Cost-Volume-Profit

Analysis
 Questions Addressed by
Cost-Volume-Profit Analysis

CVP analysis is used to answer questions

such as:
 How much must I sell to earn my desired income?
 How will income be affected
if I reduce selling prices to
increase sales volume?
 What will happen to
profitability if I expand
capacity?
 Total Fixed Cost
Total fixed costs remain unchanged
when activity changes.
Telephone Bill
Monthly Basic

Your monthly basic

telephone bill probably
does not change when
Number of Local Calls you make more local calls.
 Fixed Cost Per Unit
Fixed costs per unit decline
as activity increases.

Monthly Basic Telephone

Bill per Local Call
Your average cost per
local call decreases as
more local calls are made.
Number of Local Calls
 Total Variable Cost
Total variable costs change
when activity changes.
Total Long Distance
Telephone Bill

Your total long distance

telephone bill is based
on how many minutes
Minutes Talked you talk.
 Variable Cost Per Unit
Variable costs per unit do not change
as activity increases.

Telephone Charge
The cost per long distance Per Minute
minute talked is constant.
For example, 10
cents per minute. Minutes Talked
 Cost Behavior Summary

Summary of Variable and Fixed Cost Behavior

Cost In Total Per Unit

Changes as activity level Remains the same over wide

Variable
changes. ranges of activity.
Remains the same even Dereases as activity level
Fixed
when activity level changes. increases.
 Mixed Costs
Mixed costs contain a fixed portion that is
incurred even when facility is unused, and a
variable portion that increases with usage.
Example: monthly electric utility charge
 Fixed service fee
 Variable charge per
kilowatt hour used
 Mixed Costs
Slope is
variable cost
per unit
of activity.
Total Utility Cost

Variable
Utility Charge

Fixed Monthly
Utility Charge
Activity (Kilowatt Hours)
 Stair-Step Costs

Total cost remains

constant within a
narrow range of
activity.

Cost
Activity
 Stair-Step Costs
Total cost increases to a
new higher cost for the
next higher range of
activity.

Cost
Activity
 Curvilinear Costs
Curvilinear
Cost Function
Total Cost

A straight line
closely (constant
unit variable cost)
approximates a
Relevant Range curvilinear variable
cost line within
the relevant range.
Volume of Output
Cost-Volume-Profit
(CVP) Analysis

Let’s extend our

knowledge of
cost behavior to
CVP analysis.
 Computing Break-Even Point
The break-even point (expressed in units of
product or dollars of sales) is the unique
sales level at which a company neither
earns a profit nor incurs a loss.
 Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000

Contribution margin is amount by which revenue

exceeds the variable costs of producing the revenue.
 Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000

How much contribution margin must this company

have to cover its fixed costs (break even)?
 Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000

How much contribution margin must this company

have to cover its fixed costs (break even)?
Answer: $30,000
 Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000

How many units must this company sell to cover its

fixed costs (break even)?
 Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) $ 100,000 $ 50
Less: Variable costs 60,000 30
Contribution margin $ 40,000 $ 20
Less: Fixed costs 30,000
Operating income $ 10,000

How many units must this company sell to cover its

fixed costs (break even)?
Answer: $30,000 ÷ $20 per unit = 1,500 units
 Formula for Computing
Finding the Break-Even
Break-Even Point
Sales (in Units)
We have just seen one of the basic CVP
relationships – the break-even computation.

Fixed costs
Break-even point in units =
Contribution margin per unit

Unit sales price less unit variable cost

($20 in previous example)
 Formula for Computing
Break-Even Sales (in Dollars)
The break-even formula may also be
expressed in sales dollars.

Fixed costs
Break-even point in dollars =
Contribution margin ratio

Unit sales price

Unit variable cost
 Computing Break-Even Sales
Question 1
ABC Co. sells product XYZ at $5.00 per unit. If
fixed costs are $200,000 and variable costs are
$3.00 per unit, how many units must be sold to
break even?

a. 100,000 units
b. 40,000 units
c. 200,000 units
d. 66,667 units
 Computing Break-Even Sales
Question 1
ABC Co. sells product XYZ at $5.00 per unit. If
fixed costs are $200,000 and variable costs are
$3.00 per unit, how many units must be sold to
break even?

a. 100,000 units
b. 40,000 units
Unit contribution = $5.00 - $3.00 = $2.00
c. 200,000 unitsFixed costs $200,000
= $2.00 per unit
Unit
d. 66,667 units contribution
= 100,000 units
 Computing Break-Even Sales
Question 2
Use the contribution margin ratio formula to
determine the amount of sales revenue ABC must
have to break even. All information remains
unchanged: fixed costs are $200,000; unit sales
price is $5.00; and unit variable cost is $3.00.

a. $200,000
b. $300,000
c. $400,000
d. $500,000
 Computing Break-Even Sales
Question 2
Use the contribution margin ratio formula to
determine the amount of sales revenue ABC must
have to break even. All information remains
unchanged: fixed costs are $200,000; unit sales
price is $5.00; and unit variable cost is $3.00.
Unit contribution = $5.00 - $3.00 = $2.00
a. $200,000
Contribution margin ratio = $2.00 ÷ $5.00 = .40
b. $300,000
Break-even revenue = $200,000 ÷ .4 = $500,000
c. $400,000
d. $500,000
 Preparing a CVP Graph
 Starting at the origin, draw the total revenue
line with a slope equal to the unit sales price. Revenue
Costs and Revenue
in Dollars

 Total fixed cost

extends horizontally
from the vertical axis.

Total fixed cost

Volume in Units
 Preparing a CVP Graph
 Draw the total cost line with a slope
equal to the unit variable cost. Revenue
Costs and Revenue

Break-
Profit
even
in Dollars

Point
Total cost

Loss
Total fixed cost

Volume in Units
 Computing Sales Needed to
Achieve Target Operating Income
Break-even formulas may be adjusted to
show the sales volume needed to earn
any amount of operating income.

Fixed costs + Target income

Unit sales =
Contribution margin per unit

Fixed costs + Target income

Dollar sales =
Contribution margin ratio
 Computing Sales Needed to
Achieve Target Operating Income
ABC Co. sells product XYZ at $5.00 per unit. If
fixed costs are $200,000 and variable costs
are $3.00 per unit, how many units must be
sold to earn operating income of $40,000?

a. 100,000 units
b. 120,000 units
c. 80,000 units
d. 200,000 units
 Computing Sales Needed to
Achieve Target Operating Income
ABC Co. sells product XYZ at $5.00 per unit. If
fixed costs are $200,000 and variable costs
are $3.00 per unit, how many units must be
sold to earn operating income of $40,000?

Unit contribution = $5.00 - $3.00 = $2.00

a. 100,000 units
Fixed costs + Target income
b. 120,000 units Unit contribution
c. 80,000 units$200,000 + $40,000
= 120,000 units
d. 200,000 units $2.00 per unit
 What is our Margin of Safety?
Margin of safety is the amount by which sales may
decline before reaching break-even sales:

Margin of safety = Actual sales - Break-even sales

Margin of safety provides a quick means of

estimating operating income at any level of sales:

Operating Margin Contribution

Income = of safety × margin ratio
 What is our Margin of Safety?
Oxco’s contribution margin ratio is 40
percent. If sales are $100,000 and break-
even sales are $80,000, what is operating
income?

Operating Margin Contribution

Income = of safety × margin ratio

Operating
Income = $20,000 × .40 = $8,000
 What Change in Operating Income
Do We Anticipate?
Once break-even is reached, every additional dollar
of contribution margin becomes operating income:

Change in Change in Contribution

operating income = sales volume × margin ratio

Oxco expects sales to increase by $15,000. How

much will operating income increase?

Change in
operating income = $15,000 × .40 = $6,000
Business Applications of CVP
 Business Applications of CVP
Consider the following information
developed by the accountant at CyclCo, a
bicycle retailer:
Total Per Unit Percent
Sales (500 bikes) $ 250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $ 100,000 $ 200 40%
Less: fixed expenses 80,000
Operating income $ 20,000
 Business Applications of CVP
Should CyclCo spend $12,000 on
advertising to increase sales by 10 percent?

Total Per Unit Percent

Sales (500 bikes) $ 250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $ 100,000 $ 200 40%
Less: fixed expenses 80,000
Operating income $ 20,000
 Business Applications of CVP
Should CyclCo spend $12,000 on
advertising to increase sales by 10 percent?
500 550
550 × $500
Bikes Bikes
Sales $ 250,000 $ 275,000
Less: variable expenses 150,000 550 × $300 165,000
Contribution margin $ 100,000 $ 110,000
Less: fixed expenses 80,000 92,000
Operating income $ 20,000 $80K + $12K $ 18,000

No, income is decreased.

 Business Applications of CVP
Now, in combination with the advertising,
CyclCo is considering a 10 percent price reduction that will
increase sales by 25 percent. What is the income effect?
500
Bikes
Sales $ 250,000
Less: variable expenses 150,000
Contribution margin $ 100,000
Less: fixed expenses 80,000
Operating income $ 20,000
 Business Applications of CVP
Now, in combination with the advertising,
CyclCo is considering a 10 percent price reduction that will
increase sales by 25 percent. What is the income effect?
500 1.25 × 500 625
Bikes Bikes
Sales $ 250,000 625 × $450 $ 281,250
Less: variable expenses 150,000 187,500
Contribution margin $ 100,000 625 × $300 $ 93,750
Less: fixed expenses 80,000 92,000
Operating income $ 20,000 $80K + $12K $ 1,750

Income is decreased even more.

 Business Applications of CVP
Now, in combination with advertising and a price cut, CyclCo
will replace $50,000 in sales salaries with a $25 per bike
commission, increasing sales by 50 percent above the
original 500 bikes. What is the effect on income?
500
Bikes
Sales $ 250,000
Less: variable expenses 150,000
Contribution margin $ 100,000
Less: fixed expenses 80,000
Operating income $ 20,000
 Business Applications of CVP
Now, in combination with advertising and a price cut, CyclCo
will replace $50,000 in sales salaries with a $25 per bike
commission, increasing sales by 50 percent above the
original 500 bikes. What is the effect on income?
500 1.5 × 500 750
Bikes Bikes
Sales $ 250,000 750 × $450 $ 337,500
Less: variable expenses 150,000 243,750
Contribution margin $ 100,000 750 × $325 $ 93,750
Less: fixed expenses 80,000 42,000
Operating income $ 20,000 $92K - $50K $ 51,750

The combination of advertising, a price cut,

and change in compensation increases income.
Additional Considerations in CVP
 Different products with
different contribution margins.

 Determining semivariable
cost elements.

 Complying with the

assumptions of CVP analysis.
 CVP Analysis When a Company
Sells Many Products

Sales mix is the relative combination in which

a company’s different products are sold.
Different products have different selling
prices, costs, and contribution margins.
If CyclCo sells bikes and carts, how
will we deal with break-even analysis?
 CVP Analysis When a Company
Sells Many Products
CyclCo provides us with the following
information:
Bikes Carts Total
Sales $ 250,000 100% $ 300,000 100% $ 550,000 100%
Var. exp. 150,000 60% 135,000 45% 285,000 52%
Contrib. margin $ 100,000 40% $ 165,000 55% $ 265,000 48%
Fixed exp. 170,000
Net income $ 95,000
 CVP Analysis When a Company
Sells Many Products
The overall contribution margin ratio is:

Bikes Carts Total

Sales $ 250,000 100% $ 300,000 100% $ 550,000 100%
Var. exp. 150,000 60% 135,000 45% 285,000 52%
Contrib. margin $ 100,000 40% $ 165,000 55% $ 265,000 48%
Fixed exp. 170,000
Net income $ 95,000

$265,000
= 48% (rounded)
$550,000
 CVP Analysis When a Company
Sells Many Products
Break-even in sales dollars is:

Bikes Carts Total

Sales $ 250,000 100% $ 300,000 100% $ 550,000 100%
Var. exp. 150,000 60% 135,000 45% 285,000 52%
Contrib. margin $ 100,000 40% $ 165,000 55% $ 265,000 48%
Fixed exp. 170,000
Operating income $ 95,000

$170,000
= $354,167 (rounded)
.48
 The High-Low Method
OwlCo recorded the following production activity
and maintenance costs for two months:

Units Cost
High activity level 9,000 $ 9,700
Low activity level 5,000 6,100
Change 4,000 $ 3,600

Using these two levels of activity, compute:

 the variable cost per unit.
 the total fixed cost.
 total cost formula.
 The High-Low Method
Units Cost
High activity level 9,000 $ 9,700
Low activity level 5,000 6,100
Change 4,000 $ 3,600

 in cost $3,600
 Unit variable cost = in units = 4,000 = $0.90 per unit
 The High-Low Method
Units Cost
High activity level 9,000 $ 9,700
Low activity level 5,000 6,100
Change 4,000 $ 3,600

 in cost $3,600
 Unit variable cost = in units = 4,000 = $0.90 per unit
 Fixed cost = Total cost – Total variable cost
 The High-Low Method
Units Cost
High activity level 9,000 $ 9,700
Low activity level 5,000 6,100
Change 4,000 $ 3,600

 in cost $3,600
 Unit variable cost = in units = 4,000 = $0.90 per unit
 Fixed cost = Total cost – Total variable cost
Fixed cost = $9,700 – ($0.90 per unit × 9,000 units)
Fixed cost = $9,700 – $8,100 = $1,600
 The High-Low Method
Units Cost
High activity level 9,000 $ 9,700
Low activity level 5,000 6,100
Change 4,000 $ 3,600

 in cost $3,600
 Unit variable cost = in units = 4,000 = $0.90 per unit
 Fixed cost = Total cost – Total variable cost
Fixed cost = $9,700 – ($0.90 per unit × 9,000 units)
Fixed cost = $9,700 – $8,100 = $1,600
 Total cost = $1,600 + $.90 per unit
 The High-Low Method
Question 1
If sales commissions are $10,000 when 80,000 units
are sold and $14,000 when 120,000 units are sold,
what is the variable portion of sales commission per
unit sold?

a. $.08 per unit

b. $.10 per unit
c. $.12 per unit
d. $.125 per unit
 The High-Low Method
Question 1
If sales commissions are $10,000 when 80,000 units
are sold and $14,000 when 120,000 units are sold,
what is the variable portion of sales commission per
unit sold?
Units Cost
a. $.08 per unit High level 120,000 $ 14,000
Low level 80,000 10,000
b. $.10 per unit
Change 40,000 $ 4,000
c. $.12 per unit
d. $.125 per unit $4,000 ÷ 40,000 units
= $.10 per unit
 The High-Low Method
Question 2

If sales commissions are $10,000 when 80,000 units

are sold and $14,000 when 120,000 units are sold,
what is the fixed portion of the sales commission?

a. $ 2,000
b. $ 4,000
c. $10,000
d. $12,000
 The High-Low Method
Question 2

If sales commissions are $10,000 when 80,000 units

are sold and $14,000 when 120,000 units are sold,
what is the fixed portion of the sales commission?
Total cost = Total fixed cost +
Total variable cost
a. $ 2,000
$14,000 = Total fixed cost +
b. $ 4,000 ($.10 × 120,000 units)
c. $10,000 Total fixed cost = $14,000 - $12,000
d. $12,000 Total fixed cost = $2,000
 Assumptions Underlying
CVP Analysis
 A limited range of activity, called the relevant
range, where CVP relationships are linear.
Unit selling price remains constant.
Unit variable costs remain constant.
Total fixed costs remain constant.
 Sales mix remains constant.
 Production = sales (no inventory changes).
End of Chapter 19