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CHAPTER 3

Cost-Volume-Profit
(CVP)
Analysis

3-2 . All rights reserved. by Horngren/Datar/Foster.Basic Assumptions  Changes in production/sales volume are the sole cause for cost and revenue changes  Total costs consist of fixed costs and variable costs  Revenue and costs behave and can be graphed as a linear function (a straight line) To accompany Cost Accounting 12e. Copyright © 2006 by Pearson Education.

variable cost per unit. and fixed costs are all known and constant  In many cases only a single product will be analyzed. All rights reserved. their relative sales proportions are known and constant  The time value of money (interest) is ignored To accompany Cost Accounting 12e. 3-3 . continued  Selling price. Copyright © 2006 by Pearson Education. If multiple products are studied. by Horngren/Datar/Foster.Basic Assumptions.

All rights reserved. 3-4 . Copyright © 2006 by Pearson Education.Basic Formulae Operating Income = Net Income Total Revenues from Operations = Operating Income Cost of Goods Sold Pretax Operating Expenses Income Taxes To accompany Cost Accounting 12e. by Horngren/Datar/Foster.

Copyright © 2006 by Pearson Education. 3-5 . All rights reserved.Contribution Margin  Contribution Margin equals sales less variable costs  CM = S – VC  Contribution Margin per unit equals unit selling price less variable cost per unit  CMu = SP – VCu To accompany Cost Accounting 12e. by Horngren/Datar/Foster.

All rights reserved. Copyright © 2006 by Pearson Education.Contribution Margin  Contribution Margin also equals contribution margin per unit multiplied by the number of units sold  CM = CMu x Q  Contribution Margin Ratio (percentage) equals contribution margin per unit divided by selling price  CMR = CMu ÷ SP To accompany Cost Accounting 12e. 3-6 . by Horngren/Datar/Foster.

Copyright © 2006 by Pearson Education. it will be used again in a moment To accompany Cost Accounting 12e. by Horngren/Datar/Foster.Contribution Margin Income Statement Derivations  A horizontal presentation of the Contribution Margin Income Statement:  Sales – VC – FC = Operating Income (OI)  (SP x Q) – (VCu x Q) – FC = OI  Q (SP – VCu) – FC = OI  Q (CMu) – FC = OI  Remember this last equation. 3-7 . All rights reserved.

000 y Operating income Total revenues line $8. Copyright © 2006 by Pearson Education. by Horngren/Datar/Foster.000 $5. All rights reserved.CVP.000 Breakeven point = 25 units Operating income area Dollars $6.000 Total costs line $2. 3-8 .000 Total costs line Variable costs Breakeven point = 25 units $4.000 Operating loss area Operating loss area x 10 20 25 30 40 Fixed costs 50 Units Sold To accompany Cost Accounting 12e. Graphically $10.

a firm has no profit or loss at a given sales level To accompany Cost Accounting 12e. All rights reserved. Copyright © 2006 by Pearson Education. 3-9 . and setting OI to zero will result in the Breakeven Point (quantity):  BEQ = FC ÷ CMu  At this point. by Horngren/Datar/Foster.Breakeven Point  Recall the last equation in an earlier slide:  Q (CMu) – FC = OI  A simple manipulation of this formula.

by Horngren/Datar/Foster. continued  If per-unit values are not available. All rights reserved.Breakeven Point. the Breakeven Point may be restated in its alternate format:  BE Sales = FC ÷ CMR To accompany Cost Accounting 12e. Copyright © 2006 by Pearson Education. 3-10 .

All rights reserved. the Breakeven Point formula can be modified to become a Profit Planning tool   Profit is now reinstated to the BE formula. changing it to a simple sales volume equation Q = (FC + OI) CM To accompany Cost Accounting 12e. Copyright © 2006 by Pearson Education. extended: Profit Planning  With a simple adjustment. by Horngren/Datar/Foster.Breakeven Point. 3-11 .

All rights reserved. Copyright © 2006 by Pearson Education. 3-12 . by Horngren/Datar/Foster.CVP and Income Taxes  From time to time it is necessary to move back and forth between pre-tax profit (OI) and after-tax profit (NI). depending on the facts presented  After-tax profit can be calculated by:  OI x (1-Tax Rate) = NI  NI can substitute into the profit planning equation through this form:  OI = I I NI I (1-Tax Rate) To accompany Cost Accounting 12e.

Sensitivity Analysis  CVP provides structure to answer a variety of “what-if” scenarios  “What” happens to profit “if”:    Selling price changes Volume changes Cost structure changes   Variable cost per unit changes Fixed cost changes To accompany Cost Accounting 12e. 3-13 . Copyright © 2006 by Pearson Education. by Horngren/Datar/Foster. All rights reserved.

3-14 . All rights reserved. and expresses itself in the form of a percentage:  MOS Ratio = MOS ÷ Budgeted Sales To accompany Cost Accounting 12e. the Margin of Safety (MOS) measures the distance between budgeted sales and breakeven sales:  MOS = Budgeted Sales – BE Sales  The MOS Ratio removes the firm’s size from the output. by Horngren/Datar/Foster.Margin of Safety  One indicator of risk. Copyright © 2006 by Pearson Education.

by Horngren/Datar/Foster. except for fixed costs To accompany Cost Accounting 12e. 3-15 . expressed as changes in contribution margin   OL = Contribution Margin Operating Income Notice these two items are identical. Copyright © 2006 by Pearson Education. All rights reserved.Operating Leverage  Operating Leverage (OL) is the effect that fixed costs have on changes in operating income as changes occur in units sold.

Effects of Sales-Mix on CVP  The formulae presented to this point have assumed a single product is produced and sold  A more realistic scenario involves multiple products sold. in different volumes. only two products will be presented. with different costs  For simplicity’s sake. All rights reserved. by Horngren/Datar/Foster. 3-16 . Copyright © 2006 by Pearson Education. but this could easily be extended to even more products To accompany Cost Accounting 12e.

Copyright © 2006 by Pearson Education. by Horngren/Datar/Foster. 3-17 .Effects of Sales-Mix on CVP  A weighted-average CM must be calculated (in this case. for two products) Weighted ( Product #1 CMu x Product #1 Q ) + ( Product #2 CMu x Product #2 Q ) Average = CMu Total Units Sold (Q) for Both Products  This new CM would be used in CVP equations Multi- Fixed Costs Product = Weighted Average CM per unit BE To accompany Cost Accounting 12e. All rights reserved.

by Horngren/Datar/Foster.Multiple Cost Drivers  Variable costs may arise from multiple cost drivers or activities. 3-18 . All rights reserved. Examples include:     Customer or patient count Passenger miles Patient days Student credit-hours To accompany Cost Accounting 12e. Copyright © 2006 by Pearson Education. A separate variable cost needs to be calculated for each driver.

Contribution Margin vs. 80 65 $15 3-19 . Copyright © 2006 by Pearson Education. Gross Profit Comparative Statements Contribution Margin Income Statement (Internal-Use Only) Revenues: Less: Variable Cost of Goods Sold Variable Operating Costs Contribution Margin Fixed Operating Costs Operating Income Financial Accounting Income Statement GAAP . All rights reserved. by Horngren/Datar/Foster.Based $200 $120 45 165 35 20 $15 Revenues: Less: Cost of Goods Sold $200 $120 Gross Margin (Profit) Fixed & Variable Operating Costs Operating Income To accompany Cost Accounting 12e.