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M Naveed Alam
Questions Addressed by
Cost-Volume-Profit Analysis
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?
What will happen to
profitability if I expand
capacity?
M. Naveed Alam
Types of Costs
Variable
Fixed
Mixed
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Total Fixed Cost
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Fixed Cost Per Unit All Night
F&F
Your total
telephone bill is based
on how many minutes
Minutes you talk.
Talked
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Variable Cost Per Unit
Variable costs per unit do not change
as activity increases.
Telephone Charge
Per Minute
The cost per
minute talked is constant.
For example, 0.65 Rs.
per minute. Minutes Talked
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Cost Behavior Summary
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Rental
Mixed Costs Generator
Metro Rent-
A Car
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Mixed Costs
Slope is
variable cost
per unit
Total Utility Cost
of activity.
Variable
Utility Charge
Fixed Monthly
Utility Charge
Activity (Kilowatt Hours)
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Stair-Step Costs
Cost
Activity
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Public
Transport
Stair-Step Costs Fare
Cost
Activity
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What is 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.
M. Naveed Alam
Relevant Range
$160,000 –
Fixed Costs
$120,000 –
$40,000 –
–
–
0 5,000 10,000 15,000 20,000 25,000
Volume in Units
M. Naveed Alam
Cost-Volume-Profit
(CVP) Analysis
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Computing Break-Even Point
The break-even point (expressed in units of
product or dollars of sales) is the unique sales
level at which a company neither earns a profit
nor incurs a loss.
M. Naveed Alam
Computing Break-Even Point
To ta l Unit
S a le s R e v e nue (2 ,0 0 0 units ) $ 10 0 ,0 0 0 $ 50
Le s s : Va ria ble c o s ts 6 0 ,0 0 0 30
C o ntributio n m a rg in $ 4 0 ,0 0 0 $ 20
Le s s : F ixe d c o s ts 3 0 ,0 0 0
Ope ra ting inc o m e $ 10 ,0 0 0
M. Naveed Alam
Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000
M. Naveed Alam
Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000
M. Naveed Alam
Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000
M. Naveed Alam
Formula for Computing Break-Even Sales (in $)
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Computing Break-Even Sales Question 1
a. 100,000 units
b. 40,000 units
c. 200,000 units
d. 66,667 units
M. Naveed Alam
Computing Break-Even Sales Question 1
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 Unit contribution = $5.00 - $3.00 = $2.00
d. 66,667 units
Fixed costs $200,000
Unit contribution = $2.00 per unit
= 100,000 units
M. Naveed Alam
Computing Break-Even Sales Question 2
a. $200,000
b. $300,000
c. $400,000
d. $500,000
M. Naveed Alam
Computing Break-Even Sales Question 2
d. $500,000
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Preparing a CVP Graph
Starting at the origin, draw the total revenue
line with a slope equal to the unit sales price. Revenue
Costs and Revenue
in Dollars
Volume in Units
M. Naveed Alam
Preparing a CVP Graph
Draw the total cost line with a slope
equal to the unit variable cost. Revenue
Costs and Revenue
Break-
Profit
even
in Dollars
Point
Total cost
Loss
Total fixed cost
Volume in Units
M. Naveed Alam
Computing Sales Needed to Achieve
Target Operating Income
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Computing Sales Needed to Achieve Target
Operating Income
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Computing Sales Needed to Achieve
Target Operating Income
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What is our Margin of Safety?
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What is our Margin of Safety?
Operating
Income = $20,000 × .40 = $8,000
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What Change in Operating Income Do
We Anticipate?
Once break-even is reached, every additional dollar
of contribution margin becomes operating income:
Change in
= $15,000 × .40 = $6,000
operating income
M. Naveed Alam
Business Applications of CVP
M. Naveed Alam
Business Applications of CVP
Consider the following information developed by
the accountant at CyclCo, a bicycle retailer:
500
Total Per Unit Percent
550 Sales (500 bikes) $ 250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
625 Contribution margin $ 100,000 $ 200 40%
Less: fixed expenses 80,000
750 Operating income $ 20,000
M. Naveed Alam
Business Applications of CVP
Should CyclCo spend $12,000 on advertising to
increase sales by 10 percent?
500 550
Bikes 550 × $500 Bikes
Sales $ 250,000 $ 275,000
Less: variable expenses 150,000 165,000
Contribution margin $ 100,000 550 × $300 $ 110,000
Less: fixed expenses 80,000 92,000
Operating income $ 20,000 $80K + $12K $ 18,000
M. Naveed Alam
Business Applications of CVP
M. Naveed Alam
Business Applications of CVP
Now, in combination with the advertising,
CyclCo is considering a 10 percent price reduction that will
increase sales by 25 percent. What is the income effect?
500 1.25 × 500 625
Bikes Bikes
Sales $ 250,000 625 × $450 $ 281,250
Less: variable expenses 150,000 187,500
Contribution margin $ 100,000 $ 93,750
Less: fixed expenses 80,000
625 × $300 92,000
Operating income $ 20,000 $ 1,750
$80K + $12K
M. Naveed Alam
Business Applications of CVP
Now, in combination with advertising and a price cut, CyclCo
will replace $50,000 in sales salaries with a $25 per bike
commission, increasing sales by 50 percent above the
original 500 bikes. What is the effect on income?
500
Bikes
Sales $ 250,000
Less: variable expenses 150,000
Contribution margin $ 100,000
Less: fixed expenses 80,000
Operating income $ 20,000
M. Naveed Alam
Business Applications of
CVP
Now, in combination with advertising and a price cut, CyclCo
will replace $50,000 in sales salaries with a $25 per bike
commission, increasing sales by 50 percent above the
original 500 bikes. What is the effect on income?
500 1.5 × 500 750
Bikes Bikes
Sales $ 250,000 750 × $450 $ 337,500
Less: variable expenses 150,000 243,750
Contribution margin $ 100,000 750 × $325 $ 93,750
Less: fixed expenses 80,000 42,000
Operating income $ 20,000 $92K - $50K $ 51,750
Determining semivariable
cost elements.