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Chapter Eight
Cost-VolumeCost-Volume-Profit Analysis

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The Break-Even Point

The break-even point is the point in the volume of breakactivity where the organizations revenues and expenses are equal.
Sales $ 250,000 Less: variable expenses 150,000 Contribution margin 100,000 Less: fixed expenses 100,000 Net income $ -

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Contribution-Margin Approach
Consider the following information developed by the accountant at Curl, Inc.:
Sales (500 surf boards) Less: variable expenses Contribution margin Less: fixed expenses Net income Total $250,000 150,000 $100,000 80,000 $ 20,000 Per Unit $ 500 300 $ 200 Percent 100% 60% 40%

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Contribution-Margin Approach
For each additional surf board sold, Curl generates $200 in contribution margin.
Sales (500 surf boards) Less: variable expenses Contribution margin Less: fixed expenses Net income Total $250,000 150,000 $100,000 80,000 $ 20,000 Per Unit $ 500 300 $ 200 Percent 100% 60% 40%

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Contribution-Margin Approach
Fixed expenses Unit contribution margin BreakBreak-even point = (in units)
Per Unit $ 500 300 $ 200 Percent 100% 60% 40%

Sales (500 surf boards) Less: variable expenses Contribution margin Less: fixed expenses Net income

Total $250,000 150,000 $100,000 80,000 $ 20,000

$80,000 $200
McGraw-Hill/Irwin

= 400 surf boards

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Contribution-Margin Approach
Here is the proof!
Sales (400 surf boards) Less: variable expenses Contribution margin Less: fixed expenses Net income Total $200,000 120,000 $ 80,000 80,000 $ Per Unit $ 500 300 $ 200 Percent 100% 60% 40%

400 $500 = $200,000

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400 $300 = $120,000

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Contribution Margin Ratio

Calculate the break-even point in sales dollars rather breakthan units by using the contribution margin ratio.

Contribution margin Sales Fixed expense CM Ratio

= CM Ratio

BreakBreak-even point = (in sales dollars)

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Contribution Margin Ratio

Sales (400 surf boards) Less: variable expenses Contribution margin Less: fixed expenses Net income Total $200,000 120,000 $ 80,000 80,000 $ Per Unit $ 500 300 $ 200 Percent 100% 60% 40%

$80,000 40%
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$200,000 sales

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Equation Approach
Sales revenue Variable expenses Fixed expenses = Profit

Unit Sales sales volume price in units

Unit Sales variable volume expense in units

($500 X)

($300 X)

$80,000 = $0

($200X) $80,000 = $0 X) X = 400 surf boards

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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.:
Income 300 units Sales $ 150,000 Less: variable expenses 90,000 Contribution margin $ 60,000 Less: fixed expenses 80,000 Net income (loss) $ (20,000) Income 400 units $ 200,000 120,000 $ 80,000 80,000 $ Income 500 units $ 250,000 150,000 $ 100,000 80,000 $ 20,000

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Cost-Volume-Profit Graph
450,000 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 McGraw-Hill/Irwin

BreakBreak-even point

Total sales

Total expenses Fixed expenses

100

200

300

400

500

600

700

800

Units Sold

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Profit-Volume Graph
Some managers like the profit-volume profit$80,000 graph because it focuses on profits and volume.
$60,000 $40,000 $20,000 $$$(20,000) $(40,000) $(60,000) $(80,000) $(100,000)
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$100,000

$50

$100

$150

$200

$250

$300

$350

$400

Break-even point
1 2 3 4 5 6 7 8

Units sold (00s)

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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. approach.
Fixed expenses + Target profit Unit contribution margin = Units sold to earn the target profit

$80,000 + $100,000 $200

McGraw-Hill/Irwin

= 900 surf boards

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Equation Approach
Sales revenue Variable expenses Fixed expenses = Profit

($500 X)

($300 X) $80,000 = $100,000 ($200X) = $180,000 X) X = 900 surf boards

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Applying CVP Analysis

Safety Margin
The difference between budgeted sales revenue and break-even sales revenue. breakThe amount by which sales can drop before losses begin to be incurred.

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Safety Margin
Curl, Inc. has a break-even point of $200,000. If breakactual sales are $250,000, the safety margin is $50,000 or 100 surf boards.
Break-even sales 400 units $ 200,000 120,000 80,000 80,000 $ Actual sales 500 units $ 250,000 150,000 100,000 80,000 $ 20,000

Sales Less: variable expenses Contribution margin Less: fixed expenses Net income
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Changes in Fixed Costs

Curl is currently selling 500 surf boards per month. The owner believes that an increase of $10,000 in the monthly advertising budget, would increase bike sales to 540 units. Should we authorize the requested increase in the advertising budget?

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Changes in Fixed Costs

Current Sales (500 Boards) $ 250,000 150,000 $ 100,000 80,000 $ 20,000 Proposed Sales (540 Borads) $ 270,000 162,000 $ 108,000 90,000 $ 18,000

Sales Less: variable expenses Contribution margin Less: fixed expenses Net income

540 units $500 per unit = $270,000 $80,000 + $10,000 advertising = $90,000
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Changes in Fixed Costs

Sales will increase by $20,000, but net income decreased by $2,000. .
Current Sales (500 Boards) $ 250,000 150,000 $ 100,000 80,000 $ 20,000 Proposed Sales (540 Borads) $ 270,000 162,000 $ 108,000 90,000 $ 18,000

Sales Less: variable expenses Contribution margin Less: fixed expenses Net income

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Changes in Unit Contribution Margin

Because of increases in cost of raw materials, Curls variable cost per unit has increased from $300 to $310 per surf board. With no change in selling price per unit, what will be the new break-even point?

($500 X)

($310 X) $80,000 = $0 X = 422 units (rounded)

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Predicting Profit Given Expected Volume

Given: Fixed expenses Unit contribution margin Target net profit Find: {required sales volume}

Given:

Fixed expenses Unit contribution margin Expected sales volume

Find: {expected profit}

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Predicting Profit Given Expected Volume

In the coming year, Curls owner expects to sell 525 surfboards. The unit contribution margin is expected to be $190, and fixed costs are expected to increase to $90,000.
Total contribution Fixed cost = Profit

($190 525) $90,000 = X X = $99,750 $90,000 X = $9,750 profit

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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 surf boards and sail boards and see how we deal with breakbreakeven analysis.
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CVP Analysis with Multiple Products

Curl provides us with the following information:
Unit Unit Number Selling Variable Contribution of Price Cost Margin Boards $ 500 $ 300 $ 200 500 1,000 450 550 300 800
% of Total 62.5% (500 800) 37.5% (300 800) 100.0%

Description Surfboards Sailborads Total sold

Number Description of Boards Surfboards 500 Sailborads 300 Total sold 800
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CVP Analysis with Multiple Products

WeightedWeighted-average unit contribution margin
Contribution Weighted Margin Description % of Total Contribution Surfboards $ 200 62.5% $ 125.00 Sailborads 550 37.5% 206.25 Weighted-average contribution margin $ 331.25
$200 62.5%

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CVP Analysis with Multiple Products

BreakBreak-even point
Break-even Fixed expenses = point Weighted-average unit contribution margin Break-even = point $170,000 $331.25

Break-even = 514 combined unit sales point

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CVP Analysis with Multiple Products

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

Description Surfboards Sailborads Total units

Breakeven Sales 514 514

% of Individual Total Sales 62.5% 321 37.5% 193 514

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Assumptions Underlying CVP Analysis

Selling price is constant throughout the entire relevant range. Costs are linear over the relevant range. In multi-product companies, the multisales mix is constant. In manufacturing firms, inventories do not change (units produced = units sold).
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Cost Structure and Operating Leverage

The cost structure of an organization is the relative proportion of its fixed and variable costs. Operating leverage is . . .


the extent to which an organization uses fixed costs in its cost structure. greatest in companies that have a high proportion of fixed costs in relation to variable costs.

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Measuring Operating Leverage

Operating leverage factor = Contribution margin Net income
Actual sales 500 Board $ 250,000 150,000 100,000 80,000 $ 20,000

Sales Less: variable expenses Contribution margin Less: fixed expenses Net income

$100,000 $20,000
McGraw-Hill/Irwin

= 5

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Measuring Operating Leverage

A measure of how a percentage change in sales will affect profits. If Curl increases its sales by 10%, what will be the percentage increase in net income?

Percent increase in sales Operating leverage factor Percent increase in profits

McGraw-Hill/Irwin

10% 5 50%

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CVP Analysis, Activity-Based Costing, and Advanced Manufacturing Systems

An activity-based costing system can activityprovide a much more complete picture of cost-volumecost-volume-profit relationships and thus provide better information to managers. BreakBreak-even = Fixed costs point Unit contribution margin

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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 volume, drivers. respect to other cost drivers. This is the fundamental distinction between a traditional CVP analysis and an activityactivity-based costing CVP analysis.

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End of Chapter 8
We made it!

McGraw-Hill/Irwin