Cost-Volume-Profit Analysis

Chapter 22
Objective 1
Identify how changes in volume affect costs.
Variable
Fixed
Mixed
Types of Costs
Minutes Talked
T
o
t
a
l

L
o
n
g

D
i
s
t
a
n
c
e

T
e
l
e
p
h
o
n
e

B
i
l
l

Total variable costs change
when activity changes.
Your total long distance
telephone bill is based
on how many minutes
you talk.
Total Variable Cost
Minutes Talked
P
e
r

M
i
n
u
t
e

T
e
l
e
p
h
o
n
e

C
h
a
r
g
e

Variable Cost Per Unit
Variable costs per unit do not change
as activity increases.
The cost per long
distance
minute talked is
constant.
For example, 10
cents per minute.
Variable Costs Example
Consider Grand Canyon Railway.
Assume that breakfast costs Grand Canyon
Railway $3 per person.
If the railroad carries 2,000 passengers, it will
spend $6,000 for breakfast services.
Variable Costs Example
0 1 2 3 4 5
$24

$18

$12

$6

Volume
(Thousands of passengers)
T
o
t
a
l

V
a
r
i
a
b
l
e

C
o
s
t
s

(
t
h
o
u
s
a
n
d
s
)

Number of Local Calls
M
o
n
t
h
l
y

B
a
s
i
c

T
e
l
e
p
h
o
n
e

B
i
l
l

Total fixed costs remain unchanged
when activity changes.
Your monthly
basic
telephone bill
probably
does not change
when
you make more
local calls.
Total Fixed Cost
Mixed Costs
Contain fixed portion that is incurred even when
facility is unused & variable portion that increases
with usage.
Example: monthly electric utility charge
Fixed service fee
Variable charge per kilowatt hour used
Variable
Utility Charge
Activity (Kilowatt Hours)
T
o
t
a
l

U
t
i
l
i
t
y

C
o
s
t

Fixed Monthly
Utility Charge
Mixed Costs
Relevant Range...
is a band of volume in which a specific
relationship exists between cost and volume.
Outside the relevant range, the cost either
increases or decreases.
A fixed cost is fixed only within a given relevant
range and a given time span.
Relevant Range
F
i
x
e
d

C
o
s
t
s

Volume in Units
$160,000

$120,000

$80,000

$40,000
0 5,000 10,000 15,000 20,000 25,000

Relevant Range
Objective 2
Use CVP analysis to compute breakeven point.
Assumptions of CVP Analysis
Expenses can be classified as either variable or
fixed.
CVP relationships are linear over a wide range of
production and sales.
Sales prices, unit variable cost, and total fixed
expenses will not vary within the relevant range.
Assumptions of CVP Analysis
Volume is the only cost driver.
The relevant range of volume is specified.
Inventory levels will be unchanged.
The sales mix remains unchanged during the
period.
Contribution Margin Income
Statement
Sales
- Variable Costs
Contribution Margin
- Fixed Costs
Operating Income
Contribution Margin Example
Luis and Tom manufacture a device that allows
users to take a closer look at icebergs from a
ship.
The usual price for the device is $100.
Variable costs are $70 per unit.
They receive a proposal from a company in
Newfoundland to sell 20,000 units at a price of
$85.
Contribution Margin Example
There is sufficient capacity to produce the order.
How do we analyze this situation?
$85 $70 = $15 contribution margin.
$15 20,000 units = $300,000 (total increase in
contribution margin)
Contribution Margin Income
Statement
Sales (20,000 x $85) $1,700,000
Variable costs
(20,000 x $70) (1,400,000)
Contribution margin $300,000
Computing Break-Even Point
The unique sales level at which a
company earns neither a profit nor
incurs a loss.

Sales Variable Costs Fixed Costs = 0

Breakeven Point Example
Lets look back at Luis and Toms
manufacturing, assuming that the fixed cost
are $90,000.
Objective 3
Use CVP analysis for profit planning and graph
the cost-volume-profit relations
Volume in Units
C
o
s
t
s

a
n
d

R
e
v
e
n
u
e

i
n

D
o
l
l
a
r
s

Total fixed costs
Plot total fixed costs on the vertical axis.
Preparing a CVP Chart
Total costs
Draw the total cost line with a slope
equal to the unit variable cost.
Volume in Units
C
o
s
t
s

a
n
d

R
e
v
e
n
u
e

i
n

D
o
l
l
a
r
s

Total fixed costs
Preparing a CVP Chart
Total costs
Sales
Starting at the origin, draw the sales line
with a slope equal to the unit sales price.
Break-
even
Point
Various Sales Levels Example
What operating income is expected when sales
are _____ units?

Target Operating Income
Example
Suppose that our business would be content with
operating income of _________________.
How many units must be sold?

Objective 4
Use CVP method to perform sensitivity analysis.
Change in Sales Price Example
Suppose that the sales price per device is _____
rather than ____
What is the revised breakeven sales in units?

Change in Variable Costs
Example
Suppose that variable expenses per device are
____ instead of ____
Other factors remain unchanged.

Change in Fixed Costs Example
Suppose that fixed costs increased by $30,000.
What are the new fixed costs?
What is the new breakeven point?

Margin of Safety Example
Excess of expected sales over breakeven sales.

E22-7
Atlanta Braves
$-
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
$7,000
- 50 100 150 200 250
(in thousands)
(
i
n

t
h
o
u
s
a
n
d
s
)
Revenues
Total Expense
Fixed expense
Break even point
Break even in units = 1,200,000
Break even in $ = 1,200,000 x 24 = $28,800,000
Effect of sales mix on CVP
analysis.
Computing Multiproduct
Break-Even Point
Unit contribution margin is replaced with
contribution margin for a composite unit.
A composite unit is composed of specific numbers
of each product in proportion to the product sales
mix.
Sales mix is the ratio of the volumes of the
various products.
Computing Multiproduct
Break-Even Point
The resulting break-even formula
for composite unit sales is:
Break-even point
in composite units
Fixed costs
Contribution margin
per composite unit
=

Windows Doors
Selling Price $200 $500
Variable Cost 125 350
Unit Contribution 75 $ 150 $
Sales Mix Ratio 4 1
Computing Multiproduct
Break-Even Point
A company sells windows and doors. They sell
4 windows for every door.
Step 1: Compute contribution margin per
composite unit.
Computing Multiproduct
Break-Even Point
Windows Doors
Selling Price $200 $500
Variable Cost 125 350
Unit Contribution 75 $ 150 $
Sales Mix Ratio
Composite C/M
Break-even point
in composite units
Fixed costs
Contribution margin
per composite unit
=
Step 2: Compute break-even point in
composite units.
Computing Multiproduct
Break-Even Point
Break-even point
in composite units
Fixed costs
Contribution margin
per composite unit
=
Break-even point
in composite units
$900,000
$450 per composite
unit
=
Step 2: Compute break-even point in
composite units.
Computing Multiproduct
Break-Even Point
Break-even point
in composite units
= 2,000 composite units
Sales Composite
Product Mix Units Units
Window 4 2,000 = 8,000
Door 1 2,000 = 2,000

Step 3: Determine the number of windows and
doors that must be sold to break even.
Computing Multiproduct
Break-Even Point

Windows Doors Combined
Selling Price $200 $500
Variable Cost 125.00 350.00
Unit Contribution 75.00 $ 150.00 $
Sales Volume 8,000 2,000
Total Contribution 600,000 $ 300,000 $ 900,000 $
Fixed Costs 900,000
Income $ 0
Step 4: Verify the results.
Multiproduct Break-Even
Income Statement