Cost-Volume-Profit Analysis

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 LEARNING OBJECTIVES

1) Determine how changes in volume affect costs

2) Calculate operating income using contribution

margin and contribution margin ratio

3) Use cost-volume-profit (CVP) analysis for profit

planning

4) Use CVP analysis to perform sensitivity analysis

5) Use CVP analysis to calculate margin of safety,

operating leverage, and multiproduct breakeven
points

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 LEARNING OBJECTIVE 1

Determine how changes in volume

affect costs

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How Do Costs Behave When there Is a Change in
Volume?

Some costs change as the volume of sales increases or

decreases. Other costs are not affected by changes in volume.

Different types of costs are:

 Variable costs
 Fixed costs
 Mixed costs

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 VARIABLE COSTS
FIXED COSTS

* Variable
costs remain constant per unit but change in total as
volume changes.

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VARIABLE
FIXED COSTS
COSTS

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 MIXED COSTS

*Mixed costs have both fixed and variable components.

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 HIGH-LOW METHOD

A method to separate mixed costs into variable and fixed

components is the high-low method.

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 HIGH-LOW METHOD

Use three steps to separate the variable and fixed costs.

Step 1: Identify the highest and lowest levels of activity and calculate
the variable cost per unit.

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 HIGH-LOW METHOD

Now that we have calculated the variable costs per unit, we can
calculate the portion of the mixed costs that relates to the fixed costs.

Step 2: Calculate the total fixed costs.

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 HIGH-LOW METHOD
Using the variable costs per unit and the fixed costs per unit, we
can determine the total mixed costs at various levels of
productivity.

Step 3: Create and use an equation to show the behavior of a

mixed cost.

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 LEARNING OBJECTIVE 2

Calculate operating income using

contribution margin and contribution
margin ratio

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What Is Contribution Margin, And How Is It Used to
Compute Operating Income?

A traditional income statement classifies costs by function:

 Product costs
 Period costs
A contribution margin income statement classifies costs by
behavior:
 Variable costs
 Fixed costs

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CONTRIBUTION MARGIN INCOME STATEMENT

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 CONTRIBUTION MARGIN

* The difference between net sales revenue and variable costs is the
contribution margin.

* It is called contribution margin because it is the amount that

contributes to covering fixed costs.

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 CONTRIBUTION MARGIN

* The contribution margin can be expressed as a unit amount.

* Note: The terms unit contribution margin and contribution margin per
unit are used interchangeably.

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 CONTRIBUTION MARGIN

* A third way to express contribution margin is as a ratio.

* Contribution margin ratio is the ratio of contribution margin to
net sales revenue.

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 LEARNING OBJECTIVE 3

Use cost-volume-profit (CVP) analysis

for profit planning

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How Is Cost-Volume-Profit (CVP) Analysis Used?

* Managers use information about cost behavior to make

business decisions.

* Cost-volume-profit (CVP) analysis is a planning tool that looks

at the relationships among costs and volume and how they
affect profits (or losses).

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 ASSUMPTIONS

• The price per unit does not change as volume changes.

• Managers can classify each cost as variable, fixed, or
mixed.
• The only factor that affects total costs is change in
volume, which increases or decreases variable and mixed
costs.
• Fixed costs do not change.
• There are no changes in inventory levels.

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 Target Profit—Three Approaches

* CVPanalysis can be used to estimate the amount of sales

needed to achieve a target profit.

* There are three methods of estimated sales required to make

a profit:

 Equation approach
 Contribution margin approach
 Contribution margin ratio approach

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 The Equation Approach

* An equation can be used to estimate the number of units a company

needs to sell to achieve target profit or total sales revenue.

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 The Equation Approach
* If Smart Touch Learning desires a target profit of $6,000, using the
equation approach, it finds it needs to sell 80 units.

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 The Contribution Margin Approach

* The contribution margin approach is a shortcut method of computing

the required sales in units.

* The equation approach is rewritten to derive the following equation:

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 Contribution Margin Ratio Approach

* The contribution margin ratio approach computes required

sales in terms of sales dollars rather than in units.

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 Breakeven Point—A Variation of
Target Profit

* The breakeven point calculation is a variation of the target

profit calculation.

* The breakeven point is the point at which total revenues

equal total costs.

* The same three approaches used for target profit can be

used to determine the breakeven point.

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CVP Graph—A Graphic Portrayal

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 LEARNING OBJECTIVE 4

Use CVP analysis to perform

sensitivity analysis

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How Is CVP Analysis Used for Sensitivity
Analysis?

* Managers can use CVP relationships to conduct sensitivity

analysis.

* Sensitivity analysis is a “what if” technique that estimates

profit or loss results if sales price, cost, volume, or
underlying assumptions change.

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 CHANGES IN THE SALES PRICE

* If the sales price changes from $500 to $475, the number of

units needed to breakeven increases from 54 to 60.

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 CHANGES IN VARIABLE COSTS

*If one of Smart Touch Learning’s suppliers raises prices and

variable costs increase from $275 to $285, the number of
units needed to break even increases from
54 to 56.

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 CHANGES IN FIXED COSTS

*If Smart Touch Learning ’ s fixed costs increase from

$12,000 to $15,000, the number of units needed to break
even increases from 54 to 67.

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How Is CVP Analysis Used for Sensitivity
Analysis?

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 LEARNING OBJECTIVE 5

Use CVP analysis to calculate margin of

safety, operating leverage, and multiproduct
breakeven points

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What Are Some Other Ways CVP Analysis Can Be
Used?

* CVP analysis can be used for estimating target profits and

breakeven points, as well as sensitivity analysis.

* Three additional applications of CVP are:

 Margin of safety
 Operating leverage
 Sales mix

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 Margin of Safety
* Margin of safety is the excess of expected sales over breakeven
sales.
* Used to evaluate the risk of current operations and their plans
for the future.

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 OPERATING LEVERAGE

*The cost structure of a company is the proportion of

fixed costs to variable costs.
*Operating leverage predicts the effects that fixed costs
will have on changes in operating income when sales
volume changes.
*The degree of operating leverage can be measured by
dividing the contribution margin by the operating
income.
For Company A, the percentage change in operating
income will be 2.5 times the percentage change in sales.

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 SALES MIX

* Most companies sell more than one product.

* Sales price and variable costs differ for each product.
* Sales mix, or product mix, is the combination of products that make

up total sales.

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