1. Copyright © 2013 Nelson Education Ltd.
PowerPoint Presentations for Cornerstones of
Cost Accounting
First Canadian Edition
Adapted by
George Gekas
Ryerson University
Copyright © 2013 Nelson Education Ltd.

2. COST-VOLUME- PROFIT ANALYSIS3
CHAPTER
3-2
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3. The Break-Even Point and Target Profit in Units and Sales Revenue
OBJECTIVE 1
Cost-Volume-Profit (CVP) analysis is a powerful tool for planning and decision making
Emphasizes the interrelationships of costs, quantity sold, and price and profit
Brings together all of the firm’s financial information
All manufacturing, marketing, and administrative costs are separated into fixed and variable components
3-3
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4. The Break-Even Point and Target Profit in Units and Sales Revenue
OBJECTIVE 1
Break-Even Point:
Where revenues equal expenses and there is zero operating income/profit
3-4
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5. The Break-Even Point and Target Profit in Units and Sales Revenue
OBJECTIVE 1
How many units will yield the desired profit?
Operating income = Sales revenues – Variable expenses – Fixed expenses
Operating income = (Price × Number of units) – (Variable cost per unit × Number of units) – Total fixed costs
Note: All further CVP equations are derived from the contribution- margin-based income statement.
See Cornerstones 3-1 and 3-2
3-5
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6. The Break-Even Point and Target Profit in Units and Sales Revenue
OBJECTIVE 1
Contribution Margin = Sales revenue – Total variable costs
Income Statement Equation:
Sales – Variable expenses – Fixed costs = Profit
Price × Quantity – Variable cost per unit XQ – FC = Profit
Price – Var. cost per unit)X – FC=Profit
Contribution margin × Q – FC = Profit
For BE profit is zero, so CM × Q = FC
BE Number of units = Fixed costs /CM per unit
See Cornerstone 3-3
3-6
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7. The Break-Even Point and Target Profit in Units and Sales Revenue
OBJECTIVE 1
3-7
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8. After-Tax Profits
OBJECTIVE 2
When calculating the break-even point, income taxes play no role because the taxes paid on zero income are zero
After-tax profit = Operating income – Income taxes or
AT Profit = BT Profit – Profit × Tax rate)
AT Profit = BT Profit(1– t)
BT Profit = AT Profit /(1 – Tax rate)
See Cornerstone 3-4
3-8
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9. Multiple-Product Analysis
OBJECTIVE 3
Direct fixed expenses: Fixed costs that can be traced to each segment and would be avoided if the segment did not exist
Common fixed expenses: Fixed costs that are not traceable to the segments and that would remain even if one of the segments was eliminated
Sales mix: The relative combination of products being sold by a firm
Break-even sales = Fixed costs/Contribution margin ratio
See Cornerstone 3-5
3-9
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10. Graphical Representation of CVP Relationships
OBJECTIVE 4
Profit-volume graph: Portrays the relationship between profits and sales volume
The vertical axis is measured in dollars
The horizontal axis is measured in units sold
Operating income is the dependent variable
Number of units is the independent variable
The fixed cost line is a parallel line to the horizontal axis intercepting the vertical axis
The variable cost line is an upwards line originating at the intercept of the two axis
3-10
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11. Graphical Representation of CVP Relationships
OBJECTIVE 4
3-11
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12. Graphical Representation of CVP Relationships
OBJECTIVE 4
The total cost line is an upwards line parallel to the VC line originating at the intercept of the fixed cost and the vertical axis
The 45 degree line is the dichotomy on which every point, revenue equals expenditures
It is necessary to graph two separate lines:
Total revenue line: Revenue = Price × Units
Total cost line: (Unit variable cost × Units) + Fixed costs
3-12
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13. Graphical Representation of CVP Relationships
OBJECTIVE 4
3-13
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14. Graphical Representation of CVP Relationships
OBJECTIVE 4
Assumptions of Cost-Volume-Profit Analysis
Assumes a linear revenue function and a linear cost function.
Assumes that price, total fixed costs, and unit variable costs can be accurately identified and remain constant over the relevant range.
Assumes that what is produced is sold.
For multiple-product analysis, the sales mix is assumed to be known.
Selling price and costs are assumed to be known with certainty.
3-14
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15. Graphical Representation of CVP Relationships
OBJECTIVE 4
3-15
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16. Changes in the CVP Variables
OBJECTIVE 5
3-16
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17. Changes in the CVP Variables
OBJECTIVE 5
3-17
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18. Changes in the CVP Variables
OBJECTIVE 5
3-18
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19. Changes in the CVP Variables
OBJECTIVE 5
Margin of Safety
The units sold or expected to be sold or the revenue earned or expected to be earned above the break-even volume
If a firm’s margin of safety is large, the risk of suffering losses should sales take a downward turn is less than if the margin of safety was small.
See Cornerstone 3-6
3-19
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20. Changes in the CVP Variables
OBJECTIVE 5
Operating Leverage
The use of fixed costs to extract higher percentage changes in profits as sales activity changes
The greater the degree of operating leverage, the more that changes in sales activity will affect profits
The greater the proportion of fixed costs, the greater the operating leverage
See Cornerstone 3-7
3-20
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21. Changes in the CVP Variables
OBJECTIVE 5
Operating Leverage
The mix of costs than an organization chooses can have a considerable influence on its operating risk and profit level
Degree of operating leverage = Total contribution margin/profit
See Cornerstone 3-7
3-21
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22. Changes in the CVP Variables
OBJECTIVE 5
3-22
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23. Changes in the CVP Variables
OBJECTIVE 5
Conventional CVP Analysis
Assumes that all costs can be divided into variable category that varies with sales (a linear relationship) and fixed costs that remain constant
3-23
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24. Changes in the CVP Variables
OBJECTIVE 5
ABC System
Divides costs into unit- and non-unit-based categories
Some products are produced in batches (no unit variability) and some fixed costs under the conventional CVP actually vary
Example: number of setups, engineering cost
More accurately depicts cost behaviour
3-24
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25. CVP Analysis and Non-Unit Cost Drivers
OBJECTIVE 6
The ABC Cost Equation Total cost = Fixed costs + (Unit variable cost × Number of units) + (Setup cost × Number of setups) + (Engineering cost × Number of engineering hours) Operating Income Operating income = Total revenue – [Fixed costs + (Unit variable cost × Number of units) + (Setup cost × Number of setups) + (Engineering cost × Number of engineering hours)]
3-25
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26. CVP Analysis and Non-Unit Cost Drivers
OBJECTIVE 6
Break-Even in Units
Break-even units = [Fixed costs + (Setup cost × Number of setups) + (Engineering cost × Number of engineering hours)]/Price – Unit variable cost)
Differences between ABC Break-Even and Conventional Break-Even
Fixed costs differ
Numerator of ABC break-even equation has two non-unit-variable cost terms
3-26
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27. End of Chapter 3