Management Accounting

Lecture 3
Dr. Jagriti Arora
 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 $ -

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 Per Unit Percent

Sales (500 surf boards) $250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $100,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ 20,000

7-4
 Contribution-Margin Approach

Fixed expenses Break-even point

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

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

Here is the proof!

Total Per Unit Percent

Sales (400 surf boards) $200,000 $ 500 100%
Less: variable expenses 120,000 300 60%
Contribution margin $ 80,000 $ 200 40%
Less: fixed expenses 80,000
Net 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 Per Unit Percent

Sales (400 surf boards) $200,000 $ 500 100%
Less: variable expenses 120,000 300 60%
Contribution margin $ 80,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ -

$80,000
= $200,000 in 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.:

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

7-9
 Cost-Volume-Profit Graph
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

7-10
 Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000

250,000
Dollars

200,000
ns es
x p e
150,000 ot a le
T
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
x p e
150,000 ot a le
T
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
le s
350,000 l s a
a
Tot
300,000

250,000
Dollars

200,000
ns es
x p e
150,000 ot a le
T
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
le s
l s a a
350,000
a re
Break-even Tot fi t a
300,000
point Pr o
250,000
Dollars

200,000
ns es
x p e
150,000 ot a le
T
Fixed expenses
r ea
100,000
s a
50,000
L os

100 200 300 400 500 600 700 800

Units

7-14
 Profit-Volume Graph
Some managers like the profit-volume
graph because it focuses on profits and volume.

100,000

80,000

60,000
Break-even
point r ea
it a
40,000

r of
20,000 P
Profit

0 `

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

r ea Units
(40,000) s a
s
(60,000)
Lo

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
 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.

7-18
 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.
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

7-19
 Changes in Fixed Costs

••Curl
Curl isis currently
currently selling
selling 500
500 surfboards
surfboards perper
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 to
to 540
540 units.
units.

Should
Should the
the company
company increase
increase the
the advertising
advertising
budget?
budget?
7-20
 Changes in Fixed Costs

Current Proposed
Sales Sales
(500 Boards) (540 Boards)
Sales $ 250,000 $ 270,000
Less: variable expenses 150,000 162,000
Contribution margin $ 100,000 $ 108,000
Less: fixed expenses 80,000 90,000
Net income $ 20,000 $ 18,000

540 units × $500 per unit = $270,000

$80,000 + $10,000 advertising = $90,000

7-21
 Changes in Fixed Costs

Sales will increase by Current Proposed

$20,000, but net income Sales Sales
decreased by $2,000. (500 Boards) (540 Boards)
Sales $ 250,000 $ 270,000
Less: variable expenses 150,000 162,000
Contribution margin $ 100,000 $ 108,000
Less: fixed expenses 80,000 90,000
Net income $ 20,000 $ 18,000

7-22
 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)

7-23
 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
7-24
 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 7-25
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 sailboards

and see how we deal with break-even analysis.

7-26
CVP Analysis with Multiple Products

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%

7-27
CVP Analysis with Multiple Products

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%
7-28
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

7-29
CVP Analysis with Multiple Products

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

Breakeven % of Individual
Description Sales Total Sales
Surfboards 514 62.5% 321
Sailboards 514 37.5% 193
Total units 514

7-30
 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).
7-31