Download Chapter 3 – CVP

Chapter 3: Cost, Volume, Pricing (CVP) Analysis,
Break-Even, Profitability & Taxation issues
Accounting 2220 so far…
- Product vs. Period Costs, Sarbanes-Oxley, Intl Ctrl, Fraud Triangle.
- Financial Acct I/Stmt: cost classification by organizational function.
- Managerial Acct income statement: costs classified by cost behavior.
- Cost Behavior, Relevant Range and Operating Leverage.
- Cost-Prediction Models (Scatter, High-Low, Regression Analysis).
- New Income Stmt format using the Contribution Margin (CM).
Second part of the course: Planning Topics:
- More of “getting to know your business better”……
- Determining break-even, desired profitability and taxation impact.
- CVP is primarily for short-run planning issues & tactical strategies.
- Your mgmt decisions will affect the organizational cost structure.
A) Break-Even & Desired Profitability: (Pg 110, P3-20A & Others)
What level of sales (in units or sales dollars) is required to earn a
profit of zero (i.e. where the Contribution Margin equates to FC)?
Three approaches to answering this question:
1) Break-Even (in units) = Fixed costs / CM per Unit (pg 111)
2) Break-Even (in sales dollars) = Fixed costs / CM Ratio (pg 112)
3) Break-Even (units or sales) using the Equation method (pg 110):
 Recommended approach: Sales - VC - FC = “Something”
Example: Bright Day – Pg 110
Sales price (per unit)
VC (per bottle/unit)
FC (Advertising Campaign)
Unit %
$ 36 100%
$ 24 ~67%
$60,000
What is Break-Even here??
- Use and benefit of “What-If” (i.e. Pro-Forma) scenarios:
- What if we have a change in sales price? VC? FC?
- Using Excel for “Sensitivity Analysis” (pg 123).
B) Adding Taxes to Break-Even Analysis (Not shown in text):
Desired level of profits after taxes =
Sales - VC - FC = desired profits after taxes / (1 - tax rate)
Same Example Facts as earlier:
Sales price (per unit)
VC (per unit)
FC (in total)
After-tax profit desired
Assumed Tax rate (Federal, State, Local)
$ 36
$ 24
$60,000
$20,000
40%
36x - 24x - 60,000 = 20,000 / (1 - .40 tax rate)
12x - 60,000 = 20,000 / .60
12x = 60,000 + 33,333
12x = 93,333, X = 7,778 units @ $36 = ~$280,008 in total sales
* All answers can be easily “proven” by constructing a CM Income
Statement template as shown in class *
C) Pricing Strategies (Example discussion - pg 114 & H/W E3-9A):
1) “Cost-plus pricing”: adding a mark-up to VC.
2) “Prestige Pricing”: Marketing & First-to-Market issues.
3) Target Pricing / Target Costing (Market-based strategy):
 Market sales price less desired profit = allowable cost.
D) Margin of Safety (Pg 120/121 & H/W E3-11A):
1) How far can sales fall prior to Break-Even?
2) Two-step process: Calculate B/E first, then compare to
expected sales volume to determine our “sales cushion”.
E) CVP Assumptions & Limitations (Pg 129):
1) The Selling Price is constant regardless of sales volume.
2) Linear cost behavior exists within the Relevant Range (RR).
3) Constant sales mix of products is assumed.
4) Inventory levels are constant (i.e. Production = Sales).
5) Costs can be classified as either variable or fixed within RR:
a. If not known, use regression analysis to predict
VC and FC components (from Chp 2 discussion)