ACG 2071
Cot Behavior and Cost Volume Profit Analysis
Cost-Volume-Profit Analysis (CVP)
 Which helps them predict how changes in costs and sales
levels affect income
 CVP analysis involves computing the sales level at which a
company neither earns an income nor incurs a loss – break
even point
Cost behavior – refers to the manner in which a cost changes as a
related activity changes.
 Activity bases – activities that are thought to cause the cost to
be incurred.
 Relevant range – range of activity over which the changes in the
cost that are of interest.
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ACG 2071
Cot Behavior and Cost Volume Profit Analysis

Cost Classification
o Variable costs – costs that vary in proportion to changes
in the level of activity.
 Direct materials
 Direct labor
Units Produced
5,000 units
10,000 units
15,000 units
Direct Materials per
unit
$10
$10
$10
Total Direct
Material Costs
$ 50,000
100,000
150,000
Direct Material Cost
Total Variable Cost Curve
$0
5,000
10,000
15,000
Total units Produced
o Fixed Costs – costs that remain the same in total dollar
amounts as the level of activity changes.
Number of Bottles
50,000
100,000
150,000
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Total Salary for
Supervisor
$75,000
$75,000
75,000
Salary per bottle
produced
$1.50
$0.75
$0.50
ACG 2071
Cot Behavior and Cost Volume Profit Analysis
Total Fixed Costs
0
50,000
100,000
150,000
Total Units Produced.
o Mixed Costs – has characteristics of both a variable and
a fixed cost.
o Could behave as a fixed costs for part of the
relevant range and then variable cost
Cost
Total Amount
Increases and
decreases
proportionately with
activity level
Remains the same
regardless of activity
level
Per Unit Amount
Remains the same
regardless of activity
level
Variable Cost
Direct materials
Fixed Cost
Depreciation expense
Direct labor
Property Taxes
Electricity expense
Sales commissions
Officers Salaries
Insurance Expense
Mixed Cost
Quality Control Dept
Salaries
Purchasing Dept
Salaries
Maintenance expenses
Warehouse Expense
Variable
Fixed
Increases and
decreases inversely
with activity level
Types of Costs
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ACG 2071
Cot Behavior and Cost Volume Profit Analysis
Contribution Margin Concept
o Contribution margin = Sales – Variable costs
o Contribution margin ratio =
Sales – Variable costs
Sales
Is most useful when the increase or decrease
in sales volume is measured in sales dollars
o Unit contribution margin
= Sales price per unit – Variable cost per unit
Example: The Company has sales of $1,000,000, variable costs of
$800,000. The company sold 50,000 units. Compute the contribution
margin and the contribution margin ratio.
Contribution margin = Sales – Variable cost
= $1,000,000 - $800,000 = $200,000
Contribution margin ratio = (Sales – VC)/Sales
= (1,000,000 – 800,000)/1,000,000
= 20%
Unit Contribution margin = Contribution margin
Units sold
= $200,000
50,000
= $4
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Fall, 2007
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ACG 2071
Cot Behavior and Cost Volume Profit Analysis
The mathematical approach to cost-volume-profit analysis
uses equations
1. to determine the units of sales necessary to achieve the
break even pint in operations
2. to determine the units of sales necessary to achieve a
target or desired profit
Break-Even Point
Is the level of operations at which a business’s revenues
and expired costs are exactly equal?
A business will have neither an income nor a loss from
operations.
Break Even Exists when
Revenues
Costs
Formula
BEP =
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Fall, 2007
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Fixed Costs__________
Unit contribution margin
ACG 2071
Cot Behavior and Cost Volume Profit Analysis
Example: Suppose that selling price is $25, variable cost $15 and
fixed costs are $90,000. What is break even point?
BEP = Fixed costs / Unit Contribution Margin
= $90,000/ (25 – 15) = $90,000/$10 = 9,000 units
At sales level of 9,000 units will result in no gain or loss to the
company.
Proof:
Sales: ($25 X 9,000)
Variable cost: ($15 x 9,000)
Contribution margin
Fixed costs
Operating income
$225,000
135.000
90,000
90,000
-0-
Effect of Changes on BEP
 Changes in fixed costs
o Example: Suppose that selling price is $25, variable cost
$15 and fixed costs are $90,000. What is break even point if
fixed costs increase to $100,000?
BEP = Fixed costs/ Unit Contribution margin
= $100,000/ (25-15) = 10,000 units
Due to an increase in fixed costs from $90,000 to $100,000, break
even point increased to 10,000 units from 9,000 units or an increase
of 1,000 units.
 Changes in variable costs
o Example: Suppose that selling price is $25, variable cost
$15 and fixed costs are $90,000. What is break even point if
variable costs decrease to $10?
BEP = Fixed costs/ Unit Contribution margin
= $90,000/ (25-10) = 6,000 units
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Fall, 2007
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ACG 2071
Cot Behavior and Cost Volume Profit Analysis
Due to a decrease in variable costs from $15 to $10, break even point
decreased to 6,000 units from 9,000 units or a decrease of 3,000
units.
 Changes in selling price
o Example: Suppose that selling price is $25, variable cost
$15 and fixed costs are $90,000. What is break even point if
selling price increase to $30?
BEP = Fixed costs/ Unit Contribution margin
= $90,000/ (30-15) = 6,000 units
Due to an increase in sales price from $25 to $30, break even point
decreased to 6,000 units from 9,000 units or a decrease of 3,000
units.
Effect on
Break Even
Decreases
Increases
Selling Price
Increases
Decreases
Variable Costs
Decreases
Increases
Fixed Costs
Decreases
Increases
Desired or Target Profit
o Firms would like to earn a profit and not just to break even.
Formula changes to :
BEP = Fixed costs + Desired Profit
Unit contribution margin
o Example: Suppose that selling price is $45, variable cost
$30, and fixed costs are $60,000. The company wants a
desired profit of $45,000. What is break even point?
BEP = Fixed costs + Desired profit/ Unit Contribution margin
= ($60,000)/ (45-30) = 4,000 units
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ACG 2071
Cot Behavior and Cost Volume Profit Analysis
BEP = Fixed costs + Desired profit/ Unit Contribution margin
= ($60,000 + $45,000)/ (45-30) = 7,000 units
To create $45,000 of profit, must sell 7,000 units or 3,000 more than
break even point.
Cost-Volume-Profit Chart
Break even Point
Sales
Profit Area
Total
Costs
Loss Area
Computing Multi-product Break-Even Point – (Sales Mix
Analysis)
o More than one product is sold at varying selling prices.
o Products often have different unit variable costs and each
product makes a different contribution to profits.
o Sales volume necessary to beak even or to earn a target
profit for a business selling two or more products depends
upon the sales mix.
o It is the relative distribution of sales among the various
products sold by a business.
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Fall, 2007
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ACG 2071
Cot Behavior and Cost Volume Profit Analysis
o Example: Cascade Company had fixed costs of $200,000 in
the production of Yuk and Guk. Yuk has a selling price of
$90, variable cost of $70, and is 80% of total sales. Guk has
a selling price of $140, variable cost of $95, and is 20% of
total sales. What is the break even point for the sales mix?
o Step 1: Compute the sales mix contribution margin. This is
done by multiplying the contribution margin for each product
by the sales percentage. Then we add the individual
contribution margins to get the sale mix contribution margin.
Product
Yuk
Guk
Selling Variable Contribution
Price
Cost
Margin
$90
$140
$70
$95
$90-$70 =
$20
$140-95 =
$45
Total
Sales mix
Sales
contribution
Percentage
margin
80%
$20 x 80% = $16
20%
$45 x 20% = $9
$25
o STEP 2: Compute the break even point using the regular
formula and the sales mix contribution margin
BEP = Fixed costs / Unit contribution margin
= $200,000/$25 = 8,000 units
The 8,000 units must be allocated between the two products based on
the sales percentage.
o STEP 3: Allocate the break even units between products by the
sales percentage.
Yuk is 80% x 8,000 units = 6,400 units
Guk is 20% x 8,000 units = 1,600 units
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ACG 2071
Cot Behavior and Cost Volume Profit Analysis
Applying Cost-Volume-Profit Analysis
Margin of Safety –
o The difference between the current sales revenue and the
sales at the break-even point.
o It indicates the possible decrease in sales that may occur
before an operating loss results.
Margin of safety =
Sales – Sales at break even point
Sales
o Example: if sales are $400,000, and sales at break even are
$300,000 what is the margin of safety?
Ms =
Sales – Sales at break even point
Sales
= $400,000 - $300,000
$400,000
= 25%
High-Low Method
Cost estimation technique that may be used for this purpose
STEPS:
1. Find the highest and lowest level of production
2. Find the difference in total cost from highest to lowest
level of production
3. Find the difference in total units from highest to lowest
level of production
4. Variable cost per unit = Difference in total cost
Difference in total units
5. Find fixed cost by solving this equation:
Total cost = Fixed cost + Variable cost
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Fall, 2007
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ACG 2071
Cot Behavior and Cost Volume Profit Analysis
Example: Find the variable cost per unit and fixed cost from the
information below:
Month
Total Cost
June
July
August
September
October
Production
(in units)
1,000
1,500
2,100
1,800
1,290
Month
High: August
Low: October
Difference
Production
2,100
1,290
810
Total Cost
$61,500
$41,250
20,250
$45,550
$ 52,000
61,500
57,500
41,250
Variable costs: difference in Total Cost = 20,250
difference in production = 810
Variable costs: $25 per unit
Using the highest month of production:
TOTAL COST = Fixed Cost + Variable Cost
$61,500 = FC + ($25 x 2,100)
$61,500 = FC + $52,500
FC = $9,000
What is the total cost at 1,500 units of production given the
information derived above?
Total Cost = Fixed Cost + Variable Cost
From above we know at Fixed cost is $9,000 and variable cost is $25
per unit
Total Cost = $9,000 + ($25 X 1,500) = $9,000 + $37,500 = $46,500
is total cost at 1,500 units of production
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Fall, 2007
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ACG 2071
Cot Behavior and Cost Volume Profit Analysis
Operating Leverage
o The relative mix of a business’s variable costs and fixed costs is
measured by the operating leverage
Operating Leverage = Contribution Margin
Income from operations
o Since the difference between contribution margin and income
from operations is fixed costs, companies with large amounts of
fixed costs will generally have a high operating leverage.
o Indicates that a small increase in sales will yield a large
percentage increase in income from operations.
o Low operating leverage
o Indicates that a large increase in sales is necessary to
significantly increase income from operations.
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Fall, 2007
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