Cost-Volume-

Profit
Relationships
BASTRCSX Module 3

Strategic Cost Management 1

 Learning
Outcomes
1. Explain how changes in activity affect contribution margin and net operating income.
2. Prepare and interpret a cost-volume-profit (CVP) graph and a profit graph.
3. Use the contribution margin ratio (CM ratio) to compute changes in contribution margin and net
operating income resulting from changes in sales volume.
4. Explain the effects on contribution margin of changes in variable costs, fixed costs, selling price, and
volume.
5. Analyze the relationship of costs, volume and sales to calculate break-even points and target profit.
6. Determine the level of sales needed to attain a target profit.
7. Determine the break-even point.
8. Compute the margin of safety and explain its significance.
9. Compute the degree of operating leverage at a particular level of sales and explain how it can be used
to predict changes in net operating income.
10. Compute the break-even point for a multiproduct company and explain the effects of shifts in the sales
mix on contribution margin and the break-even point.
11. Discuss the impact of non-unit cost drivers on cost-volume-profit analysis

Strategic Cost Management 2

 Learning
Outcome 1
Explain how changes in
activity affect
contribution margin and
net operating income.

Strategic Cost Management 3

 Basics of Cost-Volume-Profit Analysis
The contribution income statement is helpful to managers
in judging the impact on profits of changes in selling price,
cost, or volume. The emphasis is on cost behavior.
Racing Bicycle Company
Contribution Income Statement
For the Month of June
Sales (500 bicycles) $ 250,000
Less: Variable expenses 150,000
Contribution margin 100,000
Less: Fixed expenses 80,000
Net operating income $ 20,000

Contribution Margin (CM) is the amount remaining from

sales revenue after variable expenses have been deducted.
Strategic Cost Management 4
 Basics of Cost-Volume-Profit Analysis
Racing Bicycle Company
Contribution Income Statement
For the Month of June
Sales (500 bicycles) $ 250,000
Less: Variable expenses 150,000
Contribution margin 100,000
Less: Fixed expenses 80,000
Net operating income $ 20,000

CM is used first to cover fixed expenses. Any

remaining CM contributes to net operating income.
Strategic Cost Management 5
 The Contribution Approach
Sales, variable expenses, and contribution margin can also be
expressed on a per unit basis. If Racing sells an additional
bicycle, $200 additional CM will be generated to cover fixed
expenses and profit.

Racing Bicycle Company

Contribution Income Statement
For the Month of June
Total Per Unit
Sales (500 bicycles) $ 250,000 $ 500
Less: Variable expenses 150,000 300
Contribution margin 100,000 $ 200
Less: Fixed expenses 80,000
Net operating income $ 20,000

Strategic Cost Management 6

 The Contribution Approach
Each month, RBC must generate at least
$80,000 in total contribution margin to
break-even (which is the level of sales at
which profit is zero).
Racing Bicycle Company
Contribution Income Statement
For the Month of June
Total Per Unit
Sales (500 bicycles) $ 250,000 $ 500
Less: Variable expenses 150,000 300
Contribution margin 100,000 $ 200
Less: Fixed expenses 80,000
Net operating income $ 20,000
Strategic Cost Management 7
 The Contribution Approach
If RBC sells 400 units in a month, it
will be operating at the break-even
point.
Racing Bicycle Company
Contribution Income Statement
For the Month of June
Total Per Unit
Sales (400 bicycles) $ 200,000 $ 500
Less: Variable expenses 120,000 300
Contribution margin 80,000 $ 200
Less: Fixed expenses 80,000
Net operating income $ -

Strategic Cost Management

8
 The Contribution Approach
If RBC sells one more bike (401 bikes), net
operating income will increase by $200.

Racing Bicycle Company

Contribution Income Statement
For the Month of June
Total Per Unit
Sales (401 bicycles) $ 200,500 $ 500
Less: Variable expenses 120,300 300
Contribution margin 80,200 $ 200
Less: Fixed expenses 80,000
Net operating income $ 200

Strategic Cost Management 9

 The Contribution Approach
We do not need to prepare an income statement to
estimate profits at a particular sales volume. Simply
multiply the number of units sold above break-even
by the contribution margin per unit.

If Racing sells
430 bikes, its net
operating income
will be $6,000.

Strategic Cost Management 10

 CVP Relationships in Equation Form
The contribution format income statement can be
expressed in the following equation:
Profit = (Sales – Variable expenses) – Fixed expenses

Racing Bicycle Company

Contribution Income Statement
For the Month of June
Total Per Unit
Sales (401 bicycles) $ 200,500 $ 500
Less: Variable expenses 120,300 300
Contribution margin 80,200 $ 200
Less: Fixed expenses 80,000
Net operating income $ 200

Strategic Cost Management 11

 CVP Relationships in Equation Form
This equation can be used to show the profit RBC
earns if it sells 401. Notice, the answer of $200 mirrors
our earlier solution.
Profit = (Sales – Variable expenses) – Fixed expenses

$80,000
401 units × $500
401 units × $300

$200 = ($200,500 – $120,300)

Profit – $80,000
Variable expenses) – Fixed
Fixed expenses

Strategic Cost Management 12

 CVP Relationships in Equation Form
When a company has only one product we can further
refine this equation as shown on this slide.
Profit = (Sales – Variable expenses) – Fixed expenses

Quantity sold (Q) Quantity sold (Q)

× Selling price per unit (P) × Variable expenses per unit (V)
= Sales (Q × P) = Variable expenses (Q × V)

Profit = (P × Q – V × Q) – Fixed expenses

Strategic Cost Management 13

 CVP Relationships in Equation Form
This equation can also be used to show the $200
profit RBC earns if it sells 401 bikes.

Profit = (Sales – Variable expenses) – Fixed expenses

Profit = (P × Q – V × Q) – Fixed expenses

Profit = ($500 × 401 – $300 × 401) – $80,000

$200 = ($500 × 401 – $300 × 401) – $80,000

Strategic Cost Management 14

 CVP Relationships in Equation Form
It is often useful to express the simple profit equation in
terms of the unit contribution margin (Unit CM) as follows:

Unit CM = Selling price per unit – Variable expenses per unit

Unit CM = P – V
Profit = (P × Q – V × Q) – Fixed expenses
Profit = (P – V) × Q – Fixed expenses
Profit = Unit CM × Q – Fixed expenses

Strategic Cost Management 15

 CVP Relationships in Equation Form
Profit = (P × Q – V × Q) – Fixed expenses
Profit = (P – V) × Q – Fixed expenses
Profit = Unit CM × Q – Fixed expenses

Profit = ($500 – $300) × 401 – $80,000

Profit = $200 × 401 – $80,000
This equation
Profit = $80,200 – $80,000 can also be
Profit = $200 used to
compute RBC’s
$200 profit if it
sells 401 bikes.
Strategic Cost Management 16
 Learning
Outcome 2
Prepare and interpret a
cost-volume-profit
(CVP) graph and a profit
graph.

Strategic Cost Management 17

 CVP Relationships in Graphic Form
The relationships among revenue, cost, profit and
volume can be expressed graphically by preparing
a CVP graph. Racing Bicycle developed
contribution margin income statements at 0, 200,
400, and 600 units sold. We will use this
information to prepare the CVP graph.
Units Sold
0 200 400 600
Sales $ - $ 100,000 $ 200,000 $ 300,000
Total variable expenses - 60,000 120,000 180,000
Contribution margin - 40,000 80,000 120,000
Fixed expenses 80,000 80,000 80,000 80,000
Net operating income (loss) $ (80,000) $ (40,000) $ - $ 40,000

Strategic Cost Management

18
 Preparing the CVP Graph
$350,000

$300,000

$250,000

$200,000

$150,000

$100,000
In a CVP graph, unit volume is usually
$50,000
represented on the horizontal (X) axis
and dollars on the vertical (Y) axis.
$0
0 100 200 300 400 500 600

Strategic Cost Management

Units 19
 Preparing the CVP Graph
$350,000 
Draw a line parallel to the volume axis to
$300,000 represent total fixed expenses.

$250,000

$200,000

Fixed expenses
$150,000

$100,000

$50,000

$0
0 100 200 300 400 500 600

Units
Strategic Cost Management 20
 Preparing the CVP Graph
$350,000

Choose some sales volume, say 400 units, and plot the point representing
$300,000
total expenses (fixed and variable). Draw a line through the data point
back to where the fixed expenses line intersects the dollar axis.
$250,000

$200,000

Total expenses
Fixed expenses
$150,000

$100,000

$50,000

$0
0 100 200 300 400 500 600

Units
Strategic Cost Management 21
 Preparing the CVP Graph
$350,000

Choose $300,000
some sales volume, say 400 units, and plot the point representing
total sales. Draw a line through the data point back to the point of origin.
$250,000

$200,000
Sales
Total expenses
$150,000 Fixed expenses

$100,000

$50,000

$0
0 100 200 300 400 500 600

Units
Strategic Cost Management 22
 Preparing the CVP Graph
$350,000 Break-even point
(400 units or $200,000 in sales) Profit Area
$300,000

$250,000

$200,000
Sales
Total expenses
$150,000 Fixed expenses

$100,000

$50,000

$0
0 100 200 300 400 500 600

Loss Area Units

Strategic Cost Management 23
 Preparing the CVP Graph
Profit = Unit CM × Q – Fixed Costs
$ 60,000

$ 40,000

$ 20,000
Profit

$0

-$20,000 An even simpler form of

-$40,000 the CVP graph is called
the profit graph.
-$60,000

0 100 200 300 400 500 600

Number of bicycles sold

Strategic Cost Management 24

 Preparing the CVP Graph
$ 60,000 Break-even point, where
profit is zero , is 400
$ 40,000 units sold.

$ 20,000
Profit

$0

-$20,000

-$40,000

-$60,000

0 100 200 300 400 500 600

Number of bicycles sold

Strategic Cost Management 25

 Learning
Outcome 3
Use the contribution
margin ratio (CM ratio)
to compute changes in
contribution margin and
net operating income
resulting from changes
in sales volume.

Strategic Cost Management 26

 Contribution Margin Ratio (CM Ratio)
The CM ratio is calculated by dividing the total
contribution margin by total sales.
Racing Bicycle Company
Contribution Income Statement
For the Month of June
Total Per Unit CM Ratio
Sales (500 bicycles) $ 250,000 $ 500 100%
Less: Variable expenses 150,000 300 60%
Contribution margin 100,000 $ 200 40%
Less: Fixed expenses 80,000
Net operating income $ 20,000

$100,000 ÷ $250,000 = 40%

Strategic Cost Management 27
Contribution Margin Ratio (CM Ratio)
The contribution margin ratio at Racing Bicycle is:

CM per unit $200

CM Ratio = = = 40%
SP per unit $500

The CM ratio can also be calculated by

dividing the contribution margin per unit by
the selling price per unit.

Strategic Cost Management

28
 Contribution Margin Ratio (CM Ratio)
If Racing Bicycle increases sales by $50,000, contribution
margin will increase by $20,000 ($50,000 × 40%).
Here is the proof:
400 Units 500 Units
Sales $ 200,000 $ 250,000
Less: variable expenses 120,000 150,000
Contribution margin 80,000 100,000
Less: fixed expenses 80,000 80,000
Net operating income $ - $ 20,000

A $50,000 increase in sales revenue results in a $20,000

increase in CM. ($50,000 × 40% = $20,000)
Strategic Cost Management 29
 Quick Check ✓
Coffee Klatch is an espresso stand in a
downtown office building. The average selling
price of a cup of coffee is $1.49 and the
average variable expense per cup is $0.36. The
average fixed expense per month is $1,300.
2,100 cups are sold each month on average.
What is the CM Ratio for Coffee Klatch?
a. 1.319
b. 0.758
c. 0.242
d. 4.139

Strategic Cost Management

30
 Quick Check ✓
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense per
cup is $0.36. The average fixed expense per month is
$1,300. 2,100 cups are sold each month on average.
What is the CM Ratio for Coffee Klatch?
a. 1.319 Unit contribution margin
CM Ratio =
b. 0.758 Unit selling price
c. 0.242 ($1.49-$0.36)
=
d. 4.139 $1.49
$1.13
= = 0.758
$1.49 Strategic Cost Management
31
 Contribution Margin Ratio (CM Ratio)
The relationship between profit and the CM ratio
can be expressed using the following equation:
Profit = CM ratio × Sales – Fixed expenses

If Racing Bicycle increased its sales volume to 500

bikes, what would management expect profit or net
operating income to be?
Profit = 40% × $250,000 – $80,000
Profit = $100,000 – $80,000
Profit = $20,000
Strategic Cost Management 32
 Learning
Outcome 4
Explain the effects on
contribution margin of
changes in variable
costs, fixed costs,
selling price, and
volume.

Strategic Cost Management 33

 The Variable Expense Ratio
The variable expense ratio is the ratio of variable
expenses to sales. It can be computed by dividing the
total variable expenses by the total sales, or in a single
product analysis, it can be computed by dividing the
variable expenses per unit by the unit selling price.
Racing Bicycle Company
Contribution Income Statement
For the Month of June
Total Per Unit CM Ratio
Sales (500 bicycles) $ 250,000 $ 500 100%
Less: Variable expenses 150,000 300 60%
Contribution margin 100,000 $ 200 40%
Less: Fixed expenses 80,000
Net operating income $ 20,000

Strategic Cost Management 34

Changes in Fixed Costs and Sales Volume
What is the profit impact if Racing
Bicycle can increase unit sales
from 500 to 540 by increasing
the monthly advertising budget
by $10,000?

Strategic Cost Management

35
 Changes in Fixed Costs and Sales Volume
$80,000 + $10,000 advertising = $90,000

500 units 540 units

Sales $ 250,000 $ 270,000
Less: Variable expenses 150,000 162,000
Contribution margin 100,000 108,000
Less: Fixed expenses 80,000 90,000
Net operating income $ 20,000 $ 18,000

Sales increased by $20,000, but net operating

income decreased by $2,000.
Strategic Cost Management 36
Changes in Fixed Costs and Sales Volume
A shortcut solution using
incremental analysis
Increase in CM (40 units X $200) $ 8,000
Increase in advertising expenses 10,000
Decrease in net operating income $ (2,000)

Strategic Cost Management

37
 Change in Variable Costs and Sales Volume
What is the profit impact if Racing
Bicycle can use higher quality raw
materials, thus increasing variable costs
per unit by $10, to generate an increase
in unit sales from 500 to 580?

Strategic Cost Management 38

 Change in Variable Costs and Sales Volume
580 units × $310 variable cost/unit = $179,800

500 units 580 units

Sales $ 250,000 $ 290,000
Less: Variable expenses 150,000 179,800
Contribution margin 100,000 110,200
Less: Fixed expenses 80,000 80,000
Net operating income $ 20,000 $ 30,200

Sales increase by $40,000, and net operating income

increases by $10,200.
Strategic Cost Management 39
 Change in Fixed Cost, Sales Price
and Volume
What is the profit impact if RBC: (1) cuts its
selling price $20 per unit, (2) increases its
advertising budget by $15,000 per month,
and (3) increases sales from 500 to 650
units per month?

Strategic Cost Management 40

 Change in Fixed Cost, Sales Price
and Volume
650 units × $480 = $312,000

500 units 650 units

Sales $ 250,000 $ 312,000
Less: Variable expenses 150,000 195,000
Contribution margin 100,000 117,000
Less: Fixed expenses 80,000 95,000
Net operating income $ 20,000 $ 22,000

Sales increase by $62,000, fixed costs increase by

$15,000, and net operating income increases by $2,000.
Strategic Cost Management 41
 Change in Variable Cost, Fixed Cost
and Sales Volume
What is the profit impact if RBC: (1) pays a
$15 sales commission per bike sold instead
of paying salespersons flat salaries that
currently total $6,000 per month, and (2)
increases unit sales from 500 to 575 bikes?

Strategic Cost Management 42

 Change in Variable Cost, Fixed Cost
and Sales Volume
575 units × $315 = $181,125
500 units 575 units
Sales $ 250,000 $ 287,500
Less: Variable expenses 150,000 181,125
Contribution margin 100,000 106,375
Less: Fixed expenses 80,000 74,000
Net operating income $ 20,000 $ 32,375

Sales increase by $37,500, fixed expenses decrease by

$6,000. Net operating income increases by $12,375.
Strategic Cost Management 43
 Change in Regular Sales Price
If RBC has an opportunity to sell 150
bikes to a wholesaler without disturbing
sales to other customers or fixed
expenses, what price would it quote to
the wholesaler if it wants to increase
monthly profits by $3,000?

Strategic Cost Management 44

 Change in Regular Sales Price
$ 3,000 ÷ 150 bikes = $ 20 per bike
Variable cost per bike = 300 per bike
Selling price required = $ 320 per bike

150 bikes × $320 per bike = $ 48,000

Total variable costs = 45,000
Increase in net operating income = $ 3,000

Strategic Cost Management 45

 Learning
Outcome 5
Determine the level of
sales needed to attain a
target profit.

Strategic Cost Management 46

 Target Profit Analysis
We can compute the number of units that
must be sold to attain a target profit
using either:
1. Equation method
2. Formula method.

Strategic Cost Management 47

 Equation Method
Profit = Unit CM × Q – Fixed expenses

Our goal is to solve for the unknown “Q”

which represents the quantity of units that
must be sold to attain the target profit.

Strategic Cost Management 48

 Target Profit Analysis
Suppose Racing Bicycle management
wants to know how many bikes must be
sold to earn a target profit of $100,000.

Profit = Unit CM × Q – Fixed expenses

$100,000 = $200 × Q – $80,000
$200 × Q = $100,000 – $80,000
Q = ($100,000 + $80,000) ÷ $200
Q = 900
Strategic Cost Management 49
 The Formula Method
The formula uses the following
equation.
Unit sales to attain Target profit + Fixed expenses
=
the target profit CM per unit

Strategic Cost Management

50
 Target Profit Analysis in Terms of Unit Sales
Suppose Racing Bicycle Company wants to know
how many bikes must be sold to earn a profit of
$100,000.
Unit sales to attain Target profit + Fixed expenses
=
the target profit CM per unit

$100,000 + $80,000
Unit sales =
$200
Unit sales = 900

Strategic Cost Management 51

 Target Profit Analysis
We can also compute the target profit in terms of
sales dollars using either the equation method or
the formula method.

Equation OR Formula
Method Method

Strategic Cost Management 52

 Equation Method
Profit = CM ratio × Sales – Fixed expenses
Our goal is to solve for the unknown “Sales” which
represents the dollar amount of sales that must be
sold to attain the target profit.
Suppose RBC management wants to know
the sales volume that must be generated
to earn a target profit of $100,000.
$100,000 = 40% × Sales – $80,000
40% × Sales = $100,000 + $80,000
Sales = ($100,000 + $80,000) ÷ 40%
Sales = $450,000
Strategic Cost Management 53
 Formula Method
We can calculate the dollar sales needed to attain a
target profit (net operating profit) of $100,000 at
Racing Bicycle.
Dollar sales to attain Target profit + Fixed expenses
=
the target profit CM ratio

$100,000 + $80,000
Dollar sales =
40%
Dollar sales = $450,000

Strategic Cost Management 54

 Quick Check ✓
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense
per cup is $0.36. The average fixed expense per
month is $1,300. Use the formula method to
determine how many cups of coffee would have to
be sold to attain target profits of $2,500 per month.
a. 3,363 cups
b. 2,212 cups
c. 1,150 cups
d. 4,200 cups
Strategic Cost Management 55
 Quick Check ✓
Coffee Klatch is an espresso stand in a
downtown office building. The average selling
price of a cup of coffee is $1.49 and the average
variable expense per cup is $0.36. The average
fixed expense per month is $1,300. Use the
Unit sales
formula method to determine
to attain = how
Target many
profit +cups
Fixedofexpenses
coffee would have to be sold
target profit to attain target
Unit CM
profits of $2,500 per month.
$2,500 + $1,300
a. 3,363 cups = $1.49 - $0.36
b. 2,212 cups
$3,800
c. 1,150 cups =
$1.13
d. 4,200 cups
= 3,363 cups Strategic Cost Management
56
 Quick Check ✓
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense
per cup is $0.36. The average fixed expense per
month is $1,300. Use the formula method to
determine the sales dollars that must be generated
to attain target profits of $2,500 per month.
a. $2,550
b. $5,011
c. $8,458
d. $10,555
Strategic Cost Management 57
 Quick Check ✓
Coffee Klatch is an espresso stand in a downtown office
building. The average selling price of a cup of coffee is
$1.49 and the average variable expense per cup is
$0.36. The average fixed expense per month is $1,300.
Use the formula method
Sales $ to determine the sales dollars
Target profit + Fixed expenses
that must be to
generated
attain = to attain target profits of $2,500
CM ratio
per month. target profit
a. $2,550 $2,500 + $1,300
=
b. $5,011 ($1.49 – 0.36) ÷ $1.49
c. $8,458 $3,800
=
d. $10,555 0.758
= $5,011 Strategic Cost Management
58
 Target Return on Sales

𝑆𝑎𝑙𝑒𝑠, 𝑖𝑛 𝑑𝑜𝑙𝑙𝑎𝑟𝑠 𝑡𝑜 𝑎𝑐ℎ𝑖𝑒𝑣𝑒 𝑡𝑎𝑟𝑔𝑒𝑡 𝑅𝑂𝑆

𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
=
𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 − 𝑡𝑎𝑟𝑔𝑒𝑡 𝑅𝑂𝑆

Strategic Cost Management 59

 Illustration: Target ROS
° Exeler wishes to earn a 15% ROS. The variable cost is
60% and the fixed cost is $40,000. What is the sales to
achieve the target ROS?

𝑆𝑎𝑙𝑒𝑠, 𝑖𝑛 𝑑𝑜𝑙𝑙𝑎𝑟𝑠, 𝑡𝑜 𝑎𝑐ℎ𝑖𝑒𝑣𝑒 𝑡𝑎𝑟𝑔𝑒𝑡 𝑅𝑂𝑆

40,000
= = $160,000
100% − 60% − 15%

Strategic Cost Management 60

 Illustration: Target Selling Price
° Exeter’s target is $10,000 per month and it expects to sell 6,000
backpacks per month. The variable costs are $10 to purchase a
backpack, $1 for packing and shipping, and a 5% sales
commission. The total fixed cost is $40,000.

𝑡𝑜𝑡𝑎𝑙 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠 + 𝑡𝑎𝑟𝑔𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡

𝑃𝑟𝑖𝑐𝑒 = + 𝑢𝑛𝑖𝑡 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡
𝑢𝑛𝑖𝑡 𝑣𝑜𝑙𝑢𝑚𝑒
40,000 + 10,000
𝑃𝑟𝑖𝑐𝑒 = + 11 + (5% × 𝑝𝑟𝑖𝑐𝑒)
6,000
𝑃𝑟𝑖𝑐𝑒 = $20.35 𝑟𝑜𝑢𝑛𝑑𝑒𝑑

Strategic Cost Management 61

 Effect of Income Taxes

𝑆𝑎𝑙𝑒𝑠 𝑡𝑜 𝑎𝑐ℎ𝑖𝑒𝑣𝑒 𝑡𝑎𝑟𝑔𝑒𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 𝑝𝑟𝑜𝑓𝑖𝑡

𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 𝑝𝑟𝑜𝑓𝑖𝑡
𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠 + 1 − 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒
=
𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 % 𝑜𝑟 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡

Strategic Cost Management 62

 Effect of Income Taxes
° Exeter wants to earn an after-tax profit of $6,300 and
its tax rate is 30%. The fixed cost is $40,000 and the
contribution margin percentage is 40%
6,300
40,000 + 1 − 0.40
𝑆𝑎𝑙𝑒𝑠 𝑡𝑜 𝑎𝑐ℎ𝑖𝑒𝑣𝑒 𝑡𝑎𝑟𝑔𝑒𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 𝑝𝑟𝑜𝑓𝑖𝑡 =
40%

𝑆𝑎𝑙𝑒𝑠 𝑡𝑜 𝑎𝑐ℎ𝑖𝑒𝑣𝑒 𝑡𝑎𝑟𝑔𝑒𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 𝑝𝑟𝑜𝑓𝑖𝑡 = 122,500

Strategic Cost Management 63

 Learning
Outcome 6
Determine the break-
even point

Strategic Cost Management 64

 Break-even Analysis
The equation and formula methods can be used to
determine the unit sales and dollar sales needed to
achieve a target profit of zero. Let’s us the RBC
information to complete the break-even analysis.
Racing Bicycle Company
Contribution Income Statement
For the Month of June
Total Per Unit CM Ratio
Sales (500 bicycles) $ 250,000 $ 500 100%
Less: Variable expenses 150,000 300 60%
Contribution margin 100,000 $ 200 40%
Less: Fixed expenses 80,000
Net operating income $ 20,000

Strategic Cost Management 65

 Break-even in Unit Sales:
Equation Method
Profits = Unit CM × Q – Fixed expenses
Suppose RBC wants to know how many
bikes must be sold to break-even
(earn a target profit of $0).

$0 = $200 × Q + $80,000

Profits are zero at the break-even point.

Strategic Cost Management 66

 Break-even in Unit Sales:
Equation Method
Profits = Unit CM × Q – Fixed expenses
$0 = $200 × Q + $80,000

$200 × Q = $80,000

Q = 400 bikes

Strategic Cost Management 67

 Break-even in Unit Sales:
Formula Method
Let’s apply the formula method to solve for the
break-even point.
Unit sales to Fixed expenses
=
break even CM per unit

$80,000
Unit sales =
$200
Unit sales = 400

Strategic Cost Management 68

 Break-even in Dollar Sales:
Equation Method
Suppose Racing Bicycle wants to compute
the sales dollars required to break-even (earn
a target profit of $0). Let’s use the equation
method to solve this problem.
Profit = CM ratio × Sales – Fixed expenses

Solve for the unknown “Sales.”

Strategic Cost Management 69

 Break-even in Dollar Sales:
Equation Method
Profit = CM ratio × Sales – Fixed expenses
$ 0 = 40% × Sales – $80,000

40% × Sales = $80,000

Sales = $80,000 ÷ 40%

Sales = $200,000

Strategic Cost Management 70

 Break-even in Dollar Sales:
Formula Method
Now, let’s use the formula method to calculate the
dollar sales at the break-even point.

Dollar sales to Fixed expenses

=
break even CM ratio

$80,000
Dollar sales =
40%
Dollar sales = $200,000

Strategic Cost Management 71

 Quick Check ✓
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense per
cup is $0.36. The average fixed expense per month is
$1,300. 2,100 cups are sold each month on average.
What is the break-even sales dollars?
a. $1,300
b. $1,715
c. $1,788
d. $3,129

Strategic Cost Management 72

 Quick Check ✓
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense
per cup is $0.36. The average fixed expense per
month is $1,300. 2,100 cups are sold each month on
average. What is the break-even sales dollars?
a. $1,300 Break-even Fixed expenses
b. $1,715 =
sales CM Ratio
c. $1,788 $1,300
=
0.758
d. $3,129
= $1,715
Strategic Cost Management
73
 Quick Check ✓
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense per
cup is $0.36. The average fixed expense per month is
$1,300. 2,100 cups are sold each month on average.
What is the break-even sales in units?
a. 872 cups
b. 3,611 cups
c. 1,200 cups
d. 1,150 cups

Strategic Cost Management 74

 Quick Check ✓
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense per
cup is $0.36. The average fixed expense per month is
$1,300. 2,100 cups are sold each Fixedonexpenses
month average.
Break-even =
What is the break-even sales in units?CM per Unit
a. 872 cups $1,300
=
$1.49/cup - $0.36/cup
b. 3,611 cups
c. 1,200 cups $1,300
=
$1.13/cup
d. 1,150 cups
= 1,150 cups
Strategic Cost Management
75
 Learning
Outcome 7
Compute the margin of
safety and explain its
significance.

Strategic Cost Management 76

 The Margin of Safety in Dollars
The margin of safety in dollars is the excess of budgeted
(or actual) sales over the break-even volume of sales.

Margin of safety in dollars = Total sales - Break-even sales

Let’s look at Racing Bicycle Company and

determine the margin of safety.

Strategic Cost Management 77

 The Margin of Safety in Dollars
If we assume that RBC has actual sales of
$250,000, given that we have already determined the
break-even sales to be $200,000, the
margin of safety is $50,000 as shown.
Break-even
sales Actual sales
400 units 500 units
Sales $ 200,000 $ 250,000
Less: variable expenses 120,000 150,000
Contribution margin 80,000 100,000
Less: fixed expenses 80,000 80,000
Net operating income $ - $ 20,000
Strategic Cost Management 78
 The Margin of Safety Percentage
RBC’s margin of safety can be expressed as 20% of
sales.
($50,000 ÷ $250,000)
Break-even
sales Actual sales
400 units 500 units
Sales $ 200,000 $ 250,000
Less: variable expenses 120,000 150,000
Contribution margin 80,000 100,000
Less: fixed expenses 80,000 80,000
Net operating income $ - $ 20,000
Strategic Cost Management 79
 The Margin of Safety
The margin of safety can be expressed in terms of the number of
units sold. The margin of safety at RBC is $50,000, and each
bike sells for $500; hence, RBC’s margin of safety is 100 bikes.

Margin of $50,000
= = 100 bikes
Safety in units $500

Strategic Cost Management 80

 Quick Check ✓
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup
of coffee is $1.49 and the average variable
expense per cup is $0.36. The average fixed
expense per month is $1,300. 2,100 cups are sold
each month on average. What is the margin of
safety expressed in cups?
a. 3,250 cups
b. 950 cups
c. 1,150 cups
d. 2,100 cups
Strategic Cost Management 81
 Quick Check ✓
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup
of coffee is $1.49 and the average variable
expense per cup is $0.36. The average fixed
expense per month is $1,300. 2,100 cups are sold
each month on average. What is the margin of
safety expressed in cups?
a. 3,250 cups
b. 950 cups
c. 1,150 cups Margin of safety = Total sales – Break-even sales
d. 2,100 cups = 2,100 cups – 1,150 cups
= 950 cups
Strategic Cost Management
82
 Cost Structure and Profit Stability
Cost structure refers to the relative proportion
of fixed and variable costs in an organization.
Managers often have some latitude in
determining their organization’s cost structure.

Strategic Cost Management 83

 Cost Structure and Profit Stability
There are advantages and disadvantages to high fixed cost
(or low variable cost) and low fixed cost (or high variable
cost) structures.
An advantage of a high fixed
cost structure is that income A disadvantage of a high fixed
will be higher in good years cost structure is that income
compared to companies will be lower in bad years
with lower proportion of compared to companies
fixed costs. with lower proportion of
fixed costs.
Companies with low fixed cost structures enjoy greater
stability in income across good and bad years.
Strategic Cost Management 84
 Cost Structure and Profit Stability illustration
° The contribution format income statements given below for two blueberry
farms. Bogside Farm depends on migrant workers to pick its berries by hand,
whereas Sterling Farm has invested in expensive berry-picking machines.
Consequently, Bogside Farm has higher variable costs, but Sterling Farm has
higher fixed costs:

Strategic Cost Management

85
 Which farm has the better cost structure?
° The answer depends on many factors, including the long-run
trend in sales, year-to-year fluctuations in the level of sales, and
the attitude of the owners toward risk.
° If sales are expected to exceed $100,000 in the future, then
Sterling Farm probably has the better cost structure. The reason
is that its CM ratio is higher, and its profits will therefore increase
more rapidly as sales increase.

Strategic Cost Management

86
 Which farm has the better cost structure?
° To illustrate, assume that each farm experiences a 10% increase
in sales without any increase in fixed costs. The new income
statements would be as follows:

Strategic Cost Management

87
 Which farm has the better cost structure?
° What if sales drop below $100,000? What are the farms’ break-even points?
What are their margins of safety?
° The computations needed to answer these questions are shown below using
the contribution margin method:

Strategic Cost Management

88
 Indifference Point
° It is the level of volume at which total costs, and hence
profits, are the same under both cost structures.
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 𝑓𝑜𝑟 𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝐴 = 𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 𝑓𝑜𝑟 𝑃𝑟𝑜𝑐𝑒𝑠𝑠 𝐵
𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡 + 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡 = 𝑓𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡 + 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡

40,000 + 7𝑄 = 95,000 + 4𝑄

𝑄 = 18,333 (𝑟𝑜𝑢𝑛𝑑𝑒𝑑)
Strategic Cost Management 89
 Learning
Outcome 8
Compute the degree of
operating leverage at a
particular level of sales
and explain how it can
be used to predict
changes in net operating
income.

Strategic Cost Management 90

 Operating Leverage
Operating leverage is a measure of how sensitive net operating
income is to percentage changes in sales. It is a measure, at
any given level of sales, of how a percentage change in sales
volume will affect profits.
Degree of Contribution margin
operating leverage = Net operating income

Strategic Cost Management 91

 Operating Leverage
To illustrate, let’s revisit the contribution income statement
for RBC.
Actual sales
500 Bikes
Sales $ 250,000
Less: variable expenses 150,000
Contribution margin 100,000
Less: fixed expenses 80,000
Net income $ 20,000

Degree of
Operating $100,000
= $20,000 = 5
Leverage

Strategic Cost Management 92

 Operating Leverage
With an operating leverage of 5, if RBC
increases its sales by 10%, net operating
income would increase by 50%.

Percent increase in sales 10%

Degree of operating leverage × 5
Percent increase in profits 50%

Here’s the verification!

Strategic Cost Management 93
 Operating Leverage
Actual sales Increased
(500) sales (550)
Sales $ 250,000 $ 275,000
Less variable expenses 150,000 165,000
Contribution margin 100,000 110,000
Less fixed expenses 80,000 80,000
Net operating income $ 20,000 $ 30,000

10% increase in sales from

$250,000 to $275,000 . . .

. . . results in a 50% increase in

income from $20,000 to $30,000.
Strategic Cost Management 94
 Operating Leverage
° The degree of operating leverage for the two farms at $100,000
sales would be computed as follows:

Strategic Cost Management

95
 Operating Leverage
° The degree of operating leverage is not a
constant; it is greatest at sales levels near the
break-even point and decreases as sales and
profits rise.

Strategic Cost Management

96
 Operating Leverage
° The following table shows the degree of operating leverage for
Bogside Farm at various sales levels. (Data used earlier for
Bogside Farm are shown in color.)

Strategic Cost Management

97
 Quick Check ✓
Coffee Klatch is an espresso stand in a
downtown office building. The average selling
price of a cup of coffee is $1.49 and the average
variable expense per cup is $0.36. The average
fixed expense per month is $1,300. 2,100 cups
are sold each month on average. What is the
operating leverage?
a. 2.21
b. 0.45
c. 0.34
d. 2.92
Strategic Cost Management 98
 Quick Check ✓
Coffee Klatch is an espresso stand in a downtown Actual sales
office building. The average selling price of a2,100 cupcups
of coffee is $1.49 and the average variable $ 3,129
Sales
expense per cup is $0.36.Less:The average
Variable fixed
expenses 756
expense per month is $1,300. 2,100
Contribution cups are 2,373
margin
sold each month on average. What
Less: Fixed is the
expenses 1,300
operating leverage? Net operating income $ 1,073
a. 2.21
b. 0.45
c. 0.34
Operating Contribution margin
d. 2.92 leverage = Net operating income
$2,373
= $1,073 = 2.21
Strategic Cost Management
99
 Quick Check ✓
At Coffee Klatch the average selling price of a cup of
coffee is $1.49, the average variable expense per cup
is $0.36, the average fixed expense per month is
$1,300 and an average of 2,100 cups are sold each
month.
If sales increase by 20%, by how much should net
operating income increase?
a. 30.0%
b. 20.0%
c. 22.1%
d. 44.2%
Strategic Cost Management 100
 Quick Check ✓
At Coffee Klatch the average selling price of a cup of
coffee is $1.49, the average variable expense per cup
is $0.36, the average fixed expense per month is
$1,300 and an average of 2,100 cups are sold each
month.
If sales increase by 20%, by how much should net
operating income increase?
a. 30.0%
Percent increase in sales 20.0%
b. 20.0%
× Degree of operating leverage 2.21
c. 22.1% Percent increase in profit 44.20%
d. 44.2%

Strategic Cost Management

101
 Verify Increase in Profit
Actual Increased
sales sales
2,100 cups 2,520 cups
Sales $ 3,129 $ 3,755
Less: Variable expenses 756 907
Contribution margin 2,373 2,848
Less: Fixed expenses 1,300 1,300
Net operating income $ 1,073 $ 1,548
% change in sales 20.0%
% change in net operating income 44.2%
Strategic Cost Management
102
 Structuring Sales Commissions
Companies generally compensate salespeople
by paying them either a commission based on
sales or a salary plus a sales commission.
Commissions based on sales dollars can lead to
lower profits in a company.

Let’s look at an example.

Strategic Cost Management 103

 Structuring Sales Commissions
Pipeline Unlimited produces two types of surfboards,
the XR7 and the Turbo. The XR7 sells for $100 and
generates a contribution margin per unit of $25. The
Turbo sells for $150 and earns a contribution margin
per unit of $18.

The sales force at Pipeline Unlimited is

compensated based on sales commissions. 104
Strategic Cost Management
 Structuring Sales Commissions
If you were on the sales force at Pipeline, you would
push hard to sell the Turbo even though the XR7
earns a higher contribution margin per unit.

To eliminate this type of conflict, commissions can

be based on contribution margin rather than on
selling price alone.

Strategic Cost Management 105

 Learning
Outcome 9
Compute the break-
even point for a
multiproduct company
and explain the effects
of shifts in the sales mix
on contribution margin
and the break-even
point.

Strategic Cost Management 106

 The Concept of Sales Mix
° Sales mix is the relative proportion in
which a company’s products are sold.
° Different products have different selling
prices, cost structures, and contribution
margins.
° When a company sells more than one
product, break-even analysis becomes
more complex as the following example
illustrates.

Let’s assume Racing Bicycle Company

sells bikes and carts and that the sales
mix between the two products remains
the same.

Strategic Cost Management 107

 Multi-Product Break-Even Analysis
Bikes comprise 45% of RBC’s total sales revenue
and the carts comprise the remaining 55%. RBC
provides the following information:
Bicycle Carts Total
Sales $ 250,000 100% $ 300,000 100% $ 550,000 100.0%
Variable expenses 150,000 60% 135,000 45% 285,000 51.8%
Contribution margin 100,000 40.0% 165,000 55% 265,000 48.2%
Fixed expenses 170,000
Net operating income $ 95,000

Sales mix $ 250,000 45% $ 300,000 55% $ 550,000 100%

$265,000 = 48.2% (rounded)

$550,000
Strategic Cost Management
108
 Multi-Product Break-Even Analysis
Dollar sales to Fixed expenses
=
break even CM ratio

Dollar sales to $170,000 = $352,697

=
break even 48.2%

Bicycle Carts Total

Sales $ 158,714 100% $ 193,983 100% $ 352,697 100.0%
Variable expenses 95,228 60% 87,293 45% 182,521 51.8%
Contribution margin 63,485 40% 106,691 55% 170,176 48.2%
Fixed expenses 170,000
Net operating income Rounding error $ 176

Sales mix $ 158,714 45% $ 193,983 55% $ 352,697 100.0%

Strategic Cost Management

109
 Key Assumptions of CVP Analysis
 Selling price is constant.
 Costs are linear and can be accurately
divided into variable (constant per unit)
and fixed (constant in total) elements.
 In multiproduct companies, the sales mix
is constant.
 In manufacturing companies, inventories
do not change (units produced = units
sold).

Strategic Cost Management

110
 Learning
Outcome 10
Discuss the impact of
non-unit cost drivers on
cost-volume-profit
analysis

Strategic Cost Management 111

 CVP Analysis and Non-Unit Cost Drivers
° CVP can be modified to take in account costs
that vary with non-unit cost drivers
• Modification helps provide accurate insights
concerning cost behavior

Strategic Cost Management 112

 ABC equation for CVP analysis
° ABC equation for CVP analysis
• Total cost = Fixed costs + (Unit variable cost × Number of
units) + (Setup cost × Number of setups) + (Engineering cost
× Number of engineering hours)
• Operating income = Total revenue – [Fixed costs + (Unit
variable cost × Number of units) + (Setup cost × Number of
setups) + (Engineering cost × Number of engineering hours)]
• Break-even units = [Fixed costs + (Setup cost × Number of
setups) + (Engineering cost × Number of engineering
hours)]/Price – Unit variable cost)

Strategic Cost Management 113

 Comparing the Conventional and ABC Analysis
° Assume a company wants to compute the units that must be
sold to earn a before-tax profit of $20,000. The analysis is based
on the following data:
Cost driver Data about variables and Unit Variable Cost Level of Cost
Driver
Units sold $ 10 -
Setups 1,000 20
Engineering hours 30 1,000
Other data:
Total fixed costs conventional $ 100,000
Total fixed costs (ABC) 50,000
Unit selling price 20
Strategic Cost Management 114
 Conventional CVP Analysis Solution
° The units that must be sold to earn a before-tax profit
of $20,000 are computed as follows:

𝑇𝑎𝑟𝑔𝑒𝑡𝑒𝑑 𝑖𝑛𝑐𝑜𝑚𝑒 + 𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠

𝑈𝑛𝑖𝑡𝑠 =
𝑃𝑟𝑖𝑐𝑒 − 𝑈𝑛𝑖𝑡 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡

20,000 + 100,000
𝑈𝑛𝑖𝑡𝑠 =
20 − 10

𝑈𝑛𝑖𝑡𝑠 = 12,000

Strategic Cost Management 115

 ABC - CVP Analysis Solution
° The units that must be sold to earn a before-tax profit
of $20,000 are computed as follows:
𝑇𝑎𝑟𝑔𝑒𝑡𝑒𝑑 𝑖𝑛𝑐𝑜𝑚𝑒 + 𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠 + 𝑆𝑒𝑡𝑢𝑝 𝑐𝑜𝑠𝑡𝑠 × 𝑆𝑒𝑡𝑢𝑝𝑠 + (
𝐸𝑛𝑔𝑖𝑛𝑒𝑒𝑟𝑖𝑛𝑔 𝑟𝑎𝑡𝑒 × 𝐸𝑛𝑔𝑖𝑛𝑒𝑒𝑟𝑖𝑛𝑔 ℎ𝑜𝑢𝑟𝑠)
𝑈𝑛𝑖𝑡𝑠 =
𝑃𝑟𝑖𝑐𝑒 − 𝑈𝑛𝑖𝑡 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡
20,000 + 50,000 + 20,000 + 30,000
𝑈𝑛𝑖𝑡𝑠 =
20 − 10

𝑈𝑛𝑖𝑡𝑠 = 12,000

Strategic Cost Management 116

 CVP Analysis and Non-Unit Cost Drivers
° Results for the conventional and ABC computations will
be the same as long as the levels of activity for the
non-unit-based cost drivers remain the same
° ABC equation for CVP analysis is a richer representation
of the underlying cost behavior

Strategic Cost Management 117

 Strategic Implications: Conventional CVP vs ABC
Analysis
° Suppose that after the conventional CVP analysis, marketing indicates
that only 10,000 units can be sold, not the 12,000 anticipated earlier.
° The president of the company directs the product design engineers to
find a way to reduce the cost of making the product. The engineers
also have been told that the conventional cost equation, with fixed
costs of $100,000 and a unit variable cost of $10, holds. The variable
cost of $10 per unit consists of the following: direct labor, $4; direct
materials, $5; and variable overhead, $1.
° To comply with the request to reduce the BEP, engineering produces a
new design that requires less labor, thereby reducing the direct labor
cost by $2 per unit.
° The design would not affect direct materials or variable overhead.
Strategic Cost Management 118
 Conventional CVP Analysis Solution
𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝐵𝑟𝑒𝑎𝑘 − 𝑒𝑣𝑒𝑛 𝑃𝑜𝑖𝑛𝑡 𝑖𝑛 𝑈𝑛𝑖𝑡𝑠 =
𝑃𝑟𝑖𝑐𝑒 − 𝑈𝑛𝑖𝑡 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡

100,000
𝐵𝐸𝑃 𝑖𝑛 𝑈𝑛𝑖𝑡𝑠 =
20 − 8

𝐵𝐸𝑃 𝑖𝑛 𝑈𝑛𝑖𝑡𝑠 = 8,333

Strategic Cost Management 119

 Conventional CVP Analysis Solution
Project Income if 10,000 units are sold
Sales ($20, x 10,000) $200,000
Less: Variable expenses: ($8 x 10,000) 80,000
Contribution Margin $120,000
Less: Fixed expenses 100,000
Operating Income $ 20,000

Excited, the president approves the new design. A year

later, the president discovers that the expected increase
in income did not materialize. In fact there is a loss.
Why?

Strategic Cost Management 120

 Using ABC Analysis
° The answer is provided by an ABC approach to CVP
analysis.
° The original ABC cost relationship for the example is as
follows:

𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡
= $50,000 + $10 × 𝑈𝑛𝑖𝑡𝑠 + $1,000 × 𝑆𝑒𝑡𝑢𝑝𝑠 + ($30 × 𝐸𝑛𝑔𝑖𝑛𝑒𝑒𝑟𝑖𝑛𝑔 ℎ𝑜𝑢𝑟𝑠)

Strategic Cost Management 121

 Using ABC Analysis
° Suppose that the new design requires a more complex setup,
increasing the cost per setup from $1,000 to $1,600. Also,
suppose that the new design, because of increased technical
content, requires a 40% increase in engineering support (from
1,000 hours to 1,400 hours). The new cost equation, including
the deduction in unit-level variable costs, is as follows:

𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡
= $50,000 + $8 × 𝑈𝑛𝑖𝑡𝑠 + $1,600 × 𝑆𝑒𝑡𝑢𝑝𝑠 + ($30 × 𝐸𝑛𝑔𝑖𝑛𝑒𝑒𝑟𝑖𝑛𝑔 ℎ𝑜𝑢𝑟𝑠)

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 ABC - CVP Analysis Solution
° The break-even point, setting operating income to zero and using
the ABC equation, is calculated as follows (assume that 20
setups are still performed):
𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡𝑠 + 𝑆𝑒𝑡𝑢𝑝 𝑐𝑜𝑠𝑡𝑠 × 𝑆𝑒𝑡𝑢𝑝𝑠 + (
𝐸𝑛𝑔𝑖𝑛𝑒𝑒𝑟𝑖𝑛𝑔 𝑟𝑎𝑡𝑒 × 𝐸𝑛𝑔𝑖𝑛𝑒𝑒𝑟𝑖𝑛𝑔 ℎ𝑜𝑢𝑟𝑠)
𝐵𝐸𝑃 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠 =
𝑃𝑟𝑖𝑐𝑒 − 𝑈𝑛𝑖𝑡 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡
50,000 + (1,600 × 20) + (30 × 1,400)
𝐵𝐸𝑃 𝑖𝑛 𝑈𝑛𝑖𝑡𝑠 =
20 − 8

𝐵𝐸𝑃 𝑖𝑛 𝑈𝑛𝑖𝑡𝑠 = 10.333

Strategic Cost Management 123

 ABC Analysis
Project Income if 10,000 units are sold
Sales ($20, x 10,000) $200,000
Less: Variable expenses: ($8 x 10,000) 80,000
Contribution Margin $120,000
Less: Non-unit based variable expenses
Setups ($1,600 x 20) $32,000
Engineering support ($30 x 1,400) 42,000 74,000
Traceable margin $ 46,000
Less: Fixed expenses 50,000
Operating Income (loss) $ (4,000)

Strategic Cost Management 124

 ABC Analysis vs Conventional CVP Analysis
Project Income if 10,000 units are sold (using ABC Analysis) Project Income if 10,000 units
Sales ($20, x 10,000) $200,000 are sold (using Conventional
CVP analysis)
Less: Variable expenses: ($8 x 80,000
10,000) Sales $200,000
Contribution Margin $120,000 Less: Variable
Less: Non-unit based variable
expenses: 80,000
expenses Contribution Margin $120,000
Setups ($1,600 x 20) $32,000 Less: Fixed
Engineering support ($30 x 1,400) 42,000 74,000 expenses 100,000
Traceable margin $ 46,000 Operating Income $ 20,000
Less: Fixed expenses 50,000
Operating Income (loss) $ (4,000)

Strategic Cost Management 125

 CVP Analysis and JIT
• Cost equation for JIT
• Total cost = Fixed costs + (Unit variable cost ×
Units) + (Engineering cost × Number of
engineering hours)

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 CVP Analysis in Nonprofit entities
° CVP analysis is helpful in not-for-profit entities
• Managers should be aware of the different types of costs, the
different drivers, and the underlying economic conditions that
affect them

Strategic Cost Management 127

 References:
° Garrison, R. H., Noreen, E. W. & Brewer, P. C., 13th edition
(2010). Managerial Accounting, McGraw-Hill/Irwin
° Hansen, Don R. & Mowen, Maryanne M. (2019), Strategic Cost
Management, Cengage Learning
° Louderback III, J. G & Holmen, J. S. (2003), Managerial
Accounting, South-Western Thomson Learning

Strategic Cost Management

128
 Trust in Lord will all
thine heart; and
lean not unto thine
own
understanding. In
all thy ways
acknowledge Him,
and He shall direct
thy paths.

Proverbs 3:5-6

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