Unit 2.

Cost Volume Profit Analysis

Learning Objectives:
Upon the completion of this unit, you should be able to:
 describe the assumptions underlying CVP
 demonstrate three methods for determining the breakeven point and target operating income
 illustrate how CVP can incorporate income taxes.
 describe the effect of sales mix on operating income and break even analysis.
2.1 COST BEHAVIOUR
Activities that affect costs are often called cost drivers. Cost behavior refers to how a cost will
react or respond to changes in the level of business activity. As the activity level rises and falls, a
particular cost may rise and fall as well or it may remain constant.

TYPES OF COST BEHAVIOUR

VARIABLE COSTS
A variable cost is a cost that changes in total in direct proportion to a change in the level of activity
(or cost driver). However, the variable cost per unit remains the same as activity changes.
Examples of variable costs include
 In a manufacturing company,
 direct materials,
 direct labour,
 some items of manufacturing overhead (such as utilities, supplies, and lubricants)
 sales commissions

FIXED COST
A fixed cost remains unchanged in total as the level of activity (or cost driver) varies. It means that
they are not immediately affected by changes in the cost driver.
 Examples of some manufacturing overhead fixed costs
 Rent or depreciation expenses for factory building.
 Depreciation on factory machinery and equipment.
 Insurance and property taxes on manufacturing facilities and
 Production supervisory salaries.
 Examples of some non-manufacturing fixed costs
 Office property taxes.
 Office fire insurances.
 Advertising and promotion and
 Supervisory salaries (related to administrative functions)

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 Fixed costs can be classified in to discretionary fixed costs and committed fixed costs.
DISCRETIONARY FIXED COSTS
 These are costs determined by management as part of the periodic planning process in order
to meet the organization’s goals.
 Discretionary fixed costs can be discontinued at management’s discretion in a relatively
short time in comparison with committed fixed costs.
 Examples of discretionary fixed costs include
 amounts spend on advertising and promotion,
 research and development,
 contributions to charitable organizations,
 employee training program, system development,
 administrative salaries and short term renewable costs.
COMMITTED FIXED COSTS:
 They usually arise from an organizations ownership or use and its basic organization
structure. Committed fixed costs are large, individual chunks of cost that the organization is
obligated to incur or usually would not consider avoiding.
Examples of committed fixed costs
 mortgage or lease payments,
 interest payments on long-term debt,
 property taxes,
 depreciation on buildings and equipment,
 salaries of key personnel, and insurance for plant and equipment.
MIXED COSTS
 Mixed costs include both fixed and variable components. Many costs, such as repair and
maintenance costs, are incurred in such a way that part of the cost varies with the level of
activity and part of it does not.
STEP COSTS
Step costs, sometimes called semi fixed costs, remain fixed over a range of activity, but beyond
some activity level they change usually by intermittent jumps rather than continuously. Step costs
are costs that change abruptly at intervals of activity because the resources and their costs come in
indivisible chunks.
2.2 WHAT IS CVP ANALYSIS?
Studies the behavior and relationship among
 Total revenues
 total costs, and
 Operating income
As changes occur in the units sold, the selling price, the variable cost per unit, or the fixed costs
of a product.
It examines the interaction of a firm’s sales volume, selling price, cost structure, and profitability.
CPV Analysis is a method for analyzing how operating decisions and marketing decisions affect
profit based on an understanding of the relationship between variable costs, fixed costs, unit selling
price, and the output level.

Cost-volume-profit (CVP) analysis is a technique that examines changes in profits in response to

changes in sales volumes, costs, and prices. Accountants often perform CVP analysis to plan future

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levels of operating activity and provide information about:
 Which products or services to emphasize
 The volume of sales needed to achieve a targeted level of profit
 The amount of revenue required to avoid losses
 Whether to increase fixed costs
 How much to budget for discretionary expenditures
 Whether fixed costs expose the organization to an unacceptable level of risk

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Assumptions in CVP Analysis
CVP analysis makes several assumptions. Among the more important assumptions are:
 There is only one activity cost driver—unit or birr sales volume. That means changes in the
level of revenues and costs arise only because of changes in the number of units produced
and sold.
 All costs are classified as fixed or variable with unit level activity cost drivers.
 When graphed, the behavior of total revenues and total costs is linear (straight-line) in
relation to output units within the relevant range.
 The unit selling price, unit variable costs, and total fixed costs are known and constant.
 It ignores time value of money. In CVP analysis, all revenues and costs can be added and
compared without taking into account the time value of money.
 For multiproduct companies, sales mix is constant. Sales mix is the relative proportion of
quantities of products or services that make up total revenue.
 In manufacturing companies, inventories do not change or beginning inventory equals
ending inventory. This implies that units produced equal units sold.
 Workers and machine efficiency and productivity will be unchanged.
2.3 CONTRIBUTION MARGIN VS GROSS MARGIN
Contribution margin can be expressed in three ways: in total, on a per unit basis, and as percentage of
revenues.
 The total contribution margin is total revenue minus total variable costs.
Total CM= Total revenue – Total VC
 The contribution margin per unit is the selling price per unit minus the variable cost per
unit.
Unit CM= Unit sales price – Unit VC
 Contribution margin percentage (also called contribution margin ratio or P/V ratio**) is
the percentage of contribution margin in sales.
CM ratio= Total CM/Total sales or
CM ratio= Unit CM÷ Unit Selling Price
**P/V Ratio =profit/volume ratio

Contribution margin per unit tells us how much revenue from each unit sold can be applied toward
fixed costs. Once enough units have been sold to cover all fixed costs, then the contribution margin
per unit from all remaining sales becomes profit.
The gross margin (also called gross profit) is total revenue minus cost of goods sold (COGS).
Gross margin= Total revenue - COGS
CVP analysis begins with the basic profit equation.
Profit = Total revenue - Total costs
Separating costs into variable and fixed categories, we express profit as:
Profit = Total revenue - Total variable costs - Total fixed costs
Profit =P.Q-V.Q-FC
Where P=sales price per unit
V=Variable cost per unit
Q=units sold
FC=Fixed cost per period

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Variable cost ratio is the percentage of variable cost in sales.
Variable cost ratio= Total VC or Unit variable cost
Total sales Unit sales price
2.4 BREAK EVEN ANALYSIS
Break-even point (BEP) can be defined as the point where total sales revenue equals total costs, i.e.,
total variable cost plus total fixed costs. It is a point where the total contribution margin equals total
fixed expenses. Stated differently, it is a point where the operating income is zero.
There are three ways to compute the BEP
a. Equation Technique
It is the most general form of break-even analysis that may be adapted to any
conceivable cost-volume-profit situation. This approach is based on the profit equation.
Income (or profit) is equal to sales revenue minus expenses.
b. Contribution Margin Technique
The contribution margin technique is merely a short version of the equation technique.
Under this method, the breakeven point (BEP) in units and in revenues is computed as
follows:
BEP units = Total fixed costs
CM per unit
BEP revenues = Total fixed costs
CM Ratio
c. Graphical Method
In the graphical method, the point of intersection of the total cost line and revenue line is
the breakeven point.
Example 1. Zoom Company manufactures and sells a telephone answering machine. The company’s
income statement for the most recent year is given below:
Total Per Unit Percent
Sales (20,000 units) Br. 1,200,000 Br. 60 100
Variable expenses 900,000 45 ?
Contribution Margin Br. 300,000 Br. 15 ?
Fixed Expenses 240,000
Net Income Br.60,000
Based on the above data, answer the following questions.
Required:
a. Compute the company’s CM ratio and variable expense ratio.
b. Compute the company’s break-even point in both units and sales birrs. Use the above three
approaches to compute the break-even.
c. Assume that sales increase by Br. 400,000 next year. If cost behavior patterns remain
unchanged, by how much will the company’s net income increase?
Solution:
a. CM – ratio = 60-45 = 0.25 (25%)
60
Variable expense ratio = 1 – CM-ratio = P-V
P
= 1-0.25 = 60 – 15 = 0.75 (75%)
60

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b. Method 1: Equation Method
i) Net Income (NI) = PQ – VQ – FC
0 = Q (60-45) – 240,000
15Q = 240,000
Q = 240,000
15
Q = 16,000 units,
units, at Br. 60 per unit, Br. 960,000

ii) Let “X” be sales volume in birrs to breakeven

CM- ratio = 0.25
Variable expense ratio = 0.75
Net Income = Total revenue – Total variable expense – total fixed cost 0 =
X – 0.75X-240, 000
0.25X = 240,000
X = 240,000
0.25
X = Br. 960,000
Method 2. Contribution Margin Method
i) BEP (in units) = Fixed expenses
CM per unit
= Br. 240,000
Br. 60 – Br. 45
= 16,000 units
ii) BEP (in birrs) = Fixed expenses
CM – ratio
= Br. 240,000= Br. 960,000
0.25
Method 3. Graphical Method
To plot fixed costs, measure Br. 240,000 on the vertical axis and extend a line horizontally.
Select a point (say, 20,000 units) and determine the total costs (the total of fixed and variable) at
the selected activity level. The total costs at this output level are Br. 1,140,000= Br. 240,000 +
(20,000 x Br. 45). Then, starting from the selected point draw a line back to the origin where the
fixed cost line touches the vertical axis. The break-even point (BEP) is where the total revenues
line and the total costs line intersect. At this point, total revenues equal total costs. Refer Exhibit
1.1.

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 TR
Y (Cost, revenue) TC

Br.1,500,000

1,000,000

750,000

500,000

250,000
X(unit sold)

0 10,000 20,000 30,000 40,000

Exhibit 1.1 Cost-Volume-Profit Chart

TR= Total revenues line TC = Total costs line
c. Since the fixed expenses are not expected to change, net income will increase by the entire Br.
100,000 increase in contribution margin.
Increase in sales Br. 400,000
Multiply by the CM ratio X 25%
Expected increase in contribution margin Br. 100.000
2.5 MARGIN OF SAFETY
The margin of safety is the excess of budgeted (or actual) sales over the breakeven volume of sales.
It states the amount by which sales can drop before losses begin to be incurred. In other words, it is
the amount of sales revenue that could be lost before the company’s profit would be reduced to
zero. The formula for its calculations follows:
Margin of safety= Total sales - Break even Sales
The margin of safety can also be expressed in percentage form. This percentage is obtained by
dividing the margin of safety in birr terms by total sales:
Margin of safety ratio = Margin of safety
Total sales
Example 1. Zumura Company manufactures and sells a telephone answering machine. The
company’s income statement for the most recent year is given below:
Total Per Unit
Sales (20,000 units) Br 1,200,000 Br 60
Variable expenses 900,000 45
Contribution Margin Br 300,000 Br 15
Fixed Expenses 240,000
Net Income 60,000
Required: Based on the above data, answer the following questions.
a. Compute the company’s CM ratio and variable cost ratio.
b. Compute the company’s break-even point in both units and sales birrs.

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 Solution:
a. CM ratio = 60-45 = 0.25 (25%)
60
Variable cost ratio = 1 – CM-ratio = P-V
P
= 1-0.25 = 60 – 15 = 0.75 (75%)
60
b. BEP (in units) = Fixed expenses = Br 240,000 = 16,000 units
CM per unit Br 60 – Br 45
BEP (in birrs) = Fixed expenses = Br 240,000= Br 960,000
CM ratio 0.25
Or computed alternatively
BEP (in birrs) = BEP (in units) x P= 16,000 X 60= Br 960,000
Example 2. The Dollar Company manufactures and sells pens. Present sales output is 500,000 per
year at a selling price of Br 2.50 per unit. Fixed costs are Br 350,000 per year. Variable costs are Br
1.50 per unit.
Required:
a. What is the current yearly operating income?
b. What is the current breakeven point of birr?
c. What is the firm’s margin of safety?
Solution:
a. Operating income = P.Q- V.Q - Fixed costs
=2.5(500,000)-1(500,000)-350,000
=1,250,000-500,000-350,000
=Br 400,000
b. BEP (in units) = Fixed expenses = Br 350,000 = 350,000 pens
CM per unit Br 2.50 – Br 1.50
BEP (in birrs) = BEP (in units) x P= 350,000 x 2.50 =Br 875,000
c. Computations of margin of safety
Margin of safety (in units) =Actual sales –Break even sales
=500,000-350,000
=150,000 pens
Margin of safety (in birrs)= Margin of safety (in units) x P
=150,000 X 2.5
=Br 375,000
Or computed alternatively
Margin of safety (in birrs)=Actual sales (in birrs)-Breakeven sales (in birrs)
=(500,000 x 2.5) -875,000
=1,250,000-875,000
=Br 375,000
Margin of safety ratio= 150,000 pens = Br 375,000 =0.30(30%)
500,000 pens Br 1,250,000

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2.6 WHAT IS SENSITIVITY ANALYSIS?
Sensitivity analysis is a "what if" technique that managers use to examine how a result will change
if the original predicted data are not achieved or if an underlying assumption changes. In the context
of CVP analysis, sensitivity analysis examines how operating income (or the breakeven point)
changes if the predicted data for selling price, variable costs per unit, fixed costs, or units sold are
not achieved. The sensitivity to various possible outcomes broadens managers' perspectives as to
what might actually occur before they make cost commitments.

Example 1 : Addis Matador Tires, Inc. sells tires to service stations for an average of Br 450 each.
The variable cost of each tire is Br 300 and monthly fixed manufacturing costs total Br 150,000.
Other monthly fixed costs of the company total Br 120,000.
Required:
a. What is the break-even sale of Addis?
b. What is the break-even level in tires, assuming variable costs increase by 20 percent?
c. What is the break-even level in tires, assuming the selling price goes up by 10 percent, fixed
manufacturing costs and other fixed costs decline by 10% and Br 1,500, respectively?
Assume all other factors remain unchanged.
Solution:
a. BEP (in units) = Fixed expenses = Br 270,000 = 1,800 tires
CM per unit Br 450– Br 300
BEP (in birrs) = BEP (in units) x P=1,800 x 450= Br 810,000
b. BEP (in units) = Fixed expenses = Br 270,000 = 3,000 tires
CM per unit Br 450– Br 360
New VC= 300 X 1.2=Br 360
c. BEP (in units) = Fixed expenses = Br 253,500 = 1,300 tires
CM per unit Br 495– Br 300
New fixed cost= Br 270,000 -150,000(10%)-1,500=Br 253,500
New sales price= 450 x 1.1=Br 495
2.7 TARGET PROFIT ANALYSIS
CVP analysis often assists in the development of detailed profit plans by allowing management to
manipulate the cost-volume profit relationships to determine the required sales volume needed to
achieve the desired profit. The sales volume necessary to achieve a target profit can be determined
using the following formulae:
Target sales (in units) = Total Fixed Costs+ NIBT**
CM per unit
Target sales (in dollars) = Total Fixed Costs+ NIBT
CM Ratio
**NIBT=Net income before taxes
Thus, the target profit indicates the level of activity or dollar sales amount at which total
contribution margin equals total fixed costs plus the desired profit amount.

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2.8 IMPACT OF TAXES ON CVP ANALYSIS
In order to determine the level of sales required to achieve a profit level on an after-tax basis, it is
necessary to first convert the after-tax profit-to-profit before-tax as follows:
NIBT=NIAT
1-t
In this equation “t”& NIAT are the prevailing company tax rate and net income after taxes,
respectively.
Example 1. Selam Company has revenues of Br 500,000, variable costs of Br 350,000 and fixed
costs of Br 135,000.
Required:
a. Compute contribution margin percentage.
b. Compute total revenues needed to break even.
c. Compute total revenues needed to achieve a target operating income of Br 45,000.
d. Compute total revenues needed to achieve a target after tax net income of Br 63,000,
assuming the income tax rate is 40%.
Solution:
a. CM Ratio= 500,000-350,000 =0.3(30%)
500,000
b. BEP revenue= 135,000=Br 450,000
0.3
c. Target revenue= 135,000+45,000=Br 600,000
0.3
d. Target revenue = FC + NIBT=135,000+105,000=Br 800,000
CM Ratio 0.3
Example 2. Beza Company manufactures and sells a single product. During the year just ended the
company produced and sold 60,000 units at an average price of Br 20 per unit. Variable
manufacturing costs were Br 8 per unit, and variable marketing costs were Br 4 per unit sold. Fixed
costs amounted to Br 180,000 for manufacturing and Br 72, 000 for marketing. The company is
subject to a 40% income tax rate.
Required:
a. Determine the annual break-even point
b. Compute the number of sales units required to earn a before tax income of Br 180,000
c. Compute the number of sales units required to earn an after tax income of Br 136,800
d. What is the break-even point in units if management makes a decision that increases fixed
costs by Br 57,000?
Solution:
a. BEP (in units)= Fixed expenses= Br252, 000 = 31,500 units
CM 8
BEP (in birrs)= BEP (in units) x P = 31,500 x 20 = Br 630,000
b. Target sales (in units)=FC + NIBT =252,000 +180,000=54,000 units
CM 8
Target sales (in birrs)= 54,000 x 20 = Br 1,080,000
c. Target sales (in units)=FC + NIBT **=252,000 +228,000=60,000 units
CM 8
Target sales (in birrs)= 60,000 x 20 = Br 1,200,000
**NIBT= 136,800/1-0.4=Br 228,000

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0
 d. BEP (in units)= Fixed expenses= Br309, 000 = 38,625 units
CM 8
Example 3. Zelalem Company manufactures only one product. The income statement for the year just
ended is presented below:

Zelalem Company Income

Statement
For the Year Ended December 31, 2012
Sales ...................................................................................................................Br 400,000
Variable expenses
Direct materials..........................................Br 80,000
Direct labor..................................................120,000
Variable Factory Overhead.............................24,000
Variable S, G & A Expense............................16,000 240,000
Total Contribution margin.....................................................................................Br 160,000
Fixed expenses
Factory overhead...............................................Br 40,000
Fixed S, G & A Expense.........................................25,000 Br
65,000 Income before taxes..................................................................................................Br
95,000
Income tax expense......................................................................................................28,500
Net income..............................................................................................................Br
income..............................................................................................................Br 66,500
In 2012 the company sold 40,000 units at a selling price of Br 10 a unit.
The management of the company is considering a plant expansion program that will permit an
increase of 10,000 units in yearly sales. The expansion will increase fixed costs by Br 20,000 but
will not affect the relation between sales and variable costs.
Required:
a. Compute the firm’s breakeven point in birrs of sales and units.
b. What was the company’s margin of safety in birrs and in percentages?
c. Compute the breakeven point under the proposed program.
d. Determine the net operating income with the expanded plant.
2.9 CVP ANALYSIS AND MULTIPRODUCT COMPANIES
To this point the discussion on CVP analysis focused on a firm that sells a single product; such a
firm is generally unrealistic, existing only in the minds of textbook writers. This section of the unit
examines the usefulness of the CVP technique for firms that deal in several products.

The term sales mix (also called revenue mix) is defined as the relative proportions or combinations
of quantities of products that comprise total sales. If the proportions of the mix change, the CVP
relationships also change. Thus, managers try to achieve the combination, or mix, that will yield the
greatest amount of profit.
In the general case the CVP equation could be presented as:
P1Q1 + P2Q2+...+PnQn – V1Q1 – V2Q2-...VnQn-FC = NI
where Pi = Selling price per unit of product i
Qi = Number units of i produced and sold
Vi = Unit variable cost of product i
FC = Fixed Cost per Period
NC = Net Income

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 In a multi product firm, break-even analysis is somewhat more complex. The reason is that different
products will have different selling prices, different costs, and different contribution margins. Using
contribution margin approach, the computation of the break-even point (BEP) in multi product firm
follows:
BEP (in units) = Total fixed expenses
Weighted average CM BEP
(in birrs) = Total Fixed Expenses
CM – ratio
Weighted average unit contribution margin is the average of the several products’ unit contribution
margins, weighted by the relative sales proportion of each product.

For a company manufacturing and selling two products (X and Y), with sales of mix of n1 and n2,
respectively, the breakeven point may be given by the following short cut formula:
BEP (in units) = Total fixed costs
Cm1n1 + Cm2n2
n1 + n2
where cmi = Unit contribution margin for product i.
Example 1. Addis Marine Products Inc. plans to manufacture and sell accessories for recreational
fishing craft and pleasure boats. Three of the principal product lines are manufactured at the Awassa
plant. Operating data for the coming year is estimated as follows:

Product Lines
Ethio-01 Ethio-02 Ethio-03
Sales price Br150 Br80 Br40
Variable costs 100 60 10
Units sales 3, 200 units 1, 600 units 4, 800 units
The total annual fixed cost on the three-product lines amount to Br 840,000
Required:
a. Assuming the above sales mix, determine the BEP (break-even point) for Addis Company
during the coming year. Also determine the number of units of each product that should be
sold to break even in units and in birrs.
b. What volume of sales in birrs for each product must Addis Marine Products Inc. achieve to
earn a net income of Br 73,500 after taxes in the coming year? Assume the company is
subject to a 30% income tax rate.
Solution:
a. BEP (in units for Addis) = Fixed Costs
Cm1n1 + Cm2n2 + Cm3n3
n1 + n2 + n3
= Br840, 000
50(2)+20(1)+30(3)
2 +1+3
= Br840, 000
210
6
= 24, 000 units

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 Product Lines BEP in units BEP in birrs
Ethio-01 24, 000 x 2/6 = 8, 000 units 8, 000 x 150 =Br1, 200,000
Ethio-02 24, 000 x 1/6 = 4, 000 4, 000 x 80 = 320, 000
Ethio-03 24, 000 x 3/6 = 12, 000 12, 000 x 40 = 480, 000
Total 24 , 000 units Br2, 000, 000
Or computed alternatively:
BEP (in birrs for Addis) = Fixed expenses
Cm1n1 + Cm2n2 + Cm3n3
P1n1 + P2 n2 + P3n3
= Br840, 000
50(2)+20(1)+30 (3)
150(2)+80(1)+40(3)
= Br2, 000, 000
b. NIAT = Br73, 500. This implies that NIBT= Br10, 500
Target sales (in units)= FC + NIBT = 840, 000 +105, 000 = 27, 000 units
Average CM 50(2)+20(1)+30(3)
2 +1+3
Product Lines Target sales in units Target sales in birrs
Ethio-01 27, 000 x 2/6 = 9, 000 units 9, 000 x150 =Br1, 350,000
Ethio-02 27, 000 x 1/6 = 4, 500 4, 500 x 80 = 360, 000
Ethio-03 27, 000 x 3/6 = 13, 500 13, 500 x 40 = 540, 000
Total 27 , 000 units Br 2, 250, 000

Target Sales (in birrs for Addis) = Fixed expenses +NIBT

Cm1n1 + Cm2n2 + Cm3n3
P1n1 + P2 n2 + P3n3
=Br 840, 000 +105, 000
50(2)+20(1)+30(3)
150(2)+80(1)+40(3)
= Br 945, 000
210
500
= Br2, 250, 000
2.10 CVP ANALYSIS IN SERVICE & NFP ORGANIZATIONS
So far, our CVP analysis has focused on merchandising and manufacturing company. Of course,
managers at service companies and not-for-profit organizations use CVP analysis to make
decisions. To apply CVP analysis in service and not-for-profit organizations, we need to focus on
measuring their output, which is different from the tangible units sold by manufacturing and
merchandising companies. Examples of output measures in various service industries (for example,
airlines, hotels/motels, and hospitals) and not-for-profit organizations (for example, universities) are as
follows:

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 Industry Measure of Output
Airlines …………………………..Passenger miles
Hotels/motels…………………...Room-nights occupied
Hospitals………………………...Patient days
Universities……………………...Student credit-hours
Example 1: Experience Ethiopia Travel Agency specializes in flights between Bahir Dar and Addis
Ababa. It books passengers on Abyssinia Airlines at Br900 per round-trip ticket. Until last month,
Abyssinia paid Experience Ethiopia a commission of 10% of the ticket price paid by each
passenger. This commission was Experience Ethiopia’s only source of revenues. Experience
Ethiopia’s fixed costs are Br14,000 per month (for salaries, rent, and so on), and its variable costs,
such as sales commissions and bonuses, are Br20 per ticket purchased for a passenger.

Abyssinia Airlines has just announced a revised payment schedule for all travel agents. It will now
pay travel agents a 10% commission per ticket up to a maximum of Br50. Any ticket costing more
than Br500 generates only a Br50 commission, regardless of the ticket price. Experience Ethiopia’s
managers are concerned about how Abyssinia’s new payment schedule will affect its breakeven
point and profitability.
Required:
a. Under the old 10% commission structure, how many round-trip tickets must Experience
Ethiopia sell each month (i) to break even and (ii) to earn an operating income of Br7,000?
b. How does Abyssinia’s revised payment schedule affect your answers to (i) and (ii) in
requirement a?
Solution:
a. Experience Ethiopia receives a 10% commission on each ticket: 10% * Br900 = Br90.
Thus,
Selling price = Br90 per ticket
Variable cost per unit = Br20 per ticket
Contribution margin per unit = Br90 - Br20 = Br70 per ticket Fixed
costs = Br14,000 per month
i. Breakeven number of tickets =Fixed costs
Contribution margin per unit
=Br14,000
Br70 per ticket
= 200 tickets

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 ii. When target operating income = Br7,000 per month,
Quantity of tickets required to be sold = Fixed costs + Target operating income
Contribution margin per unit
=Br14,000 + Br7,000
Br70 per ticket
=Br21,000
Br70 per ticket
= 300 tickets
b. Under the new system, Experience Ethiopia would receive only Br50 on the Br900
ticket. Thus,
Selling price = Br50 per ticket
Variable cost per unit = Br20 per ticket
Contribution margin per unit = Br50 - Br20 = Br30 per ticket Fixed
costs = Br14,000 per month
i. Breakeven number of tickets = Br14,000
Br30 per ticket
= 467 tickets (rounded up)
ii. Quantity of tickets required to be sold = Br21,000
Br30 per ticket
= 700 tickets

The Br50 cap on the commission paid per ticket causes the breakeven point to more than
double (from 200 to 467 tickets) and the tickets required to be sold to earn Br7,000 per
month to also more than double (from 300 to 700 tickets). As would be expected, managers
at Experience Ethiopia reacted very negatively to the Abyssinia Airlines announcement to
change commission payments. Unfortunately for Experience Ethiopia, other airlines also
changed their commission structure in similar ways.
Example 2. Hydro System Engineering Associates, Inc. provides consulting services to city water
authorities. The consulting firm’s contribution margin ratio is 20%, and its annual fixed expenses
are Br 120, 000. The firm’s income-tax rate is 40%.
Required:
a. Calculate the firm’s break-even volume of service revenue.
b. How much before-tax income must the firm earn to make an after-tax net income of Br 48,
000?
c. What level of revenue for consulting services must the firm generate to earn an after-tax
income of Br48, 000?

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 d. Suppose the firm’s income-tax rate rises to 45 percent. What will happen to break-even
level of consulting service revenue?
Solution:
a. Break-even sales= Fixed expenses = Br120, 000= Br 600, 000
CM ratio 0.2
b. NIBT = NIAT = Br48,000 =Br80, 000
1- tax rate 1-0.4
c. Target sales (in birrs)= FC + NIBT = Br120, 000+ Br80, 000= Br1, 000, 000
CM ratio 0.2
d. The change in income-tax rate has no effect on break-even sales.

Nov 2015 15 Admas University