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Chapter 3

Cost
Volume
Profit
Analysis

SYNOPSIS
This chapter presents the cost-volume-profit (CVP) analysis model
and illustrates how managers use that model to help answer
important what-if business questions.
CVP analysis also helps management accountants alert managers to
the risks and rewards of decisions they are considering by
illustrating how the bottom-line is affected by changes in activity
levels or key pricing or cost components.
CVP analysis is based on several assumptions, one of which is that
fixed costs can be distinguished from variable costs.
However, whether a cost is variable or fixed depends on the time
period for the decision and also the range of activity (relevant
range) being considered.
We also look at a method for applying CVP analysis to companies
with multiple products and to situations where there is more than
one cost driver.
The applicability of CVP to manufacturers, service organizations,
and nonprofits is discussed.
Contribution margin is also defined and distinguished from gross
margin

Management
accounting
information
helps
managers
perform each
of these
functions
more
effectively.

Process of
Management
Strategy
Formulation

The process
of
management
involves
formulating
strategy,
planning,
control,
decision
making and
directing
operational
activities.

Planning

Managers need cost information to


perform each of these functions.

Directing

Control
Decision
Making

2-3

Calculating the cost of products,


services, and other cost objects
Obtaining information for
planning & control, and
performance evaluation

Analyzing the relevant


information for making decisions

Basis of
classification :
Direct costs can be conveniently and
(CAS 1)

economically traced (tracked) to a cost object


i)
ii)
iii)
iv)
v)
vi)
vii)

Nature of
expenses
Relation to
object traceability
Functions/acti
vities
Behaviour
Management
decision
making
Production
process
Time period

Indirect costs cannot be conveniently or


economically traced (tracked) to a cost object.
Instead of being traced, these costs are
allocated to a cost object in a rational and
systematic manner
Whether a cost is a direct cost or an indirect
cost of a department often depends on which
department is under consideration.
A cost can be a direct cost of one department
or subunit in the organization but an indirect
cost of other departments.

Basis of classification
: (CAS 1)
i)
ii)

iii)
iv)

v)
vi)
vii)

Nature of
expenses
Relation to
object traceability
Functions/acti
vities
Behaviour fixed, semivariable or
variable
Management
decision
making
Production
process
Time period

When management examine the relationship of


various costs to the activities performed.
It is referred to as cost behavior.
Costs are classified into two types of cost behavior:
variable and fixed costs.

A variable cost changes in total in direct


proportion to a change in the level of activity (or
cost driver). It varies directly with the output. So,
these are also known as direct costs
A fixed cost remains unchanged in total as the level
of activity (or cost driver) varies. Also known as
period cost

Your total cable pay-perview bill is based on how


many movies you watch.

The cost per movie


watched is constant.
For example, $4.00
per movie.

Pay-Per-View
Movies Watched

Per Movie Charge

Variable Cost Per Unit

Total Pay-Per-View Bill

Total Variable Cost

Movies
Watched

2-7

Total Fixed Cost

The average cost per HBO


movie decreases as more
HBO movies are
watched.

Monthly Charge for HBO


Bill

Monthly HBO Bill per Movie


Watched

Your monthly cable bill probably does


not change when you watch movies
on channels that you have elected to
be paid on a monthly basis (HBO).

Fixed Cost Per Unit

Number of HBO Movies


Watched

Number of HBO
Movies Watched
2-8

Introduction
Till now we allocated all manufacturing costs
to products regardless of whether they are
fixed or variable. This approach is known as
absorption costing/full costing
However, now, we will use only variable costs
which are relevant to decision-making (why?).
This is known as marginal costing/variable
costing
9

So, in Marginal costing, The costs that vary


with a decision should only be included in
decision analysis.
This is wrt short term, so, For many decisions
that involve relatively small variations from
existing practice and/or are for relatively
limited periods of time, fixed costs are not
relevant to the decision.
This is because either fixed costs tend to be
impossible to alter in the short term or
managers are reluctant to alter them in the
short term.

Since fixed costs are not included in product costs, it


becomes easy to find out directly the effect on
profit due to change in volume or type of output
Also commonly known as direct costing, variable
costing
The term Cost-Volume-Profit (CVP ) analysis is also
frequently used in this context.
CVP analysis examines the behaviour of total
revenues, total costs and operating income as
changes occur in the output level, selling price, the
variable cost per unit or the fixed cost of a product.

BE Analysis
Or,
CVP analysis refers to the study of the effects on
future profits of changes in fixed cost, variable cost,
sales price, quantity and mix.
The analysis provides solutions to various alternative
business plans
Cost-volume profit analysis is also known as
Breakeven analysis and is used for decision making
Therefore, Breakeven analysis is the study of the
relationship between selling prices, sales volumes,
fixed costs, variable costs and profits at various levels
of activity

Theory of Marginal Costing


As set out by CIMA London.
In relation to a given volume of output, additional output
can normally be obtained at less than proportionate cost
because within limits, the aggregate of certain items of cost
will tend to remain fixed and only the aggregate of the
remainder will tend to rise proportionately with an increase
in output.
Conversely, a decrease in the volume of output will normally
be accompanied by less than proportionate fall in the
aggregate cost.

Simple Steps to Understand the above


theory

If the volume of output increases, the cost per


unit in normal circumstances reduces.
Conversely, if an output reduces, the cost per
unit increases.
Eg: If a factory produces 1000 units at a total cost
of Rs.3,000 and if by increasing the output by
one unit the cost goes up to Rs.3,002, the
marginal cost of additional output will be Rs.2.
(3002-3000)

Continue.

If an increase in output is more than one, the total


increase in cost divided by the total increase in output
will give the average marginal cost per unit.
Eg: The output is increased to 1020 units from 1000 units
and the total cost to produce these units is Rs.1,045, the
average marginal cost per unit is Rs.2.25.
(i.e. Additional cost/Additional units=45/20=Rs.2.25)

Assumption of Marginal costing or CVP analysis:


All costs can be classified into two categories- fixed and variable.
Fixed costs remain constant at all level of activity
Prices of variable cost factors remain unchanged ie. it is constant per unit,
so that variable cost are truly variable ie. Variable costs vary in total
Semi variable/semi fixed cost can be segregated into variable and fixed
elements
Operating efficiency will remain uniform
Product specifications and method of manufacturing and selling will not
change, product mix will not change, product risk remains unchanged
Pricing policy remains unchanged even under different volume,
competitions ie. Selling price remains unchanged at different level of
activity
The number of unit of sales will coincide with the units produced, so that
there is no opening/closing stock. Alternatively, the changes in opening and
closing stocks are insignificant and that they are valued at the same prices
or at variable cost

Marginal cost:
It is the additional cost of producing an additional unit of a product.
Defined as: the amount at any given volume of output by which
aggregate costs are changed if the volume of output is increased or
decreased by one unit. Thus, it is measured by the total variable cost
attributable to one unit
DL are included in marginal
cost on the assumption that
they are variable. If not, they
should be excluded
It has to be understood that
all variable costs are
generally direct costs but all
direct costs need not be
variable
In India Direct labour cost
are generally treated as
fixed, only casual labour are
treated as variable

Absorption Costing

Variable + Fixed divided into


sold & unsold

Cost
Manufacturing cost

Direct
Materials

Direct
Labour

Finished goods

Non-manufacturing cost

Overheads

Period cost

Unsold is
added to
stock

Profit and loss account

Cost of goods sold

Variable into sold & unsold

Marginal Costing
Cost
Manufacturing cost

Direct
Materials

Direct
Labour

Finished goods

Non-manufacturing cost
Variable
Overheads

Fixed
overhead

Cost of goods sold

Period cost

Unsold is
added to
stock

Profit and loss account


18

Therefore, Marginal cost = Prime cost + total variable cost

or total cost fixed cost


Marginal Costing: defined as the ascertainment of marginal cost and
of the effect on profit of changes in volume or type of output by
differentiating between fixed costs and variable costs.
Features:
1. Cost classification: The marginal costing technique makes a sharp
distinction between variable costs and fixed costs.
It is the variable cost on the basis of which production and sales policies
are designed by a firm following the marginal costing technique.
In other words, marginal costing is a technique of control or decision
making.
Under marginal costing the total cost is classified as fixed and variable
cost. Fixed costs are treated as period cost and charged to profit and
loss a/c for the period for which they are incurred. The variable costs
are regarded as the costs of the products

Features (contd):
2. Stock/Inventory Valuation : Under marginal costing, inventory/stock for
profit measurement is valued at marginal cost. It is in sharp contrast to the
total unit cost under absorption costing method.
3. Marginal Contribution: Marginal costing technique makes use of marginal
contribution for marking various decisions. Marginal contribution is the
difference between sales and marginal cost. It forms the basis for judging
the profitability of different products or departments.
4. Prices are determined on the basis of marginal cost
Advantages of marginal costing:
Simple, less confusing and less complicated
Stock valuation--Under this technique net profit is not effected by the
changes in production level or changes in stock volume; in fact profit is
directly related to sales.
Meaningful reporting--Reports based on this technique provide
information based on sales rather than production conveying real estate of
efficiency.

Advantages of marginal costing (contd):

Fixation of selling price


Profit planning, particularly of short term nature
Cost control and cost reduction
Pricing policy and its determination
Management decision making
Production planning
Make or buy decisions

Limitation of marginal costing:

Classification of cost assumptions


It lays too much emphasis on selling function, and as such production function has
been considered to be less significant.
Valuation of stock only at Marginal cost may amount to under-valuation from the
financial managers view point and this may have working capital problem.
Not suitable for external reporting, viz., for tax authorities where marginal income
is not considered to be taxable profit.
This technique does not attach due importance to time factor.
Lack of long term perspective
Not applicable in all type of business

So
What is Marginal cost ?
The cost of producing one more unit
Or
the cost which could be avoided by
not producing a unit
What is Marginal costing ?
An approach in which only variable costs are
included in cost of sales
fixed costs are treated as period costs
and are written off as incurred

Contribution Margin
Profit (Net Margin) = Gross margin fixed cost
Gross margin is also known as the contribution margin
Contribution margin is the portion of sales revenue
available to cover fixed costs and provide a profit.

Sales revenue
Variable costs
Contribution margin
Fixed costs
Profit

Contribution
Is the difference between the sales value and the marginal or
variable cost of sales
Contribution may be defined as the profit before the recovery of
fixed costs
contribution goes toward the recovery of fixed cost and profit, and
is equal to fixed cost plus profit (C = F + P).
In case a firm neither makes profit nor suffers loss, contribution
will be just equal to fixed cost (C = F).
This is known as break even point.

Break Even Analysis --is the study of the relationship between


selling prices, sales volumes, fixed costs, variable costs and profits at
various levels of activity
Here, we also use a Break even Chart to do the analysis.
The Break even chart is a graphical representation of marginal
costing or CVP analysis and helps in profit planning
24

Contribution Margin Approach


If a computer sells for Rs 2,000 with Rs 800 variable costs per computer and Rs
350,000 fixed costs per year:
What is the total contribution margin on 500 computers?
What is the contribution margin per unit?
What is the contribution margin ratio?
What is the total Rs. profit after one year?

Sales revenue
Less variable costs
Contribution margin
Less fixed costs
Profit

Total
Rs1,000,000
400,000
Rs 600,000
350,000
Rs 250,000

Per Unit
Rs2,000
800
Rs1,200

Ratio
100%
40%
60%

We have already seen that


Contribution is the difference between sales
And the marginal (Variable) costand
Contribution =sales-variable cost
C= S-V
Contribution = Fixed Cost+ Profit
C= F+P

Sales =Rs 12,000


V Cost=RS 7,000
F Cost=Rs 4,000

PROFIT ?

Therefore
S-V = F+P
If any 3 factors in the equation are known
The 4th could be found out
P=S-V-F
P=C-F
F=C-P
S=F+P+V
V=S-C.

SALES?

F COST?

V Cost?

C=S-V
=12,000-7000=5000
P=C-F
=5,000-4000
=Rs 1,000

S=C+V
=5,000+7,000
=Rs 12,000
F=C-P
=5,000-1,000
=Rs 4,000
V=S-C

=12,000-5000
=Rs 7,000

Contribution margin is the difference between total


revenues and total variable costs. This is an indication
of why operating income changes as the number of
units sold changes.
Contribution margin per unit is the difference between
selling price and variable cost per unit; i.e., contribution
margin per unit is the change in operating income for
each additional unit sold.
Contribution income statement is an income statement
that groups costs into their variable and fixed
components. Variable costs are subtracted from
revenues to highlight contribution margin. Fixed costs
are subtracted from contribution margin to arrive at
operating income.

Break Even Analysis shows the profitability or otherwise of an


undertaking at various levels of activity
CostVolumeProfit
And, as a result it indicates the
A point of no profit no loss
Analysis

A point where revenue equals cost


It depicts the following information at various
levels of activity
1.
2.
3.
4.

Variable costs, fixed costs and total costs


Sales value
Profit or less
Break even point the point at which total costs just equal or break even with
sales. This is the activity point at which neither profit is made nor loss is incurred
5. Margin of safety

At different activity levels, the interaction of volume, selling price,


variable costs and fixed costs, the relevant variables and their impact
upon profit are considered simultaneously.
Hence based on this function it is also known as profit planning chart

So, .The Break-Even Point


The break-even point is the point in the volume of activity where the
organizations revenues and expenses are equal. At this amount of sales, the
organization has no profit or loss; it breaks even.
The statement also shows the total contribution margin, which is total sales
revenue minus total variable expenses. Total contribution margin is the amount
of revenue that is available to contribute to covering fixed expenses after all
variable expenses have been covered.

Sales
$ 250,000
Less: variable expenses 150,000
Contribution margin
100,000
Less: fixed expenses
100,000
Net income
$
7-29

What are BEP---assumptions


All costs are fixed or variable
VC remains Constant
Total FC remains Constant
Selling Price dont change With
Volume
Synchronization of Prod & Sales
No Change in Productivity per
workers
Methods
Equation
Method

Graphic
Method

Profit way
At the output level when total revenue
equal to total cost.
(Selling price X number of units)
(variable cost per unit x number of units)
fixed cost = operating profit
At Break even level operating income is
zero
Break even quantity = Fixed cost /
(selling price variable cost)

Contribution margin way

(Contribution margin x quantity) fixed cost =


operating income
Break even quantity = Fixed cost / contribution
margin
Expressing CVP relationship

CVP relationships and the calculation of operating income can


be illustrated using three methods:
Equation Method. The equation method is based on
the following formula:
(Selling price Quantity of units sold) (Variable cost
per unit Quantity of units sold) Fixed costs =
Operating income
Contribution Margin Method. Under this approach
fixed costs are divided by the unit contribution margin
to give the breakeven point in units.
Graph Method. The graph method represents total costs and total
revenues graphically. When costs and revenues are netted and
graphed as one line, this is often referred to as a profit-volume or
PV graph

CP 1-2-3
Which of the following is not a factor in cost-volume-profit analysis?
a. Units sold
b. Selling price
c. Total variable costs
d. Fixed costs of a product
Which of the following is not an assumption of cost-volume-profit analysis?
a. The time value of money is incorporated in the analysis.
b. Costs can be classified into variable and fixed components.
c. The behavior of revenues and expenses is accurately portrayed as linear over
the relevant range.
d. The number of output units is the only driver.
Contribution margin is calculated as
a. total revenue total fixed costs.
b. total revenue total manufacturing costs (CGS).
c. total revenue total variable costs.
d. operating income + total variable costs.

Equation Approach
Sales revenue Variable expenses Fixed expenses = Profit

Unit
Sales
sales volume
price
in units

(Rs500 X)

Unit
Sales
variable volume
expense in units

(Rs300 X)

The equation approach can be


used to find the break-even
point.
This approach is based on the
profit equation. That is ..Income
(or profit) is equal to sales revenue
minus expenses

Rs80,000 = Rs0

(Rs200X) Rs80,000 = Rs0

X = 400 units
Expenses can be separated in variable and fixed
expenses. At the break-even point, income is
Rs0.

7-33

Contribution-Margin Approach
Consider the following information developed by the accountant at Curl,
Inc.:
Curl, Inc. manufactures surf boards.
Each surf board sells for $500 and
has variable costs of $300.

For each additional surf board sold, Curl


generates $200 in contribution margin.

Sales (500 surf boards)


Less: variable expenses
Contribution margin
Less: fixed expenses
Net income

Total
$250,000
150,000
$100,000
80,000
$ 20,000

Per Unit
$
500
300
$
200

Percent
100%
60%
40%

7-34

Contribution-Margin Approach

Fixed expenses
Unit contribution margin
Therefore, the contribution margin per unit
is $200. When enough surf boards are sold
so that the total contribution margin is
$80,000, Curl Inc. will break even for the
period.

Sales (500 surf boards)


Less: variable expenses
Contribution margin
Less: fixed expenses
Net income

$80,000
$200

= Break-even point
(in units)
To compute the break-even volume of surf
boards, divide the total fixed expenses by the
unit contribution margin. For Curl, Inc.,
$80,000 is divided by $200, which is 400 surf
boards. That means that the break-even
point is 400 surf boards.

Total
$250,000
150,000
$100,000
80,000
$ 20,000

Per Unit
$
500
300
$
200

Percent
100%
60%
40%

= 400 surf boards


7-35

Contribution-Margin Approach
The break-even point of 400 units can be proven by first calculating total sales:
multiply $500 x 400 units for $200,000 in total sales. The variable expenses are
$300 per unit x 400 units which is $120,000. Total sales less total variable
expenses is total contribution margin of $80,000. When fixed expenses 0f
$80,000 are deducted from the total contribution margin, that leaves $0 in net
income.

Here is the proof!

Sales (400 surf boards)


Less: variable expenses
Contribution margin
Less: fixed expenses
Net income

400 $500 = $200,000

Total
$200,000
120,000
$ 80,000
80,000
$
-

Per Unit
$
500
300
$
200

Percent
100%
60%
40%

400 $300 = $120,000


7-36

Contribution Margin Ratio

For Curl, Inc., the fixed costs of $80,000 are divided by the
contribution margin ratio of 40% to determine the breakeven sales of $200,000.

Sales (400 surf boards)


Less: variable expenses
Contribution margin
Less: fixed expenses
Net income

$80,000
40%

Total
$200,000
120,000
$ 80,000
80,000
$
-

Per Unit
$
500
300
$
200

Percent
100%
60%
40%

$200,000 sales
7-37

Contribution Margin Ratio

We can alsoCalculate the break-even point in sales Rs. Or $


rather than units by using the contribution margin ratio.
This is
also
known
as the
P/V
ratio

Sometimes management prefers that the break-even point be expressed in sales


dollars rather than units. This can be accomplished by using the contribution
margin ratio. The formula for the contribution margin ratio is contribution
margin divided by sales. Then divide fixed expenses by the contribution margin
ratio to determine the total sales dollars at the break-even point.

Contribution margin
Sales
AND

Fixed expense
CM Ratio

= CM Ratio
Break-even point
(in sales dollars)
7-38

Therefore

CostVolumeProfit Analysis
Fixed
Cost
BEP (Units) = --------------Contribution PU

Equation
METHOD

= F
S-V

Fixed Cost
BEP (Rs ) = ----------------- x Sales
Contribution
Fixed Cost
Fixed Cost
BEP (Rs) = ------------------ = -----------------P/V Ratio
C/S
When P/V is calculated using unit contribution and unit
selling prices . We can write
Total fixed costs
BEP = ---------------------x Unit selling prices
Unit contribution
And if P/V is calculated at given level of activity
Total fixed costs
BEP = ------------------------ x total sales
total contribution

Breakeven Point (BEP). The breakeven point is that quantity


of output sold at which total revenues equal total costs.
Following is the formula for calculating BEP in units:
Fixed costs
Unit contribution margin
However, BEP, and therefore -0- profit is not what companies
should strive for, managers are concerned with how they can
achieve their goals for operating profit.
Target Operating Income is the level of sales needed to attain
a specified dollar amount of operating income.
In order to determine TOI, add the desired operating income to
fixed cost in the breakeven calculation.

Target Net Profit


When a company has a net profit they are trying to achieve, or a target net
profit, the contribution margin approach can be used to determine the
number of units that must be sold. This is very similar to finding the breakeven point. The numerator is fixed expenses plus the target profit. The
denominator is the contribution margin per unit. The result is the units
that need to be sold to earn the 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
Unit contribution margin

$80,000 + $100,000
$200

Units sold to earn


the target profit

= 900 surf boards


7-41

Equation Approach
The equation approach also can be used to find the units of sales required to earn a target net
profit. Recall that in the profit equation, profit is equal to revenues minus variable and fixed
expenses. Recall that profit was set to zero to determine the break-even point. When
management has determined a target net profit greater than zero, that number becomes
profit variable in the equation

Sales revenue Variable expenses Fixed expenses = Profit

($500 X)

($300 X)

$80,000 = $100,000

($200X) = $180,000
X = 900 surf boards
7-42

Net income is operating income plus nonoperating


revenues (such as interest revenues) minus
nonoperating expenses (such as interest expense) minus
income taxes.
To this point, we have ignored the effect of income
taxes in our CVP analysis. To make net income
evaluations, however, we must state results in terms of
target net income rather than target operating income.
The TOI calculation can be easily adjusted to
accommodate this change:
Target NI = TOI (TOI Tax rate) or stated
another way
Target NI = TOI (1 Tax rate)

Effect of Income Taxes


The requirement that companies pay income taxes affects their cost-volume-profit
relationships. To earn a particular after-tax net income, a greater before-tax income will be
required. To determine what the before-tax net income is, the after-tax net income is divided
by 1 minus the tax rate. The formulas presented in this chapter can now be used with the
before-tax net income to provide for the effect of taxes.

Income taxes affect a companys CVP


relationships. To earn a particular aftertax net income, a greater before-tax
income will be required.

Target after-tax net income


1 - t

Before-tax
=
net income
7-44

Tee Times, Inc. produces and


sells the finest quality golf clubs
in all of Clay County. The
company expects the following
revenues and costs in 2004 for
its Elite Quality golf club sets:
Revenues (400 sets sold @ 600
per set) 240,000
Variable costs
160,000
Fixed costs 50,000

many sets of clubs must


be sold to earn a target
operating income of 90,000?
a.
700
b.
500
c.
400
d.
300

4.How many sets of clubs must be


sold for Tee Times, Inc. to reach
their breakeven point?
a.
400
b.
250
c.
200
d.
150

6. What amount of sales must


Tee Times, Inc. have to earn a
target net income of 63,000 if
they have a tax rate of 30
percent?
a.
489,000
b.
429,000
c.
420,000
d.
300,000

5.How

4. Variable costs per unit = 160,000/400 units


sold = 400
Contribution Margin = 600 400 = 200 per
unit
Breakeven point = 50,000/200 = 250 units
5.

TOI = 50,000 + 90,000/200 = 700 units

6. TNI = 50,000 + 63,000/(1 .30)/200


= 700 units 600
= 420,000

Break-Even Analysis - Graphical Presentation


Costs/Revenu
e

Initially a firm will


incur fixed costs,
these do not depend
on output or sales.

FC

Q1

Output/Sales

Total revenue is determined by the price


charged and the quantity sold again this
will be determined by expected forecast
sales initially.
Costs/Revenu
e

Break-Even Analysis

TR

TR

TC

As output is generated, the firm will


incur variable costs these vary directly
with the amount produced

VC

Initially a firm will incur


fixed costs, these do not
depend on output or sales.

The total costs therefore


(assuming accurate
forecasts!) is the sum of
FC+VC

The lower the


price, the less
steep the total
revenue curve.

FC

Q1

Output/Sales
The Break-even point occurs where total revenue equals total costs the firm, in this example would have to
sell Q1 to generate sufficient revenue to cover its costs.

Break-Even Analysis

Costs/Revenue

TR

TR

TC

VC

If the firm chose to set


price higher than Rs2
(say Rs3) the TR curve
would be steeper they
would not have to sell as
many units to break
even

FC

Q2

Q1

Output/Sales

Break-Even Analysis

TR)

Costs/Revenue

TR

TC

VC
If the firm chose to set
prices lower it would
need to sell more units
before covering its
costs
FC

Q1

Q3

Output/Sales

Break-Even Analysis

TR

Costs/Revenue

TC
Profit

VC

Loss
FC

Q1

Output/Sales

Angle of Incidence
Break-Even Analysis

Costs/Revenue

TR

TR

Assume
current
sales at Q2

TC
VC

Margin of safety shows


how far sales can fall
before losses made. If Q1
= 1000 and Q2 = 1800,
sales could fall by 800
units before a loss would
be made

Margin of Safety
FC

Q3

Q1

Q2

A higher price would lower the break even point and


the margin of safety would widen

Output/Sales

Applying BE

Safety Margin

Curl, Inc. has a break-even point of $200,000. if actual sales are


$250,000, the safety margin is $50,000 or 100 surf boards.

The
difference
between
budgeted
sales
revenue
and breakeven sales
revenue.

Sales
Less: variable expenses
Contribution margin
Less: fixed expenses
Net income

Break-even
sales
400 units
$ 200,000
120,000
80,000
80,000
$
-

Actual sales
500 units
$ 250,000
150,000
100,000
80,000
$
20,000

The
amount
by
which
sales
can
drop
before
losses
begin
to be
incurre
d.

7-53

low angle ---low rate profit---variable costs


are high

Costs/Revenue

TR

TR

Angle of The aim of the


management
Incidence
will be to have
TC
large angle
which will
VC
indicate earning
of high margin
of profit once
fixed OH are
covered.

Angle of
Incidence:
The angle
between
Margin of Safety
sales and
total cost
FC
line. This
angle is an
indicator of
Q1
Q3
Q2
Output/Sales
profit earning
capacity over A large angle of incidence with high MS indicates monopoly conditions
the BEP.