1. Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
Chapter 7
Cost-Volume-
Profit Analysis

2. 7-2
The Break-Even PointThe Break-Even Point
The break-even point is the point in the
volume of activity where the organization’s
revenues and expenses are equal.
Sales 250,000$
Less: variable expenses 150,000
Contribution margin 100,000
Less: fixed expenses 100,000
Net income -$

3. 7-3
Equation ApproachEquation Approach
Sales revenue – Variable expenses – Fixed expenses = Profit
UnitUnit
salessales
priceprice
SalesSales
volumevolume
in unitsin units
××
UnitUnit
variablevariable
expenseexpense
SalesSales
volumevolume
in unitsin units
××
($500 × X)× X) ($300 × X)× X)–– –– $80,000 = $0
($200X)X) –– $80,000 = $0
X = 400 surf boardsX = 400 surf boards

4. 7-4
Contribution-Margin ApproachContribution-Margin Approach
For each additional surf board sold,
Curl generates $200 in contribution
margin.
Total Per Unit Percent
Sales (500 surf boards) 250,000$ 500$ 100%
Less: variable expenses 150,000 300 60%
Contribution margin 100,000$ 200$ 40%
Less: fixed expenses 80,000
Net income 20,000$
Consider the following information
developed by the accountant at Curl, Inc.:

5. 7-5
Contribution-Margin ApproachContribution-Margin Approach
Fixed expensesFixed expenses
Unit contribution marginUnit contribution margin ==
Break-even pointBreak-even point
(in units)(in units)
Total Per Unit Percent
Sales (500 surf boards) 250,000$ 500$ 100%
Less: variable expenses 150,000 300 60%
Contribution margin 100,000$ 200$ 40%
Less: fixed expenses 80,000
Net income 20,000$
$$80,00080,000
$$200200
== 400 surf boards400 surf boards

6. 7-6
Contribution-Margin ApproachContribution-Margin Approach
Here is the proof!
Total Per Unit Percent
Sales (400 surf boards) 200,000$ 500$ 100%
Less: variable expenses 120,000 300 60%
Contribution margin 80,000$ 200$ 40%
Less: fixed expenses 80,000
Net income -$
400 × $500 = $200,000400 × $500 = $200,000 400 × $300 = $120,000400 × $300 = $120,000

7. 7-7
Contribution Margin RatioContribution Margin Ratio
Calculate the break-even point in sales dollars
rather than units by using the contribution margin
ratio.
Contribution margin
Sales
= CM
Ratio
Fixed expenseFixed expense
CM RatioCM Ratio
Break-even pointBreak-even point
(in sales dollars)(in sales dollars)
==

8. 7-8
Total Per Unit Percent
Sales (400 surf boards) 200,000$ 500$ 100%
Less: variable expenses 120,000 300 60%
Contribution margin 80,000$ 200$ 40%
Less: fixed expenses 80,000
Net income -$
Contribution Margin RatioContribution Margin Ratio
$80,000$80,000
40%40%
$200,000 sales$200,000 sales==

9. 7-9
Graphing Cost-Volume-ProfitGraphing Cost-Volume-Profit
RelationshipsRelationships
Viewing CVP relationships in a graph gives
managers a perspective that can be obtained in
no other way.
Consider the following information for Curl, Inc.:

10. 7-10
Cost-Volume-Profit GraphCost-Volume-Profit Graph
Dollars
600 700 800
Units
200 300 400 500
450,000
100
200,000
150,000
100,000
50,000
400,000
350,000
300,000
250,000
Fixed expenses

11. 7-11
Cost-Volume-Profit GraphCost-Volume-Profit Graph
Dollars
600 700 800
Units
200 300 400 500
450,000
100
200,000
150,000
100,000
50,000
400,000
350,000
300,000
250,000
Fixed expenses
Total expenses

12. 7-12
Cost-Volume-Profit GraphCost-Volume-Profit Graph
Dollars
600 700 800
Units
200 300 400 500
450,000
100
200,000
150,000
100,000
50,000
400,000
350,000
300,000
250,000
Fixed expenses
Total expenses

13. 7-13
Cost-Volume-Profit GraphCost-Volume-Profit Graph
Dollars
600 700 800
Units
200 300 400 500
450,000
100
200,000
150,000
100,000
50,000
400,000
350,000
300,000
250,000
Fixed expenses
Total expenses
Total sales

14. 7-14
Cost-Volume-Profit GraphCost-Volume-Profit Graph
Dollars
600 700 800
Units
200 300 400 500
450,000
100
200,000
150,000
100,000
50,000
400,000
350,000
300,000
250,000
Fixed expenses
Total expenses
Total sales
Break-even
point
Break-even
point Profit area
Loss area

15. 7-15
Profit-Volume GraphProfit-Volume Graph
Some managers like the profit-volume
graph because it focuses on profits and volume.
Some managers like the profit-volume
graph because it focuses on profits and volume.
`
100 200 300 400 500 600 700
Units
Profit
0
100,000
(20,000)
(40,000)
(60,000)
80,000
60,000
40,000
20,000
Loss area
Profit area
Break-even
point
Break-even
point

16. 7-16
Target Net ProfitTarget Net Profit
We can determine the number of surfboards
that Curl must sell to earn a profit of $100,000
using the contribution margin approach.
We can determine the number of surfboards
that Curl must sell to earn a profit of $100,000
using the contribution margin approach.
Fixed expenses + Target profit
Unit contribution margin
=
Units sold to earn
the target profit
$80,000 + $100,000
$200
= 900 surf boards

17. 7-17
Equation ApproachEquation Approach
Sales revenue – Variable expenses – Fixed expenses = Profit
($500 × X)× X) ($300 × X)× X)–– –– $80,000 = $100,000$100,000$80,000 = $100,000$100,000
($200X)X) = $180,000= $180,000
X = 900 surf boardsX = 900 surf boards

18. 7-18
Applying CVP AnalysisApplying CVP Analysis
Safety Margin
• The difference between budgeted sales
revenue and break-even sales revenue.
• The amount by which sales can drop before
losses begin to be incurred.
Safety Margin
• The difference between budgeted sales
revenue and break-even sales revenue.
• The amount by which sales can drop before
losses begin to be incurred.

19. 7-19
Safety MarginSafety Margin
Curl, Inc. has a break-even point of $200,000.
If actual sales are $250,000, the safety margin is
$50,000 or 100 surf boards.

20. 7-20
Changes in Fixed CostsChanges in Fixed Costs
• Curl is currently selling 500 surfboards per
year.
• The owner believes that an increase of
$10,000 in the annual advertising budget,
would increase sales to 540 units.
Should the company increase the advertising
budget?
• Curl is currently selling 500 surfboards per
year.
• The owner believes that an increase of
$10,000 in the annual advertising budget,
would increase sales to 540 units.
Should the company increase the advertising
budget?

21. 7-21
Changes in Fixed CostsChanges in Fixed Costs
$80,000 + $10,000 advertising = $90,000$80,000 + $10,000 advertising = $90,000
540 units × $500 per unit = $270,000540 units × $500 per unit = $270,000

22. 7-22
Changes in Fixed CostsChanges in Fixed Costs
Sales will increase by
$20,000, but net income
decreaseddecreased by $2,000..
Sales will increase by
$20,000, but net income
decreaseddecreased by $2,000..

23. 7-23
Changes in UnitChanges in Unit
Contribution MarginContribution Margin
Because of increases in cost of raw materials,
Curl’s variable cost per unit has increased
from $300 to $310 per surfboard. With no
change in selling price per unit, what will be
the new break-even point?
Because of increases in cost of raw materials,
Curl’s variable cost per unit has increased
from $300 to $310 per surfboard. With no
change in selling price per unit, what will be
the new break-even point?
($500 × X)× X)($500 × X)× X) ($310 × X)× X)($310 × X)× X)–– – $80,000 = $0$80,000 = $0
X = 422 unitsX = 422 units (rounded)(rounded)

24. 7-24
Changes in UnitChanges in Unit
Contribution MarginContribution Margin
Suppose Curl, Inc. increases the price of
each surfboard to $550. With no change
in variable cost per unit, what will be the
new break-even point?
Suppose Curl, Inc. increases the price of
each surfboard to $550. With no change
in variable cost per unit, what will be the
new break-even point?
($550 × X)× X)($550 × X)× X) ($300 × X)× X)($300 × X)× X)–– – $80,000 = $0$80,000 = $0
X = 320 unitsX = 320 units

25. 7-25
Predicting Profit Given ExpectedPredicting Profit Given Expected
VolumeVolume
Fixed expenses
Unit contribution margin
Target net profit
Find: {req’d sales volume}Given:Given:
Fixed expenses
Unit contribution margin
Expected sales volume
Find: {expected profit}Given:Given:

26. 7-26
Predicting Profit GivenPredicting Profit Given
Expected VolumeExpected Volume
In the coming year, Curl’s owner expects to sell
525 surfboards. The unit contribution margin is
expected to be $190, and fixed costs are
expected to increase to $90,000.
In the coming year, Curl’s owner expects to sell
525 surfboards. The unit contribution margin is
expected to be $190, and fixed costs are
expected to increase to $90,000.
($190 × 525)× 525)($190 × 525)× 525) – $90,000 = X$90,000 = X
X = $9,750 profit
X = $99,750 – $90,000
Total contribution - Fixed cost = ProfitTotal contribution - Fixed cost = Profit

27. 7-27
CVP Analysis with MultipleCVP Analysis with Multiple
ProductsProducts
For a company with more than one product,
sales mix is the relative combination in which a
company’s products are sold.
Different products have different selling prices,
cost structures, and contribution margins.
Let’s assume Curl sells surfboards and sail
boards and see how we deal with break-
even analysis.
For a company with more than one product,
sales mix is the relative combination in which a
company’s products are sold.
Different products have different selling prices,
cost structures, and contribution margins.
Let’s assume Curl sells surfboards and sail
boards and see how we deal with break-
even analysis.

28. 7-28
CVP Analysis with MultipleCVP Analysis with Multiple
ProductsProducts
Curl provides us with the following
information:

29. 7-29
CVP Analysis with MultipleCVP Analysis with Multiple
ProductsProducts
Weighted-average unit contribution margin
$200 × 62.5%$200 × 62.5%
$550 × 37.5%$550 × 37.5%

30. 7-30
CVP Analysis with MultipleCVP Analysis with Multiple
ProductsProducts
Break-even point
Break-even
point
=
Fixed expenses
Weighted-average unit contribution margin
Break-even
point
=
$170,000
$331.25
Break-even
point
= 514 combined unit sales514 combined unit sales

31. 7-31
CVP Analysis with MultipleCVP Analysis with Multiple
ProductsProducts
Break-even point
Break-even
point
= 514 combined unit sales

32. 7-32
Assumptions UnderlyingAssumptions Underlying
CVP AnalysisCVP Analysis
1. Selling price is constant throughout
the entire relevant range.
2. Costs are linear over the relevant
range.
3. In multi-product companies, the
sales mix is constant.
4. In manufacturing firms, inventories
do not change (units produced =
units sold).
1. Selling price is constant throughout
the entire relevant range.
2. Costs are linear over the relevant
range.
3. In multi-product companies, the
sales mix is constant.
4. In manufacturing firms, inventories
do not change (units produced =
units sold).

33. 7-33
CVP Relationships andCVP Relationships and
the Income Statementthe Income Statement
A. Traditional Format
Sales $500,000
Less: 380,000
Gross margin $120,000
Less: Operating expenses:
Selling expenses $35,000
Administrative expenses 35,000 70,000
Net income $50,000
ACCUTIME COMPANY
Income Statement
For the Year Ended December 31, 20x1

34. 7-34
CVP Relationships andCVP Relationships and
the Income Statementthe Income Statement
B. Contribution Format
Sales $500,000
Less: Variable expenses:
Variable manufacturing $280,000
Variable selling 15,000
Variable administrative 5,000 300,000
Contribution margin $200,000
Less: Fixed expenses:
Fixed manufacturing $100,000
Fixed selling 20,000
Fixed administrative 30,000 150,000
Net income $50,000
Income Statement
For the Year Ended December 31, 20x1
ACCUTIME COMPANY

35. 7-35
Cost Structure and OperatingCost Structure and Operating
LeverageLeverage
• The cost structure of an organization is the
relative proportion of its fixed and variable
costs.
• Operating leverage is . . .
– the extent to which an organization uses fixed
costs in its cost structure.
–greatest in companies that have a high
proportion of fixed costs in relation to
variable costs.
• The cost structure of an organization is the
relative proportion of its fixed and variable
costs.
• Operating leverage is . . .
– the extent to which an organization uses fixed
costs in its cost structure.
–greatest in companies that have a high
proportion of fixed costs in relation to
variable costs.

36. 7-36
Measuring Operating LeverageMeasuring Operating Leverage
Contribution margin
Net income
Operating leverage
factor
=
$100,000$100,000
$20,000$20,000
= 5= 5

37. 7-37
Measuring Operating LeverageMeasuring Operating Leverage
A measure of how a percentage change in
sales will affect profits. If Curl increases its
sales by 10%, what will be the percentage
increase in net income?
A measure of how a percentage change in
sales will affect profits. If Curl increases its
sales by 10%, what will be the percentage
increase in net income?
Percent increase in sales 10%
Operating leverage factor × 5
Percent increase in profits 50%

38. 7-38
Measuring Operating LeverageMeasuring Operating Leverage
A firm with proportionately high fixed costs has
relatively high operating leverage On the other
hand, a firm with high operating leverage has a
relatively high break-even point.

39. 7-39
CVP Analysis, Activity-Based Costing,CVP Analysis, Activity-Based Costing,
and Advanced Manufacturing Systemsand Advanced Manufacturing Systems
An activity-based costing system can provide
a much more complete picture of cost-
volume-profit relationships and thus provide
better information to managers.
Break-evenBreak-even
pointpoint
== Fixed costsFixed costs
Unit contribution marginUnit contribution margin

40. 7-40
Overhead costs like setup, inspection, and material
handling are fixed with respect to sales volume,
but they are not fixed with respect to other cost
drivers.
This is the fundamental distinction between a
traditional CVP analysis and an activity-based
costing CVP analysis.
Overhead costs like setup, inspection, and material
handling are fixed with respect to sales volume,
but they are not fixed with respect to other cost
drivers.
This is the fundamental distinction between a
traditional CVP analysis and an activity-based
costing CVP analysis.
A Move Toward JIT andA Move Toward JIT and
Flexible ManufacturingFlexible Manufacturing

41. 7-41
Effect of Income TaxesEffect of Income Taxes
Target after-tax net
income
1 - t
=
Before-tax
net income
Income taxes affect a company’s
CVP relationships. To earn a
particular after-tax net income, a
greater before-tax income will be
required.

42. 7-42
End of Chapter 7End of Chapter 7
We madeWe made
it!it!