MARGINAL COSTING: CVP-BEP

Analysis
Profit planning and Short-term decision making
COST-VOLUME-PROFIT AND BREAK-
EVEN ANALYSIS DEFINED
 Cost-volume-profit (CVP)analysis, together with cost
behavior information, helps managers perform many
useful analyses.
 CVP analysis deals with how PROFIT and COSTS
change with a change in VOLUME.
 More specifically, it looks at the effects on profits of
changes in such factors as :

• VARIABLE COSTS,
• FIXED COSTS,
• SELLING PRICES, Profit/(loss)
• VOLUME, AND
• MIX OF
PRODUCTS SOLD.
 By studying the relationships among costs, sales, and net
income, management is better able to cope with many
planning decisions.
 Break-even analysis, is branch of CVP analysis, determines
the break-even sales, which is the level of sales at which
TOTAL COST ‘EQUAL’ TOTAL REVENUE.
QUESTIONS ANSWERED BY CVP
ANALYSIS
 CVP analysis tries to answer the following questions:
 (a) What sales volume is required to break even?
 (b) What sales volume is necessary in order to earn a desired
profit?
 (c) What profit can be expected on a given sales volume?
 (d) How would changes in selling price, variable costs, fixed
costs, and output affect profits?
 (e) How would a change in the mix of products sold affect the
break-even and target income volume and profit potential?
CONCEPT OF CONTRIBUTION MARGIN
 For accurate CVP analysis, a distinction must be
made between costs as being either variable or
fixed.
 Semivariable costs (or mixed costs) must be separated
into their variable and fixed components, which were
discussed in the previous class.
 In order to compute the break-even point and perform
various CVP analyses, note the following important
concepts:
 1. Contribution margin (CM). The contribution
margin is the excess of sales (S) over the variable costs
(VC) of the product. It is the amount of money available
to cover fixed costs (FC) and to generate profits.
 Symbolically, CM = S – VC
 2. Unit CM. The unit CM is the excess of the unit selling
rice ( p ) over the unit variable cost (u).
 Symbolically, unit CM = p – u
 3. CM ratio. The CM ratio is the contribution margin as
a percentage of sales, i.e.,
 CM ratio = CM/S = (S – VC)/S = 1 – VC/S
 The CM ratio can also be computed using per-unit
data as follows:
Unit CM p  v v
CM Ratio    1
p p p
 Note that the CM ratio is 1minus the variable cost ratio.
 For example, if variable costs account for 70 percent of the
price, the CM ratio is 30 percent.
 To illustrate the various concepts of CM, consider the
following data for Company Z:
 Sales Price $25,
 Variable costs $10,
 Units Sold 1,500,
 Fixed Costs $15,000

Per Unit Total Perentage

Sales (1,500 units) $25 $37,500 100%
Less:Variable costs -10 15,000 40
Contribution margin $15 $22,500 60%
Less: Fixed costs 15,000
Net income $7,500
 From the data listed above, CM, unit CM, and the
CM ratio are computed as:
 CM = S -VC = $37,500 - $15,000 = $22,500
 Unit CM =p - u = $25 - $10 = $15
 CM ratio = CM/S=$22,500/$37,500 = 60% or
 CM Ratio = 1- VC/S = 1- 0.4 = 0.60 or 60%
BREAK-EVEN ANALYSIS
 The break-even point, the point of no profit and no loss,
provides managers with insights into Profit planning. It
can be computed in three different ways:
 1. The equation approach
 2. The contribution approach
 3. The graphical approach
1. The equation approach
 The equation approach is based on the cost-volume
equation, which shows the relationships among sales,
variable and fixed costs, and net income:
 S = VC +FC +Net income
 At the break-even volume, S = VC + FC +0.
 Defining x = volume in units, the above relationship can be
rewritten in terms of x:
 px = ux +FC
 To find the break-even point in units, simply solve the
equation for x.
 In previous problem, p = $25, U = $10, and FC =
$15,000.Thus, the equation is :
 $ 25x = $10x+ $15,000
 $ 25x -$10x= $15,000
 ($25 -$10)x= $15,000
 $ 15x = $15,000
 x = 15,000/15 = 1000 units
 Therefore, Company Z breaks even at a sales volume of
1,000 units
2. The contribution approach
 The contribution margin approach, another technique for
computing the break-even point, is based on solving the
cost-volume equation.
 Solving the equation px = ux + FC for x yields
FC
xBE 
pv

 Where p - v is the unit CM by definition, and xBE = break-

even unit sales volume.

Fixed Costs
Break - even point in units 
Unit CM
 If the break-even point is desired in terms of dollars, then
 Break-even point in dollars = Break-even point in units X
Unit sales price or, alternatively,

Fixed Costs
Break - even point in dollars 
CM Ratio
 Using the same data given in previous problem,
where: unit CM = $25 - $10 = $15 and the CM ratio
= 60%, we get:
 Break-even point in units =$15,000/$15 = 1,OOO units
 Break-even point in dollars = 1,000 units X $25 =
$25,000
 or, alternatively, $15,000/0.60 = $25,000
3. The graphical approach
 The graphical approach is based on the so-called break-
even chart as shown in Fig. 1.
 SALES REVENUE,
 VARIABLE COSTS, AND
 FIXED COSTS
 are plotted on the vertical axis, while volume, x, is
plotted on the horizontal axis.
 The break-even point is the point where the TOTAL SALES
REVENUE line intersects the TOTAL COST LINE.
Fig. 1 Break-even chart.
Profit-volume (P-V)chart
 The chart can also effectively report profit potentials
over a wide range of activity.
 The profit-volume (P-V)chart, as shown in Fig. 2, focuses
more directly on how profits vary with changes in
volume. Profits are plotted on the vertical axis, while units of
output are shown on the horizontal axis. Note that the
slope of the chart is the unit CM.
Fig. 2 Profit-volume (P-V) chart
TARGET INCOME VOLUME AND MARGIN
OF SAFETY(MOS)
 DETERMINATION OF TARGET INCOME
VOLUME
 Besides being able to determine the break-even point, CVP
analysis determines the sales required to attain a particular
income level or target net income.
 There are two ways in which target net income can be
expressed:
 Case 1. As a specific dollar amount
 Case 2. As a percentage of sales
 Case 1. As a specific dollar amount: As a specific dollar
amount, the cost-volume equation specifying target net
income is
 px = ux + FC + Target income
 Solving the equation for x yields
FC  Target income
xTI 
p-v
 where xTI= sales volume required to achieve a given
target income
 In words, Target income sales volume = (Fixed costs + Target
income) / Unit CM
 Case2 Specifying target income as a percentage of sales,
the cost-volume equation
 px = ux + FC + %(px)
 Solving this for x yields:
FC
xTI 
 In words, p - v - %(p)

Fixed costs
Target income sales volume 
Unit CM - % of unit sales price
 Using the same data given in previous problem, assume
that Company Z wishes to attain:
 Case 1. A target income of $15,000 before tax
 Case 2. A target income of 20% of sales
In Case 1, target income sales volume (in units) required is
=$15,000 + $15,000 / $25 -$10
XTI = FC + Target income /P-u = 2,000 units

To prove:
Sales (2,000 units) $50,000
VC (2,000 units) -20,000
CM $30,000
FC -15000
Net income $15,000

In Case 2, the target income volume required is

$15,000 /$15 -(20%)($25)
=$15'000$15-$5
XTI =FC / p – v -%(p) =1,500 units

To prove:
Sales (1,500 units) $37,500 (100%)
VC (1,500 units) -15,000
CM $22,500 (60%)
FC -15,000
Net income $ 7,500 (20%)
IMPACT OF INCOME TAXES
 If target income is given on an after-tax basis, the target
income volume formula becomes

Fixed costs  [Target after tax income/(l - tax rate)]

Target income volume 
Unit CM
 Assume in previous example that Company Z wants to
achieve an after-tax income of $6,000. An income tax is
levied at 40 percent. Then,

Target income volume = $15,000 + [$6,000/(1-0.4)]/ $15

= $15,000 + $10,000/ $15
= 1,667 units
MARGIN OF SAFETY
 The margin of safety is a measure of difference between
the ACTUAL/Budgeted LEVEL OF SALES and the
BREAK-EVEN SALES. It is the amount by which sales
revenue may drop before losses begin, and is expressed as
a percentage of budgeted sales:
Budgeted sales - Break - even sale
Margin of safety 
Budgeted sales
 The margin of safety is often used as a MEASURE OF
RISK.
 The larger the ratio, the safer is the situation, since
there is less risk of reaching the break-even point.
 Assume that Company Z projects sales of $30,000 with a
break-even sales level of $25,000.The expected margin of
safety is
 $30,000 - $25,000 / $30,000 = 16.7%
Budgeted/ BEP MOS
Actual Sales($) Sales($) (%)

15,000 10,000 33.33

12,000 10,000 16.67

10,000 10,000 0.00

8,000 10,000 -25.00

6,000 10,000 -66.67

SOME APPLICATIONS OF CVP ANALYSIS
 The concepts of contribution margin have many
applications in Profit planning and Short-term
decision making.
 1. Recall from previous Example that Company Z has a
CM of 60 percent and fixed costs of $15,000 per period.
 Assume that the company expects sales to go up by $10,000
for the next period. How much will income increase?
 Using the CM concepts, we can quickly compute the
impact of a change in sales on profits. The formula for
computing the impact is :
 Change in net income
 = Dollar change in sales X CM ratio
 Thus, in this question,
 Increase in net income = $10,000 X 60% = $6,000
 Therefore, the income will go up by $6,000, assuming there is
no change in fixed costs.
 If we are given the change in sales in units instead of dollars,
then the formula becomes
 Change in net income
 = Change in unit sales X Unit CM
 2. What before-tax income is expected on sales of
$47,500?
 CM: $47,500 x 60% $28,500
 Less: Fixed costs 15,000
 Net income $13,500

The answer is the difference between the CM

and the fixed costs:
 3. Company Z is considering increasing the advertising
budget by $5,000, which would increase sales revenue by
$8,000. Should the advertising budget be increased?

Increase in CM: $8,000 X 60% $4,800

Increase in advertising 5,000
Decrease in net income ($200)

 The answer is no, since the increase in the CM is less

than the increased cost:
 4. Company Z’s sales manager is considering a $3,000
increase in sales salaries. What additional sales are
required to cover the higher cost?
 The increase in fixed cost must be matched by an equal
increase in CM:
 Increase in CM = Increase in fixed cost
 0.60 * sales = $3,000
 Sales = $5,000
 5. Consider the original data. Assume again that Company
Z is currently selling 1,500 units per period. In an effort
to increase sales, management is considering cutting its
unit price by $5 and increasing the advertising budget by
$1,000. If these two steps are taken, management feels
that unit sales will go up by 60 percent. Should the two
steps be taken?
 A $5 reduction in the selling price will cause the unit CM
to decrease from $15 to $10. Thus,
Proposed CM: 2,400 units X $10 $24,000
Present CM: 1,500 units X $15 22,500
Increase in CM $1,500
Increase in advertising outlay 1,000
Increase in net income $500

The answer, therefore, is yes.

 Alternatively, the same answer can be obtained by
developing comparative income statements in
contribution margin format:

Present Proposed
(1,500 units) (2,400 units) Difference
Sales $37,500 (@$25) $48,000 (@$20) $10,500
Less: Variable costs 15,000 24,000 9,000
CM $22,500 $24,000 $1,500
Less: Fixed costs 15,000 16,000 1,000
Net income $7,500 $8,000 $500
SALES MIX ANALYSIS
 Break-even and cost-volume-profit analysis requires some
additional computations and assumptions when a
company produces and sells more than one product.
 Different selling prices and different variable costs result
in different unit CM and CM ratios.
 As a result, break-even points vary with the relative proportions
of the products sold, called the sales mix.
 In break-even and CVP analysis, it is necessary to predetermine the
sales mix and then compute a weighted-average CM.
 It is also necessary to assume that the sales mix does not
change for a specified period.
  The break-even formula for the company as a whole is
Fixed costs
Companywid e break - even in units (or in dollars) 
Average unit CM (or average CM ratio)

Composite Break-even point (in Rs. or Dollar)

Total Fixed Cost

Composite P/V Ratio
Composite PV Ratio
Total Contributi on
*100
Total Sales
 Example 2: Assume that Company X has two
products with the following CM data:
A B
Selling price $15 $10
Variable cost 12 5
Unit CM $3 $5
Sales mix 60% 40%
Fixed costs $76,000

 The weighted-average unit CM = ($3) (0.6) + ($5) (0.4) =

$3.80. Therefore the company’s break-even point in units
is
 $76,000/$3.80 = 20,000 units
 Which Is Divided As Follows:
 A: 20,000 units X 60% = 12,000 units
 B: 20,000 units X 40% = 8,000
 = 20,000 units
 Example 3: Assume that Company Y produces and sells
three products with the following data:
A B C Total
Sales $30,000 $60,000 $10,000 $100,000
Sales mix 30% 60% 10% 100%
Less: VC 24,000 40,000 5,000 69,000
CM $6,000 $20,000 $5,000 $31,000
CM ratio 20% 331/3% 50% 31%
Total fixed costs are $18,600

 The CM ratio for Company Y is $31,000/$100,000 = 31

percent.
 Therefore the break-even point in dollars is
 $18,600/0.31 = $60,000
 which will be split in the mix ratio of 3:6:1 to give us the
following break-even points for the individual products A,
B, and C:
A: $60,000 X 30% = $18,000
B: $60,000 X 60% = 36,000
C: $60,000X 10% = 6,000
$60,000

 One of the most important assumptions underlying

CVP analysis in a multiproduct firm is that the sales mix
will not change during the planning period. If the sales mix
changes, the break-even point will also change.
 Assume that total sales from Example 3 remain unchanged at
$100,000 but that a shift is expected in mix from product B to
product C, as follows:
A B C Total
Sales $30,000 $30,000 $40,000 $100,000
Sales mix 30% 30% 40% 100%

Less: VC 24,000 20,000* 20,000** 64,000

CM $6,000 $10,000 $20,000 $36,000
CM ratio 20% 33 1/3% 50% 36%
*$20,000 = $30,000 X 66 2/3% (i.e. 1-33 1/3%).
**$20,000=$40000 x 50% (i.e. 1-50%)

 Note that the shift in sales mix toward the more profitable line C
has caused the CM ratio for the company as a whole to go up from
31 percent to 36 percent. The new break-even point is $18,600/0.36
= $51,667. The break-even dollar volume has decreased from
$60,000 to $51,667.
Example 4
The Tape Red Company has three major products, whose contribution margins
are shown below:
A B C
Sales price $15 $10 $8
Variable cost per unit 10 6 5
CM/unit $5 $4 $3
Total fixed costs are $100,000.
Compute (a) the break-even point in units in total and for each product if the
three products are sold in the proportions of 30,50, and 20
percent, and
(b) the break-even point in total and for each product if the sales mix
ratio changes to 50, 30, and 20 percent.
 (a) Average contribution margin per unit =
($5)(30%) + ($4)(50%) + ($3)(20%) = $4.10 per unit
 Company break-even point = 100000/4.10= 24,390 units
 which will be broken up, per product, into:
 A 30% X 24,390 units = 7,317 units
 B 50% X 24,390 units = 12,195 units
 C 20% X 24,390 units = 4,878 units

 (b) Average contribution margin per unit =

($5)(50%)+ ($4)(30 %) + ($3)(20%) = $4.30 per unit
 Company break-even point = 100000/4.30 = 23,256 units
 Individually,
 A 50% X 23,256 units = 11,628 units
 B 30% X 23,256 units = 6,977 units
 C 20% X 23,256 units = 4,651 units
BREAK-EVEN AND CVP ANALYSIS
ASSUMPTIONS
 The basic break-even and CVP models are subject to a
number of limiting assumptions:
 (a) The behavior of both sales revenue and expenses is linear
throughout the entire relevant range of activity.
 (b) All costs are classified as fixed or variable.
 (c) There is only one product or a constant sales mix.
 ( d ) Inventories do not change significantly from period to
period.
 (e) Volume is the only factor affecting variable costs.
MARGINAL COSTING/CPV imp formulas
 Statement of profit
Particulars Amount
Sales ***
Less:-Variable cost ***
Contribution ***
Less:- Fixed cost ***
Profit ***
1) Sales = Total cost + Profit = Variable cost + Fixed cost + Profit

2) Total Cost = Variable cost + Fixed cost

3) Variable cost = It changes directly in proportion with volume

4) Variable cost Ratio = {Variable cost / Sales} * 100

5) Sales – Variable cost = Fixed cost + Profit

 6) Contribution = Sales * P/V Ratio
 7) Profit Volume Ratio [P/V Ratio]:-
 {Contribution / Sales} * 100
 {Contribution per unit / Sales per unit} * 100
 {Change in profit / Change in sales} * 100
 {Change in contribution / Change in sales} * 100
 8) Break Even Point [BEP]:-
 Fixed cost / Contribution per unit [in units]
 Fixed cost / P/V Ratio [in value] or
 Fixed Cost * Sales value per unit / (Sales – Variable cost per
unit)
 9) Margin of safety [MOP]
 Actual sales – Break even sales
 Net profit / P/V Ratio
 Profit / Contribution per unit [In units]
 10) Sales unit at Desired profit = {Fixed cost +
Desired profit} / Cont. per unit
 11) Sales value for Desired Profit = {Fixed cost +
Desired profit} / P/V Ratio
 12) At BEP Contribution = Fixed cost
 13) Variable cost Ratio = Change in total cost /Change in
total sales * 100
 Note :-
 1) When comparison of profitability of two products if P/V
Ratio of one product is greater than P/V Ratio of other
Product then it is more profitable.
 2) In case of Indifference point if
 Sales > Indifference point --- Select option with higher
fixed cost (or) select option with lower fixed cost.

Problem1
The following information pertains to the budget of Quality Products, Inc.,
for the next year: (in, 000)
Sales $50,000
Variable expenses 45,000
Fixed costs 3,000
Calculate the expected net income for each of the following independent
cases:
(a) 10 percent increase in sales volume
(b) 10 percent increase in fixed costs
(c) 10 percent decrease in sales volume
(d) 10 percent increase in variable expenses
(e) 15 percent increase in fixed costs and 15 percent decrease in variable
expenses
 (in, 000)
Sales Variable costs CM Fixed costs Net Income
(a) $55,000 $49,500 $5,500 $3,000 $2,500
(b) 50,000 45,000 5,000 3,300 1,700
(c) 45,000 40,500 4,500 3,000 1,500
(d) 50,000 49,500 500 3,000 -2,500
(e) 50,000 38,250 11,750 3,450 8,300
Problem 2
For each of the following cases, find the missing amounts:
Contribution
Sales in Sales in Variable Margin Fixed Net
Units Dollars Expenses per Unit costs Income
Case 1 5,000 $90,000 $40,000 $(a) $15,000 $(b)
Case 2 3,000 (c ) 4,000 3 (d) 2,000
Case 3 10,000 50,000 (e) (f) 20,000 5,000
 Unit CM = $90,000 -$40,000 /5,000 units = $10 per unit
a
Net income = $90,000 -$40,000 -$15,000 = $35,000
b
CM = 3,000 units X $3 = $9,000
c Sales -$4,000 = $9,000
Sales = $13,000

$13,000 -$4,000 -Fixed costs = $2,000

d Fixed costs = $7,000

$50,000 -Variable expenses -$20,000 = $5,000

e Variable expenses = $25,000

Unit CM = $50,000 -$25,000 /10,000 units = $2.50

f
Problem 3
The following information is given for Egele-Kamp, Inc.:
Unit sales price $10
Variable cost per unit 6
Total fixed costs 50,000
Determine the following:
(a) Contribution margin per unit
(b) Contribution margin ratio
(c) Break-even sales in units
(d) Break-even sales in dollars
(e) Sales in units required to achieve a net income of $4,000
(f) Sales in units required to achieve a net income of 15 percent of sales
a Contribution margin per unit = $I10 - $6 = $4

b Contribution margin ratio = 4/10 = 40%

c Break-even sales in units = 50000/4= 12,500 units

d Break-even sales in dollars = 12,500 units X $10 = $125,000

or, alternatively, 50,000/0.40 = 125000

e Target income sales in units = 50000+4000/4 = 13,500 units

f Target income sales in units = 50,000/4- 15%($10) = 50000/ 2.5 = 20,000 units
Problem 4
The following information is given for the Vendor Company
Fixed costs $30,000 per period
Variable cost $5/unit
Selling price $8/unit
a Compute the break-even sales in units and in dollars.
b Calculate the margin of safety at the 12,000-unit level.
c Find the net income when sales are $120,000.
d Compute the sales in units required to produce a net income of $10,000.
e Calculate the sales in units required to produce a net income of 10% of
sales.
f Find the break-even in units if variable costs are increased by $1 per unit
and if total fixed costs are decreased by $5,000.
 a = 10,000 units
 Break-even point in dollars = 10,000 units X $8 = $80,000
 b = Margin of safety = 16.7%
 c = Sales $120,000
 Variable costs 75,000 (15,000 units @$5)
 CM $45,000
 Fixed costs 30,000
 Net income $ 15,000
 d = Target income volume = -$300000+ $10’000/ 8-5 =
13,333 units
 e =Target income volume = 30000/8-5-10%(8) /
=30000/2.2 = 13,636 units
 f = Break-even in units = 25000/8-6 = 12,500 units