Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
21-1
CHAPTER 21
COST-VOLUME-PROFIT ANALYSIS
Related Assignment Materials
Student Learning Objectives
Discussion
Questions
Quick
Studies*
Exercises*
Problems*
Beyond the
Numbers
Conceptual objectives:
C1. Describe different types of cost
behavior in relation to
production and sales volume.
1,2, 3, 5, 10,
12, 19
21-1, 21-2,
21-1, 21-2,
21-3
21-1, 21-3,
21-5, 21-7
cost-volume-profit analysis.
21-13, 21-14,
21-18, 21–19,
21-20, 21–21
Analytical objectives:
A1. Compute the contribution
margin and describe what it
reveals about a company’s cost
structure.
6, 7, 8
21-5, 21-21
21-8
21-1, 21-4,
21-5, 21-6
21-7
the degree of operating
leverage.
21–25
Procedural objectives:
P1. Determine cost estimates using
the scatter diagram, high-low,
and regression methods of
estimating costs.
13
21-3, 21-4
21-4, 21–5,
21-6, 21-7
21-2, ES
for a single product company.
21-9, 21-10,
21-11, 21-12
21-6, ES
P3. Graph costs and sales for a
single product company.
15, 16
21-15
21-10
21-3
P4. Compute the break-even point
for a multiproduct company.
20
21-14
21-22, 21-23
21-5, 21-7,
SP
21-8, 21-9
P5. Compute unit cost and income
under both absorption and
variable costing (Appendix
21B).
22
21-17, 21-18,
21-19, 21-20
21–26
*See additional information on next page that pertains to these quick studies, exercises and problems.
SP refers to the Serial Problem
ES refers to Excel Simulations
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Additional Information on Related Assignment Material
Connect
Available on the instructor’s course-specific website) repeats all numerical Quick Studies, all Exercises
and Problems Set A. Connect also provides algorithmic versions for Quick Study, Exercises and
Connect Insight
The first and only analytics tool of its kind, Connect Insight is a series of visual data displays that are each framed
by an intuitive question and provide at-a-glance information regarding how an instructor’s class is performing.
Connect Insight is available through Connect titles.
The Serial Problem (SP) for Success Systems continues in this chapter.
General Ledger
Assignable within Connect, General Ledger (GL) problems offer students the ability to see how transactions post
from the general journal all the way through the financial statements. Critical thinking and analysis components are
added to each GL problem to ensure understanding of the entire process. GL problems are auto-graded and provide
instant feedback to the student.
Excel Simulations
Assignable within Connect, Excel Simulations allow students to practice their Excel skills—such as basic formulas
Synopsis of Chapter Revision
NEW opener—Sweetgreen and entrepreneurial assignment.
New exhibit on building blocks of CVP analysis.
Revised discussion on uses of CVP analysis.
Revised discussion of fixed and variable costs.
Added data points to margin of fixed and variable cost exhibit.
New graphic on examples of fixed, variable, and mixed costs.
Revised discussion on step-wise and curvilinear costs.
Revised cost data for measuring cost behavior.
Reorganized break-even section into three methods.
Revised discussions of contribution margin income statement and CVP charts.
Moved margin of safety to section on applying CVP.
Added discussion of sales mix and break-even for Amazon.
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Chapter Outline
I. Identifying Cost Behavior (CVP analysis)
A. Cost-volume-profit analysis is a tool to predict how changes in costs
and sales levels affect profit
2. The concept of relevant range is important when classifying costs
3. Conventional CVP analysis requires that all costs must be
B. Fixed Costs
1. Total fixed costs remain unchanged in amount when volume of
activity varies from period to period within a relevant range.
3. When production volume and cost are graphed, units of product
are usually plotted on the horizontal axis and dollars of cost are
4. Fixed costs per unit decrease as production increases. This drop is
known as economies of scale.
C. Variable Costs
1. Variable costs change in proportion to changes in volume of
activity.
3. When production volume and cost are graphed, (Exhibit 21.2)
a. Variable cost is represented by a straight line starting at the
zero cost level.
D. Mixed Costs
1. Include both fixed and variable cost components.
2. When volume and cost are graphed, the mixed cost is represented
by a straight line with an upward (positive) slope. Start of line is at
Notes
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Chapter Outline
E. Step-wise Costs
1. Fixed within a relevant range of the current production volume. If
2. Treated as either fixed or variable cost in CVP analysis; depends
on width of range, and requires judgment.
F. Curvilinear (or Nonlinear) Costs
1. Increase at a non-constant rate as volume increases.
2. When volume and costs are graphed, curvilinear costs appear as a
3. Often treated as variable costs in CVP analysis within a relevant
range.
II. Measuring Cost Behavior⎯After establishing that cost data are reliable
and useful in predicting future costs, three methods are commonly used to
analyze past cost behavior. Goal is to develop a cost equation.
A. Scatter Diagrams
2. Units are plotted on horizontal axis, cost on the vertical axis.
4. Estimated line of cost behavior⎯drawn with a line that best “fits”
the points visually.
a. Intersection point of line on cost axis is at fixed cost amount.
b. The variable cost per unit of volume equals the slope of the
line.
i. Select any two levels of units produced.
ii. Identify total costs at each of those production levels.
iii. Compute the slope of the line as follows:
Notes
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Chapter Outline
B. High-low Method
1. Step 1: Identify the highest and lowest volume levels. Note that
these may not be the highest or lowest level of costs.
2. Step 2: Compute the slope (variable cost per unit) using the high
low volume levels
3. Step #3: Compute the estimated fixed costs by first computing the
total variable costs at either the high or low volume level and then
4. Deficiency of high-low method⎯ignores all data points except the
highest and lowest resulting in less precision.
C. Least-Squares Regression⎯computation details covered in advanced
cost accounting courses.
2. Cost equation readily calculated using most spreadsheet programs.
Illustrated in Appendix 21A using Excel®
III. Break-Even Analysis
A. Contribution Margin
2. The amount by which a product’s unit selling prices exceeds its
3. Contribution margin per unit is computed as:
B. Contribution margin ratio
1. The percent of a unit’s selling price that exceeds total unit
2. Contribution margin ratio is computed as:
Notes
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Chapter Outline
C. Break-Even Point
1. Break-even point
2. Computation of break-even point
a. Break-even units = Fixed costs
CM per unit
D. Contribution Margin Income Statement Method (Exhibit 21.13)
1. Differs from a conventional income statement in two ways:
i. Classifies costs and expenses as variable and fixed
ii. Reports contribution margin
Revenues
E. Margin of safety can be expressed in units, dollars, or as a percent of
predicted level of sales. It is the excess of expected sales over break-
even sale. It is the amount that sales can drop before the company
incurs a loss.
F. Cost-Volume-Profit Chart (also called a break-even graph or chart)
(Exhibit 21.14)
1. Horizontal axis⎯number of units produced and sold (volume)
3. Three steps:
a. Plot fixed costs on vertical axis; draw horizontal line at this
Notes
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Chapter Outline
iii. Compute total costs for any volume level, and connect
this point with the vertical axis intercept.
iv. Stop line at productive capacity for the planning period.
c. Draw sales line.
i. Line starts at origin (zero units and zero dollars of sales).
4. The break-even point is at the intersection of total cost line and
sales line.
5. On either side of break-even point, the area between sales line
and total cost line at any specific sales volume reflects the profit
or loss expected at that point.
IV. Applying Cost-Volume-Profit Analysis ⎯Useful in helping managers
forecast future sales or income.
A. Computing Income from Sales and Costs
1. Sales (# units sold x unit selling price)
– Variable Costs (# units sold x unit variable cost)
B. Computing Sales for a Target Income
1. Sales (in dollars) required for target pretax income equals:
2. Sales (in units) required for target income equals
Notes
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Chapter Outline
C. Evaluating Strategies⎯knowing the effects of changing some
estimates used in CVP analysis by substituting new estimated
amounts (in total or per unit as appropriate) in the related formula can
be helpful in making predictions. Can also use the contribution
margin income statement.
D. Sales Mix and Break-Even ⎯Modify basic CVP analysis when
company produces and sells several products.
1. Important assumption⎯Sales mix of the different products is
known and remains constant.
3. When companies sell more than one product or service, estimate
break-even point by using a composite unit.
a. Determine sales mix of various products.
b. Composite Unit—a specific number of units of each product
d. Compute the variable cost of a composite unit in the same
manner.
e. Determine the CM per composite unit by subtracting the total
variable price from the total selling price of the composite
unit
Notes
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Chapter Outline
E. Assumptions in Cost-Volume-Profit Analysis
1. CVP analysis relies on several assumptions:
a. Costs can be classified as variable or fixed.
Sales mix is constant.
V. Decision Analysis—Degree of Operating Leverage⎯
A. Useful tool in assessing the effect of changes in the level of sales on
income is the degree of operating leverage computation.
B. Operating leverage is the extent, or relative size, of fixed costs in the
total cost structure.
C. Degree of operating leverage (DOL) is computed as:
VI. Variable Costing and Performance Reporting – contribution margin
income statement also known as a variable costing income statement.
A. Variable costing – only costs that change in total with changes in
production levels are included in product costs.
B. Includes direct materials, direct labor and variable overhead costs.
Notes
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
21–10
Chapter 21 Alternate Demo Problem
Problem #1
Trimble Company sells an electronic toy for $40. The variable cost is $24
per unit and the fixed cost is $32,000 per year. Management is considering
the following changes:
Alternative #1
Alternative #2
Alternative #3
Reduce fixed cost by 25 percent by moving to a lower rent location. This
would have the effect of increasing variable costs by 10 percent.
Required:
Consider and answer each of the following questions independently:
Round calculations to the nearest unit
(a) Determine the current break-even point in units and dollars.
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Chapter 21 Alternative Demo Problem
Multi-product breakeven point
Problem #2
Handy Home sells window and doors in the ratio of 8:2 (windows:doors).
The selling price of each window is $200 and of each door is $500. The
variable cost of a window is $125 and of a door is $350. Fixed costs are
$900,000.
Required:
1. Determine the contribution margin for one composite unit
2. Compute the break-even point in composite units
3. Compute the number of units of each product that will be sold at the
Break–even point.
4. Compute the number of units of each product that need to be sold to
achieve a net income of $180,000.
Wild, Shaw & Chiappetta: Fundamental Accounting Principles, 23rd Edition
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Chapter 21 Solution: Alternate Demo Problem
Problem #1
(a)
Break-even point (in units) = Fixed costs/CM per unit
(b)
Net income = (CM per unit x number of units sold) – Fixed costs
New fixed costs = $32,000 + $4,000 = $36,000
New CM = $40 per unit – $23 per unit = $17 per unit
($17 per unit x 3,200 units) – $36,000 = $18,400
(c)
Break-even point (in units) = Fixed costs/CM per unit
New fixed costs = $32,000 + $8,000 = $40,000
New CM = $44 per unit – $24 per unit = $20 per unit
$40,000/$20 per unit = 2,000 units
2,000 units x $44 per unit = $88,000
(d)
Break-even point (in units) = Fixed costs/CM per unit
New fixed costs = $32,000 – $8,000 = $24,000
New CM = $40 per unit – $26.40 per unit = $13.60 per unit
$24,000/$13.60 per unit = 1,765 units
1,765 units x $40 per unit = $70,600
(e)
Required sales (in units) = (Fixed costs + Target NI)/CM per unit
($24,000 + $23,600)/$13.60 per unit = 3,500 units
$32,000/($40 per unit – $24 per unit) = 2,000 units
2,000 units x $40 per unit = $80,000 dollars
Break-even point (in dollars) = Fixed costs/CM ratio
$32,000/[($40 per unit –$16 per unit)/$40 per unit] = $80,000
$80,000 dollars/$40 per unit = 2,000 units
21–13
Problem #2
Selling Price per Composite Unit
Windows: 8 x $200
$1,600
$2,600
Variable Cost per Composite Unit
Windows: 8 x $125
$1,000
Breakeven point in Composite Units:
Number of units of each product to sell to break even
Composite Units to sell to achieve target Income:
Number of units of each product to sell for target income