Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Chapter 7

Cost-Volume-Profit Analysis

7-2

The Break-Even PointThe Break-Even Point

The break-even point is the point in the volume of activity where the organization’s

revenues and expenses are equal.

Sales 250,000$ Less: variable expenses 150,000 Contribution margin 100,000 Less: fixed expenses 100,000 Net income -$

7-3

Equation ApproachEquation Approach

Sales revenue – Variable expenses – Fixed expenses = Profit

UnitUnitsalessalespriceprice

SalesSalesvolumevolumein unitsin units

××UnitUnit

variablevariableexpenseexpense

SalesSalesvolumevolumein unitsin units

××

($500 × X)× X) ($300 × X)× X)–– –– $80,000 = $0

($200X)X) –– $80,000 = $0

X = 400 surf boardsX = 400 surf boards

7-4

Contribution-Margin ApproachContribution-Margin Approach

For each additional surf board sold, Curl generates $200 in contribution margin.

Total Per Unit PercentSales (500 surf boards) 250,000$ 500$ 100%Less: variable expenses 150,000 300 60%Contribution margin 100,000$ 200$ 40%Less: fixed expenses 80,000 Net income 20,000$

Consider the following information developed by the accountant at Curl, Inc.:

7-5

Contribution-Margin ApproachContribution-Margin Approach

Fixed expensesFixed expenses Unit contribution margin Unit contribution margin ==

Break-even pointBreak-even point(in units)(in units)

Total Per Unit PercentSales (500 surf boards) 250,000$ 500$ 100%Less: variable expenses 150,000 300 60%Contribution margin 100,000$ 200$ 40%Less: fixed expenses 80,000 Net income 20,000$

$$80,00080,000 $$200200 = 400 surf boards= 400 surf boards

7-6

Contribution-Margin ApproachContribution-Margin Approach

Here is the proof!

Total Per Unit PercentSales (400 surf boards) 200,000$ 500$ 100%Less: variable expenses 120,000 300 60%Contribution margin 80,000$ 200$ 40%Less: fixed expenses 80,000 Net income -$

400 × $500 = $200,000400 × $500 = $200,000 400 × $300 = $120,000400 × $300 = $120,000

7-7

Contribution Margin RatioContribution Margin Ratio

Calculate the break-even point in sales dollars rather than units by using the contribution margin ratio.

Contribution margin Sales

= CM Ratio

Fixed expenseFixed expense CM RatioCM Ratio

Break-even pointBreak-even point(in sales dollars)(in sales dollars)==

7-8

Total Per Unit PercentSales (400 surf boards) 200,000$ 500$ 100%Less: variable expenses 120,000 300 60%Contribution margin 80,000$ 200$ 40%Less: fixed expenses 80,000 Net income -$

Contribution Margin RatioContribution Margin Ratio

$80,000$80,000 40%40% $200,000 sales$200,000 sales==

7-9

Graphing Cost-Volume-Profit Graphing Cost-Volume-Profit RelationshipsRelationships

Viewing CVP relationships in a graph gives managers a perspective that can be obtained in no other way.Consider the following information for Curl, Inc.:

7-10

Cost-Volume-Profit GraphCost-Volume-Profit GraphD

olla

rs

600 700 800Units

200 300 400 500

450,000

100

200,000

150,000

100,000

50,000

400,000

350,000

300,000

250,000

Fixed expensesTotal expenses

Total sales

Break-evenpoint Profit a

rea

Loss area

7-11

Target Net ProfitTarget Net Profit

We can determine the number of surfboards that Curl must sell to earn a profit of $100,000

using the contribution margin approach.

Fixed expenses + Target profit Unit contribution margin = Units sold to earn

the target profit

$80,000 + $100,000 $200 = 900 surf boards

See the Equation Approach example in text book (LO1)See the Equation Approach example in text book (LO1)

7-12

Applying CVP AnalysisApplying CVP Analysis

Safety Margin• The difference between budgeted sales

revenue and break-even sales revenue.• The amount by which sales can drop before

losses begin to be incurred.

See example the Safety Margin example in text book (LO4)See example the Safety Margin example in text book (LO4)

7-13

What would happen to BREAK What would happen to BREAK EVEN POINT if there is a:EVEN POINT if there is a:

• Changes in Fixed Costs: See example in text book (LO4)

• Changes in Unit Contribution Margin: See example in text book (LO4) for:– Unit Variable expenses– Sale prices

7-14

Predicting Profit Given Expected Predicting Profit Given Expected VolumeVolume

Fixed expensesUnit contribution marginTarget net profit

Find: {req’d sales volume}Given:Given:

Fixed expensesUnit contribution marginExpected sales volume

Find: {expected profit}GivenGiven::

See the example in text book (LO4)See the example in text book (LO4)

7-15

CVP Analysis with Multiple CVP Analysis with Multiple ProductsProducts

For a company with more than one product, sales mix is the relative combination in which a company’s products are sold.

Different products have different selling prices, cost structures, and contribution

margins.

See the example in text book (LO5)See the example in text book (LO5)