Lecture 7 - CVP Analysis

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Cost-VolumeProfit Analysis
Accounting: A Malaysian Perspective, 4th ed
(Adapted from Accounting 22nd ed)
Warren, Reeve and Duchac
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Contents
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Contribution margin / Contribution margin
ratio / Unit contribution margin
Break-even point
Cost-volume-profit chart
Volume-profit chart
Margin of safety
Operating leverage
Assumptions underlying CVP analysis
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Cost-Volume-Profit
Relationships
8-2
Cost-volume-profit analysis is the systematic

examination of the relationships among selling
prices, sales and production volume, costs,
expenses, and profits.
The contribution margin is the excess of sales over

variable costs. It contributes first toward covering
fixed costs, then contributes to profit.
i.e. Contribution = Sales Variable cost
ClickContribution
to edit Master title
Margin Income Statement
4
Sales (50,000 units)

Variable costs
Contribution margin
Fixed costs
Net profit
style
8-2
RM1,000,000
600,000
RM 400,000
300,000
RM 100,000
Contribution Margin Ratio

Variable costs
Contribution margin
Fixed costs
Net profit
RM1,000,000
600,000
RM 400,000
300,000
RM 100,000
8-2
100%
60%
40%
30%
10%
Sales Variable Costs

Contribution Margin Ratio =
Sales
RM1,000,000 RM600,000
Contribution Margin Ratio =
RM1,000,000
Contribution Margin Ratio = 40%
5
Unit
Contribution
Click
to editMargin
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8-2
The unit contribution margin

is also useful for analyzing the
profit potential of proposed
projects. The unit contribution
margin is the selling price less
the variable cost per unit.
Using Contribution Margin per

to edit Master title
UnitClick
as a Shortcut
50,000
units
style
8-2
65,000
units
Sales (RM20)
RM1,000,000 RM1,300,000
780,000
Variable costs (RM12)
600,000
Contribution margin (RM8)RM400,000 RM 520,000
300,000
Fixed costs
300,000
Net profit
RM 100,000 RM220,000
The increase in the net profit of RM120,000

could have been determined quickly by
multiplying the increase in unit sold (15,000) by
the contribution margin per unit (RM8).

Variable costs
Contribution margin
Fixed costs
Net profit
RM1,000,000
600,000
RM 400,000
300,000
RM 100,000
100%
60%
40%
30%
10%
Unit contribution margin

analyses can provide useful
information for managers.
8-2
RM20
12
RM 8
Review

Variable costs
Contribution margin
Fixed costs
Net profit
RM1,000,000
600,000
RM 400,000
300,000
RM 100,000
100%
60%
40%
30%
10%
8-2
RM20
12
RM 8
The contribution margin can be expressed three ways:

1. Total contribution margin in dollars.
2. Contribution margin ratio (percentage).
3. Unit contribution margin (dollars per unit).
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8-2

Example: Exercise 8-2
Syarikat Molly sells 20,000 units at RM12 per

unit. Variable costs are RM9 per unit, and
fixed costs are RM25,000.
Determine:
(a)contribution margin;
(b)contribution margin ratio;
(c)unit contribution margin; and
(d)net profit.
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11
8-2

Solution for Exercise 8-2:
(a) Contribution = Sales Variable cost
margin
= (20,000 units x RM12) (20,000 units x RM9)
= RM240,000 RM180,000
= RM60,000
(b) Contribution margin ratio = Contribution / Sales
= RM60,000 / RM240,000 = 25%
(c) Unit contribution margin = Selling price/unit Variable cost/unit
= RM12 RM9
11
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= RM3
12
8-2

Solution for Exercise 8-2:
(d) Sales
Variable costs
Contribution margin
Fixed costs
Net profit
RM240,000 (20,000 x RM12)

RM180,000 (20,000 x RM9)
RM 60,000 [20,000 x (RM12 RM9)]
RM 25,000
RM 35,000
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13

Objective
8-3
Using the unit contribution

margin, determine the break-even
point and the volume necessary to
achieve a target profit.
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Break-Even
Point
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8-3
The break-even point is the level of operations at

which a businesss total contribution is equal to
the total fixed cost.
This is also known as no profit, no loss situation.
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8-3
Syarikat Bakars fixed costs are estimated to

be RM90,000. The unit contribution margin
is calculated as follows:
Unit selling price
RM25
Unit variable cost
RM15
Unit contribution margin RM10
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8-3
The break-even point is calculated using the

following equation:
Break-even point (units) =
Fixed Costs
Unit Contribution Margin
RM90,000
RM10
Break-even point (units) = 9,000 units
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17
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title
ProofClick
of the Preceding
Computation
style
8-3
Sales (RM25 x 9,000)

RM225,000
Variable costs (RM15 x 9,000) 135,000
Contribution margin
RM 90,000
Fixed costs
90,000
Net profit
RM
0
Net profit is zero when 9,000 units are

sold - hence, break-even point is at
9,000 units.
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Effect
of Changes
Fixed Costs
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to editin Master
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style
If
Fixed
Costs
Then
BreakEven
If
Fixed
Costs
Then
BreakEven
8-3
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Increasing
Click toFixed
edit Costs
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8-3
Syarikat Lazer is evaluating a

proposal to budget an additional
RM100,000 for advertising. Fixed
costs before the additional
advertising are estimated at
RM600,000, and the unit
contribution margin is RM20.
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20
8-3
Without additional advertising:

Fixed Costs
RM600,000
30,000
=
units
RM20
With additional advertising:

RM700,000
35,000
=
units
RM20
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Effect
of to
Changes
in
Click
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Unit Variable Costs
If
Unit
Variable
Cost
If
Unit
Variable
Costs
title style
Then
BreakEven
Then
BreakEven
8-3
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8-3
Syarikat Antah. is evaluating a proposal to pay an

additional 2% commission on sales to its salespeople
(a variable cost) as an incentive to increase sales.
Fixed costs are estimated at RM840,000. The unit
contribution margin before the additional 2%
commission on sales is determined as follows:
Unit selling price

RM250
Unit variable cost
145
Unit contribution marginRM105
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8-3
Without additional 2% commission:

Fixed Costs
RM840,000
8,000
=
units
RM105
With additional 2% commission:

RM840,000
8,400
=
units
RM100
RM250 [RM145 + (RM250 x 2%)]

= RM100
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Effect
of to
Changes
in the
Click
edit Master
Unit Selling Price
If
Unit
Selling
Price
Then
If
Unit
Selling
Price
Then
title style
8-3
BreakEven
BreakEven
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8-3
Syarikat Jendi is evaluating a proposal to increase

the unit selling price of a product from RM50 to
RM60. The following data have been gathered:
Current Proposed
Unit selling price
RM50
RM60
Unit variable cost
30
30
Unit contribution margin RM20
RM30
Total fixed costs
RM600,000 RM600,000
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8-3
Without selling price increase:

Fixed Costs
RM600,000
30,000
=
units
RM20
With selling price increase:

RM600,000
20,000
=
units
RM30
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Summary
of Effects
of
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to
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Changes on Break-Even
Point
Effect of Change
Direction of
Change
on Break-even
Point (Units)
Fixed cost
Increase
Decrease
Increase
Decrease
Variable cost per unit
Increase
Decrease
Increase
Decrease
Unit selling price
Increase
Decrease
Decrease
Increase
Types of Change
8-3
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8-3

Nik Enterprise sells a product for RM60 per unit. The
variable cost is RM35 per unit, while fixed costs are
RM80,000. Determine the (a) break-even point in sales
units, and (b) break-even point if the selling price were
increased to RM67 per unit.
Solution for Example 8-3
a. RM80,000/(RM60 RM35) = 3,200 units
b. RM80,000/(RM67 RM35) = 2,500 units
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Target
Click Profit
to edit
Master title style
8-3
The sales volume required to earn a target

profit is determined by modifying the breakeven equation.
Fixed Costs + Target Profit
Sales (units) =
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30
Units
Required
for Target
Profittitle
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to edit
Master
style
8-3
Fixed costs are estimated at RM200,000, and

the desired profit is RM100,000. Unit
contribution margin is RM30.
Unit selling price
RM75
Unit variable cost
45
Unit contribution marginRM30
RM200,000
RM100,000
Fixed Costs + Target
Profit
Sales (units) =
Unit
Contribution Margin
RM30
Sales (units) = 10,000 units
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Proof
of earlier
calculation:
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to edit
Master
title style
8-3
Sales (10,000 units x RM75) RM750,000

Variable costs (10,000 x RM45) 450,000
Contribution margin (10,000
x RM30)
RM300,000
Fixed costs
200,000
Net profit
RM100,000
Proof that sales of 10,000 units will provide a
profit of RM100,000.
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8-3

Syarikat Fika sells a product for RM140 per unit. The
variable cost is RM60 per unit, and fixed costs are
RM240,000. Determine the (a) break-even point in
sales units, and (b) break-even point in sales units if the
company desires a target profit of RM50,000.
Follow My Example 8-4
a. RM240,000/(RM140 RM60) = 3,000 units
b. (RM240,000 + RM50,000)/(RM140 RM60) = 3,625 units
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Objective
8-4
Using a cost-volume-profit chart

and a profit-volume chart,
determine the break-even point
and the volume necessary to
achieve a target profit.
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Cost-Volume-Profit
Click to edit Master
(Break-Even) Chart
title style
8-4
A cost-volume-profit chart,
sometimes called a break-even
chart, may assist management
in understanding relationships
among costs, sales, and
operating profit or loss.
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8-4
Example: Question 1
The cost-volume-profit chart in Exhibit 5 (next page) is

based on the following data:
Unit selling price
Unit variable cost
Unit contribution margin
Total fixed costs
RM50
RM30
RM20
RM100,000
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Dollar
amounts
are
indicated
along the
vertical
axis.
Sales and Costs (in thousands)
ClickCost-Volume-Profit
to edit MasterChart
title style
8-4
RM500
RM450
RM400
RM350
RM300
RM250
RM200
RM150
RM100
RM 50
0
2 3
4 5
6 7
8
Units of Sales (in thousands)
9 10
Volume is (Continued)
shown on the horizontal axis.
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Cost-Volume-Profit
Chart (Continued)
8-4
Point A
RM500
RM450
RM400
RM350
RM300
RM250
RM200
RM150
RM100
RM 50
0
2 3 4 5
6 7 8
9 10
At sales of RM500,000 and knowing that each unit sells for RM50, we
37
can find the values of the two axis. Where the horizontal sales and costs
line intersects the vertical 10,000 unit of sales line is Point A.
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Cost-Volume-Profit
Chart (Continued)
8-4
Point A
RM500
RM450
RM400
RM350
RM300
RM250
RM200
RM150
RM100
RM 50
0
2 3 4 5
6 7 8
9 10
Now, beginning at zero on the left corner of the graph, connect

a straight line to the dot (Point A). Note: Point A could have
been plotted at any sales level because linearity is assumed.
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Cost-Volume-Profit
Chart (Continued)
8-4
RM500
RM450
RM400
RM350
RM300
RM250
RM200
RM150
RM100
RM 50
0
2 3
4 5
6 7
8
Fixed cost of RM100,000 is a horizontal line.
9 10
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Cost-Volume-Profit
Chart (Continued)

RM500
RM450
RM400
RM350
RM300
RM250
RM200
RM150
RM100
RM 50
8-4
Point B
2 3
4 5
6 7
8
9 10
Similar to the sales line, a point is determined on the total cost line40
(10,000 x RM30) + RM100,000 = RM400,000 (Point B).
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Cost-Volume-Profit
Chart (Continued)

RM500
RM450
RM400
RM350
RM300
RM250
RM200
RM150
RM100
RM 50
8-4
Point B
2 3
4 5
6 7
8
9 10
Beginning with the total fixed cost at the vertical axis

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(RM100,000), draw a line to Point B. This is the total cost line.
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Cost-Volume-Profit
Chart (Continued)
8-4
RM500
RM450
RM400
RM350
RM300
RM250
RM200
RM150
RM100
RM 50
0
2 3
4 5
6 7
8
9 10
Horizontal and vertical lines are drawn at the

intersection point of the sales line and the costs line,
which is the break-even point.
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Cost-Volume-Profit
Chart (Continued)
8-4
RM500
RM450
RM400
RM350
RM300
RM250
RM200
RM150
RM100
RM 50
0
2 3
4 5
6 7
8
Break-even point is at sales of 5,000 units or RM250,000.
9 10
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Cost-Volume-Profit
Chart (Concluded)

RM500
RM450
RM400
RM350
RM300
RM250
RM200
RM150
RM100
RM 50
8-4
Profit area
2 3
4 5
6 7
8
9 10
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Revised Cost-Volume-Profit Chart
8-4
Using the data in Question 1, assume

that a proposal to reduce fixed cost by
RM20,000 is to be evaluated. A costvolume-profit chart can be created to
assist in this evaluation.
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Revised CostVolume- Profit Chart

RM500
RM450
RM400
RM350
RM300
RM250
RM200
RM150
RM100
RM 50
8-4
RM80,000
0
2 3
4 5
6 7
8
9 10
If fixed costs can be reduced to RM80,000, the new breakeven point is now at sales of RM200,000, or 4,000 units.
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Profit-Volume
Chart
Click to edit
Master
title style
8-4
Another graphic approach to cost-volumeprofit analysis, the profit-volume chart,

plots only the difference between total
sales and total costs (or profits). Again, the
data from Question 1 will be used.
Unit selling price
RM 50
Unit variable cost
RM 30
Unit contribution margin RM 20
Total fixed costs
RM100,000
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to
edit
Master
title
style
The maximum operating loss is equal to the
8-4
fixed costs of RM100,000. Assuming that the

maximum unit sales within the relevant range is
10,000 units, the maximum operating profit is
RM100,000, computed as follows:
Sales (10,000 units x RM50)
RM500,000
Variable costs (10,000 units x RM30)
300,000
Contribution margin (10,000 units x RM20) 200,000
Fixed costs
100,000
Net profit
RM100,000
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Maximum profit
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Operating Profit (Loss)
Chart title
ClickProfit-Volume
to edit Master
style
8-4
RM100,000
RM75,000
Profit Line
RM50,000
Operating
RM25,000
profit
RM 0
RM(25,000) Operating
Break-Even Point
RM(50,000) loss
RM(75,000)
RM(100,000)
1 2
3 4 5
6 7 8 9 10
Maximum loss is
RM100,000, the fixed costs.
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Margin
ClickoftoSafety
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title style
8-5
Margin of safety is the difference between the

estimated level of sales and break-even point.
The higher the margin of safety, the more likely a
profit will be made.
That means, even if sales drop, if margin of
safety is large, there will be more leeway before
the organisation will begin making losses.
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Margin
(MOS) title style
ClickoftoSafety
edit Master
8-5
MOS = Estimated sales unit Break-even point units

= ___ units
OR
MOS = Estimated sales Break-even point
Estimated sales
= ___% of sales
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to
edit
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title
style
If estimated sales are RM250,000, the unit selling price
8-5
is RM25, and the sales at the break-even point are

RM200,000, the margin of safety is ____%.
Sales Sales at break-even point
Margin of Safety =
Sales
RM250,000 RM200,000
Margin of Safety =
RM250,000
Margin of Safety = 20%
This means, estimated sales

can drop by 20% before a
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loss would incurred.
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8-5
The margin of safety may also be stated in

terms of units. In this illustration, for
example, the margin of safety of 20% is
equivalent to RM50,000 in sales value
(RM250,000 x 20%).
In units, the margin of safety is 2,000 units
(RM50,000/RM25).
This means, estimated sales units
can drop by 2,000 units before a
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loss would incurred.
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8-5
Example Exercise 8-6
Syarikat Rafiq has sales of RM400,000, and the

break-even point in sales dollars is RM300,000.
Determine the companys margin of safety in %.
Follow My Example 8-6
(RM400,000 RM300,000)/RM400,000 = 25%
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Objective
8-2
List the assumptions underlying

cost-volume-profit analysis.
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Assumptions
of Cost-VolumeClick
to
edit
Master
title
Profit Analysis
style
8-6
The primary assumptions are:

1. Total sales and total costs can be represented by a
straight line.
2. Within the relevant range of operating activity, the
efficiency of operations does not change.
3. Costs can be accurately divided into fixed and
variable components.
4. The sales mix is constant.
5. There is no change in the inventory quantities during
the period.
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57

End of Lecture. Thank you!
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Lecture 7 - CVP Analysis

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1

Click to edit Master

Cost-volume-profit analysis is the systematic

The contribution margin is the excess of sales over

i.e. Contribution = Sales Variable cost

Sales (50,000 units)

Contribution Margin Ratio

Click to edit Master title style

Sales Variable Costs

The unit contribution margin

Using Contribution Margin per

The increase in the net profit of RM120,000

Click to edit Master title style

Unit contribution margin

Click to edit Master title style

Sales (50,000 units)

The contribution margin can be expressed three ways:

Click to edit Master title style

Syarikat Molly sells 20,000 units at RM12 per

Click to edit Master title style

Click to edit Master title style

RM240,000 (20,000 x RM12)

Click to edit Master title style

Using the unit contribution

The break-even point is the level of operations at

Click to edit Master title style

Syarikat Bakars fixed costs are estimated to

Click to edit Master title style

The break-even point is calculated using the

Sales (RM25 x 9,000)

Net profit is zero when 9,000 units are

Syarikat Lazer is evaluating a

Click to edit Master title style

Without additional advertising:

Break-even point (units) =

With additional advertising:

Click to edit Master title style

Syarikat Antah. is evaluating a proposal to pay an

Unit selling price

Click to edit Master title style

Without additional 2% commission:

Break-even point (units) =

With additional 2% commission:

RM250 [RM145 + (RM250 x 2%)]

Click to edit Master title style

Syarikat Jendi is evaluating a proposal to increase

Click to edit Master title style

Without selling price increase:

Break-even point (units) =

With selling price increase:

Variable cost per unit

Unit selling price

Click to edit Master title style

Master title style

The sales volume required to earn a target

Fixed costs are estimated at RM200,000, and

Sales (10,000 units x RM75) RM750,000

Click to edit Master title style

Click to edit Master title style

Using a cost-volume-profit chart

Click to edit Master title style

The cost-volume-profit chart in Exhibit 5 (next page) is

Sales and Costs (in thousands)

Sales and Costs (in thousands)