Chapter 22

Cost-Volume-Profit Analysis
Objective 1
 Identify how changes in volume
affect costs.
 Types of
Costs

Variable

Fixed

Mixed
 Total Variable Cost
Total variable costs change
when activity changes.
Total Long Distance

Your total long distance

Telephone Bill

telephone bill is based

on how many minutes
you talk.

Minutes Talked
 Variable Cost Per Unit
Variable costs per unit do not change
as activity increases.
The cost per long

Telephone Charge
distance

Per Minute
minute talked is
constant.
For example, 10
cents per minute.

Minutes Talked
 Variable Costs
Example
Consider Grand Canyon Railway.
 Assume that breakfast costs Grand

Canyon Railway $3 per person.

 If the railroad carries 2,000

passengers, it will spend $6,000

for breakfast services.
 Variable Costs
Example
$24 –
$18 –
$12 –
$6 –
) s dnas uo ht(
ai r a Vl at o T

–
–

0 1 2 3 4 5
Volume
(Thousands of passengers)
 Total Fixed Cost
Total fixed costs remain unchanged
when activity changes.
Your monthly
basic
Telephone Bill
Monthly Basic

telephone bill
probably
does not change
when
you make more
Number of Local Calls local calls.
Mixed Costs
 Contain fixed portion that is incurred
even when facility is unused & variable
portion that increases with usage.
 Example: monthly electric utility
charge
 Fixed service fee
 Variable charge per kilowatt hour used
 Mixed Costs
Total Utility Cost

ost
d c Variable
i xe
l m Utility Charge
o ta
T
Fixed Monthly
Utility Charge
Activity (Kilowatt Hours)
Relevant Range...

…is a band of volume in which a

specific relationship exists between
cost and volume.
 Outside the relevant range, the cost

either increases or decreases.

 A fixed cost is fixed only within a

given relevant range and a given

time span.
 Relevant
Range
$160,000 –

$120,000 –
Relevant Range
$80,000 –
st s o C de xi F

$40,000
–

–
0 5,000 10,000 15,000 20,000 25,000
Volume in Units
Objective 2
 Use CVP analysis to compute
breakeven point.
Assumptions of CVP
Analysis
 Expenses can be classified as either
variable or fixed.
 CVP relationships are linear over a
wide range of production and sales.
 Sales prices, unit variable cost, and
total fixed expenses will not vary
within the relevant range.
Assumptions of CVP
Analysis
 Volume is the only cost driver.
 The relevant range of volume is
specified.
 Inventory levels will be unchanged.
 The sales mix remains unchanged
during the period.
Contribution Margin
Income Statement
Sales
- Variable Costs
Contribution Margin
- Fixed Costs
Operating Income
Contribution Margin
Example
 Luis and Tom manufacture a device
that allows users to take a closer look
at icebergs from a ship.
 The usual price for the device is
$100.
 Variable costs are $70 per unit.
 They receive a proposal from a
company in Newfoundland to sell
20,000 units at a price of $85.
Contribution Margin
Example
 There is sufficient capacity to
produce the order.
 How do we analyze this situation?
 $85 – $70 = $15 contribution
margin.
 $15 × 20,000 units = $300,000
(total increase in contribution
margin)
Contribution Margin
Income Statement
Sales (20,000 x $85) $1,700,000
Variable costs
(20,000 x $70) (1,400,000)
Contribution margin $300,000
 Computing Break-Even
Point

The unique sales level at which a

company earns neither a profit nor
incurs a loss.

Sales – Variable Costs – Fixed Costs = 0

 Breakeven Point Example

Let’s look back at Luis and Tom’s

manufacturing, assuming that the fixed
cost are $90,000.
Objective 3
 Use CVP analysis for profit
planning and graph the cost-
volume-profit relations
 Preparing a CVP Chart
➊ Plot total fixed costs on the vertical axis.
Costs and Revenue

Total fixed costs

in Dollars

Total costs

Draw the total cost line with a slope

equal to the unit variable cost.

Volume in Units
 Preparing a CVP Chart
Starting at the origin, draw the sales line Sales
with a slope equal to the unit sales price.
Costs and Revenue

Total fixed costs

in Dollars

Total costs

Break-even
Point

Volume in Units
Various Sales Levels
Example
 What operating income is
expected when sales are _____
units?
Target Operating Income
Example
 Suppose that our business would
be content with operating income
of _________________.
 How many units must be sold?
Objective 4
 Use CVP method to perform
sensitivity analysis.
Change in Sales Price
Example
 Suppose that the sales price per
device is _____ rather than ____
 What is the revised breakeven
sales in units?
Change in Variable Costs
Example
 Suppose that variable expenses
per device are ____ instead of ____
 Other factors remain unchanged.
Change in Fixed Costs
Example
 Suppose that fixed costs increased
by $30,000.
 What are the new fixed costs?
 What is the new breakeven point?
Margin of Safety Example

 Excess of expected sales over

breakeven sales.
 E22-7Atlanta Braves
$7,000
$6,000
(in thousands)

$5,000
$4,000
$3,000 rofi
t Revenues
$2,000 Break even in units = 1,200,000
P
Total Expense
Break
$1,000 even in s$ = 1,200,000 x 24 = $28,800,000
$- Los
- 50 100 150 200 250
(in thousands)

Break even point

Fixed expense
Effect of sales mix on CVP
analysis.
Computing Multiproduct
Break-Even Point
 Unit contribution margin is replaced
with contribution margin for a
composite unit.
 A composite unit is composed of
specific numbers of each product in
proportion to the product sales mix.
 Sales mix is the ratio of the volumes
of the various products.
 Computing Multiproduct
Break-Even Point
The resulting break-even formula
for composite unit sales is:

Break-even point Fixed costs

= Contribution margin
in composite units
per composite unit
 Computing Multiproduct
Break-Even Point
A company sells windows and doors.
They sell 4 windows for every door.

Windows Doors
Selling Price $200 $500
Variable Cost 125 350
Unit Contribution $ 75 $ 150
Sales Mix Ratio 4 1
 Computing Multiproduct
Break-Even Point
Step 1: Compute contribution margin per
composite unit.
Windows Doors
Selling Price $200 $500
Variable Cost 125 350
Unit Contribution $ 75 $ 150
Sales Mix Ratio
Composite C/M
Computing Multiproduct
Break-Even Point

Step 2: Compute break-even point in

composite units.

Break-even point = Fixed costs

in composite units Contribution margin
per composite unit
 Computing Multiproduct
Break-Even Point
Step 2: Compute break-even point in
composite units.
Break-even point Fixed costs
= Contribution margin
in composite units
per composite unit
$900,000
Break-even point =
in composite units $450 per composite
unit
Break-even point = 2,000 composite units
in composite units
 Computing Multiproduct
Break-Even Point

Step 3: Determine the number of windows and

doors that must be sold to break even.

Sales Composite
Product Mix Units Units
Window 4 × 2,000 = 8,000
Door 1 × 2,000 = 2,000
 Multiproduct Break-Even
Income Statement
Step 4: Verify the results.

W indow s Doors Com bine d

Se lling Price $200 $500
Va ria ble Cost 125.00 350.00
Unit Contribution $ 75.00 $ 150.00
Sa le s Volum e × 8,000 × 2,000
Tota l Contribution $ 600,000 $ 300,000 $ 900,000
Fix e d Costs 900,000
Incom e $ 0