Because learning changes everything.

Chapter 20
Cost-Volume-Profit Analysis

© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
 Introduction: GoPro
Many companies have gotten very serious about controlling
costs. At GoPro, Inc., executives are also keenly aware of the
strategic importance of product mix management. By
gathering information about market demand and combining it
with a marketing strategy that focuses on higher margin
products, the company has been able to survive in what has
become a crowded marketplace.
Most managers understand the economic consequences of
cost structure, contribution margin, and break-even sensitivity
on the company’s profitability and strategic decision making.
Moreover, they realize that a company’s continued success
depends, in large part, on their handling of resource
constraints, production bottlenecks, and an array of complex
nonfinancial issues.
© McGraw Hill LLC 2
 Introduction: CVP Analysis 1

• CVP analysis is a means of learning how costs and profits

behave in response to changes in the level of business
activity.
• An understanding of these relationships is essential in
developing plans and budgets for future business
operations.

Key Point
The concepts of cost-volume-profit analysis may be applied
to the business as a whole; to individual segments of the
business such as a division, a branch, or a department; or to
a particular product line.

© McGraw Hill LLC 3

 Introduction: CVP Analysis 2

Cost-volume-profit analysis may be used by managers to answer

questions such as the following:
• What level of sales must be reached to cover all expenses, that
is, to break even?
• How many units of a product must be sold to earn a specific
operating income?
• What will happen to our profitability if we expand capacity?
• What will be the effect of changing salespeople’s compensation
from fixed monthly salaries to a commission of 10 percent on
sales?
• If we increase our spending on advertising to $100,000 per
month, what increase in sales volume will be required to
maintain our current level of income from operations?
© McGraw Hill LLC 4
 Business for Illustration: McKinley
• To illustrate the relationships between costs and activity
levels, we examine the operation of McKinley Airlines, a
small charter service based in Fairbanks, Alaska.
• Assume that the average monthly cost of operating the
airline is $66,000.
• Airlines often consider passenger miles flown to be their
most significant cost driver. Accordingly, we will use this
measurement for studying the behavior of costs at
McKinley Airlines.
• Having identified passenger miles as an appropriate
activity base, we will next classify each of the airline’s
operating costs into one of three broad categories: fixed
costs, variable costs, and semi variable costs.
© McGraw Hill LLC 5
 Fixed Costs
Fixed costs are those costs and expenses that do not
change significantly in response to changes in an activity
base.
• McKinley’s depreciation expense is an example of a fixed
cost, as the monthly depreciation expense does not vary
with the number of passenger miles flown.

Key Point
Depending on the nature of a particular business, fixed costs
can also include administrative and executive salaries,
property taxes, rents and leases, and many types of
insurance protection.

© McGraw Hill LLC 6

 Variable Costs
A variable cost is one whose total rises or falls in
approximate proportion to changes in an activity base.
• McKinley’s fuel expense is an example of a variable cost,
as it changes in approximate proportion to the number of
passenger miles flown.
• For instance, if total passenger miles were to increase by
10 percent in a given month, we would expect to see a
similar increase in fuel expense.

© McGraw Hill LLC 7

 Semi variable Costs
Semivariable costs are sometimes called mixed costs
because they contain both a fixed and a variable component.
• The monthly fee McKinley pays to the Fairbanks airport is
a good example of a semi variable cost, since it contains
both a fixed base rate and an added charge for each
passenger mile flown.
• The fixed portion pertains to the rental of hangar space for
McKinley’s aircraft, which remains constant regardless of
its flight activity.
• The variable portion pertains to the airline’s use of the
passenger terminal.

© McGraw Hill LLC 8

 International Case in Point
Identifying and separating fixed and variable costs is not easy.
This task is significantly more complicated when products are
manufactured in and transferred between international locations.
For example, in Jordan, because of cultural and legal differences,
some costs that might be classified as fixed costs in the United
States are classified as variable costs in Jordanian accounts or
vice versa. Examples of the costs impacted are product warranty,
freight expenses, interest expenses, and wages. Culturally
acceptable methods for delaying payments, bargaining for lower
sales prices, and bureaucratic delays may transform a cost
thought of as variable in the United States into a fixed recurring
expense in an international location. In Jordan, for instance,
clearing items through customs takes inordinate numbers of repeat
visits to airports or seaports and is frequently mentioned as an
additional cost of doing business in Jordan.
© McGraw Hill LLC 9
 Cost Information for McKinley Airlines

Type of Cost Amount

Fixed costs
Insurance $11,000 per month
Depreciation $8,000 per month
Salaries $20,000 per month
Variable costs
Fuel and maintenance 8 cents per passenger mile
Semivariable costs
Airport usage fees $3,000 per month + 2 cents
per passenger mile

© McGraw Hill LLC 10

 Graphic Analysis of Operating Costs

Access the text alternative for slide images.

© McGraw Hill LLC 11

 Average Cost per Passenger Mile
McKinley Airlines’s Cost per Passenger Mile

Total passenger miles 200,000 300,000 400,000

Costs
Variable (8 cents per passenger mile) $16,000 $24,000 $32,000
Fixed ($11,000 + $8,000 + $20,000) 39,000 39,000 39,000
Semivariable:
Variable portion (2 cents per passenger mile) 4,000 6,000 8,000
Fixed portion 3,000 3,000 3,000
Total operating costs $62,000 $72,000 $ 82,000
Cost per passenger mile $ 0.31 $ 0.24 $ 0.205

© McGraw Hill LLC 12

 Costs per Passenger Mile

Access the text alternative for slide images.

© McGraw Hill LLC 13

 The Behavior of Per-Unit Costs

Access the text alternative for slide images.

© McGraw Hill LLC 14

 Your Turn: You as a Manager
Assume that you are the manager of ground operations for
American Airlines at Detroit Metro Airport. You have just been
informed that the plane size between Philadelphia and
Detroit will be increased from a Boeing 737 to a 747 and is
expected to generate 50 additional passengers per flight.
What ground operations costs do you think will increase
because of the additional 50 passengers per flight? What
ground operations costs will not be affected?

© McGraw Hill LLC 15

 Economies of Scale 1

• Economies of scale refers to the reduction in unit costs by

using the company’s productive assets more efficiently.
• To illustrate, assume that an automobile plant incurs fixed
costs of $8.4 million per month and has the capacity to
produce 7,000 automobiles per month.
Fixed Costs per Level of Fixed Cost per
Month Production Unit
$8,400,000 4,000 cars $2,100
8,400,000 6,000 cars 1,400
8,400,000 7,000 cars 1,200

© McGraw Hill LLC 16

 Economies of Scale 2

Economies of scale are most apparent in businesses with

high fixed costs, such as:
• Airlines.
• Oil refineries.
• Steel mills.
• Utility companies.
Key Point
Most large companies automatically realize some economies
of scale. This is one of the reasons why it is difficult for a
small company to compete with a much larger one. But
smaller companies also can realize their own economies of
scale by using their facilities as intensively as possible.
© McGraw Hill LLC 17
 Case in Point: Southwest Airlines
Many airlines, including some of the nation’s largest, have
been losing money in recent years. But several smaller
airlines are doing much better than their larger competitors.
Why? Because they have operated at or near full capacity—
that is, with a paying passenger in almost every seat.
As a result, these smaller airlines incur lower fixed costs per
passenger mile than their competitors. This enables them to
earn higher margins than some major airlines and to offer
very competitive fares— which keeps those seats full.

© McGraw Hill LLC 18

 Additional Cost Behavior Patterns 1

*Stated as a percentage of plant capacity.

Access the text alternative for slide images.

© McGraw Hill LLC 19

 Additional Cost Behavior Patterns 2

Taking all the possible variations of cost behavior into account

would add greatly to the complexity of cost-volume analysis.
Unusual patterns of cost behavior tend to offset one another.
Unusual patterns of cost behavior are most likely to occur at
extremely high or extremely low levels of volume.
• For example, if output were increased to near 100 percent
of plant capacity, variable costs would curve sharply upward
because of payments for overtime.
• An extreme decline in volume, on the other hand, might
require shutting down plants and extensive layoffs, thereby
reducing some expenditures that are usually considered
fixed costs.

© McGraw Hill LLC 20

 Additional Cost Behavior Patterns 3

• Most businesses, however, operate somewhere between

perhaps 45 percent and 80 percent of capacity and try to avoid
large fluctuations in volume.
• The range over which output may be expected to vary is called
the relevant range.

*Stated as a percentage of plant capacity.

Access the text alternative for slide images.

© McGraw Hill LLC 21

 Cost Behavior and Operating Income
• Operating income is computed as follows.
Revenue − Variable costs − Fixed costs = Operating Income
• This basic relationship sets the stage for introducing cost-
volume-profit analysis, a widely used management planning
tool.
• Cost-volume-profit analysis is often called break-even
analysis, in reference to the point at which total revenue
exactly equals total cost.
• The break-even point may be defined as the level of activity
at which operating income is equal to zero. Its computation
often serves as a starting point in decisions involving cost-
volume-profit relationships.

© McGraw Hill LLC 22

 CVP: Important Points
The term profit in cost-volume-profit analysis refers to
operating income, not net income.
• This is because income taxes and nonoperating gains and
losses do not possess the characteristics of variable or
fixed costs.

Cost-volume-profit analysis conveys very little information

about cash flows.
• Revenue, for example, often results from both cash and
credit sales, whereas expenses often result from both cash
payments and charges made on account.

© McGraw Hill LLC 23

 CVP Analysis: An Illustration
Assume that SnowGlide Company manufactures entry-level
snowboards. The company currently sells its product to
wholesale distributors in Colorado, Washington, and Oregon.
Because of the popularity of snowboarding, the company is
considering distributing to several East Coast wholesalers as
well. Although wholesale prices vary depending on the
quantity of boards purchased by a distributor, revenue
consistently averages $90 per board sold.

© McGraw Hill LLC 24

 Illustration: SnowGlide’s Operating
Information
Percentage of Sales
Dollars Price
Average selling price per board $ 90.00 100%
Variable expenses per board
Direct labor cost 2.25 2.5
Direct materials cost 28.25 31.4
Variable manufacturing overhead 3.10 3.4
Variable administrative expenses 2.40 2.7
Total variable cost per board 36.00 40.0%
Unit contribution margin and contribution margin ratio $ 54.00 60.0%
Fixed costs
Administrative salaries $23,000
Insurance 1,300
Depreciation 5,000
Advertising 8,500
Total fixed cost per month $37,800

© McGraw Hill LLC 25

 Illustration: Monthly CVP Graph

Access the text alternative for slide images.

© McGraw Hill LLC 26

 Contribution Margin: A Key Relationship

Contribution Margin = Revenue − Variable

Contribution Margin per Unit =
Contribution Margin Ratio
costs
Unit Selling Price −
Variable Cost per Unit
= Contribution Margin per
Unit ÷ Unit Sales Price

© McGraw Hill LLC 27

 Contribution Margin at SnowGlide

Unit Contribution Margin = Unit Selling Price − Variable Cost per Unit
$54 = $90 − $36

Access the text alternative for slide images.

© McGraw Hill LLC 28

 How Many Units Must We Sell?
• The concept of contribution margin provides a quick
means of determining the unit sales volume required for a
business to break even or earn any desired level of
operating income.
• Knowing the break-even sales volume can be of vital
importance, especially to companies deciding whether to
introduce a new product line, build a new plant or, in some
cases, remain in business.

© McGraw Hill LLC 29

 How Many Units Must SnowGlide Sell?
Given a contribution margin of $54 from each board, the company must
sell 700 units per month to break even, as follows.
$37,800
Sales Volume (in units) = = 700 units per month
$54
This reasoning can be taken one step further to find not only the unit
sales volume needed to break even but also the unit sales volume
needed to achieve any desired level of operating income. The following
formula enables us to do this.
Fixed cost+Target Operating Income
Sales Volume(in units) =
Contribution Margin Per Unit
For example, how many snowboards must SnowGlide sell to earn a
monthly operating income of $5,400?
$37,800 + $5, 400
Sales Volume(in units) = = 800 units per month
$54
© McGraw Hill LLC 30
 How Many Dollars in Sales Must We
Generate?
To find the dollar sales volume a company must generate for a given target
of operating income, we could first compute the required sales volume in
units and then multiply our answer by the average selling price per unit.
Taking a more direct approach to compute the required sales volume, we
can simply substitute the contribution margin ratio for the contribution
margin per unit in our C VP formula, as follows.

Fixed Costs + Target Operating Income

Sales Volume (in dollars) =
Contribution Margin Ratio
To illustrate, let us again compute the sales volume required for
SnowGlide to earn a monthly operating income of $5,400.

$37,800 + $5,400
Sales Volume(in dollars) = = $72,000 per month
60%

© McGraw Hill LLC 31

 What Is Our Margin of Safety?
The dollar amount by which actual sales volume exceeds the break-even
sales volume is called the margin of safety. It also represents the dollar
amount by which sales can decline before an operating loss is incurred.
SnowGlide’s monthly sales volume required to break even is as follows.

$37,800
Sales Volume(in dollars) = = $63,000 per month
60%
Thus, if monthly sales total $73,000, the margin of safety for that month is
$10,000 ($73,000 − $63,000).
The margin of safety can provide a quick means of estimating operating
income at any projected sales level. This relationship is summarized as
follows.
Operating Income = Margin of Safety × Contribution Margin Ratio

© McGraw Hill LLC 32

 Business Applications of CVP: SnowGlide

• The use of cost-volume-profit analysis is not limited to

accountants.
• To illustrate, let us consider several ways in which cost-
volume-profit relationships might be used by the
management of SnowGlide Company.
• As previously mentioned, the popularity of snowboarding
has prompted SnowGlide to consider distribution to East
Coast wholesalers.
• Different managers within the company will naturally have
different, yet interrelated, planning concerns regarding the
implementation of this new market strategy.

© McGraw Hill LLC 33

 SnowGlide: Director of Advertising 1

• Assume that SnowGlide is currently selling approximately

900 snowboards each month.
• In response to the new market strategy, the company’s
director of advertising is asking for an increase of $1,500 in
her monthly budget. She plans to use these funds to
advertise in several East Coast trade publications.
• From her experience, she is confident that the
advertisements will result in monthly orders from East
Coast distributors for 500 boards. She wishes to
emphasize the impact of her request on the company’s
operating income.

© McGraw Hill LLC 34

 SnowGlide: Director of Advertising 2

We begin by calculating the company’s current monthly

income based on current sales of 900 units. We will then
compute estimated monthly income based on 1,400 units,
taking into account the additional advertising costs of $1,500.

Sales (900 units @ $90) $81,000

Variable costs (40% of sales) (32,400)
Contribution margin (60% of sales) 48,600
Current monthly fixed costs (37,800)
Current monthly operating income $ 10,800

© McGraw Hill LLC 35

 SnowGlide: Director of Advertising 3

As the proposed advertising is viewed as a fixed cost, this expenditure

does not affect SnowGlide’s contribution margin ratio of 60 percent.
Based on projected monthly sales of $126,000 (1,400 units × $90), the
projected monthly operating income can be determined as follows.
Fixed costs + Projected Operating Income
Projected sales =
Contribution Margin Ratio
$39,300 + Projected Operating Income
$126,000 =
60%
Projected Operating Income = 60% ($126,000)−$39,300
=$36,300 per month

The target income figure is $25,500 higher than the present monthly figure
of $10,800 ($36,300 − $10,800 = $25,500). Thus, the director of advertising
believes that her request for an additional $1,500 is well justified.

© McGraw Hill LLC 36

 SnowGlide: Plant Manager 1

• SnowGlide’s plant manager does not completely agree

with the advertising director’s projections. He believes that
the increased demand for the company’s product will
initially put pressure on the plant’s production capabilities.
• To cope with the pressure, he asserts that many factory
workers will be required to work excessive overtime hours,
causing an increase in direct labor costs of approximately
$1.80 per unit.
• Assuming that he is correct, he wants to know the sales
volume in units required to achieve the advertising
director’s projected monthly income figure of $36,300.

© McGraw Hill LLC 37

 SnowGlide: Plant Manager 2

Holding the selling price at $90 per unit, the $1.80 overtime premium will
reduce SnowGlide’s current contribution margin from $54 per unit to
$52.20 per unit as follows.
Unit Contribution Margin = Selling Price − Unit Variable Cost
= $90,00−($36,00+$1.80)
= $52.20
If the director of advertising receives a monthly increase of $1,500 in her
budget, and if a $36,300 income target is established, the number of units
that must be sold is computed as follows.
Fixed costs + Target Operating Income
Projected Unit Sales =
Unit Contribution Margin
$39,300 + $36,300
=
$52.20
= 1,448 units per month
© McGraw Hill LLC 38
 Your Turn: You as a Plant Accountant
Assume you are the plant accountant and that you have a budgeted fixed
overhead of $20,800 per month for a production level at normal capacity of
1,000 units per month. Thus, your overhead application rate has been set at
$20,800 1,000 units,or $20.80 per unit. You realize that a production
increase to 1,500 units per month will result in overapplying fixed overhead
to the tune of $10,400 per month (500 units × $20.80). You are hesitant to
bring up the problem of the overhead application rate with the plant
manager because both of you receive a yearly bonus based on plant
profitability. If overhead is being overapplied because production is at 1,500
units, the application rate is too high
($20.80 versus$20,800 1,500 =$13.87 per unit).
If the projected sales volume of 1,500 units does not occur, significant fixed
overhead costs will be assigned to the unsold inventories. As a result, plant
income will be larger and your bonus—as well as the plant manager’s—will
be larger. What should you do?
© McGraw Hill LLC 39
 SnowGlide: Vice President of Sales 1

• The vice president of sales isn’t convinced that an increase in

the monthly advertising budget of $1,500 will yield sales of 500
units per month in the East Coast region. Her estimate is more
conservative, at 350 units per month (for total monthly sales of
1,250 units).
• Assume that the monthly advertising budget is increased by
$1,500, and that direct labor costs actually do increase by $1.80
per unit because of the overtime premium required to meet
increased production demands.
• If the vice president of sales is correct regarding her 1,250-unit
projection, she wants to know the extent to which the company
would have to raise its selling prices (above the current price of
$90 per unit) to achieve a target monthly income figure of
$36,300.

© McGraw Hill LLC 40

 SnowGlide: Vice President of Sales 2

If 1,250 units are sold each month instead of 1,400 units, the contribution margin
per unit must increase in order for the company to achieve the same target income.
Fixed costs + Target Operating Income
Projected Unit Sales =
Contribution Margin per Unit
$39,300 + $36,300
1, 250 units =
Contribution Margin per Unit
$39,300 + $36,300
Contribution Margin per Unit =
1, 250 units
= $60.48
Given a required unit contribution margin of $60.48 and a variable cost per unit of
$37.80, we can easily solve for the required unit selling price as follows.
$60.48 = Unit Selling Price − $37.80
Unit Selling Price = $60.48 + $37.80
= $98.28

© McGraw Hill LLC 41

 Additional Considerations in CVP
In practice, the application of cost-volume-profit analysis is
often complicated by various operating factors, including:
1. Different products with different contribution margins.
2. Determining semi variable cost elements.
3. Complying with the assumptions of cost-volume-profit
analysis.

© McGraw Hill LLC 42

 CVP Analysis When a Company Sells
Many Products
• Most companies sell a mix of many different products.
• Sales mix describes the relative percentages of total sales
provided by different products.
• Different products usually have different contribution
margin ratios.
• Managers often use an average contribution margin ratio
for decision-making purposes.
• The average contribution margin ratio may be computed
by weighting the contribution margin ratios of each product
line by the percentage of total sales which that product
represents.

© McGraw Hill LLC 43

 SnowGlide: Average Contribution Margin
Ratio
Assume that, in addition to snowboards, SnowGlide sells
goggles. Contribution margin ratios for the two product lines
are snowboards, 60 percent, and goggles, 80 percent.
Snowboards account for 90 percent of total sales, and
goggles, the other 10 percent.

Product Percentage
CM Ratio of Sales
Snowboards 60% × 90% = 54%
Goggles 80% × 10% = 8%
Average contribution margin ratio 62%

© McGraw Hill LLC 44

 Assumptions Underlying CVP Analysis
Throughout the chapter we have relied on certain assumptions
that have simplified the application of cost-volume-profit analysis.
These assumptions include:
1. Sales price per unit is assumed to remain constant.
2. If more than one product is sold, the proportion of the various
products sold (the sales mix) is assumed to remain constant.
3. Fixed costs (expenses) are assumed to remain constant at all
levels of sales within a relevant range of activity.
4. Variable costs (expenses) are assumed to remain constant as
a percentage of sales revenue.
5. For manufacturing companies, the number of units produced is
assumed to equal the number of units sold each period.

© McGraw Hill LLC 45

 Cost-Volume-Profit Mathematical
Relationships
Measurement
Contribution Margin (in total)
Contribution Margin (per unit)
Contribution Margin Ratio
Required Sales volume (in units)
Required Sales volume (in dollars)
Margin of Safety
Operating Income
Change in Operating Income
© McGraw Hill LLC
Method of Computation
Sales Revenue − Total Variable Costs
Unit Sales Price − Variable Costs per Unit
(Unit Sales Price − Variable Costs per Unit) ÷ (Units
Sales Price) Or (in total) (Sales Revenue − Total
Variable Costs) ÷ (Sales Revenue)
(Fixed Costs + Target Operating Income) ÷ (Unit
Contribution Margin)
(Fixed Costs + Target Operating Income) ÷
(Contribution Margin Ratio)
Actual Sales Volume − Break-Even Sales Volume
Margin of Safety × Contribution Margin Ratio
Change in Sales Volume × Contribution Margin Ratio
46
 Ethics and Social Responsibility 1

Classifying costs into fixed and variable elements was an

unambiguous and simple task in most of the illustrations used
throughout this chapter. As such, performing cost-volume-
profit analysis (CVP) also appeared to be a fairly
straightforward endeavor. In reality, this isn’t always the case.
or instance, many environmental, social, and governance (E S
G) concerns associated with sustainability efforts make cost
classification and CVP computations challenging. In fact,
many ESG activities require sophisticated accounting
systems to track, classify, evaluate, and maintain the integrity
of ESG cost data.

© McGraw Hill LLC 47

 Ethics and Social Responsibility 2

Environmental activities to reduce carbon footprints, purify

wastewater, dispose of hazardous material, and attain LEED
certifications are complex to measure and difficult to manage.
Social policies associated with ensuring nondiscriminatory
hiring practices, paying living wages, and protecting the
safety, heath, and well-being of employees are often
intertwined with personal biases and political ideologies.
Governance concerns related to SEC reporting, sustainability
audits, investor transparency, internal control compliance, and
board member recruitment are diverse in scope and
demanding to coordinate.

© McGraw Hill LLC 48

 Ethics and Social Responsibility 3

The challenges of measuring and analyzing costs associated

with ESG initiatives notwithstanding, the potential benefits of
embracing ESG efforts are many. ESG benefits include
improved credit ratings, reduced costs of capital, enhanced
risk management, and more favorable perceptions in the
minds of employees, customers, investors, and other key
stakeholders.

© McGraw Hill LLC 49

 Learning Objective Summary LO20-1
LO20-1: Explain how fixed, variable, and semi variable
costs respond to changes in the volume of business
activity. Fixed costs (fixed expenses) remain unchanged
despite changes in sales volume, while variable costs (or
expenses) change in direct proportion to changes in sales
volume. With a semi variable cost, part of the cost is fixed and
part is variable. Semivariable costs change in response to a
change in the level of activity, but they change by less than a
proportionate amount.

© McGraw Hill LLC 50

 Learning Objective Summary LO20-2
LO20-2: Explain how economies of scale can reduce unit
costs. Economies of scale are reductions in unit cost that can
be achieved through a higher volume of activity. One
economy of scale is fixed costs that are spread over a larger
number of units, thus reducing unit cost.

© McGraw Hill LLC 51

 Learning Objective Summary LO20-3
LO20-3: Prepare a cost-volume-profit graph. The vertical
axis on a cost-volume-profit graph is dollars of revenue or
costs, and the horizontal axis is unit sales. Lines are plotted
on the graph showing revenue and total costs at different
sales volumes. The vertical distance between these lines
represents the amount of operating income (or loss). The
lines intersect at the break-even point.

© McGraw Hill LLC 52

 Learning Objective Summary LO20-4
LO20-4: Compute contribution margin and explain its
usefulness. Contribution margin is the excess of revenue
over variable costs. Thus, it represents the amount of revenue
available to cover fixed costs and to provide an operating
profit. Contribution margin is useful in estimating the sales
volume needed to achieve earnings targets, or the income
likely to result from a given sales volume.

© McGraw Hill LLC 53

 Learning Objective Summary LO20-5
LO20-5: Determine the sales volume required to earn a
desired level of operating income. The sales volume (in
units) required to earn a target profit is equal to the sum of the
fixed costs plus the target profit, divided by the unit
contribution margin. To determine the sales volume in dollars,
the sum of the fixed costs plus the target profit is divided by
the contribution margin ratio.

© McGraw Hill LLC 54

 Learning Objective Summary LO20-6
LO20-6: Use the contribution margin ratio to estimate the
change in operating income caused by a change in sales
volume. Multiplying the expected dollar change in sales
volume by the contribution margin ratio indicates the
expected change in operating income.

© McGraw Hill LLC 55

 Learning Objective Summary LO20-7
LO20-7: Use CVP relationships to evaluate a new
marketing strategy. An understanding of CVP relationships
assists managers in estimating the changes in revenue and
costs that are likely to accompany a change in sales volume.
Thus, they are able to estimate the likely effects of marketing
strategies on overall profitability.

© McGraw Hill LLC 56

 Learning Objective Summary LO20-8
LO20-8: Use CVP when a company sell multiple products.
For companies that sell multiple products, C VP analysis is
performed using a weighted-average contribution margin. The
weighted-average contribution margin is based on each
product’s individual contribution margin and the percentage it
comprises of the company’s overall sales mix.

© McGraw Hill LLC 57

 Learning Objective Summary LO20-9
LO20-9: Determine semi variable cost elements.
Semivariable costs have both a fixed component and a
variable component. Separating semi variable costs into their
fixed and variable components is a constant challenge faced
by managers. The high-low method is a simple approach
used by managers to better understand the structure of semi
variable costs.

© McGraw Hill LLC 58

 Because learning changes everything. ®

www.mheducation.com

© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.