Chapter 22

Cost-Volume-Profit Analysis

Objective 1

Identify how changes in volume affect costs.

Types of Costs
Variable Fixed Mixed

Total Variable Cost

Total variable costs change when activity changes.
Total Long Distance Telephone Bill

Your total long distance telephone bill is based on how many minutes you talk.

Minutes Talked

Variable Cost Per Unit

Variable costs per unit do not change as activity increases.
Per Minute Telephone Charge Minutes Talked

The cost per long distance minute talked is constant. For example, 10 cents per minute.

Variable Costs Example

Consider Grand Canyon Railway. Assume that breakfast costs Grand Canyon Railway $3 per person. If the railroad carries 2,000 passengers, it will spend $6,000 for breakfast services.

Variable Costs Example

$24 $18 $12
a r a Vl at o T i ) s dnas uo h ( t

$6

Volume (Thousands of passengers)

Total Fixed Cost

Total fixed costs remain unchanged when activity changes.
Your monthly basic telephone bill probably does not change when you make more local calls.
Monthly Basic Telephone Bill Number of Local Calls

Mixed Costs

Contain fixed portion that is incurred even when facility is unused & variable portion that increases with usage. Example: monthly electric utility charge

Fixed service fee Variable charge per kilowatt hour used

Mixed Costs
Total Utility Cost

st o dc ixe m tal To

Variable Utility Charge Fixed Monthly Utility Charge

Activity (Kilowatt Hours)

Relevant Range...
is a band of volume in which a specific relationship exists between cost and volume. Outside the relevant range, the cost either increases or decreases. A fixed cost is fixed only within a given relevant range and a given time span.

Relevant Range
$160,000 $120,000 $80,000 Relevant Range

st s o C de x F i

$40,000

5,000 10,000 15,000 20,000 25,000 Volume in Units

Objective 2

Use CVP analysis to compute breakeven point.

Assumptions of CVP Analysis

Expenses can be classified as either variable or fixed. CVP relationships are linear over a wide range of production and sales. Sales prices, unit variable cost, and total fixed expenses will not vary within the relevant range.

Assumptions of CVP Analysis

Volume is the only cost driver. The relevant range of volume is specified. Inventory levels will be unchanged. The sales mix remains unchanged during the period.

Contribution Margin Income Statement

Sales - Variable Costs Contribution Margin - Fixed Costs Operating Income

Contribution Margin Example

Luis and Tom manufacture a device that allows users to take a closer look at icebergs from a ship. The usual price for the device is $100. Variable costs are $70 per unit. They receive a proposal from a company in Newfoundland to sell 20,000 units at a price of $85.

Contribution Margin Example

There is sufficient capacity to produce the order. How do we analyze this situation? $85 $70 = $15 contribution margin. $15 20,000 units = $300,000 (total increase in contribution margin)

Contribution Margin Income Statement

Sales (20,000 x $85) $1,700,000 Variable costs (20,000 x $70) (1,400,000) Contribution margin

Computing Break-Even Point

The unique sales level at which a company earns neither a profit nor incurs a loss.
Sales Variable Costs Fixed Costs = 0

Breakeven Point Example

Lets look back at Luis and Toms manufacturing, assuming that the fixed cost are $90,000.

Objective 3

Use CVP analysis for profit planning and graph the cost-volume-profit relations

Preparing a CVP Chart

Costs and Revenue in Dollars

Plot total fixed costs on the vertical axis.

Total fixed costs

Total costs

Draw the total cost line with a slope equal to the unit variable cost.

Volume in Units

Preparing a CVP Chart

Starting at the origin, draw the sales line with a slope equal to the unit sales price.

Sales

Costs and Revenue in Dollars

Total fixed costs

Total costs Break-even Point

Volume in Units

Various Sales Levels Example

What operating income is expected when sales are _____ units?

Target Operating Income Example

Suppose that our business would be content with operating income of _________________. How many units must be sold?

Objective 4

Use CVP method to perform sensitivity analysis.

Change in Sales Price Example

Suppose that the sales price per device is _____ rather than ____ What is the revised breakeven sales in units?

Change in Variable Costs Example

Suppose that variable expenses per device are ____ instead of ____ Other factors remain unchanged.

Change in Fixed Costs Example

Suppose that fixed costs increased by $30,000. What are the new fixed costs? What is the new breakeven point?

Margin of Safety Example

Excess of expected sales over breakeven sales.

E22-7
(in thousands)

Atlanta Braves

$7,000 $6,000 $5,000 $4,000 ofit Pr1,200,000 Break even in units = Revenues $3,000 Break even in s$ = 1,200,000 x 24 = $28,800,000 Total Expense $2,000 os L $1,000 $50 100 150 200 250
(in thousands)
Break even point

Fixed expense

Effect of sales mix on CVP analysis.

Computing Multiproduct Break-Even Point

Unit contribution margin is replaced with 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

The resulting break-even formula for composite unit sales is:
Break-even point in composite units = Fixed costs Contribution margin per composite unit

Computing Multiproduct Break-Even Point

A company sells windows and doors. They sell 4 windows for every door.

Selling Price Variable Cost Unit Contribution Sales Mix Ratio

Windows Doors $200 $500 125 350 $ 75 $ 150 4 1

Computing Multiproduct Break-Even Point

Step 1: Compute contribution margin per composite unit.
Selling Price Variable Cost Unit Contribution Sales Mix Ratio Composite C/M Windows Doors $200 $500 125 350 $ 75 $ 150

Computing Multiproduct Break-Even Point

Step 2: Compute break-even point in composite units. Fixed costs Break-even point = Contribution margin in composite units per composite unit

Computing Multiproduct Break-Even Point

Step 2: Compute break-even point in composite units.
Break-even point in composite units Break-even point in composite units Break-even point in composite units = Fixed costs Contribution margin per composite unit $900,000 $450 per composite unit 2,000 composite units

Computing Multiproduct Break-Even Point

Step 3: Determine the number of windows and doors that must be sold to break even.
Sales Composite Product Mix Units Window 4 2,000 = Door 1 2,000 =

Units 8,000 2,000

Multiproduct Break-Even Income Statement

Step 4: Verify the results.
W indow s Se lling Price $200 Va ria ble Cost 125.00 Unit Contribution $ 75.00 Sa le s Volum e 8,000 Tota l Contribution $ 600,000 Fix e d Costs Incom e Doors $500 350.00 $ 150.00 2,000 $ 300,000 Com bine d

$ 900,000 900,000 $ 0