CHAPTER 6

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

7-2
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
7-3
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
Total Per
Per Unit
Unit Percent
Percent
Sales
Sales(500
(500surf
surfboards)
boards) $$250,000
250,000 $$ 500500 100%
100%
Less:
Less: variable
variableexpenses
expenses 150,000
150,000 300
300 60%
60%
Contribution
Contributionmargin
margin $$100,000
100,000 $$ 200200 40%
40%
Less:
Less: fixed
fixedexpenses
expenses 80,000
80,000
Net
Net income
income $$ 20,000
20,000

7-4
Contribution-Margin Approach

Fixed expenses Break-even point

=
(in units)
Unit contribution margin
Total
Total Per
PerUnit
Unit Percent
Percent
Sales
Sales(500
(500surf
surfboards)
boards) $$250,000
250,000 $$ 500
500 100%
100%
Less: variable expenses
Less: variable expenses 150,000
150,000 300
300 60%
60%
Contribution
Contributionmargin
margin $$100,000
100,000 $$ 200
200 40%
40%
Less:
Less:fixed
fixedexpenses
expenses 80,000
80,000
Net
Netincome
income $$ 20,000
20,000

$80,000
= 400 surf boards
$200
7-5
Contribution-Margin Approach

Here is the proof!

Total
Total Per
Per Unit
Unit Percent
Percent
Sales
Sales(400
(400surf
surfboards)
boards) $$200,000
200,000 $$ 500500 100%
100%
Less:
Less: variable
variableexpenses
expenses 120,000
120,000 300
300 60%
60%
Contribution
Contributionmargin
margin $$ 80,000
80,000 $$ 200200 40%
40%
Less:
Less: fixed
fixedexpenses
expenses 80,000
80,000
Net
Net income
income $$ --

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

7-6
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)
7-7
Contribution Margin Ratio

Total
Total Per
Per Unit
Unit Percent
Percent
Sales
Sales(400
(400surf
surfboards)
boards) $$200,000
200,000 $$ 500500 100%
100%
Less:
Less: variable
variableexpenses
expenses 120,000
120,000 300
300 60%
60%
Contribution
Contributionmargin
margin $$ 80,000
80,000 $$ 200200 40%
40%
Less:
Less: fixed
fixedexpenses
expenses 80,000
80,000
Net
Net income
income $$ --

$80,000
= $200,000 sales
40%
7-8
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.:

7-9
Cost-Volume-Profit Graph

450,000

400,000

350,000

300,000

250,000
Dollars

200,000

150,000
Fixed expenses
100,000

50,000

100 200 300 400 500 600 700 800

Units
7-10
Cost-Volume-Profit Graph

450,000

400,000

350,000

300,000

250,000
Dollars

200,000
ns es
l ex pe
150,000 Tota
100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

7-11
Cost-Volume-Profit Graph

450,000

400,000

350,000

300,000

250,000
Dollars

200,000
ns es
l ex pe
150,000 Tota
100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

7-12
Cost-Volume-Profit Graph

450,000

400,000
a les
350,000
t als
To
300,000

250,000
Dollars

200,000
ns es
l ex pe
150,000 Tota
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
a les
350,000
t als r ea
Break-even To fit a
300,000 P r o
point
250,000
Dollars

200,000
ns es
l ex pe
150,000 Tota
Fixed expenses
100,000
re a
s a
s
50,000
Lo

100 200 300 400 500 600 700 800

Units

7-14
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
point rea
40,000
a
r ofit
20,000 P
Profit

0 `

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

re a Units
(40,000) s a
o s
(60,000)
L

7-15
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

7-16
Equation Approach

Sales revenue – Variable expenses – Fixed expenses = Profit

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

($200X) = $180,000

X = 900 surf boards

7-17
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

7-18
Applying CVP Analysis

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

7-19
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.

7-20
Changes in Fixed Costs


 Curl
Curlisiscurrently
currentlyselling
selling500
500surfboards
surfboardsper
peryear.
year.
 The

Theowner
ownerbelieves
believesthat
thatan
anincrease
increaseof
of$10,000
$10,000in
inthe
theannual
annualadvertising
advertising
budget, would increase sales to 540 units.
budget, would increase sales to 540 units.

 Should
Shouldthe
thecompany
companyincrease
increasethe
theadvertising
advertisingbudget?
budget?

7-21
 Changes in Fixed Costs

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
7-22
Changes in Fixed Costs

Sales
Sales will
will increase
increase by
by
$20,000,
$20,000, but
but net
net income
income
decreased
decreased byby $2,000
$2,000..

7-23
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)

7-24
Changes in Unit
Contribution Margin

Suppose
Suppose Curl,
Curl, Inc.
Inc. increases
increases the
the price
price of
of each
each surfboard
surfboard to
to $550.
$550. With
With no
no
change
change in
in variable
variable cost
cost per
per unit,
unit, what
what will
will be
be the
the new
new break-even
break-even point?
point?

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

X = 320 units
7-25
 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

7-26
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 7-27
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
Let’s assume
assume Curl
Curl sells
sells surfboards
surfboards and
and sail
sail boards
boards and
and see
see how
how we
we deal
deal with
with
break-even
break-even analysis.
analysis.

7-28
CVP Analysis with Multiple Products

Curl provides us with the following: information:

7-29
CVP Analysis with Multiple Products

Weighted-average unit contribution margin

$200 × 62.5%

$550 × 37.5%
7-30
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

7-31
CVP Analysis with Multiple Products

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

7-32
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

7-33
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
7-34
Cost Structure and Operating Leverage

 The
 The cost
cost structure
structure of
of an
an organization
organization is
is the
the
relative
relative proportion
proportion of
of its
its fixed
fixed and
and variable
variable costs.
costs.
 Operating
 Operating leverage
leverage is:
is:

 the
the extent
extent to
to which
which an
an organization
organization uses
uses fixed
fixed costs
costs in
in its
its cost
cost structure.
structure.

 greatest
greatest in
in companies
companies that
that have
have aa high
high proportion
proportion of
of fixed
fixed costs
costs in
in relation
relation to
to
variable
variable costs.
costs.

7-35
Measuring Operating Leverage

Operating leverage Contribution margin

=
factor Net income

$100,000
= 5
$20,000 7-36
Measuring Operating Leverage

AA measure
measure of
of how
how aa percentage
percentage change
change in in sales
sales will
will affect
affect profits.
profits. IfIf Curl
Curl
increases
increases its
its sales
sales by
by 10%,
10%, what
what will
will be
be the
the percentage
percentage increase
increase in in net
net
income?
income?

Percent increase in sales 10%

Operating leverage factor × 5
Percent increase in profits 50%

7-37
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.

7-38
End of Chapter 6

We made
it!

7-39