Chapter 22

CostvolumeProfit Analysis
"/ective 1
!dentify how changes in volume affect
costs.
VariabIe
Fixed
Mixed
'ypes of Costs
Minutes TaIked
T
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L
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D
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T
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B
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Total variable costs change
when activity changes.
Your totaI Iong distance
teIephone biII is based
on how many minutes
you taIk.
'otal varia/le Cost
Minutes TaIked
P
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M
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T
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p
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C
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a
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g
e
varia/le costs per unit do not change
as activity increases.
The cost per Iong
distance
minute taIked is
constant.
For exampIe, 10
cents per minute.
varia/le Cost Per Unit
varia/le Costs Example
Consider Crand Canyon Railway.
Assume that /reakfast costs Crand
Canyon Railway $3 per person.
!f the railroad carries 2,000 passengers,
it will spend $6,000 for /reakfast
services.
varia/le Costs Example
0 1 2 3 4 5
$24
$18
$12
$6

Volume
(Thousands of passengers)
T
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V
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C
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(
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umber of LocaI CaIIs
M
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B
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T
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p
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B
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Total fixed costs remain unchanged
when activity changes.
Your monthIy
basic
teIephone biII
probabIy
does not change
when
you make more
IocaI caIIs.
'otal Fixed Cost
ixed Costs
Contain fixed portion that is incurred
even when facility is unused S varia/le
portion that increases with usage.
Example: monthly electric utility charge
Fixed service fee
varia/le charge per kilowatt hour used
VariabIe
UtiIity Charge
Activity (KiIowatt Hours)
T
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U
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C
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Fixed MonthIy
UtiIity Charge
ixed Costs
Relevant Range...
.is a /and of volume in which a specific
relationship exists /etween cost and
volume.
"utside the relevant range, the cost
either increases or decreases.
A fixed cost is fixed only within a given
relevant range and a given time span.
Relevant Range
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C
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Volume in Units
$160,000
$120,000
$80,000
$40,000
0 5,000 10,000 15,000 20,000 25,000

Relevant Range
"/ective 2
Use CvP analysis to compute /reakeven
point.
Assumptions of CvP Analysis
Expenses can /e classified as either
varia/le or fixed.
CvP relationships are linear over a wide
range of production and sales.
Sales prices, unit varia/le cost, and
total fixed expenses will not vary within
the relevant range.
Assumptions of CvP Analysis
volume is the only cost driver.
'he relevant range of volume is
specified.
!nventory levels will /e unchanged.
'he sales mix remains unchanged
during the period.
Contri/ution argin !ncome
Statement
Sales
varia/le Costs
Contri/ution argin
Fixed Costs
"perating !ncome
Contri/ution argin Example
Luis and 'om manufacture a device
that allows users to take a closer look
at ice/ergs from a ship.
'he usual price for the device is $100.
varia/le costs are $70 per unit.
'hey receive a proposal from a
company in Newfoundland to sell
20,000 units at a price of $8S.
Contri/ution argin Example
'here is sufficient capacity to produce
the order.
How do we analyze this situation?
$8S - $70 = $1S contri/ution margin.
$1S 20,000 units = $300,000 (total
increase in contri/ution margin)
Contri/ution argin !ncome
Statement
Sales (20,000 x $8S) $1,700,000
varia/le costs
(20,000 x $70) (1,400,000)
Contri/ution margin $300,000
'he unique sales level at which a
company earns neither a profit nor
incurs a loss.
Sales - varia/le Costs - Fixed Costs = 0
Computing BreakEven Point
Breakeven Point Example
Let's look /ack at Luis and 'om's
manufacturing, assuming that the fixed cost
are $30,000.
"/ective 3
Use CvP analysis for profit planning and
graph the costvolumeprofit relations
VoIume in Units
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a
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R
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D
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s
TotaI fixed costs
PIot totaI fixed costs on the verticaI axis.
Preparing a CvP Chart
TotaI costs
Draw the totaI cost Iine with a sIope
equaI to the unit variabIe cost.
VoIume in Units
C
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a
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d

R
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D
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TotaI fixed costs
Preparing a CvP Chart
TotaI costs
SaIes
Starting at the origin, draw the saIes Iine
with a sIope equaI to the unit saIes price.
Break-
even
Point
various Sales Levels Example
What operating income is expected
when sales are _____ units?
'arget "perating !ncome
Example
Suppose that our /usiness would /e
content with operating income of
_________________.
How many units must /e sold?
"/ective 4
Use CvP method to perform sensitivity
analysis.
Change in Sales Price Example
Suppose that the sales price per device
is _____ rather than ____
What is the revised /reakeven sales in
units?
Change in varia/le Costs
Example
Suppose that varia/le expenses per
device are ____ instead of ____
"ther factors remain unchanged.
Change in Fixed Costs
Example
Suppose that fixed costs increased /y
$30,000.
What are the new fixed costs?
What is the new /reakeven point?
argin of Safety Example
Excess of expected sales over
/reakeven sales.
E227
AtIanta Braves
$-
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
$7,000
- 50 100 150 200 250
(in thousands)
(
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t
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)
Revenues
Total Expense
Fixed expense
Break even point
Break even in units = 1,200,000
Break even in $ = 1,200,000 x 24 = $28,800,000
Effect of sales mix on CvP
analysis.
Computing ultiproduct
BreakEven Point
Unit contri/ution margin is replaced
with contri/ution margin for a
composite unit.
A composite unit is composed of
specific num/ers of each product in
proportion to the product sales mix.
Sales mix is the ratio of the volumes of
the various products.
'he resulting /reakeven formula
for composite unit sales is:
Break-even point
in composite units
Fixed costs
Contribution margin
per composite unit
=
Computing ultiproduct
BreakEven Point

Windows Doors
SeIIing Price $200 $500
VariabIe Cost 125 350
Unit Contribution 75 $ 150 $
SaIes Mix Ratio 4 1
Computing ultiproduct
BreakEven Point
A company sells windows and doors. 'hey sell
4 windows for every door.
Step 1: Compute contribution margin per
composite unit.
Computing ultiproduct
BreakEven Point
Windows Doors
SeIIing Price $200 $500
VariabIe Cost 125 350
Unit Contribution 75 $ 150 $
SaIes Mix Ratio
Composite C/M
Break-even point
in composite units
Fixed costs
Contribution margin
per composite unit
=
Step 2: Compute break-even point in
composite units.
Computing ultiproduct
BreakEven Point
Break-even point
in composite units
Fixed costs
Contribution margin
per composite unit
=
Break-even point
in composite units
$900,000
$450 per composite
unit
=
Step 2: Compute break-even point in
composite units.
Computing ultiproduct
BreakEven Point
Break-even point
in composite units
= 2,000 composite units
SaIes Composite
Product Mix Units Units
Window 4 2,000 = 8,000
Door 1 2,000 = 2,000

Step 3: Determine the number of windows and
doors that must be soId to break even.
Computing ultiproduct
BreakEven Point

Windows Doors Combined
SeIIing Price $200 $500
VariabIe Cost 125.00 350.00
Unit Contribution 75.00 $ 150.00 $
SaIes VoIume 8,000 2,000
TotaI Contribution 600,000 $ 300,000 $ 900,000 $
Fixed Costs 900,000
Income $ 0
Step 4: Verify the resuIts.
ultiproduct BreakEven
!ncome Statement