Chapter Five

Cost Volume Profit

(CVP) Analysis
Learning Objectives

Understand the Cost Behavior Concepts

Understand the concept of cost-volume-

profit (CVP) analysis.

Use of cost-volume-profit (CVP) analysis to

analyze decisions.

Target net profit after tax

Summary of cost behavior
concept
 What is CVP analysis?
• Cost-volume-profit analysis is the examination
of the relationships among selling prices, sales
and production volume, costs, expenses, and
profits.
• Cost-volume-profit analysis is useful for
managerial decision making. Some of the ways
cost-volume-profit analysis may be used include:
• Analyzing the effects of changes in selling prices on
profits
• Analyzing the effects of changes in costs on profits
• Analyzing the effects of changes in volume on profits
• Setting selling prices
• Selecting the mix of products to sell
• Choosing among marketing strategies
Profit Equation
The Income Statement

Total revenues
– Total costs
= Operating profit

The Income Statement written horizontally

Operating profit = Total revenues – Total costs
Profit = TR – TC
Profit Equation
Total revenue (TR)
Average selling price per unit (P)
× Units of output produced and sold (Q)
TR = PQ

Total cost (TC)

[Variable cost per unit (V) × Units of output (Q)]
+ Fixed costs (F)
TC = VQ + F
 Profit Equation

Profit = Total revenue – Total costs

= TR – TC
TC = VQ + F

Therefore, Profit = PQ – (VQ + F)

Profit = (Price – Variable costs) × Units of output – Fixed costs

= Q(P – V) – F
 Contribution Margin
This is the difference between price and variable cost.

It is what is leftover to cover fixed costs and then add to

operating profit.

Contribution margin = Price per unit – Variable cost per unit

P–V
CVP Example

Contribution margin per unit = $2,880 ÷ 12,000 = $0.24

Break-Even Volume in Units
This is the volume level at which profits equal zero.
Profit 0 = Q(P – V) – F
If profit = 0, then Q = F ÷ (P – V)

Fixed costs
Break-even volume (in units) =
Unit contribution margin
= $1,500 ÷ $0.24

= 6,250 prints
Break-Even Volume in Sales Dollars

Contribution margin percentage (contribution

margin ratio) is the contribution margin as a
percentage of sales revenue.

Contribution Margin Percentage

$0.24 ÷ $0.60 = 0.40 (or 40%)

Break-even in Sales Dollars

$1,500 ÷ 0.40 = $3,750
Target profit
Assume that management wants to have a
profit of $1,800.
How many prints must be sold?
What is the target dollar sales?

Target Volume in Units

($1,500 + $1,800) ÷ $0.24 = 13,750

Target Volume in Sales Dollars

($1,500 + $1,800) ÷ 0.40 = $8,250
CVP Summary: Break-Even
Break-even volume Fixed costs
(units) =
Unit contribution margin

Break-even volume Fixed costs

=
(sales dollars) Contribution margin ratio
CVP Summary: Target Volume
Target volume Fixed costs + Target profit
(units) =
Unit contribution margin

Target volume Fixed costs + Target profit

=
(sales dollars) Contribution margin ratio
Graphic Presentation
Total cost
TC = $1,500 + $0.36X

$3,750

6,250 prints
Total revenue
TR = $0.60X
Margin of Safety
The excess of projected or actual sales volume over
break-even volume
or
The excess of projected or actual sales revenue over
break-even revenue

Suppose U-Develop sells 8,000 prints.

At a break-even volume of 6,250, its margin of
safety is:
Sales – Break-even
8,000 – 6,250 = 1,750 prints
Extensions of the CVP Model:
Income Taxes

The owners of U-Develop want to generate after-tax

operating profits of $1,800.

The tax rate is 25%.

What is the target operating profit?

Target operating profit = TOP ÷ (1 – Tax rate)
TOP = $1,800 ÷ (1 – 0.25)
TOP = $2,400
Extensions of the CVP Model:
Income Taxes
How many units must be sold?

Fixed costs + [Target profit ÷ (1 – Tax rate)]

Unit contribution margin

($1,500 + $2,400)
= 16,250 prints
$0.24
Extensions of the CVP Model:
Income Taxes
Proof:
Sales: 16,250 × $0.60 $9,750
Variable costs: 16,250 × $0.36 5,850
Contribution margin $3,900
Fixed costs 1,500
Net income before taxes $2,400
Income taxes: $2,400 × 25% 600
Net income $1,800
End of Chapter 5