Cost-Volume-Profit
Analysis
Chapter 3
Accounting Principles II
AC 2102 - Fall Semester, 1999
Chapter 15 - 1
Overview of CVP Analysis
• Is a powerful tool for planning & decision
making
• Focuses on the interrelationships between
costs, quantity sold, and price
• Can quickly show the economic impact of
different operational/financial
circumstances and decisions
• Can be a valuable tool to identify economic
problems & assist in pinpointing the
necessary solution
Chapter 15 - 2
Some of the Key Issues
CVP Analysis Addresses
• The number of units or dollars of revenue
required to break-even
• The impact of a given reduction in fixed
costs on the break-even point and overall
profitability
• The impact of an increase in price on
profitability
• The sensitivity of profits to changes in
Chapter 15 - 3
prices, costs or volume levels
Break-Even Point In Units
• The break-even point is where total
revenues equals total cost
– The point of zero profit
• In terms of units, the break-even point is the
number of units sold which will result in a
zero profit level
• Several work steps are required to perform a
break-even analysis
Chapter 15 - 4
Work Steps Required To Perform
a Cost-Volume-Profit Analysis
• 1st Step: Define a “unit”
• 2nd Step: Separate costs into fixed and
variable components
– Note: this second step requires the separating of
mixed costs into their fixed and variable
components
• 3rd Step: Apply the appropriate
mathematical analysis and
equations
Chapter 15 - 5
Some Possible Definitions of a “Unit”
(i.e., units “produced” and sold)
• Automobile Company: Cars
• Hospital: Patient-Days
• Hotel: (1) Guest-Days
(2) Number of Occupied Rooms
(3) % of Rooms Occupied
• Soft-drink Company: Cans of 12-ounce
equivalents
• Pharmacy: Cannot be defined in “units”
Chapter 15 - 6
Separating Costs Into Their
Fixed & Variable Components
• In most problems presented in text books this step
has already been performed
– i.e., in most C-V-P problems, the costs that are
fixed and variable are already defined
• It should be clearly understood that in practice this
is the most difficult step in a C-V-P analysis
• In the accounting records costs are only defined by
nature of the expense (salaries, insurance, etc.)
– i.e., the cost behavior pattern of each cost is
not identified in the accounting records
Chapter 15 - 7
Contribution Margin
• Contribution margin is an extremely useful
and insightful concept
• Two Definitions:
Price - Variable Costs per Unit = CM per unit
or
Total Revenue - Total Variable Costs
= Total Contribution Margin
• Note: It is not the same as Gross Margin
– Gross Margin = Revenues - Cost of Goods Sold
Chapter 15 - 8
Two Ways of Calculating
The Contribution Margin
Per Unit Basis:
= Contribution Per Unit/Price Per Unit
Contribution Margin Ratio:
= Total Contribution Margin/Total Revenues
Chapter 15 - 9
Mathematical Analysis
When Dealing With Unit Data
• Breakeven Point:
= Total Fixed Costs/Contrib. Margin Per Unit
• Sales Required to Achieve Targeted Profit
Level (Before Taxes):
= (FC+Targ. PBT) /Contrib. Margin Per Unit
Chapter 15 - 10
Mathematical Analysis When
Dealing With Total Sales Dollars
• Breakeven Point:
= Total Fixed Costs/Contrib. Margin Ratio
• Sales Required to Achieve Targeted Profit
Level (Before Taxes):
= (FC+Targ. PBT) /Contrib. Margin Ratio
Chapter 15 - 11
Other Key Concepts
• Margin of Safety:
= Actual Sales - Breakeven Sales
- can be expressed in units or sales dollars
• Operating Leverage:
= The ratio of a firm’s fixed costs to its
variable costs
• Degree of Operating Leverage:
= Contribution Margin/Operating Income Chapter 15 - 12