AFM CH 5

Chapter Five
Cost Volume Profit

(CVP) Analysis
Learning Objectives
Understand the Cost Behavior Concepts
Understand the concept of cost-volume-
profit (CVP) analysis.
Use of cost-volume-profit (CVP) analysis
to analyze decisions.
Use Understand the extension of CVP
model for:
Target net profit after tax
Product mix BEP
Summary of cost behavior
concept
What is CVP analysis?
• Cost-volume-profit analysis is the examination of
the relationships among selling prices, sales and
production volume, costs, expenses, and profits.
• Cost-volume-profit analysis is useful for
managerial decision making. Some of the ways
cost-volume-profit analysis may be used include:
• Analyzing the effects of changes in selling prices on
profits
• Analyzing the effects of changes in costs on profits
• Analyzing the effects of changes in volume on profits
• Setting selling prices
• Selecting the mix of products to sell
• Choosing among marketing strategies
Profit Equation
The Income Statement
Total revenues
– Total costs
= Operating profit
The Income Statement written horizontally

Operating profit = Total revenues – Total costs
Profit = TR – TC
Profit Equation
Total revenue (TR)
Average selling price per unit (P)
× Units of output produced and sold (Q)
TR = PQ
Total cost (TC)

[Variable cost per unit (V) × Units of output (Q)]
+ Fixed costs (F)
TC = VQ + F
Profit Equation
Profit = Total revenue – Total costs

= TR – TC
TC = VQ + F
Therefore, Profit = PQ – (VQ + F)
Profit = (Price – Variable costs) × Units of output – Fixed costs

= Q(P – V) – F
Contribution Margin
This is the difference between price and variable cost.
It is what is leftover to cover fixed costs and then add to

operating profit.
Contribution margin = Price per unit – Variable cost per unit
P–V
CVP Example
Contribution margin per unit = $2,880 ÷ 12,000 = $0.24

Break-Even Volume in Units
This is the volume level at which profits equal zero.
Profit 0 = Q(P – V) – F
If profit = 0, then Q = F ÷ (P – V)
Fixed costs
Break-even volume (in units) =
Unit contribution margin
= $1,500 ÷ $0.24
= 6,250 prints
Break-Even Volume in Sales Dollars
Contribution margin percentage (contribution

margin ratio) is the contribution margin as a
percentage of sales revenue.
Contribution Margin Percentage

$0.24 ÷ $0.60 = 0.40 (or 40%)
Break-even in Sales Dollars

$1,500 ÷ 0.40 = $3,750
Effect of change in equation item on
break even point
Target profit
Assume that management wants to have a
profit of $1,800.
How many prints must be sold?
What is the target dollar sales?
Target Volume in Units

($1,500 + $1,800) ÷ $0.24 = 13,750
Target Volume in Sales Dollars

($1,500 + $1,800) ÷ 0.40 = $8,250
CVP Summary: Break-Even
Break-even volume Fixed costs
(units) =
Break-even volume Fixed costs

=
(sales dollars) Contribution margin ratio
CVP Summary: Target Volume
Target volume Fixed costs + Target profit
(units) =
Target volume Fixed costs + Target profit

=
(sales dollars) Contribution margin ratio
Graphic Presentation
Total cost
TC = $1,500 + $0.36X
$3,750
6,250 prints
Total revenue
TR = $0.60X
Margin of Safety
The excess of projected or actual sales volume over
break-even volume
or
The excess of projected or actual sales revenue over
break-even revenue
Suppose U-Develop sells 8,000 prints.

At a break-even volume of 6,250, its margin of
safety is:
Sales – Break-even
8,000 – 6,250 = 1,750 prints
Extensions of the CVP Model:
Income Taxes
The owners of U-Develop want to generate after-tax

operating profits of $1,800.
The tax rate is 25%.
What is the target operating profit?

Target operating profit = TOP ÷ (1 – Tax rate)
TOP = $1,800 ÷ (1 – 0.25)
TOP = $2,400
Income Taxes
How many units must be sold?
Fixed costs + [Target profit ÷ (1 – Tax rate)]

($1,500 + $2,400)
= 16,250 prints
$0.24
Income Taxes
Proof:
Sales: 16,250 × $0.60
Variable costs: 16,250 × $0.36 5,850
Contribution margin
Fixed costs
Net income before taxes $2,
Income taxes: $2,400 × 25%
Net income
Multiproduct Analysis
Management expects to sell 9 prints at $0.60 each
for every enlargement it sells 1 at $1.00.
Prints Enlargements
Selling price $0.60 $1.00
Less: Variable cost .36 .56
Contribution margin $0.24 $0.44
Total fixed costs = $1,820

What is the weighted-average contribution

margin of the mix?
(.90 × $0.24) + (.10 × $0.44) = $0.26
What is the break-even of the mix?
7,000 × 90% = 6,300 prints

7,000 × 10% = 700 enlargements
Total units = 7,000
$1,820 fixed costs ÷ $0.26 = 7,000 units
Break-even Sales in Dollars

6,300 prints × $0.60 = $3,780
700 enlargements × $1.00 = $ 700
Total dollars = $4,480
Weighted Average Revenue

(.90 × $0.60 for prints) + (.10 × $1.00 for enlargements) = $0.64
What is the weighted-average

contribution margin percentage?
$0.26 ÷ $0.64 = 40.625%
Weighted Average Revenue
(.90 × $0.60) + (.10 × $1.00 ) = $0.64 Information
from
previous
Weighted Average Contribution Margin slide.
$0.26 ÷ $0.64 = 40.625%
Break-even Sales in Dollars

$1,820 ÷ 0.40625 = $4,480
Exercise
Megan Company has fixed costs of $180,000. The unit
selling price, variable cost per unit, and contribution
margin per unit for the company’s two products are
provided below.
Product Selling price per Variable cost per
unit Unit
X 160 100
Z 100 80
• The sales mix for products Q and Z is 75% and 25%,

respectively.
• Required: Determine the break-even point in units of
Q and Z.
End of Chapter 5

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Chapter Five

Cost Volume Profit

The Income Statement written horizontally

Total cost (TC)

Profit = Total revenue – Total costs

Therefore, Profit = PQ – (VQ + F)

Profit = (Price – Variable costs) × Units of output – Fixed costs

It is what is leftover to cover fixed costs and then add to

Contribution margin = Price per unit – Variable cost per unit

Contribution margin per unit = $2,880 ÷ 12,000 = $0.24

Contribution margin percentage (contribution

Contribution Margin Percentage

Break-even in Sales Dollars

Target Volume in Units

Target Volume in Sales Dollars

Break-even volume Fixed costs

Target volume Fixed costs + Target profit

Suppose U-Develop sells 8,000 prints.

The owners of U-Develop want to generate after-tax

The tax rate is 25%.

What is the target operating profit?

Fixed costs + [Target profit ÷ (1 – Tax rate)]

Total fixed costs = $1,820

What is the weighted-average contribution

7,000 × 90% = 6,300 prints

$1,820 fixed costs ÷ $0.26 = 7,000 units

Break-even Sales in Dollars

Weighted Average Revenue

What is the weighted-average

Break-even Sales in Dollars

• The sales mix for products Q and Z is 75% and 25%,

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