Chapter 4 Cost-Volume-Profit Analysis

CHAPTER

71

COST-VOLUME-PROFIT ANALYSIS

CHAPTER INTRODUCTION
The analysis of how costs and profit change when volume changes is referred to as cost-volume-profit
(CVP) analysis. In this chapter, tools are developed to enable managers to answer questions relating to
planning, control, and decision making.

Objectives, Terms, and Discussions

LO1

Identify common cost behavior patterns.

COMMON COST BEHAVIOR PATTERNS

To perform cost-volume-profit analysis (CVP), you need to know how costs behave when business
activity (e.g., production volume or sales volume) changes. This section describes some common
patterns of cost behavior.
Variable costs are costs that change in proportion to changes in volume or activity. For
example, if production volume increases by 10 percent, direct materials are expected to increase in
total by 10 percent. Examples of variable costs are direct material, direct labor, indirect material, and
sales commissions. The variable cost per unit does not change when volume or activity changes.
Exactly how activity should be measured in analyzing a variable cost depends on the situation. For
example, a caterers food cost (direct material) varies with number of guests served while an airlines
fuel cost varies with the number of miles flown.
Fixed costs are costs that do not change in response to changes in activity levels. Examples of
fixed costs are depreciation, supervisory salaries, building maintenance, and rent. For example, if fixed
costs total $94,000 for the period, whatever the number of units produced, the amount of fixed costs
remains at $94,000. However, the amount of fixed cost per unit does change with the level of activity.
For example, if 1,000 units are produced, fixed cost per unit is $94 ($94,000/1,000 units), but if
production increases to 2,000 units, fixed cost per unit decreases to $47 ($94,000/2,000 units).
In the short-run, some fixed costs can be changed while others cannot. Discretionary fixed
costs are those fixed costs that management can easily change in the short-run. Examples include
advertising, research and development, and repair and maintenance. Committed fixed costs are those

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fixed costs that cannot be easily changed in the short-run. Such costs include rent, depreciation of
buildings and equipment, and insurance related to buildings and equipment.
Mixed costs (also referred to as semivariable costs) are costs that contain both a variable cost
element and a fixed cost element. For example, if a salesperson is paid $80,000 per year (fixed cost)
plus a commission equal to 1 percent of sales (variable cost), the salespersons total compensation is a
mixed cost. Note especially that total production cost is also a mixed cost since it contains material,
labor, and both variable and fixed overhead costs.
Step costs are those costs that are fixed for a range of value but increase to a higher level
when the upper bound of the range is exceeded. At that point the costs again remain fixed until another
upper bound is exceeded. Step costs are often classified as either step variable or step fixed costs
depending on the range of activity for which the cost remains fixed. If the range is relatively large, the
cost is considered to be a step fixed cost. The relevant range is the range of activity for which
assumptions as to how a cost behaves are reasonable valid.
LO2

Estimate the relation between cost and activity using account analysis and the high-low
method.

COST ESTIMATION METHODS

To predict how much cost will be incurred at various levels of activity, how much of the total cost is
fixed and how much is variable must be determined. Frequently cost information is not broken out in
terms of fixed and variable cost components. Therefore, the amount of fixed and variable cost must be
estimated. In this chapter, three techniques are presented for estimating the amount of fixed and
variable cost: account analysis, the high-low method, and regression analysis.
Account analysis is the most common approach to estimating fixed and variable costs. This
method requires that the manager use professional judgement to classify costs as either fixed or
variable. The total of the costs classified as variable can be divided by a measure of activity to
calculate the variable cost per unit of activity. The total of the costs classified as fixed provides the
estimate of fixed cost. The account analysis approach is subjective in that different managers using the
same set of facts may reach different conclusions regarding the classification of costs into fixed and
variable components. Illustrations 4-7 and 4-8 in the textbook provide examples of estimating fixed and
variable costs using account analysis.
Scattergraphs In some cases, a manager may have cost information from several reporting
periods available to estimate how costs change in response to changes in activity. A manager can gain
insight into the relationship between production cost and activity by plotting costs and activity levels.
The plot of the data is referred to as a scattergraph. Generally, scattergraphs are prepared with cost
measured on the vertical axis and activity level measured on the horizontal axis. Each point in the
scattergraph represents one pair of cost and activity values. The preparation of scattergraphs is a
simple procedure using the graphical features in spreadsheet programs. To make predictions, managers
visually fit a line to the data points with the general idea to try to minimize the deviations of the data
points from the fitted line. The methods we use to estimate cost behavior assume that costs are linear.
In other words, they assume that costs are well represented by straight lines. A scattergraph is useful in
assessing whether this assumption is reasonable. The scattergraph is also useful in assessing whether
there are any outliers (data points that are markedly at odds with the trend of other data points).
Illustrations 4-9 and 4-10 in the textbook give an example of estimating fixed and variable cost using
the scattergraph approach.
The high-low method fits a straight line to the data points representing the highest and lowest
levels of activity. The slope of the line is the estimate of variable cost (because the slope measures the
change in cost per unit change in activity), and the intercept (where the line meets the cost axis) is the

Chapter 4 Cost-Volume-Profit Analysis

73

estimate of total fixed cost. The slope is equal to the change in cost divided by the change in activity.
Thus the estimate of variable cost (the slope) is calculated as:
Estimate of Variable Cost =
Estimate of
Variable Cost

Change in cost
Change in activity

Cost at highest level of activity Cost at lowest level of activity

Highest level of activity Lowest level of activity

The fixed cost equals the difference between total cost and estimated total variable cost at
either the high or low point. Fixed costs will be the same whether calculated using the highest level of
activity or the lowest level of activity. The high-low method is simple to do, but not reliable. Because
only the highest and lowest measures of activity are used, these may not be representative of the typical
cost behavior.
Regression analysis is a statistical technique that uses all the available data points to estimate
the intercept and slope of a cost equation. The line fitted to the data by regression is the best straightline fit to the data. The formulas used in conducting regression analysis are complex. However,
software programs that perform regression analysis are widely available. How to use Excel to
conduct regression analysis is explained in the appendix to this chapter. Regression analysis is covered
in introductory statistics classes. The application of regression analysis yields the following equation:
Total cost = Fixed cost + (Variable cost per unit x activity level in units)
Estimates of fixed and variable costs are only valid for a limited range of activity. The relevant
range is the range of activity for which estimates and predictions are expected to be accurate. Outside
the relevant range, estimates of fixed and variable costs may not be very useful. Often, managers are
not confident using estimates of fixed and variable costs in making predictions for activity levels that
have not been encountered in the past. Since the activity levels have not been encountered in the past,
past relations between cost and activity may not be a useful basis for estimating costs in this situation.
In some cases, actual costs behave in a manner that is different from the cost behavior patterns
discussed above. All those patterns imply linear (straight line) relations between cost and activity. In the
real world, some costs are nonlinear.
LO3

Perform cost-volume-profit analysis for single products.

COST-VOLUME-PROFIT ANALYSIS
The Profit Equation Once fixed and variable costs have been estimated, cost-volume-profit (CVP)
analysis can be conducted. CVP analysis is any analysis that explores the relations among cost, volume
or activity levels, and profit. Fundamental to CVP analysis is the profit equation which states that
profit is equal to revenue (selling price times quantity) minus variable cost (variable cost per unit times
quantity) minus total fixed cost.
Where

Profit
x
SP
VC
TFC

= SP(x) VC(x) TFC

= Quantity of units produced and sold
= Selling price per unit
= Variable cost per unit
= Total fixed cost

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Break-Even Point One of the primary uses of CVP analysis is to calculate the break-even
point. The break-even point is the number of units that must be sold for a company to break evento
neither earn a profit nor incur a loss.
To calculate the break-even point, we set the profit equation equal to zero. Then we insert the
appropriate selling price, variable cost, and fixed cost information and solve for the quantity (x). For
example, suppose CodeConnect produces a product that sells for $200 per unit, variable costs are
estimated to be $90.83 per unit, and total fixed costs are estimated to be $160,285. As shown below, a
company must sell 1,468 units to break even in a given period.
0
0
$109.17x
x

= $200(x) - $90.83(x) - $160,285

= $109.17(x) - $160,285
= $160,285
= 1,468 units

Solving for x yields a break-even quantity of 1,468 units. To express the break-even in dollars
of sales rather than units, the quantity is simply multiplied by the selling price of $200 to yield
$293,600.
Margin of Safety To express how close managers expect to be to the break-even level, they
may calculate the margin of safety. The margin of safety is the difference between the expected level of
sales and break-even sales. For example, if break-even sales are $293,600 and management expects to
have sales of $350,000, the margin of safety is $56,400 ($350,000 - $293,600).
Margin of Safety = Expected sales Break-even sales
The margin of safety can also be expressed as a ratio called the margin of safety ratio. It is
equal to the margin of safety divided by expected sales.
Margin of
Safety Ratio

Margin of Safety
Expected Sales

Contribution Margin The profit equation can be rewritten by combining the terms with x in
them to yield the contribution margin per unit. The contribution margin is defined as the difference
between the selling price per unit (SP) and variable cost per unit (VC). Profit is then calculated as the
difference between the contribution margin times the level of activity and the total fixed costs (TFC).
Profit = SP(x) VC(x) TFC
Profit = (SP-VC)(x) TFC
Profit = Contribution margin per unit (x) TFC
The contribution margin per unit measures the amount of incremental profit generated by
selling an additional unit. When sales and production increase by one unit the company benefits from
revenue (selling price), but that benefit is reduced by variable cost per unit. Fixed costs do not affect
the incremental profit associated with selling an additional unit because fixed costs are not affected by
changes in volume. Note that if we multiply the contribution margin per unit by the number of units
sold, we obtain the total incremental profit related to the units sold.
Units needed to Achieve Profit Target If we solve the profit equation for the sales quantity
in units, we get a formula for calculating the break-even for the level of sales in units or for calculating
the number of units needed to achieve a specified or target level of profit.

Chapter 4 Cost-Volume-Profit Analysis

Unit sales (X) needed
to attain specified
profit

Unit sales (X) needed to

attain specified profit

75

Profit + TFC
SP VC
Profit + TFC
Contribution margin per unit

The contribution margin ratio measures the amount of incremental profit generated by an
additional dollar of sales. It is equal to the contribution margin per unit divided by the selling price.
Contribution margin ratio =

SP VC
SP

We can express the profit equation in terms of the contribution margin ratio as:
Dollar sales needed to
attain specified profit

Profit + TFC
Contribution margin ratio

The profit equation also can show how profit will be affected by various options under
consideration by management. Such analysis is sometimes referred to as what if analysis because it
examines what will happen if a particular action is taken.
LO4

Perform cost-volume-profit analysis for multiple products.

MULTIPLEPRODUCT ANALYSIS
Contribution Margin Approach CVP analysis can be extended to cover multiple products. If the
products a company sells are similar (e.g. various flavors of ice cream, various models of similar
boats), the weighted average contribution margin per unit can be used in CVP analysis. The weighted
average contribution margin per unit is calculated exactly the same as contribution margin per unit for
a single product except that overall figures are used.
Contribution Margin Ratio Approach If the products that a company sells are substantially
different, CVP analysis should be performed using the contribution margin ratio. When a company sells
many different products, how many units must be sold to break even or make a profit is not
appropriate. A more appropriate measure is how much sales must be made to break even or generate a
profit. To calculate how much sales dollars are needed, the contribution margin ratio, rather than the
contribution margin per unit, should be used. The contribution margin ratio can also be used to analyze
the effect on net income of a change in total company sales.
ASSUMPTIONS IN CVP ANALYSIS
Whenever CVP analysis is performed, a number of assumptions are made that affect the validity of the
analysis:
Costs can be accurately separated into their fixed and variable components.
Fixed costs remain fixed.
Variable costs per unit do not change over the activity levels of interest.
When performing multiproduct CVP analysis, it is assumed that the mix remains constant.
Selling price per unit does not change.

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LO5

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Discuss the effect of operating leverage.

OPERATING LEVERAGE
Operating leverage relates to the level of fixed versus variable costs in a firms cost structure. Firms
that have relatively high levels of fixed cost are said to have high operating leverage. The level of
operating leverage is important because it affects the change in profit when sales change. Firms that
have high operating leverages are generally thought to be more risky because they tend to have large
fluctuations in profit when sales fluctuate.
Because of fixed costs in the cost structure, when sales increase by say 10 percent, profit will
increase by more than 10 percent. The only time profit will increase by the same percent as sales is
when all costs are variable. If all costs vary in proportion to sales (i.e., all costs are variable), then
profit will vary in proportion to sales.
LO6

Use the contribution margin per unit of the constraint to analyze situations involving a
resource constraint.

CONSTRAINTS
In many cases there are constraints on how many items can be produced or how much service can be
provided. Examples of constraints faced by managers include shortages of space, equipment, or labor.
In such cases, the focus shifts from the contribution margin per unit to the contribution margin per
unit of the constraint. For example, suppose a company can produce either Product A or Product B
using the same equipment. The contribution margin of A is $200. The contribution margin of B is $100.
Assume only 1,000 machine hours are available and Product A requires 10 hours of machine time to
produce one unit while Product B requires only 2 hours per unit. The company would only produce
Product B. Although its contribution margin is smaller, it contributes $50 per machine hour, whereas
Product A contributes only $20 per machine hour. With 1,000 machine hours available, Product A can
generate $20,000 of contribution margin while B can generate $50,000 of contribution margin.
APPENDIX

Using Regression in Excel to Estimate Fixed and Variable Costs.

The appendix uses data for CodeConnect presented in Illustration 4-7 in the textbook to illustrate the
Regression function in Excel. The spreadsheet program makes performing regression analysis very
easy. However, it does not make understanding regression analysis easy!
Once you have installed the data analysis programs, open a spreadsheet and enter the
production and cost data from Illustration 4-7. Now go under Data tab and scroll down to Data
Analysis. Then scroll down to Regression and click OK. Under Input Y, scroll down from B1 to B13
(note that this includes the heading Cost). Under Input X, scroll down from A1 to A13 (this includes the
heading Production). Click on Labels which indicates that you have labels in Production and Cost data
columns. Under output options, click on New workbook. Under residuals, click on Line fit plot. This
indicates that you want a plot of data and the regression line.
Interpretation of critical elements (the plot, R Square, Intercept and Slope of the Regression
Line, and P-Value) of the regression output is important. The plot of the data and the plot of the
regression line indicate that the data line up quite close to the regression line. This suggests that a
straight line fit to the data will be quite successful. R Square is a statistical measure of how well the
regression line fits the data. R Square ranges from a low of 0, indicating that there is no linear relation
between cost and production, to a high of 1, indicating that there is a perfect linear relation between

Chapter 4 Cost-Volume-Profit Analysis

77

cost and production. The intercept of the regression line is interpreted as the estimate of fixed cost
while the slope of the regression line is interpreted as the variable cost per unit. The p-values
corresponding to the intercept and the slope measure the probability of observing values as large as the
estimated coefficients when the true values are zero.

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Review of Key Terms

Account analysis: A method of estimating cost
behavior which requires professional
judgment to classify costs as either fixed or
variable. The total of the costs classified as
variable are divided by a measure of activity
to calculate the variable cost per unit of
activity. The total of the costs classified as
fixed provides the estimate of fixed cost.
(123)
Break-even point: The number of units a
company must sell to earn a zero profit.
(130)
Committed fixed costs: Those fixed costs that
cannot be easily changed in the short-run.
(122)
Contribution margin: The difference between
sales and variable costs. (132)
Contribution margin ratio: The contribution
margin divided by sales or the contribution
margin per unit divided by the selling price.
(133)
Cost-volume-profit (CVP): The analysis of
how costs and profit change when volume
changes. (119)
Discretionary fixed costs: Those fixed costs
that management can easily change in the
short-run. (121)
Fixed cost: Costs that do not change when
there is a change in business activity. (120)
High-low method: A method of estimating
fixed and variable cost components in which
a straight line is fitted to the data points
representing the highest and lowest levels of
activity. (126)
Margin of safety: The difference between the
expected level of sales and break-even sales.
(131)

Mixed cost: Costs that contain both variable

and fixed cost elements. (122)
Operating leverage: Level of fixed versus
variable costs in a firms cost structure.
Firms that have relatively high levels of fixed
cost are said to have high operating leverage.
(140)
Profit equation: Equation that states that
profit is equal to revenue (selling price times
quantity) minus variable cost (variable cost
per unit times quantity) minus total fixed
cost. (130)
Regression analysis: A statistical technique
used to estimate the intercept (an estimate of
fixed cost) and the slope (an estimate of
variable cost) of a cost equation. (128)
Relevant range: The range of activity for
which estimates and predictions are likely to
be accurate. (128)
Scattergraph: A graph of costs at various
activity levels. (125)
Semivariable costs: Costs that contain both
variable and fixed cost elements. (122)
Step costs: Those costs that are fixed for a
range of value but increase to a higher level
when the upper bound of the range is
exceeded. (122)
Variable costs: Those costs that increase or
decrease in response to increases or
decreases in business activity. (120)
What if analysis: An examination of the
results of various courses of action. (133)

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Chapter 4 True/False
________ 1. Two common fixed costs are rent and sales commissions.
________ 2. Variable costs, in total, change inversely with changes in activity.
________ 3. Mixed costs contain elements of both direct material and direct labor.
________ 4. The account analysis method is subjective in that different managers using the same
set of facts may reach different conclusions regarding the classification of costs into
fixed and variable components.
________ 5. Using the high-low method to classify costs as fixed or variable, the slope of the line is
the estimate of variable cost.
________ 6. The level of operating leverage is important because it affects the change in profit
when sales change.
________ 7. To calculate the break-even point, the profit equation is set to $1, and then the
appropriate selling price, variable cost, and fixed cost information are inserted into the
equation.
________ 8. The contribution margin is equal to the difference in the selling price per unit and fixed
cost per unit.
________ 9. Firms that have relatively high levels of fixed cost are said to have high operating
leverage.
________ 10.

The contribution margin per unit measures the amount of incremental profit generated
by selling an additional unit.

________ 11.

One of the primary uses of CVP analysis is to calculate the break-even point.

________ 12.

Fixed costs do not affect the incremental profit associated with selling an additional
unit because fixed costs are not affected by changes in volume.

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Chapter 4 Key Terms Matching

Match the terms found in Chapter 4 with the following definitions:
a.
b.
c.
d.
e.
f.

Account analysis
Break-even point
Contribution margin
High-low method
Mixed cost
Margin of safety

g. Operating leverage
h. Profit equation
i. Regression analysis
j. Scattergraph
k. Step costs
l. What if analysis

________ 1. A graph of costs at various activity levels.

________ 2. Equation that states that profit is equal to revenue (selling price times quantity) minus
variable cost (variable cost per unit times quantity) minus total fixed cost.
________ 3. An examination of the results of various courses of action.
________ 4. The number of units a company must sell to earn a zero profit.
________ 5. Costs that contain both variable and fixed elements.
________ 6. A method of estimating cost behavior which requires professional judgment to classify
costs as either fixed or variable.
________ 7. The difference between sales and variable costs.
________ 8. A statistical technique used to estimate the intercept (an estimate of fixed cost) and the
slope (an estimate of variable cost) of a cost equation.
________ 9. The difference between the expected level of sales and break-even sales.
________ 10. Those costs that are fixed for a range of value but increase to a higher level when the
upper bound of the range is exceeded.
________ 11. Level of fixed versus variable costs in a firms cost structure.
________ 12. A method of estimating fixed and variable cost components in which a straight line is
fitted to the data points representing the highest and lowest levels of activity.

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Chapter 4 Multiple Choice

1.

Mixed costs are also referred to as:

a. double costs.
b. assorted costs.
c. sundry costs.
d. semivariable costs.

2.

Which of the following methods uses a statistical technique to estimate fixed and variable
costs?
a. Scattergraph.
b. Regression analysis.
c. Account analysis.
d. High-low method.

3.

An example of a discretionary fixed cost is:

a. advertising.
b. indirect labor.
c. rent.
d. depreciation.

Use the following information to answer questions 4 through 8.

Vick Company produces boat motors. The selling price per motor is $1,200. The variable cost per
motor is $500 and the fixed cost per period is $8,700. Vick expects to sell 25 motors during the period
4.

The contribution margin per unit is:

a. $348.
b. $500.
c. $700.
d. $852.

5.

The break-even point in units is:

a. 10.
b. 13.
c. 18.
d. 25.

6.

The break-even point in dollars is:

a. $12,000.
b. $15,600.
c. $21,600.
d. $30,000.

7.

The contribution margin ratio is:

a. 29.0%.
b. 41.7%.
c. 58.3%.
d. 70.8%.

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8.

The margin of safety is:

a. $8,700.
b. $14,400.
c. $18,000.
d. $30,000.

9.

The three elements of the profit equation are:

a. selling price per unit, variable cost per unit, and fixed cost per unit.
b. total revenue, total variable costs per unit, and total fixed cost.
c. selling price per unit, variable cost per unit, and total fixed costs.
d. selling price per unit, total variable costs, and fixed cost per unit.

10.

The contribution margin ratio provides a measure of:

a. the contribution of every sales dollar to covering fixed cost and generating a profit.
b. the contribution of every sales dollar to covering variable cost and generating a profit.
c. the contribution of every sales dollar to covering variable and fixed costs and generating a
profit.
d. none of the above.

11.

Which of the following assumptions made when using CVP analysis might affect the validity of
the analysis?
a. Costs can be accurately separated into their fixed and variable components.
b. Fixed costs remain fixed and variable costs per unit do not change over the activity levels
of interest.
c. Both a and b.
d. Neither a nor b.

12.

Dalton Company can produce Product A and Product B using the same equipment. The
contribution margin for A is $200 while the contribution margin for B is $150. Dalton has only
1,000 hours of machine time available. Product A requires 1 machine hour to produce one unit
while Product B requires 1/2 machine hour to produce one unit. Which of the following units
should Dalton produce?
a. Product A because the contribution margin of $200 is greater than the contribution margin
of $150 for Product B.
b. Product B because the contribution margin per constraint of $300 is greater than the
contribution margin per constraint of $200 for Product A.
c. Product A and Product B proportionately according to their respective contribution
margins.
d. Product A and Product B equally.

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83

Exercise 4 1

During a recent six-month period, Connies Wholesale Cupcakes had the

following monthly volume of cupcakes sold and total monthly utilities expense:
Month
January
February
March
April
May
June

Number of Cupcakes
3,500
5,400
4,900
9,000
7,800
6,300

Utilities Expense
$ 900
1,320
1,800
2,110
2,000
2,600

Required:
1.

Compute the estimated variable cost per cupcake for utilities expense.
Number of Cupcakes

Utilities Expense

High level of activity

Low level of activity
Change
Estimate of
Variable cost
2.

Change in cost
Change in activity

_
cupcakes

= $_____ per cupcake

Compute the total estimated fixed cost per month for utilities expense.
Total cost at the high level of activity

________

Less variable cost

________

Fixed cost
3.

Compute the total amount of utilities expense that would be incurred at a level of
2,200 cupcakes.
Variable cost at a level of 2,200 cupcakes

________

Fixed cost at a level of 2,200 cupcakes

________

Total utility cost at a level of 2,200 cupcakes

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Exercise 4 2

Warren, Inc. has a selling price of $800 per unit for its products.. Variable costs
per unit are $600 and fixed costs total $150,000
1.

What is the contribution margin per unit?

2.

What is the contribution margin ratio?

3.

Compute the break-even point in units.

4.

Compute the break-even point in dollar volume of revenue.

5.

Prove your answers in parts 3 and 4 by preparing a contribution margin income

statement in good order.

Revenue

Warren, Inc.
Contribution Margin Income Statement
June 30, 2013
________

Less variable costs

________

Contribution margin

________

Less fixed costs

________

Net income

Chapter 4 Cost-Volume-Profit Analysis

Exercise 4-3

85

For several years, Bellagios Restaurant has offered a lunch special for
$7.00. Monthly fixed expenses have been $4,200. The variable cost of a meal has been $2.10.
Anthony Bellagio, the owner, believes that by remodeling the restaurant and upgrading the food
services, he can increase the price of the lunch special to $7.40. Monthly fixed expenses would
increase to $4,800 and the variable expenses would increase to $2.96 per meal.
1.

Compute Bellagio's monthly break-even sales in dollars before remodeling.

2.

Compute Bellagio's monthly break-even sales in dollars after remodeling.

3.

What recommendation would you make to Anthony Bellagio concerning

remodeling the restaurant?

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Problem 4 4

Hogan Manufacturing Company makes and sells a single product. The

company's sales and expenses for the most recent month are given below:
Total
Sales
Less variable expenses
Contribution margin
Less fixed expenses
Net income

$500,000
340,000
$160,000
80,000
$ 80,000

Per Unit
$
%
25
17
8

100
68
32

1. What is the monthly break-even point in units and in sales dollars?

2. Without resorting to computations, what is the total contribution margin at the break-even
point?

3. How many units would have to be sold each month to earn a minimum target net income of
$100,000? Prove your answer by preparing a contribution income statement at the target level
of sales.

4. Assuming Hogan increases sales by 10%, how much will net income increase?

5. Prove your answer in part 4 by preparing a contribution margin income statement at that level
of activity.

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87

Solutions True/False
1.
2.
3.
4.
5.
6.
7.

F
F
T
T
T
F

8. F
9.
10.
11.
12.

F A common fixed cost is rent and a common variable cost is sales commissions.
Variable costs in total change proportionately with changes in activity.
Mixed costs contain elements of both fixed cost and variable cost.

To calculate the break-even point, the profit equation is set to zero, and then insert the
appropriate selling price, variable cost, and fixed cost information.
The contribution margin is equal to the difference in the selling price per unit and variable cost
per unit.

T
T
T
T

Solutions Key Terms Matching

1.
2.
3.
4.
5.
6.

j. Scattergraph
h. Profit equation
l. What if analysis
b. Break-even point
e. Mixed cost
a. Account analysis

7.
8.
9.
10.
11.
12.

c. Contribution margin
i. Regression analysis
f. Margin of safety
k. Step costs
g. Operating leverage
d. High-low method

Solutions Multiple Choice

1.
2.
3.
4.
5.
6.

d
b
a
c
b
b

7.
8.
9.
10.
11.
12.

c
b
c
a
c
b

88

Study Guide to accompany Jiambalvo Managerial Accounting

Solution Exercise 4 1

During a recent six-month period, Connies Wholesale Cupcakes

had the following monthly volume of cupcakes sold and total monthly utilities expense:
Month
January
February
March
April
May
June

Number of Cupcakes
3,500
5,400
4,900
9,000
7,800
6,300

Utilities Expense
$ 900
1,320
1,800
2,110
2,000
2,600

Required:
a. Compute the estimated variable cost per cupcake for utilities expense.
High level of activity
Low level of activity
Change
Estimate of
Variable cost
b.

Number of Cupcakes
9,000
3,500
5,500

Change in cost _
Change in activity

$1,210
5,500 cupcakes

= $0.22 per cupcake

Compute the total estimated fixed cost per month for utilities expense.
Total cost at the high level of activity
Less variable cost (9,000 x $0.22)
Fixed cost

c.

Utilities Expense
$2,110
900
$1,210

$2,110
1,980
$ 130

Compute the total amount of utilities expense that would be incurred at a level of
2,200 cakes.
Variable cost at a level of 2,200 cupcakes
Fixed cost at a level of 2,200 cupcakes
Total utility cost at a level of 2,200 cupcakes

$484
130
$6146

Chapter 4 Cost-Volume-Profit Analysis

89

Solution Exercise 4 2 Warren, Inc. has a selling price of $800 per unit for its products..
Variable costs per unit are $600 and fixed costs total $150,000
1. What is the contribution margin per unit?
Revenue
$800
Variable cost
600
Contribution margin
$200
2. What is the contribution margin ratio?
Revenue
Variable costs
Contribution margin

$800
600
$200

100%
75%
25%

3. Compute the break-even point in units.

$150,000 $200 = 750 units
4. Compute the break-even point in dollar volume of revenue.
$150,000 .25 = $600,000
5. Prove your answers in parts 3 and 4 by preparing a contribution margin income statement in
good order.
Warren, Inc.
Contribution Margin Income Statement
June 30, 2013
Revenue (750 units @ $800)
Less variable costs (750 units @ $600)
Contribution margin
Less fixed costs
Net income

$600,000
450,000
$150,000
150,000
-0-

90

Study Guide to accompany Jiambalvo Managerial Accounting

Solution Exercise 4 - 3

For several years, Bellagios Restaurant has offered a lunch

special for $7.00. Monthly fixed expenses have been $4,200. The variable cost of a meal has been
$2.10. Anthony Bellagio, the owner, believes that by remodeling the restaurant and upgrading the food
services, he can increase the price of the lunch special to $7.40. Monthly fixed expenses would increase
to $4,800 and the variable expenses would increase to $2.96 per meal.
1. Compute Bellagio's monthly break-even sales in dollars before remodeling.
Sales
Variable costs
ontribution margin

$7.00 100%
2.10
30%
$4.90
70%

Fixed costs CM ratio = BEP in $ volume

$4,200 .70 = $6,000
2. Compute Bellagio's monthly break-even sales in dollars after remodeling.
Sales
Variable costs
Contribution margin

$7.40 100%
2.96
40%
$4.44
60%

Fixed costs CM ratio = BEP in $ volume

$4,800 .60 = $8,000
3. What recommendation would you make to Anthony Bellagio concerning remodeling
remodeling the restaurant?
Anthony should not remodel the restaurant building. At the present time, he needs to have monthly
revenue of only $6,000 to break even. However, with the remodeling, he would need monthly revenue
of $8,000 to break-even.

Chapter 4 Cost-Volume-Profit Analysis

91

Solution Problem 4 4

Hogan Manufacturing Company makes and sells a single

product. The company's sales and expenses for the most recent month are given below:
Total
Sales
Less variable expenses
Contribution margin
Less fixed expenses
Net income

$500,000
340,000
$160,000
80,000
$ 80,000

Per Unit
$
%
25
17
8

100
68
32

1. What is the monthly break-even point in units and in sales dollars?

$80,000 $8 = 10,000 units
$80,000 .32 = $250,000
2. Without resorting to computations, what is the total contribution margin at the break-even
point?
$80,000 At the breakeven point, contribution margin is always equal to fixed costs.
3. How many units would have to be sold each month to earn a minimum target net income of
$100,000? Prove your answer by preparing a contribution income statement at the target level
of sales.
($80,000 + $100,000) $8 = 22,500 units
Sales (22,500 x 25)
Variable costs (22,500 x $17)
Contribution margin
Fixed cost
Net income

$562,500
382,500
180,000
80,000
$100,000

4. Assuming Hogan increases sales by 10%, how much will net income increase?
$180,000 x .10 = $18,000
5. Prove your answer in part 45 by preparing a contribution income statement at that
level of activity.
Sales (22,000 x $25)
$550,000
Variable costs (22,000 x $17)
374,000
Contribution margin
176,000
Fixed cost
80,000
Net income
$ 96,000
$500,000/$25 = 20,000 units; 20,000x 1.10 = 22,000 units