Cost-Volume-Profit Analysis

Chapter 20

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin Copyright © 2012 The McGraw-Hill Companies, Inc.
Cost-Volume-Profit Relationships

Cost-volume-profit (CVP) analysis is

used to answer questions such as:
 How much must I sell to earn my desired
income?
 How will income be affected
if I reduce selling prices to
increase sales volume?
 What will happen to
profitability if I expand
capacity?

20-2
 Fixed Costs (and Fixed Expenses)

Monthly Basic Telephone

Bill per Local Call
Telephone Bill
Monthly Basic

Number of Local Calls Number of Local Calls

Total fixed costs Cost per call
remain constant as declines as
activity increases. activity increases.

20-3
 Variable Costs (and Variable
Expenses)
Total Long Distance

Cost per Minute

Telephone Bill

Minutes Talked Minutes Talked

Total variable Cost per Minute

costs increase as is constant as
activity increases. activity increases.

20-4
Cost Behavior Summary

Summary of Variable and Fixed Cost Behavior

Variable Costs Fixed costs

Remains the same even Dereases as activity level

Per Unit
when activity level changes. increases.
Changes as activity level Remains the same over wide
Total
changes. ranges of activity.

20-5
Semivariable Costs (Mixed Costs)
Mixed costs contain a fixed portion that is
incurred even when facility is unused, and a
variable portion that increases with usage.

Example: monthly electric utility charge

 Fixed service fee
 Variable charge per
kilowatt hour used

20-6
 Semivariable Costs (Mixed Costs)
Slope is
variable cost
per unit
of activity.
Total Utility Cost

Variable
Utility Charge

Fixed Monthly
Utility Charge
Activity (Kilowatt Hours)
20-7
 CVP Relationships : A Graphical
Analysis
 Starting at the origin, draw
the total revenue line with a slope
equal to the unit sales price.
Draw the
total cost line
Costs and Revenue

Break-even Profit with a slope

Point equal to the
in Dollars

unit variable
cost.

 Total fixed
Loss cost extends
horizontally
from the
vertical axis.
Volume in Units 20-8
Economies of Scale
Economies of scale are most apparent
in business with high fixed costs.

Utility Oil Steel

Companies Refineries Mills

Number
Fixed Costs of Flights Fixed Cost
per Month per Month per Flight
$ 100,000,000 1,000 $ 100,000
100,000,000 2,000 50,000
100,000,000 4,000 25,000
100,000,000 8,000 12,500
Airlines
20-9
Semivariable Costs
Total cost increases to a
new higher cost for the next
higher range of activity.

Total cost remains

Cost
constant within a
narrow range of
activity. Activity

20-10
Computing Break-Even Point
The break-even point (expressed in units
of product or dollars of sales) is the
unique sales level at which a company
neither earns a profit nor incurs a loss.

20-12
Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000

Contribution margin is the amount by which revenue

exceeds the variable costs of producing the revenue.

How many units must this company sell to cover its

fixed costs (break even)?
Answer: $30,000 ÷ $20 per unit = 1,500 units
20-13
How Many Units Must We Sell?
We have just seen one of the basic CVP
relationships – the break-even computation.
Break-even Fixed costs
=
point in units Contribution margin per unit

Unit sales price less unit variable cost

($50 – $30 = $20 in previous example)

20-14
How Many Dollars in Sales Must
We Generate?
The break-even formula may also be
expressed in sales dollars.

Break-even Fixed costs

=
point in dollars Contribution margin ratio

Unit contribution margin

Unit sales price

20-15
Computing Break-Even Sales
ABC Co. sells product XYZ at $5.00 per unit. If
fixed costs are $200,000 and variable costs are
$3.00 per unit, how many units must be sold to
break even?
a. 100,000 units
b. 40,000 units
c. 200,000 units
d. 66,667 units

20-16
Computing Break-Even Sales
ABC Co. sells product XYZ at $5.00 per unit. If
fixed costs are $200,000 and variable costs are
$3.00 per unit, how many units must be sold to
break even?
a. 100,000 units
b. 40,000 units
c. 200,000 units
Unit contribution = $5.00 - $3.00 = $2.00
d. 66,667 units
Fixed Costs $200,000
=
Unit contribution $2.00 per unit
= 100,000 units
20-17
Computing Break-Even Sales
Use the contribution margin ratio formula to
determine the amount of sales revenue ABC
must have to break even. All information
remains unchanged: fixed costs are $200,000;
unit sales price is $5.00; and unit variable cost
is $3.00.
a. $200,000
b. $300,000
c. $400,000
d. $500,000

20-18
Computing Break-Even Sales
Use the contribution margin ratio formula to
determine the amount of sales revenue ABC
must have to break even. All information
remains unchanged: fixed costs are $200,000;
unit sales price is $5.00; and unit variable cost
is $3.00.
a. $200,000
Unit contribution = $5.00 - $3.00 = $2.00
Contribution margin ratio = $2.00 ÷ $5.00 = .40
b. $300,000
Break-even revenue = $200,000 ÷ .4 = $500,000
c. $400,000
d. $500,000

20-19
Computing Sales Needed to
Achieve Target Operating Income
Break-even formulas may be adjusted
to show the sales volume needed to earn
any amount of operating income.

Fixed costs + Target income

Unit sales =
Contribution margin per unit

Fixed costs + Target income

Dollar sales =
Contribution margin ratio

20-20
Computing Sales Needed to
Achieve Target Operating Income
ABC Co. sells product XYZ at $5.00 per unit.
If fixed costs are $200,000 and variable
costs are $3.00 per unit, how many units
must be sold to earn operating income of
$40,000?
a. 100,000 units
b. 120,000 units
c. 80,000 units
d. 200,000 units

20-21
Computing Sales Needed to
Achieve Target Operating Income
ABC Co. sells product XYZ at $5.00 per unit.
If fixed costs are $200,000 and variable
costs are $3.00 per unit, how many units
must be sold to earn operating income of
$40,000?
Unit contribution = $5.00 - $3.00 = $2.00
a. 100,000 units
Fixed costs + Target income
b. 120,000 units
Unit contribution
c. 80,000 units
$200,000 + $40,000
d. 200,000 units $2.00 per unit = 120,000 units

20-22
What is Our Margin of Safety?
Margin of safety is the amount by which sales
may decline before reaching break-even sales:

Margin of safety = Actual sales – Break-even sales

Margin of safety provides a quick means of

estimating operating income at any level of sales:

Operating Margin Contribution

= ×
Income of safety margin ratio

20-23
What is Our Margin of Safety?
ADM contribution margin ratio is 40
percent. If sales are $100,000 and break-
even sales are $80,000, what is operating
income?

Operating Margin Contribution

Income = of safety × margin ratio

Operating
Income = $20,000 × .40 = $8,000

20-24
 What Change in Operating
Income Do We Anticipate?
Once break-even is reached, every additional
dollar of contribution margin becomes
operating income:
Change in Change in Contribution
operating income = sales volume × margin ratio

ADM expects sales to increase by $15,000 and

has a contribution margin ratio of 40%. How
much will operating income increase?
Change in
operating income = $15,000 × .40 = $6,000
20-25
Business Applications of CVP
Consider the following information
developed by the accountant at Speedo,
a bicycle retailer:

Total Per Unit Percent

Sales (500 bikes) $ 250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $ 100,000 $ 200 40%
Less: fixed expenses 80,000
Operating income $ 20,000

20-26
 Business Applications of CVP
Should Speedo spend $12,000 on
advertising to increase sales by 10 percent?

Total Per Unit Percent

Sales (500 bikes) $ 250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $ 100,000 $ 200 40%
Less: fixed expenses 80,000
Operating income $ 20,000

20-27
Business Applications of CVP
Should Speedo spend $12,000 on
advertising to increase sales by 10
percent?
500 550
550 × $500
Bikes Bikes
Sales $ 250,000 $ 275,000
Less: variable expenses 150,000 550 × $300 165,000
Contribution margin $ 100,000 $ 110,000
Less: fixed expenses 80,000 $80K + $12K 92,000
Operating income $ 20,000 $ 18,000

No, income is decreased.

20-28
 Business Applications of CVP
Now, in combination with the advertising,
Speedo is considering a 10 percent price reduction that will
increase sales by 25 percent. What is the income effect?
500 1.25 × 500 625
Bikes Bikes
Sales $ 250,000 625 × $450 $ 281,250
Less: variable expenses 150,000 187,500
Contribution margin $ 100,000
625 × $300 $ 93,750
Less: fixed expenses 80,000 92,000
Operating income $ 20,000 $80K + $12K $ 1,750

Income is decreased even more.

20-29
Business Applications of CVP
Now, in combination with advertising and a price cut, Speedo
will replace $50,000 in sales salaries with a $25 per bike
commission, increasing sales by 50 percent above the
original 500 bikes. What is the effect on income?
500 1.5 × 500 750
Bikes Bikes
750 × $450
Sales $ 250,000 $ 337,500
Less: variable expenses 150,000 243,750
750 × $325
Contribution margin $ 100,000 $ 93,750
Less: fixed expenses 80,000 $92K - $50K 42,000
Operating income $ 20,000 $ 51,750

The combination of advertising, a price cut,

and change in compensation increases income.

20-30
CVP Analysis When a Company
Sells Many Products
Sales mix is the relative combination in
which a company’s different products are
sold.
Different products have different selling
prices, costs, and contribution margins.
If Speedo sells bikes and carts, how
will we deal with break-even analysis?

20-32
CVP Analysis When a Company
Sells Many Products
Speedo provides us with the following
information:
Bikes Carts Total
Sales $ 250,000 100% $ 300,000 100% $ 550,000 100%
Var. exp. 150,000 60% 135,000 45% 285,000 52%
Contrib. margin $ 100,000 40% $ 165,000 55% $ 265,000 48%
Fixed exp. 170,000
Operating income $ 95,000

20-33
CVP Analysis When a Company
Sells Many Products
The overall contribution margin ratio is:
Bikes Carts Total
Sales $ 250,000 100% $ 300,000 100% $ 550,000 100%
Var. exp. 150,000 60% 135,000 45% 285,000 52%
Contrib. margin $ 100,000 40% $ 165,000 55% $ 265,000 48%
Fixed exp. 170,000
Operating income $ 95,000

$265,000
= 48% (rounded)
$550,000

20-34
CVP Analysis When a Company
Sells Many Products
Break-even in sales dollars is:
Bikes Carts Total
Sales $ 250,000 100% $ 300,000 100% $ 550,000 100%
Var. exp. 150,000 60% 135,000 45% 285,000 52%
Contrib. margin $ 100,000 40% $ 165,000 55% $ 265,000 48%
Fixed exp. 170,000
Operating income $ 95,000

$170,000
= $354,167 (rounded)
.48

20-35
 Determining Semivariable Cost
Elements : The High-Low Method
Matrix, Inc. recorded the following production
activity and maintenance costs for two months:

Units Cost
High activity level 9,000 $ 9,700
Low activity level 5,000 6,100
Change 4,000 $ 3,600

Using these two levels of activity, compute:

 the variable cost per unit.
 the total fixed cost.
 total cost formula.
20-36
 Determining Semivariable Cost
Elements : The High-Low Method
Units Cost
High activity level 9,000 $ 9,700
Low activity level 5,000 6,100
Change 4,000 $ 3,600

 Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit

 Fixed cost = Total cost – Total variable cost
Fixed cost = $9,700 – ($0.90 per unit × 9,000 units)
Fixed cost = $9,700 – $8,100 = $1,600
Total cost = $1,600 + $.90 per unit

20-37
The High-Low Method
If sales commissions are $10,000 when
80,000 units are sold and $14,000 when
120,000 units are sold, what is the variable
portion of sales commission per unit sold?

a. $0.08 per unit

b. $0.10 per unit
c. $0.12 per unit
d. $0.125 per unit
20-38
The High-Low Method
If sales commissions are $10,000 when
80,000 units are sold and $14,000 when
120,000 units are sold, what is the variable
portion of sales commission per unit sold?

Units Cost
a. $0.08 per unit
High level 120,000 $ 14,000
b. $0.10 perLow
unitlevel 80,000 10,000

c. $0.12 per Change

unit 40,000 $ 4,000
$4,000 ÷ 40,000 units
d. $0.125 per unit = $0.10 per unit
20-39
The High-Low Method
If sales commissions are $10,000 when
80,000 units are sold and $14,000 when
120,000 units are sold, what is the fixed
portion of the sales commission?
a. $ 2,000
b. $ 4,000
c. $10,000
d. $12,000

20-40
The High-Low Method
If sales commissions are $10,000 when
80,000 units are sold and $14,000 when
120,000 units are sold, what is the fixed
portion of the sales commission?
a. $ 2,000
b. $ 4,000 Total cost = Total fixed cost +
Total variable cost
c. $10,000
$14,000 = Total fixed cost +
d. $12,000 ($.10 × 120,000 units)
Total fixed cost = $14,000 - $12,000
Total fixed cost = $2,000
20-41
End of Chapter 20

20-44