The document discusses key concepts of cost-volume-profit (CVP) analysis including: 1) CVP analysis uses contribution margin, the difference between sales revenue and variable costs, and fixed costs to calculate break-even point and profit at different sales volumes. 2) Break-even point is the sales volume where total revenue equals total costs, and is calculated as fixed costs divided by contribution margin per unit or contribution margin ratio. 3) Sensitivity analysis uses the CVP model to evaluate the impact of changes in factors like price, costs, sales on profit.

1. CHAPTER 3
Cost-Volume-Profit
(CVP)
Analysis

2. 3-2
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Basic Assumptions
 Changes in production/sales volume are the
sole cause for cost and revenue changes
 Total costs consist of fixed costs and variable
costs
 Revenue and costs behave and can be
graphed as a linear function (a straight line)

3. 3-3
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Basic Assumptions, continued
 Selling price, variable cost per unit, and fixed
costs are all known and constant
 In many cases only a single product will be
analyzed. If multiple products are studied,
their relative sales proportions are known and
constant
 The time value of money (interest) is ignored

4. 3-4
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Basic Formulae
Total Cost Pretax
Operating Revenues of Operating
Income from Goods Expenses
Operations Sold
=
Net Operating Income
Income Income Taxes
=

5. 3-5
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Contribution Margin
 Contribution Margin equals sales less
variable costs
 CM = S – VC
 Contribution Margin per unit equals unit
selling price less variable cost per unit
 CMu = SP – VCu

6. 3-6
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Contribution Margin
 Contribution Margin also equals contribution
margin per unit multiplied by the number of
units sold
 CM = CMu x Q
 Contribution Margin Ratio (percentage)
equals contribution margin per unit divided by
selling price
 CMR = CMu ÷ SP

7. 3-7
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Contribution Margin
Income Statement Derivations
 A horizontal presentation of the Contribution
Margin Income Statement:
 Sales – VC – FC = Operating Income (OI)
 (SP x Q) – (VCu x Q) – FC = OI
 Q (SP – VCu) – FC = OI
 Q (CMu) – FC = OI
 Remember this last equation, it will be used
again in a moment

8. 3-8
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
CVP, Graphically
Total
costs
line
Operating
loss area
Breakeven point = 25 units
$10,000
y
$8,000
$6,000
$5,000
$4,000
$2,000
Dollars
10 20 25 30 40 50
x
Units Sold
Total
costs
line
Operating
loss area
Operating
income area
Breakeven
point
= 25 units
Total
revenues
line
Operating
income
Variable
costs
Fixed
costs

9. 3-9
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Breakeven Point
 Recall the last equation in an earlier slide:
 Q (CMu) – FC = OI
 A simple manipulation of this formula, and
setting OI to zero will result in the Breakeven
Point (quantity):
 BEQ = FC ÷ CMu
 At this point, a firm has no profit or loss at
a given sales level

10. 3-10
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Breakeven Point, continued
 If per-unit values are not available, the
Breakeven Point may be restated in its
alternate format:
 BE Sales = FC ÷ CMR

11. 3-11
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Breakeven Point, extended:
Profit Planning
 With a simple adjustment, the Breakeven
Point formula can be modified to become a
Profit Planning tool
 Profit is now reinstated to the BE formula,
changing it to a simple sales volume equation
 Q = (FC + OI)
CM

12. 3-12
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
CVP and Income Taxes
 From time to time it is necessary to move back and forth
between pre-tax profit (OI) and after-tax profit (NI),
depending on the facts presented
 After-tax profit can be calculated by:
 OI x (1-Tax Rate) = NI
 NI can substitute into the profit planning equation
through this form:
 OI = I I NI I
(1-Tax Rate)

13. 3-13
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Sensitivity Analysis
 CVP provides structure to answer a variety of
“what-if” scenarios
 “What” happens to profit “if”:
 Selling price changes
 Volume changes
 Cost structure changes
 Variable cost per unit changes
 Fixed cost changes

14. 3-14
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Margin of Safety
 One indicator of risk, the Margin of Safety
(MOS) measures the distance between
budgeted sales and breakeven sales:
 MOS = Budgeted Sales – BE Sales
 The MOS Ratio removes the firm’s size from
the output, and expresses itself in the form of
a percentage:
 MOS Ratio = MOS ÷ Budgeted Sales

15. 3-15
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Operating Leverage
 Operating Leverage (OL) is the effect that fixed
costs have on changes in operating income as
changes occur in units sold, expressed as
changes in contribution margin
 OL = Contribution Margin
Operating Income
 Notice these two items are identical, except for
fixed costs

16. 3-16
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Effects of Sales-Mix on CVP
 The formulae presented to this point have assumed a
single product is produced and sold
 A more realistic scenario involves multiple products
sold, in different volumes, with different costs
 For simplicity’s sake, only two products will be
presented, but this could easily be extended to even
more products

17. 3-17
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Effects of Sales-Mix on CVP
 A weighted-average CM must be calculated (in this
case, for two products)
 This new CM would be used in CVP equations
Weighted ( Product #1 CMu x Product #1 Q ) + ( Product #2 CMu x Product #2 Q )
Average
CMu
=
Total Units Sold (Q) for Both Products
Multi- Fixed Costs
Product Weighted Average CM per unit
BE
=

18. 3-18
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Multiple Cost Drivers
 Variable costs may arise from multiple cost
drivers or activities. A separate variable cost
needs to be calculated for each driver.
Examples include:
 Customer or patient count
 Passenger miles
 Patient days
 Student credit-hours

19. 3-19
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
Contribution Margin vs.
Gross Profit Comparative Statements
Revenues: $200
Less:
Variable Cost of Goods Sold $120
Variable Operating Costs 45 165
Contribution Margin 35
Fixed Operating Costs 20
Operating Income $15
Contribution Margin Income Statement
(Internal-Use Only)
Revenues: $200
Less:
Cost of Goods Sold $120
Gross Margin (Profit) 80
Fixed & Variable Operating Costs 65
Operating Income $15
Financial Accounting Income Statement
GAAP - Based