1. Chapter 3 Cost, Revenue, and Income Behavior

2. The Contribution Format
Used primarily for external reporting.
Used primarily by management.

3. Contribution Margin Practice
(d)
(e)
(f)
Per Unit
Var. Cost
Total
Total
Total
Operating
Selling
Per
Units CM
Fixed
Income
Price
Unit
Sold
Costs
$30
120,000
$720,000
$640,000 $ 10 $6
100,000
$320,000 $9
80,000 $
160,000
$120,000

4. Contribution Margin Method to Determine Break-even
Fixed expenses
Unit contribution margin =
Break-even point
in units sold
Break-even point in
total sales dollars
Fixed expenses
CM ratio =

5. CVP Graph
Total Sales
Total Expenses
Dollars
Fixed expenses
Units

6. CVP Graph
Profit Area
Dollars
Break-even point
Loss Area
Units

7. Profit-Volume Graph Profit area Loss area Break-even point Profit1 3 4 5 2 6 7 8
Profit
Revenues (000s), Units sold (00s)
Profit area
Loss area
Break-even
point

8. Target Operating Profit - CM Approach
Original contribution margin formula:
Break Even Point in Units = Fixed Expenses Contribution Margin per Unit
Target operating profit modification:
Units Sold to Earn Target Profit = Fixed Expenses +Target Op. Profit Unit Contribution Margin

9. After-Tax Profit Targets
Net income = Operating profit – Income taxes
= Operating profit – (Tax rate x Operating profit)
= Operating profit (1 – Tax rate) Or
Operating profit =
Net income
(1 – Tax rate)

10. After-Tax Profit Targets
Fisher Company has a selling price of $40 for its only product. Variable cost per unit is $24, and fixed costs are $800,000 for the year. The Company wants to achieve an annual net income (after taxes) of $487,500. How many units must it sell if its income tax rate is 35 percent.

11. The Margin of Safety
Excess of budgeted (or actual) sales over the break-even volume of sales. The amount by which sales can drop before losses begin to be incurred.
Margin of safety = Total sales - Break-even sales

12. Cost Structure and Profitability
Alpha
Beta
Gamma
Amount %
Sales
$800,000
100%
Variable Expenses
400,000
50%
300,000
37.5%
200,000
25%
Contribution Margin
500,000
62.5%
600,000
75%
Fixed Expenses
Op. Income
$ 100,000

13. Effect on Profit of 10% Increase in Sales Revenue
Contribution Margin Ratio
Increase in Op.Income
Alpha
$80, X
50% =
$40,000
+40%
Beta
62.5% =
$50,000
+50%
Gamma
75% =
$60,000
+60%

14. Break-Even Points Fixed Expenses $300,000 / $400,000 / $500,000 /
$300, /
$400, /
$500, /
Contribution Margin Ratio
50% =
62.5% =
75% =
Break-Even Sales Revenue
$600,000
$640,000
$666,667
Alpha
Beta
Gamma

15. Break-Even Sales Revenue
Margin of Safety
Actual Sales Revenue
Break-Even Sales Revenue
Margin of
Safety
Alpha
Beta
Gamma
$800,
800,
800,
$600, =
640, =
666, =
$200,000
160,000
133,333

16. Definition of Operating Leverage
The relative mix of a firm’s fixed and variable costs determines its operating leverage.
At a given level of sales:
Degree of operating = Contribution Margin
leverage Operating Income
The higher a firm’s fixed cost as compared to its variable cost, the greater its operating leverage.
Operating leverage acts like a multiplier. The greater the operating leverage, the greater the change in operating income for a given change in sales.
Let’s calculate the operating leverage for each firm.

17. Application of Operating Leverage
At a given level of sales, the operating leverage is a measure of how a given percentage change in sales will affect operating profits.
In fact, the operating profit will increase by the operating leverage times the percentage change in sales.
For a 10% increase in sales , Firm Alpha’s operating income increased 40% (4 times 10%).
For a 10% increase in sales , Firm Beta’s operating income increased 50% (5 times 10%).
For a 10% increase in sales , Firm Gamma’s operating income increased 60% (6 times 10%).

18. Break-even Analysis (in Units) with Multiple Products
Curl Company provides us with the following information:
Fixed cost is $120,000. What is the break-even point in units? What are the sales of Surfboards and Sailboards at the break-even point?

19. Break-even Analysis (in Sales Dollars) with Multiple Products
Curl’s Contribution Margin income statement is shown below:
$150,000
$450,000
= 33.3%
What is the break-even point in Sales? What are the sales of Surfboards and Sailboards at the break-even point?