Ninth Edition: Cost-Volume-Profit Analysis: Additional Issues

Managerial Accounting
Ninth Edition
Weygandt Kimmel Mitchell
Chapter 6
Cost-Volume-Profit Analysis: Additional
Issues
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Copyright ©2021 John Wiley & Sons, Inc.

Chapter Outline
Learning Objectives
LO 1 Apply basic CVP concepts.
LO 2 Explain the term sales mix and its effects on break-even sales.
LO 3 Determine sales mix when a company has limited resources.
LO 4 Indicate how operating leverage affects profitability.
Copyright ©2021 John Wiley & Sons, Inc. 2

Basic CVP Concepts
LEARNING OBJECTIVE 1
Apply basic CVP concepts.
CVP analysis:
• Study of the effects of changes in costs and volume on
a company’s profit.
• Important to profit planning.
• Critical in management decisions such as:
o determining product mix,
o maximizing use of production facilities, and
o setting selling prices.
LO 1 Copyright ©2021 John Wiley & Sons, Inc. 3

Basic CVP Concepts
• Management often wants the information reported in
a special format income statement.
• CVP income statement is for internal use only:
o Costs and expenses classified as fixed or variable.
o Reports contribution margin as a total amount and on
a per unit basis.

Basic CVP Concepts
Detailed CVP income statement
Illustration 6.1

Break-Even Analysis
Break-even point in units
Vargo Electronic’s CVP income statement (Ill. 6.1) shows that
total contribution margin is $320,000, and the company’s
contribution margin per unit is $200. Contribution margin
can also be expressed as the contribution margin ratio
which is 40% ($200 ÷ $500).
Illustration 6.2

Break-Even Analysis
Break-even point in dollars
Vargo Electronic’s CVP income statement (Ill. 6.1) shows that
total contribution margin is $320,000, and the company’s
contribution margin per unit is $200. Break-even point in
sales dollars is $500,000 ($200,000 ÷ .40).
Illustration 6.3

Target Net Income
Target net income in units
Once a company achieves break-even sales, it then sets a
sales goal that will generate a target net income.
Illustration: Assume Vargo’s management has a target net
income of $250,000. Compute the required sales in units to
achieve its target net income:
Illustration 6.4

Target Net Income
Target net income in dollars
Once a company achieves break-even sales, it then sets a
sales goal that will generate a target net income.
Illustration: The contribution margin ratio is used to
compute required sales in dollars.
Illustration 6.5

Margin of Safety
Margin of safety in dollars
• tells us how far sales can drop before the company will
operate at a loss.
• can be expressed in dollars or as a ratio.
Illustration: Assume Vargo’s sales are $800,000:
Illustration 6.6

Margin of Safety
Margin of safety ratio
• tells us how far sales can drop before the company will
operate at a loss.
• can be expressed in dollars or as a ratio.
Illustration: Vargo’s sales could drop by $300,000, or 37.5%,
before the company would operate at a loss
Illustration 6.7

CVP and Changes in the Bus.
Environment
Illustration: Original cell phone sales and cost data for Vargo
Electronics is as shown.
Illustration 6.8
Unit selling price $500
Unit variable costs $300
Total fixed costs $200,000
Break-even sales $500,000 or 1,000 units

CVP and Changes in the Bus. Environment
Case I
A competitor is offering a 10% discount on the selling price

of its cell phones. What effect will a 10% discount on selling
price ($500 × 10% = $50) have on the breakeven point?
Illustration 6.9

Case II
Management invests in new robotic equipment that will

lower the amount of direct labor required to make cell
phones. The company estimates that total fixed costs will
increase 30% and that unit variable cost will decrease 30%.
What effect will the new equipment have on the sales
volume required to break even?
Illustration 6.10

Case III
Vargo’s principal supplier of raw materials has just

announced a price increase. The higher cost is expected to
increase the unit variable cost of cell phones by $25.
Management decides that it does not want to increase the
selling price of the cell phones. It plans a cost-cutting
program that will save $17,500 in fixed costs per month.
Vargo is currently realizing monthly net income of $80,000
on sales of 1,400 cell phones. What increase in units sold will
be needed to maintain the same level of net income?

Case III continued
Unit variable costs increase to $325 ($300 + $25).

Fixed costs are reduced to $182,500 ($200,000 − $17,500).
Unit contribution margin becomes $175 ($500 − $325).
Illustration 6.11

Basic CVP Concepts
Review Question
Croc Catchers calculates its contribution margin to be less
than zero. Which statement is true?
a. Its fixed costs are less than the unit variable cost.
b. Its profits are greater than its total costs.
c. The company should sell more units.
d. Its selling price is less than its variable costs.

Basic CVP Concepts
Review Answer
Croc Catchers calculates its contribution margin to be less
than zero. Which statement is true?
a. Its fixed costs are less than the unit variable cost.
b. Its profits are greater than its total costs.
c. The company should sell more units.
d. Answer: Its selling price is less than its variable costs.

DO IT! 1: CVP Analysis
Krisanne Company reports the following operating
results for the month of June.
To increase net income, management is considering

reducing the selling price by 10%, with no changes to unit
variable costs or fixed costs. Management is confident
that this change will increase unit sales by 25%.
Solution
Using the contribution margin technique, compute the break-
even point in sales units and sales dollars and margin of
safety in dollars assuming no changes to sales price or costs.
Break-even point in units = 4,167 units (rounded) ($100,000 ÷ $24)

Break-even point in sales dollars = $250,000 ($100,000 ÷ 40a)
Margin of safety in dollars = $50,000 ($300,000 − $250,000)
a
$24 ÷ $60

Solution continued
Using the contribution margin technique, compute the
break-even point in sales units and sales dollars and margin
of safety in dollars assuming changes to sales price and
volume as described.
Break-even point in units = 5,556 units (round) ($100,000 ÷ $18b)
Break-even point in sales dollars = $300,000 ($100,000 ÷ ($18 ÷ $54c))
Margin of safety in dollars = $37,500 ($337,500d − $300,000)
b
($60 − (.10 × $60) − 36 = $18)
c
($60 − (.10 × $60)
d
(5,000 + (.25 × 5,000) = 6,250 units, 6,250 units × $54 = $337,500)
Sales Mix and Break-Even Sales
Explain the term sales mix and its effects on break-even

sales.
• Sales mix is the relative percentage in which a

company sells its products.
• If a company’s unit sales are 80% printers and 20% PCs,
its sales mix is 80% to 20%.
• Sales mix is important because different products often
have very different contribution margins.

Break-Even Sales in Units
Sales mix as a percentage of units sold
Companies can compute break-even sales for a mix of
two or more products by determining the weighted-
average unit contribution margin of all the products.
Illustration: Vargo Electronics sells not only cell phones
but high-definition TVs as well. Vargo sells its two
products in the following amounts: 1,500 cell phones and
500 TVs.
Illustration 6.12
Cell Phones TVs

1,500 units ÷ 2,000 units = 75% 500 units ÷ 2,000 units = 25%

Per unit data-sales mix
Additional information related to Vargo Electronics.
Illustration 6.13
Unit Data Cell Phones TVs
Selling price $500 $1,000
Variable costs 300 500
Contribution margin $200 $500
Sales mix ─ units 75% 25%
Fixed costs = $275,000

Weighted-average unit contribution margin
First, determine weighted-average unit contribution

margin.
Illustration 6.14

For a given sales mix
Then, compute the break-even point in sales units by
dividing the fixed costs by the weighted-average unit
contribution margin.
Illustration 6.15

Break-even proof – sales units
• With break-even point of 1,000 units, Vargo must sell:
o 750 cell phones (1,000 units × 75%)
o 250 TVs (1,000 units × 25%)
• At this level, the total contribution margin will equal

the fixed costs of $275,000.
Illustration 6.16

Break-Even Sales in Dollars
• Works well if company has many products.
• Calculates break-even point in terms of sales dollars for
o divisions or
o product lines,
o not individual products.

Cost-volume-profit data
Kale Garden Supply Company has two divisions.
Illustration 6.17
Illustration 6.18

Weighted average contribution margin
Determine weighted-average contribution margin.
Illustration 6.19

Break-even point
Calculate break-even point in sales dollars.
Illustration 6.20

More information
• With break-even sales of $937,500 and a sales mix of

20% to 80%, Kale must sell:
o $187,500 from the Indoor Plant Division
o $750,000 from the Outdoor Plant Division
• If sales mix becomes 50% to 50%, the weighted-

average contribution margin ratio changes to 35%,
resulting in a lower break-even point of $857,143.

Review Question
Net income will be:

a. Greater if more higher-contribution margin units are
sold than lower-contribution margin units.
b. Greater if more lower-contribution margin units are
sold than higher-contribution margin units.
c. Equal as long as total sales remain equal, regardless of
which products are sold.
d. Unaffected by changes in the mix of products sold.

Review Answer
Net income will be:

a. Answer: Greater if more higher-contribution margin
units are sold than lower-contribution margin units.
b. Greater if more lower-contribution margin units are
sold than higher-contribution margin units.
c. Equal as long as total sales remain equal, regardless of
which products are sold.
d. Unaffected by changes in the mix of products sold.

DO IT! 2: Sales Mix Break-Even
Manzeck Bicycles International produces and sells three
different types of mountain bikes. Information regarding
the three models is shown below.
Pro Intermediate Standard Total
Units sold 5,000 10,000 25,000 40,000
Selling price $800 $500 $350
Variable costs $500 $300 $250
The company’s total fixed costs to produce the bicycles

are $7,500,000.

Part (a) with solution
a) Determine the sales mix as a function of units sold for the
three products.
Units sold 5,000 10,000 25,000 40,000
Solution
5,000 10,000 25,000
Pro = = 12.5% Intermediate = = 25% Standard = = 62.5%
40,000 40,000 40,000

Part (b) with solution
b) Determine the weighted-average unit contribution
margin.
Units sold 5,000 10,000 25,000 40,000
Solution
[.125 × ($800 - $500)] +
[. 25 × ($500 - $300)] +
[ .625 × ($350 - $250)] = $150

Part (c) with solution
c) Determine the total number of units that the company
must sell to break even.
Units sold 5,000 10,000 25,000 40,000
Solution
$7,500,000 ÷ $150 = 50,000 units

Part (d) with solution
d) Determine the number of units of each model that the
company must sell to break even.
Units sold 5,000 10,000 25,000 40,000
Solution
Pro: 50,000 units × 12.5% = 6,250 units
Intermediate: 50,000 units × 25% = 12,500 units
Standard: 50,000 units × 62.5% = 31,250 units
50,000 units

Sales Mix with Limited Resources
Determine sales mix when a company has limited
resources.
• All companies have limited resources whether it be floor
space, raw materials, direct labor hours, etc.
• Management must decide which products to sell in order
to maximize net income.
Illustration: Vargo manufactures cell phones and TVs.
Machine capacity is limited to 3,600 hours per month.
Illustration 6.21
Cell Phones TVs
Unit contribution margin $200 $500
Machine hours required per unit .2 .625

Contribution margin per unit of limited resource
Calculate the contribution margin per unit of limited

resource.
Illustration 6.22
This would suggest that, given sufficient demand for cell

phones, Vargo should shift the sales mix to produce more
cell phones or increase machine capacity.
• Approach used to identify and manage constraints so
as to maximize the contribution margin given the
constraint.
• Company must continually
o identify its constraints and
o find ways to reduce or eliminate them, where
appropriate.

Review Question
If the unit contribution margin is $15 and it takes 3.0
machine hours to produce the unit, the contribution
margin per unit of limited resource is:
a. $25.
b. $5.
c. $4.
d. No correct answer is given.

Review Answer
If the unit contribution margin is $15 and it takes 3.0
machine hours to produce the unit, the contribution
margin per unit of limited resource is:
a. $25.
b. Answer: $5.
c. $4.
d. No correct answer is given.

DO IT! 3: Sales Mix with Limited
Resources
Carolina Corporation manufactures and sells three
different types of high-quality sealed ball bearings for
mountain bike wheels. The bearings vary in terms of their
quality specifications—primarily with respect to their
smoothness and roundness. They are referred to as Fine,
Extra-Fine, and Super-Fine bearings. Machine time is
limited. More machine time is required to manufacture
the Extra-Fine and Super-Fine bearings.

DO IT! 3: Sales Mix with Limited Resources
Additional information

DO IT! 3: Sales Mix with Limited Resources
Solution
What is the contribution margin per unit of limited resource

for each type of bearing?
Fine Extra - Fine Super - Fine
Unit Contribution margin $2 $3.5 $5
= $100 = $87.50 = $62.50
Limited resource consumed per unit .02 .04 .08

Operating Leverage and Profitability
Indicate how operating leverage affects profitability.
Cost Structure is the relative proportion of fixed versus

variable costs that a company incurs.
• May have a significant effect on profitability
• Company must carefully consider its cost structure.

Vargo Electronics and one of its competitors, New Wave
Company, both make consumer electronics. Vargo uses a
traditional, labor-intensive manufacturing process. New
Wave has invested in a completely automated system.
The factory employees are involved only in setting up,
adjusting, and maintaining the machinery.

CVP income statements for two companies
Illustration 6.24

Contribution margin ratio for two companies
Illustration 6.25
• New Wave contributes 80 cents of contribution margin for

each dollar of increased sales while Vargo only contributes
40 cents.
• New Wave’s cost structure, which relies on fixed costs, is
more sensitive to changes in sales revenue.
Effect on Break-Even Point
Illustration 6.26
• New Wave needs to generate $150,000 more in sales

($650,000 − $500,000) than Vargo to break-even.
• Because of the greater break-even sales required, New
Wave is a riskier company than Vargo.

Effect on Margin of Safety
Illustration 6.27
• The difference in ratios reflects the difference in risk

between New Wave and Vargo.
• Vargo can sustain a 38% decline in sales before operating
at a loss versus only a 19% decline for New Wave.

Operating Leverage
• Extent that net income reacts to a given change in
sales.
• Higher fixed costs relative to variable costs cause a
company to have higher operating leverage.
• When sales revenues are increasing, high operating
leverage means that profits will increase rapidly.
• When sales revenues are declining, too much
operating leverage can have devastating
consequences.

Degree of Operating Leverage
• Provides a measure of a company’s earnings volatility.

• Computed by dividing contribution margin by net
income.
Illustration 6.28

Operating Leverage
Review Question
The degree of operating leverage:

a. Can be computed by dividing contribution margin by
net income.
b. Provides a measure of the company’s earnings
volatility.
c. Affects a company’s break-even point.
d. All of the above.

Operating Leverage
Review Answer
The degree of operating leverage:

a. Can be computed by dividing contribution margin by
net income.
b. Provides a measure of the company’s earnings
volatility.
c. Affects a company’s break-even point.
d. Answer: All of the above.

DO IT! 4: Operating Leverage
Rexfield Corp., a company specializing in crime scene
investigations, is contemplating an investment in
automated mass-spectrometers. Its current process relies
on a high number of lab technicians. The new equipment
would employ a computerized expert system. The
company’s CEO has requested a comparison of the old
technology versus the new technology. The accounting
department has prepared the following CVP income
statements for use in your analysis.

DO IT! 4: Operating Leverage
Solution
Compute the degree of operating leverage.

Contribution Margin ÷ Net Income = Degree of Operating Leverage
Old $600,000 ÷ $200,000 = 3.00
New $1,400,000 ÷ $200,000 = 7.00

Absorption Costing vs. Variable Costing
Explain the differences between absorption costing and

variable costing.
• In earlier chapters, we classified both variable and

fixed manufacturing costs as product costs. This
costing approach is referred to as full or absorption
costing.
• We now present an alternative approach, variable
costing, which is consistent with the cost-volume-
profit material presented in Chapters 5 and 6.

Absorption Costing versus Variable
Costing
Under variable costing, product costs consist of:
• Direct Materials
• Direct Labor
• Variable Manufacturing Overhead
Difference between absorption and variable costing is:
Illustration 6A.1

Absorption Costing versus Variable
Costing
Additional differences
The difference between absorption and variable costing:
• Under both costing methods, selling and
administrative expenses are treated as period costs.
• Companies may not use variable costing for external
financial reports because GAAP requires that fixed
manufacturing overhead be treated as a product cost.

Absorption Costing versus Variable Costing
Illustration
Premium Products Corporation manufactures a polyurethane

sealant, called Fix-It, for car windshields. Relevant data for Fix-It in
January 2022, the first month of production are shown.
Illustration 6A.2
Selling Price $20 per unit.
Units Produced 30,000; sold 20,000; beginning inventory zero.
Unit variable Manufacturing $9 (direct materials $5, direct labor $3, and variable
costs overhead $1).
Selling and administrative expenses $2.
Fixed costs Manufacturing overhead $120,000.
Selling and administrative expenses $15,000.

Absorption versus Variable Costing
Contribution of per unit manufacturing cost
Illustration 6A.3
Manufacturing cost per unit is $4 ($13 − $9) higher for

absorption costing because fixed manufacturing costs are
treated as product costs.

Absorption Costing Example
Illustration 6A.4

Variable Costing Example
Illustration 6A.5

Review Question
Fixed manufacturing overhead costs are recognized as:

a. Period costs under absorption costing.
b. Product costs under absorption costing.
c. Product costs under variable costing.
d. Part of ending inventory costs under both absorption
and variable costing.

Review Answer
Fixed manufacturing overhead costs are recognized as:

a. Period costs under absorption costing.
b. Answer: Product costs under absorption costing.
c. Product costs under variable costing.
d. Part of ending inventory costs under both absorption
and variable costing.

Decision-Making Concerns
• Generally accepted accounting principles require that
absorption costing be used for the costing of inventory
for external reporting purposes.
• Net income measured under GAAP (absorption
costing) is often used internally to
o evaluate performance,
o justify cost reductions, or
o evaluate new projects.

Decision-Making Concerns
• Net income calculated using GAAP may not highlight
differences between variable and fixed costs and may
lead to poor business decisions.
• Thus, some companies use variable costing for internal
reporting purposes.

Advantages of Variable Costing
1. Net income computed under variable costing is unaffected
by changes in production levels.
2. Variable costing readily supports cost-volume-profit
analysis.
3. Net income computed under variable costing is closely
tied to changes in sales levels and therefore provides a
more realistic assessment of a company’s success or
failure.
4. The presentation of fixed-cost and variable-cost
components on the variable costing income statement
makes it easier to identify these costs.
DO IT! 5: Variable Costing
Franklin Company produces and sells tennis balls. The following
costs are available for the year ended December 31, 2022. The
company has no beginning inventory. In 2022, 8,000,000 units were
produced, but only 7,500,000 units were sold. The unit selling price
was $0.50 per ball. Costs and expenses were as follows.
Unit variable costs
Direct materials $0.10
Direct labor 0.05
Variable manufacturing overhead 0.08
Variable selling and administrative expenses 0.02
Annual fixed costs and expenses
Manufacturing overhead $500,000
Selling and administrative expenses 100,000

Solution to part a.
Unit variable costs
Direct materials $0.10
Direct labor 0.05
Variable selling and administrative expenses 0.02
Annual fixed costs and expenses
Manufacturing overhead $500,000
Selling and administrative expenses 100,000
a. Compute the manufacturing cost of one unit of product using

variable costing. Direct materials $0.10
Direct labor 0.05
$0.23

Solution to part b.
b. Prepare a 2022 income statement for Franklin
Company using variable costing.

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Managerial Accounting

Copyright ©2021 John Wiley & Sons, Inc.

Copyright ©2021 John Wiley & Sons, Inc. 2

Apply basic CVP concepts.

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LO 1 Copyright ©2021 John Wiley & Sons, Inc. 12

A competitor is offering a 10% discount on the selling price

LO 1 Copyright ©2021 John Wiley & Sons, Inc. 13

Management invests in new robotic equipment that will

LO 1 Copyright ©2021 John Wiley & Sons, Inc. 14

Vargo’s principal supplier of raw materials has just

LO 1 Copyright ©2021 John Wiley & Sons, Inc. 15

Unit variable costs increase to $325 ($300 + $25).

LO 1 Copyright ©2021 John Wiley & Sons, Inc. 16

LO 1 Copyright ©2021 John Wiley & Sons, Inc. 17

LO 1 Copyright ©2021 John Wiley & Sons, Inc. 18

To increase net income, management is considering

Break-even point in units = 4,167 units (rounded) ($100,000 ÷ $24)

LO 1 Copyright ©2021 John Wiley & Sons, Inc. 20

Explain the term sales mix and its effects on break-even

• Sales mix is the relative percentage in which a

LO 2 Copyright ©2021 John Wiley & Sons, Inc. 22

Cell Phones TVs

LO 2 Copyright ©2021 John Wiley & Sons, Inc. 23

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First, determine weighted-average unit contribution

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• At this level, the total contribution margin will equal

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• With break-even sales of $937,500 and a sales mix of

• If sales mix becomes 50% to 50%, the weighted-

LO 2 Copyright ©2021 John Wiley & Sons, Inc. 32

Net income will be:

LO 2 Copyright ©2021 John Wiley & Sons, Inc. 33

Net income will be:

LO 2 Copyright ©2021 John Wiley & Sons, Inc. 34

The company’s total fixed costs to produce the bicycles

LO 2 Copyright ©2021 John Wiley & Sons, Inc. 35

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$7,500,000 ÷ $150 = 50,000 units

LO 2 Copyright ©2021 John Wiley & Sons, Inc. 38

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LO 3 Copyright ©2021 John Wiley & Sons, Inc. 40

Calculate the contribution margin per unit of limited

This would suggest that, given sufficient demand for cell

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