1. COST–VOLUME–PROFIT ANALYSIS: ADDITIONAL ISSUES
CHAPTER 6
COST–VOLUME–PROFIT ANALYSIS: ADDITIONAL ISSUES
Managerial Accounting, Fifth Edition

2. Preview of Chapter
The relationship between a company’s fixed and variable costs can have a huge impact on its profitability.
The current trend is toward companies with cost structures dominated by fixed costs.
This has significantly increased the
volatility of many companies’ net income.
Thus, the use of CVP analysis has additional uses in making sound business decisions.

3. Basic Concepts
CVP is so important, management often wants the information reported in a special format income statement.
The CVP income statement is for internal use only, classifies costs and expenses as fixed or variable, reports a contribution margin in the body of the statement.
Contribution margin – amount of revenue remaining after deducting all variable costs.
The contribution margin is often reported as a total amount and on a per unit basis.
SO 1: Describe the essential features of
a cost-volume-profit income statement.

4. Basic Computations – A Review
Break-Even Analysis:
Desossa Music Player’s CVP income statement shows that total CM (sales minus variable expenses) is $175,000 and the company’s CM per unit is $50. The Contribution margin ratio (contribution margin divided by sales) is 41.67% ($50 / $120). Desossa’s breakeven point in units (using contribution margin per unit) or in dollars (using contribution margin ratio) are calculated as follows:
Fixed cost ÷ Contribution margin per unit = Break-even point in units
$94, ÷ $ = 1,890 units
Fixed cost ÷ Contribution margin ratio = Break-even point in dollars
$94, ÷ = $226,800

5. E6-2 – page 279 in text
In the month of June, Paula’s Beauty Salon gave 3500 haircuts, shampoos and permanents at an average price of $30. During the month fixed costs were $16,800 and variable cost were 80% of sales.
Instructions:
Determine the contribution margins in dollars, per unit and as a ratio.
Using the contribution margin technique, compute the breakeven point in dollars and in units.
Compute the margin of safety in dollars and as a ratio.

6. Contribution Margin in dollars , units and ratios
Contribution margin in dollars equals to sales in dollars minus the variable cost in dollars. ($Sales – $VC = $CM )
Contribution margin per unit equals the units selling price minus the unit variable cost. (Unit Sales – Unit VC = CM/unit)
Contribution margin ratio equals the CM per unit divided by the unit selling price
Sales: 3,500 X $30 = 105,000
Variable cost: 105,000 X .8 = $84,000
$CM: 105,000 – 84,000 = 21,000
CM/unit: $30 - $24 = $6 (UVC: $84,000 / 3500 = $24)
CM ratio: $6/$30 = .20 or 20%

7. Break even in Dollars and Units –
Break Even points in Dollars: Fixed Cost divided by Contribution Margin Ratio
Break Even points in Units: Fixed Cost divided by Contribution margin per unit.
$16,800 (Fixed Cost) / 20% (CM ratio) = $84,000
$16,800 /$6 (CM/unit) = 2,800 units

8. Basic Computations – A Review
Target Net Income
Once a company achieves break-even sales, a sales goal can be set that will result in a target net income.
Assuming Paula’s target net income is $18,000, required sales in units and dollars to achieve this are:
16, ,000 / $6 = 5800 units
(Fixed cost plus Target Net Income divided by Contribution Margin per unit = Required sales in units)
16, ,000 / .20 = $174,000
(Fixed cost plus Target Net Income divided by the CM ratio = Required Sales in dollars.)
SO 2: Apply basic CVP concepts.

9. Example / = ($94,500 + $100,000) ÷ $50 = 3,890 units / =
Assuming Desossa’s management has a target net income of $100,000, the required sales in units and dollars to achieve its target net income are calculated as follows:
(Fixed cost +
Target net income) /
Contribution Margin per unit =
Required Sales in units
($94,500 + $100,000) ÷ $50 = 3,890 units
(Fixed cost +
Target net income) /
Contribution Margin ratio =
Required Sales in dollars
($94,500 + $100,000) ÷ = $466,762

10. Basic Computations: Margin of Safety
Remember from Chapter 5, the margin of safety tells us how far sales can drop before the company will operate at a loss.
The margin of safety can be expressed in dollars or as a ratio.
Assuming Desossa’s sales are $420,000:
Actual (expected) sales – Break-even sales = Margin of safety in dollars
$420,000 – $226,800 = $193,200
Margin of safety in dollars ÷ Actual (expected) sales =Margin of safety ratio
$193,200 ÷ $420,000 = 46%

11. Margin of Safety in Dollars and Units – E 6-2 continued
Sales (Actual or Expected) minus Break Even Sales equals Margin of Safety in Dollars
Margin of Safety in Dollars divided by the Sales (Actual or Expected) equals Margin of Safety Ratio
$105,000 (Sales) - $84,000 (BE) = $21,000
$21,000 / 105,000 = 20%

12. CVP – Changes in Business Environment
To better understand how CVP analysis works, let’s assume that shipping costs have increased significantly causing the unit variable cost to increase by 10%, what effect will this have on Desossa’s break-even point?
Answer: A 10% increase in variable costs increases the per unit variable cost to $77 [$70 + ($70 X 10%)]. The new contribution margin per unit is therefore $43 ($120 – $77). Thus the new break-even point in units is calculated as follows:
Fixed cost ÷ Contribution margin per unit = Break-even point in units
$94,500 ÷ $43 = 2,198 units .

13. It is important to understand
Sales Mix
When a company sells more than one product:
It is important to understand
its sales mix.
The sales mix is the relative percentage in which a company sells its products.
If a company’s unit sales are 80% printers and 20% computers, its sales mix is 80% to 20%.
Sales mix is important because different products often have very different contribution margins.
SO 3: Explain the term sales mix and its effects on break-even sales.

14. Break-Even Sales in Units
A company can compute break-even sales for a mix of two or more products by determining the:
Weighted-average unit contribution margin of all products.
The weighted-average unit contribution margin is the sum of the weighted contribution margin of each product.
SO 3: Explain the term sales mix and its effects on break-even sales.

15. Break-Even Sales in Units – BE 6-7 & 6-8
Information for Bruno Corporation sells three different models of mosquito “zapper.”
Model A12 sells for $50 and has variable cost of $40
Model B22 sells for $100 and has a variable cost of $70
Model C124 sells for $400 and has a variable cost of $300
What is the weighted average unit contribution margin?
If the company has a fixed cost of 199,500 how many units of each model must the company sell in order to break even?
SO 3: Explain the term sales mix and its effects on break-even sales.

16. Break-Even Sales in Units – BE 6-7 & 6-8
Model A12 sells for $50 and has variable cost of $40
Model B22 sells for $100 and has a variable cost of $70
Model C124 sells for $400 and has a variable cost of $300
What is the weighted average unit contribution margin?
Model A12: 10 X .60 = $6.00
Model B22: 30 X .25 = $7.50
Model C124: 100 X.15 = $15.00
Total $28.50
Weighted-average contribution margin: CM multiplied by the sales mix
SO 3: Explain the term sales mix and its effects on break-even sales.

17. Break-Even Sales in Units – BE 6-7 & 6-8
Model A12 sells for $50 and has variable cost of $40
Model B22 sells for $100 and has a variable cost of $70
Model C124 sells for $400 and has a variable cost of $300
b) If the company has a fixed cost of 199,500 how many units of each model must the company sell in order to break even?
Breakeven: fixed cost divided by the Weighted-average CM
199,500 / $28.50 = 7,000
Model A12 7,000 X .60 = 4,200
Model B22 7,000 X .25 = 1,750
Model C124 7,000 X .15 = 1,050
Multiply the # of units by the sales mix in order to reach the number of units for each products in the mix

18. Break-Even Sales in Dollars
The calculation of break-even point in units works well if the company has only a few products.
Consider 3M which has over 30,000 different products:
3M would need to calculate 30,000 different
unit contribution margins.
When there are many products, calculate the break-even point in terms of sales dollars for divisions or product lines, NOT individual products.
SO 3: Explain the term sales mix and its effects on break-even sales.

19. Break-Even Sales in Dollars - Example
Compute sales mix as a percentage of total dollar sales rather than units sold,
and
Compute the contribution margin ratio rather than the contribution margin per unit.
SO 3: Explain the term sales mix and its effects on break-even sales.

20. Chapter Review - Brief Exercise 6-9
Presto Candle Supply makes candles. The sales mix (as a percent of total dollar sales) of its three product lines is as follows: birthday candles, 30%; standard tapered candles, 50%; and large scented candles, 20%. The contribution margin ratio of each candle type is shown below.
Candle Type Contribution Margin Ratio
Birthday %
Standard tapered %
Large scented %
What is the weighted-average contribution margin ratio?

21. Chapter Review - Brief Exercise 6-9
Type of Candles CMR Sales Mix
Birthday 10% × 30% = 3%
Standard tapered 20% × 50% = 10%
Large scented 45% × 20% = 9%
Weighted Average Contribution Margin Ratio 22%
If the company’s fixed costs are $440,000 per year, what is the dollar amount of each type of candle that must be sold to break even?
Step 1: Fixed Costs:
$440,000 ÷ WACMR 22% = $ BEP = $2,000,000
Step 2:
Birthday candles $2,000,000 × % = $ 600,000
Standard tapered $2,000,000 × % = 1,000,000
Large scented $2,000,000 × % = 400,000

22. Let’s Review Net income will be:
a. Greater if more higher-contribution margin units are sold than lower-contribution margin units.
b. Greater if more lower-contribution margin units are sold than higher-contribution margin units.
c. Equal as long as total sales remain equal, regardless of which products are sold.
d. Unaffected by changes in the mix of products sold.
SO 3: Explain the term sales mix and its effects on break-even sales.

23. Sales Mix with Limited Resources (BE 6-11)
All companies have limited resources whether it be floor space, raw materials, direct labor hours, etc.
Limited resources force management to decide which products to sell to maximize net income.
Example: In Larissa Company, data concerning two products are:
Contribution margin per unit – Product A $10, Product B $12;
Machine house required for one unit – Product A 2hrs, Product B 3hrs.
Compute the contribution margin per unit of limited resource for each product

24. Sales Mix with Limited Resources – BE 6-11
Product B seems to be more profitable since it has the higher contribution margin per unit, but they require more machine hours to produce than Product A.
To determine the appropriate sales mix, compute the contribution margin per unit of limited resource:
Product A $10 / 2 hours = 5
Product B $12 / 3 hours = 4
(contribution margin per unit / machine hours)
Product A has the higher contribution margin per unit of limited resources. Management would likely produce more of these instead of Product B – depending on demand… or increase machine capacity

25. Contribution Margin per unit of limited resources
When a company has limited resources (e.g., floor space, raw materials, direct labor hours), management must decide which products to make and sell in order to maximize net income. Assume that Seth Inc. has limited machine capacity which is 2,600 hours per month. Relevant data consist of the following:
Tables Chairs
Contribution margin per unit $40 $10
Machine hours required per unit

26. The contribution margin per unit of limited resource is calculated as follows:
Tables Chairs
Contribution margin
per unit (a) $ $10
Machine hours required (b)
per unit of
limited resource (a/b) $50 $62.50

27. If Seth Inc. increases machine capacity hours by 400 hours per month, it would be better to use the hours to produce more chairs.
Tables Chairs
Machine hours (a)
Contribution margin
per unit of
limited resource (b) $ 50 $
[(a) X (b)] $20,000 $25,000

28. Let’s Review
If the contribution margin per unit is $15 and it takes 3.0 machine hours to produce the unit, the contribution margin per unit of limited resource is:
a. $25.
b. $5.
c. $4.
d. No correct answer is given.
SO 4: Determine the sales mix when a company has limited resources.

29. Cost Structure and Operating Leverage
Cost Structure is the relative proportion of fixed versus variable costs that a company incurs.
May have a significant effect on profitability.
Thus, a company must carefully choose its cost structure.
SO 5: Understand how operating leverage affects profitability.

30. Operating Leverage
Operating leverage refers to the extent that net income reacts to a given change in sales.
Higher fixed costs relative to variable costs cause a company to have higher operating leverage.
When sales revenues are increasing, high operating leverage means that profits will increase rapidly – a good thing.
When sales revenues are declining, too much operating leverage can have devastating consequences.
SO 5: Understand how operating leverage affects profitability.

31. Let’s Review The degree of operating leverage:
a. Can be computed by dividing total contribution margin by net income.
b. Provides a measure of the company’s earnings volatility.
c. Affects a company’s break-even point.
d. All of the above.
SO 5: Understand how operating leverage affects profitability.

32. ANY QUESTIONS?