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I. Cost - Volume - Profit (Break - Even) Analysis

A.
1. Cost - Volume - Profit (CVP) Analysis: is a means of predicting the relationships among revenues, variable costs, and fixed costs at various production levels. It allows management to discern the probable effects of changes in sales volume, sales price, product mix. 2. Breakeven Point: is the level of sales at which total revenues equal total costs. No profit or loss at the breakeven point, i.e., operating income is Zero. Fixed Costs: remain unchanged over short periods regardless of changes in volume. However, a per-unit fixed cost varies directly with the activity level.
3.

Definitions

Variable Costs: vary directly and proportionally with changes in volume. However, the variable cost per unit remains constant.
4.

Relevant Range: is the range of activity over which cost relationships are valid, i.e., It establishes limits within which the cost and revenue relationships remain linear and fixed costs are fixed.
5.

Margin of Safety: is the excess of budgeted sales dollars over breakeven sales Dollars (or budgeted units over breakeven units)
6.

Sales Mix: is the composition of total sales in terms of various products, i.e., the percentages of each product included in total sales.
7.

Unit Contribution Margin (UCM) (Target Profit): is the unit selling price minus the unit variable cost. It is the contribution from the sale of one unit to cover fixed costs.
8.

Contribution Margin Ratio: is the unit contribution margin divided by the unit-selling price.
9.

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The Slope of a Line: (on a graph with the X Axis as volume and the Y Axis as $) equals the contribution margin per unit of volume.
10.

B.

1. Costs and revenues are predictable and are linear over the relevant range. 2. All costs can be classified as either fixed or variable. 3. Total variable costs change proportionally with activity level 4. Unit variable costs are unchanged (fixed) . 5. Fixed costs remain constant over the relevant range volume. 6. Selling prices remain unchanged. 7. Inventory is either zero or kept constant, i.e., production equal sales. 8. There is only one product or product mix is constant. 9. A relevant range exists in which the various relationships are true for a given time span. 10. Sales volume is the only relevant factor affecting cost.

Assumptions of CVP Analysis

C.

1. Equation method Operating profit = Sales - Total Fixed Costs - Total Variable Costs (Quantity x Unit Selling Price) (Quantity x Unit Variable

Breakeven Point (BEP) Methods

Cost) Because at the breakeven point operating profit is zero, the equation can be as follows: Sales = Total Fixed Costs + Total Variable Costs Example (1) :Lambers manufacturing company sells T- shirts at $100 per unit .The variable cost is $30 per unit and total fixed are $ 21,000. Required: What is the breakeven point? Solution U = Units of Production = Sales $100 U = $ 21,000 + $ 30 U $ 70 U = $ 21,000 U = 300 units

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This means that to cover $ 21,000 of fixed costs, 300 units must be sold to break even. 2. Contribution margin method
Total fixed costs Total fixed costs

Breakeven Point in Quantity =

Unit contribution margin Unit selling

price - Unit variable cost

Total fixed costs Breakeven Point in Dollars = Unit contribution margin % (Unit Selling Price - Unit Variable Cost) Unit Selling Price OR Breakeven Point in Dollars = Breakeven Point in Quantity x Unit Selling Price Example (2):Using the same data in Example (1): $ 21,000 Breakeven point in Quantity = $ 100 - $ 30 $21,000 Breakeven point in Dollars = 70% OR = 300 units x $ 100 = $ 30,000 = $ 30,000 = 300 units

3. Chart method Total Revenue $ Revenue (Y)

Breakeven Point Profit Area Total Cost

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Varia ble Cost

Loss Area Fixed Cost

Uni ts (X) If an amount of profit, either in dollars or as a percentage of sales is required Total Fixed Costs + Target Profit before Tax Target sales in Quantity (Units) = Unit Selling Price - Unit Variable Cost Total Fixed Costs + Target Profit before Tax Target sales in Dollars = Unit Contribution Margin % Target Profit after Tax = Target Profit after Tax / (1- Tax Rate)

Margin of Safety (in units or $) is the excess of actual or budgeted sales over sales at The break - even point. It reveals the amount by which sales could decrease before losses Occur. Margin of Safety (in units or $) = Target Sales Level (in units or $) BEP (in units or $) Target Sales Margin of Safety Percentage = Target Sales - Breakeven Point Example (3):Using the same data in example (1) plus the company wishes to achieve $ 7,000 before Tax profit . $ 21,000 + $ 7,000

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Target sales in Quantity = units $ 100 - $ 30 $ 21, 0000 + $ 7,000 Target Sales in Dollars = 40,000 70%

= 400

=$

Note If the desired profit were stated in total dollars ($ 7,000 above) , it would be treated as a fixed cost ,and if the desired profit were stated in percentage , it would be treated as a variable cost. If multiple products are involved in calculating a breakeven point. Example (4):If Y and Z account for 70% and 30% of total sales, respectively, and variable costs are 50% and 60%, respectively, what is the breakeven point, given fixed costs of $188,000? Total Fixed Costs Breakeven Point in Dollars = Weighted Average Contribution Margin $188,000 Breakeven Point in Dollars = $400,000 (.50 x .7) + (.4 x .3) Y = 400,000 x 70 % = 28,000 30 % = 120,000 Z = 400,000 x =

III. Relevant Costs

Costs are relevant if they affect a decision. Variable costs are relevant within the relevant range. Fixed costs are irrelevant within the relevant range. Example:
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Lambers Company operates at 90 % of plant capacity, producing 90,000 units of product. The total cost of manufacturing 90,000 units is $76,500 (variable costs = $49,500, Fixed cost = $27,000), resulting in a cost per unit of $ .85 Recently, a large customer, who purchases 15,000 units per year, canceled his orders for The following year. Rather than operate at 75 % of capacity, the company is seeking new Customers. A potential customer, Buy - More Co. has offered to purchase 20,000 units at $ .65 per unit. Required: Should Lambers Co. accept this special order?? Solution: Unit Selling Price Less: Unit Variable Cost Unit Contribution Margin $.65 $.55 ($49,500 90,000) $.10

Yes, Lambers Co. should accept this special order because it makes a contribution to the Recovery of fixed cost and profit.

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