Cost-Volume-Profit Analysis
Chapter 3
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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Learning Objective 1
Understand the assumptions
underlying cost-volume-profit
(CVP) analysis.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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Cost-Volume-Profit Assumptions
and Terminology
1. Changes in the level of revenues and costs arise
only because of changes in the number of product
(or service) units produced and sold.
2. Total costs can be divided into a fixed component
and a component that is variable with respect to
the level of output.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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Cost-Volume-Profit Assumptions
and Terminology
3. When graphed, the behavior of total revenues
and total costs is linear (straight-line) in relation
to output units within the relevant range
(and time period).
4. The unit selling price, unit variable costs, and
fixed costs are known and constant.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
3-4
Cost-Volume-Profit Assumptions
and Terminology
5. The analysis either covers a single product or
assumes that the sales mix when multiple
products are sold will remain constant as the
level of total units sold changes.
6. All revenues and costs can be added and
compared without taking into account the time
value of money.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
3-5
Cost-Volume-Profit Assumptions
and Terminology
Operating income
= Total revenues from operations
– Cost of goods sold and operating costs
(excluding income taxes)
Net income = Operating income – Income taxes
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
3-6
Learning Objective 2
Explain the features
of CVP analysis.
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Essentials of Cost-Volume-Profit
(CVP) Analysis Example
Assume that the Pants Shop can purchase pants
for $32 from a local factory; other variable costs
amount to $10 per unit.
The local factory allows the Pants Shop to
return all unsold pants and receive a full $32
refund per pair of pants within one year.
The average selling price per pair of pants is $70
and total fixed costs amount to $84,000.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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Essentials of Cost-Volume-Profit
(CVP) Analysis Example
How much revenue will the business receive if
2,500 units are sold?
2,500 × $70 = $175,000
How much variable costs will the business incur?
2,500 × $42 = $105,000
$175,000 – 105,000 – 84,000 = ($14,000)
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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Essentials of Cost-Volume-Profit
(CVP) Analysis Example
What is the contribution margin per unit?
$70 – $42 = $28 contribution margin per unit
What is the total contribution margin when
2,500 pairs of pants are sold?
2,500 × $28 = $70,000
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
3 - 10
Essentials of Cost-Volume-Profit
(CVP) Analysis Example
Contribution margin percentage (contribution
margin ratio) is the contribution margin per
unit divided by the selling price.
What is the contribution margin percentage?
$28 ÷ $70 = 40%
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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Essentials of Cost-Volume-Profit
(CVP) Analysis Example
If the business sells 3,000 pairs of pants,
revenues will be $210,000 and contribution
margin would equal 40% × $210,000 = $84,000.
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©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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Learning Objective 3
Determine the breakeven point
and output level needed to achieve
a target operating income using
the equation, contribution margin,
and graph methods.
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
3 - 13
Breakeven Point
Sales
–
Variable
expenses
=
Fixed
expenses
Total revenues = Total costs
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Abbreviations
SP = Selling price
VCU = Variable cost per unit
CMU = Contribution margin per unit
CM% = Contribution margin percentage
FC = Fixed costs
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Abbreviations
Q = Quantity of output units sold
(and manufactured)
OI = Operating income
TOI = Target operating income
TNI = Target net income
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Equation Method
(Selling price × Quantity sold) – (Variable unit cost
× Quantity sold) – Fixed costs = Operating income
Let Q = number of units to be sold to break even
$70Q – $42Q – $84,000 = 0
$28Q = $84,000
Q = $84,000 ÷ $28 = 3,000 units
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Contribution Margin Method
$84,000 ÷ $28 = 3,000 units
$84,000 ÷ 40% = $210,000
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$(000)
Graph Method
Breakeven
378
336
294
252
210
168
126
84
42
0
Fixed costs
0
1000
2000
3000
4000
5000
Units
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Target Operating Income
(Fixed costs + Target operating income)
divided either by Contribution margin
percentage or Contribution margin per unit
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Target Operating Income
Assume that management wants to have an
operating income of $14,000.
How many pairs of pants must be sold?
($84,000 + $14,000) ÷ $28 = 3,500
What dollar sales are needed to achieve this income?
($84,000 + $14,000) ÷ 40% = $245,000
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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Learning Objective 4
Understand how income
taxes affect CVP analysis.
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Target Net Income
and Income Taxes Example
Management would like to earn
an after tax income of $35,711.
The tax rate is 30%.
What is the target operating income?
Target operating income
= Target net income ÷ (1 – tax rate)
TOI = $35,711 ÷ (1 – 0.30) = $51,016
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Target Net Income
and Income Taxes Example
How many units must be sold?
Revenues – Variable costs – Fixed costs
= Target net income ÷ (1 – tax rate)
$70Q – $42Q – $84,000 = $35,711 ÷ 0.70
$28Q = $51,016 + $84,000
Q = $135,016 ÷ $28 = 4,822 pairs of pants
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
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Target Net Income
and Income Taxes Example
Proof:
Revenues: 4,822 × $70
Variable costs: 4,822 × $42
Contribution margin
Fixed costs
Operating income
Income taxes: $51,016 × 30%
Net income
$337,540
202,524
$135,016
84,000
51,016
15,305
$ 35,711
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
3 - 25
Learning Objective 5
Explain CVP analysis
in decision making and
how sensitivity analysis helps
managers cope with uncertainty.
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