Chapter 7

Cost-Volume-
Profit Analysis

Copyright 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
The Break-Even Point
The break-even point is the point in the volume of
activity where the organizations revenues and
expenses are equal.

Sales
Sales $$250,000
250,000
Less:
Less: variable
variable expenses
expenses 150,000
150,000
Contribution
Contribution margin
margin 100,000
100,000
Less:
Less: fixed
fixed expenses
expenses 100,000
100,000
Net
Net income
income $$ --

7-2
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
7-3
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
Total Per
Per Unit
Unit Percent
Percent
Sales
Sales(500
(500surf
surfboards)
boards) $$250,000
250,000 $$ 500500 100%
100%
Less:
Less: variable
variableexpenses
expenses 150,000
150,000 300
300 60%
60%
Contribution
Contributionmargin
margin $$100,000
100,000 $$ 200200 40%
40%
Less:
Less: fixed
fixedexpenses
expenses 80,000
80,000
Net
Net income
income $$ 20,000
20,000

7-4
Contribution-Margin Approach
Fixed expenses Break-even point
=
(in units)
Unit contribution margin
Total
Total Per
PerUnit
Unit Percent
Percent
Sales
Sales(500
(500surf
surfboards)
boards) $$250,000
250,000 $$ 500
500 100%
100%
Less: variable expenses
Less: variable expenses 150,000
150,000 300
300 60%
60%
Contribution
Contributionmargin
margin $$100,000
100,000 $$ 200
200 40%
40%
Less:
Less:fixed
fixedexpenses
expenses 80,000
80,000
Net
Netincome
income $$ 20,000
20,000

$80,000
= 400 surf boards
$200
7-5
Contribution-Margin Approach

Here is the proof!

Total
Total Per
Per Unit
Unit Percent
Percent
Sales
Sales(400
(400surf
surfboards)
boards) $$200,000
200,000 $$ 500500 100%
100%
Less:
Less: variable
variableexpenses
expenses 120,000
120,000 300
300 60%
60%
Contribution
Contributionmargin
margin $$ 80,000
80,000 $$ 200200 40%
40%
Less:
Less: fixed
fixedexpenses
expenses 80,000
80,000
Net
Netincome
income $$ --

400 $500 = $200,000 400 $300 = $120,000

7-6
Contribution Margin Ratio

Calculate the break-even point in sales dollars rather

than units by using the contribution margin ratio.

Contribution margin
= CM Ratio
Sales
Fixed expense Break-even point
=
CM Ratio (in sales dollars)
7-7
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.:

7-8
Cost-Volume-Profit Graph

n s es
l exp e
Tota
Fixed expenses

7-9
Cost-Volume-Profit Graph

n s es
l exp e
Tota
Fixed expenses

7-10
Cost-Volume-Profit Graph

le s
l s a
a
Tot

n s es
l exp e
Tota
Fixed expenses

7-11
Cost-Volume-Profit Graph

le s
s a
a l rea
Break-even Tot r ofit a
P
point

n s es
l exp e
Tota
Fixed expenses
r ea
s a
s
Lo

7-12
Profit-Volume Graph
Some
Some managers
managers like like the
the profit-volume
profit-volume
graph
graph because
because itit focuses
focuses on
on profits
profits and
and volume.
volume.

Break-even
point rea
a
r ofit
P

r ea
s sa
Lo

7-13
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

7-14
Equation Approach

Sales revenue Variable expenses Fixed expenses = Profit

($500 X) ($300 X) $80,000 = $100,000

($200X) = $180,000

X = 900 surf boards

7-15
Applying CVP Analysis
Safety Margin
The difference between budgeted sales revenue
and break-even sales revenue.
The amount by which sales can drop before
losses occur.

7-16
CVP Analysis with Multiple
Products
For a company with more than one
product, sales mix is the relative
combination in which a companys
products are sold.
Different products have different selling
prices, cost structures, and contribution
margins.

Lets assume Curl sells surfboards and sail boards

and see how we deal with break-even analysis.
7-17
CVP Analysis with Multiple
Products
Curl provides us with the following: information:

7-18
CVP Analysis with Multiple
Products
Weighted-average unit contribution margin

$200 62.5%

$550 37.5%
7-19
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

7-20
CVP Analysis with Multiple
Products

Break-even point
Break-even
= 514 combined unit sales
point

7-21
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).
7-22
CVP Relationships and the Income
Statement

7-23
CVP Relationships and the Income
Statement

7-24
Cost Structure and Operating
Leverage
The
The cost
cost structure
structure of
of an
an organization
organization is
is the
the
relative
relative proportion
proportion of
of its
its fixed
fixed and
and variable
variable
costs.
costs.
Operating
Operating leverage
leverage is:
is:
the
the extent
extent to
to which
which an
an organization
organization uses
uses fixed
fixed
costs
costs in
in its
its cost
cost structure.
structure.
greatest
greatest in in companies
companies that
that have
have aa high
high proportion
proportion
of
of fixed
fixed costs
costs in
in relation
relation to
to variable
variable costs.
costs.

7-25
 Measuring Operating
Leverage
Operating leverage Contribution margin
=
factor Net income

$100,000
= 5
$20,000 7-26
Measuring Operating
Leverage
A
A measure
measure of of how
how aa percentage
percentage change
change inin sales
sales
will
will affect
affect profits.
profits. If
If Curl
Curl increases
increases its
its sales
sales by
by
10%,
10%, what
what will
will be
be the
the percentage
percentage increase
increase in
in
net
net income?
income?

Percent increase in sales 10%

Operating leverage factor 5
Percent increase in profits 50%

7-27
CVP Analysis, Activity-Based Costing,
and Advanced Manufacturing Systems
An activity-based costing system provides a much
more complete picture of cost-volume-profit
relationships and, thus, it provides better
information to managers.

Break-even = Fixed costs

point Unit contribution margin

7-28
A Move Toward JIT and
Flexible Manufacturing
Overhead costs like setup, inspection, and
material handling are fixed with respect to
sales volume, but they are not fixed with
respect to other cost drivers.

This is the fundamental distinction between

a traditional CVP analysis and an activity-
based costing CVP analysis.

7-29
Effect of Income Taxes
Income taxes affect a companys
CVP relationships. To earn a
particular after-tax net income, a
greater before-tax income will be
required.

Target after-tax net income Before-tax

=
net income
1 - t

7-30