University of Transport and Communications

Department of Accounting and Auditing

MANAGERIAL ACCOUNTING

Instructor: Dr. Do Thi Hai Yen

Email: yendth_ph@utc.edu.vn
 CHAPTER 3
COST – VOLUME – PROFIT RELATIONSHIPS
SUBJECTIVES

(1) Basic of Cost – Volume – Profit (CVP)

(2) Cost – Volume – Profit Relationships

(3) Concept, analyze leverage

(4) Break-even point

 CONTRIBUTION MARGIN

Contribution margin = Revenue – Variable costs

The contribution margin is first used to offset fixed costs, the

remainder after offsetting fixed costs is profit before corporate
income tax.

Can be calculated for product unit, each product type and all
product types
Consumption: x
Unit selling price: g
Unit variable cost: a
Unit fixed cost: b

Þ Contribution margin for each product: g-a

Þ Contribution margin for once product type: (g-a)*x
Þ Contribution margin for all product types: (gi – ai)* xi
Basics of Cost-Volume-Profit Analysis

Contribution Margin (CM) is the amount remaining

from sales revenue after variable expenses have been
deducted.
Basics of Cost-Volume-Profit Analysis

CM is used first to cover fixed expenses.

Any remaining CM contributes to net
operating income.
The Contribution Approach
Sales, variable expenses, and contribution margin can also be
expressed on a per unit basis. If Racing sells an additional
bicycle, $200 additional CM will be generated to cover fixed
expenses and profit.
The Contribution Approach
Each month Racing must generate at least $80,000 in total
CM to break even.
The Contribution Approach
If Racing sells 400 units in a month, it will be
operating at the break-even point.
The Contribution Approach
If Racing sells one more bike (401 bikes), net
operating income will increase by $200.
The Contribution Approach
We do not need to prepare an income statement to estimate profits at a particular sales
volume. Simply multiply the number of units sold above break-even by the contribution
margin per unit.

If Racing sells
430 bikes, its
net income will
be $6,000.
CVP Rela)onships in Graphic Form
The relationship among revenue, cost, profit and volume
can be expressed graphically by preparing a CVP graph.
Racing developed contribution margin income
statements at 300, 400, and 500 units sold. We will use
this information to prepare the CVP graph.

Income Income Income

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 operating income $ (20,000) $ - $ 20,000
CVP Graph
450,000

400,000

350,000

300,000

250,000
Dollars

200,000
In a CVP graph, unit volume is usually
150,000
represented on the horizontal (X) axis
100,000
and dollars on the vertical (Y) axis.
50,000

-
- 100 200 300 400 500 600 700 800

Units
CVP Graph
450,000

400,000

350,000

300,000

250,000
Dollars

200,000

150,000 Fixed Expenses

100,000

50,000

-
- 100 200 300 400 500 600 700 800

Units
CVP Graph
450,000

400,000

350,000

300,000

250,000
Total Expenses
Dollars

200,000

150,000 Fixed Expenses

100,000

50,000

-
- 100 200 300 400 500 600 700 800

Units
CVP Graph
450,000

400,000

350,000 Total Sales

300,000

250,000
Total Expenses
Dollars

200,000

150,000 Fixed Expenses

100,000

50,000

-
- 100 200 300 400 500 600 700 800

Units
CVP Graph
450,000
Break-even point
400,000
(400 units or $200,000 in sales)
350,000
rea
fit A
Pro
300,000

250,000
Dollars

200,000

150,000

rea
ss A
100,000

50,000 Lo
-
- 100 200 300 400 500 600 700 800

Units
Conclusion - Contribution margin
Ø If the contribution margin < Fixed expenses, enterprise will suffer a loss because it is
not enough to cover fixed expenses
Ø If contribution margin = Fixed costs, enterprise breaks even because then the
contribution margin just covers the fixed costs.
Ø If the contribution margin > Fixed costs, enterprise is profitable because it has more
than enough to cover the fixed costs
Ø To analyze the business results of each activity and each product, we need to
calculate the total contribution margin, average contribution margin, contribution
margin for each type of product and for each product unit.
Ø Products with high contribution margin have a higher level of profit generation.
Therefore, when having to reduce the same level of quantity in many products,
enterprises should choose products with low contribution margin
Contribution Margin Ratio
The contribution margin ratio is:
Total CM
CM Ra;o =
Total sales
For Racing Bicycle Company the ratio is:
$80,000
= 40%
$200,000
Each $1.00 increase in sales results in a total
contribution margin increase of 40¢.
Contribution Margin Ratio
Or, in terms of units, the contribution margin ratio is:
Unit CM
CM Ratio =
Unit selling price
For Racing Bicycle Company the ratio is:

$200 = 40%
$500
Contribution Margin Ratio
400 Bikes 500 Bikes
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 operating income $ - $ 20,000

A $50,000 increase in sales revenue

results in a $20,000 increase in CM.
($50,000 × 40% = $20,000)
Quick Check ü
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
CM Ratio for Coffee Klatch?
a. 1.319
b. 0.758
c. 0.242
d. 4.139
Quick Check ü
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 CM Ratio for
Coffee Klatch? Unit contribuJon margin
CM Ratio =
a. 1.319 Unit selling price
b. 0.758 ($1.49-$0.36)
=
c. 0.242 $1.49
d. 4.139 $1.13
= = 0.758
$1.49
Changes in Fixed Costs and Sales Volume

What is the profit impact if Racing can

increase unit sales from 500 to 540 by
increasing the monthly adver<sing
budget by $10,000?
Changes in Fixed Costs and Sales Volume
$80,000 + $10,000 advertising = $90,000

Sales increased by $20,000, but net operating income

decreased by $2,000.
Changes in Fixed Costs and 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)
Change in Variable Costs and Sales Volume
What is the profit impact if Racing can use
higher quality raw materials, thus increasing
variable costs per unit by $10, to generate an
increase in unit sales from 500 to 580?
Change in Variable Costs and Sales Volume
580 units × $310 variable cost/unit = $179,800

Sales increase by $40,000, and net operating income

increases by $10,200.
Change in Fixed Cost, Sales Price and Volume

What is the profit impact if Racing (1) cuts its

selling price $20 per unit, (2) increases its
advertising budget by $15,000 per month, and
(3) increases unit sales from 500 to 650 units
per month?
Change in Fixed Cost, Sales Price and Volume

Sales increase by $62,000, fixed costs increase by $15,000, and

net operating income increases by $2,000.
Change in Variable Cost, Fixed Cost and Sales Volume

What is the profit impact if Racing (1) pays a

$15 sales commission per bike sold instead of
paying salespersons flat salaries that currently
total $6,000 per month, and (2) increases unit
sales from 500 to 575 bikes?
Change in Variable Cost, Fixed Cost and Sales Volume

Sales increase by $37,500, variable costs increase by $31,125,

but fixed expenses decrease by $6,000.
Change in Regular Sales Price

If Racing has an opportunity to sell 150 bikes to

a wholesaler without disturbing sales to other
customers or fixed expenses, what price would
it quote to the wholesaler if it wants to
increase monthly profits by $3,000?
Change in Regular Sales Price
$ 3,000 ÷ 150 bikes = $ 20 per bike
Variable cost per bike = 300 per bike
Selling price required = $ 320 per bike

150 bikes × $320 per bike = $ 48,000

Total variable costs = 45,000
Increase in net income = $ 3,000
Conclusion – Cost Structure
Ø A cost structure with a variable cost ratio greater than the fixed cost ratio => profit will change
slower when revenue changes;

Ø A cost structure with a fixed cost ratio greater than the variable cost ratio => profit will change
faster when revenue changes;

Ø Enterprises have a high variable cost ratio => many costs of raw materials + labor in production
and business => do not spend much capital to invest in modern equipment and machinery. When
consumption declines, profits decline more slowly and capital losses are also less;

Ø Enterprises with low variable costs and high fixed costs => often use many modern production
and business equipment, associated with large investment capital. When business conditions are
favorable, they will have better competitiveness and gain more profits. When the business
process faces difficulties and revenue declines, profits decrease rapidly => losses and many risks;

Ø There is no optimal cost structure for every business. Depending on capital conditions, market
situation of labor materials, consumable products => choose the appropriate cost structure.
Break-Even Analysis
Break-even analysis can be approached in two
ways:
1. Equation method
2. Contribution margin method
Equation Method
Profits = (Sales – Variable expenses) – Fixed expenses

OR

Sales = Variable expenses + Fixed expenses + Profits

At the break-even point

profits equal zero
Break-Even Analysis
Here is the informaLon 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
Contribution Margin Method
The contribution margin method has two key
equations.

Break-even point Fixed expenses

=
in units sold Unit contribution margin

Break-even point in Fixed expenses

total sales dollars =
CM ratio
Contribution Margin Method
Let’s use the contribution margin method to
calculate the break-even point in total sales
dollars at Racing.
Break-even point in Fixed expenses
total sales dollars =
CM ratio

$80,000
40% = $200,000 break-even sales
Quick Check ü
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 ü
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? Fixed expenses
Break-even =
a. 872 cups Unit CM
$1,300
b. 3,611 cups =
$1.49/cup - $0.36/cup
c. 1,200 cups = $1,300
d. 1,150 cups $1.13/cup
= 1,150 cups
Quick Check ü
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 ü
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
=
b. $1,715 sales CM Ratio
$1,300
c. $1,788 =
0.758
d. $3,129
= $1,715
Target Profit Analysis
The equation and contribution margin methods can be used
to determine the sales volume needed to achieve a target
profit.

Suppose Racing Bicycle Company wants to know how

many bikes must be sold to earn a profit of $100,000.
The CVP Equation Method
Sales = Variable expenses + Fixed expenses + Profits

$500Q = $300Q + $80,000 + $100,000

$200Q = $180,000

Q = 900 bikes
The Contribution Margin Approach
The contribution margin method can be used to
determine that 900 bikes must be sold to earn
the target profit of $100,000.

Unit sales to attain Fixed expenses + Target profit

=
the target profit Unit contribution margin

$80,000 + $100,000
= 900 bikes
$200/bike
Quick Check ü
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.
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
Quick Check ü
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. How many cups of
coffee would have to be sold to attain target profits
of $2,500 per month?
Unit sales Fixed expenses + Target profit
a. 3,363 cups to attain =
Unit CM
b. 2,212 cups target profit $1,300 + $2,500
=
c. 1,150 cups $1.49 - $0.36
d. 4,200 cups = $3,800
$1.13
= 3,363 cups
The Margin of Safety
The margin of safety is the excess of budgeted
(or actual) sales over the break-even volume
of sales.

Margin of safety = Total sales - Break-even sales

Let’s look at Racing Bicycle Company and

determine the margin of safety.
The Margin of Safety
If we assume that Racing Bicycle Company has actual sales
of $250,000, given that we have already determined the
break-even sales to be $200,000, the margin of safety is
$50,000 as shown

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 operating income $ - $ 20,000
The Margin of Safety
The margin of safety 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 operating income $ - $ 20,000
The Margin of Safety
The margin of safety can be expressed in terms of
the number of units sold. The margin of safety
at Racing is $50,000, and each bike sells for
$500.

Margin of $50,000
Safety in units = $500 = 100 bikes
Quick Check ü
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
Quick Check ü
Coffee Klatch is an espresso stand in a
downtown office building.
Margin of safetyThe average
= Total selling price
sales – Break-even sales
of a cup of coffee is $1.49
= 2,100and
cupsthe average
– 1,150 cups variable
expense per cup is $0.36. The average fixed
= 950 cups
expense per month is $1,300. or 2,100 cups are sold
each month on of
Margin average.
safety What iscups
950 the margin of
safety? = 2,100 cups = 45%
percentage
a. 3,250 cups
b. 950 cups
c. 1,150 cups
d. 2,100 cups
Cost Structure and Profit Stability
Cost structure refers to the relaNve proporNon of
fixed and variable costs in an organizaNon.
Managers oRen have some laNtude in determining
their organizaNon’s cost structure.
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
with lower proportion of A disadvantage of a high fixed
fixed costs. cost structure is that income
will be lower in bad years
compared to companies
with lower proportion of
fixed costs.
Operating Leverage
• A measure of how sensitive net operating income is to
percentage changes in sales.

Degree of Contribution margin

opera4ng leverage = Net operating income
Operating Leverage
At Racing, the degree of operating leverage is 5.
Actual sales
500 Bikes
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
Operating Leverage
With an operating leverage of 5, if Racing increases
its sales by 10%, net operating income would
increase by 50%.

Percent increase in sales 10%

Degree of operating leverage × 5
Percent increase in profits 50%

Here’s the verification!

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 ü
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 ü
Actual sales
Coffee Klatch is an espresso stand in2,100 a 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 ContribuJon margin
b. 0.45 leverage = Net operaJng income
c. 0.34 $2,373
= $1,073 = 2.21
d. 2.92
Quick Check ü
At Coffee Klatch the average selling price of a cup of
coffee is $1.49, the average variable expense per cup is
$0.36, and the average fixed expense per month is $1,300.
2,100 cups are sold each month on average.
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 ü
At Coffee Klatch the average selling price of a cup
of coffee is $1.49, the average variable expense per
cup is $0.36, and the average fixed expense per
month is $1,300. 2,100 cups are sold each month on
average.
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%
Structuring Sales Commissions
Companies generally compensate salespeople by
paying them either a commission based on sales
or a salary plus a sales commission. Commissions
based on sales dollars can lead to lower profits in
a company.

Let’s look at an example.

Structuring Sales Commissions
Pipeline Unlimited produces two types of surfboards, the
XR7 and the Turbo. The XR7 sells for $100 and generates
a contribution margin per unit of $25. The Turbo sells for
$150 and earns a contribution margin per unit of $18.

The sales force at Pipeline Unlimited is compensated

based on sales commissions.
Structuring Sales Commissions
If you were on the sales force at Pipeline, you would push
hard to sell the Turbo even though the XR7 earns a higher
contribuLon margin per unit.

To eliminate this type of conflict, commissions can be

based on contribuLon margin rather than on selling price
alone.
The Concept of Sales Mix
• Sales mix is the relative proportion in which a
company’s products are sold.
• Different products have different selling prices, cost
structures, and contribution margins.

Let’s assume Racing Bicycle Company sells bikes and

carts and that the sales mix between the two
products remains the same.
Multi-product break-even analysis
Racing Bicycle Co. provides the following information:

$265,000
= 48.2% (rounded)
$550,000
Multi-product break-even analysis
Break-even = Fixed expenses
sales CM RaJo
$170,000
=
48.2%
= $352,697
Key Assumptions of CVP Analysis
ŒSelling price is constant.
Costs are linear.
ŽIn multi-product companies, the sales mix
is constant.
In manufacturing companies, inventories
do not change (units produced = units
sold).
End of Chapter 3