H1 H2

Chapter 7

Cost-Volume-Profit
Analysis

McGraw-Hill/Irwin Copyright © 2014 The McGraw-Hill Companies, Inc. All rights reserved.
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H2 CHAPTER 1 CORRECTIONS REQUIRED

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Learning Objective 7-1 – Compute a break-even
point using the contribution-margin approach and
the equation approach.

7-2
 The Break-Even Point
The break-even point is the point in the volume of
activity where the organization’s revenues
and expenses are equal.

Sales $ 250,000
Less: variable expenses 150,000
Contribution margin 100,000
Less: fixed expenses 100,000
Net income $ -

7-3
 Equation Approach
Sales revenue – Variable expenses – Fixed expenses = Profit

Unit Sales Unit Sales

sales × volume variable × volume
price in units expense in units

($500 × X) – ($300 × X) – $80,000 = $0

($200X) – $80,000 = $0
X = 400 surf boards
7-4
Learning Objective 7-2 – Compute the
contribution-margin ratio and use it to find the
break-even point in sales dollars.

7-5
H3

Contribution-Margin Approach
Consider the following information
developed by the accountant at Curl, Inc.:
For each additional surf board sold, Curl
generates $200 in contribution margin.

Total Per Unit Percent

Sales (500 surf boards) $250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $100,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ 20,000

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 Contribution-Margin Approach
Fixed expenses Break-even point
=
Unit contribution margin (in units)

Total P e r U n it P ercent
S a le s ( 5 0 0 s u r f b o a r d s ) $ 2 5 0 ,0 0 0 $ 500 100%
L e s s : v a r ia b le e x p e n s e s 1 5 0 ,0 0 0 300 60%
C o n t r ib u t io n m a r g in $ 1 0 0 ,0 0 0 $ 200 40%
L e s s : fix e d e x p e n s e s 8 0 ,0 0 0
N e t in c o m e $ 2 0 ,0 0 0

$80,000
= 400 surf boards
$200
7-7
 Contribution-Margin Approach

Here is the proof!

Total Per Unit Percent

Sales (400 surf boards) $200,000 $ 500 100%
Less: variable expenses 120,000 300 60%
Contribution margin $ 80,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ -

400 × $500 = $200,000 400 × $300 = $120,000

7-8
 Contribution Margin Ratio

Calculate the break-even point in sales dollars

rather than units by using the contribution
margin ratio.
Contribution margin
= CM Ratio
Sales

Fixed expense Break-even point

=
CM Ratio (in sales dollars)
7-9
 Contribution Margin Ratio

Total Per Unit Percent

Sales (400 surf boards) $200,000 $ 500 100%
Less: variable expenses 120,000 300 60%
Contribution margin $ 80,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ -

$80,000
= $200,000 in sales
40%
7-10
Learning Objective 7-3 – Prepare a cost-
volume-profit (CVP) graph and explain how it is
used.

7-11
Graphing Cost-Volume-Profit Relationships
Viewing CVP relationships in a graph gives managers a
perspective that can be obtained in no other way.
Consider the following information for Curl, Inc.:

300 units 400 units 500 units

Sales $ 150,000 $ 200,000 $ 250,000
Less: variable expenses 90,000 120,000 150,000
Contribution margin $ 60,000 $ 80,000 $ 100,000
Less: fixed expenses 80,000 80,000 80,000
Net income (loss) $ (20,000) $ - $ 20,000

7-12
 Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000

250,000
Dollars

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

7-13
 Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000

250,000
Dollars

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

7-14
 Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000

250,000
Dollars

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

7-15
 Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000

250,000
Dollars

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

7-16
 Cost-Volume-Profit Graph
450,000

400,000

350,000
Break-even
300,000
point
250,000
Dollars

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

7-17
 Profit-Volume Graph
Some managers like the profit-volume
graph because it focuses on profits and volume.

100,000

80,000

60,000
Break-even
40,000 point
20,000
Profit

(20,000) 100 200 300 400 500 600 700

Units
(40,000)

(60,000)

7-18
Learning Objective 7-4 – Apply CVP analysis to determine
the effect on profit of changes in fixed expenses, variable expenses,
sales prices, and sales volume.

7-19
 Target Net Profit

We can determine the number of surfboards that Curl must

sell to earn a profit of $100,000 using the contribution
margin approach.

Fixed expenses + Target profit Units sold to earn

=
Unit contribution margin the target profit

$80,000 + $100,000
= 900 surf boards
$200

7-20
H4

Equation Approach

Sales revenue – Variable expenses – Fixed expenses = Profit

($500 × X) – ($300 × X) – $80,000 = $100,000

($200X) = $180,000

X = 900 surf boards

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 Applying CVP Analysis

Safety Margin
 The difference between budgeted sales
revenue and break-even sales revenue.
 The amount by which sales can drop before
losses occur.

7-22
H5

Safety Margin
Curl, Inc. has a break-even point of
$200,000 in sales. If actual sales are
$250,000, the safety margin is $50,000,
or 100 surf boards.
Break-even
sales Actual sales
400 units 500 units
Sales $ 200,000 $ 250,000
Less: variable expenses 120,000 150,000
Contribution margin 80,000 100,000
Less: fixed expenses 80,000 80,000
Net income $ - $ 20,000

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H6

Changes in Fixed Costs

 Curl is currently selling 500 surfboards per year.

 The owner believes that an increase of $10,000 in
the annual advertising budget, would increase
sales to 540 units.

Should the company increase the advertising

budget?
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 Changes in Fixed Costs
Current Proposed
Sales Sales
(500 Boards) (540 Boards)
Sales $ 250,000 $ 270,000
Less: variable expenses 150,000 162,000
Contribution margin $ 100,000 $ 108,000
Less: fixed expenses 80,000 90,000
Net income $ 20,000 $ 18,000

540 units × $500 per unit = $270,000

$80,000 + $10,000 advertising = $90,000

7-25
 Changes in Fixed Costs
Current Proposed
Sales will increase by Sales Sales
$20,000, but net income (500 Boards) (540 Boards)
decreased
Sales by $2,000. $ 250,000 $ 270,000
Less: variable expenses 150,000 162,000
Contribution margin $ 100,000 $ 108,000
Less: fixed expenses 80,000 90,000
Net income $ 20,000 $ 18,000

7-26
 Changes in Unit
Contribution Margin

Because of increases in cost of raw materials, Curl’s

variable cost per unit has increased from $300 to $310
per surfboard. With no change in selling price per
unit, what will be the new break-even point?

($500 × X) – ($310 × X) – $80,000 = $0

X = 422 units (rounded)

7-27
 Changes in Unit
Contribution Margin

Suppose Curl, Inc. increases the price of each surfboard to

$550. With no change in variable cost per unit, what will
be the new break-even point?

($550 × X) – ($300 × X) – $80,000 = $0

X = 320 units
7-28
 Predicting Profit Given Expected Volume

Fixed expenses
Given: Unit contribution margin Find: {req’d sales volume}
Target net profit

Fixed expenses
Given: Unit contribution margin Find: {expected profit}
Expected sales volume

7-29
 Predicting Profit Given
Expected Volume
In the coming year, Curl’s owner expects to sell 525
surfboards. The unit contribution margin is expected to
be $190, and fixed costs are expected to increase to
$90,000.

Total contribution - Fixed cost = Profit

($190 × 525) – $90,000 = X

X = $99,750 – $90,000
X = $9,750 profit 7-30
Learning Objective 7-5 – Compute the break-
even point and prepare a profit-volume graph for a
multiproduct enterprise.

7-31
H7

CVP Analysis with Multiple Products

For a company with more than one product, sales mix is
the relative combination in which a company’s
products are sold.

Different products have different selling prices, cost

structures, and contribution margins.

Let’s assume Curl sells surfboards and sailboards and see

how we deal with break-even analysis.
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CVP Analysis with Multiple Products
Curl provides us with the following: information:
Unit Unit Number
Selling Variable Contribution of
Description Price Cost Margin Boards
Surfboards $ 500 $ 300 $ 200 500
Sailboards 1,000 450 550 300
Total sold 800

Number % of
Description of Boards Total
Surfboards 500 62.5% (500 ÷ 800)
Sailboards 300 37.5% (300 ÷ 800)
Total sold 800 100.0%
7-33
CVP Analysis with Multiple Products
Weighted-average unit contribution margin

Contribution Weighted
Description Margin % of Total Contribution
Surfboards $ 200 62.5% $ 125.00
Sailboards 550 37.5% 206.25
Weighted-average contribution margin $ 331.25

$200 × 62.5%

$550 × 37.5%
7-34
CVP Analysis with Multiple Products

Break-even point
Break-even Fixed expenses
=
point Weighted-average unit contribution margin

Break-even $170,000
=
point $331.25

Break-even
= 514 combined unit sales
point

7-35
CVP Analysis with Multiple Products

Break-even point
Break-even 514 combined unit sales
=
point

Breakeven % of Individual
Description Sales Total Sales
Surfboards 514 62.5% 321
Sailboards 514 37.5% 193
Total units 514

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Learning Objective 7-6 – List and discuss the
key assumptions of CVP analysis.

7-37
H8

Assumptions Underlying
CVP Analysis
1. Selling price is constant throughout the
entire relevant range.
2. Costs are linear over the relevant range.
3. In multi-product companies, the sales
mix is constant.
4. In manufacturing firms, inventories do
not change (units produced = units sold).

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Learning Objective 7-7 – Prepare and interpret
a contribution income statement.

7-39
 CVP Relationships and the
Income Statement

A. Traditional Format
ACCUTIME COMPANY
Income Statement
For the Year Ended December 31, 20x1

Sales $500,000
Less: 380,000
Gross margin $120,000
Less: Operating expenses:
Selling expenses $35,000
Administrative expenses 35,000 70,000
Net income $50,000

7-40
 CVP Relationships and the
Income Statement
B. Contribution Format
ACCUTIME COMPANY
Income Statement
For the Year Ended December 31, 20x1

Sales $500,000
Less: Variable expenses:
Variable manufacturing $280,000
Variable selling 15,000
Variable administrative 5,000 300,000
Contribution margin $200,000
Less: Fixed expenses:
Fixed manufacturing $100,000
Fixed selling 20,000
Fixed administrative 30,000 150,000
Net income $50,000
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Learning Objective 7-8 – Explain the role of
cost structure and operating leverage in CVP
relationships.

7-42
Cost Structure and Operating Leverage
 The cost structure of an organization is the relative
proportion of its fixed and variable costs.

 Operating leverage is:

 the extent to which an organization uses fixed costs
in its cost structure.
 greatest in companies that have a high proportion of
fixed costs in relation to variable costs.

7-43
Measuring Operating Leverage
Operating leverage Contribution margin
=
factor Net income
Actual sales
500 Board
Sales $ 250,000
Less: variable expenses 150,000
Contribution margin 100,000
Less: fixed expenses 80,000
Net income $ 20,000

$100,000
= 5
$20,000 7-44
 Measuring Operating Leverage
A measure of how a percentage change in sales
will affect profits. If Curl increases its sales by
10%, what will be the percentage increase in
net income?

Percent increase in sales 10%

Operating leverage factor × 5
Percent increase in profits 50%

7-45
 Measuring Operating Leverage

A firm with proportionately high fixed costs has

relatively high operating leverage. On the other
hand, a firm with high operating leverage has a
relatively high break-even point.
7-46
Learning Objective 7-9 – Understand the
implications of activity-based costing for CVP
analysis.

7-47
 CVP Analysis, Activity-Based Costing, and
Advanced Manufacturing Systems
An activity-based costing system provides a much
more complete picture of cost-volume-profit
relationships and, thus, it provides better
information to managers.
Break-even = Fixed costs
point Unit contribution margin

7-48
Learning Objective 7-10 – Be aware of the
effects of advanced manufacturing technology on
CVP relationships.

7-49
 A Move Toward JIT and
Flexible Manufacturing
Overhead costs like setup, inspection, and
material handling are fixed with respect to sales
volume, but they are not fixed with respect to
other cost drivers.

This is the fundamental distinction between a

traditional CVP analysis and an activity-based
costing CVP analysis.
7-50
Learning Objective 7-11 – Understand the
effect of income taxes on CVP analysis (appendix).

7-51
Effect of Income Taxes
Income taxes affect a company’s
CVP relationships. To earn a
particular after-tax net income, a
greater before-tax income will be
required.

Target after-tax net income Before-tax

=
1 - t net income

7-52
End of Chapter 7

7-53