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Cost-Volume-Profit Analysis

Chapter 7

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The Break-Even PointThe Break-Even PointThe 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 -$

7-2

Equation ApproachEquation ApproachSales revenue – Variable expenses – Fixed expenses = Profit

UnitUnitsalessalespriceprice

SalesSalesvolumevolumein unitsin units

××UnitUnit

variablevariableexpenseexpense

SalesSalesvolumevolumein unitsin units

××

($500 × X)× X) ($300 × X)× X)–– –– $80,000 = $0

($200X)X) –– $80,000 = $0

X = 400 surf boardsX = 400 surf boards7-3

Contribution-Margin ApproachContribution-Margin Approach

For each additional surf board sold, Curl generates $200 in contribution margin.

Total Per Unit PercentSales (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$

Consider the following information developed by the accountant at Curl, Inc.:

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Contribution-Margin ApproachContribution-Margin Approach Fixed expensesFixed expenses Unit contribution margin Unit contribution margin

== Break-even pointBreak-even point(in units)(in units)

Total Per Unit PercentSales (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$

$$80,00080,000 $$200200 == 400 surf boards400 surf boards

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Contribution-Margin ApproachContribution-Margin Approach Here is the proof!

Total Per Unit PercentSales (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 = $200,000400 × $500 = $200,000 400 × $300 = $120,000400 × $300 = $120,0007-6

Contribution Margin RatioContribution Margin Ratio

Calculate the break-even point in sales dollars rather than units by using the contribution margin ratio.

Contribution margin Sales

= CM Ratio

Fixed expenseFixed expense CM RatioCM Ratio

Break-even pointBreak-even point(in sales dollars)(in sales dollars)==

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Graphing Cost-Volume-Profit Graphing Cost-Volume-Profit RelationshipsRelationshipsViewing CVP relationships in a graph gives managers a perspective that can be obtained in no other way.Consider the following information for Curl, Inc.:

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Cost-Volume-Profit GraphCost-Volume-Profit GraphD

olla

rs

600 700 800Units

200 300 400 500

450,000

100

200,000

150,000

100,000

50,000

400,000

350,000

300,000

250,000

Fixed expensesTotal expenses

7-9

Cost-Volume-Profit GraphCost-Volume-Profit GraphD

olla

rs

600 700 800Units

200 300 400 500

450,000

100

200,000

150,000

100,000

50,000

400,000

350,000

300,000

250,000

Fixed expensesTotal expenses

7-10

Cost-Volume-Profit GraphCost-Volume-Profit GraphD

olla

rs

600 700 800Units

200 300 400 500

450,000

100

200,000

150,000

100,000

50,000

400,000

350,000

300,000

250,000

Fixed expensesTotal expenses

Total sales

7-11

Cost-Volume-Profit GraphCost-Volume-Profit GraphD

olla

rs

600 700 800Units

200 300 400 500

450,000

100

200,000

150,000

100,000

50,000

400,000

350,000

300,000

250,000

Fixed expensesTotal expenses

Total sales

Break-evenpoint Profit a

rea

Loss area

7-12

Profit-Volume GraphProfit-Volume GraphSome managers like the profit-volume

graph because it focuses on profits and volume.

`

100 200 300 400 500 600 700Units

Pro

fit

0

100,000

(20,000)

(40,000)

(60,000)

80,000

60,000

40,000

20,000

Loss area

Profit areaBreak-even

point

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Target Net ProfitTarget Net Profit 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 Unit contribution margin = Units sold to earn

the target profit

$80,000 + $100,000 $200 = 900 surf boards

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Equation ApproachEquation Approach

Sales revenue – Variable expenses – Fixed expenses = Profit

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

($200X)X) = $180,000

X = 900 surf boardsX = 900 surf boards

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Applying CVP AnalysisApplying CVP AnalysisSafety Margin

The difference between budgeted sales revenue and break-even sales revenue.

The amount by which sales can drop before losses occur.

7-16

CVP Analysis with Multiple CVP Analysis with Multiple ProductsProducts

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.

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CVP Analysis with Multiple CVP Analysis with Multiple ProductsProductsCurl provides us with the following: information:

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CVP Analysis with Multiple CVP Analysis with Multiple ProductsProducts

Weighted-average unit contribution margin

$200 × 62.5%

$550 × 37.5%7-19

CVP Analysis with Multiple CVP Analysis with Multiple ProductsProducts

Break-even pointBreak-evenpoint = Fixed expenses

Weighted-average unit contribution margin

Break-evenpoint = $170,000

$331.25

Break-evenpoint = 514 combined unit sales514 combined unit sales

7-20

CVP Analysis with Multiple CVP Analysis with Multiple ProductsProducts

Break-even pointBreak-even

point = 514 combined unit sales

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Assumptions UnderlyingAssumptions UnderlyingCVP AnalysisCVP Analysis1. Selling price is constant

throughout the entire relevant range.

2. Costs are linear over the relevant range.

3. In multi-product companies, the sales mix is constant.

4. In manufacturing firms, inventories do not change (units produced = units sold).

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CVP Relationships and the Income CVP Relationships and the Income StatementStatement

A. Traditional Format

Sales $500,000Less: 380,000Gross margin $120,000Less: Operating expenses:Selling expenses $35,000Administrative expenses 35,000 70,000Net income $50,000

ACCUTIME COMPANYIncome Statement

For the Year Ended December 31, 20x1

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CVP Relationships and the Income CVP Relationships and the Income StatementStatement

B. Contribution Format

Sales $500,000Less: Variable expenses:Variable manufacturing $280,000Variable selling 15,000Variable administrative 5,000 300,000Contribution margin $200,000Less: Fixed expenses:Fixed manufacturing $100,000Fixed selling 20,000Fixed administrative 30,000 150,000Net income $50,000

Income StatementFor the Year Ended December 31, 20x1

ACCUTIME COMPANY

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Cost Structure and Operating Cost Structure and Operating LeverageLeverageThe 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.

7-25

Measuring Operating Measuring Operating LeverageLeverage

Contribution margin Net income

Operating leveragefactor =

$100,000 $100,000 $20,000$20,000 = 5= 5

7-26

Measuring Operating Measuring Operating LeverageLeverageA 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 × 5Percent increase in profits 50%

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CVP Analysis, Activity-Based Costing, CVP Analysis, Activity-Based Costing, and Advanced Manufacturing Systemsand Advanced Manufacturing SystemsAn activity-based costing system provides a much

more complete picture of cost-volume-profit relationships and, thus, it provides better

information to managers.

Break-evenBreak-evenpointpoint

== Fixed costsFixed costsUnit contribution marginUnit contribution margin

7-28

AA Move Toward JIT andMove Toward JIT andFlexible ManufacturingFlexible Manufacturing

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.

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Effect of Income TaxesEffect of Income Taxes

Target after-tax net income 1 - t

=Before-tax net income

Income taxes affect a company’s CVP relationships. To earn a

particular after-tax net income, a greater before-tax income will be

required.

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