1-CVP Analysis

Chapter 16
Cost-Volume-Profit Analysis
Hansen/Mowen, Cornerstones of Cost Management, 4 th Edition. © 2018 Cengage. All Rights Reserved. May
not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objectives (1 of 2)
1. Determine the number of units and amount of sales revenue needed to
break even and to earn a target profit
2. Determine the number of units and sales revenue needed to earn an after-
tax target profit
3. Apply cost-volume-profit analysis in a multiple-product setting
Hansen/Mowen, Cornerstones of Cost Management, 4 th Edition. © 2018 Cengage. All Rights Reserved. May not
be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objectives (2 of 2)
4. Prepare a profit-volume graph and a cost-volume-profit graph, and explain
the meaning of each
5. Explain the impact of risk, uncertainty, and changing variables on cost-
volume-profit analysis
6. Discuss the impact of non-unit cost drivers on cost-volume-profit analysis
Cost-Volume-Profit (CVP) Analysis and Break-even
Point
• CVP analysis: Emphasizes the interrelationships of costs, quantity sold, and
price
o Brings together all of the financial information of the firm
• Break-even point: Point of zero profit
o Approaches to finding break-even point
• Operating income approach
• Contribution margin approach
Steps in implementing Units-sold approach to c vp
Analysis
• Determine what a unit is
• Separate costs into fixed and variable components
o CVP focuses on the firm as a whole and all costs of the company are taken into
account
Basic Concepts for CVP Analysis (1 of 2)
• Variable product cost per unit = Direct materials + Direct labor + Variable
overhead
• Variable cost per unit = Direct materials + Direct labor + Variable overhead +
Variable selling expense
• Contribution margin per unit = Price − Variable cost per unit
• Contribution margin ratio
Basic Concepts for CVP Analysis (2 of 2)
• Contribution-margin-based operating income statement - Useful tool for
organizing the firm’s costs into fixed and variable categories
o Operating income - Income before income taxes
o Net income: Operating income minus income taxes
Equation Method for Break-Even and Target Income
• Equation for a target profit put in terms of units
o Units for a target profit =  Total fixed cost + Target income 

 Price - Variable cost per unit 
• Break-even equation when target income is zero
o Break- even units =  Total fixed cost 

(Price - Variable cost per unit)
Calculating Units Needed to Break Even and to
Achieve a Target Profit (1 of 4)
• Blazin-Boards Company plans to sell 10,000 snowboards at $400 each in the
coming year
o Product costs include:
• Direct materials per snowboard - $80
• Direct labor per snowboard - $125
• Variable overhead per snowboard - $15
• Total fixed factory overhead - $800,000
o Variable selling expense is a commission of 5 percent of price
• Fixed selling and administrative expense totals $400,000
• Calculate the number of units Blazin-Boards must sell to break even
o Prepare a contribution-margin-based income statement for the calculated units
• Calculate the number of units Blazin-Boards must sell to achieve target
operating income (profit) of $240,000
• Solution:
o Break- even units = Total fixed costs
 Price - Unit variable cost 
$1,200,000
= = 7,500
 $400 - $240 
Sales (7,500 units @ $400) $3,000,000
Less: Variable expenses 1,800,000
Contribution margin $1,200,000
Less: Fixed expenses 1,200,000
Operating income $0
Indeed, selling 7,500 units does yield a zero profit.

• Units for $240,000 =
 Total fixed costs + Target profit 
(Price  Unit variable cost)

 $1,200,000  $240,000 
 9,000
($400  $240)
Contribution Margin Approach
• Recognizes that total contribution margin equals the fixed expenses at break-
even
• Contribution margin: Sales revenue minus total variable costs
o Number of units = Fixed costs
Unit contribution margin
Break Even Point and Target Income in Sales
Revenue (1 of 2)
• Units-sold measure can be converted to a sales-revenue measure by
multiplying the unit sales price by the units sold
o To calculate the break-even point in sales revenue, variable costs are defined as
a percentage of sales
• Variable cost ratio should be computed to express variable cost in terms of
sales revenue
o Variable cost ratio: Proportion of each sales dollar that must be used to cover
variable costs
Exhibit 16.1 - Division of Revenue into Variable Cost
and Contribution Margin
Division of Revenue into Variable Cost and Contribution Margin
Break Even Point and Target Income in Sales
Revenue (2 of 2)
• Contribution margin ratio: Proportion of each sales dollar available to cover
fixed costs and provide for profit
• Sales-revenue approach
o Sales = (Total fixed costs + Operating income)
Contribution margin ratio
o At break even, operating income equals zero
Total fixed costs
• §Break- even sales =
Calculating Revenue for Break-Even and for Target
Profit (1 of 3)
• Blazin-Boards Company plans to sell 10,000 snowboards at $400 each in the
coming year
o Unit variable cost equals $240
o Total fixed costs equal $1,200,000
o What is the contribution margin per unit? What is the contribution margin ratio?
o Calculate the sales revenue needed to break even
o Calculate the sales revenue needed to achieve a target profit of $240,000
Profit (2 of 3)
• Solution:
o Contribution margin per unit = Price − Unit variable cost = $400 − $240 = $160
$160
o Contribution margin ratio = = 0.40, or 40%
$400
o Break- even sales revenue =

Total fixed cost
$1,200,000
= = $3,000,000
0.40
Profit (3 of 3)
o Target sales revenue =  Total fixed cost + Target profit 
=
 $1,200,000 + $240,000 
= $3,600,000
0.40
Calculating the Number of Units to Generate an After-
Tax Target Profit (1 of 4)
• Blazin-Boards Company wants to earn $390,000 in net (after-tax) income
next year
o Snowboards are priced at $400 each for the coming year
o Product costs include:
• Direct materials per snowboard - $80
• Direct labor per snowboard - $125
• Variable overhead per snowboard - $15
• Total fixed factory overhead - $800,000
• Variable selling expense is a commission of 5 percent of price
o Fixed selling and administrative expense totals $400,000
o Blazin-Boards has a tax rate of 35 percent
• Calculate the before-tax profit needed to achieve an after-tax target of
$422,500
o Calculate the number of boards that will yield operating income
o Prepare an income statement for Blazin-Boards Company for the coming year
based on the number of boards computed
• Before- tax income = After- tax income
 1 - Tax rate 
$422,500
=
 1 - 0.35 
$422,500
= = $650,000
 0.65 
• Number of boards = 
Total fixed cost + Target profit 
 Price  Variable cost per unit 
=
 $1,200,000 + $650,000 
 $400  $240 
= 11,563 (rounded)
Blazin-Boards Company Income Statement For the Coming Year
Total Per Unit

Sales ($400 × 11,563 snowboards) $4,625,200 $400
Total variable expense ($240 × 11,563) 2,775,120 240
Total contribution margin $1,850,080 $160
Total fixed expense 1,200,000
Operating income $ 650,080
Less: Income taxes ($650,080 × 0.35) 227,528
Net income* $ 422,552
*Note that net income is $52 higher than the target due to rounding the units up from 11,562.5
to 11,563.
Direct and Common Fixed Expenses
• Direct fixed expenses: Fixed costs that can be traced to each segment
o Would be avoided if the segment did not exist
• Common fixed expenses: Fixed costs that are not traceable to the
segments
o Would remain even if one of the segments was eliminated
Break-Even Point in Units for the Multiple-Product Setting
• Multiple-product analysis requires the expected sales mix

o Sales mix: Relative combination of products being sold by a firm
o Defining sales mix allows one to convert a multiple-product problem to a single-
product CVP format
Calculating the Break-Even Number of Units in a
Multiproduct Firm (1 of 5)
• Blazin-Boards Company plans to sell 10,000 regular snowboards and 2,500
deluxe snowboards in the coming year
• Product price and cost information includes:
Regular Snowboard Deluxe Snowboard

Price $ 400 $ 600
Unit variable cost 240 300
Direct fixed cost 600,000 200,000
Common fixed selling and administrative expense totals $550,000.
• What is the sales mix estimated for next year (calculated to the lowest whole
number for each product)?
o Using the sales mix, form a package of regular and deluxe snowboards
• Taking the package contribution margin to three decimal places, calculate the break-
even number of regular snowboards and deluxe snowboards
• Prepare a contribution-margin-based income statement for Blazin-Boards Company
based on the unit sales
• Solution:
o Sales mix of regular to deluxe snowboards = 10,000:2,500 = 4:1
Product Price Unit Variable Unit Contribution Sales Unit Contribution

Cost Margin Mix Margin × Sales Mix
Regular $400 $240 $160 4 $640a
Deluxe $600 $300 $300 1 300b
Package $940
contribution
margin
a
Found by multiplying the number of units in the package (4) by the unit contribution margin
($160).
b
Found by multiplying the number of units in the package (1) by the unit contribution margin
($300).
o Break- even packages = Total fixed cost
Package contribution margin
=
 $600,000 + $200,000 + $550,000 
940
= 1,436.170 packages
Break-even regular snowboards = (4×1,436.170) = 5,745
Break-even deluxe snowboards = (1×1,436.170) = 1,436
Blazin-Boards Income Statement For the Coming Year
Regular Snowboards Deluxe Snowboards Total

Sales $2,298,000 $861,600 $3,159,600
Less: Variable expenses 1,378,800 430,800 1,809,600
Contribution margin $ 919,200 $430,800 $1,350,000
Less: Direct fixed expenses 600,000 200,000 800,000
Product margin $ 319,200 $230,800 $ 550,000
Less: Common fixed 550,000
expenses
Operating income $0
Break-even point in sales revenue
• Uses the assumed sales mix
• Avoids the requirement of building a package contribution margin
• Computational effort is similar to that used in the single-product setting
Graphical Representation of CVP Relationships - Data
• Gordon Company produces a single product with the following cost and price
data:
o Total fixed costs - $100
o Variable cost per unit - $5
o Selling price per unit - $10
• Operating income =($10 × Units) − ($5 × Units) − $10 =($5 × Units) − $100
• Revenue = $10 × Units
• Total cost = ($5×Units) + $100
Graphical Representation of CVP Relationships -
Profit-Volume Graph
• Portrays the relationship between profits and sales volume
• Graph of the operating income equation
o Operating income = (Price × Units) − (Unit variable cost × Units) − Fixed Costs
• Operating income is the dependent variable
• Number of units is the independent variable
Exhibit 16.2 - Profit-Volume Graph
Profit-Volume Graph
Graphical Representation of CVP Relationships -
Cost-Volume-Profit Graph
• Depicts relationships among cost, volume, and profits
• To obtain more detailed relationships, it is necessary to graph the total
revenue line and the total cost line
Exhibit 16.3 - Cost-Volume graph
Cost-Volume-Profit Graph
Assumptions of Cost-Volume-Profit Analysis
• Linear revenue function and a linear cost function
• Price, total fixed costs, and unit variable costs can be accurately identified
and remain constant over the relevant range
• What is produced is sold
• For multiple-product analysis, the sales mix is assumed to be known
• Selling price and costs are assumed to be known with certainty
Risk and Uncertainty in CVP Analysis
• Ways in which managers deal with risk and uncertainty
o Realize the uncertain nature of future prices, costs, and quantities
o Consider a break-even band instead of a break-even point
o Engage in sensitivity or what-if analyses
• Concepts used to measure risk
o Margin of safety
o Operating leverage
Margin of Safety
• Units sold or expected to be sold or revenue earned or expected to be
earned above the break-even volume
• If a firm’s margin of safety is large given the expected sales for the coming
year, the risk of suffering losses is less
Operating Leverage
• Use of fixed costs to extract higher percentage changes in profits as sales
activity changes
• Greater the degree of operating leverage, the more that changes in sales
activity will affect profits
o Mix of costs that an organization chooses can have a considerable influence on
its operating risk and profit level
Sensitivity Analysis and CVP
• Sensitivity analysis: What-if technique that examines the impact of changes
in underlying assumptions on an answer
• One can input data and set up formulas to calculate break-even points and
expected profits
o Data can be varied as desired to see what impact changes have on the expected
profit
CVP Analysis and Non-Unit Cost Drivers (1 of 3)
• CVP can be modified to take in account costs that vary with non-unit cost
drivers
o Modification helps provide accurate insights concerning cost behavior
• ABC equation for CVP analysis
o Total cost = Fixed costs + (Unit variable cost × Number of units) + (Setup cost ×
Number of setups) + (Engineering cost × Number of engineering hours)
o Operating income = Total revenue – [Fixed costs + (Unit variable cost × Number
of units) + (Setup cost × Number of setups) + (Engineering cost × Number of
engineering hours)]
o Break-even units = [Fixed costs + (Setup cost × Number of setups) +
(Engineering cost × Number of engineering hours)]/Price – Unit variable cost)
o Cost equation for JIT
• Total cost = Fixed costs + (Unit variable cost × Units) + (Engineering cost × Number
of engineering hours)
• Results for the conventional and ABC computations will be the same as long
as the levels of activity for the non-unit-based cost drivers remain the same
• ABC equation for CVP analysis is a richer representation of the underlying
cost behavior
CVP Analysis in Nonprofit entities
• CVP analysis is helpful in not-for-profit entities
o Managers should be aware of the different types of costs, the different drivers,
and the underlying economic conditions that affect them

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Chapter 16

• Equation for a target profit put in terms of units

o Units for a target profit =  Total fixed cost + Target income 

o Break- even units =  Total fixed cost 

Indeed, selling 7,500 units does yield a zero profit.

o Break- even sales revenue =

Total Per Unit

• Multiple-product analysis requires the expected sales mix

Regular Snowboard Deluxe Snowboard

Common fixed selling and administrative expense totals $550,000.

Product Price Unit Variable Unit Contribution Sales Unit Contribution

Regular Snowboards Deluxe Snowboards Total

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