Cost-Volume-Profit Analysis

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 Learning Objective 1

Classify costs by their behavior as

variable costs, fixed costs, or mixed
costs.

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 Cost Behavior

• Cost behavior is the manner in which a cost

changes as a related activity changes.
• Costs are normally classified as variable costs, fixed
costs, or mixed costs

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 Cost Behavior: Variable Costs

Variable cost is a cost that varies, in total, in

direct proportion to changes in the level of
activity.

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 Cost Behavior: Variable Costs

Costs that vary in proportion to changes in the activity level.

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Cost Behavior: Variable Costs

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 Variable Costs and Their Activity Bases

Types of Business Cost Activity Base

University Instructor salaries Number of classes

Passenger airline Fuel Number of miles flown

Manufacturing Direct materials Number of units produced

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 Cost Behavior: Fixed Costs

Fixed cost is a cost that remains constant,

in total, regardless of changes in the level
of activity. Unlike variable cost.

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Cost Behavior: Fixed Costs

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Cost Behavior: Fixed Costs

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 Behavior of the Cost (within the relevant range)

Cost In Total Per Unit

Variable cost Total variable cost Viable cost per unit
increases and remains constant
decreases in
proportion to changes
in the activity level

Fixed cost Total fixed cost is not Fixed cost per unit
affected by changes in decreases as the
the activity level within activity level rises and
the relevant range increases as the
activity level falls
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 Cost Behavior: Mixed Costs

• Characteristics of both a variable and a fixed cost. They

are fixed over some range, but change per unit over a
different range.

• Also called semivariable or semifixed.

• The high-low method is used to identify fixed and

variable components.

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 High-Low Method

Total costs during

the last five
months.

Total cost at
highest and
lowest levels of
production.
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High-Low Method

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 Learning Objective 2

Compute the contribution margin, the

contribution margin ratio, and the unit
contribution margin, and explain how they
may be useful to managers.

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 Cost-Volume-Profit Analysis

• The systematic examination of the relationships among

selling prices, sales and production volume, costs, expenses,
and profits.
• Provides management with useful information for decision
making:
• Setting selling prices
• Selecting product mix
• Choosing marketing strategies
• Analyzing the effects of cost changes on profit

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 Contribution Margin

Contribution margin – identifies revenues available

to cover fixed costs and contribute to net income.

Contribution Margin =
Sales – Variable Costs

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Contribution Margin Income Statement

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 Contribution Margin Ratio

• Contribution margin ratio – percentage of each

sales dollar available to cover fixed costs and
provide income from operations.
• Measures the effect of an increase/decrease in
sales volume on income from operations.

Contribution Margin Ratio = Sales – Variable Costs

Sales

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 Contribution Margin Ratio

Sales $1,000,000
Variable Costs 600,000
Contribution Margin 400,000

CM Ratio = $1,000,000 – $600,000 = 40%

$1,000,000

An $80,000 increase in sales volume would

increase net income by $32,000.
($80,000 × 40%)
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 Contribution Margin Ratio

An $80,000 increase in sales would go 60% to variable

costs, 40% to contribution margin and income from
operations because fixed costs stay fixed.

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 Unit Contribution Margin

Useful when an increase/decrease in sales volume is

measured in units (not dollars).

Unit Contribution Margin =

Sales Price – Variable Cost per Unit

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 Unit Contribution Margin

Sales Price/Unit $20

Unit Variable Cost 12
Unit Contribution Margin $ 8

If sales could be increased by 15,000 units, net

income would increase by $120,000:

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 Learning Objective 3

Using the unit contribution margin, determine

the break-even point and the volume necessary
to achieve a target profit.

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 Break-Even Point

• Level of operations where revenues and costs are

the same.
• Useful in business planning, especially when
increasing or decreasing operations.

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 Break-Even Point

Sales Price/Unit $25

Unit Variable Cost 15
Unit Contribution Margin (UCM) $10
Fixed Costs = $90,000

Break-Even Sales (Units) = Fixed Costs

UCM

$90,000/$10 = 9,000 units needed to break even

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 Break-Even Point

$90,000/$10 = 9,000 units needed to break even

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Effect of Changes in Fixed Costs

There is a
direct
relationship
between
fixed costs
and break-
even units.

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 Effect of Changes in Fixed Costs

How would a $100,000

increase in fixed costs affect
the break-even sales units?

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 Effect of Changes in Fixed Costs

Unit Contribution Margin (UCM) = $20

Fixed Costs = $600,000

$600,000/$20 = 30,000 units needed to break even

Unit Contribution Margin (UCM) = $20

Fixed Costs = $700,000

$700,000/$20 = 35,000 units needed to break even

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Effect of Changes in Unit Variable Costs

There is a
direct
relationship
between unit
variable
costs and
break-even
units.
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Effect of Changes in Unit Variable Costs

How would an extra 2%

commission (increase in
variable cost per unit) affect
the break-even sales units?

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 Effect of Changes in Unit Variable Costs

Unit Contribution Margin (UCM) = 250-145 = $105

Fixed Costs = $840,000
$840,000/$105 = 8,000 units needed to break even

Unit Contribution Margin (UCM) = 250-150 = $100

Fixed Costs = $840,000

$840,000/$100 = 8,400 units needed to break even

When unit variable cost increases by $5, break-even units increases by 400.
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Effect of Changes in Unit Selling Price

There is an
inverse
relationship
between unit
selling price
and break-
even units.

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Effect of Changes in Unit Selling Price

How would a $10 price

increase affect the break-even
sales units?

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 Effect of Changes in Unit Selling Price

Unit Contribution Margin (UCM) = 50-30 = $20

Fixed Costs = $600,000
$600,000/$20 = 30,000 units needed to break even

Unit Contribution Margin (UCM) = 60-30 = $30

Fixed Costs = $600,000

$600,000/$30 = 20,000 units needed to break even

When unit selling price increases by $10, break-even units decreases by 10,000.
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 Target Profit

To find units needed to attain a certain target profit, add the

target profit to the fixed costs in the break-even formula.

Break-Even Sales (Units) = Fixed Costs + Target Profit

UCM

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 Calculating Target Profit

Sales Price/Unit $75

Unit Variable Cost 45
Unit Contribution Margin (UCM) $30
Fixed Costs = $200,000
Target Profit = $100,000
Target Profit Units = $200,000 + $100,000
$30
= 10,000 units

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 Income Statement

Sales (10,000 units x 75) 750,000

Variable Costs (10,000 units x 45) (450,000)
Contribution Margin (10,000 units x 30) 300,000
Fixed Costs 200,000
Operating income 100,000

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 Learning Objective 4

Using a cost-volume-profit chart and a profit-

volume chart, determine the break-even
point and the volume necessary to achieve a
target profit.

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 CVP (Break-Even) Chart

• Cost-volume-profit charts assist management in

understanding relationships among costs, sales, and
operating profit or loss.
• We’ll construct a CVP chart assuming:
• $50 selling price
• $30 unit variable cost
• $20 unit contribution margin
• $100,000 in fixed costs

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CVP (Break-Even) Chart

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CVP (Break-Even) Chart

When fixed costs

decrease by $20,000,
break-even decreases by
4,000 units ($200,000).

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 Learning Objective 5

Calculate the break-even point for a

business selling more than one
product.

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 Sales Mix Considerations

• Most businesses sell more than one product, and each

product contributes differently to overall profit.
• Sales mix is the relative distribution of sales among the
various products sold.
• The sales volume necessary to break even when more than
one product is sold depends on the sales mix.

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 Sales Mix

Assume Cascade Company sold 8,000 units of

Product A and 2,000 units of Product B last year.

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 Sales Mix

When computing the break-even point, the

individual products need to be combined to
represent one single product – Product E.

Assuming fixed costs are $200,000, 8,000 units of Product E

are needed to break even ($200,000/$25).
But how many of Products A and B does that mean?
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 Sales Mix

Product A: 8,000 × 80% = 6,400 units

Product B: 8,000 × 20% = 1,600 units

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 Summary

• Variable costs vary in proportion to changes in the level of

activity.
• Fixed costs remain the same in total dollar amount as the level of
activity changes
• Contribution margin is the excess of sales revenue over variable
costs and can be expressed as a ratio (contribution margin ratio)
or a dollar amount (unit contribution margin)
• The break-even point is the point at which a business’s revenues
exactly equal costs. The mathematical approach to cost-volume-
profit analysis uses the unit contribution margin concept and
mathematical equations to determine the break-even point and
the volume necessary to achieve target profit.

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 Summary

• Graphical methods can be used to determine the break-even

point and the volume necessary to achieve a target profit.
• A cost-volume-profit chart focuses on the relationship among
costs, sales, and operating profit or loss.

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In-class exercise

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