Chapter 17
Cost volume profit analysis
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
1
Cost volume profit (CVP)
analysis
 A technique used to determine the effects
of changes in an organisation’s sales
volume on its costs, revenue and profit
 Can be used in profit-seeking and not-for
profit organisations
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
2
The break-even point
 The volume of sales where the total
revenues and expenses are equal, and the
operation breaks even
 Can be calculated for an entire organisation
or individual projects or activities
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
3
Formulas
Fixed expenses
Break - even point (in units) =
Unit contribution margin
Break - even point (in sales dollar) =
Fixed expenses
Unit contribution marginratio
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
4
Terminology
 Contribution margin (or variable costing)
statement
A reporting format where costs are reported by
cost behaviour and a contribution margin is
calculated
 Total contribution margin
The difference between the sales revenue and
the variable costs
The amount available to cover fixed costs and
then contribute to profits
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
5
Terminology
 Unit contribution margin
The difference between the sales price per unit
and variable cost per unit
 Contribution margin ratio
The unit contribution margin divided by the unit
sales price
The proportion of each sales dollar available to
cover fixed costs and earn a profit
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
6
Terminology
 Contribution margin percentage
The unit contribution margin ratio multiplied by
100
The percentage of each sales dollar available to
cover fixed costs and earn a profit
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
7
Cost volume profit (CVP)
graph
 Shows how costs, revenue and profits
change as sales volume changes
 Five steps
Draw the fixed expense line
Draw the total expense line
Draw the total revenue line
Break-even point—where the total revenue and
total expense lines intersect
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
8
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
9
Profit volume (PV) graph
 Shows the total amount of profit or loss at
different sales volumes
 The graph intercept the vertical axis at the
amount equal to the fixed costs
 The break-even point is the point at which
the line crosses the horizontal axis
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
10
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
11
Target net profit
 A desired profit level determined by
management
 Can be used within the break-even formula
Target sales volume =
Fixed expenses + target profit
Unit contribution margin
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
12
CVP analysis and
management decision making
 Common applications include
Safety margin
Changes in fixed expenses
Changes in the unit contribution margin
Multiple changes in key variables
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
13
Safety margin
 Difference between the budgeted sales
revenue and the break-even sales revenue
 Gives a feel for how close projected
operations are to the break-even point
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
14
Changes in fixed expenses
 When estimates of fixed costs are revised,
the break-even point will change
Percentage change in fixed expenses will lead to
similar increase in the break-even point (in units
or dollars)
 Different fixed costs may apply to different
levels of sales/production volume
More than one break-even point
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
15
Changes in the unit
contribution margin
 Change in unit variable expenses
Changes the unit contribution margin
A new break-even point
An increase in unit variable expenses will
increase the break-even point
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
16
Changes in the unit
contribution margin
 Change in sales price
Changes the unit contribution margin
A new break-even point
An increase in unit price will lower the breakeven point
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
17
Multiple changes in key
variables
 May involve
Increasing unit prices
Undertaking an advertising campaign
Hiring a new storage facility
 An incremental approach
Focuses on the difference in the total
contribution margin, fixed expenses and profits
under the two alternatives
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
18
CVP analysis with multiple
products
 Sales mix
The relative proportions of each type of product
sold by the organisation
 Weighted average unit contribution margin
The average of the products’ unit contribution
margins, weighted by the sales mix
Break - even point =
Fixed expenses
Weighted average unit contribution margin
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
19
Including income taxes
Sales volume required to earn target after - tax profit
target net profit after tax
Fixed expenses +
(1 - t)
=
Unit contribution margin
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
20
Assumptions underlying
CVP analysis
 The behaviour of total revenue is linear
 The behaviour of total costs is linear over a
relevant range
Costs can be categorised as fixed, variable or
semivariable
Labour productivity, production technology and
market conditions do not change
There are no capacity changes during the period
under consideration
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
21
Assumptions underlying
CVP analysis
 For both variable and fixed costs, sales
volume is the only cost driver
 The sales mix remains constant over the
relevant range
 In manufacturing firms, levels of inventory
at the beginning and end of the period are
the same
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
22
CVP analysis and longterm decisions
 CVP analysis is usually regarded a shortterm or tactical decision tool
 Classification of costs as variable or fixed is
usually based on cost behaviour over the
short-term
 The financial impact of long-term decisions
best analysed using capital budgeting
techniques
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
23
Treating CVP analysis with
caution
 CVP analysis is merely a simplified model
 The usefulness of CVP analysis may be
greater in less complex smaller firms, or
stand-alone projects
 For larger firms, CVP analysis can be
valuable as a decision tool for the planning
stages of new projects and ventures
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
24
An activity-based
approach to CVP analysis
 ABC categorises activities as facility,
product, batch or unit costs
Facility, product and batch activities are nonvolume activity costs
Break - even point =
Total batch, product and facility level costs
Sellingprice per unit - costs per unit
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
25
Limiting assumption of
using activity-based costs
 Batch costs are based on likely production
levels
 New planned production levels lead to
changes in the number of production
batches, and changes in total non-volume
activity costs -> new break-even or target
profit volume
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
26
Sensitivity analysis and
CVP analysis
 Sensitivity analysis
An approach which examines how an outcome
may change due to variations in the predicted
data or underlying assumptions
 Can be run using spreadsheet software,
such as Excel
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
27
continued
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
28
Sensitivity analysis and
CVP analysis
 Goal seeking approaches
Allows the analyst to specify the outcome, so
that software can specify the necessary inputs
 What-if analysis
The analyst specifies changes in assumptions to
examine the effect of these changes on the
output
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
29
Copyright  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Management Accounting: An
Australian Perspective 3/e by Langfield-Smith, Thorne & Hilton
Slides prepared by Kim Langfield-Smith
30