CIA2009: Management Accounting

Lecture 6: 18 October 2017

CHAPTER 7

Cost-Volume-Profit
(CVP) Analysis

Dr. Elaine Y.N. Oon

 Learning Objective 1

Compute a break-even point using the

contribution-margin approach and the
equation approach.

7-2
The Break-Even Point
The break-even point is the point in the volume of activity where the
organizations revenues and expenses are equal.

Sales $ 250,000
Less: variable expenses 150,000
Contribution margin 100,000
Less: fixed expenses 100,000
Net income $ -

7-3
The Break-Even Point
Break-even analysis can be approached in two ways:
1. Equation method
2. Contribution margin method
 The Equation Method
Profits = (Sales Variable expenses) Fixed expenses

OR

Sales = Variable expenses + Fixed expenses + Profits

At the break-even point

profits equal zero
Remember:
Break-Even Analysis
Here is the information from Racing Bicycle Company:

Total Per Unit Percent

Sales (500 bikes) $ 250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $ 100,000 $ 200 40%
Less: fixed expenses 80,000
Net operating income $ 20,000
 Equation Method
We calculate the break-even point as follows:
Sales = Variable expenses + Fixed expenses + Profits

$500Q = $300Q + $80,000 + $0

Where:
Q = Number of bikes sold
$500 = Unit selling price
$300 = Unit variable expense
$80,000 = Total fixed expense
 Equation Method
We calculate the break-even point as follows:

Sales = Variable expenses + Fixed expenses + Profits

$500Q = $300Q + $80,000 + $0

$200Q = $80,000
Q = $80,000 $200 per bike
Q = 400 bikes
 Equation Method
The equation can be modified to calculate the
break-even point in sales dollars.

Sales = Variable expenses + Fixed expenses + Profits

X = 0.60X + $80,000 + $0

Where:
X = Total sales dollars
0.60 = Variable expenses as a % of sales
$80,000 = Total fixed expenses
 Equation Method
The equation can be modified to calculate
the break-even point in sales dollars.
Sales = Variable expenses + Fixed expenses + Profits

X = 0.60X + $80,000 + $0
0.40X = $80,000
X = $80,000 0.40
X = $200,000
Summary: The Equation Approach
Sales revenue Variable expenses Fixed expenses = Profit

Unit Sales Unit Sales

sales volume variable volume
price in units expense in units

($500 X) ($300 X) $80,000 = $0

($200X) $80,000 = $0
X = 400 bikes
7-11
 Contribution Margin (CM) Method
The contribution margin (CM) method has two key
equations.

Break-even point Fixed expenses

=
in units sold CM per unit

Break-even point in Fixed expenses

total sales dollars = CM ratio
 Learning Objective 2

Compute the contribution-margin ratio and use it

to find the break-even point in sales dollars.

7-13
CONTRIBUTION MARGIN:
Definition

SALES REVENUE
minus
VARIABLE COSTS
(Sales VC)

14
The Contribution-Margin Approach
Consider the following information
developed by the accountant at Curl, Inc.:
For each additional surf board sold, Curl
generates $200 in contribution margin.

Total Per Unit Percent

Sales (500 surf boards) $250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $100,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ 20,000

7-15
Contribution-Margin Approach
Fixed expenses Break-even point
=
Unit contribution margin (in units)
also known as CM per unit

Total Per Unit Percent

Sales (500 surf boards) $250,000 $ 500 100%
Less: variable expenses 150,000 300 60%
Contribution margin $100,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ 20,000

$80,000
= 400 surf boards
$200
7-16
Contribution-Margin Approach

Here is the proof!

Total Per Unit Percent

Sales (400 surf boards) $200,000 $ 500 100%
Less: variable expenses 120,000 300 60%
Contribution margin $ 80,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ -

400 $500 = $200,000 400 $300 = $120,000

7-17
Contribution Margin Ratio

Calculate the break-even point in sales dollars rather than units by

using the contribution margin ratio.

Contribution margin
= CM Ratio
Sales

Fixed expense Break-even point

=
CM Ratio (in sales dollars)
7-18
Contribution Margin Ratio

Total Per Unit Percent

Sales (400 surf boards) $200,000 $ 500 100%
Less: variable expenses 120,000 300 60%
Contribution margin $ 80,000 $ 200 40%
Less: fixed expenses 80,000
Net income $ - CM Ratio

$80,000
= $200,000 sales
40%
7-19
CONTRIBUTION MARGIN RATIO

The contribution margin ratio is:

Total CM
CM Ratio =
Total sales

Or, in terms of units, the contribution margin ratio is:

Unit CM
CM Ratio =
Unit selling price

20
Quick Check
Coffee Klatch is an espresso stand in a downtown office
building. The average selling price of a cup of coffee is $1.49
and the average variable expense per cup is $0.36. The
average fixed expense per month is $1,300. 2,100 cups are
sold each month on average. What is the break-even sales in
units?
a. 872 cups
b. 3,611 cups
c. 1,200 cups
d. 1,150 cups
Quick Check
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup
of coffee is $1.49 and the average variable
expense per cup is $0.36. The average fixed
expense per month is $1,300. 2,100 cups
Fixed are sold
expenses
each month on average.Break-even
What is theCMbreak-even
per Unit
sales in units? =
$1,300
a. 872 cups =
$1.49/cup - $0.36/cup
b. 3,611 cups $1,300
=
c. 1,200 cups $1.13/cup
d. 1,150 cups = 1,150 cups
Quick Check
Coffee Klatch is an espresso stand in an office
building. The average selling price of a cup of coffee
is $1.49 and the average variable expense per cup is
$0.36. The average fixed expense per month is
$1,300. 2,100 cups are sold each month on average.
What is the CM Ratio for Coffee Klatch?
a. 1.319
b. 0.758
c. 0.242
d. 4.139
23
Quick Check
Coffee Klatch is an espresso stand in an office
building. The average selling price of a cup of coffee
is $1.49 and the average variable expense per cup is
$0.36. The average fixed expense per month is
$1,300. 2,100 cups are sold each month on average.
What is the CM Ratio for Coffee Klatch?
a. 1.319 Unit contribution margin
CM Ratio =
b. 0.758 Unit selling price
c. 0.242 ($1.49 - $0.36)
=
$1.49
d. 4.139
$1.13
= = 0.758
$1.49
24
Quick Check
Coffee Klatch is an espresso stand in a downtown office building.
The average selling price of a cup of coffee is $1.49 and the
average variable expense per cup is $0.36. The average fixed
expense per month is $1,300. 2,100 cups are sold each month
on average. What is the break-even sales in dollars?
a. $1,300
b. $1,715
c. $1,788
d. $3,129
Quick Check
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense
per cup is $0.36. The average fixed expense per
month is $1,300. 2,100 cups are sold each month
on average. What is the break-even sales in
dollars?
a. $1,300 Break-even Fixed expenses
=
sales CM Ratio
b. $1,715 $1,300
=
c. $1,788 0.758
d. $3,129 = $1,715
 Learning Objective 3

Prepare a cost-volume-profit (CVP) graph

and explain how it is used.

7-27
Graphing Cost-Volume-Profit Relationships
Viewing CVP relationships in a graph gives managers a
perspective that can be obtained in no other way.
Consider the following information for Curl, Inc.:

300 units 400 units 500 units

Sales $ 150,000 $ 200,000 $ 250,000
Less: variable expenses 90,000 120,000 150,000
Contribution margin $ 60,000 $ 80,000 $ 100,000
Less: fixed expenses 80,000 80,000 80,000
Net income (loss) $ (20,000) $ - $ 20,000
7-28
Cost-Volume-Profit (CVP) Graph
450,000

400,000

350,000

300,000

250,000

200,000 In a CVP graph, unit volume is

150,000 usually represented on the
100,000 horizontal (X) axis and dollars on
50,000 the vertical (Y) axis.
-
- 100 200 300 400 500 600 700 800

Units
29
Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000
Dollars

250,000

200,000

150,000 Fixed expenses

= $80,000
100,000

50,000

100 200 300 400 500 600 700 800

Units

7-30
Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000
Dollars

250,000

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

7-31
Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000
Dollars

250,000

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

7-32
Cost-Volume-Profit Graph
450,000

400,000

350,000

300,000
Dollars

250,000

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

7-33
Cost-Volume-Profit Graph
450,000

400,000
Break-even Point
350,000 = 400 units or
300,000
$200,000 in sales
Dollars

250,000

200,000

150,000

100,000
Fixed expenses

50,000

100 200 300 400 500 600 700 800

Units

7-34
Profit-Volume Graph
Some managers like the profit-volume
graph because it focuses on profits and volume.
100,000

80,000

60,000
Break-even
40,000 point
20,000
Profit

0 `

(20,000) 100 200 300 400 500 600 700

Units
(40,000)

(60,000)

7-35
 Learning Objective 4

Apply CVP analysis to determine the effect on

profit of changes in fixed expenses, variable
expenses, sales prices, and sales volume.

7-36
Target Net Profit (The CM Approach)

We can determine the number of surfboards that Curl must

sell to earn a profit of $100,000 using the contribution
margin approach.

Fixed expenses + Target profit Units sold to earn

=
Unit contribution margin the target profit

$80,000 + $100,000
= 900 surf boards
$200

7-37
The Equation Approach

Sales revenue Variable expenses Fixed expenses = Profit

($500 X) ($300 X) $80,000 = $100,000

($200X) = $180,000

X = 900 surf boards

7-38
Quick Check
Coffee Klatch is an espresso stand in an office building. The
average selling price of a cup of coffee is $1.49 and the
average variable expense per cup is $0.36. The average fixed
expense per month is $1,300. How many cups of coffee
would have to be sold to attain target profits of $2,500 per
month?
a. 3,363 cups
b. 2,212 cups
c. 1,150 cups
d. 4,200 cups

39
 Unit sales
Quick Check
to attain =
Fixed expenses + Target profit
Unit CM
target is
Coffee Klatch profit
an espresso stand in a downtown
$1,300
office building. The average + $2,500
selling price of a cup of
=
$1.49 - $0.36
coffee is $1.49 and the average variable expense per
cup is $0.36. The average $3,800
fixed expense per month is
=
$1,300. How many cups $1.13 of coffee would have to be
= 3,363
sold to attain target profits cups per month?
of $2,500
a. 3,363 cups
b. 2,212 cups
c. 1,150 cups
d. 4,200 cups
40
Applying CVP Analysis:
Safety Margin
Managers often want to know how close expected sales are
to the break-even point.
The margin of safety represents the amount by which sales
can fall before the company incurs a loss.
The margin of safety helps management assess how far above
or below the break-even point the company is currently
operating.
The margin of safety can be expressed in units or dollars.

41
Applying CVP Analysis
Safety Margin
The difference between budgeted (or actual) sales revenue/volume
and break-even sales revenue/volume.
The amount by which sales can drop before losses occur.

Margin of safety = Total sales - Break-even sales

7-42
Safety Margin
Curl, Inc. has a break-even point of $200,000
in sales. If actual sales are $250,000, the safety margin is
$50,000, or 100 surf boards.

Break-even
sales Actual sales
400 units 500 units
Sales $ 200,000 $ 250,000
Less: variable expenses 120,000 150,000
Contribution margin 80,000 100,000
Less: fixed expenses 80,000 80,000
Net income $ - $ 20,000

7-43
Safety Margin
The safety margin can be expressed as
20% of sales.
($50,000 $250,000)

Break-even
sales Actual sales
400 units 500 units
Sales $ 200,000 $ 250,000
Less: variable expenses 120,000 150,000
Contribution margin 80,000 100,000
Less: fixed expenses 80,000 80,000
Net income $ - $ 20,000

7-44
 Safety Margin

The margin of safety can be expressed in terms of the

number of units sold. The margin of safety of surf
boards is $50,000, and each surf board sells for $500.

Margin of $50,000
= = 100 surfboards
Safety in units $500
Quick Check
Coffee Klatch is an espresso stand in a downtown office building.
The average selling price of a cup of coffee is $1.49 and the
average variable expense per cup is $0.36. The average fixed
expense per month is $1,300. 2,100 cups are sold each month
on average. What is the margin of safety?
a. 3,250 cups
b. 950 cups
c. 1,150 cups
d. 2,100 cups
 Break even sales =
$1300 / ($1.49 - $0.36)
Quick Check = 1,150 cups

CoffeeMargin
Klatchofissafety
an espresso
= Total stand
sales inBreak-even
a downtownsales
office building. The average
= 2,100selling 1,150
cups price of cups
a cup of
coffee is $1.49 and the=average
950 cupsvariable expense
per cup is $0.36. The averageor
fixed expense per
month is Margin
$1,300.of2,100 cups are
safety 950 sold
cupseach month
on average.percentage = 2,100
What is the margin of cups = 45%
safety?
a. 3,250 cups
b. 950 cups
c. 1,150 cups
d. 2,100 cups
Changes in Fixed Costs & Sales
Volume

Curl is currently selling 500 surfboards per year.

The owner believes that an increase of $10,000 in the annual
advertising budget, would increase sales to 540 units.

Should the company increase the advertising budget?

7-48
 Changes in Fixed Costs & Sales
Volume

Current Proposed
Sales Sales
(500 Boards) (540 Boards)
Sales $ 250,000 $ 270,000
Less: variable expenses 150,000 162,000
Contribution margin $ 100,000 $ 108,000
Less: fixed expenses 80,000 90,000
Net income $ 20,000 $ 18,000

540 units $500 per unit = $270,000

$80,000 + $10,000 advertising = $90,000

7-49
Changes in Fixed Costs & Sales
Volume
Current Proposed
Sales will increase by
Sales Sales
$20,000, but net income
(500 Boards) (540 Boards)
decreased by $2,000.
Sales $ 250,000 $ 270,000
Less: variable expenses 150,000 162,000
Contribution margin $ 100,000 $ 108,000
Less: fixed expenses 80,000 90,000
Net income $ 20,000 $ 18,000

7-50
Changes in Fixed Costs & Sales
Volume

The Shortcut Solution

Increase in CM (40 units X $200) $ 8,000
Increase in advertising expenses 10,000
Decrease in net operating income $ (2,000)

51
Changes in Variable Cost &
Unit Contribution Margin

Because of increases in cost of raw materials, Curls

variable cost per unit has increased from $300 to $310
per surfboard. With no change in selling price per
unit, what will be the new break-even point?

($500 X) ($310 X) $80,000 = $0

X = 422 units (rounded)

7-52
Changes in Sales Price &
Unit Contribution Margin

Suppose Curl, Inc. increases the price of each surfboard to

$550. With no change in variable cost per unit, what will
be the new break-even point?

($550 X) ($300 X) $80,000 = $0

X = 320 units
7-53
 Predicting Profit Given Expected Volume

Fixed expenses
Given: Unit contribution margin Find: {reqd sales volume}
Target net profit

Fixed expenses
Given: Unit contribution margin Find: {expected profit}
Expected sales volume

7-54
Predicting Profit Given
Expected Volume
In the coming year, Curls owner expects to sell 525
surfboards. The unit contribution margin is expected to
be $190, and fixed costs are expected to increase to
$90,000.

Total contribution Fixed cost = Profit

($190 525) $90,000 = X

X = $99,750 $90,000
X = $9,750 profit
7-55
 Learning Objective 5

Compute the break-even point and prepare

a profit-volume graph for a multiproduct
enterprise.

7-56
CVP Analysis with Multiple Products
For a company with more than one product, sales mix is the
relative combination in which a companys products are
sold.
Different products have different selling prices, cost
structures, and contribution margins.

Lets assume Curl sells surfboards and sail boards and see how we deal
with break-even analysis.

7-57
 SALES MIX
Because most companies sell multiple products that have
different selling prices and different variable costs, the
break-even or target profit point depends on the sales mix.

The sales mix is the proportion of one products sales to

total sales.

When calculating break-even or target profit points we will

assume that the sales mix will remain the same at different
sales levels.

58
CVP Analysis with Multiple Products
Sales mix is:
the relative proportions of each type of product sold by
the organisation
Weighted average unit contribution margin is:
the average of the products unit contribution margins,
weighted by the sales mix

Fixed costs
Break - even point =
Weighted average unit contribution margin

59
CVP Analysis with Multiple Products
Curl provides us with the following information:

Unit Unit Number

Selling Variable Contribution of
Description Price Cost Margin Boards
Surfboards $ 500 $ 300 $ 200 500
Sailboards 1,000 450 550 300
Total sold 800

Number % of
Description of Boards Total
Surfboards 500 62.5% (500 800)
Sailboards 300 37.5% (300 800)
Total sold 800 100.0%
7-60
CVP Analysis with Multiple Products
Weighted-average unit contribution margin

Contribution Weighted
Description Margin % of Total Contribution
Surfboards $ 200 62.5% $ 125.00
Sailboards 550 37.5% 206.25
Weighted-average contribution margin $ 331.25

$200 62.5%

$550 37.5%
7-61
CVP Analysis with Multiple Products
Break-even point

Break-even Fixed expenses

=
point Weighted-average unit contribution margin

Break-even $170,000
=
point $331.25

Break-even
= 514 combined unit sales
point

7-62
CVP Analysis with Multiple Products
Break-even point
Break-even
= 514 combined unit sales
point

Breakeven % of Individual
Description Sales Total Sales
Surfboards 514 62.5% 321
Sailboards 514 37.5% 193
Total units 514

7-63
 Learning Objective 6

List and discuss the key assumptions of

CVP analysis.

7-64
Assumptions Underlying
CVP Analysis
1. Selling price is constant throughout the
entire relevant range.
2. Costs are linear over the relevant range.
3. In multi-product companies, the sales mix is
constant.
4. In manufacturing firms, inventories do not
change (units produced = units sold).

7-65
 Learning Objective 7

Prepare and interpret a contribution

income statement.

7-66
CVP Relationships and the Income Statement

A. Traditional Format
ACCUTIME COMPANY
Income Statement
For the Year Ended December 31, 20x1

Sales $500,000
Less: 380,000
Gross margin $120,000
Less: Operating expenses:
Selling expenses $35,000
Administrative expenses 35,000 70,000
Net income $50,000

7-67
CVP Relationships and the Income Statement

B. Contribution Format
ACCUTIME COMPANY
Income Statement
For the Year Ended December 31, 20x1

Sales $500,000
Less: Variable expenses:
Variable manufacturing $280,000
Variable selling 15,000
Variable administrative 5,000 300,000
Contribution margin $200,000
Less: Fixed expenses:
Fixed manufacturing $100,000
Fixed selling 20,000
Fixed administrative 30,000 150,000
Net income $50,000
7-68
 Learning Objective 8

Explain the role of cost structure and

operating leverage in CVP relationships.

7-69
OPERATING LEVERAGE: Definition

is the use of fixed costs to

extract higher percentage
changes in profits as sales
activity changes.

Meaning: The greater the degree of operating leverage,

the more the changes in sales activity will affect profits.
70
To understand operating
leverage, we need to..

....understand the relationship

between an organizations cost
structure and its profits.

71
 What is an Organizations Cost Structure?
Every company has a specific cost structure.
Managers have some latitude in determining their
organizations cost structure.
An organizations cost structure is the proportion of
fixed and variable costs to total costs.
For example, if an organization has $80,000 in fixed costs
and $20,000 in variable costs, the cost structure is
described as 80% fixed costs and 20% variable costs.

72
Operating Leverage
Operating leverage refers to the level of fixed cost within an
organization.
Companies with a high proportion of fixed costs have high
operating leverage.
Businesses that have large investments in facilities and equipment
generally have a cost structure with high fixed costs.
Firms that rely on direct labor and direct materials tend to have
higher variable costs.

73
Why is Operating Leverage Important?
Operating leverage is important because it affects how
sensitive profits are to changes in sales volume.
Firms with higher fixed costs, and thus a high level of
operating leverage, tend to profit more from increasing
sales.
Conversely, firms with higher fixed costs and high
operating leverage will lose more from decreasing sales
than a firm with low operating leverage.

74
In summary:
Cost Structure and Operating Leverage
The cost structure of an organization is the relative proportion
of its fixed and variable costs.
Operating leverage is:
the extent to which an organization uses fixed costs in its cost
structure.
greatest in companies that have a high proportion of fixed costs in
relation to variable costs.

7-75
 Cost Structure and Profit Stability
There are advantages and disadvantages to high fixed cost
(or low variable cost) and low fixed cost (or high variable cost)
structures.

An advantage of a high fixed

cost structure is that income
will be higher in good years
compared to companies A disadvantage of a high fixed
with lower proportion of cost structure is that income
fixed costs. will be lower in bad years
compared to companies
with lower proportion of
fixed costs.
 Operating Leverage
A measure of how sensitive net income is to percentage
changes in sales.

Degree of Contribution margin

=
operating leverage Net income
Measuring Operating Leverage
Operating leverage Contribution margin
=
factor Net income

Actual sales
500 Board
Sales $ 250,000
Less: variable expenses 150,000
Contribution margin 100,000
Less: fixed expenses 80,000
Net income $ 20,000
$100,000
= 5
$20,000 7-78
Measuring Operating Leverage
A measure of how a percentage change in sales will affect profits. If
Curl increases its sales by 10%, what will be the percentage
increase in net income?

Percent increase in sales 10%

Operating leverage factor 5
Percent increase in profits 50%

Heres the verification!

7-79
Operating Leverage
Actual sales Increased
(500) sales (550)
Sales $ 250,000 $ 275,000
Less variable expenses 150,000 165,000
Contribution margin 100,000 110,000
Less fixed expenses 80,000 80,000
Net operating income $ 20,000 $ 30,000

10% increase in sales from

$250,000 to $275,000 . . .
. . . results in a 50% increase in
income from $20,000 to $30,000.
Quick Check
Coffee Klatch is an espresso stand in a downtown office
building. The average selling price of a cup of coffee is
$1.49 and the average variable expense per cup is
$0.36. The average fixed expense per month is $1,300.
2,100 cups are sold each month on average. What is the
operating leverage?
a. 2.21
b. 0.45
c. 0.34
d. 2.92
Quick Check
Actual sales
Coffee Klatch is an espresso stand in a 2,100 cups
downtown office building.
Sales The average $ 3,129
selling price of a cupLess:
of coffee isexpenses
Variable $1.49 and 756
the average variableContribution
expense margin
per cup is 2,373
Less: Fixed expenses 1,300
$0.36. The average fixed expense per month
Net operating income $ 1,073
is $1,300. 2,100 cups are sold each month
on average. What is the operating leverage?
a. 2.21 Operating Contribution margin
b. 0.45 leverage = Net operating income
c. 0.34 $2,373
= $1,073 = 2.21
d. 2.92
 Quick Check
At Coffee Klatch the average selling price of a cup of
coffee is $1.49, the average variable expense per cup
is $0.36, the average fixed expense per month is
$1,300 and an average of 2,100 cups are sold each
month.
If sales increase by 20%, by how much should net
operating income increase?
a. 30.0%
b. 20.0%
c. 22.1%
d. 44.2%
 Quick Check
At Coffee Klatch the average selling price of a cup of
coffee is $1.49, the average variable expense per cup
is $0.36, the average fixed expense per month is
$1,300 and an average of 2,100 cups are sold each
month.
If sales increase by 20%, by how much should net
operating income increase?
a. 30.0%
Percent increase in sales 20.0%
b. 20.0%
Degree of operating leverage 2.21
c. 22.1% Percent increase in profit 44.20%
d. 44.2%
 Verify Increase in Profit
Actual Increased
sales sales
2,100 cups 2,520 cups
Sales $ 3,129 $ 3,755
Less: Variable expenses 756 907
Contribution margin 2,373 2,848
Less: Fixed expenses 1,300 1,300
Net operating income $ 1,073 $ 1,548
% change in sales 20.0%
% change in net operating income 44.2%
Measuring Operating Leverage

A firm with proportionately high fixed costs has

relatively high operating leverage. Such a firm can
generate large percentage increase in net income
from a small percentage increase in sales revenue.
On the other hand, a firm with high operating
leverage has a relatively high break-even point.
7-86
 Learning Objective 9

Understand the implications of activity-

based costing for CVP analysis.

7-87
CVP Analysis, Activity-Based Costing, and
Advanced Manufacturing Systems
An activity-based costing system provides a much more complete
picture of cost-volume-profit relationships and, thus, it provides
better information to managers.

Break-even = Fixed costs

point Unit contribution margin

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 Learning Objective 10

Be aware of the effects of advanced

manufacturing technology on CVP relationships.

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A Move Toward JIT and
Flexible Manufacturing
Overhead costs like setup, inspection, and material handling are
fixed with respect to sales volume, but they are not fixed with
respect to other cost drivers.

This is the fundamental distinction between a traditional CVP

analysis and an activity-based costing CVP analysis.

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Learning Objective 11

Understand the effect of income

taxes on CVP analysis (appendix).

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Effect of Income Taxes
Income taxes affect a companys
CVP relationships. To earn a
particular after-tax net income (after-
tax profit), a greater before-tax
income (before-tax profit) will be
required.

Target after-tax net income Before-tax

=
1 - t income

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 Example: After-Tax Target Income
If ABC Company has a 35% tax rate &
wants Net Income (after-tax profit) of
$48,750. How much is ABC Companys
Operating Income (before-tax profit )?

After-tax target profit:

Net income = Operating income (1 Tax rate)
$48,750 = Operating income (1 0.35)
$75,000 = Operating income

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End of Chapter 7
We made
it!

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