CHAPTER

Cost-VolumeProfit
Analysis: A
Managerial
Planning Tool

Objectives
After studying this chapter, you should be able
to:
1. Determine the number of units that must be
sold to break even or earn a target profit.
2. Calculate the amount of revenue required to
break even or to earn a targeted profit.
3. Apply cost-volume-profit analysis in a
multiple-product setting.
4. Prepare a profit-volume graph and a costvolume-profit graph, and explain the meaning
of each.

Objectives
5. Explain the impact of risk, uncertainty, and
changing variables on cost-volume-profit
analysis.
6. Discuss the impact of activity-based costing
on cost-volume-profit analysis

Break-Even Point in Units

The break-even point is the point where total
revenue equals total cost, the point of zero profit.
The firms initial decision in implementing a unitssold approach to CVP analysis is the
determination of just what a unit is.
A second decision centers on the separation of
costs into fixed and variable components. CVP
analysis focuses on the factors that effect a
change in the components of profits.

Using Operating Income in CVP Analysis

Narrative Equation

Sales revenue

Variable expenses
Fixed expenses

= Operating income

Using Operating Income in CVP Analysis

Sales (1,000 units @ $400)
Less: Variable expenses
Contribution margin

Less: Fixed expenses

Operating income

$400,000
325,000
$ 75,000

45,000
$ 30,000

Using Operating Income in CVP Analysis

Break Even in Units
0 = ($400 x Units) ($325 x Units) $45,000

$400,000
1,000

$325,000
1,000

Using Operating Income in CVP Analysis

Break Even in Units
0 = ($400 x Units) ($325 x Units) $45,000
0 = ($75 x Units) $45,000
$75 x Units = $45,000
Units = 600

Proof
Sales (600 units)
Less: Variable exp.
Contribution margin
Less: Fixed expenses
Operating income

$240,000
195,000
$ 45,000
45,000
$
0

Shortcut to Calculating Break-Even Units

Number of units = Fixed cost/Unit contribution margin
To calculate the break-even number of units for
Whitter Company, use the fundamental break-even
equation as follows :
Number of units = $45,000/($400-$325)
= $45,000/$75
= 600
Of course, the answer is identical to that computed
using the income statement,

Achieving a Targeted Profit

Desired Operating Income of $60,000
$60,000 = ($400 x Units) ($325 x Units) $45,000
$105,000 = $75 x Units
Units = 1,400
Proof
Sales (1,400 units)
Less: Variable exp.
Contribution margin
Less: Fixed expenses
Operating income

$560,000
455,000
$105,000
45,000
$ 60,000

Targeted Income as a Percent of Sales Revenue

Desired Operating Income of
15% of Sales Revenue
0.15($400)(Units) = ($400 x Units) ($325 x Units) $45,000

$60 x Units = ($400 x Units) $325 x Units) $45,000

$60 x Units = ($75 x Units) $45,000
$15 x Units = $45,000
Units = 3,000

After-Tax Profit Targets

Net income = Operating income Income taxes
= Operating income (Tax rate x Operating income)
= Operating income (1 Tax rate)
Or

Operating income =

Net income
(1 Tax rate)

After-Tax Profit Targets

If the tax rate is 35 percent and a firm wants
to achieve a profit of $48,750. How much is
the necessary operating income?
$48,750 = Operating income (0.35 x Operating income)
$48,750 = 0.65 (Operating income)
$75,000 = Operating income

After-Tax Profit Targets

How many units would have to be sold to
earn an operating income of $48,750?
Units = ($45,000 + $75,000)/$75
Units = $120,000/$75
Proof
Sales (1,600 units)
$640,000
Units = 1,600
Less: Variable exp.
520,000
Contribution margin
$120,000
Less: Fixed expenses
45,000
Operating income
$ 75,000
Less: Income tax (35%) 26,250
Net income
$ 48,750

Break-Even Point in Sales Dollars

EXHIBIT 16.1
$10
Contribution
margin
6
Revenue
Variable
cost

10

Unit

Break-Even Point in Sales Dollars

First, the contribution margin
ratio must be calculated.
Sales
Less: Variable
expenses
Contribution
margin
Less: Fixed exp.
Operating income

$400,000 100.00%
325,000

81.25%

$ 75,000 18.75%
45,000
$ 30,000

Break-Even Point in Sales Dollars

Given a contribution margin ratio of 18.75%, how
much sales revenue is required to break even?
Operating income = Sales Variable costs Fixed costs
$0 = Sales (Variable costs ratio x Sales)
$45,000
$0 = Sales (1 0.8125) $45,000
Sales (0.1875) = $45,000
Sales = $240,000

Relationships Among Contribution

Margin, Fixed Cost, and Profit
EXHIBIT 16.2

Fixed Cost = Contribution Margin

Fixed Cost
Contribution Margin

Revenue
Total Variable Cost

Relationships Among Contribution

Margin, Fixed Cost, and Profit
Fixed Cost < Contribution Margin
Fixed Cost
Contribution Margin

Revenue
Total Variable Cost

Profit

Relationships Among Contribution

Margin, Fixed Cost, and Profit
Fixed Cost > Contribution Margin
Fixed Cost
Contribution Margin

Revenue
Total Variable Cost

Loss

 If we multiply both sides of this equation by

price, the left-hand side will equal sales
revenue at break-even :
Break-even units X Price = Price X [ fixed cost/(Price unit variable
cost)]
break-even sales = Fixed cost X [(Price/(Price unit variable
cost)]
break-even sales = Fixed cost X (Price/Cpntribution margin)
break-even sales = Fixed cost /Contribution margin ration

Profit Targets and Sales Revenue

How much sales revenue must a firm generate to
earn a before-tax profit of $60,000. Recall that
fixed costs total $45,000 and the contribution
margin ratio is .1875.

Sales = ($45,000 + $60,000)/0.1875

= $105,000/0.1875
= $560,000