1

Cost-Volume-Profit

8 Kimmel ● Weygandt ● Kieso

Accounting, Sixth Edition
 CHAPTER OUTLINE
LEARNING OBJECTIVES
Explain variable, fixed, and mixed costs and the relevant range.
1
Apply the high-low method to determine the components of mixed
2
costs.

Prepare a CVP income statement to determine contribution

3
margin.

Compute the break-even point using three approaches.

4
Determine the sales required to earn target net income and
5
determine margin of safety.
 Explain variable, fixed, and mixed costs and
LEARNING
OBJECTIVE 1 the relevant range.

Cost Behavior Analysis is the study of how specific costs

respond to changes in the level of business activity.

Some costs change; others remain the same.

Helps management plan operations and decide between

alternative courses of action.

Applies to all types of businesses and entities.

Starting point is measuring key business activities.

L
O
Cost Behavior Analysis

Cost Behavior Analysis is the study of how specific costs

respond to changes in the level of business activity.

Activity levels may be expressed in terms of:

Sales dollars (in a retail company)

Miles driven (in a trucking company)

Room occupancy (in a hotel)

Dance classes taught (by a dance studio)

Many companies use more than one measurement base.

L
O
Cost Behavior Analysis

Cost Behavior Analysis is the study of how specific costs

respond to changes in the level of business activity.

Changes in the level or volume of activity should be

correlated with changes in costs.

Activity level selected is called activity or volume index.

Activity index:

Identifies the activity that causes changes in the

behavior of costs.

Allows costs to be classified as variable, fixed, or mixed.

L
O
VARIABLE COSTS

Costs that vary in total directly and

proportionately with changes in the activity
level.

Example: If the activity level increases 10

percent, total variable costs increase 10
percent.

Example: If the activity level decreases by 25

percent, total variable costs decrease by 25
percent.

Variable costs remain the same per unit at every L

O
VARIABLE COSTS

Illustration: Damon Company manufactures tablet

computers that contain a $10 camera. The activity
tablets
index isproduced. Asof
the number Damon
manufactures each tablet, the
total cost of the cameras used
increases by $10. As part (a) of
ILLUSTRATION 18-1 shows, total
cost of the cameras will be
$20,000 if Damon produces
2,000 tablets, and $100,000
when it produces 10,000
tablets. We also can see that a 18-1
ILLUSTRATION
Behavior of total
variable cost remains the same
and unit variable
L
costs
O
VARIABLE COSTS

Illustration: Damon Company manufactures tablet

computers that contain a $10 camera. The activity
tablets
index isproduced. Asof
the number Damon
manufactures each tablet, the
total cost of the cameras used
increases by $10. As part (b) of
ILLUSTRATION 18-1 shows, the
unit cost of $10 for the camera
is the same whether Damon
produces 2,000 or 10,000
tablets.
ILLUSTRATION 18-1
Behavior of total
and unit variable
L
costs
O
VARIABLE COSTS

ILLUSTRATION 18-1
Behavior of total and unit variable costs

L
O
FIXED COSTS

Costs that remain the same in total regardless of

changes in the activity level within a relevant
range.

Fixed cost per unit cost varies inversely with activity:

As volume increases, unit cost declines, and
vice versa

Examples:
Property taxes
Insurance
Rent L
O
FIXED COSTS

Illustration: Damon Company leases its productive

facilities at a cost of $10,000 per month. Total fixed
facilities will remain constant at
costs of the
every level of activity, as part
(a) of ILLUSTRATION 18-2
shows.

ILLUSTRATION 18-2
Behavior of total
and unit fixed
costs L
O
FIXED COSTS

Illustration: Damon Company leases its productive

facilities at a cost of $10,000 per month. Total fixed
facilities will remain constant at
costs of the
every level of activity. But, on a
per unit basis, the cost of rent will decline
as activity increases, as part (b) of
ILLUSTRATION 18-2 shows. At
2,000 units, the unit cost per
tablet computer is $5 ($10,000 ÷
2,000). When Damon produces
10,000 tablets, the unit cost of
the rent is only $1 per tablet ILLUSTRATION 18-2
Behavior of total
($10,000 ÷ 10,000). and unit fixed
costs L
O
FIXED COSTS

ILLUSTRATION 18-2
Behavior of total and unit fixed costs

L
O
FIXED COSTS

Question
Variable costs are costs that:

a. Vary in total directly and proportionately

with changes in the activity level.

b. Remain the same per unit at every

activity level.

c. Neither of the above.

d. Both (a) and (b) above.

L
O
L
O
RELEVANT RANGE

Throughout the range of possible levels of activity , a

straight-line relationship usually does not
exist for either variable costs or fixed costs.

Relationship between variable costs and

changes in activity level is often curvilinear.
For fixed costs, the relationship
is also nonlinear – some fixed
costs will not change
over the entire range of
activities, while other
L
fixed costs may change. O
RELEVANT RANGE

ILLUSTRATION 18-3
Nonlinear behavior of variable and fixed
costs

L
O
RELEVANT RANGE

Range of activity over which a company

ILLUSTRATION 18-
expects to operate during a year. 4
Linear behavior
within relevant
range

L
O
RELEVANT RANGE

Question
The relevant range is:

a. The range of activity in which variable costs

will be curvilinear.

b. The range of activity in which fixed costs will

be curvilinear.

c. The range over which the company expects to

operate during a year.

d. Usually from zero to 100% of operating

capacity.
L
O
MIXED COSTS

Costs that have both a variable element and a fixed element.

Change in total but not proportionately with changes in activity level.

ILLUSTRATION 18-5
Behavior of a
mixed cost

L
O
 MIXED COST Line Equation

Y= a + bX

Where:
Y = Total Mixed Cost
a= Total Fixed Cost
b= The Variable Cost per Unit
X= The level of Activity
DO IT! 1 Types of Costs

Helena Company, reports the following total

costs at two levels of production.
Classify each cost as variable, fixed, or
mixed.

Variable
Fixed
Mixed

L
O
 Apply the high-low method to determine the
LEARNING
OBJECTIVE 2 components of mixed costs.

HIGH-LOW METHOD

High-Low Method uses the total costs incurred

at the high and the low levels of activity to
classify mixed costs into fixed and variable
components.

The difference in costs between the high and

low levels represents variable costs, since
only variable-cost element can change as
activity levels change.
L
O
 HIGH-LOW METHOD

STEP 1: Determine variable cost per unit using the following formula:

ILLUSTRATION 18-6
Formula for variable cost per unit using high-
low method

L
O
HIGH-LOW METHOD

Illustration: Metro Transit Company has the

following maintenance costs and mileage data
ILLUSTRATION 18-7
for its fleet of buses over a 6-month period. Assumed
maintenance costs
and mileage data

Change in (63,000 - 30,000) $33,000 $1.10

=
Costs
High minus (50,000 - 20,000) 30,000 cost
per
Low
unit

L
O
HIGH-LOW METHOD

STEP 2: Determine the fixed cost by subtracting the

total variable cost at either the high or the low activity
level from the total cost at that activity level. (Total
Mixed Cost (Y) – Variable cost (bX) = Fixed Cost (a))

ILLUSTRATION 18-8
High-low method computation of fixed
costs L
O
HIGH-LOW METHOD

Maintenance costs are therefore $8,000 per month

of fixed costs plus $1.10 per mile of variable costs.
This is represented by the following formula: (Y = a
+ bX)
Maintenance costs (Y) = (a) $8,000 + (b) ($1.10 x
Miles driven) (X)
Example:Fixed
At 45,000 miles, estimated
$ 8,000 maintenance
costs would be:
Variable ($1.10 x 45,000)
49,500
$57,500

L
O
HIGH-LOW METHOD

ILLUSTRATION 18-9
Scatter plot for Metro
Transit Company
L
O
HIGH-LOW METHOD

Question
Mixed costs consist of a:

a. Variable cost element and a fixed cost

element.

b. Fixed cost element and a controllable

cost element.

c. Relevant cost element and a controllable

cost element.

d. Variable cost element and a relevant cost

L
element. O
L
O
DO IT! 2 High-Low Method

Byrnes Company accumulates the following data

concerning a mixed cost, using units produced as
the activity level.

(a) Compute the variable- and fixed-cost elements

using the high-low method.
(b) Estimate the total cost if the company produces
8,000 units. L
O
DO IT! 2 High-Low Method

(a) Compute the variable and fixed cost elements

using the high-low method.
Variable cost: ($14,740 - $11,100) / (9,800 - 7,000) =
$1.30 per unit
Fixed cost: $14,740 - $12,740 ($1.30 x 9,800 units) =
$2,000
L
O
DO IT! 2 High-Low Method

(a) Estimate the total cost if the company produces

8,000 units.
Total cost (8,000 units):
$2,000 + $10,400 ($1.30 x 8,000) = $12,400

L
O
Your turn…

Attempt Exercise 2 and 3 (from Chapter 18

Questions on Moodle)
 Prepare a CVP income statement to
LEARNING
OBJECTIVE 3 determine contribution margin.

Cost-volume-profit (CVP) analysis is the study of the effects

of changes in costs and volume on a company’s profits.

Important in profit planning.

Critical factor in management decisions as

Setting selling prices,

Determining product mix, and

Maximizing use of production facilities.

L
O
 Cost-Volume-Profit Analysis

BASIC COMPONENTS

ILLUSTRATION 18-10
Components of CVP
analysis

L
O
 BASIC COMPONENTS

Assumptions
1.

1. Behavior of both costs and revenues is linear throughout

the relevant range of the activity index.

2. Costs can be classified accurately as either variable or

fixed.

3. Changes in activity are the only factors that affect costs.

4. All units produced are sold.

5. When more than one type of product is sold, the sales

mix will remain constant.

L
O
BASIC COMPONENTS

Question
Which of the following is not involved in CVP
analysis?

a. Sales mix.

b. Unit selling prices.

c. Fixed costs per unit.

d. Volume or level of activity.

L
O
Cost-Volume-Profit Analysis

CVP INCOME STATEMENT

A statement for internal use.

Classifies costs and expenses as fixed or variable.

Reports contribution margin in the body of the

statement.

Contribution margin – amount of revenue remaining

after deducting variable costs.

Reports the same net income as a traditional income

statement.

L
O
 CVP INCOME STATEMENT

Illustration: Vargo Video Company produces a high-definition

digital camcorder. Relevant data for the camcorders sold
by this company in June 2017 are as follows.

ILLUSTRATION 18-11
Assumed selling and cost data for Vargo Video

L
O
CVP INCOME STATEMENT

Illustration: The CVP income statement for Vargo

Video therefore would be reported as follows.

ILLUSTRATION 18-12
CVP income statement, with net income
L
O
 CVP INCOME STATEMENT

Unit Contribution Margin

Contribution margin is available to cover fixed

costs and to contribute to income.

Formula for contribution margin per unit and the

computation for Vargo Video are:

ILLUSTRATION 18-13
Formula for unit contribution margin

L
O
CVP INCOME STATEMENT

Unit Contribution Margin

Vargo’s CVP income statement ILLUSTRATION 18-14
CVP income
assuming a zero net income. statement, with
zero net income

L
O
CVP INCOME STATEMENT

Unit Contribution Margin

Assume that Vargo sold one more ILLUSTRATION 18-15
CVP income
camcorder, for a total of 1,001 statement, with net
income and per unit
camcorders sold. data

L
O
 CVP INCOME STATEMENT

Contribution Margin Ratio

Shows the percentage of each sales dollar

available to apply toward fixed costs and
profits.

Formula for contribution margin ratio and the

computation for Vargo Video are:

ILLUSTRATION 18-17
Formula for contribution margin
ratio

L
O
 CVP INCOME STATEMENT

Contribution Margin Ratio

ILLUSTRATION 18-16
CVP income statement, with net income and percent of
sales data

L
O
 CVP INCOME STATEMENT

Contribution Margin Ratio

Assume Vargo Video’s current sales are $500,000 and
it wants to know the effect of a $100,000 (200-unit)
increase in sales.

ILLUSTRATION 18-18
Comparative CVP income
statements
L
O
CVP INCOME STATEMENT

Question
Contribution margin:

a. Is revenue remaining after deducting

variable costs.

b. May be expressed as contribution

margin per unit.

c. Is selling price less cost of goods sold.

d. Both (a) and (b) above.

L
O
DO IT! 3 CVP Income Statement

Ampco Industries produces and sells a cell phone-

operated thermostat. Information regarding the
costs and sales of thermostats during September
2017 are provided below.

Unit selling price of thermostat $85

Unit variable costs $32
Total monthly fixed costs $190,000
Units sold 4,000

Prepare a CVP income statement for Ampco

Industries for the month of September. Provide per
unit values and total values. L
O
DO IT! 3 CVP Income Statement

Prepare a CVP income statement for Ampco

Industries for the month of September. Provide per
unit values and total values.

L
O
 Compute the break-even point using three
LEARNING
OBJECTIVE 4 approaches.

Break-Even Analysis
Process of finding the break-even point level of
activity at which total revenues equal total costs (both
fixed and variable).

Can be computed or derived

from a mathematical equation,

by using contribution margin, or

from a cost-volume profit (CVP) graph.

Expressed either in sales units or in sales dollars.

L
O
 MATHEMATICAL EQUATION

Break-even occurs where total sales equal

variable costs plus fixed costs; i.e., net income
is zero
Computat
ion of
break-
even
point in
units.

ILLUSTRATION 18-
20
L
O
CONTRIBUTION MARGIN TECHNIQUE

At the break-even point, contribution margin must equal

total fixed costs

(CM = total revenues – variable costs)

Break-even point can be computed using either

contribution margin per unit or contribution margin ratio.

L
O
 CONTRIBUTION MARGIN TECHNIQUE

Contribution Margin In Units

When the break-even-point in units is desired, contribution

margin per unit is used in the following formula which shows
the computation for Vargo Video:

ILLUSTRATION 18-21
Formula for break-even point in units using unit contribution
margin

L
O
 CONTRIBUTION MARGIN TECHNIQUE

Contribution Margin Ratio

When the break-even-point in dollars is desired, contribution

margin ratio is used in the following formula which shows the
computation for Vargo Video:

ILLUSTRATION 18-22
Formula for break-even point in dollars using contribution
margin ratio

L
O
L
O
 GRAPHIC PRESENTATION

Because this
graph also shows
costs, volume, and
profits, it is
referred to as a
cost-volume-profit
(CVP) graph.

ILLUSTRATION 18-
23
CVP graph

L
O
Break-Even Analysis

Question
Gossen Company is planning to sell 200,000
pliers for $4 per unit. The contribution
margin ratio is 25%. If Gossen will break
even at this level of sales, what are the fixed
costs?

a. $100,000.

b. $160,000.

c. $200,000.
L
d. $300,000. O
DO IT! 4 Break-Even Analysis

Lombardi Company has a unit selling price of

$400, variable costs per unit of $240, and fixed
costs of $180,000. Compute the break-even point in
units using (a) a mathematical equation and (b)
ILLUSTRATION 18-
contribution margin per unit. 19

Sales Variable Fixed Net

- - =
Costs Costs Income

$400 - $240 - $180,00 = 0

Q Q 0
$160 - $180,00
Q = 0 units
1,125
Q

L
O
DO IT! 4 Break-Even Analysis

Lombardi Company has a unit selling price of

$400, variable costs per unit of $240, and fixed
costs of $180,000. Compute the break-even point in
units using (a) a mathematical equation and (b)
ILLUSTRATION 18-
contribution margin per unit. 21

Fixed Contribution Break-Even

Costs ÷ =
Margin per Unit Point in Units

$180,00 ÷ $160 = 1,125 units

0

L
O
Your turn…

Attempt Exercise 1 and 4 (from Chapter 18

Questions on Moodle)
 Determine the sales required to earn target
LEARNING
OBJECTIVE 5 net income and determine margin of safety.

Target Net Income

Level of sales necessary to achieve a specified

income.

Can be determined from each of the approaches

used to determine break-even sales/units:

from a mathematical equation,

by using contribution margin technique, or

from a cost-volume profit (CVP) graph.

Expressed either in sales units or in sales dollars.

L
O
 TARGET NET INCOME

Mathematical Equation
Formula for required sales to meet target net
income.

ILLUSTRATION 18-24
Formula for required sales to meet target
net income

L
O
TARGET NET INCOME

Mathematical Equation
Using the formula for the break-even point, simply
ILLUSTRATION 18-25
include the desired net income as a factor.
Computation of
required sales

L
O
 TARGET NET INCOME

Contribution Margin Technique

To determine the required sales in units for Vargo
Video:

ILLUSTRATION 18-26
Formula for required sales in units using unit contribution
margin

L
O
 TARGET NET INCOME

Contribution Margin Technique

To determine the required sales in dollars for Vargo
Video:

ILLUSTRATION 18-27
Formula for required sales in dollars using contribution
margin ratio

L
O
TARGET NET INCOME

Graphic
Presentation
Suppose Vargo
Video sells 1,400
camcorders.
ILLUSTRATION 18-
23 shows that a
vertical line drawn
at 1,400 units
intersects the sales
line at $700,000
and the total cost
line at $620,000.
The differenceILLUSTRATION 18-
23
between the two
L
amounts represents O
TARGET NET INCOME

Question
The mathematical equation for computing required
sales to obtain target net income is:
Required sales =
a. Variable costs + Target net income.
b. Variable costs + Fixed costs + Target net
income.
c. Fixed costs + Target net income.
d. No correct answer is given.

L
O
 MARGIN OF SAFETY

Difference between actual or expected sales and sales at the

break-even point.

Measures the “cushion” that a particular level of sales

provides.

May be expressed in dollars or as a ratio.

Assuming actual/expected sales are $750,000:

ILLUSTRATION 18-28
Formula for margin of safety in dollars

L
O
Margin of Safety Ratio

Computed by dividing the margin of safety in dollars by the

actual (or expected) sales.
ILLUSTRATION 18-
Assuming actual/expected sales are $750,000: 29
Formula for
margin of safety
ratio

The higher the dollars or percentage, the

greater the margin of safety.

L
O
MARGIN OF SAFETY

Question
Marshall Company had actual sales of $600,000
when break-even sales were $420,000. What is the
margin of safety ratio?
a. 25%.
b. 30%.
c. 33 1/3%.
d. 45%.

L
O
L
O
 Break-Even, Margin of Safety, and
DO IT! 5 Comprehensive
Target Net Income

Zootsuit Inc. makes travel bags that sell for $56

each. For the coming year, management expects
fixed costs to total $320,000 and variable costs
to be $42 per unit. Compute the following:

break-even point in dollars using the

contribution margin (CM) ratio;

the margin of safety and margin of safety ratio

assuming actual sales are $1,382,400; and

the sales dollars required to earn net income of L

O
 Break-Even, Margin of Safety, and
DO IT! 5 Comprehensive
Target Net Income

Zootsuit Inc. makes travel bags that sell for $56

each. For the coming year, management expects
fixed costs to total $320,000 and variable costs
to be $42 per unit. Compute break-even point in dollars
using the contribution margin (CM) ratio.
Contribution margin ratio = [($56 - $42) ÷ $56] =
25%

Break-even sales in dollars = $320,000 ÷ 25% =

$1,280,000

L
O
 Break-Even, Margin of Safety, and
DO IT! 5 Comprehensive
Target Net Income

Zootsuit Inc. makes travel bags that sell for $56

each. For the coming year, management expects
fixed costs to total $320,000 and variable costs
to be $42 per unit. Compute the margin of safety and
margin of safety ratio assuming actual sales are $1,382,400.
Margin of safety = $1,382,400 - $1,280,000 =
$102,400

Margin of safety ratio = $102,400 ÷ $1,382,400 =

7.4%

L
O
 Break-Even, Margin of Safety, and
DO IT! 5 Comprehensive
Target Net Income

Zootsuit Inc. makes travel bags that sell for $56

each. For the coming year, management expects
fixed costs to total $320,000 and variable costs
to be $42 per unit. Compute the sales dollars required to
Required salesofin$410,000.
earn net income dollars =

($320,000 + $410,000) ÷ 25% = $2,920,000

L
O
Your turn…

Attempt Exercise 5 (from Chapter 18 Questions on

Moodle)
Copyright

Copyright © 2016 John Wiley & Sons, Inc. All rights

reserved. Reproduction or translation of this work
beyond that permitted in Section 117 of the 1976
United States Copyright Act without the express
written permission of the copyright owner is unlawful.
Request for further information should be addressed to
the Permissions Department, John Wiley & Sons, Inc.
The purchaser may make back-up copies for his/her
own use only and not for distribution or resale. The
Publisher assumes no responsibility for errors,
omissions, or damages, caused by the use of these
programs or from the use of the information contained