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CHAPTER 21 … COST-VOLUME-PROFIT ANALYSIS

Objective 1: Identify how changes in volume affect costs.

A. A cost driver is any factor whose change makes a difference in a related total cost (defined in
Chapter 20). Volume (units or dollars) is the most prominent cost driver in cost-volume-profit
(CVP) analysis.

B. Cost behavior describes how costs change in response to changes in a cost driver.
1. Variable costs change in total in direct proportion to changes in volume (sales or production).
Refer to Exhibit 21-1 for the graph of a variable cost.

2. Fixed costs do not change in total as volume changes. Refer to Exhibit 21-2 for the graph of a
fixed cost.

3. Mixed costs have both fixed and variable components. Exhibit 21-3 shows the graph of a mixed
cost.

C. The relevant range is the range of volume in which a business expects to operate and in which costs
will behave as defined. See Exhibit 21-4.

D. In the conventional income statement, expenses are classified by value chain functions. In the
contribution margin income statement, expenses are classified as either variable or fixed.

1. Contribution margin is the excess of revenues over variable expenses and is the amount that
contributes to covering fixed costs and providing a profit for the company.

Objective 2: Use CVP analysis to compute breakeven points.

A. As volume increases, income will increase by the contribution margin of the additional number
of units sold.

B. The breakeven point is the sales level at which operating income is zero.

C. Breakeven can be computed by using either the income statement approach or the contribution
margin formula approach.

1. With the income statement equation approach, breakeven sales in units is calculated as
follows:
(unit sale price x units sold) - (variable unit cost x units sold) - fixed expenses = operating

21-1

6. 4. and graph the CVP relations. the contribution margin covers fixed expenses and provides the target profit. At this level of sales. and solve for either target sales in dollars or units. Draw the fixed expense line parallel to the horizontal axis. Choose a sales volume and plot that point on the graph. 5. C. The formula to calculate the breakeven point in units is: Fixed expenses + Operating income Unit contribution margin 7. The contribution margin per unit equals sales per unit minus variable expenses per unit. 1. Exhibit 21-5 illustrates the breakdown of $1 of revenue into variable costs and contribution margin. A. Calculate the total expense line at a sales volume. Then draw a line from the origin through that point. this is the total revenue line. B. The formula to calculate the breakeven point in dollars is: Fixed expenses + Operating income Contribution margin ratio Objective 3: Use CVP analysis for profit planning. Exhibit 21-6 illustrates a Cost-Volume-Profit graph. 21-2 . This is the total expense line (variable expenses plus fixed expenses). 4. sales minus variable expenses equals fixed expenses (there is no operating income at breakeven). 3. The breakeven point is the point at which the total revenue line intersects the total expense line. Insert the target operating income in the formula (rather than zero. At the breakeven point. 2. income (solve for units sold to get breakeven unit sales) 2. The contribution margin ratio is the contribution margin divided by sales (CM% = CM/Sales). Draw a line through that point so that the line intersects the vertical axis at fixed costs. 3. as for breakeven calculations).

A weighted-average unit contribution margin must first be found and then inserted into the original formulas. Margin of safety in dollars = Margin of safety in units x unit sale price D. B. Computer spreadsheet programs produce income statements for changes in variables so that the impact on the income statement can be seen easily and quickly. Margin of safety in units = Expected unit sales . Because most companies sell more than one product. Use the following formulas to compute the margin of safety: 1. C. 2. and profits. 1. To prove that the calculations are correct. Managers use this output in order to plan the best course of action. The margin of safety tells how much sales can drop before the business incurs a net loss. Learning Objective 4: Use CVP methods to perform sensitivity analyses.Breakeven unit sales 2. 21-3 . D. B. The margin of safety is the excess of expected sales over breakeven sales. 5. a contribution margin income statement may be prepared. A. The computer output covers many different levels of sales. sales mix is an important consideration in CVP analysis. C. The area between the two lines to the right of the breakeven point is the operating income area. Computers are especially helpful when performing CVP analysis. Sensitivity analysis is a "what if" technique that asks what a result will be if a predicted amount is not achieved or if an underlying assumption changes. The breakeven point in total units is then broken down into units of each product in the mix. To calculate breakeven. costs. A. Objective 5: Compute the breakeven point for multiple product lines or services. The area to the left is the operating loss area. the original equation can be adapted.

Variable costing income will be greater than absorption costing income when unit sales are greater than units produced. C. Exhibit 21A-2 illustrates an absorption costing and variable costing income statement. 2. 2. Variable costing assigns only variable manufacturing costs to products. 1. the conventional method of product costing. Absorption costing. 3. both fixed overhead costs and all nonmanufacturing costs are expensed as period costs. The difference in operating income between these two methods is merely a timing difference. Variable costing income and absorption costing income will be equal if units produced and sold are equal. 1. B. Variable costing income will be less than absorption costing income when units produced are greater than unit sales. 21-4 .Appendix: Variable costing and absorption costing. The contribution margin income statement is often referred to as a variable costing statement. assigns both variable and fixed manufacturing costs to products. A. 1. Exhibit 21A-1 illustrates the differences between absorption costing and variable costing.