CVP Analysis

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©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2-2
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 Variable and Fixed Cost Behavior

A variable cost A fixed cost is

changes in direct not immediately
proportion to changes affected by changes
in the cost-
cost-driver level. in the cost-driver..
cost-driver

Think of variable Think of fixed costs

costs on a per-
per-unit basis. on a total-
total-cost basis.

The per-
per-unit variable
Total fixed costs remain
cost remains unchanged
unchanged regardless of
regardless of changes in
changes in the cost-
cost-driver.
the cost-
cost-driver.
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 CVP Scenario

Cost-volume-profit (CVP) analysis is the study of the

effects of output volume on revenue (sales), expenses
(costs), and net income (net profit).

Per Unit Percentage of

Sales
Selling price $1.50 100%
Variable cost of each item 1.20 80
Selling price less variable cost $ .30 20%

Monthly fixed expenses:

Rent $3,000
Wages for replenishing and
servicing 13,500
Other fixed expenses 1,500
Total fixed expenses per month $18,000

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 Break-Even Point

The break-even point is the level of sales at which

revenue equals expenses and net income is zero.

Sales
- Variable expenses
- Fixed expenses
Zero net income (break-even point)

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 Contribution Margin Method

Contribution margin Contribution margin ratio

Per Unit Per Unit %
Selling price $1.50 Selling price 100
Variable costs 1.20 Variable costs 80
Contribution margin$ .30 Contribution margin 20

$18,000 fixed costs ÷ $.30

= 60,000 units (break even)

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 Contribution Margin Method

60,000 units × $1.50 (Sales Price) = $90,000

in sales to break even

$18,000 fixed costs

÷ 20% (contribution-margin percentage)
= $90,000 of sales to break even

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 Equation Method

Let N = number of units

to be sold to break even.

Variable Fixed
Sales – Expenses – Expenses = net income
$1.50N – $1.20N – $18,000 = 0
$.30N = $18,000
N = $18,000 ÷ $.30
N = 60,000 Units

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 Equation Method

Let S = sales in dollars

needed to break even.

S – .80S – $18,000 = 0
.20S = $18,000
S = $18,000 ÷ .20
S = $90,000

Shortcut formulas:
Break-even = fixed expenses = $18,000 = 60,000
volume in units unit contribution margin .30

Break-even = fixed expenses = $18,000 = $90,000

volume in sales contribution margin ratio .2

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 Cost-Volume-Profit Graph

$150,000 A
Net Income
138,000 Sales C
120,000 Net Income Area
Dollars

D
90,000 Variable
Total Break-
Break-Even Point Expenses
60,000 Expenses 60,000 units
Net Loss
30,000 or $90,000
Area
18,000 B
Fixed Expenses
0 10 20 30 40 50 60 70 80 90 100

Units (thousands)

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 Target Net Profit

Managers use CVP analysis

to determine the total sales,
in units and dollars, needed
to reach a target net profit.

Target sales
– variable expenses $1,440 per month
– fixed expenses is the minimum
target net income acceptable net income.

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 Target Net Profit

Target sales volume in units =

(Fixed expenses + Target net income)
÷ Contribution margin per unit

Selling price $1.50

Variable costs 1.20
Contribution margin per unit $ .30

($18,000 + $1,440) ÷ $.30 = 64,800 units

Target sales dollars = sales price X sales volume in units

Target sales dollars = $1.50 X 64,800 units = $97,200.

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 Target Net Profit

Contribution margin ratio

Per Unit %
Selling price 100
Variable costs 80
Contribution margin 20

Target sales volume in dollars =

Fixed expenses + target net income
contribution margin ratio
Sales volume in dollars =
18,000 + $1,440 = $97,200
.20

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 Operating Leverage

Operating leverage:
a firm’s ratio of fixed costs to variable costs.

Highly leveraged firms have high fixed costs

and low variable costs. A small change in sales
volume = a large change in net income.

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 Operating Leverage

Low leveraged firms have lower fixed costs

and higher variable costs.
Changes in sales volume will have a
smaller effect on net income.

Margin of safety = planned unit sales –

break-even sales. How far can sales fall
below the planned level before losses occur?

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 Contribution Margin
and Gross Margin

Sales price – Cost of goods sold = Gross margin

Sales price - all variable expenses =

Contribution margin

Per Unit
Selling price $1.50
Variable costs (acquisition cost) 1.20
Contribution margin and
gross margin are equal $ .30

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 Contribution Margin and Gross Margin

Suppose the firm paid a commission of $.12 per unit sold.

Contribution Gross
Margin Margin
Per Unit Per Unit
Sales $1.50 $1.50
Acquisition cost of unit sold 1.20 1.20
Variable commission .12
Total variable expense $1.32
Contribution margin .18
Gross margin $.30
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 Sales Mix Analysis

Sales mix is the relative proportions or

combinations of quantities of products
that comprise total sales.

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 Sales Mix Analysis

Ramos Company Example

Wallets Key Cases
(W) (K) Total

Sales in units 300,000 75,000 375,000

Sales @ $8 and $5 $2,400,000 $375,000 $2,775,000
Variable expenses
@ $7 and $3 2,100,000 225,000 2,325,000
Contribution margins
@ $1 and $2 $ 300,000 $150,000 $ 450,000
Fixed expenses 180,000
Net income $ 270,000

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 Sales Mix Analysis

Let K = number of units of K to break even, and

4K = number of units of W to break even.

Break-even point for a constant sales mix

of 4 units of W for every unit of K.
sales – variable – fixed = zero net income
expense expenses
[$8(4K) + $5(K)] – [$7(4K) + $3(K)] – $180,000 = 0
32K + 5K - 28K - 3K - 180,000 = 0
6K = 180,000
K = 30,000
W = 4K = 120,000
30,000K + 120,000W = 150,000 units.

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 Sales Mix Analysis

If the company sells only key cases:

break-even point = fixed expenses
contribution margin per unit
= $180,000
$2
= 90,000 key cases

If the company sells only wallets:

break-even point = fixed expenses
contribution margin per unit
= $180,000
$1
= 180,000 wallets

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 Sales Mix Analysis

Suppose total sales

were equal to the
budget of 375,000 units.

However, Ramos sold

only 50,000 key cases
And 325,000 wallets.
What is net income?

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 Sales Mix Analysis

Ramos Company Example

Wallets Key Cases
(W) (K) Total

Sales in units 325,000 50,000 375,000

Sales @ $8 and $5 $2,600,000 $250,000 $2,850,000
Variable expenses
@ $7 and $3 2,275,000 150,000 2,425,000
Contribution margins
@ $1 and $2 $ 325,000 $100,000 $ 425,000
Fixed expenses 180,000
Net income $ 245,000

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 Nonprofit Application

Suppose a city has a $100,000

lump-sum budget appropriation
to conduct a counseling program.

Variable costs per prescription

are $400 per patient per day.

Fixed costs are $60,000 in the

relevant range of 50 to 150 patients.

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 Nonprofit Application

If the city spends the entire budget

appropriation, how many patients
can it serve in a year?

Variable + Fixed
Sales = expenses + expenses
$100,000 = $400N + $60,000
$400N = $100,000 – $60,000
N = $40,000 ÷ $400
N = 100 patients

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 Nonprofit Application

If the city cuts the total budget appropriation by

10%, how many Patients can it serve in a year?

Budget after 10% Cut

$100,000 X (1 - .1) = $90,000

Variable + Fixed
Sales = expenses + expenses
$90,000 = $400N + $60,000
$400N = $90,000 – $60,000
N = $30,000 ÷ $400
N = 75 patients
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