8-1

8 Chapter Eight

Cost-Volume-Profit
Analysis

McGraw-Hill/Irwin
 8-2

The Break-Even Point

The break-even point is the point in the volume of
activity where the organization’s revenues and
expenses are equal.

Sales
Sales $$250,000
250,000
Less:
Less: variable
variable expenses
expenses 150,000
150,000
Contribution
Contribution margin
margin 100,000
100,000
Less:
Less: fixed
fixed expenses
expenses 100,000
100,000
Net
Net income
income $$ --

McGraw-Hill/Irwin
 8-3

Contribution-Margin Approach
Consider the following information developed
by the accountant at Curl, Inc.:

Total
Total Per
Per Unit
Unit Percent
Percent
Sales
Sales(500
(500surf
surfboards)
boards) $$250,000
250,000 $$ 500500 100%
100%
Less:
Less: variable
variableexpenses
expenses 150,000
150,000 300
300 60%
60%
Contribution
Contributionmargin
margin $$100,000
100,000 $$ 200200 40%
40%
Less:
Less: fixed
fixedexpenses
expenses 80,000
80,000
Net
Net income
income $$ 20,000
20,000

McGraw-Hill/Irwin
 8-4

Contribution-Margin Approach
For each additional surf board sold, Curl
generates $200 in contribution margin.

Total
Total Per
Per Unit
Unit Percent
Percent
Sales
Sales(500
(500surf
surfboards)
boards) $$250,000
250,000 $$ 500500 100%
100%
Less:
Less: variable
variableexpenses
expenses 150,000
150,000 300
300 60%
60%
Contribution
Contributionmargin
margin $$100,000
100,000 $$ 200200 40%
40%
Less:
Less: fixed
fixedexpenses
expenses 80,000
80,000
Net
Net income
income $$ 20,000
20,000

McGraw-Hill/Irwin
 8-5

Contribution-Margin Approach
Fixed expenses Break-even point
=
Unit contribution margin (in units)

Total
Total Per
PerUnit
Unit Percent
Percent
Sales
Sales(500
(500surf
surfboards)
boards) $$250,000
250,000 $$ 500
500 100%
100%
Less: variable expenses
Less: variable expenses 150,000
150,000 300
300 60%
60%
Contribution
Contributionmargin
margin $$100,000
100,000 $$ 200
200 40%
40%
Less:
Less:fixed
fixedexpenses
expenses 80,000
80,000
Net
Netincome
income $$ 20,000
20,000

$80,000
= 400 surf boards
$200
McGraw-Hill/Irwin
 8-6

Contribution-Margin Approach
Here is the proof!

Total
Total Per
Per Unit
Unit Percent
Percent
Sales
Sales(400
(400surf
surfboards)
boards) $$200,000
200,000 $$ 500500 100%
100%
Less:
Less: variable
variableexpenses
expenses 120,000
120,000 300
300 60%
60%
Contribution
Contributionmargin
margin $$ 80,000
80,000 $$ 200200 40%
40%
Less:
Less: fixed
fixedexpenses
expenses 80,000
80,000
Net
Net income
income $$ --

400 × $500 = $200,000 400 × $300 = $120,000

McGraw-Hill/Irwin
 8-7

Contribution Margin Ratio

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

Contribution margin
= CM Ratio
Sales

Fixed expense Break-even point

=
CM Ratio (in sales dollars)

McGraw-Hill/Irwin
 8-8

Contribution Margin Ratio

Total
Total Per
Per Unit
Unit Percent
Percent
Sales
Sales(400
(400surf
surfboards)
boards) $$200,000
200,000 $$ 500500 100%
100%
Less:
Less: variable
variableexpenses
expenses 120,000
120,000 300
300 60%
60%
Contribution
Contributionmargin
margin $$ 80,000
80,000 $$ 200200 40%
40%
Less:
Less: fixed
fixedexpenses
expenses 80,000
80,000
Net
Net income
income $$ --

$80,000
= $200,000 sales
40%

McGraw-Hill/Irwin
 8-9

Equation Approach
Sales revenue – Variable expenses – Fixed expenses = Profit

Unit Sales Unit Sales

sales × volume variable × volume
price in units expense in units

($500 × X) – ($300 × X) – $80,000 = $0

($200X) – $80,000 = $0
X = 400 surf boards
McGraw-Hill/Irwin
 8-10

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.:

McGraw-Hill/Irwin
 8-11

Cost-Volume-Profit Graph
Break-even Total sales
point
rea
f it a
o
Sales in Dollars

Pr
Total expenses

Fixed expenses
r ea
s sa
Lo

McGraw-Hill/Irwin Units Sold

 8-12

Profit-Volume Graph
Some
Some managers
managers likelike the
the profit-volume
profit-volume
graph
graph because
because itit focuses
focuses on
on profits
profits and
and volume.
volume.

rea
f it a
o
Pr
Profit

rea
s a
o s Break-even
L
point
1 2 3 4 5 6 7 8
Units sold (00s)
McGraw-Hill/Irwin
 8-13

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.

Fixed expenses + Target profit Units sold to earn

=
Unit contribution margin the target profit

$80,000 + $100,000
= 900 surf boards
$200

McGraw-Hill/Irwin
 8-14

Equation Approach
Sales revenue – Variable expenses – Fixed expenses = Profit

($500 × X) – ($300 × X) – $80,000 = $100,000

($200X) = $180,000

X = 900 surf boards

McGraw-Hill/Irwin
 8-15

Applying CVP Analysis

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

McGraw-Hill/Irwin
 8-16

Safety Margin
Curl, Inc. has a break-even point of $200,000. If
actual sales are $250,000, the safety margin is
$50,000 or 100 surf boards.

McGraw-Hill/Irwin
 8-17

Changes in Fixed Costs

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

 Should
Should we
we authorize
authorize the
the requested
requested increase
increase in
in
the
the advertising
advertising budget?
budget?

McGraw-Hill/Irwin
 8-18

Changes in Fixed Costs

540
540 units
units ×× $500
$500 per
per unit
unit == $270,000
$270,000

$80,000
$80,000 ++ $10,000
$10,000 advertising
advertising == $90,000
$90,000
McGraw-Hill/Irwin
 8-19

Changes in Fixed Costs

Sales
Sales will
will increase
increase by
by
$20,000,
$20,000, but
but net
net income
income
decreased
decreased byby $2,000
$2,000..

McGraw-Hill/Irwin
 8-20

Changes in Unit
Contribution Margin
Because of increases in cost of raw materials,
Curl’s 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)

McGraw-Hill/Irwin
 8-21

Predicting Profit Given Expected

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

Fixed expenses
Given: Unit contribution margin Find: {expected profit}
Expected sales volume

McGraw-Hill/Irwin
 8-22

Predicting Profit Given

Expected Volume
In the coming year, Curl’s 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
McGraw-Hill/Irwin
 8-23

CVP Analysis with Multiple

Products
For a company with more than one product,
sales mix is the relative combination in which
a company’s products are sold.
Different products have different selling prices,
cost structures, and contribution margins.

Let’s assume Curl sells surf boards and sail

boards and see how we deal with break-
even analysis.

McGraw-Hill/Irwin
 8-24

CVP Analysis with Multiple

Products
Curl provides us with the following information:

McGraw-Hill/Irwin
 8-25

CVP Analysis with Multiple

Products
Weighted-average unit contribution margin

$200 × 62.5%

McGraw-Hill/Irwin
 8-26

CVP Analysis with Multiple

Products
Break-even point
Break-even Fixed expenses
=
point Weighted-average unit contribution margin

Break-even $170,000
=
point $331.25

Break-even
= 514 combined unit sales
point

McGraw-Hill/Irwin
 8-27

CVP Analysis with Multiple

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

McGraw-Hill/Irwin
 8-28

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
sales mix is constant.
 In manufacturing firms, inventories
do not change (units produced =
units sold).

McGraw-Hill/Irwin
 8-29

Cost Structure and Operating

Leverage
 The
The cost
cost structure
structure of
of an
an organization
organization is
is the
the
relative
relative proportion
proportion of
of its
its fixed
fixed and
and variable
variable
costs.
costs.
 Operating
Operating leverage
leverage is
is .. .. ..

 the
the extent
extent to
to which
which anan organization
organization uses
uses
fixed
fixed costs
costs in
in its
its cost
cost structure.
structure.
 greatest

greatest in
in companies
companies thatthat have
have aa high
high
proportion
proportion of
of fixed
fixed costs
costs in
in relation
relation to
to variable
variable
costs.
costs.

McGraw-Hill/Irwin
 8-30

Measuring Operating Leverage

Operating leverage Contribution margin
=
factor Net income

$100,000
= 5
$20,000
McGraw-Hill/Irwin
 8-31

Measuring Operating Leverage

A
A measure
measure of of how
how aa percentage
percentage changechange in
in
sales
sales will
will affect
affect profits.
profits. IfIf Curl
Curl increases
increases its
its
sales
sales by
by 10%,
10%, what
what will
will bebe the
the percentage
percentage
increase
increase inin net
net income?
income?

Percent increase in sales 10%

Operating leverage factor × 5
Percent increase in profits 50%

McGraw-Hill/Irwin
 8-32

CVP Analysis, Activity-Based Costing,

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

McGraw-Hill/Irwin
 8-33

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
respect to other cost drivers.

This is the fundamental distinction

between a traditional CVP analysis and an
activity-based costing CVP analysis.

McGraw-Hill/Irwin
 8-34

End of Chapter 8
We made
it!

McGraw-Hill/Irwin