ACCTG 505 -- CHAPTER 3
COST-VOLUME-PROFIT ANALYSIS
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1. Introduction

Basic Planning Tool -- Answers “what if?” questions.

Examines behavior of total revenues, total costs, and operating income as changes occur in output level, selling price, variable costs per unit, and/or fixed costs.

50% surveyed companies use some form

Underlying Assumptions Show Fragility of Model

Volume of units produced and sold is the only driver affecting changes in revenue and costs

Total costs can be divided into fixed and variable components.

All costs and revenues are linear

Unit SP, VC, and total fixed costs are known and constant

Sales mix, if multi-product company, remains constant

Inventories are kept constant or at zero

There is a relevant range of volume within which the above assumptions are valid

Time value of money not usually considered
2. Mechanics

Income = ƒ[SP, Q, VC, FC] + [“Other stuff]

Contribution Margin income statement:

Sales (10,000 units @$80/unit $800,000
Less All Variable Costs (1,000 @ $48/unit) 480,000
Contribution Margin $320,000
Less All fixed costs 180,000
Operating Income $ 140,000

Contribution Margin: --
Contribution Margin Ratio: --

Use to determine following:

Breakeven sales in units and in dollars
Sales needed to determine target net income
Indifference point between options
Alternative cost structure models
Multi-product breakeven and target income
A. Breakeven in Units

(USP x Q) – (UVC x Q) – FC = OI

Essentially boils down to this --

Fixed Costs/UCM = Breakeven in Units
Fixed Costs/CM Ratio = Breakeven in $ sales

Graph Approach – Plot total revenue, total costs. Intersection point of two lines is BE. CVP graph shown

Total $

Quantity in units
Profit-Volume Graph: Shows operating income at different volume levels

Operating income $

$0 Units

B. Target Net Income

(Fixed Costs + BEFORE TAX Income)/CM or CM%

Assume example company has tax rate of 35%. How many units must be sold to achieve an after-tax income of $100,000?

1.
2.
3.

C. Sensitivity Analysis: -- How will results change if predicted data not achieved or an underlying assumption changes?

What if unit SP or VC change? CM and BE will change
What if fixed costs change? BE will change
By how much can sales fall before hit BE? Margin of safety

D. Indifference Point:

At what volume level is there no difference between the options being examined?

Alternative 1. USP $80, UVC $48, FC $260,000
Alternative 2 USP $80, UVC $30, FC $440,000

Significance of Above?

1.

2.

What factors would influence your choice?
E. Operating Leverage

The extent to which fixed costs are