MANAGERIAL ACCOUNTING

COST-VOLUME-PROFIT
ANALYSIS

8-1
 COST-VOLUME-PROFIT ANALYSIS
After completing this chapter, you should be able to:
1. Compute a break-even point using the contribution-margin approach
and the equation approach.
2. Compute the contribution-margin ratio and use it to find the break-even
point in sales dollars.
3. Prepare a cost-volume-profit (CVP) graph and explain how it is used.
4. Apply CVP analysis to determine the effect on profit of change in fixed
expenses, variable expenses, sales prices, and sales volume.
5. Compute the break-even point and prepare a profit-volume graph for a
multiproduct enterprise.
6. List and discuss the key assumptions of CVP analysis.
7. Prepare and interpret a contribution income statement.
8. Explain the role of cost structure and operating leverage in CVP
relationships.
9. Understand the implications of activity-based costing for CVP analysis.
10. Be aware of the effects of advanced manufacturing technology on
CVP relationships.
11. Understand the effect of income taxes on CVP analysis.
8-2
 Introduction to Cost Drivers

How well the accountant does at identifying

the most appropriate cost drivers determines
how well managers understand cost behavior
and how well costs are controlled.

8-3
 Comparison of
Variable and Fixed Costs

A variable cost is a cost that changes in

Direct proportion to changes in the cost
driver.

A fixed cost is not immediately affected

by changes in the cost driver.

8-4
 Cost Behavior

What is cost behavior?

It is how costs are related to, and affected

by, the activities of an organization.

8-5
 Rules of Thumb

Think of variable costs on a per-unit basis.

The per-unit variable cost remains

changed regardless of changes
in the cost-driver activity.

8-6
 Break-Even Point
Techniques
• There are two basic techniques for
computing break-even point:
1 Contribution margin
2 Equation
2 Graph method

8-7
 The Break-Even Point
Learning Objective 1
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 $ -

8-8
 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
8-9
 Contribution-Margin Approach
Learning Objective 2

Consider the following information

developed by the accountant at Curl, Inc.:

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

8-10
 Contribution-Margin Approach

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

8-11
 Contribution-Margin Approach

Fixed expenses Break-even point

=
Unit contribution margin (in units)

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
8-12
 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

8-13
 Contribution Margin Ratio

Calculate the break-even point in sales dollars

rather than units by using the contribution
margin ratio.
Contribution margin
= CM
Sales
Ratio
Fixed expense Break-even point
=
CM Ratio (in sales dollars)

8-14
 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 sales
40%
8-15
 Graphing Cost-Volume-Profit
Relationships
Learning Objective 3
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

8-16
 Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000
Dollars

250,000

200,000

150,000

100,000

50,000

100 200 300 400 500 600 700 800

Units

8-17
 Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000
Dollars

250,000

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

8-18
 Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000
Dollars

250,000

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

8-19
 Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000
Dollars

250,000

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

8-20
 Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000
Dollars

250,000

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

8-21
 Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000
Dollars

250,000

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

8-22
 Cost-Volume-Profit Graph
450,000

400,000

350,000
Break-even
300,000
point
Dollars

250,000

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

8-23
 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
40,000 point
20,000
Profit

0 `

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

Units
(40,000)

(60,000)

8-24
 Target Net Profit
Learning Objective 4

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

8-25
 Equation Approach

Sales revenue – Variable expenses – Fixed expenses = Profit

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

($200X) = $180,000

X = 900 surf boards

8-26
 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.

8-27
 Margin of Safety

• The margin of safety shows how far

sales can fall below the planned level
before losses occur.
Planned unit sales
–

Break-even unit sales

Margin of safety

8-28
 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.

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

8-29
 Changes in Fixed Costs

• Curl is currently selling 500 surfboards per

year.
• The owner believes that an increase of
$10,000 in the annual advertising budget,
would increase sales to 540 units.

Should the company increase the advertising

budget?
8-30
 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

8-31
 Changes in Fixed Costs
Current Proposed
Sales will increase by
Sales Sales
$20,000, but net income
(500 Boards) (540 Boards)
decreased by $2,000.
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

8-32
 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)

8-33
 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

8-34
 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

8-35
 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
8-36
 CVP Analysis with Multiple
Products
Learning Objective 5
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.

8-37
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%

8-38
 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%
8-39
 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

8-40
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

8-41
 Assumptions Underlying
CVP Analysis
Learning Objective 6

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).
8-42
 CVP Relationships and
the Income Statement
Learning Objective 7

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

8-43
 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

8-44
 Cost Structure and Operating
Leverage
Learning Objective 8
• The cost structure of an organization is the
relative proportion of its fixed and variable
costs.
• Operating leverage is . . .
– the extent to which an organization uses fixed
costs in its cost structure.
– greatest in companies that have a high
proportion of fixed costs in relation to
variable costs.

8-45
Measuring Operating Leverage
Operating leverage Contribution margin
=
factor Net income
Actual sales
500 Board
Sales $ 250,000
Less: variable expenses 150,000
Contribution margin 100,000
Less: fixed expenses 80,000
Net income $ 20,000

$100,000
= 5
$20,000
8-46
Measuring Operating Leverage
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%

8-47
Measuring Operating Leverage

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.
8-48
CVP Analysis, Activity-Based Costing,
and Advanced Manufacturing Systems
Learning Objective 9

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

8-49
 A Move Toward JIT and
Flexible Manufacturing
Learning Objective 10

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.

8-50
 Effect of Income Taxes
Learning Objective 11

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

=
1 - t net income

8-51
End and Thank You
We made
it!

8-52