Manac II

Term II PGP 18 Batch

Pankaj Baag
Faculty Block 01, Room No 21
Mob: 8943716269
Ph (O): 0495-2809121
Ext. 121
Email: baagpankaj@iimk.ac.in

Chapter
3
Cost
Volume
Profit
Analysis

SYNOPSIS
Thischapterpresentsthecost-volume-profit(CVP)analysismodeland
illustrateshowmanagersusethatmodeltohelpanswerimportantwhat-if
businessquestions.
CVPanalysisalsohelpsmanagementaccountantsalertmanagerstothe
risksandrewardsofdecisionstheyareconsideringbyillustratinghowthe
bottom-lineisaffectedbychangesinactivitylevelsorkeypricingorcost
components.
CVPanalysisisbasedonseveralassumptions,oneofwhichisthatfixed
costscanbedistinguishedfromvariablecosts.
However,whetheracostisvariableorfixeddependsonthetimeperiodfor
thedecisionandalsotherangeofactivity(relevantrange)being
considered.
WealsolookatamethodforapplyingCVPanalysistocompanieswith
multipleproductsandtosituationswherethereismorethanonecostdriver.
TheapplicabilityofCVPtomanufacturers,serviceorganizations,and
nonprofitsisdiscussed.
Contributionmarginisalsodefinedanddistinguishedfromgrossmargin

Process of Management The

Manageme
process of
nt
manageme
accounting
Strategy
nt involves
Planning
information Formulation
formulatin
helps
g strategy,
managers
planning,
perform
control,
each of
decision
Managers need cost information to
these
perform each of these functions. making
functions
and
more
directing
effectively.
operational
Directingactivities.
Control
Decision
Making
2-4

 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 :
(CAS 1)
i)
ii)

iii)
iv)
v)

vi)
vii)

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

Direct costs can be conveniently

and economically traced (tracked) to
a cost object
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
Whether
a cost
is a direct
cost or an
rational and
systematic
manner
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

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

iii)
iv)

v)
vi)
vii)

Nature of
expenses
Relation to
object traceability
Functions/activit
ies
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

Per Movie Charge

Variable Cost Per Unit

Total Pay-Per-View
Bill

Total Variable Cost

Movies
Watche

2-8

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
2-9

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

10

 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
DL are included in
measured by the total variable cost
attributable
marginal
cost on to
theone
unit
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

Absorption Costing
Cost
Manufacturing cost
Direct
Materials

Direct
Labour

Finished goods

Variable + Fixed
divided into sold &
unsold
Non-manufacturing
cost

Overheads

Period cost

Cost of goods sold

Cost

Direct
Materials

Direct
Labour

Finished goods

Profit and loss account

Variable into sold &
unsold

Marginal Costing
Manufacturing cost

Unsold is
added to
stock

Non-manufacturing cost
Variable
Overheads

Fixed
overhead

Cost of goods sold

Unsold
is
Period cost
added
to
stock
Profit and loss account
19

 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 undervaluation 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
25

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

Sales =Rs 12,000
Contribution is the difference between salesV Cost=RS 7,000
And the marginal (Variable) costand
F Cost=Rs 4,000
Contribution =salesvariable cost
C= S-V
Contribution = Fixed Cost+
Profit
C= F+P

Therefore

If any 3 factors in the equation

S-V = F+P
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.

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

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

=12,000-5000
=Rs 7,000

Contribution marginisthedifferencebetweentotal
revenuesandtotalvariablecosts.Thisisanindication
ofwhyoperatingincomechangesasthenumberof
unitssoldchanges.
Contribution margin per unit isthedifferencebetween
sellingpriceandvariablecostperunit;i.e.,contribution
marginperunitisthechangeinoperatingincomefor
eachadditionalunitsold.
Contribution income statementisanincomestatement
thatgroupscostsintotheirvariableandfixed
components.Variablecostsaresubtractedfrom
revenuestohighlightcontributionmargin.Fixedcosts
aresubtractedfromcontributionmargintoarriveat
operatingincome.

Break Even Analysis shows the profitability or

otherwise of an undertaking at various levels of activity
Cost- Volume- Profit
And, as a result it indicates the
Analysis A point of no profit no loss

A point where revenue equals cos

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 loss
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.

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
$
7-30

Profit way
What are BEP---assumptions
At the output level when total
All costs are fixed or
revenue equal to total cost.
variable
(Selling price X number of
VC remains Constant
units) (variable cost per unit
x number of units) fixed cost
Total FC remains
= operating profit
Constant
At Break even level operating
Selling Price dont
income is zero
change With Volume
Break even quantity = Fixed
Synchronization of Prod & cost / (selling price variable
cost)
Sales
No
Change in Contribution margin way
Methods
Productivity per workers
(Contribution margin x quantity)
Equation
fixed cost = operating income
Method
Break even quantity = Fixed cost /
contribution margin
Graphic
Method
Expressing CVP relationship

CVPrelationshipsandthecalculationofoperatingincomecan
beillustratedusingthreemethods:
Equation Method.Theequation methodisbasedonthe
followingformula:
(SellingpriceQuantityofunitssold)(Variablecostper
unitQuantityofunitssold)Fixedcosts=Operating
income

Contribution Margin Method. Underthisapproachfixed

costsaredividedbytheunitcontributionmargintogive
thebreakevenpointinunits.
Graph Method.Thegraph method representstotalcostsandtotal
revenuesgraphically.Whencostsandrevenuesarenettedand
graphedasoneline,thisisoftenreferredtoasaprofit-volumeor
PVgraph

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
Unit
Sales
sales volume variablevolume
price in units expense in units

(Rs500 X) (Rs300 X) Rs80,000 = Rs0

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

(Rs200X)
Rs80,000 = Rs0
X = 400 units
Expenses can be separated in variable
and fixed expenses. At the breakeven point, income is Rs0.

7-34

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%

7-35

Contribution-Margin Approach

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

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 breakeven point is 400 surf boards.

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

Per Unit
$
500
300
$
200

$80,000
= 400 surf boards
$200

Percent
100%
60%
40%

7-36

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

7-37

Contribution Margin Ratio

For Curl, Inc., the fixed costs of $80,000 are

divided by the contribution margin ratio of 40%
to determine the break-even 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
7-38

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
know
n as
the
P/V
ratio

AND

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 breakeven point.

Contribution
= CM
margin
Ratio
Sales
Fixed expense Break-even point
=
CM Ratio
(in sales dollars)

7-39

Therefore

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

Equation
METHOD
F
S-V

Fixed Cost
BEP (Rs ) = ----------------x Sales
Contribution
BEP (Rs)

Fixed Cost
Fixed Cost
= ------------------ = -----------------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

Breakeven Point (BEP). Thebreakevenpointisthatquantity

ofoutputsoldatwhichtotalrevenuesequaltotalcosts.
FollowingistheformulaforcalculatingBEPinunits:
Fixedcosts
Unitcontributionmargin
However,BEP,andtherefore-0-profitisnotwhatcompanies
shouldstrivefor,managersareconcernedwithhowtheycan
achievetheirgoalsforoperatingprofit.
Target Operating Income isthelevelofsalesneededtoattain
aspecifieddollaramountofoperatingincome.
InordertodetermineTOI,addthedesiredoperatingincometo
fixedcostinthebreakevencalculation.

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 break-even 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 Units sold to earn

=
Unit contribution margin
the target profit

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

7-42

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

$80,000 = $100,000
($500 X) ($300 X)$80,000
($200X)
= $180,000
X = 900 surf boards
7-43

Net incomeisoperatingincomeplusnonoperating
revenues(suchasinterestrevenues)minusnonoperating
expenses(suchasinterestexpense)minusincometaxes.
Tothispoint,wehaveignoredtheeffectofincometaxes
inourCVPanalysis.Tomakenetincomeevaluations,
however,wemuststateresultsintermsoftargetnet
incomeratherthantargetoperatingincome.
TheTOIcalculationcanbeeasilyadjustedto
accommodatethischange:
TargetNI=TOI(TOITaxrate)orstatedanother
way
TargetNI=TOI(1Taxrate)

Effect of Income Taxes

The requirement that companies pay income taxes affects their costvolume-profit relationships. To earn a particular after-tax net income, a
greater before-tax income will be required. To determine what the beforetax 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 after-tax net income, a
greater before-tax income will
be required.

Target after-tax net

income

Before-tax
=
net

7-45

 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

5.How

many sets of clubs

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

6. What amount of sales

4.How many sets of clubs must be must Tee Times, Inc.
sold for Tee Times, Inc. to reach
have to earn a target net
their breakeven point?
income of 63,000 if they
a. 400
have a tax rate of 30
b. 250
percent?
c. 200
a. 489,000
d. 150
b. 429,000

c. 420,000

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

Initiallyafirmwill
incurfixedcosts,
thesedonotdepend
onoutputorsales.

FC

Q1

Output/Sales

Totalrevenueisdeterminedbytheprice
chargedandthequantitysoldagainthis
willbedeterminedbyexpectedforecast
salesinitially.
Costs/Revenu
e

Break-Even Analysis

TR

TR

TC

Asoutputisgenerated,thefirmwill
incurvariablecoststhesevarydirectly
withtheamountproduced

VC

Initiallyafirmwillincur
fixedcosts,thesedonot
dependonoutputorsales.

Thetotalcoststherefore
(assumingaccurate
forecasts!)isthesumof
FC+VC

Thelowerthe
price,theless
steepthetotal
revenuecurve.

FC

Q1

Output/Sales
TheBreak-evenpointoccurswheretotalrevenueequalstotalcoststhefirm,inthisexamplewouldhaveto
sellQ1togeneratesufficientrevenuetocoveritscosts.

Break-Even Analysis

Costs/Revenue

TR

TR

TC

VC

Ifthefirmchosetoset
pricehigherthanRs2
(sayRs3)theTRcurve
wouldbesteeperthey
wouldnothavetosellas
manyunitstobreak
even

FC

Q2

Q1

Output/Sales

Break-Even Analysis

TR)

Costs/Revenue

TR

TC

VC
Ifthefirmchosetoset
pricesloweritwould
needtosellmoreunits
beforecoveringits
costs
FC

Q1

Q3

Output/Sales

Break-Even Analysis

TR

Costs/Revenue

TC
Profit

Loss

VC

FC

Q1

Output/Sales

Angle of
Incidence

Break-Even Analysis

Costs/Revenue

TR

Assume
current
salesatQ2

TC

TR

VC

Marginofsafetyshows
howfarsalescanfall
beforelossesmade.IfQ1
=1000andQ2=1800,
salescouldfallby800
unitsbeforealosswould
bemade

MarginofSafety
FC

Q3

Q1

Q2

Ahigherpricewouldlowerthebreakevenpointand
themarginofsafetywouldwiden

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
differenc
e
between
budgeted
sales
revenue
and
breakeven
sales

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
amou
nt by
which
sales
can
drop
before
losses
begin
to be
incurr
ed.

7-54

 low angle ---low rate profit--variable costs are high

Costs/Revenue

TR

TR

Angle of The aim of

Incidence the
manageme
TC
nt will be to
have large
VC
angle which
will
indicate
earning of
high margin
of profit
MarginofSafety
once fixed
FC
OH are
covered.

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