CHP 4

Chapter Four
Cost-Volume-
Profit Analysis
McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning
Objective
1
 Managers want to know how profits will
change as units sold, variable costs, fixed
costs or selling price change.
 Managers like to use “what-if” analysis to
examine the possible outcomes of different
decisions so they can make the best one.
 In Chapter 2, we discussed total revenues,
total costs and income. In this chapter, we
take a closer look at the relationship among
the elements (selling price, variable costs,
fixed costs).
Copyright © 2015 Pearson Education
Cost-volume-profit (CVP)
analysis
• Cost-volume-profit (CVP) analysis
examines the behavior of total revenues,
total costs, and operating income as
changes occur in the units sold, the selling
price, the variable cost per unit, or the fixed
costs of a product
A Five-Step Decision Making
Process in Planning & Control
Revisited
1. Identify the problem and uncertainties.
Every managerial decision involves
selecting a course of action.
2. Obtain information. Managers obtain
information that might help them
understand the uncertainties more
clearly.
3. Make predictions about the future using
all the information available to them.
A Five-Step Decision Making
Process in Planning & Control
Revisited
4. Make decisions by choosing between
alternatives, using Cost-Volume-Profit
(CVP) analysis
5.Implement the decision, evaluate
performance, and learn. The actual
performance is compared with the predicted
performance
Assumptions of Cost-Volume-Profit Analysis
The reliability of cost-volume-profit analysis

depends upon several assumptions.
1. Total sales and total costs can be represented by
straight lines.
2. Within the relevant range of operating activity, the
efficiency of operations does not change.
3. Costs can be accurately divided into fixed and
variable components.
4. The sales mix is constant.
5. There is no change in the inventory quantities
during the period.
Assumptions Underlying
CVP Analysis
Selling price is constant throughout
the entire relevant range.
Costs are linear over the relevant
range.
In multi-product companies, the sales
mix is constant.
In manufacturing firms, inventories do
not change (units produced = units
sold).
Foundational Assumptions in CVP
Changes in production/sales volume are the sole cause
for cost and revenue changes
Total costs consist of fixed costs and variable costs
Revenue and costs behave and can be graphed as a
linear function (a straight line)
Selling price, variable cost per unit and fixed costs are
all known and constant
In many cases only a single product will be analyzed.
If multiple products are studied, their relative sales
proportions are known and constant
The time value of money (interest) is ignored
© 2009 Pearson Prentice Hall. All rights reserved.
Basic Formulae

CVP: Contribution Margin
Manipulation of the basic equations yields an
extremely important and powerful tool extensively
used in Cost Accounting: the Contribution Margin
Contribution Margin equals sales less variable costs
CM = S – VC
Contribution Margin per Unit equals unit selling price
less variable cost per unit
CMu = SP – VCu

Contribution Margin, continued
Contribution Margin also equals contribution margin
per unit multiplied by the number of units sold (Q)
CM = CMu x Q
Contribution Margin Ratio (percentage) equals
contribution margin per unit divided by Selling Price
CMR = CMu ÷ SP
Interpretation: how many cents out of every sales dollar
are represented by Contribution Margin

Basic Formula Derivations
The Basic Formula may be further rearranged and
decomposed as follows:
Sales – VC – FC = Operating Income (OI)
(SP x Q) – (VCu x Q) – FC = OI
Q (SP – VCu) – FC = OI
Q (CMu) – FC = OI
Remember this last equation, it will be used again in a

moment

Breakeven Point
Recall the last equation in an earlier slide:
Q (CMu) – FC = OI
A simple manipulation of this formula, and setting OI
to zero will result in the Breakeven Point (quantity):
BEQ = FC ÷ CMu
At this point, a firm has no profit or loss at the given
sales level
If per-unit values are not available, the Breakeven
Point may be restated in its alternate format:
BE Sales = FC ÷ CMR

Breakeven Point
At the breakeven point, a firm has no profit or
loss at the given sales level. Breakeven is where:
Sales – Variable Costs – Fixed Costs = 0
Calculation of breakeven number of units
Breakeven Units = Fixed Costs _
Contribution Margin per Unit

Calculation of breakeven revenues
Breakeven Revenue = Fixed Costs _
Contribution Margin Percentage

Breakeven Point, extended:
Profit Planning
With a simple adjustment, the Breakeven Point
formula can be modified to become a Profit Planning
tool.
Profit is now reinstated to the BE formula, changing it to
a simple sales volume equation
 Quantity of Units = (Fixed Costs+Target Operating Income)
Required to Be Sold Contribution Margin per Unit
Q = (FC + OI)
CM

Contribution Margin Income Statement
Total The
The
contribution
contribution
Sales (50,000 units) $1,000,000
margin
margin is
is
Variable costs 600,000
available
availabletoto
Contribution margin $400,000
cover
coverthethefixed
fixed
Fixed costs 300,000
costs
costs and
and
Income from operations$100,000
income
incomefrom
from
operations.
operations.
Variable
Variablecosts
costs
Sales
Sales Fixed
Fixedcosts
costs
Income
Incomefrom
fromoperations
operations

Total Per Unit Percent

Sales (50,000 units) $1,000,000 $20 100%
Variable costs 600,000 12
60%
Contribution margin $400,000 $ 8 40%
Fixed costs 300,000
Income from operations $100,000
The
Thestatement
statementcan
canbe
beextended
extended
to
toinclude
includeper
perunit
unitdollars
dollarsand
and
percentage
percentagenumbers.
numbers.


Sales (50,000 units) $1,000,000 $20 100%
60%
Fixed costs 300,000
Income from operations $100,000
Income
Sales Variable Fixed from
= + +
costs costs operations
Variable Contribution
Sales – =
costs margin


Sales (50,000 units) $1,000,000 $20 100%
60%
Fixed costs 300,000
Income from operations
Unit $100,000
Unit ContributionMargin
Contribution Margin
Contribution
ContributionMargin
MarginRatio
Ratio
The
Thecontribution
contributionmargin
margincan
canbebeexpressed
expressedthree
threeways:
ways:
1.
1.Total
Totalcontribution
contributionmargin
marginin
indollars.
dollars.
2.
2.Unit
Unitcontribution
contributionmargin
margin(dollars
(dollarsper
perunit).
unit).
3.
3.Contribution
Contributionmargin
marginratio
ratio(percentage).
(percentage).
Calculating the Break-Even Point

Sales (50,000 units) ? $20 100%
Variable costs ? 12
60%
Fixed costs 300,000
Income from operations $ 0
At
Atthe
thebreak-even
break-even
point,
point,fixed
fixedcosts
costs
and
andthe
thecontribution
contribution
margin
marginareareequal.
equal.


Sales (50,000 units) ? $20 100%
Variable costs ? 12 60%
Contribution margin $ 300,000 / $ 8 or 40%
Fixed costs 300,000
Income from operations $ 0 Divide by either:
$8 per unit or 40%
Break-even
sales Fixed Contribution
= /
costs margin


Sales (50,000 units) ? $20 100%
Variable costs ? 12
60%  or
Contribution margin $ 300,000 $ 8 40%
Fixed costs 300,000
Break-even
= /
costs margin
What
Whatis
isthe
thebreak-even
break-evensales
salesin
inunits?
units?


Sales (50,000 units) ? $20 100%
Variable costs ? 12
60% / or
Fixed costs 300,000
Break-even
= /
costs margin
Break-even
Break-evensales
sales==$300,000
$300,000//$8
$8==37,500
37,500units
units
What
Whatis
isthe
thebreak-even
break-evensales
salesin
indollars?
dollars?

Sales (50,000 units) ? $20 100%
Variable costs ? 12
60% / or
Fixed costs 300,000
Break-even
= /
costs margin
Break-even
Break-evensales
sales==$300,000
$300,000//$8
$8==37,500
37,500units
units
Break-even
Break-evensales
sales==$300,000
$300,000//40%
40%==$750,000
$750,000
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 $$250,000
250,000
Less:
Less: variable
variable expenses
expenses 150,000
150,000
Contribution
Contribution margin
margin 100,000
100,000
Less:
Less: fixed
fixed expenses
expenses 100,000
100,000
Net
Net income
income $$ --
Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without prior written consent of 7-26
McGraw-Hill Education.
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
Contribution-Margin Approach
Consider the following information

developed by the accountant at Curl, Inc.:
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
Contribution-Margin Approach
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 $$ 20,000
20,000
Contribution-Margin Approach (2/3)
Fixed expenses Break-even point
=
(in units)
Unit contribution margin
Total
Total Per
PerUnit
Unit Percent
Percent
Sales
Sales(500
(500surfboards)
surfboards) $$250,000
250,000 $$ 500
500 100%
100%
Less:
Less:variable
variableexpenses
expenses 150,000
150,000 300
300 60%
60%
Contribution
Contributionmargin
margin $$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 surfboards
$200
Contribution-Margin Approach (3/3)
Here is the proof!
Total
Total Per
Per Unit
Unit Percent
Percent
Sales
Sales (400
(400 surfboards)
surfboards) $$200,000
200,000 $$ 500500 100%
100%
Less:
Less: variable
variable expenses
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

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)
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 $$ --
$80,000
= $200,000 sales
40%
Learning
Objective
2
Learning
Objective
3
Cost-Volume-Profit Chart
$500
Total Sales
Sales and Costs ($000)
$450
$400
$350
$300
$250
$200
$150
$100
$ 50
0
1 2 3 4 5 6 7 8 9 10
Units of Sales (000)
Unit
Unitselling
sellingprice
price $$50
50
Unit
Unitvariable
variablecost
cost 30
30
Unit
Unitcontribution
contributionmargin
margin $$20
20
Total
Totalfixed
fixedcosts
costs $100,000
$100,000
$500
Total Sales
$450
$400
$350
$300
$250
$200
$150 60% Variable Costs
$100
$ 50
0
1 2 3 4 5 6 7 8 9 10
Unit
Unitselling
sellingprice
price $$50
50
Unit
Unitvariable
variablecost
cost 30
30
Unit
Unitcontribution
contributionmargin
margin $$
20
20
Total
Totalfixed
fixedcosts
costs $100,000
$100,000
$500
Total Sales
$450
$400
$350 Contribution
40%
$300 Margin
$250
$200
$150 60% Variable Costs
$100
$ 50
0
1 2 3 4 5 6 7 8 9 10
Unit
Unitselling
sellingprice
price $$50
50 100%
100%
Unit
Unitvariable
variablecost
cost 30
30 60%
60%
Unit
Unitcontribution
contributionmargin
margin $$20
20 40%
40%
Total
Totalfixed
fixedcosts
costs $100,000
$100,000
$500
Total Sales
$450
$400
Total Costs
$350
$300
Fixed Costs
$250
$200
Variable Costs
$150
$100
$ 50
0
1 2 3 4 5 6 7 8 9 10
Unit
Unitselling
sellingprice
price $$50
50
Unit
Unitvariable
variablecost
cost 30
30
Unit
Unitcontribution
contributionmargin
margin $$20
20
Total
Totalfixed
fixedcosts
costs $100,000
$100,000
$500
Total Sales
$450
$400
Total Costs
$350
$300
$250
$200
$150
$100
$ 50
0
1 2 3 4 5 6 7 8 9 10
Unit
Unitselling
sellingprice
price $$50
50
Unit
Unitvariable
variablecost
cost 30
30
Unit
Unitcontribution
contributionmargin
margin $$20
20
Total
Totalfixed
fixedcosts
costs $100,000
$100,000
$500
Total Sales
$450
Operating Profit Area
$400
Total Costs
$350
$300
$250
$200
$150
$100
$ 50 Operating Loss Area
0
1 2 3 4 5 6 7 8 9 10
Unit
Unitselling
sellingprice
price $$50
50
Unit
Unitvariable
variablecost
cost 30
30
Unit
Unitcontribution
contributionmargin
margin $$20
20
Total
Totalfixed
fixedcosts
costs $100,000
$100,000
$500
Total Sales
$450
$400
Total Costs
$350
$300
$250
$200
$150 Break-Even Point
$100
$ 50
0
1 2 3 4 5 6 7 8 9 10
Unit
Unitselling
sellingprice
price $$50
50
Unit
Unitvariable
variablecost
cost 30
30
Unit
Unitcontribution
contributionmargin
margin $$2020
Total
Totalfixed
fixedcosts
costs $100,000
$100,000
$500
Total Sales
$450
$400
Total Costs
$350
$300
$250
$200
$100
$ 50
0
1 2 3 4 5 6 7 8 9 10
Unit
Unitselling
sellingprice
price $$50
50
Unit
Unitvariable
variablecost
cost 30
30 $100,000
= 5,000 units
Unit
Unitcontribution
contributionmargin
margin $20
$20 $20
Total
Totalfixed
fixedcosts
costs $100,000
$100,000
Cost-Volume-Profit Chart (Break-Even)
$500
Total Sales
$450
$400
Total Costs
$350
$300
$250
$200
$100
0
1 2 3 4 5 6 7 8 9 10
Unit
Unitselling
sellingprice
price $$50
50
Unit
Unitvariable
variablecost
cost 30
30 $100,000
= 5,000 units
Unit
Unitcontribution
contributionmargin
margin $$20
20 $20
Total
Totalfixed
fixedcosts
costs $100,000
$100,000
Revised Cost-Volume-Profit Chart
$500
Total Sales
$450
$400
$350 Total Costs
$300
$250
$200
$150 Revised Break-
$100 Even Point
0
1 2 3 4 5 6 7 8 9 10
Unit
Unitselling
sellingprice
price $$50
50
Unit
Unitvariable
variablecost
cost 30
30 $80,000
= 4,000 units
Unit
Unitcontribution
contributionmargin
margin $$20
20 $20
Total
Totalfixed
fixedcosts
costs $80,000
$80,000
Profit-Volume Chart
$100
$75
$50
Operating Profit
(Loss) $000’s
$25
$ 0
$(25)
$(50) Relevant
Relevantrange
range
$(75) is
is10,000
10,000units.
units.
$(100)
1 2 3 4 5 6 7 8 9 10
Units of Sales (000’s)
Sales
Sales(10,000
(10,000units
unitsxx$50)
$50) $500,000
$500,000
Variable
Variablecosts
costs(10,000
(10,000units
unitsxx$30)
$30) 300,000
300,000
Contribution
Contributionmargin
margin(10,000
(10,000units
unitsxx$20)
$20) $200,000
$200,000
Fixed
Fixedcosts
costs 100,000
100,000
Operating
Operatingprofit
profit $100,000
$100,000
Profit-Volume Chart
$100
$75
$50
Operating Profit
(Loss) $000’s
$25
$ 0 Maximum
$(25) Maximumprofit
profit
within
withinthe
the
$(50)
relevant
relevantrange.
range.
$(75)
$(100)
1 2 3 4 5 6 7 8 9 10
Maximum Units of Sales (000’s)
Maximumlosslossisis
equal
equalto
tothe
thetotal
Sales total
(10,000
Sales (10,000units
unitsxx$50)
$50) $500,000
$500,000
fixed costs.
fixed costs.
Variable
Variablecosts
costs(10,000
(10,000units
unitsxx$30)
$30) 300,000
300,000
Contribution
Contributionmargin
margin(10,000
(10,000units
unitsxx$20)
$20) $200,000
$200,000
Fixed
Fixedcosts
costs 100,000
100,000
Operating
Operatingprofit
profit $100,000
$100,000
Profit-Volume Chart
$100
$75 Profit Line
$50
Operating Profit
(Loss) $000’s
Operating
$25
Profit
$ 0
$(25) Operating
$(50) Loss
$(75)
$(100)
1 2 3 4 5 6 7 8 9 10
Units of Sales (000’s)
Sales
Sales(10,000
(10,000units
unitsxx$50)
$50) $500,000
$500,000
Variable
Variablecosts
costs(10,000
(10,000units
unitsxx$30)
$30) 300,000
300,000
Contribution
Contributionmargin
margin(10,000
(10,000units
unitsxx$20)
$20) $200,000
$200,000
Fixed
Fixedcosts
costs 100,000
100,000
Operating
Operatingprofit
profit $100,000
$100,000
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.:
Cost-Volume-Profit Graph
450,000
400,000
350,000
300,000
250,000
Dollars
200,000
150,000
100,000
50,000
100 200 300 400 500 600 700 800

Units
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
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
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
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
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
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
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
Learning
Objective
4
Calculating a Planned Sales Level

Sales (50,000 units) ? $20 100%
Fixed costs 300,000
Income from operations $ 100,000
Fixed Target
Planned Contribution
costs + profit
sales = / margin
Fixed
Fixedcosts
costsplus
plusthe
thetarget
target
profit
profitequals
equalsthe
therequired
required
total
totalcontribution
contributionmargin.
margin.

Sales (50,000 units) ? $20 100%
Fixed costs 300,000
Planned Fixed Target Contribution

= costs + profit /
margin
sales
$8
$8per
perunit
unitor
or40%
40%


Sales (50,000 units) ? $20 100%
Fixed costs 300,000

sales = costs + profit /
margin
What
Whatis
isthe
theplanned
plannedsales
saleslevel
levelin
inunits?
units?


Sales (50,000 units) ? $20 100%
Fixed costs 300,000

sales = costs + profit / margin
Planned
Plannedsales
sales==($300,000
($300,000++$100,000)
$100,000)//$8
$8==50,000
50,000units
units
What
Whatis
isthe
theplanned
plannedsales
saleslevel
levelin
indollars?
dollars?

Sales (50,000 units) $1,000,000 $20 100%
Variable costs 600,000 12 60%
Fixed costs 300,000

sales = costs + profit / margin
Planned
Plannedsales
sales==($300,000
($300,000++$100,000)
$100,000)//$8
$8==50,000
50,000units
units
Planned
Plannedsales
sales==($300,000
($300,000++$100,000)
$100,000)//40%
40%==$1,000,000
$1,000,000
$1,000,000
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%
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
Target Net Profit
We can determine the total revenue that Curl

must make to earn a profit of $100,000 using
the contribution margin approach.
Fixed expenses + Target profit Total revenue to earn

=
contribution margin percentage the target profit
$80,000 + $100,000
= $450,000
40 %
Equation Approach
Sales revenue – Variable expenses – Fixed expenses = Profit
($500 × X) – ($300 × X) – $80,000 = $100,000
($200X) = $180,000
X = 900 surf boards or $450,000

Emma has fixed costs of $2,000 and a contribution
margin percentage of 40%.
If Emma wants to make a profit of $2,000, what
must revenue equal?
What if Emma wants to make a profit of $3,000,
what must revenue equal?
Remember the formula: (Fixed Cost+ Target

Operating Income) / Contribution Margin %
Let’s look at the details:

For OPERATING INCOME For OPERATING INCOME
of $2,000 of $3,000
Revenue=(FC+TOI)/CM% Revenue=(FC+TOI)/CM%
Revenue = Revenue =
(2,000+2,000)/.40 = (2,000+3,000)/.40 =
Revenue = $10,000 Revenue = $12,500

Profit Planning, Illustrated

Sensitivity Analysis
• CVP Provides structure to answer a variety
of “what-if” scenarios
• “What” happens to profit “if”:
– Cost structure changes
• Variable cost per unit changes
• Fixed cost changes
– Selling price changes
– Volume changes
Curl Data
Changes in Variable Costs
•• Curl
Curl is
is currently
currently selling
selling 500
500 surfboards
surfboards perper
year.
year.
•• The
The owner
owner believes
believes that
that the
the Variable
Variable Cost
Cost
would
would Increase
Increase byby 15
15 %% during
during the
the current
current
year.
year.
•• The
The owner
owner believes
believes that
that the
the Variable
Variable Cost
Cost
would
would decrease
decrease byby 10
10 %% during
during the
the current
current
year.
year.
Curl Data
Curl Data
Changes in Fixed Costs
•• Curl
Curl is
is 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 in in the
the annual
annual advertising
advertising budget,
budget,
would
would increase
increase sales
sales toto 540
540 units.
units.
 Should
Should the
the company
company increase
increase the
the advertising
advertising
budget?
budget?
Curl Data
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..
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
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)

Changes in Unit
Contribution Margin
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
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 begin to be incurred.
 The margin of safety calculation answers a
very important question:
 If budgeted revenues are above the
breakeven point, how far can they fall before
the breakeven point is reached. In other
words, how far can they fall before the
company will begin to lose money.

 An indicator of risk, the margin of safety
(MOS), measures the distance between
budgeted sales and breakeven sales:
 MOS = Budgeted Sales – BE Sales
 The MOS ratio removes the firm’s size from
the output, and expresses itself in the form
of a percentage:
 MOS Ratio = MOS ÷ Budgeted Sales

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. . Sales price and variable cost per
surfboard is $500 and $300 respectively.
Margin of Safety
Sales
Sales––Sales
Salesat
atbreak-even
break-evenpoint
point
Sales
Sales
Dollars Units
Sales $250,000 500
Break-even sales 200,000 400
Excess $ 50,000 100
Margin of Safety
Sales
Sales––Sales
Salesat
atbreak-even
break-evenpoint
point
Sales
Sales
Dollars Units
A Sales $250,000 500
Excess $ 50,000 100
Actual
Actualsales
saleslevel.
level.
Margin of Safety
Sales
Sales––Sales
Salesat
atbreak-even
break-evenpoint
point
Sales
Sales
Dollars Units
A Sales $250,000 500
B Excess $ 50,000 100
Margin of safety (B/A) 20%
Excess
Excessof
ofactual
actual What
Whatisisthe
themargin
marginof
of
sales
salesover
overthe
the safety
safetyas
asaapercentage?
percentage?
break-even
break-evensales.
sales.
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
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
Learning
Objective
5
 The formulae presented to this point have
assumed a single product is produced and
sold.
 A more realistic scenario involves multiple
products sold, in different volumes, with
different costs and different margins.
 In this case, we use the same formulae, but
use average contribution margins for the
multiple products.
 This technique assumes a constant mix at
different levels of total unit sales.

 CVP isn’t just for merchandising and
manufacturing companies.
 Service and Not-for-Profit businesses need to
focus on measuring their output which is
different from the units sold that we’ve been
dealing with.
 For example, a service agency might
measure how many persons they assist or an
airline might measure how many passenger
miles they fly.

Sales Mix Considerations
Contribution margin Products

A B
Sales $ 90 $140
Variable costs 70 95
Contribution margin $ 20 $ 45
Sales mix 80% 20%
What
Whatisisthe
theaverage
average
contribution
contributionfor
for
each
eachproduct?
product?

A B
Sales $ 90 $140
Sales mix 80% 20%
What
Whatisisthe
theaverage
average
contribution
contributionfor
for
each
eachproduct?
product?

A B
Sales $ 90 $140
Sales mix x 80% x 20%
Product contribution $ 16 $ 9
Total product contribution $ 25
Break-even sales units

Total fixed costs $200,000
Product contribution
$25
What
Whatisisthe
thebreak-even
break-evensales
salesunits?
units?

A B
Sales $ 90 $140

Product contribution
$25
What
Whatisisthe
thebreak-even
break-evensales
salesunits?
units?

A B
Sales $ 90 $140

= 8,000 units
Product contribution $25
Break-even sales units 8,000
Product A units (80%) 6,400
Product B units (20%) 1,600

A B
Sales $ 90 $ 140
Sales mix 60% 40%
IfIfthe
thesales
salesmix
mixisis60%
60%for
forproduct
product
AAandand40%
40%for
forproduct
productB,
B,what
whatis
is
the
thebreak-even
break-evensales
salesunits?
units?

A B
Sales $ 90 $140

= 6,667 units
Product contribution $30
Break-even sales units 6,667
Product A units (60%) 4,000
Product B units (40%) 2,667
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 assume Curl sells surfboards and sail

boards and see how we deal with break-
even analysis.
Products
Curl provides us with the following
information:
Products
Weighted-average unit contribution margin
$200 × 62.5%
$550 × 37.5%
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
Products
Break-even point
Break-even
= 514 combined unit sales
point
Learning
Objective
6
Learning
Objective
7
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
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
Alternative Income Statement
Formats
Learning
Objective
8
 Managers make strategic decisions that
affect the cost structure of the company.
 The cost structure is simply the relationship
of fixed costs and variable costs to total
costs.
 We can use CVP-based sensitivity analysis to
highlight the risks and returns as fixed costs
are substituted for variable costs in a
company’s cost structure.
 The risk-return trade-off across alternative
cost structures can be measured as operating
leverage.

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
the extent
extent toto which
which an
an organization
organization uses
uses fixed
fixed
costs
costs in
in its
its cost
cost structure.
structure.
– greatest in companies that have a high
proportion of fixed costs in relation to
variable costs.
 Operating leverage (OL) describes the effect that
fixed costs have on changes in operating income as
changes occur in units sold and contribution
margin.
 OL = Contribution Margin
Operating Income
Notice that the difference between the numerator

and the denominator in our formula = our fixed
costs.

Operating Leverage
• Operating Leverage (OL) is the effect that

fixed costs have on changes in operating
income as changes occur in units sold,
expressed as changes in contribution margin
– OL = Contribution Margin
Operating Income
• Notice these two items are identical, except

for fixed costs
Operating Leverage
Contribution Operating leverage is a

Contributionmargin
margin
measure of the relative mix of
Operating
Operatingincome
income variable costs and fixed costs.
Jones Inc. Wilson Inc.

Sales $400,000 $400,000
Variable costs 300,000 300,000
A Contribution margin $100,000 $100,000
Fixed costs 80,000 50,000
B Income from operations $20,000 $ 50,000
Operating leverage (A/B)
What
Whatisisthe
theoperating
operatingleverage?
leverage?
Operating Leverage

Contributionmargin
margin
Operating
Operatingincome

Sales $400,000 $400,000
Operating leverage (A/B) 5 2
What
Whatdo
dothese
thesenumbers
numbersmean?
mean?
Operating Leverage

Contributionmargin
margin
Operating
Operatingincome

Sales $400,000 $400,000
Operating leverage (A/B) 5 2
Capital Labor
intensive? intensive?
Measuring Operating Leverage
Operating leverage Contribution margin
=
factor Net income
$100,000
= 5
$20,000
The formula to estimate the change in
operating income that will result from a
percentage change in sales is:
Operating Leverage X % Change in Sales

If sales increase 50% and operating leverage is
1.67, you should expect operating income to
increase 83.5%.

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
9
CVP Analysis, Activity-Based Costing,
and Advanced Manufacturing Systems
An activity-based costing system can provide
a much more complete picture of cost-
volume-profit relationships and thus provide
better information to managers.
Break-even = Fixed costs

point Unit contribution margin
Learning
Objective
10
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
11
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
CVP and Income Taxes
• From time to time it is necessary to move back

and forth between pre-tax profit (OI) and after-tax
profit (NI), depending on the facts presented
• After-tax profit can be calculated by:
– OI x (1-Tax Rate) = NI
• NI can substitute into the profit planning equation
through this form:
– OI = I I NI I
(1-Tax Rate)
Multiple Cost Drivers
• Variable costs may arise from multiple cost
drivers or activities. A separate variable
cost needs to be calculated for each driver.
Examples include:
– Customer or patient count
– Passenger miles
– Patient days
– Student credit-hours
End of Chapter 4
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Chapter Four

The reliability of cost-volume-profit analysis

© 2009 Pearson Prentice Hall. All rights reserved.

© 2009 Pearson Prentice Hall. All rights reserved.

© 2009 Pearson Prentice Hall. All rights reserved.

Remember this last equation, it will be used again in a

© 2009 Pearson Prentice Hall. All rights reserved.

© 2009 Pearson Prentice Hall. All rights reserved.

Contribution Margin per Unit

Contribution Margin Percentage

© 2009 Pearson Prentice Hall. All rights reserved.

© 2009 Pearson Prentice Hall. All rights reserved.

© 2009 Pearson Prentice Hall. All rights reserved.

Total Per Unit Percent

© 2009 Pearson Prentice Hall. All rights reserved.

Total Per Unit Percent

© 2009 Pearson Prentice Hall. All rights reserved.

Total Per Unit Percent

Total Per Unit Percent

© 2009 Pearson Prentice Hall. All rights reserved.

Total Per Unit Percent

© 2009 Pearson Prentice Hall. All rights reserved.

Total Per Unit Percent

© 2009 Pearson Prentice Hall. All rights reserved.

Total Per Unit Percent

Total Per Unit Percent

Unit Sales Unit Sales

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

Consider the following information

For each additional surf board sold, Curl

Here is the proof!

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

Calculate the break-even point in sales dollars rather

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

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

Total Per Unit Percent

Total Per Unit Percent

Planned Fixed Target Contribution

© 2009 Pearson Prentice Hall. All rights reserved.

Total Per Unit Percent

Planned Fixed Target Contribution

© 2009 Pearson Prentice Hall. All rights reserved.

Total Per Unit Percent

Planned Fixed Target Contribution

Total Per Unit Percent

Planned Fixed Target Contribution

We can determine the number of surfboards

Fixed expenses + Target profit Units sold to earn

We can determine the total revenue that Curl

Fixed expenses + Target profit Total revenue to earn

Sales revenue – Variable expenses – Fixed expenses = Profit

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

X = 900 surf boards or $450,000

Remember the formula: (Fixed Cost+ Target

Let’s look at the details:

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Revenue = $10,000 Revenue = $12,500