1. Chapter 22
Part 2

2. Cost-Volume-Profit Analysis
Study of the effects of changes of costs and volume on a company’s profits
A critical factor in management decisions
Important in profit planning
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 4: List the five components of cost-volume-profit analysis.

3. Cost-Volume-Profit Analysis
CVP analysis considers the interrelationships among five basic components
Illustration 22-9
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 4: List the five components of cost-volume-profit analysis.

4. Assumptions Underlying CVP Analysis
Behavior of both costs and revenues is linear throughout the relevant range of the activity index
All costs can be classified as either variable or fixed with reasonable accuracy
Changes in activity are the only factors that affect costs
All units produced are sold
When more than one type of product is sold, the sales mix will remain constant
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 4: List the five components of cost-volume-profit analysis.

5. CVP Income Statement Contribution margin –
A statement for internal use
Classifies costs and expenses as fixed or variable
Reports contribution margin in the body of the statement.
Contribution margin –
amount of revenue
remaining after
deducting variable costs
Reports the same net
income as a traditional
income statement
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 5: Indicate what contribution margin is and how it can be expressed.

6. CVP Income Statement - Example
Vargo Video Company produces DVD players.
Relevant data for June 2010:
Unit selling price of DVD player $500
Unit variable costs $300
Total monthly fixed costs $200,000
Units sold ,600
Illustration 22-11
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 5: Indicate what contribution margin is and how it can be expressed.

7. Contribution Margin Per Unit
Contribution margin is available to cover fixed costs and to contribute to income
The formula for contribution margin per unit and the computation for Vargo Video are:
Illustration 22-12
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 5: Indicate what contribution margin is and how it can be expressed.

8. CVP Income Statement-CM effect
Illustration 22-13
Illustration 22-14
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 5: Indicate what contribution margin is and how it can be expressed.

9. Contribution Margin Ratio
Shows the percentage of each sales dollar available to apply toward fixed costs and profits
The formula for contribution margin ratio and the computation for Vargo Video are:
Illustration 22-15
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 5: Indicate what contribution margin is and how it can be expressed.

10. Contribution Margin Ratio
Ratio helps to determine the effect of changes in sales on net income
Illustration 22-16
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 5: Indicate what contribution margin is and how it can be expressed.

11. Break-Even Analysis
Process of finding the break-even point
level of activity at which total revenues equal total costs (both fixed and variable)
Can be computed or derived
from a mathematical equation,
by using contribution margin, or
from a cost-volume profit (CVP) graph
Expressed either in sales units or in sales dollars
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 6: Identify the three ways to determine the break-even point.

12. Break-Even Analysis: Mathematical Equation
Break-even occurs where total sales equal variable costs plus fixed costs; i.e., net income is zero.
The formula for the break-even point and the computation for Vargo Video are:
To find sales dollars required to break-even:
1000 units X $500 = $500,000 (break-even dollars)
Illustration 22-18
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 6: Identify the three ways to determine the break-even point.

13. Break-Even Analysis: Contribution Margin Technique
At the break-even point, contribution margin must equal total fixed costs
(CM = total revenues – variable costs)
The break-even point can be computed using either contribution margin per unit or contribution margin ratio.
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 6: Identify the three ways to determine the break-even point.

14. Contribution Margin Technique
When the BEP in units is desired, contribution margin per unit is used in the following formula which shows the computation for Vargo Video:
When the BEP in dollars is desired, contribution margin ratio is used in the following formula which shows the computation for Vargo Video:
Illustration 22-19
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
Illustration 22-20
LO 6: Identify the three ways to determine the break-even point.

15. Break-Even Analysis: Graphic Presentation
A cost-volume profit (CVP) graph shows costs, volume and profits.
Used to visually find the break-even point
To construct a CVP graph:
Plot the total sales line starting at the zero activity level
Plot the total fixed cost using a horizontal line
Plot the total cost line (starts at the fixed-cost line at zero activity
Determine the break-even point from the intersection of the total cost line and the total sales line
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 6: Identify the three ways to determine the break-even point.

16. Break-Even Analysis: Graphic Presentation
Illustration 22-21
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 6: Identify the three ways to determine the break-even point.

17. Break-Even Analysis: Target Net Income
Level of sales necessary to achieve a specified income
Can be determined from each of the approaches used to determine break-even sales/units:
from a mathematical equation,
by using contribution margin, or
from a cost-volume profit (CVP) graph
Expressed either in sales units or in sales dollars
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 7: Give the formulas for determining sales required to earn target net income.

18. Break-Even Analysis: Target Net Income
Mathematical Equation
Using the formula for the break-even point, simply include the desired net income as a factor. The computation for Vargo Video is as follows:
Illustration 22-23
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 7: Give the formulas for determining sales required to earn target net income.

19. Break-Even Analysis: Target Net Income
Contribution Margin Technique
To determine the required sales in units for Vargo Video:
To determine the required sales in dollars for Vargo Video:
Illustration 22-24
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
Illustration 22-25
LO 7: Give the formulas for determining sales required to earn target net income.

20. Break-Even Analysis: Margin of Safety
Difference between actual or expected sales and sales at the break-even point
Measures the “cushion” that management has if expected sales fail to materialize
May be expressed in dollars or as a ratio
To determine the margin of safety in dollars for Vargo Video assuming that actual/expected sales are $750,000:
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
Illustration 22-26
LO 8: Define margin of safety, and give the formulas for computing it.

21. Break-Even Analysis: Margin of Safety
Margin of Safety Ratio
Computed by dividing the margin of safety in dollars by the actual or expected sales
To determine the margin of safety ratio for Vargo Video assuming that actual/expected sales are $750,000:
The higher the dollars or the percentage, the greater the margin of safety
Illustration 22-27
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 8: Define margin of safety, and give the formulas for computing it.

22. CVP Income Statement Revisited
Illustration 22-33
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)
LO 9: Describe the essential features of a cost-volume-profit income statement.

23. Copyright
Copyright © 2009 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.