating
$100,000
Operatingprofit
profit
$100,000
Operating Profit
(Loss) $000s
Profit-Volume Chart
$100
$75
$50
$25
$ 0
$(25)
$(50)
$(75)
$(100)
Profit Line
Operating
Profit
Operating
Loss
9 10
Sales
$500,000
Sales(10,000
(10,000units
unitsxx$50)
$50)
$500,000
Variable
300,000
Variablecosts
costs(10,000
(10,000units
unitsxx$30)
$30)
300,000
Contribution
Contributionmargin
margin(10,000
(10,000units
unitsxx$20)
$20) $200,000
$200,000
Fixed
100,000
Fixedcosts
costs
100,000
Operating
$100,000
Operatingprofit
profit
$100,000
Graphing Cost-Volume-Profit
Relationships
Viewing CVP relationships in a graph gives
managers a perspective that can be obtained in no
other way.
Consider the following information for Curl, Inc.:
Cost-Volume-Profit Graph
Fixed expenses
Fixed expenses
es
s
n
xp e
e
l
Tota
Fixed expenses
es
s
n
xp e
e
l
Tota
Fixed expenses
a
Tot
es
s
n
xp e
e
l
Tota
le
a
s
l
Fixed expenses
Break-even
point
es
s
n
xp e
e
l
Tota
s
Lo
a
e
r
a
a
Tot
le
a
s
l
rea
a
fit
o
r
P
Fixed expenses
Profit-Volume Graph
Some
Some managers
managers like
like the
the profit-volume
profit-volume
graph
graph because
because itit focuses
focuses on
on profits
profits and
and volume.
volume.
Break-even
point
s
o
L
a
e
r
sa
fit
o
r
P
a
e
r
a
Profit Planning, Illustrated
Learning
Objective
4
McGraw-Hill/Irwin
Calculating a Planned Sales Level
Total
Per Unit
Percent

?
$20
100%
Variable costs
?
12
60%
Contribution margin
$ 400,000 / $ 8 or 40%
Fixed costs
300,000
Income from operations $ 100,000
Planned
sales
Fixed
costs
Target
profit
Contribution
margin
Fixed
Fixedcosts
costsplus
plusthe
thetarget
target
profit
profitequals
equalsthe
therequired
required
total
totalcontribution
contributionmargin.
margin.
Total
Per Unit Percent

?
$20
100%
Variable costs
?
12
60%
Contribution margin
$ 400,000 / $ 8 or 40%
Fixed costs
300,000
Planned
sales
Fixed
costs
Target
+ profit
Contribution
margin
$8
$8per
perunit
unitor
or40%
40%
Total
Per Unit Percent

?
$20 100%
Variable costs
?
12
60%
Contribution margin
$ 400,000 / $ 8 or 40%
Fixed costs
300,000
Planned
sales
Fixed
costs
Target
+ profit
Contribution
margin
What
Whatis
isthe
theplanned
plannedsales
saleslevel
levelin
inunits?
units?
Total
Per Unit Percent

?
$20 100%
Variable costs
?
12
60%
Contribution margin
$ 400,000 / $ 8 or 40%
Fixed costs
300,000
Planned
sales
Fixed
costs
Target
+ profit
Contribution
margin
Planned
Plannedsales
sales==($300,000
($300,000++$100,000)
$100,000)//$8
$8==50,000
50,000units
units
What
Whatis
isthe
theplanned
plannedsales
saleslevel
levelin
indollars?
dollars?

$1,000,000 $20 100%
Variable costs
600,000
12
60%
Contribution margin
$ 400,000 / $ 8 or 40%
Fixed costs
300,000
Planned
sales
Fixed
costs
Target
profit
Contribution
margin
Planned
Plannedsales
sales==($300,000
($300,000++$100,000)
$100,000)//$8
$8==50,000
50,000units
units
Planned
$1,000,000
Plannedsales
sales==($300,000
($300,000++$100,000)
$100,000)//40%
40%==$1,000,000
$1,000,000
Sales
Sales(400
(400surf
surfboards)
boards)
Less:
Less: variable
variableexpenses
expenses
Contribution
Contributionmargin
margin
Less:
Less: fixed
fixedexpenses
expenses
Net
Net income
income
$80,000
40%
Total
Total
$$200,000
200,000
120,000
120,000
$$ 80,000
80,000
80,000
80,000
$$
--
Per
Per Unit
Unit
$$ 500
500
300
300
$$ 200
200
= $200,000 sales
Percent
Percent
100%
100%
60%
60%
40%
40%
Target Net Profit

We can determine the number of surfboards
that Curl must sell to earn a profit of $100,000
using the contribution margin approach.
Fixed expenses + Target profit
$80,000 + $100,000
$200
Units sold to earn

the target profit
= 900 surf boards
Target Net Profit

We can determine the total revenue that Curl
must make to earn a profit of $100,000 using
the contribution margin approach.
Fixed expenses + Target profit
contribution margin percentage
$80,000 + $100,000
40 %
Total revenue to earn

the target profit
= $450,000
Equation Approach
Sales revenue Variable expenses Fixed expenses = Profit
($500 X)
($300 X) $80,000 = $100,000

($200X) = $180,000
X = 900 surf boards or $450,000
Sensitivity Analysis
CVP Provides structure to answer a variety
of what-if scenarios
What happens to profit if:
Cost structure changes
Variable cost per unit changes
Fixed cost changes
Selling price changes

Volume changes
Curl Data
Changes in Variable Costs

Curl
Curl is
is currently
currently selling
selling 500
500 surfboards
surfboards per
per
year.
year.
The
The owner
owner believes
believes that
that the
the Variable
Variable Cost
Cost
would
would Increase
Increase by
by 15
15 %
% during
during the
the current
current
year.
year.
The
The owner
owner believes
believes that
that the
the Variable
Variable Cost
Cost
would
would decrease
decrease by
by 10
10 %
% during
during the
the current
current
year.
year.
Curl Data
Curl Data
Changes in Fixed Costs

Curl
Curl is
is currently
currently selling
selling 500
500 surfboards
surfboards per
per
year.
year.
The
The owner
owner believes
believes that
that an
an increase
increase of
of
$10,000
$10,000 in
in the
the annual
annual advertising
advertising budget,
budget,
would
would increase
increase sales
sales to
to 540
540 units.
units.
Should
Should the
the company
company increase
increase the
the advertising
advertising
budget?
budget?
Curl Data

Sales
Sales will
will increase
increase by
by
$20,000,
$20,000, but
but net
net income
income
decreased
decreased by
by $2,000
$2,000..
540
540 units
units $500
$500 per
per unit
unit == $270,000
$270,000
$80,000
$80,000 ++ $10,000
$10,000 advertising
advertising == $90,000
$90,000
Changes in Unit
Contribution Margin
Because of increases in cost of raw materials,
Curls variable cost per unit has increased
from $300 to $310 per surfboard. With no
change in selling price per unit, what will be
the new break-even point?
($500 X)
($310 X) $80,000 = $0
X = 422 units (rounded)
Changes in Unit
Contribution Margin
Suppose Curl, Inc. increases the price of
each surfboard to $550. With no change
in variable cost per unit, what will be the
new break-even point?
($550 X)
($300 X) $80,000 = $0
X = 320 units
Applying CVP Analysis

Safety Margin
The difference between budgeted sales
revenue and break-even sales revenue.
The amount by which sales can drop before
losses begin to be incurred.
Safety Margin
Curl, Inc. has a break-even point of $200,000.
If actual sales are $250,000, the safety margin is
$50,000 or 100 surf boards.
Margin of Safety
Sales
SalesSales
Salesat
atbreak-even
break-evenpoint
point
Sales
Sales
Sales
Break-even sales
Excess
Dollars
$250,000
200,000
$ 50,000
Units
500
400
100
Margin of Safety
Sales
SalesSales
Salesat
atbreak-even
break-evenpoint
point
Sales
Sales
A Sales
Break-even sales
Excess
Actual
Actualsales
saleslevel.
level.
Dollars
Units
$250,000
500
200,000 400
$ 50,000 100
Margin of Safety
Sales
SalesSales
Salesat
atbreak-even
break-evenpoint
point
Sales
Sales
Dollars
Units
$250,000
500
A Sales
Break-even sales
200,000 400
$ 50,000
100
B Excess
Margin of safety (B/A) 20%
Excess
Excessof
ofactual
actual
sales
salesover
overthe
the
break-even
break-evensales.
sales.
What
Whatisisthe
themargin
marginof
of
safety
safetyas
asaapercentage?
percentage?
Margin of Safety
Sales
SalesSales
Salesat
atbreak-even
break-evenpoint
point
Sales
Sales
Sales
Break-even sales
Excess
Dollars
Units
$250,000 10,000
200,000 8,000
$ 50,000 2,000
Margin of Safety
Sales
SalesSales
Salesat
atbreak-even
break-evenpoint
point
Sales
Sales
A Sales
Break-even sales
Excess
Actual
Actualsales
saleslevel.
level.
Dollars
Units
$250,000 10,000
200,000 8,000
$ 50,000 2,000
Margin of Safety
Sales
SalesSales
Salesat
atbreak-even
break-evenpoint
point
Sales
Sales
Dollars
Units
$250,000 10,000
A Sales
Break-even sales
200,000 8,000
$ 50,000 2,000
B Excess
Margin of safety (B/A) = 20%
Excess
Excessof
ofactual
actual
sales
salesover
overthe
the
break-even
break-evensales.
sales.
What
Whatisisthe
themargin
marginof
of
safety
safetyas
asaapercentage?
percentage?
Predicting Profit Given Expected

Volume
Given:
Given:
Fixed expenses
Target net profit
Fixed expenses
Expected sales volume
Find: {reqd sales volume}
Find: {expected profit}
Predicting Profit Given

Expected Volume
In the coming year, Curls owner expects to sell
525 surfboards. The unit contribution margin is
expected to be $190, and fixed costs are
expected to increase to $90,000.
Total contribution
Fixed cost = Profit
($190 525) $90,000 = X

X = $99,750 $90,000
X = $9,750 profit
Learning
Objective
5
McGraw-Hill/Irwin
Effects of Sales-Mix on CVP

The formulae presented to this point have assumed
a single product is produced and sold
A more realistic scenario involves multiple products
sold, in different volumes, with different costs
The same formulae are used, but instead use
average contribution margins for bundles of
products.
Sales Mix Considerations
Contribution margin
Products
A
B
Sales
$ 90
$140
Variable costs
70
95
Contribution margin $ 20
$ 45
Sales mix
80%
20%
What
Whatis
isthe
theaverage
average
contribution
contributionfor
for
each
eachproduct?
product?
Contribution margin
Products
A
B
Sales
$ 90
$140
Variable costs
70
95
$ 45
Sales mix
80%
20%
What
Whatis
isthe
theaverage
average
contribution
contributionfor
for
each
eachproduct?
product?
Contribution margin
Products
A
B
Sales
$ 90
$140
Variable costs
70
95
Contribution margin
$ 20
$ 45
Sales mix
x 80% x 20%
Product contribution $ 16
$ 9
Total product contribution
$ 25
Break-even sales units

Total fixed costs
$200,000
Product contribution
$25
What
Whatis
isthe
thebreak-even
break-evensales
salesunits?
units?
Contribution margin
Products
A
B
Sales
$ 90
$140
Variable costs
70
95
Contribution margin
$ 20
$ 45
Sales mix
x 80% x 20%
Product contribution $ 16
$ 9
$ 25

Total fixed costs
$200,000
$25
What
Whatis
isthe
thebreak-even
break-evensales
salesunits?
units?
Contribution margin
Products
A
B
Sales
$ 90
$140
Variable costs
70
95
$ 45
Sales mix
x 80% x 20%
Product contribution $ 16 $ 9
$ 25

Total fixed costs
Product A units (80%)
Product B units (20%)
$200,000
$25
8,000
6,400
1,600
= 8,000 units
Contribution margin
Products
A
B
Sales
$ 90
$ 140
Variable costs
70
95
$ 45
Sales mix
60%
40%
IfIfthe
thesales
salesmix
mixis
is60%
60%for
forproduct
product
AAand
and40%
40%for
forproduct
productB,
B,what
whatis
is
the
thebreak-even
break-evensales
salesunits?
units?
Contribution margin
Products
A
B
Sales
$ 90
$140
Variable costs
70
95
$ 45
Sales mix
x 60% x 40%
$ 12 $ 18
$ 30

Total fixed costs
Product A units (60%)
Product B units (40%)
$200,000
$30
6,667
4,000
2,667
= 6,667 units
CVP Analysis with Multiple

Products
For a company with more than one product,
sales mix is the relative combination in which a
companys products are sold.
Different products have different selling prices,
cost structures, and contribution margins.
Lets assume Curl sells surfboards and sail

boards and see how we deal with breakeven analysis.

Products
Curl provides us with the following
information:

Products
Weighted-average unit contribution margin
$200 62.5%
$550 37.5%

Products
Break-even point
Break-even
Fixed expenses
=
point
Weighted-average unit contribution margin
Break-even
=
point
$170,000
$331.25
Break-even
= 514 combined unit sales
point

Products
Break-even point
Break-even
= 514 combined unit sales
point
Learning
Objective
6
McGraw-Hill/Irwin
Learning
Objective
7
McGraw-Hill/Irwin
CVP Relationships and

the Income Statement
CVP Relationships and

the Income Statement
Alternative Income Statement

Formats
Learning
Objective
8
McGraw-Hill/Irwin
Cost Structure and Operating

Leverage
The cost structure of an organization is the
relative proportion of its fixed and variable
costs.
Operating leverage is . . .
the
the extent
extent to
to which
which an
an organization
organization uses
uses fixed
fixed
costs
costs in
in its
its cost
cost structure.
structure.
greatest in companies that have a high

proportion of fixed costs in relation to
variable costs.
Operating Leverage
Operating Leverage (OL) is the effect that
fixed costs have on changes in operating
income as changes occur in units sold,
expressed as changes in contribution margin
OL = Contribution Margin
Operating Income
Notice these two items are identical, except

for fixed costs
Operating Leverage
Contribution
Contributionmargin
margin
Operating
Operatingincome
income
Operating leverage is a
measure of the relative mix of
variable costs and fixed costs.
Jones Inc.
Sales
$400,000
Variable costs
300,000
A Contribution margin $100,000
Fixed costs
80,000
B Income from operations $20,000
Wilson Inc.
$400,000
300,000
$100,000
50,000
$ 50,000
Operating leverage (A/B)

What
Whatisisthe
theoperating
operatingleverage?
leverage?
Operating Leverage
Contribution
Contributionmargin
margin
Operating
Operatingincome
income
Jones Inc.
Sales
$400,000
Variable costs
300,000
Fixed costs
80,000
5
Wilson Inc.
$400,000
300,000
$100,000
50,000
$ 50,000
2
What
Whatdo
dothese
thesenumbers
numbersmean?
mean?
Operating Leverage
Contribution
Contributionmargin
margin
Operating
Operatingincome
income
Jones Inc.
Sales
$400,000
Variable costs
300,000
Fixed costs
80,000
5
Wilson Inc.
$400,000
300,000
$100,000
50,000
$ 50,000
2
Capital
Labor
intensive? intensive?
Measuring Operating Leverage

Operating leverage
factor
Contribution margin
Net income
$100,000
= 5
$20,000

A measure of how a percentage change in
sales will affect profits. If Curl increases its
sales by 10%, what will be the percentage
increase in net income?
Percent increase in sales
Operating leverage factor
Percent increase in profits
10%
5
50%
A firm with proportionately high fixed costs has

relatively high operating leverage On the other
hand, a firm with high operating leverage has a
relatively high break-even point.
Learning
Objective
9
McGraw-Hill/Irwin
CVP Analysis, Activity-Based Costing,

and Advanced Manufacturing Systems
An activity-based costing system can provide
a much more complete picture of costvolume-profit relationships and thus provide
better information to managers.
Break-even =
Fixed costs
point
Learning
Objective
10
McGraw-Hill/Irwin
A Move Toward JIT and

Flexible Manufacturing
Overhead costs like setup, inspection, and
material handling are fixed with respect to
sales volume, but they are not fixed with
respect to other cost drivers.
This is the fundamental distinction between a
traditional CVP analysis and an activity-based
costing CVP analysis.
Learning
Objective
11
McGraw-Hill/Irwin
Effect of Income Taxes

Income taxes affect a companys
CVP relationships. To earn a
particular after-tax net income, a
greater before-tax income will be
required.
Target after-tax net income

1 - t
Before-tax
=
net income
CVP and Income Taxes

From time to time it is necessary to move back
and forth between pre-tax profit (OI) and after-tax
profit (NI), depending on the facts presented
After-tax profit can be calculated by:
OI x (1-Tax Rate) = NI
NI can substitute into the profit planning equation

through this form:
OI = I I
NI
I
(1-Tax Rate)
Multiple Cost Drivers

Variable costs may arise from multiple cost
drivers or activities. A separate variable
cost needs to be calculated for each driver.
Examples include:
Customer or patient count
Passenger miles
Patient days
Student credit-hours
End of Chapter 8
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Chapter Four

Copyright 2008 by The McGraw-Hill Companies, Inc. All

Copyright 2008 by The McGraw-Hill Companies, Inc. All

Cost-volume-profit (CVP) analysis

A Five-Step Decision Making

Identify the problem and uncertainties

Assumptions of Cost-Volume-Profit Analysis

2009 Pearson Prentice Hall. All rights reserved.

CVP: Contribution Margin

extremely important and powerful tool

Contribution Margin per Unit equals unit

selling price less variable cost per unit

Contribution Margin also equals contribution

margin per unit multiplied by the number of

Contribution Margin Ratio (percentage) equals

contribution margin per unit divided by Selling

dollar are represented by Contribution Margin

Basic Formula Derivations

and decomposed as follows:

Remember this last equation, it will be used

2009 Pearson Prentice Hall. All rights reserved.

OI to zero will result in the Breakeven Point

At this point, a firm has no profit or loss at the

given sales level

Breakeven Point, extended:

Point formula can be modified to become a

changing it to a simple sales volume equation

2009 Pearson Prentice Hall. All rights reserved.

Contribution Margin Income Statement

Contribution Margin Income Statement

Total Per Unit

2009 Pearson Prentice Hall. All rights reserved.

Contribution Margin Income Statement

Total Per Unit

2009 Pearson Prentice Hall. All rights reserved.

Contribution Margin Income Statement

Total Per Unit

Calculating the Break-Even Point

Total Per Unit

2009 Pearson Prentice Hall. All rights reserved.

Calculating the Break-Even Point

Per Unit Percent

2009 Pearson Prentice Hall. All rights reserved.

Calculating the Break-Even Point

Total Per Unit Percent

2009 Pearson Prentice Hall. All rights reserved.

Calculating the Break-Even Point

Total Per Unit Percent

Calculating the Break-Even Point

Total Per Unit Percent

The Break-Even Point

= 400 surf boards

Contribution Margin Ratio

Contribution Margin Ratio

Copyright 2008 by The McGraw-Hill Companies, Inc. All

Copyright 2008 by The McGraw-Hill Companies, Inc. All

Sales and Costs ($000)

Sales and Costs ($000)

Sales and Costs ($000)

Sales and Costs ($000)

Sales and Costs ($000)

Sales and Costs ($000)

Operating Loss Area

Sales and Costs ($000)