STUDENT EDITION

PowerPoint Presentation by
Gail B. Wright
Professor Emeritus of Accounting
Bryant University

Copyright 2007 Thomson South-Western, a part of The

Thomson Corporation. Thomson, the Star Logo, and
South-Western are trademarks used herein under license.

MANAGEMENT
ACCOUNTING
8th EDITION
BY
HANSEN & MOWEN

11 COST-VOLUME-PROFIT ANALYSIS
1

LEARNING
LEARNING OBJECTIVES
OBJECTIVES
1. Determine the number of units sold to break
even or earn a targeted profit.
2. Calculate the amount of revenue required to
break even or earn a targeted profit.
3. Apply cost-volume-profit analysis in a
multiple-product setting.
Continued
2

LEARNING
LEARNING OBJECTIVES
OBJECTIVES
4. Prepare a profit-volume graph & a costvolume-profit graph, and explain the
meaning of each.
5. Explain the impact of risk, uncertainty, &
changing variables on cost-volume-profit
analysis.
6. Discuss the impact of activity-based costing
on cost-volume-profit analysis.
3

LO 1

COST-VOLUME-PROFIT (CVP)
CVP expresses:
# units that must be sold to break even
Impact of a given reduction in fixed costs on
break-even point
Impact of an increase in price on profit
Sensitivity analysis of impact of various price or
cost levels on profit

LO 1

BREAK-EVEN
BREAK-EVEN POINT:
POINT: Definition
Definition

Is the point where total revenue

equals total cost; the point of
zero
profit
zero
profit.

LO 1

FORMULA: Operating Income

Operating income includes revenues &
expenses from the firms normal operations.

Operating Income
= Sales revenue
Variable expenses
Fixed expenses
6

LO 1

NET
NET INCOME:
INCOME: Definition
Definition

Is operating income minus

income taxes.

LO 1

FORMULA: Break-Even
Break-even is 0 profit.

Break-even:
0 = Sales revenue Variable expenses Fixed
expenses
0 = ($400 x Units) ($325 x Units) - $45,000
($75 x Units) = $45,000
Units = 600
8

LO 1

WHITTIER
WHITTIER CO.:
CO.: Income
Income Statement
Statement
Check-up on break-even
Sales (600 units @ $400)

$ 240,000

Less: Variable expenses

Contribution margin

195,000
$ 45,000

Less: Fixed expenses

Operating income

45,000
$

LO 1

CONTRIBUTION
CONTRIBUTION MARGIN:
MARGIN:
Definition
Definition

Is sales revenue minus variable

costs (Sales VC).

10

LO 1

FORMULA: Break-Even
Break-even using contribution margin.

Break-even units:
# Units = Fixed cost / Unit contribution margin
# Units = $45,000 / ($400 - $325)
= 600

11

LO 1

FORMULA: Target Profit % Sales

Target profit can be calculated as % of
revenue.

Target profit as % of sales:

0.15 ($400 x Units) =
($400 x Units) ($325 x Units) - $45,000
$60 x Units = ($75 x Units) - $45,000
# Units = 3,000
12

LO 2

VARIABLE
VARIABLE COST
COST RATIO:
RATIO:
Definition
Definition

Is the proportion of each sales

dollar used to cover variable
costs.

13

LO 2

CONTRIBUTION
CONTRIBUTION MARGIN
MARGIN RATIO:
RATIO:
Definition
Definition

Is the proportion of each sales

dollar available to cover fixed
costs & provide profit.

14

LO 2

WHITTIER
WHITTIER CO.:
CO.: Background
Background
CMR for mulching lawn mower.
Sales (1,000 units @ $400)
Less: Variable expenses
Contribution margin
Less: Fixed expenses
Operating income

$ 400,000

100.00%

325,000

81.25%

$ 75,000

18.75%

45,000
$ 30,000

15

LO 2

FORMULA: Break-Even CMR

Contribution margin ratio (CMR)
makes calculation easier.

= Sales (1 VC rate) Fixed Costs

= Sales (1 0.8125) - $45,000

Sales = $240,000
OR
Break-even Sales = Fixed cost / CMR
$240,000

= $45,000 / 0.1875
16

LO 3

Can we use CVP if

Whittier has more than 1
product?

Yes. But we have to add

direct
directfixed
fixedexpenses
expenses into
the analysis.

17

LO 3

DIRECT
DIRECT FIXED
FIXED EXPENSES:
EXPENSES:
Definition
Definition

Are fixed costs that can be

traced to each product and
would be avoided if the product
did not exist.

18

LO 3

WHITTIER
WHITTIER CO.:
CO.: Sales
Sales Mix
Mix &
& CVP
CVP
Background
Background

Margin for multiple products

Product

Unit
Price

VC

Mulching

$400

$325

$ 75

$ 225

800

600

200

400

Riding
Package Total

Package
CM Cont. Mix

Margin*

$ 625

*Margin = Units in package x CM

19

LO 3

FORMULA: Break-Even Packages

Contribution margin approach to
multiple products.

Break-even packages = Fixed cost / Package CM

= $96,250 / $625
= 154 Packages

20

LO 3

BREAK-EVEN SOLUTION
Mulching mower sales =
$400 x 3 x 154 packages.

EXHIBIT 11-1
21

LO 4

ASSUMPTIONS OF CVP
CVP analysis assumes
Linear revenue & cost functions
Price, total fixed costs, & unit variable costs can
be accurately identified & remain constant over the
relevant range
What is produced is sold
Sales mix is known
Selling prices & costs are known with certainty
22

LO 4

COST-PROFIT-VOLUME GRAPH
Yes. CVP will apply so
long as the cost &
revenue functions are
approximately linear over
the relevant range.

EXHIBIT 11-4b
23

LO 5

What can Whittier do to

increase sales of mulching
mowers?

Sales can be increased by some

combination of increased
advertising and decreased
prices.
24

LO 5

ALTERNATIVES
For
Forthe
themulching
mulchingmower
mowerare:
are:
#1
#1IfIfadvertising
advertisingexpenditures
expendituresincrease
increaseby
by$8,000,
$8,000,
sales
saleswill
willincrease
increasefrom
from1,600
1,600toto1,725
1,725mowers.
mowers.
#2
#2AAprice
pricedecrease
decreasefrom
from$400
$400toto$375
$375per
permower
mower
will
willincrease
increasesales
salesfrom
from1,600
1,600toto1,900.
1,900.
#3
#3Decreasing
Decreasingprice
pricetoto$375
$375and
andincreasing
increasing
advertising
advertisingexpenditures
expendituresby
by$8,000
$8,000will
willincrease
increase
sales
salesfrom
from1,600
1,600toto2,600
2,600mowers.
mowers.
25

LO 5

How should Whittier use

the results of analysis in
the 3 alternatives?

Whittier should consider its

choice in the context of Risk &
risk & Uncertainty.
uncertainty.

26

LO 5

RISK & UNCERTAINTY

For
ForWhittier,
Whittier,risk
riskincludes
includesthe
thefact
factthat
thatprices
pricesand
and
costs
costscan
cannot
notbe
bepredicted
predictedwith
withcertainty.
certainty.Risk
Risk
assumes
assumesthat
thatthe
thedistributions
distributionsof
ofthe
thevariables
variables
ininquestion
questionare
areknown
known(i.e.,
(i.e.,we
weknow
knowhow
how
sales
saleswill
willreact
reactininresponse
responsetotochanges
changesininprice
price
or
orcost).
cost).Under
Underuncertainty,
uncertainty,these
thesedistributions
distributions
are
arenot
notknown.
known.

27

LO 5

SENSITIVITY
SENSITIVITY ANALYSIS:
ANALYSIS:
Definition
Definition

Is the use of what if to

examine the impact of changes
in underlying assumptions on
operating results.

28

LO 5

SENSITIVITY ANALYSIS
Under 2 systems, the same
change in price will have
different effects on elements
of CVP, & response to risk
& uncertainty.

EXHIBIT 11-8
29

LO 6

ABC & CVP

ABC
ABCdivides
dividescosts
costsinto
intounit-based
unit-based&
&
non-unit-based
non-unit-basedcategories.
categories.CVP
CVP
has
hasto
toadjust
adjustits
itsformulas
formulasto
to
incorporate
incorporatethis
thisdivision.
division.

30

LO 6

What are the strategic

implications of the 2
approaches to analyzing
CVP?
An ABC approach to CVP allows
for a better defined breakdown of
costs to analyze alternative
recommendations.
31

CHAPTER 11

THE
THE END
END

32