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- Chapter 9 -- Break-Even Point and Cost-Volume-Profit Analysis

Barkley K.

Absorption costing

Traditional approach to product costing and is primarily used for external reporting

Variable costing

More commonly used for internal purposes because it makes cost behavior more transparent than does absorption costing

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Break-Even Point

Level of activity, in units or dollars, at which total revenue equal total cost

Break-Even Point

Point at which company generates neither a profit nor a loss on operating activities

1) Relevant Range

2) Revenue

3) Variable Cost

4) Fixed Cost

5) Mixed Cost

2) Revenue

3) Variable Cost

4) Fixed Cost

5) Mixed Cost

5 Costing Assumptions

Relevant Range Assumption

Company is assumed to be operating within the relevant range of activity specified in determining the revenue and cost information used in the Revenue, Variable Cost, Fixed Cost, and Mixed Cost Assumptions

Revenue Assumption

Revenue per unit is assumed to remain constant; Total revenue fluctuates in direct proportion to level of activity or volume

Variable Cost Assumption

On a per-unit basis, variable costs are assumed to remain constant; Total variable cost fluctuates in direct proportion to level of activity or volume

Fixed Cost Assumption

Total fixed costs are assumed to remain constant: Per-unit fixed cost decreases as volume increases; Per-unit cost increases as volume decreases

Mixed Cost Assumption

Mixed costs are separated into their variable and fixed elements before they are used in BEP or CVP analysis

Break-even Point

BEP

Cost-Volume-Profit Analysis

CVP

Contribution Margin

CM

Contribution Margin

Important measure in BEP that can be defined on either a per-unit or a total basis

Contribution Margin

Per Unit = Selling price per unit -- Total Variable cost

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Contribution Margin per unit =

Selling price per unit -- Total Variable cost =

Selling price per unit -- Total Variable Cost =

Contribution Margin per unit =

Unit Contribution Margin

Constant because revenue and variable cost have been defined as being constant per unit

Total CM =

Total revenue -- Total variable cost for all units sold =

Total revenue -- Total variable cost for all units sold =

Total CM =

Total CM

Amount fluctuates in direct proportion to sales volume

Contribution Margin

On either a per-unit or a total basis, indicates the amount of revenue remaining after all variable costs have been covered

Contribution Margin

Amount contributes to the coverage of fixed cost and the generation of profit

R(X) -- VC(X) -- FC = P

R = Revenue (selling price) per unit

X = Volume (number of units)

R(X) = Total Revenue

VC = Variable Cost

VC(X) = Total Variable Cost

FC = Total Fixed Cost

P = Total Profit

R = Revenue (selling price) per unit

X = Volume (number of units)

R(X) = Total Revenue

VC = Variable Cost

VC(X) = Total Variable Cost

FC = Total Fixed Cost

P = Total Profit

Formula approach:

Total Fixed Cost divided by Contribution Margin per unit (revenue per unit minus variable cost per unit)

Break-even volume =

FC/CM per unit or FC/(R per unit -- VC per unit) =

Break-even Volume=

Contribution Margin Ratio =

Contribution Margin/Revenue =

CM/R =

Contribution Margin Ratio =

Contribution Margin Ratio

Ratio indicates what proportion of revenue remains after variable cost has been deducted from sale or that portion of the revenue dollar that can be used to cover fixed cost and provide profit

Variable Cost Ratio (VC%)

100% -- CM ratio =

100% -- CM ratio =

Variable Cost Ratio =

Variable Cost Ratio

Represents variable cost as a proportion of revenue

Break-even chart

Can be prepared to graph the relationships among revenue, volume, and cost

BEP

Located at the point on a break-even chart where the total cost and total revenue lines intersect

1) Traditional Approach

2) Profit-Volume Approach

2) Profit-Volume Approach

Two approaches to graphing can be used in preparing break-even charts:

Profit

In the traditional approach of the break-even chart, the vertical distance to the right of the BEP and between the revenue and total cost lines represents:

Loss

In the traditional approach of the break-even chart, the distance between the revenue and total cost lines to the left of the BEP represents:

Profit-Volume (PV) graph

Provides a depiction of the amount of profit or loss association with each sales level

Sales volume

In the PV graph of break-even chart, the horizontal, or X-axis, represents:

Dollars of profit or loss

In the PV graph of break-even chart, the vertical, or Y-axis, represents:

Positive; Profits

In the PV graph of break-even chart, amounts shown above the x-axis are __________ and represent ___________

Negative; Losses

1) Total Fixed Cost

2) Break-even Point

2) Break-even Point

Two points can be located on the PV graph of break-even chart:

Unit Contribution Margin

In the PV graph of break-even chart, the slope of the profit line is determined by the:

Total Contribution Margin covers total fixed cost

In the PV graph of break-even chart, the line show that no profit is earned until:

Income Statement Approach

Approach to finding BEP that allows accountants to prepare budgeted statements using available revenue and cost information

Cost-Volume-Profit Analysis

Because profit cannot be achieved until the BEP is reached, the point of ___________ is the break-even point.

Cost-Volume-Profit (CVP) analysis

Examining shifts in cost and volume and the resulting effects on profits

CVP analysis

Can be used to calculate the sales volume necessary to achieve a target profit, stated as either a fixed or variable amount on a before- or after-tax basis

Incremental analysis

Process that focuses only on factors that change from one course of action or decision to another

Incremental analysis

In CVP situations ___________ is focused on changes occurring in revenue, cost, and/or volume

1) Margin of Safety

2) Degree of Operating Leverage

2) Degree of Operating Leverage

CVP relationships can be formally analyzed using standard metrics to evaluate risk/reward relationships at existing sales levels or prospective sales levels. Two of these metrics are:

Margin of Safety (MS)

When making decisions about business opportunities and changes in sales mix, managers often consider __________

Margin of Safety

Excess of budgeted or actual sales over break even sales

Margin of Safety

Amount that sales can drop before reaching the BEP and, thus provides a measure of the amount of "cushion" against losses

Margin of Safety in units =

Actual sales in units -- break-even sales in units =

Actual sales in units -- break-even sales in units =

Margin of safety in units =

Margin of safety in $ =

Actual sales in $ -- break-even sales in $ =

Actual sales in $ -- break-even sales in $ =

Margin of safety in $ =

Margin of safety % =

1) Margin of safety in units / Actual unit sales =

2) Margin of safety in $ / Actual sales $ =

2) Margin of safety in $ / Actual sales $ =

1) Margin of safety in units / Actual Sales $ =

or

2) Margin of safety in $ / Actual unit sales =

or

2) Margin of safety in $ / Actual unit sales =

Margin of safety % =

Operating Leverage

Relationship between a company's variable and fixed costs is reflected in:

Degree of Operating Leverage

DOL

Degree of Operating Leverage (DOL)

Measures how a percentage change in sales from the current level will affect company profits

Degree of Operating Leverage (DOL)

Indicates how sensitive the company's profit is to sales volume increases and decreases

Degree of Operating Leverage (DOL) =

CM / Profit before tax =

CM / Profit before tax =

Degree of Operating Leverage (DOL) =

1) Margin of Safety % (MS %) = 1 / Degree of Operating Leverage (DOL)

2) Degree of Operating Leverage (DOL) = 1 / Margin of Safety % (MS %)

2) Degree of Operating Leverage (DOL) = 1 / Margin of Safety % (MS %)

Relationship between the Margin of Safety (MS) % and Degree of Operating Leverage (DOL):

Break-even chart

Graph that depicts the relationships among revenues, variable costs, fixed costs, and profits (or losses)

Break-even point (BEP)

The level of activity, in units or dollars, at which total revenues equal total costs

Contribution Margin (CM)

Difference between selling price and variable cost per unit or between total revenue and total variable cost at a specific level of activity: the amount of each revenue dollar remaining after variable costs have been covered that goes toward coverage of fixed costs and generation of profits

Contribution Margin Ratio (CM %)

Proportion of each revenue dollar remaining after variable costs have been covered; computed as Contribution Margin divided by sales

Cost-Volume-Profit (CVP) analysis

Procedure that examines changes in costs and volume levels and the resulting effects on net income (Profits)

Degree of operating Leverage (DOL)

Factor that indicates how a percentage change in sales, from the existing or current level, will affect company profits; calculated as contribution margin divided by net income; equal to (1 / Margin of Safety %)

Incremental analysis

Process of evaluating changes that focuses only on the factors that differ from one course of action or decision to another

Margin of Safety (MS)

Excess of the budgeted or actual sales of a company over its breakeven point; can be calculated in units or dollars or as a percentage; is equal to (1 / degree of operating leverage)

Operating Leverage

Proportionate relationship between a company's variable and fixed costs; reflects the cost structure

Profit-Volume (PV) Graph

Visual representation of the amount of profit or loss associated with each level of sales

Variable cost Ratio (VC %)

Proportion of each revenue dollar represented by variable costs; computed as variable costs divided by sales or as (1 -- Contribution Margin Ratio)

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