Suggested solution to CVP questions

BREAK-EVEN ANALYSIS
APPLICATION QUESTIONS

AE9.2

Solution:

Required Formula Calculation Answer

(a) Contribution margin SP$ -VC$ $9.20 - $4.40 $4.80

($)

(b) Break-even (units) FC$/CM$ $40,320/$4.80 8,400 units

(c) Profit ($) (Units x CM$) - FC$ (11,200 x $4.80) - $40,320 $13,440

$53,760 - $40,320

(d) Margin of safety Sales units-BE units #11,200 - # 84,00 2,800 units
(units)

AE9.3

Solution:
(a)

Required Formula Calculation Answer

(i) Contribution margin (SP$ -VC$)/SP$ ($86 - $53)/$86 0.3837

ratio
$33/$86 38.37%

(ii) Fixed costs BE units x CM$ #5500 x $33 $181,500

(b)

Required Formula Calculation Answer

(i) Contribution margin SP$ -VC$ $24 - $16.80*1 $7.20

($)

(ii) Break-even ($) FC$/CMR# $32,000/0.3 $106,666.67

(iii) Margin of safety (#) Sales units-BE units #5,500*2 - # 4445*3 1,055 units

*1 VC = (1-CMR) x SP = 0.7 x $24 = $16.8

*2 Sales units =Sales $/SP $ per unit = $132000/$24 = #5500

*3 Break-even units = Break-even sales $/SP $ per unit = $106666.67/$24 = 4444.44

AE9.8 LO2, 3
(a) A company breaks even with sales of $600,000. What profit will it make if it sells
$800,000 worth of goods, the variable costs of which are $600,000? You may assume
that variable costs change directly in proportion to sales.
(b) If sales are $600,000 (at $10 per unit), fixed costs are $100,000 and profits are
$100,000, what is the break-even point?
(a)

Sales $ Total cost $ Variable cost Fixed cost $ Profit $

$
600,000 600,000 450,000 150,000 Nil
(75%)
800,000 750,000 600,000 150,000 50,000
(75%)

This activity requires some manipulation of the technique used above. The answer is
$50,000, derived as follows:
Variable costs of $600,000 are 75% of the sales revenue of $800,000. Therefore at a sales
level of $600,000 variable costs will be $450,000. Since this is the break-even point fixed
costs must be $150,000. Hence, at a sales level of $800,000 variable costs will be $600,000,
fixed costs $150,000 and profit $50,000.
(b)
For sales of $600,000 contribution is $200,000. Variable costs must therefore be $400,000.
This is for 60,000 units, so variable costs per unit must be $6.67, while contribution per unit
must be $3.33.
The break-even point can be derived by dividing fixed costs by contribution per unit, i.e.
$100,000/3.33 = 30,000 units or $300,000.
(In fact this particular answer could have been obtained very quickly. Since the fixed costs
are 50% of the contribution the break-even point must be 50% of 60,000 units.)
DISCUSSION QUESTIONS
9.6 LO3 Explain the meaning of ‘contribution’, and discuss its usefulness.
Contribution refers to the surplus of selling price over the variable cost. It is normally
expressed per unit and can relate to either a product or a service. It is effectively the
‘contribution’ of the unit sale towards both ‘fixed costs’ and ‘profit’. It is calculated by
deducting the ‘variable cost’ per unit from the ‘selling price’ per unit.
Contribution is useful in calculating the break-even point and the levels of output needed to
achieve specified profit levels. Break-even sales units are computed by dividing the ‘fixed
costs’ by the ‘contribution’ per unit. Projected profit can be calculated by multiplying the
projected sales units by the ‘contribution’ and deducting the expected fixed costs from that
figure.
9.10 LO1 Why is an understanding of cost behaviour (e.g. fixed costs, variable costs, etc.)
important? Will such understanding be more important for financial accounting or for
management accounting?
The accountant’s understanding of cost behaviour is critical in order that future costs can be
estimated for cost–volume–profit analysis to be properly conducted. Many other
management accounting functions (e.g. budgeting, decision-making) require good cost
estimates and thus require an understanding of cost behaviour. Financial accounting’s
emphasis on historical costs makes cost behaviour a non-issue for the most part for financial
accounting.
9.11 LO3 Why do we bother with break-even analysis? A business is formed to earn profit,
not just to not make a loss (e.g. break even). Discuss.
Break-even analysis is useful for a business to evaluate the profitability and the risk
associated with a business or a particular project or product. It is used in conjunction with
planned sales volumes to derive the margin of safety—an indicator of how far above the
break-even point the business expects to operate.
The standard break-even formula can be easily extended to include a desired profit level by
including the desired profit with the fixed costs in the numerator of the ‘break-even’
calculation formula. By doing this the ‘break-even’ formula is converted into a ‘desired
profit’ formula.
Answer to the additional question

Pentagon and Octagon are two companies selling distinctive products in a competitive
market. While their profitability is similar, their cost structure is different. The summary
results for each company are shown below.
Pentagon Octagon
Sales 10,000 @ $20 200,000 200,000
Less: variable cost:
10,000 @ $10 100,000
10,000 @ $5 50,000
Less: Fixed costs 75,000 125,000
Profit 25,000 25,000

Calculate:
Pentagon Octagon
Contribution per unit 20 – 10 = 10 20 – 5 = 15
Break-even point (in 75000/10 = 7500 unit 125000/15 = 8333 unit
unit)
Break-even point (in 7500 X 20 = $150,000 8333 x 20 = $166,660
value)
How much is the profit if 220000 – 110000 – 75000 220000 – 55000 – 125000
sales = 11,000 units? = $35,000 = $40,000
How much is the profit if 300000 – 150000 – 75000 300000 – 75000 – 125000
sales = 15,000 units? = $75,000 = $100,000

Complete the table above. Based on your answer, why do you think that Octagon can make
profit at a faster rate than Pentagon, when the sales volume increased from 11,000 units to
15,000 units? 
Octagon has higher contribution margin than Pentagon. Every increase in unit sold
contributed to higher profit. Since Octagon is now operating after the break-even point,
total contribution generated by sales is more than enough to cover its huge fixed cost.