Chapter 7
Cost-Volume-Profit Analysis
and Variable Costing
1
Introduction
Cost-volume-profit (CVP) analysis focuses on the
following factors:
1. The prices of products or services
2. The volume of products or services produced
and sold
3. The per-unit variable costs
4. The total fixed costs
5. The mix of products or services produced
2
The Contribution Margin Income
Statement
The contribution margin income statement is
structured by behavior rather than by
function.
Sales - All Variable Costs = Contribution Margin
Contribution Margin - All Fixed Costs = Net
Income
3
Contribution Margin Per Unit
For every unit change in sales,
contribution margin will increase
or decrease by the contribution
margin per unit multiplied by the
increase or decrease in sales
volume.
4
Contribution Margin Ratio
Contribution Margin Ratio
=
Contribution Margin (in $)
Sales (in $)
5
Contribution Margin Ratio
For every dollar change in sales,
contribution margin will increase or
decrease by the contribution margin
ratio multiplied by the increase or
decrease in sales dollars.
6
Break-Even Analysis
Break-Even Point: The level of sales
where contribution margin just covers
fixed costs and consequently net
income is equal to zero.
7
Break-Even Analysis
Fixed Costs
Break-Even
=
Contribution Margin Per Unit
(units)
Break-Even
Fixed Costs
=
(Sales $)
Contribution Margin Ratio
8
Break-Even Calculations Using ActivityBased Costing
When using activity-based-costing, costs are
classified as unit, batch, product, or facility
level instead of variable or fixed.
Break-Even (units) =
Fixed Costs + Batch-Level Costs + Product-Level Costs
Contribution Margin Per Unit
9
Target Profit Analysis
(Before and After Tax)
To determine the sales units required to
achieve a target profit before taxes:
Sales Volume =
Fixed Costs + Target Profit (before taxes)
Contribution Margin Per Unit
10
The Impact of Taxes
If
After-Tax Profit = Before-Tax Profit (1-tax rate)
then
Before-Tax Profit = After-Tax Profit / (1-tax rate)
Therefore, to determine after-tax Target Profit
Sales in units =
Fixed Costs + After-Tax Profit / (1-Tax Rate)
Contribution Margin per Unit
11
The Impact of Taxes
The payment of income tax is an
important variable in target
profit and other CVP decisions.
12
Assumptions of CVP Analysis
1. Selling price is constant throughout the relevant
range.
2. Costs are linear throughout the relevant range.
3. The sales mix used to calculate the weighted
average contribution margin is constant.
4. The amount of inventory is constant.
13
Cost Structure and Operating Leverage
Operating Leverage: The measure of the
proportion of fixed costs in a company’s cost
structure. It is used as an indicator of how
sensitive profit is to changes in sales volume.
14
Cost Structure and Operating Leverage
Contribution Margin
Operating Leverage =
Net Income
Operating Leverage X % Increase in Sales = % Increase in Net
Income
15
Cost Structure and Operating Leverage
A company operating near the breakeven point will have a high level of
operating leverage and income will be
very sensitive to changes in sales
volume.
16
Variable Costing for Decision Making
The only difference between absorption and
variable costing is the treatment of fixed overhead.
Absorption Costing: Fixed overhead is treated as a
product cost and expensed when the product is
sold.
Variable Costing: Fixed overhead is treated as a
period cost and expensed as incurred.
17
Differences Between Absorption and
Variable Costing
•When units sold equal units produced, net
income is the same under both costing methods.
•When units produced exceed units sold,
absorption costing will report higher net income
than variable costing.
•When units sold exceed units produced, variable
costing will report higher net income than
absorption costing.
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