Cost-Volume-
Profit Analysis
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
COST-VOLUME-PROFIT ANALYSIS
7-2
CVP Relationships and
the Income Statement
A. Traditional Format
ACCUTIME COMPANY
Income Statement
For the Year Ended December 31, 20x1
Sales $500,000
Less: 380,000
Gross margin $120,000
Less: Operating expenses:
Selling expenses $35,000
Administrative expenses 35,000 70,000
Net income $50,000
7-3
CVP Relationships and
the Income Statement
B. Contribution Format
ACCUTIME COMPANY
Income Statement
For the Year Ended December 31, 20x1
Sales $500,000
Less: Variable expenses:
Variable manufacturing $280,000
Variable selling 15,000
Variable administrative 5,000 300,000
Contribution margin $200,000
Less: Fixed expenses:
Fixed manufacturing $100,000
Fixed selling 20,000
Fixed administrative 30,000 150,000
Net income $50,000
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7-5
WHAT IS BREAK-
EVEN POINT?
7-6
7-7
7-8
WHAT IS BREAK-EVEN
POINT?
7-9
The Break-Even Point
The break-even point is the point in the
volume of activity where the organization’s
revenues and expenses are equal.
Sales $ 250,000
Less: variable expenses 150,000
Contribution margin 100,000
Less: fixed expenses 100,000
Net income $ -
7-10
Learning
Objective
2
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
CONTRIBUTION MARGIN
CONTRIBUTION MARGIN is the difference
between the entity’s sales and total variable
costs.
If selling price per unit is deducted with the
variable costs per unit, it becomes
contribution margin per unit. When
contribution margin is divided to sales, a
percentage is obtained called contribution
margin ratio.
7-12
Contribution-Margin Approach
Consider the following information
developed by the accountant at Curl, Inc.:
For each additional surf board sold, Curl
generates $200 in contribution margin.
Total Per Unit Percent
Sales (500 surf boards) $250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $100,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ 20,000
7-13
If selling price per unit is
deducted with the variable
costs per unit, it becomes
contribution margin per
unit.
7-14
Contribution-Margin Approach
Fixed expenses Break-even point
=
Unit contribution margin (in units)
Total Per Unit Percent
Sales (500 surf boards) $250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $100,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ 20,000
$80,000
= 400 surf boards
$200
7-15
Equation Approach
Sales revenue – Variable expenses – Fixed expenses = Profit
Unit Sales Unit Sales
sales × volume variable × volume
price in units expense in units
($500 × X) – ($300 × X) – $80,000 = $0
($200X) – $80,000 = $0
X = 400 surf boards
7-16
Contribution-Margin Approach
Here is the proof!
Total Per Unit Percent
Sales (400 surf boards) $200,000 $ 500 100%
Less: variable expenses 120,000 300 60%
Contribution margin $ 80,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ -
400 × $500 = $200,000 400 × $300 = $120,000
7-17
When contribution margin is
divided to sales, a
percentage is obtained
called contribution margin
ratio.
7-18
Contribution Margin Ratio
Calculate the break-even point in sales peso rather
than units by using the contribution margin ratio.
Contribution margin
= CM
Sales
Ratio
Fixed expense Break-even point
=
CM Ratio (in sales peso)
7-19
Contribution Margin Ratio
Total Per Unit Percent
Sales (400 surf boards) $200,000 $ 500 100%
Less: variable expenses 120,000 300 60%
Contribution margin $ 80,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ -
$80,000
= $200,000 sales
40%
7-20
7-21
BEP FORMULA
7-22
PROBLEM
7-23
7-24
7-25
7-26
7-27
Learning
Objective
3
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Graphing Cost-Volume-Profit
Relationships
Viewing CVP relationships in a graph gives
managers a perspective that can be obtained in no
other way.
Consider the following information for Curl, Inc.:
7-29
Cost-Volume-Profit Graph
450,000
400,000
350,000
300,000
250,000
Dollars
200,000
150,000
100,000
Fixed expenses
50,000
100 200 300 400 500 600 700 800
Units
7-30
Cost-Volume-Profit Graph
450,000
400,000
350,000
300,000
250,000
Dollars
200,000
ns es
l ex pe
150,000 Tota
100,000
Fixed expenses
50,000
100 200 300 400 500 600 700 800
Units
7-31
Cost-Volume-Profit Graph
450,000
400,000
350,000
300,000
250,000
Dollars
200,000
ns es
l ex pe
150,000 Tota
100,000
Fixed expenses
50,000
100 200 300 400 500 600 700 800
Units
7-32
Cost-Volume-Profit Graph
450,000
400,000
a les
350,000
t als
To
300,000
250,000
Dollars
200,000
ns es
l ex pe
150,000 Tota
100,000
Fixed expenses
50,000
100 200 300 400 500 600 700 800
Units
7-33
Cost-Volume-Profit Graph
450,000
400,000
a les
350,000
t als r ea
Break-even To fit a
300,000 P r o
point
250,000
Dollars
200,000
ns es
l ex pe
150,000 Tota
Fixed expenses
100,000
re a
s a
s
50,000
Lo
100 200 300 400 500 600 700 800
Units
7-34
Profit-Volume Graph
Some managers like the profit-volume
graph because it focuses on profits and volume.
100,000
80,000
60,000
Break-even
point rea
40,000
a
r ofit
20,000 P
Profit
0 `
(20,000) 100 200 300 400 500 600 700
re a Units
(40,000) s a
o s
(60,000)
L
7-35
Learning
Objective
4
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Contribution-Margin Approach
Consider the following information
developed by the accountant at Curl, Inc.:
For each additional surf board sold, Curl
generates $200 in contribution margin.
Total Per Unit Percent
Sales (500 surf boards) $250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $100,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ 20,000
7-37
Desired/Target Net Profit
We can determine the number of surfboards
that Curl must sell to earn a profit of $100,000
using the contribution margin approach.
Fixed expenses + Target profit Units sold to earn
=
Unit contribution margin the target profit
$80,000 + $100,000
= 900 surf boards
$200
7-38
CVP ANALYSIS WITH TARGET INCOME
7-39
PROBLEM
7-40
SOLUTION REQ. 1
7-41
SOLUTION REQ. 2
7-42
Applying CVP Analysis
Margin of Safety/Safety Margin
• The difference between budgeted
sales/actual sales and break-even sales
revenue.
• The amount by which sales can drop before
losses begin to be incurred.
7-43
MARGIN OF SAFETY
7-44
PROBLEM
7-45
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7-47
7-48
7-49
Margin of Safety/Safety Margin
Curl, Inc. has a break-even point of $200,000.
If actual sales are $250,000, the safety margin is
$50,000 or 100 surf boards.
7-50
Changes in Fixed Costs
• Curl is currently selling 500 surfboards per
year.
• The owner believes that an increase of
$10,000 in the annual advertising budget,
would increase sales to 540 units.
Should the company increase the advertising
budget?
7-51
Changes in Fixed Costs
540 units × $500 per unit = $270,000
$80,000 + $10,000 advertising = $90,000
7-52
Changes in Fixed Costs
Sales will increase by
$20,000, but net income
decreased by $2,000.
7-53
Contribution-Margin Approach
Consider the following information
developed by the accountant at Curl, Inc.:
For each additional surf board sold, Curl
generates $200 in contribution margin.
Total Per Unit Percent
Sales (500 surf boards) $250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $100,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ 20,000
7-54
Changes in Unit
Selling Price
Suppose Curl, Inc. increases the price of
each surfboard to $550. With no change
in variable cost per unit, what will be the
new break-even point?
($550 × X) – ($300 × X) – $80,000 = $0
X = 320 units
7-55
Changes in Variable Expense per
unit
Because of increases in cost of raw materials,
Curl’s variable cost per unit has increased
from $300 to $310 per surfboard. With no
change in selling price per unit, what will be
the new break-even point?
($500 × X) – ($310 × X) – $80,000 = $0
X = 421 units (rounded)
7-56
Predicting Profit Given
Expected Volume
In the coming year, Curl’s owner expects to sell
525 surfboards. The unit contribution margin is
expected to be $190, and fixed costs are
expected to increase to $90,000.
Total contribution - Fixed cost = Profit
($190 × 525) – $90,000 = X
X = $99,750 – $90,000
X = $9,750 profit
7-57
Learning
Objective
5
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
CVP Analysis with Multiple
Products
For a company with more than one product,
sales mix is the relative combination in which a
company’s products are sold.
Different products have different selling prices,
cost structures, and contribution margins.
Let’s assume Curl sells surfboards and sail
boards and see how we deal with break-
even analysis.
7-59
CVP Analysis with Multiple Products
Curl provides us with the following information:
NOTE: FIXED EXPENSES IS $170,000
7-60
CVP Analysis with Multiple
Products
Weighted-average unit contribution margin
$200 × 62.5%
$550 × 37.5%
7-61
CVP Analysis with Multiple
Products
Break-even point
Break-even Fixed expenses
=
point Weighted-average unit contribution margin
Break-even $170,000
=
point $331.25
Break-even
= 514 combined unit sales
point
7-62
CVP Analysis with Multiple
Products
Break-even point
Break-even
= 514 combined unit sales
point
7-63
PROBLEM
7-64
7-65
7-66
Learning
Objective
6
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Assumptions Underlying
CVP Analysis
1. Selling price is constant throughout
the entire relevant range.
2. Costs are linear over the relevant
range.
3. In multi-product companies, the
sales mix is constant.
4. In manufacturing firms, inventories
do not change (units produced =
units sold).
7-68
Learning
Objective
8
McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Cost Structure and Operating
Leverage
• The cost structure of an organization is the
relative proportion of its fixed and variable
costs.
• Operating leverage is . . .
– the extent to which an organization uses fixed
costs in its cost structure.
– have a high proportion of fixed costs in
relation to variable costs.
7-70
OPERATING LEVERAGE
7-71
DEGREE OF OPERATING LEVERAGE
FORMULA
7-72
Measuring Operating Leverage
Operating leverage Contribution margin
=
factor Net income
$100,000
= 5
$20,000
7-73
Measuring Operating Leverage
A measure of how a percentage change in
sales will affect profits. If Curl increases its
sales by 10%, what will be the percentage
increase in net income?
Percent increase in sales 10%
Operating leverage factor × 5
Percent increase in profits 50%
7-74
Measuring Operating Leverage
A firm with proportionately high fixed costs has relatively
high operating leverage. On the other hand, a firm with high
operating leverage has a relatively high break-even point.
7-75
PROBLEM
7-76
SOLUTION
7-77
THANK YOU!
We made
it!
7-78
