1

Chapter 7

Cost-Volume-Profit Analysis and Variable

Costing

2

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

3

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

4

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.

5

Contribution Margin Ratio

Contribution Margin Ratio

=Contribution Margin (in

$)

Sales (in $)

6

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.

7

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.

8

Break-Even Analysis

Fixed Costs Contribution Margin Per Unit

Break-Even

(Sales $)

Break-Even

(units)

=

Fixed CostsContribution Margin Ratio=

9

Break-Even Calculations Using Activity-Based

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

10

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

11

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 ProfitSales in units

=

Fixed Costs + After-Tax Profit / (1-Tax Rate)

Contribution Margin per Unit

12

The Impact of Taxes

The payment of income tax is an

important variable in target profit and other

CVP decisions.

13

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.

14

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.

15

Cost Structure and Operating Leverage

Operating Leverage =

Contribution Margin

Net Income

Operating Leverage X % Increase in Sales = % Increase in Net Income

16

Cost Structure and Operating Leverage

A company operating near the break-even point will

have a high level of operating leverage and

income will be very sensitive to changes in

sales volume.

17

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.

18

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.