CMA CMA2 BookOnline SU10 Outline

1
STUDY UNIT TEN

CVP ANALYSIS
10.1 Short-Run Profit Maximization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

10.2 Cost-Volume-Profit (CVP) Analysis -- Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
10.3 CVP Analysis -- Basic Calculations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
10.4 CVP Analysis -- Target Income Calculations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
10.5 CVP Analysis -- Multi-Product Calculations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
This study unit is the first of two on decision analysis. The relative weight assigned to this major
topic in Part 2 of the exam is 25%. The two study units are
Study Unit 10: CVP Analysis
Study Unit 11: Marginal Analysis and Pricing
If you are interested in reviewing more introductory or background material, go to
www.gleim.com/CMAIntroVideos for a list of suggested third-party overviews of this topic. The
following Gleim outline material is more than sufficient to help you pass the CMA exam. Any additional
introductory or background material is for your personal enrichment.
10.1 SHORT-RUN PROFIT MAXIMIZATION

1. Marginal Revenue and Marginal Cost
a. Marginal revenue is the additional (incremental) revenue produced by generating one more
unit of output. It is the difference in total revenue at each level of output.
1) Marginal product is the incremental output obtained by adding one unit of a variable
input factor.
2) While total revenue keeps increasing with the sale of additional units, it increases by
ever smaller amounts. This is reflected in a constantly decreasing marginal revenue.
3) EXAMPLE: A company has the following revenue data for one of its products:
Units of Unit Total Marginal
Output Price Revenue Revenue
1 × $580 = $ 580 $580
2 × 575 = 1,150 570
3 × 570 = 1,710 560
4 × 565 = 2,260 550
5 × 560 = 2,800 540
6 × 555 = 3,330 530
7 × 550 = 3,850 520
8 × 545 = 4,360 510
9 × 540 = 4,860 500
10 × 535 = 5,350 490
11 × 530 = 5,830 480
12 × 525 = 6,300 470
a) Revenue by itself cannot determine the proper level of output. Cost data must
also be considered.
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2 SU 10: CVP Analysis
b. Marginal cost is the additional (also called incremental) cost incurred by generating one
additional unit of output. Mathematically, it is the difference in total cost at each level of
output.
1) Typically, unit cost decreases for a while as the process becomes more efficient. Past
a certain point, however, the process becomes less efficient and unit cost increases.
a) Thus, while total cost increases gradually for a while, at some point it begins to
increase sharply. This is reflected in a decreasing, then increasing, marginal
cost.
2) EXAMPLE: A company has the following cost data for the product (for simplicity, each
unit of output requires exactly one unit of input):
Units of Unit Total Marginal
Output Cost Cost Cost
1 $570 $ 570 $570
2 405 810 240
3 340 1,020 210
4 305 1,220 200
5 287 1,435 215
6 279 1,675 240
7 279 1,955 280
8 284 2,275 320
9 295 2,655 380
10 310 3,095 440
11 327 3,595 500
12 347 4,165 570
2. Profit Maximization
a. The firm’s goal is to maximize profits, not revenues. Thus, marginal revenue data must be
compared with marginal cost data to determine the point of profit maximization.
1) Profit is maximized at the output level where marginal revenue equals marginal cost.
Profit Maximization
Marginal revenue = Marginal cost
a) Beyond this point, increasing production results in a level of costs so high that
the total profit is diminished.
SU 10: CVP Analysis 3
2) EXAMPLE: Comparing its marginal revenue and marginal cost data allows the
company to determine the point of profit maximization.
Units of Marginal Total
Output Revenue Cost Profit Revenue Cost Profit
1 $580 – $570 = $ 10 $ 580 – $ 570 = $ 10
2 570 – 240 = 330 1,150 – 810 = 340
3 560 – 210 = 350 1,710 – 1,020 = 690
4 550 – 200 = 350 2,260 – 1,220 = 1,040
5 540 – 215 = 325 2,800 – 1,435 = 1,365
6 530 – 240 = 290 3,330 – 1,675 = 1,655
7 520 – 280 = 240 3,850 – 1,955 = 1,895
8 510 – 320 = 190 4,360 – 2,275 = 2,085
9 500 – 380 = 120 4,860 – 2,655 = 2,205
10 490 – 440 = 50 5,350 – 3,095 = 2,255
11 480 – 500 = (20) 5,830 – 3,595 = 2,235
12 470 – 570 = (100) 6,300 – 4,165 = 2,135
a) Beyond the output level of 10 units, marginal profit turns negative. Note that this
is, by definition, the point of highest total profit.
3. Short-Run Cost Relationships
a. To make marginal analysis meaningful, total cost must be broken down into its fixed and
variable components.
1) EXAMPLE: Cost analysis reveals that the inputs to the company’s process have the
following cost structure:
Units of Total Costs Fixed Costs Variable Costs

Output In Total Average In Total Average In Total Average
1 $ 570 $570 $300 $300 $ 270 $270
2 810 405 300 150 510 255
3 1,020 340 300 100 720 240
4 1,220 305 300 75 920 230
5 1,435 287 300 60 1,135 227
6 1,675 279 300 50 1,375 229
7 1,955 279 300 43 1,655 236
8 2,275 284 300 38 1,975 247
9 2,655 295 300 33 2,355 262
10 3,095 310 300 30 2,795 280
11 3,595 327 300 27 3,295 300
12 4,165 347 300 25 3,865 322
b. These relationships can be depicted graphically as follows:

Legend
MC = marginal cost
ATC = average total cost
AVC = average variable cost
AFC = average fixed cost
Figure 10-1
1) Average fixed cost (AFC) declines for as long as production increases. This is because
the fixed amount of cost is being spread over more and more units.
a) AFC is thus an asymptotic function, always approaching the x axis without ever
intersecting with it.
2) Average variable cost (AVC) declines quickly and then gradually begins increasing.
a) AVC is at its lowest where MC crosses it, between 5 and 6 units. This is
confirmed by reference to the data in the tables (MC: $215-$240, AVC: $227-
$229).
3) Average total cost (ATC) behaves similarly. It declines rapidly and then begins a
gradual increase.
a) ATC also reaches its minimum at the point where MC crosses it, just after 7 units
(MC: $280, AVC: $279).
4) As a general statement, ATC = AFC + AVC.
a) Thus, the distance between the ATC and AVC curves is always the same as the
distance between the AFC curve and the x axis.
4. Pure Competition
a. A purely competitive market is characterized by a large number of buyers and sellers
acting independently and a homogeneous or standardized product (e.g., agricultural
commodities).
1) Marginal revenue equals price.
2) EXAMPLE: A firm in pure competition has the following revenue data:
Unit Price
Units of (Average Total Marginal
Output Revenue) Revenue Revenue
1 × $960 = $ 960 $960
2 × 960 = 1,920 960
3 × 960 = 2,880 960
4 × 960 = 3,840 960
5 × 960 = 4,800 960
6 × 960 = 5,760 960
7 × 960 = 6,720 960
8 × 960 = 7,680 960
b. The following graph depicts the relationships among total revenue (TR), average revenue
(AR), and marginal revenue (MR) for a firm in pure competition.
Figure 10-2
1) TR is a straight line with a constant positive slope. The price, MR, and AR curves are
identical.
c. As noted in item 2.a.1), short-run profit maximization is achieved when marginal revenue
equals marginal cost. As long as the next unit of output adds more in revenue (MR) than in
cost (MC), the firm will increase total profit or decrease total losses.
1) For a purely competitive firm, price = MC is the same as MR = MC.
2) EXAMPLE: The firm has performed the following marginal analysis:
Units of Revenue Cost Profit

Output Total Marginal Total Marginal Total Marginal
1 $ 960 $960 $1,800 $1,800 $(840) $(840)
2 1,920 960 2,500 700 (580) 260
3 2,880 960 3,100 600 (220) 360
4 3,840 960 3,600 500 240 460
5 4,800 960 4,200 600 600 360
6 5,760 960 5,080 880 680 80
7 6,720 960 6,040 960 680 0
8 7,680 960 7,160 1,120 520 (160)
3) The following graph depicts the short-run profit-maximizing quantity for a firm in pure
competition (a “price taker”):
Figure 10-3
a) Being in a purely competitive industry, the firm has no choice but to find its price
along the horizontal MR curve.
b) The profit-maximizing quantity to produce is found at the point where the MC
curve crosses MR.
c) Point A reveals a quantity of 7 units. This is confirmed by consulting the table
and verifying that at an output of 7, MR = MC.
5. Monopoly
a. In a monopoly market, the industry consists of one firm and the product has no close
substitutes.
1) Marginal revenue is less than price.
2) To increase sales of its product, a monopolist generally must lower its price.
3) Thus, a monopolist’s marginal revenue continuously decreases as it raises output.
Past the point where MR = $0, the monopolist’s total revenue begins to decrease.
Unit Price
Units of (Average Total Marginal
Output Revenue) Revenue Revenue
1 × $960 = $ 960 $960
2 × 910 = 1,820 860
3 × 860 = 2,580 760
4 × 810 = 3,240 660
5 × 760 = 3,800 560
6 × 710 = 4,260 460
7 × 660 = 4,620 360
8 × 610 = 4,880 260
4) The monopolist has the power to set output at the level where profits are maximized,
that is, where MR = MC. This is called “price searching.”
Price Searching for a Monopolist
Units of Revenue Cost Profit
Output Total Marginal Total Marginal Total Marginal
1 $ 960 $960 $ 800 $ 800 $ 160 $ 160
2 1,820 860 1,480 680 340 180
3 2,580 760 1,980 500 600 260
4 3,240 660 2,320 340 920 320
5 3,800 560 2,800 480 1,000 80
6 4,260 460 3,480 680 780 (220)
7 4,620 360 4,620 1,140 0 (780)
8 4,880 260 5,920 1,300 (1,040) (1,040)
a) Profit is maximized at an output of 5 units.
6. Monopolistic Competition
a. An industry in monopolistic competition has a large number of firms that produce
differentiated products. The number is fewer than in pure competition, but it is great enough
that firms cannot collude. That is, they cannot act together to restrict output and fix the
price.
1) To maximize profits (or minimize losses) in the short run or long run, a firm in
monopolistic competition produces at the level of output at which MR = MC.
7. Oligopoly
a. An oligopoly is an industry with a few large firms. Firms operating in an oligopoly are
mutually aware and mutually interdependent. Their decisions as to price, advertising, etc.,
are to a very large extent dependent on the actions of the other firms.
1) Prices tend to be rigid (sticky) because of the interdependence among firms.
2) For example, if one oligopolist lowers prices, sales will not increase because the other
firms will lower prices. As a result, profits in the industry will decline because of the
lower prices.
10.2 COST-VOLUME-PROFIT (CVP) ANALYSIS -- THEORY

1. Purpose
a. Also called breakeven analysis, CVP analysis is a tool for understanding the interaction of
revenues with fixed and variable costs.
1) It illuminates how changes in assumptions about cost behavior and the relevant
ranges (defined in CMA Part 1 in Study Unit 5, Subunit 2) in which those assumptions
are valid may affect the relationships among revenues, variable costs, and fixed costs
at various production levels.
2) Thus, CVP analysis allows management to discern the probable effects of changes in
sales volume, sales price, product mix, etc.
b. The breakeven point is the level of output at which total revenues equal total expenses.
1) It is the point at which all fixed costs have been covered and operating income is zero.
2) CVP analysis is used not only for planning but also to assist in determining whether to
accept a special order.
2. Assumptions of CVP
a. Cost and revenue relationships are predictable and linear. These relationships are true over
the relevant range of activity and specified time span.
b. Unit selling prices do not change.
c. Inventory levels do not change; i.e., production equals sales.
d. Total variable costs change proportionally with volume, but unit variable costs do not
change.
e. Fixed costs remain constant over the relevant range of volume, but unit fixed costs vary
indirectly with volume.
f. The relevant range of volume may vary based on the time frame (e.g., operating period)
being considered. Therefore, the classification of fixed and variable costs may vary each
time frame.
g. The revenue (sales) mix does not change.
h. The time value of money is ignored.
3. A managerial accountant is not limited to the CVP assumptions in item 2. on the previous page.
Alternative planning assumptions may be derived from sensitivity analysis.
a. This process observes the effects on a mathematical model when the input parameters
change. Thus, if the trade-off between fixed and variable costs has not yet been decided,
CVP analysis can be computed multiple times to determine the effects of various options.
4. Breakeven Point for a Single Product
a. The breakeven point can be calculated in units and in sales dollars.
1) The simplest calculation for breakeven in units is to divide fixed costs by the unit
contribution margin (UCM).
2) The breakeven point in sales dollars equals fixed costs divided by the contribution
margin ratio (CMR).
EXAMPLE 10-1 BEP -- One Product

A manufacturer’s product has a unit sales price of $0.60 and a unit variable cost of $0.20. Fixed costs are
$10,000.
Unit selling price $0.60
Minus: Unit variable costs (0.20)
Unit contribution margin (UCM) $0.40
Breakeven point in units = Fixed costs ÷ UCM

= $10,000 ÷ $0.40
= 25,000 units
The manufacturer’s contribution margin ratio is 66.667% ($0.40 ÷ $0.60).
Breakeven point in dollars = Fixed costs ÷ CMR
= $10,000 ÷ .66667
= $15,000
5. Margin of Safety
a. The margin of safety is the excess of budgeted sales over breakeven sales.
1) It is the amount by which sales can decline before losses occur.
Margin of safety = Planned sales – Breakeven sales
2) The margin of safety ratio shows the percent by which sales can decline before the
breakeven point is reached.
EXAMPLE 10-2 Margin of Safety

In units: In dollars:
Margin of safety = Planned sales – Breakeven sales Margin of safety = Planned sales – Breakeven sales
= 35,000 – 25,000 = (35,000 units × $0.60) – $15,000
= 10,000 units = $21,000 – $15,000
= $6,000
Margin of safety Margin of safety
Margin of safety ratio = Margin of safety ratio =
Planned sales Planned sales
10,000 $6,000
= =
35,000 $21,000
= 28.6% = 28.6%
10.3 CVP ANALYSIS -- BASIC CALCULATIONS

The ability to apply the mathematical principles of breakeven analysis quickly is a crucial skill on Part 2
of the CMA exam. This subunit consists entirely of questions that “drill” the candidate on this ability.
Please review Subunit 10.2 before attempting to answer the questions in this subunit.
10.4 CVP ANALYSIS -- TARGET INCOME CALCULATIONS

1. Target Operating Income
a. An amount of operating income, either in dollars or as a percentage of sales, is frequently
required.
1) By treating target income as an additional fixed cost, CVP analysis can be applied.
EXAMPLE 10-3 Target Unit Volume

The manufacturer from the previous example with the $0.40 contribution margin per unit wants to find out how
many units must be sold to generate $25,000 of operating income.
Target unit volume = (Fixed costs + Target operating income) ÷ UCM
= ($10,000 + $25,000) ÷ $0.40
= $35,000 ÷ $0.40
= 87,500 units
2. Target Net Income

a. A variation of this problem asks for net income (an after-tax amount) instead of operating
income (a pretax amount).
1) EXAMPLE: The manufacturer wants to generate $30,000 of net income. The effective
tax rate is 40%.
Target unit volume = {Fixed costs + [Target net income ÷ (1.0 – .40)]} ÷ UCM
= [$10,000 + ($30,000 ÷ .60)] ÷ $.40
= 150,000 units
3. Other Target Income Situations
a. Other target income situations call for the application of the standard formula for operating
income.
EXAMPLE 10-4 Target Operating Income

If units are sold at $6.00 and variable costs are $2.00, how many units must be sold to realize operating
income of 15% ($6.00 × .15 = $.90 per unit) before taxes, given fixed costs of $37,500?
Operating income = Sales – Variable costs – Fixed costs
$0.90 × Q = ($6.00 × Q) – ($2.00 × Q) – $37,500
$3.10 × Q = $37,500
Q = 12,097 units
Selling 12,097 units results in $72,582 of revenues. Variable costs are $24,194, and operating income is
$10,888 ($72,582 × 15%). The proof is that variable costs of $24,194, plus fixed costs of $37,500, plus
operating income of $10,888, equals $72,582 of sales.
b. The operating income formula can also be used in the following situation:
EXAMPLE 10-5 After-Tax Target Net Income

If variable costs are $1.20, fixed costs are $10,000, and selling price is $2, and the company targets a $5,000
after-tax profit when the tax rate is 30%, the calculation is as follows:
$ 2Q = [$5,000 ÷ (1.0 – 0.3)] + $1.20Q + $10,000
$.8Q = $7,142.86 + $10,000
$.8Q = $17,142.86
Q = $17,142.86 ÷ .8
Q = 21,428.575 units
If the company plans to sell 21,429 units at $2 each, revenue will be $42,858. The following is the pro forma
income statement for the target net income:
Sales (21,429 × $2) $ 42,858
Less: Variable costs (21,429 × $1.20) (25,715)
Contribution margin $ 17,143
Less: Fixed costs (10,000)
Operating income $ 7,143
Income taxes (30%) (2,143)
Net income $ 5,000
10.5 CVP ANALYSIS -- MULTI-PRODUCT CALCULATIONS

1. Multiple Products (or Services)
a. A multi-product breakeven point in units can be calculated as follows:
1) The weighted-average selling price and weighted-average variable costs are

calculated using the sales percentage of the individual products in the total sales mix.
2) The multi-product breakeven point provides the breakeven point of composite units,
which is a mixture of all the different products.
a) From this, individual breakeven points can be calculated.
3) No unique breakeven point exists in a multi-product problem. The breakeven point
varies with the sales mix. It is lower if a greater quantity of high-contribution-margin
product is sold and vice versa.
b. A multi-product breakeven point in sales dollars can be calculated as follows:
EXAMPLE 10-6 Multi-Product BEP

A manufacturer produces two products, Product V and Product W. Total fixed costs are $75,000. Variable cost and
sales data for these products are as follows:
Product V Product W
Selling price per unit $10 $18
Variable cost per unit $7 $14
Budget sales (units) 6,000 18,000
The multi-product breakeven point in units can be calculated as follows:
Weighted-average UCM =
= ($3 × 25%) + ($4 × 75%)
= $3.75
Multi-product breakeven point =
=
= 20,000 composite units
Therefore, the breakeven point in Product V
=
= 5,000 units
Therefore, the breakeven point for Product W
=
= 15,000 units
The multi-product breakeven point in sales dollars can be calculated as follows:
Weighted-average CMR =
$3.75
Weighted-average CMR =
$3.75
=
($10 × 25%) + ($18 × 75%)
=
= 0.234375
Multi-product breakeven point =
=
= $320,000
2. Choice of Product
a. When resources are limited, a company may produce only a single product.
1) A breakeven analysis of the point where the same operating income or loss will result,
regardless of the product selected, is calculated by setting the breakeven formulas of
the individual products equal to each other.
2) EXAMPLE: Assume a lessor can rent property to either of two lessees. One lessee
offers a rental fee of $100,000 per year plus 2% of revenues. The other lessee offers
$20,000 per year plus 5% of revenues. The optimal solution depends on the level of
revenues. A typical CMA question asks at what level the lessor will be indifferent. The
solution is to equate the two formulas as follows:
$100,000 + .02 R = $20,000 + .05 R
.03 R = $80,000
R = $80,000 ÷ .03
R = $2,666,667
Where: R = revenues
Thus, if revenues are expected to be less than $2,666,667, the lessor would prefer
the larger fixed rental of $100,000 and the smaller variable rental.

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STUDY UNIT TEN

10.1 Short-Run Profit Maximization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

10.1 SHORT-RUN PROFIT MAXIMIZATION

Units of Total Costs Fixed Costs Variable Costs

b. These relationships can be depicted graphically as follows:

Units of Revenue Cost Profit

10.2 COST-VOLUME-PROFIT (CVP) ANALYSIS -- THEORY

EXAMPLE 10-1 BEP -- One Product

Breakeven point in units = Fixed costs ÷ UCM

EXAMPLE 10-2 Margin of Safety

10.3 CVP ANALYSIS -- BASIC CALCULATIONS

10.4 CVP ANALYSIS -- TARGET INCOME CALCULATIONS

EXAMPLE 10-3 Target Unit Volume

2. Target Net Income

EXAMPLE 10-4 Target Operating Income

EXAMPLE 10-5 After-Tax Target Net Income

10.5 CVP ANALYSIS -- MULTI-PRODUCT CALCULATIONS

1) The weighted-average selling price and weighted-average variable costs are

EXAMPLE 10-6 Multi-Product BEP

Multi-product breakeven point =

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