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COST-VOLUME-PROFIT
ANALYSIS: A MANAGERIAL
PLANNING TOOL
Cornerstones of Managerial
Accounting, 5e in chapter 4 page 116
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed
Learning Objectives
1. Determine the break-even point in number of units
and in total sales dollars.
2. Determine the number of units that must be sold,
and the amount of revenue required, to earn a
targeted profit.
3. Prepare a profit-volume graph and a cost-volume-
profit graph, and explain the meaning of each.
4. Apply cost-volume-profit analysis in a multiple-
product setting.
5. Explain the impact of risk, uncertainty, and changing
variables on cost-volume-profit analysis.
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Break-Even Point
in Units and Sales Dollars
Cost-volume-profit (CVP) analysis estimates
how changes in the following three factors affect
a company’s profit.
Costs (both variable and fixed)
Sales volume
Price
Companies use CVP analysis to help them reach
important benchmarks, like breakeven point.
LO-1
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Break-Even Point in Units and in
Sales Dollars (cont.)
The break-even point is the point where total
revenue equals total cost (i.e., the point of zero
profit).
The level of sales at which contribution margin just
covers fixed costs and when operating income is
equal to zero.
If new companies experience losses (negative
operating income) initially, they view their first
break-even period as a significant milestone.
LO-1
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Break-Even Point in Units and in
Sales Dollars (cont.)
Variable
overhead
LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain
Cornerstone 4.1
Preparing a Contribution Margin
Income Statement
LO-1
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Cornerstone 4.1
Preparing a Contribution Margin
Income Statement (cont.)
LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain
Cornerstone 4.1
Preparing a Contribution Margin
Income Statement (cont.)
LO-1
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Break-Even Point in Units
If the contribution margin income statement is
recast as an equation, it becomes more useful for
solving CVP problems.
LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain
Cornerstone 4.2
Calculating the Break-Even
Point in Units
LO-1
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Cornerstone 4.2
Calculating the Break-Even Point in Units
(cont.)
LO-1
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Break-Even Point in Units
If the contribution margin income statement is
recast as an equation, it becomes more
useful for solving CVP problems.
Basic CVP
Equation
LO-1
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Break-Even Point in Units (cont.)
Break-even units are equal to the fixed cost
divided by the contribution margin per unit.
LO-1
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Break-Even Point in Sales Dollars
Managers using CVP analysis may use sales
revenue as the measure of sales activity instead
of units sold. A units sold measure can be
converted to a sales revenue measure by
multiplying the unit selling price by the units sold:
LO-1
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Break-Even Point in Sales Dollars
LO-1
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Variable Cost Ratio and Contribution Margin Ratio
Alternatively:
LO-1
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Cornerstone 4.3
Calculating the Variable Cost Ratio and the
Contribution Margin Ratio
LO-1
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Cornerstone 4.3
Calculating the Variable Cost Ratio
and the Contribution Margin Ratio (cont.)
LO-1
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Fixed Cost’s Relationship, Variable
Cost Ratio, Contribution Margin Ratio
Since the total contribution margin is the revenue
remaining after total variable costs are covered, it
must be the revenue available to cover fixed
costs and contribute to profit.
How does the relationship of fixed cost to
contribution margin affect operating income?
LO-1
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Fixed Cost’s Relationship, Variable
Cost Ratio, Contribution Margin Ratio (cont.)
LO-2
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Calculating Break-Even in Sales
Dollars
The equation to figure the break-even sales
dollars is:
LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain
Cornerstone 4.4
Calculating the Break-Even Point
in Sales Dollars
LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain
Cornerstone 4.4
Calculating the Break-Even Point
in Sales Dollars (cont.)
LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain
Cornerstone 4.4
Calculating the Break-Even Point
in Sales Dollars (cont.)
LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain
Cornerstone 4.5
Calculating Number of Units to Be Sold to
Earn A Target Operating Income (cont.)
LO-2
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Cornerstone 4.5
Calculating Number of Units to Be Sold to
Earn A Target Operating Income (cont.)
LO-2
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Sales Revenue to Achieve a Target Income (cont.)
LO-2
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Sales Revenue to
Achieve a Target Income
How much sales revenue must Whittier generate
to earn an operating income of $37,500?
This question is similar to the one we asked
earlier in terms of units but phrases the question
directly in terms of sales revenue.
LO-2
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Cornerstone 4.6
Calculating Sales Needed to
Earn a Target Operating Income
LO-2
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Cornerstone 4.6
Calculating Sales Needed to
Earn A Target Operating Income (cont.)
LO-2
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Impact of Change in Revenue
on Change in Profit
Assuming that fixed costs remain unchanged, the
contribution margin ratio can be used to find the
profit impact of a change in sales revenue.
To obtain the total change in profits from a
change in revenues, multiply the contribution
margin ratio times the change in sales:
LO-3
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The Cost-Volume-Profit Graph
LO-3
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CVP Analysis Assumptions
Major assumptions of CVP analysis include:
1 2
Linear revenue and cost
Selling prices and costs
functions remain
are known with
constant over the
certainty.
relevant range.
3 4
Sales mix is known with
All units produced are
certainty for multiple-
sold; no finished goods
product break-even
inventories remain.
settings. LO-3
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Multiple-Product Analysis
Cost-volume-profit analysis is simple in the
single-product setting. However, most firms
produce and sell a number of products or
services.
How do we adapt the formulas used in a single-
product setting to a multiple-product setting?
LO-4
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Multiple-Product Analysis (cont.)
One important distinction is to separate direct
fixed expenses from common fixed expenses.
Direct fixed expenses are those fixed costs that can
be traced to each segment and would be avoided if the
segment did not exist.
Common fixed expenses are the fixed costs that are
not traceable to the segments and would remain even if
one of the segments was eliminated.
LO-4
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Break-Even Calculations
for Multiple Products
When more than one product is produced and
sold, managers must estimate the sales mix and
calculate a package contribution margin.
Sales mix is the relative combination of products
being sold by a firm.
Fixed Costs
Break-Even Packages =
Package Contribution Margin
LO-4
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain
Cornerstone 4.7
Calculating The Break-Even Units
for a Multiple-Product Firm (cont.)
LO-4
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain
Cornerstone 4.7
Calculating The Break-Even Units
for a Multiple-Product Firm (cont.)
LO-4
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain
Cornerstone 4.7
Calculating The Break-Even Units
for a Multiple-Product Firm (cont.)
LO-4
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Cornerstone 4.8
Break-Even Sales Dollars
for a Multiple-Product Firm (cont.)
LO-4
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Cornerstone 4.8
Break-Even Sales Dollars
for a Multiple-Product Firm (cont.)
LO-4
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Cost-Volume-Profit Analysis and
Risk and Uncertainty
Managers must be aware of so many factors in
our dynamic world. CVP analysis is a tool that
managers use to handle risk and uncertainty.
?
h an g es in Risks?
C
?
prices?
Fixed
?
ainty?? costs?
r t
Unce
Variable
costs??
LO-5
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Introducing Risk and Uncertainty
An important assumption of CVP analysis is that
prices and costs are known with certainty.
However, risk and uncertainty are a part of
business decision making and must be dealt with
somehow.
LO-5
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Methods to Deal with
Uncertainty and Risk
LO-5
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Margin of Safety and
Operating Leverage
LO-5
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Margin of Safety
The margin of safety is the units sold or the
revenue earned above the break-even volume.
For example, if the break-even volume for a
company is 200 units and the company is currently
selling 500 units, the margin of safety in units is:
LO-5
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Margin of Safety (cont.)
If the break-even volume for a company is
$200,000 and the current revenues are $500,000,
the margin of safety in sales revenue is:
Revenue - Break-even volume
= $500,000 – 200,000 = $300,000
The margin of safety as a percentage of total
sales dollars can then be expressed as:
Margin of safety ÷ Revenues
= $300,000 ÷ $500,000 = 60%
LO-5
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Cornerstone 4.9
Computing the Margin of Safety
LO-5
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Operating Leverage
Operating leverage is use of fixed costs to
extract higher percentage changes in profits as
sales activity changes.
Measure of the proportion of fixed costs in a
company’s cost structure.
It is used as an indicator of how sensitive profit is
to changes in sales volume.
LO-5
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Operating Leverage
The degree of operating leverage (DOL) can be
measured for a given level of sales by taking the
ratio of contribution margin to operating income
or:
Contribution margin ÷ Operating income
LO-5
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Cornerstone 4.10
Computing the Degree of
Operating Leverage
LO-5
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Cornerstone 4.10
Computing the Degree of
Operating Leverage (cont.)
LO-5
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Summary of Operating Leverage
Operating Leverage
HIGH LOW
% profit increase with sales Large Small
increase
LO-5
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Sensitivity Analysis
LO-5
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