CORNERSTONES

of Managerial Accounting, 5e

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned,
 CHAPTER 4:
COST-VOLUME-PROFIT
ANALYSIS: A MANAGERIAL
PLANNING TOOL
Cornerstones of Managerial
Accounting, 5e

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Break-Even Point in Units and in
Sales Dollars
 Companies use CVP analysis to help them reach
important benchmarks, like breakeven point.
 The break-even point is the point where total
revenue equals total cost (i.e., the point of zero
profit).
 Also the level of sales at which contribution
margin just covers fixed costs and when
operating income is equal to zero.
Widya

LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Break-Even Point in Units and in
Sales Dollars (cont.)
 Since new companies typically experience losses
(negative operating income), they view their first
break-even period as a significant milestone.

Widya

LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Using Operating Income
in Cost-Volume-Profit Analysis
 For CVP analysis, it is useful to organize costs
into fixed and variable components.
 Below is the income statement format that is
based on the separation of costs into fixed and
variable components is called the contribution
margin income statement.

Widya

LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Using Operating Income
in Cost-Volume-Profit Analysis (cont.)
Direct Variable selling and
materials administrative costs
Direct labor

Variable
overhead

Fixed selling and

Fixed administrative costs
overhead
WidyaLO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Using Operating Income
in Cost-Volume-Profit Analysis
 Contribution margin is the difference between
sales and variable expense.
 The amount of sales revenue left over after all the
variable expenses are covered that can be used
to contribute to fixed expense and operating
income.

Widya

LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Using Operating Income in
Cost-Volume-Profit Analysis

Widya

LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Break-Even Point in Units
If the contribution margin income statement is
recast as an equation, it becomes more
useful for solving CVP problems.
Basic CVP
Equation

Fira LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Break-Even Point in Units (cont.)
 Break-even units are equal to the fixed cost
divided by the contribution margin per unit.

LO-1
Fira
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Break-Even Point
in Sales Dollars
Managers using CVP analysis may use sales revenue as the measure
of sales activity instead of units sold. A units sold measure can be
converted to a sales revenue measure by multiplying the unit selling
price by the units sold:

For example, the break-even point for Whittier is 600

mowers; the selling cost is $400 per mower.
Breakeven in Sales $’s = 600 x $400 = $240,000
LO-1
Fira
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Variable Cost Ratio and Contribution
Margin Ratio
Any answer expressed in units sold can be easily
converted to one expressed in sales revenues.

Alternatively:

LO-1
Fira
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Fixed Cost’s Relationship with
Variable Cost Contribution & Margin Ratios
 Since the total contribution margin is the revenue
remaining after total variable costs are covered, it
must be the revenue available to cover fixed
costs and contribute to profit.
 How does the relationship of fixed cost to
contribution margin affect operating income?

Fira LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Fixed Cost’s Relationship with
Variable Cost Contribution & Margin Ratios
 There are three possibilities:
 Fixed cost equals contribution margin; operating income
is zero; the company breaks even.
 Fixed cost is less than contribution margin; operating
income is greater than zero; the company makes a
profit.
 Fixed cost is greater than contribution margin; operating
income is less than zero; the company makes a loss.

Fira LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Units to Be Sold to
Achieve a Target Income
 While the break-even point is useful information
and an important benchmark for relatively young
companies, most companies would like to earn
operating income greater than $0.
 CVP allows us to do this by adding the target
income amount to the fixed cost.
 First, let’s look in terms of units that must be sold.

LO-2
Fauzaan
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Sales Revenue to
Achieve a Target Income
 How much sales revenue must Whittier generate
to earn an operating income of $37,500?
 This question is similar to the one we asked
earlier in terms of units but phrases the question
directly in terms of sales revenue.

LO-2
Fauzaan
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Sales Revenue to
Achieve a Target Income
 To answer the question, add the targeted
operating income of $37,500 to the $45,000 of
fixed cost and divide by the contribution margin
ratio. This equation is:

LO-2
Fauzaan
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Impact of Change in Revenue
on Change in Profit
 Assuming that fixed costs remain unchanged, the
contribution margin ratio can find the profit impact
of a change in sales revenue.
 To obtain the total change in profits from a
change in revenues, multiply the contribution
margin ratio times the change in sales:
Change Contribution Change
in = Margin x in
Profits Ratio Sales
LO-2
Fauzaan
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Graphs of Cost-Volume-Profit
Relationships: The Profit-Volume Graph
 A profit-volume graph visually portrays the
relationship between profits (operating income)
and units sold.
 The profit-volume graph is the graph of the
operating income equation:
Operating income = (Price x Units) –
(Unit variable cost x Units) – Total fixed cost
 In the following graph, operating income is the
dependent variable, and units is the independent
variable. LO-3
Fauzaan
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Graphs of Cost-Volume-Profit
Relationships: The Profit-Volume Graph

Fauzaan
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The Cost-Volume-Profit Graph
 The cost-volume-profit graph depicts the
relationships among cost, volume, and profits
(operating income).

EsterLO-3
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The Cost-Volume-Profit
Graph (cont.)

LO-3
Ester
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
CVP Analysis Assumptions
Major assumptions of CVP analysis include:
1 2
Linear revenue and cost
Selling prices and costs
functions remain
are known with
constant over the
certainty.
relevant range.

3 4
Sales mix is known with
All units produced are
certainty for multiple-
sold; no finished goods
product break-even
inventories remain.
settings. LO-3
Ester
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Multiple-Product Analysis
 Cost-volume-profit analysis is simple in the
single-product setting. However, most firms
produce and sell a number of products or
services.
 How do we adapt the formulas used in a single-
product setting to a multiple-product setting?

EsterLO-4
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Multiple-Product Analysis (cont.)
 One important distinction is to separate direct
fixed expenses from common fixed expenses.
 Direct fixed expenses are those fixed costs that can
be traced to each segment and would be avoided if the
segment did not exist.
 Common fixed expenses are the fixed costs that are
not traceable to the segments and would remain even if
one of the segments was eliminated.

EsterLO-4
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Break-Even Calculations
for Multiple Products
 When more than one product is produced and
sold, managers must estimate the sales mix and
calculate a package contribution margin.
 Sales mix is the relative combination of products
being sold by a firm.

EsterLO-4
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Cost-Volume-Profit Analysis and Risk and
Uncertainty
 Managers must be aware of so many factors in
our dynamic world. CVP analysis is a tool that
managers use to handle risk and uncertainty.

EsterLO-5
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Methods to Deal with
Uncertainty and Risk
1. Management must realize the
uncertain nature of future prices,
costs, and quantities.
2. Management must assume a
breakeven “band” rather than a
breakeven point.

3. Managers should use sensitivity

or “what- if” analyses.

LO-5
Aye
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Margin of Safety
 The margin of safety is the units sold or the
revenue earned above the break-even volume.
 Example: If the break-even volume for a
company is 200 units and the company is
currently selling 500 units, the margin of safety in
units is:

Sales - Break-even units = 500 – 200 = 300 units

Aye LO-5
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Margin of Safety (cont.)
 If the break-even volume for a company is
$200,000 and the current revenues are $500,000,
the margin of safety in sales revenue is:
Revenue - Break-even volume = $500,000 –
200,000 = $300,000
 The margin of safety as a percentage of total
sales dollars can then be expressed as:
Margin of safety ÷ Revenues = $300,000 ÷
$500,000 = 60%
Aye LO-5
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Operating Leverage
 Operating leverage is the use of fixed costs to
extract higher percentage changes in profits as
sales activity changes.
 Measure of the proportion of fixed costs in a company’s
cost structure.
 Used as an indicator of how sensitive profit is to
changes in sales volume.

Aye LO-5
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Operating Leverage (cont.)
 The degree of operating leverage (DOL) can be
measured for a given level of sales by taking the
ratio of contribution margin to operating income
or:
Contribution margin ÷ Operating income

Aye LO-5
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Summary of Operating Leverage

Operating Leverage
HIGH LOW
% profit increase with sales Large Small
increase

% loss increase with sales Large Small

decrease

Aye LO-5
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Sensitivity Analysis

LO-5
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website for classroom use.