Unit 4 Cost-Volume-Profit Analysis

Wild, Shaw, and Chiappetta

Managerial Accounting
6th Edition

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ACCT 650 1
 Chapter 5 Learning Objectives
CONCEPTUAL
C1 Describe different types of cost behavior in relation to production and sales volume.
C2 Describe several applications of cost-volume-profit analysis.

ANALYTICAL
A1 Compute the contribution margin and describe what it reveals about a company’s cost structure.
A2 Analyze changes in sales using the degree of operating leverage.

PROCEDURAL
P1 Determine cost estimates using the scatter diagram, high-low, and regression methods of
estimating costs.
P2 Compute the break-even point for a single product company.
P3 Graph costs and sales for a single product company.
P4 Compute the break-even point for a multiproduct company.
P5 Compute unit cost and income under both absorption and variable costing (Appendix 5B).

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ACCT 650
2 Education
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2
 Identifying Cost Behavior

Managers use cost-volume-profit analysis to make

predictions such as:
How many units must we sell to break-even?
How much does income increase if we install a new machine to reduce labor costs?
What is the change in income if selling prices decline and sales volume increases?
How will income change if we change the sales mix of our products or services?
What sales volume is needed to earn a target income?

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Learning Objective C1: Describe different types of cost behavior in relation
ACCT to production
650 and sales volume.
3 3
 Mixed Costs
Exhibit
5.2

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ACCT 650 4
 Step-Wise Costs Exhibit
5.3

Total cost increases to a new higher cost for the next higher range of
activity, but remains constant within a range of activity.
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ACCT 650 5
 Curvilinear Costs Exhibit
5.3

Costs that increase when activity

increases, but in a nonlinear manner.
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ACCT 650 6
 NEED-TO-KNOW 5-1

Determine whether each of the following is best described as a fixed, variable, mixed, step-wise, or curvilinear
cost as the number of product units changes.

Rubber used to manufacture tennis balls $0.50 per tennis ball Variable cost
Depreciation (straight-line method)
Electricity cost
Supervisory salaries
A salesperson’s commission is 7% for sales of up to $100,000, and 10% of sales for sales above $100,000

$0.50 per tennis ball - Variable

$6,000

$5,000
Total Cost

$4,000

$3,000

$2,000

$1,000

$0
0 2,000 4,000 6,000 8,000 10,000
Units Produced

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ACCT 650 7
 NEED-TO-KNOW 5-1
Determine whether each of the following is best described as a fixed, variable, mixed, step-wise, or curvilinear
cost with respect to product units.

Rubber used to manufacture tennis balls $0.50 per ball Variable cost
Depreciation (straight-line method) $2,000 per month Fixed cost
Electricity cost
Supervisory salaries
A salesperson’s commission is 7% for sales of up to $100,000, and
10% of sales for sales above $100,000

$2,000 per month - Fixed

$2,500

$2,000
Total Cost

$1,500

$1,000

$500

$0
0 2,000 4,000 6,000 8,000 10,000
Units Produced

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ACCT 650 8
 NEED-TO-KNOW 5-1

Determine whether each of the following is best described as a fixed, variable, mixed, step-wise, or curvilinear
cost with respect to product units.
Rubber used to manufacture tennis balls $0.50 per ball Variable cost
Depreciation (straight-line method) $2,000 per month Fixed cost
Electricity cost $500 + $0.10 per ball Mixed cost
Supervisory salaries
A salesperson’s commission is 7% for sales of up to $100,000, and
10% of sales for sales above $100,000

$500 + $0.10 per unit- Mixed

$1,600
$1,400
$1,200
$1,000
Total Cost

$800
$600
$400
$200
$0
0 2,000 4,000 6,000 8,000 10,000
Units Produced

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ACCT 650 9
 NEED-TO-KNOW 5-1
Determine whether each of the following is best described as a fixed, variable, mixed, step-wise, or curvilinear
cost with respect to product units.

Rubber used to manufacture tennis balls $0.50 per ball Variable cost
Depreciation (straight-line method) $2,000 per month Fixed cost
Electricity cost $500 + $0.10 per ball Mixed cost
Supervisory salaries 4,000 units per shift $5,000 per mo. per supervisor Fixed *
A salesperson’s commission is 7% for sales of up to $100,000, and
10% of sales for sales above $100,000

$5,000 per supervisor per month - Step-wise

$16,000
$14,000
$12,000
$10,000
Total Cost

$8,000
$6,000
$4,000
$2,000
$0
0 2,000 4,000 6,000 8,000 10,000
Units Produced

* If more shifts are added, then supervisory salaries behave like a step-wise cost with respect to the number of shifts.
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ACCT 650 10
 NEED-TO-KNOW 5-1
Determine whether each of the following is best described as a fixed, variable, mixed, step-wise, or curvilinear
cost with respect to product units.

Rubber used to manufacture tennis balls $0.50 per ball Variable cost
Depreciation (straight-line method) $2,000 per month Fixed cost
Electricity cost $500 + $0.10 per ball Mixed cost
Supervisory salaries 4,000 units per shift $5,000 per mo. per supervisor Step-wise cost
A salesperson’s commission is 7% for sales of up to $100,000, and Curvilinear cost
10% of sales for sales above $100,000

Sales Commissions - Curvilinear

$30,000

$25,000

$20,000
Total Cost

$15,000

$10,000

$5,000

$0
$0 $50,000 $100,000 $150,000 $200,000 $250,000 $300,000
Sales $

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ACCT 650 11
 Measuring Cost Behavior

The objective is to classify all costs as either fixed

or variable. We will look at three methods:
1. Scatter diagram
2. High-low method
3. Regression

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ACCT 650 12
 Scatter Diagrams Exhibit
5.5a

Exhibit
5.5b

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ACCT 650 13
 Exhibit
The High-Low Method 5.4
The following relationships between units
produced and total cost are observed:

Using these two levels of volume, compute:

 the variable cost per unit.
 the total fixed cost.
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ACCT 650 14
 The High-Low Method
Units Cost
High volume level - November 67,500 $ 31,000
Low volume level - June 17,500 18,500
Change in activity 50,000 $ 12,000

Exhibit
5.6

Exhibit
5.7

Total cost = $14,125 + $0.25 per unit produced

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ACCT 650 15
 Regression

Regression is usually covered in advanced

cost accounting courses. It is commonly
used with spreadsheet programs or
calculators.
The objective of the cost
analysis remains the
same: determination of
total fixed cost and the
variable unit cost.
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ACCT 650 16
 Comparison of Cost Estimation Methods
Exhibit
5.8

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ACCT 650 17
 NEED-TO-KNOW 5-2

Using the information below, use the high-low method to determine the cost equation
(total fixed costs plus variable costs per unit).

Volume Units Total Cost

Level Produced
Lowest 1,600 $9,800
Highest 4,000 17,000

Variable Cost = Cost at high point - Cost at low point ($17,000 - $9,800) $7,200
Units at high point - Units at low point (4,000 - 1,600) 2,400
$3 per unit produced

Fixed Costs (at high point) Total cost = Fixed costs + $3 per unit
$17,000 = Fixed costs + ($3 x 4,000)
$5,000 = Fixed costs

Fixed Costs (at low point) Total cost = Fixed costs + $3 per unit
$9,800 = Fixed costs + ($3 x 1,600)
$5,000 = Fixed costs

Total costs = $5,000 + $3 per unit

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ACCT 650 18
 NEED-TO-KNOW 5-2 SOLUTION

Slope = Variable Cost $3 per unit

y-intercept = Fixed Costs $5,000

Total Cost = $5,000 + $3 per unit

$18,000
$16,000 (4,000 units, $17,000)

$14,000
$12,000
Total Cost

$10,000 (1,600 units, $9,800)

$8,000
$6,000
(0 units, $5,000)
$4,000
$2,000
$0
0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500
Units Produced

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ACCT 650 19
 Contribution Margin and Its Measures Exhibit
5.9

Exhibit
5.10

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ACCT 650 20
 Break-Even Point
Sales level at which total sales equal total costs.
Company neither earns a profit nor incurs a
loss.
Can be expressed in units or dollars of sales.
Three methods to find break-even point:
Formula
Contribution margin income statement
Cost-volume-profit chart

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ACCT 650 21
 Formula Method

Exhibit
5.11

Exhibit
5.12

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ACCT 650 22
 Contribution margin income statement method

Exhibit
5.13

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ACCT 650 23
 NEED-TO-KNOW 5-3

Hudson Co. predicts fixed costs of $400,000 for 2017. Its one product sells for $170 per unit, and it incurs
variable costs of $150 per unit. The company predicts total sales of 25,000 units for the next year.

1. Compute the contribution

- margin per unit. $20 per unit →
sales -
Van
-4%7
2. Compute the break-even point (in units). 20,000 units
3. Prepare a contribution margin income statement at the break-even point. unit
per
Contribution margin per unit, or unit contribution margin, is the amount by which a
product’s unit selling price exceeds its total variable cost per unit.

*:*
Sales
Variable costs
Contribution margin
$170 per unit
150 per unit
$ 20 per unit :#
Units per unit Total
Sales 20,000 $170 $3,400,000
Variable costs 20,000 $150 3,000,000
Contribution margin -

$20
_
400,000
Fixed costs 400,000
Net income $0
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ACCT 650 24
 Graphing – Cost-volume-profit Chart

Exhibit
5.14

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ACCT 650 25
 Changes in Estimates

Exhibit
5.15

Exhibit
5.16

Exhibit
5.17

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ACCT 650 26
 Computing the Margin of Safety

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ACCT 650 27
 Computing Sales for a Target Income
Exhibit
5.22
&

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ACCT 650 28
 Computing Sales for a Target Income
Exhibit
5.23
☆

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ACCT 650 29
 NEED-TO-KNOW 5-4

A manufacturer predicts fixed costs of $502,000 for the next year. Its one product sells for $180 per unit,
and it incurs variable costs of $126 per unit. Its target income (pretax) is $200,000.
1. Compute the contribution margin ratio. 30%
2. Compute the dollar sales needed to yield the target income. 2,340,000 →
-

3. Compute the unit sales needed to yield the target income. 1,300
4. Assume break-even sales of 9,296 units. Compute the margin of safety (in dollars) if the company
-

expects to sell 10,000 units $126,720

The contribution margin ratio is the percent of a unit’s selling price that exceeds total
unit variable cost.

Contribution margin ratio = Contribution margin per unit

Selling price per unit

$180 - $126 $54

$180 $180

30%

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ACCT 650 30
 Sales Mix and Break-Even

The CVP formulas can be modified for use when a company sells more than one
product.
 The unit contribution margin is replaced with the 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.

Break-even point Fixed costs

= Contribution margin
in composite units
per composite unit

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ACCT 650 31
 Sales Mix and Break-Even

Hair-Today offers three cuts as shown below. Annual fixed

costs are $192,000. Compute the break-even point in
composite units and in number of units for each haircut at the
given sales mix.

Haircuts
Basic Ultra Budget
Selling Price $ 20.00 $ 32.00 $ 16.00
Variable Cost 13.00 18.00 8.00
Unit Contribution $ 7.00 $ 14.00 $ 8.00
Sales Mix Ratio 4 2 1

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ACCT 650 32
 Sales Mix and Break-Even

Haircuts
Basic Ultra Budget
Selling Price $ 20.00 $ 32.00 $ 16.00
Sales Mix Ratio 4.00 2.00 1.00
Selling Price/cut $ 80.00 $ 64.00 $ 16.00
Total Selling Price/Composite Unit $ 160.00

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ACCT 650 33
 Sales Mix and Break-Even
Haircuts
Basic Ultra Budget
Variable Costs $ 13.00 $ 18.00 $ 8.00
Sales Mix Ratio 4.00 2.00 1.00
Selling Price/cut $ 52.00 $ 36.00 $ 8.00
Total Variable Cost/Composite Unit $ 96.00

Exhibit
5.28

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ACCT 650 34
 Computing a Multiproduct
Break-Even Point

Exhibit
5.29

Break-even point Fixed costs

= Contribution margin
in composite units
per composite unit

Break-even point $192,000

= $64.00 per
in composite units
composite unit
Break-even point = 3,000 composite units
in composite units
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ACCT 650 35
 Computing a Multiproduct
Break-Even Point

Sales Composite
Product Mix Cuts Haircuts
Basic 4 × 3,000 = 12,000
Ultra 2 × 3,000 = 6,000
Budget 1 × 3,000 = 3,000
7 x 3,000 21,000

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ACCT 650 36
 Multiproduct Break-Even
Income Statement
Exhibit
5.30

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ACCT 650 37
 NEED-TO-KNOW 5-5
The sales mix of a company’s two products, X and Y, is 2:1. Unit variable costs for both products
are $2, and unit selling prices are $5 for X and $4 for Y. The company has $640,000 of fixed costs.
1. What is the contribution margin per composite unit? $8
2. What is the break-even point in composite units? 80,000 composite units
3. How many units of X and how many units of Y will be sold at the break-even point?
Units of each product at break-even Total
Product X 80,000 composite units x 2 units per composite unit 160,000
Product Y 80,000 composite units x 1 unit per composite unit 80,000
240,000

Total Sales Units per unit Total

Product X 160,000 $5 $800,000
Product Y 80,000 $4 320,000
Total 240,000 $1,120,000

Total Variable Costs Units per unit Total

Product X 160,000 $2 $320,000
Product Y 80,000 $2 160,000
Total 240,000 $480,000

Composite units per unit Total

Sales 80,000 $14 $1,120,000
Variable costs 80,000 $6 480,000
Contribution margin $8 640,000
Fixed costs 640,000
Net income $0
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ACCT 650 38
 Assumptions in Cost-Volume-Profit Analysis

CVP analysis relies on several assumptions:

Costs can be classified as variable or fixed
Costs are linear within the relevant range
All units produced are sold
Sales mix is constant

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ACCT 650 39
 Degree of Operating Leverage

A measure of the extent to which fixed costs are being used in an organization.

A measure of how a percentage change in

sales will affect profits.

Exhibit
5.32

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ACCT 650 40
 Operating Leverage
Rydell Company
Sales (1,200 units) $120,000
Less: variable expenses 84,000
Contribution margin 36,000
Less: fixed expenses 24,000
Pretax income $ 12,000

Exhibit
5.32

If Rydell increases sales by 10 percent, what will the

percentage increase in income be?

Exhibit
5.33
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ACCT 650 41