Cost-Volume-Profit Analysis: Mcgraw-Hill Education

Chapter 7
Cost-Volume-Profit
Analysis
Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without prior written consent of 7-1
McGraw-Hill/Irwin McGraw-Hill Education.
Learning Objective 7-1 – Compute a break-even point using
the contribution-margin approach and the equation approach.
7-2
McGraw-Hill Education.
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 $ -
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 surfboards
Learning Objective 7-2 – Compute the contribution-margin
ratio and use it to find the break-even point in sales dollars.
7-5
Contribution-Margin Approach (1/3)
Consider the following information
developed by the accountant at Curl, Inc.:
For each additional surfboard sold,
Curl generates $200 in contribution
margin.
Total Per Unit Percent
Sales (500 surfboards) $ 250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $ 100,000 $ 200 40%
Net income $ 20,000
Fixed expenses Break-even point
=
(in units)
Unit contribution margin
Net income $ 20,000
$80,000
= 400 surfboards
$200
Here is the proof!

Net income $ -
400 × $500 = $200,000 400 × $300 = $120,000

Contribution Margin Ratio (1/2)
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)
Contribution Margin Ratio (2/2)

Net income $ -
$80,000
= $200,000 in sales
40%
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
Cost-Volume-Profit Graph (Steps 1-3)
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
Cost-Volume-Profit Graph (Step 4)
450,000
400,000
350,000
300,000
250,000
Dollars
200,000
ns es
ex pe
t al
150,000 To
100,000
Fixed expenses
50,000
100 200 300 400 500 600 700 800

Units
450,000
400,000
350,000
300,000
250,000
Dollars
200,000
ns es
ex pe
t al
150,000 To
100,000
Fixed expenses
50,000
100 200 300 400 500 600 700 800

Units
450,000
400,000
le s
350,000 l s a
a
Tot
300,000
250,000
Dollars
200,000
ns es
ex pe
t al
150,000 To
100,000
Fixed expenses
50,000
100 200 300 400 500 600 700 800

Units
450,000
400,000
le s
s a
350,000 a l rea
Break-even
Break-even Tot ofit a
300,000 Pr
point
point
250,000
Dollars
200,000
ns es
ex pe
t al
150,000 To
Fixed expenses
rea
100,000
s a
s
50,000
Lo
100 200 300 400 500 600 700 800

Units
7-17
Profit-Volume Graph
Some
Some managers
managers like like the
the profit-volume
profit-volume
graph
graph because
because itit focuses
focuses onon profits
profits and
and volume.
volume.
100,000
80,000
60,000
Break-even
Break-even
point r ea
40,000 point a
f it
20,000 Pro
Profit
0 `
(20,000) 100 200 300 400 500 600 700
re a Units
(40,000) s a
o s
(60,000)
L
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, Inc. must sell to earn a profit of $100,000
using the contribution margin approach.
Fixed expenses + Target profit Units sold to earn

the target profit
Unit contribution margin
$80,000 + $100,000
== 900
900 surfboards
surfboards
$200
Equation Approach
Sales revenue – Variable expenses – Fixed expenses = Profit
($500 × X) – ($300 × X) – $80,000 = $100,000
($200X) = $180,000
X = 900 surfboards
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
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 surfboards.
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
Changes in Fixed Costs (1/3)
Curl,
 Curl, Inc.
Inc. isis currently
currently selling
selling 500
500 surfboards
surfboards
per
per year.
year.
The
 The owner
owner believes
believes that
that an
an increase
increase of
of
$10,000
$10,000 inin the
the annual
annual advertising
advertising budget
budget
would
would increase
increase sales
sales to
to 540
540 units.
units.
Should
Should the
the company
company increase
increase the
the advertising
advertising
budget?
budget?
Current Proposed
Sales Sales
(500 Boards) (540 Boards)
Sales $ 250,000 $ 270,000
Contribution margin $ 100,000 $ 108,000
Net income $ 20,000 $ 18,000
540
540 units
units ×× $500
$500 per
per unit
unit == $270,000
$270,000
$80,000
$80,000 ++ $10,000
$10,000 advertising
advertising == $90,000
$90,000
Sales
Sales will
will increase
increase by
by Current Proposed
$20,000,
$20,000, but
but net
net income
income will
will Sales Sales
decrease
decrease byby $2,000.
$2,000. (500 Boards) (540 Boards)
Sales $ 250,000 $ 270,000
Contribution margin $ 100,000 $ 108,000
Net income $ 20,000 $ 18,000
Changes in Unit
Contribution Margin (1/2)
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)

Changes in Unit
Contribution Margin (2/2)
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
Predicting Profit Given Expected
Volume (1/2)
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
Predicting Profit Given
Expected Volume (2/2)
In the coming year, Curl’s owner expects to sell 525
surfboards. The unit contribution margin is expected
to be $190, and fixed costs
costs are
are expected to
to increase
increase
to $90,000.
Total contribution - Fixed cost = Profit
($190 × 525) – $90,000 = X
X = $99,750 – $90,000
X = $9,750 profit
Learning Objective 7-5 – Compute the break-even point and
prepare a profit-volume graph for a multiproduct enterprise.
7-31
CVP Analysis with Multiple Products (1/2)
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, Inc. sells surfboards and

sailboards and see how we deal with break-even
analysis.
CVP Analysis with Multiple Products (1/2)
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%
CVP Analysis with Multiple Products – Weighted-Average Contribution
Margin
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%
CVP Analysis with Multiple Products –
Break-even Point (1/2)
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
CVP Analysis with Multiple Products –
Break-even Point (2/2)
Break-even point
Break-even
= 514 combined unit sales
point
Break-even % of Individual
Description Sales Total Sales
Surfboards 514 62.5% 321
Sailboards 514 37.5% 193
Total units 514
Learning Objective 7- 6 – List and discuss the key
assumptions of CVP analysis.
7-37
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).
Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without prior written consent of
7-38
Learning Objective 7-7 – Prepare and interpret a
contribution income statement.
7-39
CVP Relationships and the
Income Statement (1/2)
A. Traditional Format
ACCUTIME COMPANY
Income Statement
For the Year Ended December 31, 20x1
Sales $500,000
Less: Cost of Goods Sold 380,000
Gross margin $120,000
Less: Operating expenses:
Selling expenses $35,000
Administrative expenses 35,000 70,000
Net income $50,000
CVP Relationships and the
Income Statement (2/2)
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
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.
Measuring Operating Leverage (1/3)
Operating leverage Contribution margin
=
factor Net income
Actual sales
500 Boards
Sales $ 250,000
Less: variable expenses 150,000
Contribution margin 100,000
Net income $ 20,000
$100,000
= 5
$20,000
Operating leverage is 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%
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.
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 (ABC)
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
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.
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

=
net income
1 - t
End of Chapter 7
7-53

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Chapter 7

Unit Sales Unit Sales

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

Here is the proof!

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

Calculate the break-even point in sales

Total Per Unit Percent

Viewing CVP relationships in a graph gives managers

300 units 400 units 500 units

100 200 300 400 500 600 700 800

100 200 300 400 500 600 700 800

100 200 300 400 500 600 700 800

100 200 300 400 500 600 700 800

100 200 300 400 500 600 700 800

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

We can determine the number of surfboards that

Fixed expenses + Target profit Units sold to earn

Sales revenue – Variable expenses – Fixed expenses = Profit

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

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

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

X = 422 units (rounded)

Suppose Curl, Inc. increases the price of each

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

Total contribution - Fixed cost = Profit

($190 × 525) – $90,000 = X

Different products have different selling prices,

Let’s assume Curl, Inc. sells surfboards and

Curl provides us with the following information :

Weighted-average unit contribution margin

1. Selling price is constant throughout

Operating leverage is:

A firm with proportionately high fixed

This is the fundamental distinction between

Target after-tax net income Before-tax

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