Cost Volume - Profit Analysis
Cost Volume - Profit Analysis
Cost Volume - Profit Analysis
Cost-Volume-Profit
Analysis
Questions
1.
Cost-volume-profit analysis is used to accomplish the first step in the planning phase for
a business, which involves predicting the volume of activity, costs to be incurred,
revenues to be received, and profits to be earned.
2.
A variable cost is one that varies proportionately with the volume of activity that drives
the cost. Examples in a manufacturing setting include direct materials and direct labour
(when the workers are paid for completed units).
3.
Variable costs per unit stay the same because each unit consumes the same amount of
variable costs within the relevant range of activity. That is, variable costs per unit remain
constant as volume increases.
4.
Fixed costs per unit decrease because the total amount of fixed costs remains the same
while being divided among more units within the relevant fixed cost range of activity.
5.
A step-wise cost remains constant over a limited range of production, after which it
increases by a lump-sum amount, then remains constant over another limited range of
production, and so on. A curvilinear cost gradually changes in a nonlinear relationship to
volume changes.
6.
7.
The first is that individual costs classified as fixed or variable may not behave precisely
in those patterns; some variations of individual components may tend to offset each
other. The second is that management can assume that costs are either fixed or variable
within the relevant range of operations.
8.
By assuming a relevant range, management can more justifiably assume fixed and
variable relationships between costs and volume, and between revenue and volume. The
assumption also limits the alternative strategies to those that call for a volume that falls
within the relevant range.
9.
10. A scatter diagram can be used to display past costs and volumes. Then, management
(assisted by the accountant) can attempt to identify the fixed and variable components of
the total cost being graphed.
11. At break-even, profits are zero. Break-even is the point where sales equals fixed plus
variable costs.
12. The line shows the total cost, which equals the sum of the fixed and variable costs at all
volumes within the periods capacity.
Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
160
13. Fixed costs are depicted as a horizontal line on a CVP chart because they remain the
same at all volumes within the relevant range.
14. Company A has a contribution margin ratio of 50% ([$20,000 $10,000] $20,000), and
Company B has a contribution margin ratio of 80% ([$20,000 $4,000] $20,000). Thus,
compared to Company A, Company B will make more profit on each additional dollar of
sales.
15. Margin of safety.
16. The primary variable costs in making hats are cloth, thread, cardboard, and direct labour.
The costs of operating the plant and equipment are fixed because regardless of
production levels these product costs are incurred.
17. A 65% increase in production would be viewed as a substantial increase in production.
When this occurs, the sales and cost structure changes. The sales value, fixed costs,
and variable costs are likely to change as production moves out of the relevant range.
Variable cost per unit may go down, and fixed cost in total is likely to increase due to, for
example, more space needed to manage the increase in production.
161
QUICK STUDY
Quick Study 25-1
Series 1
Series 2
Series 3
Variable cost
Fixed cost
Step-wise cost
(d)
(e)
(f)
Fixed
Probably mixed
Variable
$8,000 $3,000
= $1.4286
3,500 0
$225,000
= 11,250 units
$20
(b)
$50 $30
$50
= 40%
$225,000
= $562,500
40%
$835,120
= 9,825 units
$85
163
EXERCISES
Exercise 25-1
1.
2.
3.
4.
5.
6.
f
c
d
a
b
e
Exercise 25-2
Sales
Variable
Cost
$3,000
1,960
960
$4,000
2,800
6,200
Fixed
Cost
$600
840
840
Total
Cost
$3,600
2,800
1,800
Net Income
$400
-04,400
Contribution
Margin
$1,000
840
5,240
Exercise 25-3
Series A
Series B
Series C
Series D
Series E
Curvilinear cost
Mixed cost
Variable cost
Step-wise cost
Fixed cost
Exercise 25-4
a.
b.
1.
2.
3.
4.
5.
Fixed cost
Mixed cost
Step-wise cost
Variable cost
Curvilinear cost
(1)
(2)
(3)
(4)
(5)
3
5
1
4
2
165
Exercise 25-6
CGS
$235,000
226,000
$ 9,000
Sales
$450,000
420,000
$ 30,000
Sales
$450,000
420,000
$ 30,000
Selling &
Administration
Expenses
$108,000
106,000
$ 2,000
$108,000
30,015
$ 77,985
167
$500,000
$150,000
33,350
$183,350
$316,650
$100,000
77,985
$177,985
$138,665
48,533
$ 90,132
Exercise 25-11
Income
Sales (15,000 $117.60) .........................................
Variable costs (15,000 $88.20) ........................
Contribution margin ...........................................
Fixed costs ..........................................................
Net income ..............................................................
$1,764,000
1,323,000
441,000
441,000
$
0
Exercise 25-12
Pre-tax income = After-tax income (1 tax rate)
= $530,000 (1 0.4)
= $530,000 0.6
= $883,333
Income taxes = Pre-tax income tax rate
= $883,333 0.4 = $353,333
a.
Unit sales at target income level
=
=
Fixed
costs
Net
+ Income
income
taxes
Contribution margin
+
Fixed
costs
Net
+ Income
income
taxes
Contribution ratio
= $5,297,332
169
Exercise 25-13
a.
Recall that:
Net income = Sales revenue Variable costs Fixed costs Income taxes.
Given that we are working with pre-tax income, we can ignore income taxes.
Therefore, we can rewrite the above equation as follows:
Desired pre-tax net income = Total contribution margin Fixed costs
Monroe Company must generate sales revenues of $6,300,000 to earn a pre-tax income
equal to 18% of sales.
b.
Desired sales in units = $6,300,000 $117.60 = approximately 53,572 units
Exercise 25-14
Sales (60,000 $175)..............................................
Variable costs (60,000 $100)...............................
Contribution margin ...............................................
Fixed costs..............................................................
Net income before taxes ........................................
Income taxes (40% $4,059,000) ..........................
Net income after taxes ...........................................
$10,500,000
6,000,000
4,500,000
441,000
4,059,000
(1,623,600)
$ 2,435,400
Exercise 25-15
(a) Sales = Fixed costs + Variable costs + Pre-tax income
Sales = $600,000 + $375,000 + $150,000
Sales = $1,125,000
(b) Total contribution
Total contribution
Exercise 25-16
a.
(i)
(ii)
Sales price =
Sales
units
$12,000,000
= $150 per unit
80,000
$ 8,800,000
Sales .........................................................................
Less variable costs .................................................
Less pre-tax income................................................
Fixed costs...............................................................
$12,000,000
(8,800,000)
(2,400,000)
$ 800,000
150
(40)
110
171
Exercise 25-17
(a) Dollar sales = Fixed costs + Target pre-tax income
Contribution rate
= 600,000 + $240,000
75%
= $1,120,000
(b) Sales .......................................................................
Less fixed costs .....................................................
Less pre-tax income ..............................................
Variable costs ........................................................
$1,120,000
(600,000)
(240,000)
$ 280,000
Exercise 25-18
(a) Selling price per composite unit
10 windows @ $70 per unit ..............................................
3 doors @ $450 per unit ...................................................
Selling price per composite unit .....................................
$ 700
1,350
$2,050
$ 400
870
$1,270
(c)
Break-even point in composite units =
=
Fixed costs
Contribution margin per composite unit
$975,000
$2,050 $1,270
= 1,250 units
(d) Unit sales of windows and doors at break-even point:
Windows:
Doors:
10 1,250 ..................................
3 1,250...................................
12,500 units
3,750 units
PROBLEMS
Problem 25-1A (45 minutes)
Parts 1 & 2
Note to Instructoranswers to Parts 3 and 4 will vary among students because they will
be based on imprecise visual placements of the estimated line of cost behaviour. The
better predictions of total fixed costs will fall in the range between $20,000 and $30,000.
The predicted variable cost per sales dollar should fall between $0.60 and $0.70.
According to a least-squares regression, the following coefficients apply in this case:
Fixed costs = $24,928
Variable cost = $0.665 per sales dollar
173
Sales
Total Cost
$200,000
0
$200,000
$158,000
25,000
$133,000
Problem 25-2A
Part 1
(a) Contribution margin per unit = $480 $180 = $300
Break-even point in units
175
$480,000
480,000
$
0
Part 4
Pre-tax target income
=
=
=
=
Part 5
Contribution margin at predicted sales
Problem 25-3A
Part 1
Price per unit ................................ $750,000 15,000
Variable costs per unit ................ $450,000 15,000
Contribution margin per unit ...... $50 $30
Contribution ratio ......................... ($20 $50)
Fixed costs ...................................
Break-even point .......................... $384,000 40%
=
=
=
=
= $50
= $30
$20
40%
$384,000
$960,000
=
=
=
=
=
$15
$35
70%
$504,000
$720,000
Part 2
New variable costs per unit .........
New contribution margin per unit
New contribution ratio .................
New fixed costs ............................
New break-even point ..................
Part 3
177
$750,000
225,000
$525,000
504,000
$ 21,000
6,300
$ 14,700
Part 5
Pre-tax target income
=
=
=
=
$1,020,000
306,000
$ 714,000
504,000
$ 210,000
63,000
$ 147,000
Problem 25-4A
Part 1
Sales ................................................................
Units sold ........................................................
Selling price per unit ......................................
Variable costs ...................... ...........................
Variable cost per unit .....................................
Contribution margin per unit .........................
Contribution ratio ...........................................
Fixed costs ......................................................
Break-even (fixed costs contribution rate)
Product A
Product B
$800,000
50,000
$ 16.00
$560,000
$ 11.20
$ 4.80
30.0%
$100,000
$333,333
$800,000
50,000
$ 16.00
$100,000
$ 2.00
$ 14.00
87.5%
$560,000
$640,000
Part 2
179
Part 3
Income statements, assuming that the sales volume falls to 33,000 units:
Sales ...............................................................
Fixed costs .....................................................
Variable costs .................................................
Total costs ......................................................
Income before taxes ......................................
Income taxes (32%) ........................................
Net income ......................................................
Per Unit
Units
Product A Product B
$16.00
$16.00
33,000
33,000
$528,000
$11.20
$ 2.00
33,000
33,000
$100,000
369,600
$469,600
$ 58,400
(18,688)
$ 39,712
$528,000
$560,000
66,000
$626,000
$ (98,000)
(31,360)
$ (129,360)
Sales ...............................................................
Fixed costs .....................................................
Variable costs .................................................
Total costs ......................................................
Income before taxes ......................................
Income taxes (32%) ........................................
Net income ......................................................
Per Unit
Units
Product A
$16.00
$16.00
64,000
64,000
$1,024,000
$11.20
$ 2.00
64,000
64,000
$ 100,000
716,800
$ 816,800
$ 207,200
66,304
$ 140,896
Product B
$1,024,000
$ 560,000
128,000
$ 688,000
$ 336,000
107,520
$ 228,480
Part 5
If sales were to greatly decrease, Product B would suffer the greater loss because it
would lose more contribution per unit than Product A. At zero sales, Product B would
have a loss equal to its fixed costs of $560,000, while Product As loss would be only
$100,000.
Part 6
A factor that could cause Product A to have lower fixed costs might be a labour
arrangement that pays workers for units produced. Another might be that the sales
representatives work totally on commission. Managers may be compensated with a share
of the profits instead of salaries. The fixed costs for Product B may be higher because of
a salary structure that is not based on production or sales. Another factor may be that
assets used in the production of Product A are leased and rent is based on the amount of
usage. Product Bs assets may be owned or under a lease agreement based on time, not
the amount of usage.
181
Problem 25-5A
Part 1
New variable costs:
Materials cost .......................
Direct labour ........................
Overhead variable costs ......
Selling and admin. costs .....
Total variable costs .............
$4.00 (1 60%)
$3.00 (1 40%)
=
=
=
=
=
$1.60
$1.80
$0.40
$0.20
$4.00
=
=
=
=
=
$16.00
$12.00
75%
$300,000
$400,000
=
=
=
=
=
$20.00
$16.00
80%
$300,000
$375,000
Plan 1
Selling price .........................
Contribution margin per unit $16.00 $4.00
Contribution ratio ................ $12.00 $16.00
Total fixed costs ..................
Break-even point (dollars) .. $300,000 75%
Plan 2
Selling price ......................... $16.00 (1 + 25%)
Contribution margin per unit $20.00 $4.00
Contribution ratio ................ $16.00 $20.00
Total fixed costs ...................
Break-even point (dollars) .. $300,000 80%
Part 2
Part 3
KIRBY COMPANY
Forecasted Income Statement
Sales ............................................................
Fixed costs ..................................................
Variable costs ..............................................
Total costs ...................................................
Income before taxes ...................................
Income taxes (30%) .....................................
Net income ...................................................
Per Unit
Units
Plan 1
$16.00
$20.00
35,000
31,500
$560,000
$ 4.00
$ 4.00
35,000
31,500
Plan 2
$630,000
$300,000 $300,000
140,000
126,000
$440,000 $426,000
$120,000 $204,000
61,200
36,000
$ 84,000 $142,800
183
Problem 25-6A
1.
Sales ................................................................
Variable costs:
Cost of sales ............................................... $840,000
Commissions .............................................. 210,000
Contribution margin .......................................
Contribution margin ratio (CMR)
$14,000
.25
$56,000
60%
5%
65%
= 35%
Fixed costs
Sales manager .............................................................
Three salespeople @ $42,000......................................
Administrative ..............................................................
Fixed costs .......................................................................
CMR ..................................................................................
Estimated break-even point.............................................
3.
1,050,000
$ 350,000
= $ 350,000
$1,400,000
= 25%
$1,400,000
$ 84,000
126,000
14,000
$224,000
$224,000
.35
$640,000
$336,000
14,000
$350,000
60%
20%
80%
20%
$ 350,000
.20
$1,750,000
x
.80x + $14,000
.15x
x
Problem 25-7A
(a) $1,680,000 (560,000 + 700,000 + 140,000 + VSA) = $140,000
Variable selling and administrative expense (VSA)
= $140,000
185
Problem 25-8A
Part 1
5 units of Red @ $55 per unit
4 units of White @ $85 per unit
2 units of Blue @ $110 per unit
Selling price of a composite unit
5 units of Red @ $40 per unit
4 units of White @ $60 per unit
2 units of Blue @ $80 per unit
Variable cost of a composite unit
Contribution margin of a composite unit
Contribution margin ratio
Break-even point in dollars
Break-even point in composite units
Units of Red at break-even point:
Units of White at break-even point:
Units of Blue at break-even point:
= $275
= 340
= 220
= $835
= $200
= 240
= 160
= $600
= $835 $600 = $235
= $235 $835 = 28.14%
= $150,000 28.14% = $533,049
= $150,000 $235 = 639 composite units
639 5 = 3,195 units
639 4 = 2,556 units
639 2 = 1,278 units
Part 2
Under the new plan, there would be no change in selling prices. The fixed costs would
increase by $20,000 to $170,000 per year.
5 units of Red @ ($40 $10) per unit
= $150
4 units of White @ ($60 $20) per unit
= 160
2 units of Blue @ ($80 $10) per unit
= 140
Variable cost of a composite unit
= $450
Contribution margin of a composite unit = $835 $450 = $385
Contribution margin ratio
= $385 $835 = 46.11%
Break-even point in dollars
= $170,000 46.11% = $368,683
Break-even point in composite units
= $170,000 $385 = 442 composite units
Units of Red at break-even point:
442 5 = 2,210 units
Units of White at break-even point:
442 4 = 1,768 units
Units of Blue at break-even point:
442 2 = 884 units
Part 3
When a business invests in capital assets, as in this problem, the risk of doing business
changes. The break-even point decreased, making it easier to make a profit. However, the
commitment of fixed resources is higher, therefore increasing the amount of loss in a
business failure.
ALTERNATE PROBLEMS
Problem 25-1B
Parts 1 & 2
Part 3
Using the scatter diagram and the vertical intercept, a good approximate answer for the
predicted monthly fixed cost is $90 and .30 for variable cost.
Part 4
Then, these factors can be used to predict the total costs that will be incurred at sales
levels of $150 and $250.
$250
$150
Fixed cost................................................................
$ 90
$ 90
75
Variable cost ($0.30 sales dollar).......................
45
Total cost.................................................................
$135
$165
187
Problem 25-2B
Part 1
(a) Contribution margin
Break-even point in units
(b) Contribution margin ratio
$90,000
60,000
30,000
30,000
0
Problem 25-3B
Part 1
Price per unit.................................
Variable costs per unit .................
Contribution margin per unit.......
Contribution margin ratio ............
Fixed costs....................................
Break-even point ..........................
$800,000 50,000
$900,000 50,000
$16 $18
($2 $16)
= $16.00
= $18.00
= $2
= not applicable
= $100,000
Capital will never
break even because
variable cost is
greater than selling
price per unit.
Part 2
New variable costs per unit .........
New contribution margin per unit
New contribution margin ratio ....
New fixed costs ............................
New break-even point ..................
= $5
= $11
= 68.75%
= $300,000
= $436,364
Part 3
CAPITAL COMPANY
Forecasted Income Statement
For Year Ended December 31, 2005
Sales (50,000 $16)................................................
Costs:
Fixed ($100,000 + $200,000) ............................... $300,000
Variable (50,000 $5) .........................................
250,000
Income before income taxes .................................
Income taxes ($250,000 40%) .............................
Net income ..............................................................
$800,000
550,000
250,000
100,000
$150,000
189
Necessary sales level = (Fixed costs + Target income + Taxes) Contribution margin ratio
= ($300,000 + $300,000 + $200,000) 68.75%
= $800,000 68.75%
= $1,163,637
Unit sales = $1,163,637 $16 = 72,728 units
Part 5
CAPITAL COMPANY
Forecasted Income Statement
For Year Ended December 31,2005
Sales (72,728 $16)....................................................
$1,163,648
Costs:
Fixed....................................................................... $300,000
663,640
Variable (72,728 $5) ........................................... 363,640
Income before income taxes .....................................
$ 500,008
Income taxes ($500,008 40%) .................................
200,003
Net income ..................................................................
$ 300,005
(Net income is greater than $300,000 due to rounding up in units from Part 4.)
Problem 25-4B
Part 1
Sales .....................................................................
Units sold .............................................................
Selling price per unit ...........................................
Product L
$3,000,000
120,000
$25
Product M
$3,000,000
120,000
$25
$1,800,000
$15
$600,000
$5
$10
40%
$20
80%
Fixed costs...........................................................
Break-even (fixed costs
contribution margin ratio)...............................
$ 600,000
$1,800,000
$1,500,000
$2,250,000
Part 2
Income statements, assuming that the sales volume falls to 104,000 units:
Per Unit
Units
Product L
Product M
Sales ................................
$25.00 104,000 $2,600,000
$25.00 104,000
$2,600,000
Variable costs .................
$15.00 104,000
1,560,000
520,000
$5.00 104,000
Contribution margin .......
1,040,000
2,080,000
Fixed costs......................
600,000
1,800,000
Income before taxes.......
440,000
280,000
98,000
Income tax (35%) ............
154,000
Net income ......................
$ 286,000 $ 182,000
191
Problem 25-5B
Part 1
Priced at $25.00 per unit (old plan):
Bulk material cost per unit .................................
Packaging cost per unit ......................................
Total variable costs per unit...............................
Contribution margin per unit..............................
Contribution margin ratio ...................................
Fixed costs per year............................................
Break-even point .................................................
Priced at $20.00 per unit (new plan):
Bulk material cost per unit .................................
Packaging cost per unit ......................................
Total variable costs per unit...............................
Contribution margin per unit..............................
Contribution margin ratio ...................................
Fixed costs per year............................................
Break-even point .................................................
$1,000,000 100,000
$100,000 100,000
$10.00 + $1.00
$25.00 $11.00
$14.00 $25.00
$1,250,000 56%
= $10.00
= $1.00
= $11.00
= $14.00
= 56%
= $1,250,000
= $2,232,143
$10.00 80%
$1.00 125%
$8.00 + $1.25
$20.00 $9.25
$10.75 $20.00
= $8.00
= $1.25
= $9.25
= $10.75
= 53.75%
= $1,250,000
$1,250,000 53.75% = $2,325,581
Part 2
WHITE COMPANY
Forecasted Income Statement
Sales ................................
Fixed costs......................
Variable costs:
Product ........................
Packaging ....................
Total costs.......................
Income before taxes.......
Income taxes (30%) ........
Net income ......................
Per Unit
$25.00
$20.00
Units
100,000
180,000
$10.00
$ 8.00
$ 1.00
$ 1.25
100,000
180,000
100,000
180,000
Return on sales...............
Old Plan
$2,500,000
$1,250,000
1,000,000
100,000
New Plan
$3,600,000
$1,250,000
1,440,000
$2,350,000
$ 150,000
45,000
$ 105,000
225,000
$2,915,000
$ 685,000
205,500
$ 479,500
4.2%
13.3%
193
Problem 25-6B
Part 1
Sales ................................................................
Variable costs:
Cost of sales ...............................................
Commissions ..............................................
Contribution margin .......................................
Contribution margin ratio (CMR)
$1,960,000
$1,176,000
235,200
$548,800
$1,960,000
= 28%
$21,100
.28
$75,357
60%
4%
64%
= 36%
b. Fixed costs
Sales manager .............................................................
Three salespeople @ $48,000......................................
Administrative ..............................................................
Fixed costs .......................................................................
CMR ..................................................................................
Estimated break-even point.............................................
c.
1,411,200
$ 548,800
$107,600
144,000
21,100
$272,700
$272,700
.36
$757,500
$468,900
21,100
$490,000
60%
15%
75%
25%
$ 490,000
.25
$1,960,000
x
.75x + $21,100
.11x
= sales volume
= .64x + $272,700
= $251,600
= $2,287,273
Problem 25-7B
(a) $910,000 (280,000 + 350,000 + 70,000 + VSA)
= $182,000
= $ 28,000
= $ 70,000
= $140,000
195
Problem 25-8B
Part 1
Break-even analysis assuming new machine is not acquired:
2 units of Product 1 @ $225 per unit
= $ 450
5 units of Product 2 @ $150 per unit
=
750
8 units of Product 3 @ $120 per unit
=
960
Selling price of a composite unit
= $2,160
2 units of Product 1 @ $120 per unit
5 units of Product 2 @ $102 per unit
8 units of Product 3 @ $75 per unit
Variable cost of a composite unit
= $ 240
=
510
=
600
= $1,350
Part 2
Break-even analysis assuming purchase of new machine:
Under the new plan, there would be no change in selling prices. The fixed costs would
increase by $81,000 to $874,800 per year.
2 units of Product 1 @ $120 per unit
5 units of Product 2 @ ($102 $18) per unit
8 units of Product 3 @ ($75 $9) per unit
Variable cost of a composite unit
= $ 240
= 420
= 528
= $1,188
Part 3
When a business invests in capital assets, as in this problem, there is a change in the
riskiness of conducting business. The break-even point decreased, making it easier to
make a profit with less sales. However, because of the commitment of higher fixed
resources, the risk of loss from business failure is greater.
Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
196
CAMS
$42.00
$7.00
8.40
4.20
2.80
22.40
$19.60
LIPS
$42.00
$ 7.84
10.08
6.72
2.80
27.44
$14.56
197
a.
NIKE
Reebok
100,000
300,000
100,000
340,000
400,000
440,000
30,000
50,000
80,000
480,000
10,000
$48
10,000
60,000
70,000
510,000
10,000
$51
2.
The reason why NIKE is more profitable than Reebok can be explained by the
difference in cost structures for each company. NIKE invested more in capital assets
than Reebok. Thus, the contribution margin for NIKE is greater than for Reebok. As a
result, at sales of 10,000 pairs, the savings in labour more than offsets the $10,000 of
additional investment in capital assets for NIKE.
3.
If sales significantly decline, NIKE will be less profitable. The fixed cost for each
company stays the same, and NIKE has a greater commitment to fixed costs. Thus, a
decrease in total contribution would be greater for NIKE ($12/pair) than for Reebok
($9/pair) in a sales downturn, although sales would have to decrease by more than
75% before Reebok would be more profitable than NIKE.
199