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COST-VOLUME-PROFIT
ANALYSIS
CHAPTER 16
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
CHAPTER 16 OBJECTIVES
1. Determine the number of units and amount
of sales revenue needed to break even
and to earn a target profit
2. Determine the number of units and sales
revenue needed to earn an after-tax
target profit
3. Apply cost-volume-profit analysis in a
multiple-product setting
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
CHAPTER 16 OBJECTIVES
4. Prepare a profit-volume graph and a costvolume-profit graph, and explain the
meaning of each
5. Explain the impact of risk, uncertainty, and
changing variables on cost-volume-profit
analysis
6. Discuss the impact of non-unit cost drivers
on cost-volume-profit analysis
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
THE BREAK EVEN POINT AND TARGET
PROFIT IN UNITS AND SALES REVENUE
Cost-Volume-Profit (CVP) Analysis
• Powerful tool for planning and decision making
• As it emphasizes the interrelationships of costs, quantity
sold, and price, it brings together all of the financial
information of the firm
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
THE BREAK EVEN POINT AND TARGET
PROFIT IN UNITS AND SALES REVENUE
• Two frequently used approaches to finding
the break-even point
• Operating income approach
• Contribution margin approach
• Break-even point: the point of zero profit
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
THE BREAK EVEN POINT AND TARGET
PROFIT IN UNITS AND SALES REVENUE
• First step in implementing a units-sold
approach to CVP analysis is to determine
just what a unit is
• Second step is to separate costs into fixed
and variable components
• CVP focuses on the firm as a whole
• All costs of the company—manufacturing,
marketing, and administrative—are taken into
account
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
THE BREAK EVEN POINT AND TARGET
PROFIT IN UNITS AND SALES REVENUE
Basic Concepts for CVP Analysis
• A useful tool for organizing the firm’s costs into fixed
and variable categories is the contribution-marginbased income statement
• Operating income: income before income taxes
(includes only revenues and expenses from the firm’s
normal operations)
• Net income: operating income minus income taxes
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
THE BREAK EVEN POINT AND TARGET
PROFIT IN UNITS AND SALES REVENUE
The Equation Method for Break-Even and
Target Income
Operating income = Sales revenues – Variable
expenses – Fixed expenses
Operating income = (Price × Number of units) –
(Variable cost per unit ×
Number of units) – Total fixed
costs
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
THE BREAK EVEN POINT AND TARGET
PROFIT IN UNITS AND SALES REVENUE
The Equation Method for Break-Even and
Target Income
• Equation for a target profit put in terms of units
Units for a target profit = (Total fixed cost + Target
income)/(Price - Variable
cost per unit)
• Break-even equation when target income is zero
Break-even units = (Total fixed cost + 0)/Price Variable cost per unit
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
THE BREAK EVEN POINT AND TARGET
PROFIT IN UNITS AND SALES REVENUE
Contribution Margin Approach
• Contribution margin is sales revenue minus total
variable costs
• By substituting the unit contribution margin for price
minus unit variable cost in the operating income
equation, the following break-even expression is
obtained
• Number of units = Fixed costs/Unit contribution margin
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
EXHIBIT 16.1—DIVISION OF REVENUE INTO
VARIABLE COST AND CONTRIBUTION MARGIN
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THE BREAK EVEN POINT AND TARGET
PROFIT IN UNITS AND SALES REVENUE
Break-Even Point and Target Income in Sales
Revenue
• A units sold measure can be converted to a salesrevenue measure by multiplying the unit sales price
by the units sold
• To calculate the break-even point in sales revenue,
variable costs are defined as a percentage of sales
rather than as an amount per unit sold
• The contribution margin ratio is the proportion of
each sales dollar available to cover fixed costs and
provide for profit
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
THE BREAK EVEN POINT AND TARGET
PROFIT IN UNITS AND SALES REVENUE
Sales-Revenue Approach
Operating income = Sales – Variable costs – Total
fixed costs
Operating income = Sales – (Variable cost ratio ×
Sales) – Total fixed costs
Operating income = Sales (1- Variable cost ratio) –
Total fixed costs
Operating income = Sales × Contribution margin ratio
– Total fixed costs
LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
THE BREAK EVEN POINT AND TARGET
PROFIT IN UNITS AND SALES REVENUE
Sales-Revenue Approach
Sales = (Total fixed costs + Operating income)/
Contribution margin ratio
At break even, operating income equals zero
Break-even sales = Total fixed costs/Contribution
margin ratio
LO-1
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
AFTER TAX PROFIT TARGETS
• When calculating the break-even point,
income taxes play no role because the
taxes paid on zero income are zero
• The after-tax profit, or net income, is
computed by subtracting income taxes
from the operating income (or before-tax
profit)
Operating Income = Net income /(1-tax rate)
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
MULTIPLE PRODUCT ANALYSIS
• Direct fixed expenses: fixed costs that can
be traced to each segment and would be
avoided if the segment did not exist
• Common fixed expenses: fixed costs that
are not traceable to the segments and that
would remain even if one of the segments
was eliminated
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
MULTIPLE PRODUCT ANALYSIS
Break-Even Point in Units for the MultipleProduct Setting
Break-even sales = Fixed costs/Contribution margin
ratio
• Sales mix is the relative combination of products
being sold by a firm
• Defining a particular sales mix allows us to convert a
multiple-product problem to a single-product CVP
format
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
GRAPHICAL REPRESENTATIONS OF CVP
RELATIONSHIPS
The Profit-Volume Graph
• Portrays the relationship between profits and sales
volume
• The graph of the operating income equation
[Operating income = (Price × Units) – (Unit variable
cost × Units) – Fixed Costs]
• Operating income is the dependent variable and
number of units is the independent variable
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
EXHIBIT 16.2—PROFIT VOLUME GRAPHS
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
GRAPHICAL REPRESENTATIONS OF CVP
RELATIONSHIPS
The Cost-Volume-Profit Graph
•Depicts relationships among cost, volume, and
profits
•To obtain the more detailed relationships, it is
necessary to graph two separate lines
• The total revenue line; revenue = price × units
• The total cost line; (unit variable cost × units) +
Fixed costs
•Vertical axis is measured in dollars and horizontal axis
is measured in units sold
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
EXHIBIT 16.3—COST-VOLUME-PROFIT
GRAPH
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ASSUMPTIONS OF COST-VOLUME-PROFIT
ANALYSIS
Assumptions of Cost-Volume-Profit Analysis
• A linear revenue function and a linear cost function
• Price, total fixed costs, and unit variable costs can
be accurately identified and remain constant over
the relevant range
• What is produced is sold
• For multiple-product analysis, the sales mix is
assumed to be known
• The selling price and costs are assumed to be
known with certainty
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
EXHIBIT 16.4—COST AND REVENUE
RELATIONSHIPS
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EXHIBIT 16.5—SUMMARY OF EFFECTS OF
ALTERNATIVE 1
LO-5
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EXHIBIT 16.6—SUMMARY OF EFFECTS OF
ALTERNATIVE 2
LO-5
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EXHIBIT 16.7—SUMMARY OF EFFECTS OF
ALTERNATIVE 3
LO-5
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CHANGES IN THE CVP VARIABLES
Margin of Safety
• Units sold or expected to be sold or the revenue
earned or expected to be earned above the
break-even volume
• If a firm’s margin of safety is large given the
expected sales for the coming year, the risk of
suffering losses should sales take a downward turn is
less than if the margin of safety is small
LO-5
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
CHANGES IN THE CVP VARIABLES
Operating Leverage
• Use of fixed costs to extract higher percentage
changes in profits as sales activity changes
• The greater the degree of operating leverage, the
more that changes in sales activity will affect profits
• The mix of costs than an organization chooses can
have a considerable influence on its operating risk
and profit level
Degree of operating leverage = Total contribution
margin/Profit
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CHANGES IN THE CVP VARIABLES
Sensitivity Analysis and CVP
• A what-if technique that examines the impact of
changes in underlying assumptions on an answer
• It is relatively simple to input data on prices, variable
costs, fixed costs, and sales mix and set up formulas
to calculate break-even points and expected
profits
• Then, the data can be varied as desired to see
what impact changes have on the expected profit
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© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
EXHIBIT 16.8—DIFFERENCES BETWEEN
MANUAL AND AUTOMATED SYSTEMS
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CVP ANALYSIS AND NON-UNIT COST
DRIVERS
• Conventional CVP analysis assumes that all
costs can be divided into variable and fixed
costs
• Costs are assumed to be a linear function of sales
volume
• An activity-based costing (ABC) system
divides costs into unit and non unit based
categories
LO-6
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CVP ANALYSIS AND NON-UNIT COST
DRIVERS
Total cost = Fixed costs + (Unit variable cost ×
Number of units) + (Setup cost ×
Number of setups) + (Engineering
cost X Number of engineering
hours)
LO-6
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
CVP ANALYSIS AND NON-UNIT COST
DRIVERS
Operating income = Total revenue – [Fixed
costs + (Unit variable
cost × Number of units) +
(Setup cost × Number of
setups) + (Engineering
cost × Number of
engineering hours)]
LO-6
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
CVP ANALYSIS AND NON-UNIT COST
DRIVERS
Break-even units = [Fixed costs + (Setup cost ×
Number of setups) +
(Engineering cost ×
Number of engineering
hours)]/Price – Unit
variable cost)
LO-6
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.
CVP ANALYSIS AND NON-UNIT COST
DRIVERS
Differences Between ABC Break-Even Point
and Conventional Break-Even Point
• The fixed costs differ
• The numerator of the ABC break-even equation has
two non unit-variable cost terms
LO-6
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END OF CHAPTER 16
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a passwordprotected website for classroom use.