2. CHAPTER 4
Cost-Volume-Profit Analysis

3. Common Cost Behavior Patterns
Variable Costs
Fixed Costs
Mixed Costs
Step Costs

4. Variable Costs
Costs that change in proportion to changes in volume or activity
At restaurants, food costs vary with the number of customers served
For airlines, fuel costs vary with the number of miles flown
Example
Activity increases by 10%
Cost increases by 10%

5. Variable Costs

6. Fixed Costs Do not change in response to changes in activity level
Typical fixed costs are depreciation, supervisory salaries, and building maintentance
Example
Activity increases by 10%
Costs remain unchanged

7. Fixed Costs

8. Fixed Costs Discretionary Fixed Costs Committed Fixed Costs
Management can easily change
Advertising, Research and Development
Committed Fixed Costs
Cannot be easily changed
Rent, Insurance

9. Fixed Costs

10. Mixed Costs Contain variable and fixed cost elements Example
Salesperson with base salary (fixed)
Receives commission on sales (variable)

11. Mixed Costs

12. Step Costs Fixed cost for a specific range
Increases to higher level when upper bound of range is exceeded
Example
Company adds third production shift
Costs increase to include supervisory costs

13. Step Costs

14. Direct Labor

15. Cost Estimation Methods
Account Analysis
Scattergraphs
High-Low Method
Regression Analysis

16. Account Analysis Most common approach
Requires professional judgment of management
Management classifies costs as fixed and variable

17. Account Analysis Costs are then estimated Variable cost per unit
Total fixed costs

18. Account Analysis
Estimates used to find total production costs at various production levels

19. Scattergraphs Utilization of cost information from previous periods
Weekly, monthly, or quarterly cost reports
Plot the costs at specific activity levels

20. Scattergraphs

21. High-Low Method Utilization of cost information from previous periods
Connect straight line from lowest activity level to highest activity level

22. High-Low Method

23. High-Low Method Cost Estimations
Variable cost equals the slope of the line
Fixed cost equals the intercept of cost axis
Estimates used to find total production costs at various production levels

24. Regression Analysis Statistical technique
Estimates the slope and intercept of a cost equation
Typically spreadsheet programs are utilized

25. Regression Analysis

26. The Relevant Range Limitation of estimates
Accuracy expected only for production levels within range
Difficult to assess costs outside the relevant range

27. The Relevant Range

28. Cost-Volume-Profit Analysis
Equation Abbreviations
x = Quantity of units produced and sold
SP = Selling price per unit
VC = Variable cost per unit
TFC = Total fixed cost

29. Cost-Volume-Profit Analysis
The Profit Equation
Profit = SP(x) – VC(x) – TFC
Fundamental to CVP analysis

30. Cost-Volume-Profit Analysis
Break-Even Point
Number of units sold that allow the company to neither a profit nor a loss
$0 = SP(x) – VC(x) – TFC
Margin of Safety
Difference between expected sales and break-even sales

31. Break-Even Point

32. Cost-Volume-Profit Analysis
Contribution Margin (CM)
Difference between selling price and variable cost per unit
Profit = (SP – VC)(x) – TFC OR
Profit = CM per unit(x) - TFC

33. Cost-Volume-Profit Analysis
Contribution Margin Ratio
Contribution of every sales dollar to covering fixed cost
CM Ratio = SP – VC SP
Profit Equation (utilizing CM Ratio)
Sales($) = Profit + TFC
CM Ratio

34. Cost-Volume-Profit Analysis
“What If” Analysis
Utilize profit equation to determine impact of managerial decisions
Change in Fixed and Variable Costs
Change in Selling Price

35. Cost-Volume-Profit Analysis
Taxes in CVP Analysis
Profit Formula without Tax Considerations
Before Tax Profit = SP(x) – VC(x) – TFC
Profit Formula with Tax Considerations
After Tax Profit = [SP(x) – VC(x) – TFC](1-t)

36. Break-Even

37. Exercise 1
Gabby’s Wedding Cakes creates elaborate wedding cakes. Each cake sells for $500. The variable cost of baking the cakes is $200 and the fixed cost per month is $6,000
Calculate the break-even point for a month.
How many cakes must be sold to earn a monthly profit of $9,000?

38. Solution Break-Even Point What if monthly profit is $9,000?
x = (Profit + TFC) / CM per Unit
x = ($0 + $6,000) / $300
x = 20 cakes
What if monthly profit is $9,000?
x = ($9,000 + $6,000) / $300
x = 50 cakes

39. Multiproduct Analysis
Contribution Margin Approach
Used if products are similar
Identify number of units needed to be sold to break even
Calculate weighted average contribution margin based on expected units sold

40. Multiproduct Analysis
Contribution Margin Ratio Approach
Products are substantially different
Identify dollar amount of sales needed to break even
Calculate total CM Ratio and use to determine break-even point

41. Assumptions in CVP Analysis
Costs can be accurately separated into fixed and variable components
Fixed costs remain fixed
Variable costs per unit do not change

42. Operating Leverage Level of fixed versus variable costs in a company
High level of fixed costs has a high operating leverage
Typically have large fluctuations in profit when sales fluctuate

43. Outsourcing

44. Constraints Constraints on how many items can be produced
Shortage of space, equipment, or labor
Utilize contribution margin per unit to analyze situations

45. Decisions that Increase Sales or Production

46. Exercise 2
Rhetorix, Inc. produces stereo speakers. The selling price per pair of speakers is $800. The variable cost of production is $300 and the fixed cost per month is $50,000.
Calculate the contribution margin associated with a pair of speakers.
Calculate the contribution margin ratio for Rhetorix associated with a pair of speakers.

47. Solution Contribution Margin
CM = SP – VC
CM = $800 - $300
CM = $500
If the company sells five more speakers than planned, what is the expected effect on profit of selling the additional speakers?
Expected Effect = $500 * 5 units
= $2,500

48. Solution Contribution Margin Ratio
CM Ratio = (SP – VC)/SP
= ($800 - $300)/$800
= 62.5%
If the company has sales that are $5,000 higher than expected, what is the expected effect on profit?
Expected Effect = 62.5% * $5,000
= $3,125

49. Review 1
At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Contribution Margin per unit is?
$65
$75
$175
$30

50. Review 1
At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Contribution margin per unit is?
$65
$75
$175
$30

51. Review 2
At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Break-Even Point is?
1,000 units
1,083 units
2,000 units
None of these

52. Review 2
At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Break-Even Point is?
1,000 units
1,083 units
2,000 units
None of these

53. Review 3
At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. The Margin of Safety is?
$264,000
$384,000
$143,000
$121,000

54. Review 3
At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. The Margin of Safety is?
$264,000
$384,000
$143,000
$121,000

55. Review 4
At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. What is profit expected to be?
Answer here: _________________

56. Review 4
At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. What is profit expected to be?
Answer here: $143,000

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