16 -1

CHAPTER Cost-Volume-
Profit
Analysis: A
Managerial
Planning Tool
 16 -2

Objectives
1. Determine the number
After of units
studying this that must be
sold to breakchapter,
even oryou
earnshould
a target profit.
2. Calculate the amount of to:
be able 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 cost-
volume-profit graph, and explain the meaning
of each.
 16 -3

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
 16 -4

Using Operating Income in CVP Analysis

Narrative Equation

Sales revenue
Variable expenses
Fixed expenses
= Operating income
 16 -5

Using Operating Income in CVP Analysis

Sales (1,000 units @ $400) $400,000

Less: Variable expenses 325,000
Contribution margin $ 75,000
Less: Fixed expenses 45,000
Operating income $ 30,000
 16 -6

Using Operating Income in CVP Analysis

Break Even in Units

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

$400,000 $325,000
1,000 1,000
 16 -7

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) $240,000
Less: Variable exp. 195,000
Contribution margin $ 45,000
Less: Fixed expenses 45,000
Operating income $ 0
 Break-Even Point Formula
BEP is the point where total revenue equals
total cost, the point of zero profit.
TR = TC
P.Q = FC + VC.Q
P.Q VC.Q = FC
(P-VC)Q = FC
Q = FC/(P-VC) BEP = FC/P-VC
P-VC = CM BEP = FC/CM

8
 Simple BEP Example
Fixed costs (F) = $45,000
Selling price per unit (P) =
$400
Variable cost per unit (V) =
$325
Tax rate = 40%

1. What is the break-

even point in units?
9
 Simple BEP Example
1.Let X = break-even point in units
X = FC/ (P-VC)
= 45,000 / (400-325)
= 45,000 / 75
= 600 units

2.Break-even point in sales dollars is:

600 x $400 or $240,000

This can be shown with a variable-costing

income statement.
10
 Variable-Costing Income
Statement
Sales (600 x $400) $240,000
Less: Variable costs (600 x $325) 195,000
Contribution margin $ 45,000
Less: Fixed costs 45,000
Profit before taxes $0
Less: Income taxes 0
Profit after taxes $ 0
=====

11
 Cost-Volume Profit Formula
TR = TC + Profit
P.Q = FC + VC.Q + Profit
P.Q VC.Q = FC + Profit
(P-VC)Q = FC + Profit
Q = FC + Profit/(P-VC)
CVP = (FC + Profit)/P-VC
P-VC = CM CVP = (FC + Profit)/CM

12
 Simple CVP Example
Fixed costs (F) =
$45,000
Selling price per unit (P)= $400
Variable cost per unit (V) = $325
Targeted profit =
$60,000

What sales in units and dollars are needed

to obtain targeted profit $ 60,000?
13
 CVP Example: Targeted Pretax
Income
What sales in units and dollars are needed to obtain a
targeted profit before taxes of $60,000?
Q = FC+ profit/ (P-VC)
= 45,000+60,000 / (400-325)
= 105,000 / 75
= 1,400 units
CVP in sales dollars is:
1,400 x $400 or $560,000
Check this by completing the variable-costing income statement.

14
 16 -15

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) $560,000
Less: Variable exp. 455,000
Contribution margin $105,000
Less: Fixed expenses 45,000
Operating income $ 60,000
 16 -16

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
 16 -17

After-Tax Profit Targets

Net income = Operating income Income taxes

= Operating income (Tax rate x Operating income)
= Operating income (1 Tax rate)

Or

Net income
Operating income =
(1 Tax rate)
 16 -18

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
 16 -19

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
Units = 1,600 Sales (1,600 units) $640,000
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
 16 -20

Break-Even Point in Sales Dollars

First, the contribution margin

ratio must be calculated.

Sales $400,000 100.00%

Less: Variable
expenses 325,000 81.25%
Contribution
margin $ 75,000 18.75%
Less: Fixed exp. 45,000
Operating income $ 30,000
 16 -21

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
 16 -22

Relationships Among Contribution

Margin, Fixed Cost, and Profit

Fixed Cost = Contribution Margin

Fixed Cost

Contribution Margin

Revenue
Total Variable Cost
 16 -23

Relationships Among Contribution

Margin, Fixed Cost, and Profit

Fixed Cost < Contribution Margin

Fixed Cost Profit

Contribution Margin

Revenue
Total Variable Cost
 16 -24

Relationships Among Contribution

Margin, Fixed Cost, and Profit

Fixed Cost > Contribution Margin

Fixed Cost Loss

Contribution Margin

Revenue
Total Variable Cost
 16 -25

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
 16 -26

Multiple-Product Analysis
Mulching Riding
Mower Mower Total
Sales $480,000 $640,000 $1,120,000
Less: Variable expenses 390,000 480,000 870,000
Contribution margin $ 90,000 $160,000 $ 250,000
Less: Direct fixed expenses 30,000 40,000 70,000
Product margin $ 60,000 $120,000 $ 180,000
Less: Common fixed expenses 26,250
Operating income $ 153,750
 16 -27

Income Statement: B/E Solution

Mulching Riding
Mower Mower Total
Sales $184,800 $246,400 $431,200
Less: Variable expenses 150,150 184,800 334,950
Contribution margin $ 34,650 $ 61,600 $ 96,250
Less: Direct fixed expenses 30,000 40,000 70,000
Segment margin $ 4,650 $ 23,600 $ 26,250
Less: Common fixed expenses 26,250
Operating income $ 0
 16 -28

The profit-volume graph portrays

the relationship between profits
and sales volume.
 16 -29

Example
The Tyson Company produces a single product
with the following cost and price data:
Total fixed costs $100
Variable costs per unit 5
Selling price per unit 10
 16 -30
Profit-Volume Graph
(40, $100)
I = $5X - $100
Profit $100
or Loss 80
60
40 Break-Even Point
(20, $0)
20
0 | | | | | | | | | |
5 10 15 20 25 30 35 40 45 50
- 20
Units Sold
- 40 Loss
-60
-80
-100 (0, -$100)
 16 -31

The cost-volume-profit graph

depicts the relationship among
costs, volume, and profits.
 16 -32

Cost-Volume-Profit Graph
Revenue
Total Revenue
$500 --
450 --
400 --
Total Cost
350 --
300 --
250 -- Variable Expenses
200 -- ($5 per unit)
Break-Even Point
150 --
(20, $200)
100 --
Loss
50 -- Fixed Expenses ($100)
0 -- | | | | | | | | | | | |
5 10 15 20 25 30 35 40 45 50 55 60
Units Sold
 16 -33

Assumptions of C-V-P Analysis

1. The analysis assumes a linear revenue function and a
linear cost function.
2. The analysis assumes that price, total fixed costs, and
unit variable costs can be accurately identified and
remain constant over the relevant range.
3. The analysis assumes that what is produced is sold.
4. For multiple-product analysis, the sales mix is assumed
to be known.
5. The selling price and costs are assumed to be known
with certainty.
 16 -34
Relevant Range
$

Total Revenue

Total Cost

Units
Relevant Range
Example Multiple
Product Analysis
Whittier Company has decide to
offer two models of lawn
mower: a mulching mower to
sell for $ 400 and riding mower
for $ 800. The expected mowers
can be sold are 1,200 unit
mulching mower and 800 units
riding mower. The projected
income statement shows as 35
follows:
 Whittier Company
Projected Income Statement
Mulching Riding Total
Sales $ 480,000 $ $1,120,00
640,000 0
Variable Expenses $ 390,000 $ $ 870,000
480,000
Contribution Margin $ 90,000 $ $250,000
160,000
Direct Fixed $ 30,000 40,000 $ 70,000
Expenses
Product Margin $ 60,000 120,000 $ 180,000
Common Fixed 26,250
Expenses
Operating Income $ 153,750
36
 BEP CALCULATION
BEP is calculated individually
Mulching mower:
BEP = FC/ (P-VC)
= 30,000 / (400-325)
= 45,000 / 75
= 400 units
Riding mower:
BEP = FC/ (P-VC)
= 40,000 / (800-600)
= 40,000 / 200
= 200 units

37
 Whittier Company
Income Statement
Mulching Riding Total

Sales $ 160,000 $ 160,000 $320,000

Variable Expenses $ 130,000 $ 120,000 $ 250,000

Contribution Margin $ 30,000 $ 40,000 $70,000

Direct Fixed Expenses $ 30,000 40,000 $ 70,000

Product Margin $0 0 $0

Common Fixed Expenses 26,250

Operating Income (Loss) ($ 26,250)

38
 Multiple-Product Example

ProductP - V = CM x Mix = Total CM

M $400 -$325 = $75 x 3

= $225
R 800 - 600 = 200 x 2
= 400Total CM per package
$625
===
Total fixed expenses = $96,250
39
 Multiple-Product Example
(continued)
Break-even point:
X = Fixed cost / Unit contribution margin
= $96,250 / $625
= 154 packages to break even
Each package contains 3 units of M and 2 units of R. Therefore,
to break even, we need to sell the following units of M and R:
M:3 x 154 = 462 units
R: 2 x 154 = 308 units

40
Alternative 1: If advertising expenditures increase by 16 -41
$8,000, sales will increase from 1,600 units to 1,725 units.
BEFORE THE WITH THE
INCREASED INCREASED
ADVERTISING ADVERTISING
Units sold 1,600 1,725
Unit contribution margin x $75 x $75
Total contribution margin $120,000 $129,375
Less: Fixed expenses 45,000 53,000
Profit $ 75,000 $ 76,375
DIFFERENCE IN PROFIT
Change in sales volume 125
Unit contribution margin x $75
Change in contribution margin $9,375
Less: Change in fixed expenses 8,000
Increase in profits $1,375
Alternative 2: A price decrease from $400 to $375 per 16 -42
lawn mower will increase sales from 1,600 units to 1,900
units.
BEFORE THE WITH THE
PROPOSED PROPOSED
CHANGES CHANGES
Units sold 1,600 1,900
Unit contribution margin x $75 x $50
Total contribution margin $120,000 $95,000
Less: Fixed expenses 45,000 45,000
Profit $ 75,000 $50,000

DIFFERENCE IN PROFIT

Change in contribution margin $ -25,000

Less: Change in fixed expenses --------
Decrease in profits $ -25,000
Alternative 3: Decreasing price to $375and increasing 16 -43
advertising expenditures by $8,000 will increase sales from
1,600 units to 2,600 units.
BEFORE THE WITH THE
PROPOSED PROPOSED
CHANGES CHANGES
Units sold 1,600 2,600
Unit contribution margin x $75 x $50
Total contribution margin $120,000 $130,000
Less: Fixed expenses 45,000 53,000
Profit $ 75,000 $ 77,000

DIFFERENCE IN PROFIT

Change in contribution margin $10,000

Less: Change in fixed expenses 8,000
Increase in profit $ 2,000
 16 -44

Margin of Safety
Assume that a company has the following projected
income statement:
Sales $100,000
Less: Variable expenses 60,000
Contribution margin $ 40,000
Less: Fixed expenses 30,000
Income before taxes $ 10,000
Break-even point in dollars (R):
R = $30,000 .4 = $75,000
Safety margin = $100,000 - $75,000 = $25,000
 16 -45

Degree of Operating Leverage (DOL)

DOL = $40,000/$10,000 = 4.0

Now suppose that sales are 25% higher than projected. What is
the percentage change in profits?

Percentage change in profits = DOL x percentage change in

sales
Percentage change in profits = 4.0 x 25% = 100%
 16 -46

Degree of Operating Leverage (DOL)

Proof:

Sales $125,000
Less: Variable expenses 75,000
Contribution margin $ 50,000
Less: Fixed expenses 30,000
Income before taxes $ 20,000
 16 -47

CVP and ABC

Assume the following:
Sales price per unit $15
Variable cost 5
Fixed costs (conventional) $180,000
Fixed costs (ABC) $100,000 with $80,000 subject to ABC analysis
Other Data:
Unit Level of
Variable Activity
Activity Driver Costs Driver
Setups $500 100
Inspections 50 600
 16 -48

CVP and ABC

1. What is the BEP under conventional

analysis?

BEP = $180,000 $10

= 18,000 units
 16 -49

CVP and ABC

2. What is the BEP under ABC analysis?

BEP = [$100,000 + (100 x $500) + (600 x

$50)]/$10
= 18,000 units
 16 -50

CVP and ABC

3. What is the BEP if setup cost could be reduced to

$450 and inspection cost reduced to $40?
BEP = [$100,000 + (100 x $450) + (600 x $40)]/$10
= 16,900 units
 16 -51

Chapter Sixteen

The End
16 -52