CHAPTER 4

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 and estimate the relation between cost and activity
using accounting analysis and the high-low method.

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 caterer’s food cost (direct material) varies with number of guests served while an airline’s
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
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 salesperson’s 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
72 Study Guide to accompany Jiambalvo Managerial Accounting

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.

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 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:

Change in cost _
Estimate of Variable Cost =
Change in activity

Estimate of Cost at highest level of activity – Cost at lowest level of activity

=
Variable Cost 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.
 Chapter 4 Cost-Volume-Profit Analysis 73

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
straight-line 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.

LO2 Perform cost-volume-profit analysis for single and multiple 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.

Profit = SP(x) – VC(x) – TFC

Where x = Quantity of units produced and sold
SP = Selling price per unit
VC = Variable cost per unit
TFC = Total fixed cost

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 even—
to 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 = $200(x) - $90.83(x) - $160,285

0 = $109.17(x) - $160,285
74 Study Guide to accompany Jiambalvo Managerial Accounting

$109.17x = $160,285
x = 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 Margin of Safety

=
Safety Ratio 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.

Unit sales (X) needed

Profit + TFC
to attain specified =
SP – VC
profit

Unit sales (X) needed Profit + TFC

=
to attain specified profit 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.
 Chapter 4 Cost-Volume-Profit Analysis 75

SP – VC
Contribution margin ratio =
SP

We can express the profit equation in terms of the contribution margin ratio as:

Dollar sales needed to Profit + TFC

=
attain specified profit 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.

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.

LO3 Discuss the effect of operating leverage, and use the contribution margin per unit of the
constraint to analyze situations involving a resource constraint.

OPERATING LEVERAGE

Operating leverage relates to the level of fixed versus variable costs in a firm’s 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
76 Study Guide to accompany Jiambalvo Managerial Accounting

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.

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 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.
 Chapter 4 Cost-Volume-Profit Analysis 77

Review of Key Terms

Account analysis: A method of estimating Mixed cost: Costs that contain both
cost behavior which requires professional variable and fixed cost elements.
judgment to classify costs as either fixed or Operating leverage: Level of fixed versus
variable. The total of the costs classified as variable costs in a firm’s cost structure.
variable are divided by a measure of activity Firms that have relatively high levels of
to calculate the variable cost per unit of fixed cost are said to have high operating
activity. The total of the costs classified as leverage.
fixed provides the estimate of fixed cost. Profit equation: Equation that states that
Break-even point: The number of units a profit is equal to revenue (selling price times
company must sell to earn a zero profit. quantity) minus variable cost (variable cost
Committed fixed costs: Those fixed costs per unit times quantity) minus total fixed
that cannot be easily changed in the short- cost.
run. Regression analysis: A statistical technique
Contribution margin: The difference used to estimate the intercept (an estimate of
between sales and variable costs. fixed cost) and the slope (an estimate of
Contribution margin ratio: The variable cost) of a cost equation.
contribution margin divided by sales or the Relevant range: The range of activity for
contribution margin per unit divided by the which estimates and predictions are likely to
selling price. be accurate.
Cost-volume-profit (CVP): The analysis of Scattergraph: A graph of costs at various
how costs and profit change when volume activity levels.
changes. Semivariable costs: Costs that contain both
Discretionary fixed costs: Those fixed costs variable and fixed cost elements.
that management can easily change in the Step costs: Those costs that are fixed for a
short-run. range of value but increase to a higher level
Fixed cost: Costs that do not change when when the upper bound of the range is
there is a change in business activity. exceeded.
High-low method: A method of estimating Variable costs: Those costs that increase or
fixed and variable cost components in which decrease in response to increases or
a straight line is fitted to the data points decreases in business activity.
representing the highest and lowest levels of “What if” analysis: An examination of the
activity. results of various courses of action.
Margin of safety: The difference between the
expected level of sales and break-even sales.
78 Study Guide to accompany Jiambalvo Managerial Accounting

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.
 Chapter 4 Cost-Volume-Profit Analysis 79

Chapter 4 – Key Terms Matching

Match the terms found in Chapter 4 with the following definitions:

a. Account analysis g. Operating leverage

b. Break-even point h. Profit equation
c. Contribution margin i. Regression analysis
d. High-low method j. Scattergraph
e. Mixed cost k. Step costs
f. Margin of safety 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 firm’s 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.
80 Study Guide to accompany Jiambalvo Managerial Accounting

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%.
 Chapter 4 Cost-Volume-Profit Analysis 81

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, 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.
82 Study Guide to accompany Jiambalvo Managerial Accounting

Exercise 4 – 1 During a recent six-month period, Connie’s Wholesale Cupcakes had the
following monthly volume of cupcakes sold and total monthly utilities expense:

Month Number of Cupcakes Utilities

Expense
January 3,500 $ 900
February 5,400 1,320
March 4,900 1,800
April 9,000 2,110
May 7,800 2,000
June 6,300 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 Change in cost $

= = $_____ per cupcake
Variable cost Change in activity cupcakes

2. 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

 Chapter 4 Cost-Volume-Profit Analysis 83

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.

Warren, Inc.
Contribution Margin Income Statement
June 30, 2016
Revenue ________

Less variable costs ________

Contribution margin ________

Less fixed costs ________

Net income
84 Study Guide to accompany Jiambalvo Managerial Accounting

Exercise 4-3 For several years, Bellagio’s 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?
 Chapter 4 Cost-Volume-Profit Analysis 85

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 Per Unit

$ %

Sales $500,000 25 100

Less variable expenses 340,000 17 68
Contribution margin $160,000 8 32
Less fixed expenses 80,000
Net income $ 80,000

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.
86 Study Guide to accompany Jiambalvo Managerial Accounting

Solutions – True/False
1. F A common fixed cost is rent and a common variable cost is sales commissions.
2. F Variable costs in total change proportionately with changes in activity.
3. F Mixed costs contain elements of both fixed cost and variable cost.
4. T
5. T
6. T
7. F 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.
8. F The contribution margin is equal to the difference in the selling price per unit and variable
cost per unit.
9. T
10. T
11. T
12. T

Solutions – Key Terms Matching

1. j. Scattergraph 7. c. Contribution margin
2. h. Profit equation 8. i. Regression analysis
3. l. “What if” analysis 9. f. Margin of safety
4. b. Break-even point 10. k. Step costs
5. e. Mixed cost 11. g. Operating leverage
6. a. Account analysis 12. d. High-low method

Solutions – Multiple Choice

1. d 7. c
2. b 8. b
3. a 9. c
4. c 10. a
5. b 11. c
6. b 12. b
 Chapter 4 Cost-Volume-Profit Analysis 87

Solution – Exercise 4 – 1 During a recent six-month period, Connie’s Wholesale Cupcakes

had the following monthly volume of cupcakes sold and total monthly utilities expense:

Month Number of Utilities

Cupcakes Expense
January 3,500 $ 900
February 5,400 1,320
March 4,900 1,800
April 9,000 2,110
May 7,800 2,000
June 6,300 2,600

Required:

a. Compute the estimated variable cost per cupcake for utilities expense.

Number of Cupcakes Utilities Expense

High level of activity 9,000 $2,110
Low level of activity 3,500 900
Change 5,500 $1,210

Estimate of Change in cost_ $1,210

= = $0.22 per cupcake
Variable cost Change in activity 5,500 cupcakes

b. Compute the total estimated fixed cost per month for utilities expense.

Total cost at the high level of activity $2,110

Less variable cost (9,000 x $0.22) 1,980
Fixed cost $ 130

c. 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 $484

Fixed cost at a level of 2,200 cupcakes 130
Total utility cost at a level of 2,200 cupcakes $614
88 Study Guide to accompany Jiambalvo Managerial Accounting

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 $800 100%
Variable costs 600 75%
Contribution margin $200 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, 2016

Revenue (750 units @ $800) $600,000

Less variable costs (750 units @ $600) 450,000
Contribution margin $150,000
Less fixed costs 150,000
Net income -0-
 Chapter 4 Cost-Volume-Profit Analysis 89

Solution – Exercise 4 - 3 For several years, Bellagio’s 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 $7.00 100%

Variable costs 2.10 30%
ontribution margin $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 $7.40 100%

Variable costs 2.96 40%
Contribution margin $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.
90 Study Guide to accompany Jiambalvo Managerial Accounting

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 Per Unit

$ %

Sales $500,000 25 100

Less variable expenses 340,000 17 68
Contribution margin $160,000 8 32
Less fixed expenses 80,000
Net income $ 80,000

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) $562,500

Variable costs (22,500 x $17) 382,500
Contribution margin 180,000
Fixed cost 80,000
Net income $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 4 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