Chapter 6
Cost-Volume-Profit Analysis
and Variable Costing
Introduction
Cost-Volume-Profit Analysis (CVP) 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
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
Income Statements
TRADITIONAL
Sales
Less: Cost of Goods Sold:
Variable Costs
Fixed Costs
Total Cost of Goods Sold
Gross Profit
Less: S&A Costs:
Variable Costs
Fixed Costs
Total S&A Costs
Net Income
CONTRIBUTION MARGIN
$1,000
350
150
$ 500
$ 500
$ 50
250
$ 300
$ 200
Sales
Less: Variable Costs:
Manuf. Costs
S&A Costs
Total Variable Costs
Contribution Margin
Less: Fixed Costs:
Manuf. Costs
S&A Costs
Total Fixed Costs
Net Income
$1,000
$350
50
$400
$600
$150
250
$400
$200
Contribution Margin Ratio
Contribution Margin Ratio
=
Contribution Margin (in $)
Sales (in $)
Changes in Price and Volume
If the manager changes the sales price resulting in a
change in sales volume, what will be the impact on
net income?
Raising the sales price may decrease sales volume
but the impact on total sales revenue may be offset
by the increase in sales price.
Decreasing the sales price may increase the sales
volume without increasing total sales revenue.
Changes in Cost, Price and Volume
Changes can be made to cost, price and
volume at the same time.
Changes in one variable almost always
impact one or both of the other variables.
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.
Break-Even Analysis
Fixed Costs
Break-Even
=
Contribution Margin Per Unit
(units)
Break-Even
Fixed Costs
=
(Sales $)
Contribution Margin Ratio
Break-Even Calculations with Multiple
Products
The calculation of “average” contribution
margin is really a weighted average.
Fixed Costs
Break-Even Point =
Weighted Average Contribution
Margin Per Unit
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
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
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.
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.
Cost Structure and Operating Leverage
Contribution Margin
Operating Leverage =
Net Income
Multiply Operating Leverage x % increase in Sales = % increase in
Net Income
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.
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.
End of Chapter Six
I’m ready!
Bring on the
costs!