Break-Even-Analysis . CVP . cost excerpt from the author's copyrighted Cost Management seminar/training text.

1. Management Accounting
Cost-Volume-Profit aka: Break-Even Analysis
Douglas A. Sledge, CPA, CGMA, CMA, MBA, Certified QuickBooks® ProAdvisor
Management Accountant
www.dougsledgecma.com
• Management Accounting (MA) is a profession that involves partnering in management decision making, devising planning and performance management systems, and providing expertise in financial reporting and control to assist management in the formulation and implementation of an organization’s strategy.
• Outsourced Management Accounting (MA) is the business building role of accounting and finance professionals. MA professionals are involved in:
o developing, implementing and monitoring both general and cost accounting systems
o designing and evaluating business processes, budgeting and forecasting
o implementing and monitoring internal controls
o analyzing, synthesizing, and aggregating information.
o assisting clients in planning, control and growth endeavors
o working with banks and financial institutions on behalf of clients.
• The Chartered Global Management Accountant (CGMA) is the Management Accounting designation awarded by the American Institute of Certified Public Accountants (AICPA). The Certified Management Accountant (CMA) is the Management Accountant designation awarded by the Institute of Management Accountants (IMA).
Exhibits and information presented in this seminar text are general in nature and the author does not represent that the use of such will be correct in any specific application.
Excerpted from Basics of Operations Costing . Copyright 2008
Douglas A. Sledge
This document, or any portions thereof, may not be reproduced
without the express written consent of the author
© Douglas A. Sledge Page 1

2. Cost-Volume-Profit/Break-Even Analysis
(Excerpted) Basics of Operations Costing
Manufacturing Cost Accounting
A Brief Series Publication
Douglas A. Sledge, CMA, CPA, MBA, Certified QuickBooks® ProAdvisor
The Brief Series of handbooks is designed as a quick read review of today’s hot business topics. Each handbook in the series is a short, easy to understand reading, ideal for the business executive wishing to understand and review essential, sometimes make or break, operational financial measures of small business. The Brief Series concept concentrates on management understanding rather than on technical detail.
In the Brief Series, we will confine our discussion to the small for-profit business operation. Small business is generally defined as less than fifty million dollars in annual sales. This business group has generally not been provided analytical and control support commensurate with medium and large scale operations in the area of cost accounting. In this text we will explore cost accounting for the small manufacturer.
The operations costing concept to be discussed develops the cost of the product at any stage of production from Raw Material (RM), to work-in-process (WIP), through Finished Goods (FG). Costs and inputs are developed for each product through the identification and accumulation of materials, labor and overhead expenses incurred in processing the product to each sequential step being reviewed. In addition, the identification and analysis of material, labor and overhead variances provides support for decision making and resolution of efficiency and spending issues in the operation.
For small & medium business (SMB), this methodology is generally designated as Manufacturing Resource Planning (MRPII), an extension of earlier Materials Resource Planning (MRP) methodologies. MRPII is the counterpart to Enterprise Resource Planning (ERP) for larger operations… The main difference in the two concepts is that ERP addresses cost impact through external support and interactive operations, whereas MRPII typically addresses cost influences at one location. The basic cost and analysis concepts are the same for either level of operation. The three terms, MRP, MRPII and ERP, are often used interchangeably in production environment discussions.
Disclaimer: The training, information and materials used and offered in this course of training are presented with no specific guarantee or warranty as to use, knowledge or application of such information, and/or training. While due diligence and significant review have been taken by the program developer and sponsors, neither the presenter(s), author, compiler, editor, sponsoring organizations (including, without limitation, its officers and directors) shall have any liability to any person or entity with respect to any losses, misapplication of programs, or damage caused or alleged to have been caused directly or indirectly by the use, instructions or information contained and/or presented in this program.
© Douglas A. Sledge Page 2

3. Douglas A. Sledge, CPA, CGMA, CMA, MBA, Certified Intuit (QuickBooks®) ProAdvisor
Dba: Douglas A. Sledge, CGMA Consultant Resume Brief 2014 This is not a CPA Firm
Douglas A. Sledge is a Certified Public Accountant (CPA) (Alabama & Texas), a Chartered Global Management Accountant (CGMA), a Certified Management Accountant (CMA), a Certified Intuit (QuickBooks®) ProAdvisor (Premier, On-Line & Enterprise Solutions), and holds a Master of Business Administration (MBA) from the University of North Alabama (UNA). He has been employed professionally in support of startup, turnaround and continuing operations for a diverse mix of employers and clients ranging from local shops to a major school system to national corporations. He provides Management Accounting services (Outsourced CFO/Controller/Cost Controller/Management Accountant)… he does not provide CPA attest functions.
He completed coursework for a major in accounting at the University of North Alabama (UNA) in 1973, as a Bachelor of Science post-graduate, following a three-year enlistment as a German language qualified Intelligence Agent with the US Army. Previously, he graduated with undergraduate double majors (B.S.) from UNA in Physics and Chemistry in 1968. He accomplished his MBA in 1977.
He instructed with UNA in an adjunct capacity for several years, and conducted a variety of seminars with subjects related to cost accounting, presentation techniques, general accounting and strategic planning; for UNA, Brookhaven Community College (DCCCD . Dallas), Northeast Community College (TCCD . Fort Worth), UT Arlington-SBDC, and the GulfSouth Council of the Institute of Management Accountants (IMA). He is an approved provider for continuing education with the Alabama Board of Heating and Air Conditioning Contractors.
He is a Certified Journeyman Gas Fitter and a Certified HVAC Contractor (#83142) in the State of Alabama (both inactive, but current status). Early in his career, he held supervisory positions in production manufacturing & maintenance, HVAC and gas fitting. While employed as a Cost Accountant/Analyst with Ford Motor Company, he completed a two year management development initiative, supervising production operations and industrial plant maintenance. Recently, he provided Management Accounting Consultant services in the aerospace distribution industry in Texas.
He is a former Regional Council President and National Vice President with the Institute of Management Accountants (IMA). He currently is a member of the IMA, the American Institute of Certified Public Accountants (AICPA), and the Alabama Society of Public Accountants (ASCPA). He serves on the School of Accountancy Advisory Committee with UNA (SME Management Accountant). He is an honorary member of Delta Mu Delta Business Honor Society (2000). He was a member of the national Member Services Committee of the IMA in 2003, and completed requirements for certification as an Alabama Certified School Financial Officer in 2004 (AASBO). He has been certified as a Intuit (QuickBooks®) ProAdvisor since 2008, and is a gold member of the QuickBooks National Advisors Network (NAN).
Copy & Paste: Intuit Link… http://proadvisor.intuit.com/quickbooks-help/douglas-sledge#top
© Douglas A. Sledge Page 3

4. CONTENTS
Chapter 1 Cost Volume Profit Relationships page 5
Breakeven Graph page 9
Breakeven Analysis Example page 10
Sensitivity Analysis Example page 11
• Management Accounting (MA) is a profession that involves partnering in management decision making, devising planning and performance management systems, and providing expertise in financial reporting and control to assist management in the formulation and implementation of an organization’s strategy.
• Outsourced Management Accounting (MA) is the business building role of accounting and finance professionals. MA professionals are involved in:
o developing, implementing and monitoring both general and cost accounting systems
o designing and evaluating business processes, budgeting and forecasting
o implementing and monitoring internal controls
o analyzing, synthesizing, and aggregating information.
o assisting clients in planning, control and growth endeavors
o working with banks and financial institutions on behalf of clients.
• The Chartered Global Management Accountant (CGMA) is the Management Accounting designation awarded by the American Institute of Certified Public Accountants (AICPA). The Certified Management Accountant (CMA) is the Management Accountant designation awarded by the Institute of Management Accountants (IMA).
© Douglas A. Sledge Page 4

5. Chapter 1: Cost-Volume-Profit..
Cost relationships and concepts are basic tools for management control at every operational level. Understanding the principles of cost-volume-profit (CVP) interactions (aka: break even analysis) is key to effective cost management for all business disciplines… sales, production inventory control, finance, accounting, to name a few…. A discussion of CVP (break-even analysis) follows. Let’s review some terminology to enhance understanding of the concepts..
TERM: Variable Costs are those costs which change in direct relation to, and as a result of, changes in cost object activity, within the relevant range of activity. This cost object activity is different for different businesses… Examples include:
• Production cost for manufacturing
• Installation and service cost for HVAC and other and service operations.
• Feet drilled direct cost in a energy field drilling operation.
• Material cost for merchandising
• Percentage based sales commissions
TERM: Fixed Costs are those costs which do not change as a direct result of cost object activity.
TERM: Relevant Range of Activity… That operational range of cost activity, within which the company should expect to operate, and within which, variable cost relationships and fixed costs remain reasonably stable (constant).
Intuitively we know that the generalized sales/profit equation looks like:
Profit = Sales – Expense
Or:… restated….
Sales = Profit + Expense
If we further define expense as having both fixed and variable components:
Expense = Fixed Expense + Variable Expense
Then….
Sales = Profit + Fixed Expense (cost) + Variable Expense (cost)
Sales = Profit + FC + VC
© Douglas A. Sledge Page 5

6. It follows that at breakeven sales, there will be no profit:
SBE = zero profit + FC + VC
SBE = FC + VC
It is reasonable to assume that sales activity will parallel production (cost) activity if inventory levels and mix remain unchanged. Let’s make such an assumption. Deductive reasoning then draws the conclusion that variable costs can be expressed as a direct ratio (percentage, decimal, fraction…) of sales dollars….
We qualify the breakeven equation as:
SBE= FC+ VC
Where FC is constant, and VC can be stated as a direct ratio of sales.
Now… let’s talk math equations for a minute…. The linear sales at breakeven equation is stated mathematically as:
f(x) = a + bx
y = a + bx
Applying this equation to breakeven analysis defines the components as:
• “y” represents total sales dollars.
• “a” represents fixed cost.
• “bx” represents variable cost, with “b” being the variable cost of sales ratio and x being unit volume activity..
If plotted on a two dimensional (Cartesian coordinate) graph, activity level dollars being the “y” axis, and unit volume activity being the “x” axis:
• “y” represents total sales dollars on the “y” axis.
• “a” represents fixed cost, at its intersection on the “y” axis.
• “bx” represents variable cost. The line increases on the “y” axis in linear fashion with a change in sales activity on the “x” axis.
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7. Restating the relationships graphically (Exhibit 1.1):
• On a two dimensional graph, “a” is the fixed cost intercept on the “y” axis.
• Based on the ratio represented by “b”, the value for “bx” will change linearly on the “y” axis with changes in sales volume on the “x” axis.
• The top diagram on Exhibit 1.1 demonstrates this mathematical model.
For mathematicians…. This is a linear function… Evidenced by the power (exponential) for “x” being one (unitary)…. The first derivative, with respect to “x” is a constant, also 1. It follows that the first derivative, with respect to “x” for the function “bx” is “b”, a constant….. “b” is the linear rate of change (velocity), and represents (is) the slope of the variable cost line.
Referring to Exhibit 1.1, diagram 1.1a, one can see:
• Fixed costs are portrayed by a horizontal line drawn at the “a” intercept on the “y” axis… The line continues at the same value horizontally…. The activity is considered to be in the relevant operating range, hence fixed costs remain unchanged (constant within the relevant range).
• Variable costs increase as additional sales are generated. Variable costs add to fixed cost to portray the total cost. To graphically demonstrate..
o the variable cost line originates at the “a” intercept, so as to add to fixed costs as it increases (upward slope).
• Sales revenue originates at the “xy” intercept (origin) since “zero sales equals zero revenue”. The slope of the line represents unit sales (“x” axis) extended at the unit sales price. Hopefully the slope is greater than the slope of the variable cost line….
• The breakeven point is at the intersection of the sales revenue line and the full cost line (variable cost line beginning at “a” on the “y” axis)…. A vertical line (parallel to the “y” axis) drawn to the “x” axis finds the breakeven product activity units.
Sales revenue in excess of the breakeven point provides for a profit. This is graphically demonstrated as the difference between the sales revenue line and the total cost line. Revenue less than breakeven generates a loss, likewise the difference between the sales revenue line and the total cost line.
The difference between sales revenue and variable costs is defined as the “variable contribution” (marginal contribution, marginal income). This is the amount available to cover fixed cost and provide a profit. Fixed costs are considered to be the primary user of the variable contribution, profit being realized after all fixed costs are covered. © Douglas A. Sledge Page 7

8. Diagram 1.1b on Exhibit 1.1 illustrates the variable contribution concept graphically. This is illustrated by plotting the variable cost line from the origin of the graph, and adding consistent fixed costs to the variable cost line as unit activity increases.
TERM: Variable Contribution is the excess of revenue over variable costs.
TERM: Variable Cost Ratio: The ratio of variable costs to sales price, expressed as a decimal.
TERM: Variable Contribution Ratio: The ratio of variable contribution to sales price, expressed as a decimal.
Note: The sum of the variable cost ratio and the variable contribution ratio is one (1).. (unity)…
This graphical presentation illustrates that after variable costs are covered, fixed costs are the first user of the variable contribution, profits being covered secondary to fixed costs…
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9. 1 – 1 a. y
Revenue
Dollars
Variable Cost (bx)
Break Even
Total Cost
Fixed Cost “a” Fixed Cost “a”
x
Origin Break Even
Product Activity
1 – 1 b y
Revenue
Dollars
Fixed Cost “a”
Break Even
Variable Cost
Fixed Cost “a” Total Cost
x
Origin Break Even
Product Activity
Exhibit 1.1
© Douglas A. Sledge Page 9

10. Breakeven Example:
Assumptions:
• A product sells for $1.50 each.
• Variable cost is $0.90 each.
o Variable cost ratio is ($0.90/$1.50) = 0.6
o Variable contribution ratio is: ({$1.50-$0.90}/$1.50) = 0.4
o The sum of the variable cost ratio and the variable contribution ratio is 1….. 0.6 + 0.4…..
• Fixed cost is $100,000 per year for the company.
Requirement…: Determine sales required to break-even on an annual basis. Recalling our earlier break-even equation…..
SBE = FC + VC ….. FC (fixed cost) are constant… VC (variable cost) is expressed as a ratio of sales….
SBE= $100,000 + (0.6 x SBE)
Transposing… 0.4SBE= $100,000
SBE = $250,000….. or… ($250,000/$1.50) = 166,667 units
Or view as:
SBE in revenue dollars = FC/(unit contribution ratio)
SBE = $100,000/0.4
SBE = $250,000
Term: Unit Variable Contribution is the unit sales price less the unit variable cost.
Another approach to breakeven analysis is the “unit variable contribution” approach. The breakeven equation is modified to:
SBE in units = FC/(unit variable contribution)
SBE = $100,000/$0.60…. ….. the denominator $0.60 = ($1.50 - $ 0.90)
SBE = 166,667 units……
at $1.50 unit sales price = $250,000
© Douglas A. Sledge Page 10

11. Sensitivity Analysis Example:
Sensitivity analysis is a useful aspect of the CVP relationship. Sensitivity analysis can be viewed as a “what if” exercise. For example:
Assumptions: … The same as in the prior break-even example.
Requirement: Determine the projected profit on sales of $300,000 per year?
Recall the sales with profit formula…
Sales = Profit + FC+ VC….
where VC is expressed as a decimal ratio of sales
$300,000 = Profit + $100,000 + (0.6 x $300,000)
or:
Profit = $300,000 – $100,000 – (0.6 x $300,000)
Profit = $300,000 – $100,000 – $180,000
Profit = $20,000
Projected profit can also be derived by multiplying the difference between the breakeven sales and the projected sales by the variable contribution ratio.
.
($300,000 - $250,000) X 0.40 = $20,000
A second sensitivity analysis example using the same assumptions….
Requirement: Profit must be $50,000.
Sales = FC+ VC + Profit
Sales = $100,000 + (0.6 x Sales) + $50,000
0.4 x Sales = $150,000
Sales = $375,000
Note: The set profit number “$50,000” calculates as a fixed cost.
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12. A third sensitivity analysis example…… Profits must be 10% (0.1) of sales.
Requirement: What is the projected required sales number?
Sales = FC + VC + Profit
Sales = $100,000 + (0.6 x sales) + (0.1 x sales)
(0.3 x sales) = $100,000
Sales = $333,333
Note: Profit (10.0%) behaves as a variable cost in this example.
CAUTION: If the linear relationship between fixed costs, variable costs, total costs and/or sales revenue is changed, then the total CVP relationship is changed, and must be reset. An example would be lowering the unit sales price in hopes of gaining market share; another would be increasing fixed costs of depreciation by purchase of capital assets; another, changing variable costs and fixed costs simultaneously by the purchase of automated equipment which reduces variable costs with an increase in fixed (periodic) depreciation expense.
CAUTION: If volume (sales) activity moves outside the operating relevant range of activity, the CVP relationships will change. For example, additional facility and equipment might need to be acquired, or lower margin products eliminated.
Let’s explore the effects of a change in sales price on profits. Begin with the initial example scenario assumptions and assume a decrease in sales price of 10%
Our new assumptions become…
• New unit sales price: $1.35 ($1.50 x 0.9)
• Variable cost: $0.90
• Variable contribution: $0.45
• Contribution ratio: 33.3%
• Variable cost ratio: 66.7%
• Original profit: @$300,000 $20,000
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13. Requirement .. determine the sales revenue needed to project the same profit as generated on sales of $300,000 at the original sales price?
The projection equation and calculation looks like:
Sales = Profit + FC+ VC
Sales = $100,000 + (0.667 x sales) + $20,000
0.333sales = $120,000
Sales = $360,000…… 266,667 units
In this scenario… A 10% decrease in sales price requires a 20% increase in sales revenue to generate the same bottom line profit as the original sales revenue at the original sales price…
The observant reader should be aware that CVP relationships vary for each set of product and contribution circumstances, and that the total decrease in sales price falls directly from the contribution margin (and profit), cost relationships remaining constant.
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14. GLOSSARY:
TERM: Assembly – A combination of any raw material (RM) or subassemblies through the application of conversion activity. The assembly may be constructed by any means which facilitates the combination or differentiation from the prior item. The assembly can be accomplishment by any means, to include…. welding, cooking, extrusion, chemical process, mixing, molding, injection molding, fastening, strapping… and so on…
TERM: Finished Goods (FG) are products completed and available for sale and shipment to customers.
TERM: Fixed Costs are those costs which do not change as a direct result of cost object activity.
TERM: Fixed Overhead (FOH) is made up of those production support costs which are not included in VOH as defined above. Federal regulations require that some administrative costs be included in FOH.
TERM: Job Order Costing refers to a system of cost development in which cost components are accumulated by job. Examples are repair shops, professional services, medical services, construction and so on… Costs are developed for each job, be it vehicle repair or surgery. This system remains in use in various forms in the service industry. See Appendix 1 for further discussion.
TERM: JUST IN TIME INVENTORY CONTROL SYSTEM: Early on, the Institute of Management Accountants (IMA) defined a just-in-time (JIT) inventory system as something like: “ A system whose purpose is to produce or procure the right parts at the right time, as they are needed rather than when they can be made. It is a “pull” manufacturing system that moves goods through a shop based on end-unit demand. Just-in-time focuses on maintaining a constant flow of components and products rather than batches of work-in-process inventory.”
TERM: Materials {Raw Materials (RM)} are those inventory items purchased for inclusion in the product to be manufactured. © Douglas A. Sledge Page 14

15. TERM: Process Costing refers to a system of cost development for products which are homogeneous in development (each unit is similar to any other unit of the same product). Examples are milk processors, paint manufacturers, water treatment plants, and so on. This system has been virtually obsoleted by MRPII and ERP systems. Process costing is discussed further in Appendix 2.
TERM: Relevant Range of Activity… That operational range of cost activity, within which the company should expect to operate, and within which, variable cost relationships and fixed costs remain reasonably stable (constant).
TERM: Routing.. The production path followed for development of a finished assembly (finished product)… i.e…. A sequential delineation of workcenter activity (operation) and costing for production of each subassembly and the final finished product.
TERM: Subassembly… Any assembly which is a component of another assembly.
TERM: Unit Variable Contribution is the unit sales price less the unit variable cost.
TERM: Variable Contribution is the excess of revenue over variable costs.
TERM: Variable Contribution Ratio: The ratio of variable contribution to sales price, expressed as a decimal.
TERM: Variable Costs are those costs which change in direct relation to, and as a result of, changes in cost object activity, within the relevant range of activity. This cost object activity is different for different businesses… Examples include:
• Production cost for manufacturing
• Installation and service cost for HVAC and other construction and service operations.
• Material cost for merchandising
• Percentage based sales commissions
TERM: Variable Cost Ratio: The ratio of variable costs to sales price, expressed as a decimal.
TERM: Variable Overhead (VOH) is made up of those production/service support costs which are incurred as a direct result of production/service activity and fluctuate linearly with such activity.
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16. TERM: Work-In-Process (WIP) are those partially completed inventory items at various stages of completion. © Douglas A. Sledge Page 16