PART 2

PART 2 UNIT 3

3
2C. Decision Analysis

Module

1 C.1. Cost-Volume-Profit Analysis 3

2 C.2. Marginal Analysis 27

3 C.2. Marginal Analysis

C.3. Pricing 43
 NOTES

3–2 © Becker Professional Education Corporation. All rights reserved.

1
MODULE
PART 2 UNIT 3

C.1. Cost-Volume-Profit
Analysis
Part 2
Unit 3

This module covers the following content from the IMA Learning Outcome Statements.

CMA LOS Reference: Part 2—Section C.1. Cost-Volume-Profit Analysis

The candidate should be able to:

a. demonstrate an understanding of how cost/volume/profit (CVP) analysis (breakeven
analysis) is used to examine the behavior of total revenues, total costs, and operating
income as changes occur in output levels, selling prices, variable costs per unit, or
fixed costs
b. calculate operating income at different operating levels
c. differentiate between costs that are fixed and costs that are variable with respect to
levels of output
d. explain why the classification of fixed vs. variable costs is affected by the time frame
being considered
e. calculate contribution margin per unit and total contribution margin
f. calculate the breakeven point in units and dollar sales to achieve targeted operating
income or targeted net income
g. demonstrate an understanding of how changes in unit sales mix affect operating
income in multiple-product situations
h. calculate multiple-product breakeven points given percentage share of sales and
explain why there is no unique breakeven point in multiple-product situations
i. define, calculate, and interpret the margin of safety and the margin of safety ratio
j. explain how sensitivity analysis can be used in CVP analysis when there is uncertainty
about sales
k. analyze and recommend a course of action using CVP analysis
l. demonstrate an understanding of the impact of income taxes on CVP analysis

1 Introduction to Cost‑Volume‑Profit (CVP) Analysis LOS 2C1a

Cost-volume-profit (CVP) analysis is used by managers to forecast profits at different levels

of sales and production volume. The point at which revenues equal total costs is called the
breakeven point. Cost-volume profit analysis is synonymous with breakeven analysis. CVP
analysis is based on the primary assumption that cost behaviors remain consistent over the
relevant range. Changes in volume result in incremental changes in total costs associated solely
with variable costs.

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 1 C.1. Cost-Volume-Profit Analysis PART 2 UNIT 3

1.1 Assumptions
To use the CVP analysis model, several assumptions are made.
y Cost Behaviors and Classifications
yy All costs are separated into either variable or fixed costs, depending on the behavior of
the cost.
yy Volume is the only relevant factor affecting cost.
yy All costs behave in a linear fashion in relation to production.
yy Variable costs remain constant per unit but vary in total in direct proportion to a change
in sales or production volume.
yy Fixed costs remain constant in total but vary inversely on a per-unit basis with a change
in the level of activity.
yy Mixed (semi-variable) costs can be separated into the fixed component and the variable
component.
yy Cost behaviors are anticipated to remain constant over the relevant range of production
volume because there is an assumption that the efficiency of production does
not change.
yy Costs show greater variability over time. The longer the time period, the greater the
percentage of variable costs and the shorter the time period, the greater the percentage
of fixed-costs.
y Use of Single Product
Although cost-volume-profit analysis can be performed for more than one product, in its
simplest form, it assumes that the product mix remains constant.
y Contribution Approach (Direct Costing) is Used Rather Than Absorption Approach
The contribution approach to the income statement is used for breakeven analysis.
Identifying each element of cost as fixed or variable defines its relationship to volume and to
the computation of breakeven.
y Selling Prices Remain Unchanged
The volume of transactions produces a uniform contribution margin per unit and a
predictable, projected contribution margin based on volume.

LOS 2C1c 1.2 Fixed vs. Variable Costs

LOS 2C1d Variable costs increase in total as output increases but are fixed per unit within a relevant range.
Direct materials, direct labor, and variable overhead costs all change in total as volume changes
and are examples of variable costs.
Fixed costs do not change in total within the relevant range regardless of the change in
the production level. Examples include fixed overhead costs, including insurance premium
payments and the salary for a manufacturing supervisor who is paid a fixed amount per month
rather than being paid an hourly wage.
Semi-variable costs contain both fixed and variable components.

3–4 Module 1 C.1. Cost-Volume-Profit

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Illustration 1 Cost Behaviors

Mixed
Variable Fixed (semi‑variable)
Sales 
Less: returns and allowances 
Cost of sales
Direct material 
Direct labor 
Indirect labor 
Fringe benefits (15% of labor)  
Royalties (1% of product sales) 
Maintenance and repairs of building 
Factory production supplies 
Depreciation: straight-line 
Electricity: used in the mfg. process  
Scrap and spoilage (normal) 
Selling, general, and administrative expense
Sales commissions 
Officers' salaries 
Fringe benefits (relate to labor)  
Delivery expenses 
Advertising expenses (annual contract expenses) 

Whether a cost is variable or fixed depends on the time horizon. The longer the time horizon,
the more likely a cost will be variable. The salaries paid to manufacturing supervisors are fixed
in the current year, but over the long term as production levels increase and as the factory
expands, additional supervisors are needed.

1.3 Contribution Margin

The contribution approach to the income statement uses variable costing (also called direct
costing). Although it does not represent generally accepted accounting principles, the
contribution approach is extremely useful for internal decision making because it identifies each
sale's contribution toward covering fixed costs.

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 1 C.1. Cost-Volume-Profit Analysis PART 2 UNIT 3

LOS 2C1e 1.3.1 Contribution Approach to Calculating Operating Income

The contribution margin is the excess of sales revenues over variable costs (both variable
manufacturing costs and variable selling, general, and administrative costs). Once the
contribution margin is sufficient to cover all of the fixed costs (both fixed manufacturing
costs and fixed selling, general, and administrative costs), the remaining portion of the total
contribution margin adds to (contributes to) operating income.

Sales revenue

Less: all variable costs

Contribution margin

Less: all fixed costs

Operating income

Pass Key

Variable costs include direct labor; direct materials; variable overhead; and variable selling,
general, and administrative expenses.
Fixed costs include fixed overhead and fixed selling, general, and administrative expenses.

1.3.2 Contribution Margin per Unit and Total Contribution Margin

Revenue, variable costs, and contribution margin may be expressed in total, on a per-unit
basis, as percentages or as decimals. The contribution margin per unit is the unit sales price
minus the unit variable cost. Contribution margin per unit can be used to calculate total
contribution margin.

Contribution margin per unit = Selling price per unit – Variable costs per unit
Total contribution margin (method 1) = Total sales revenue – Total variable costs
Total contribution margin (method 2) = Contribution margin per unit × Number of units sold

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1.3.3 Contribution Margin Ratio

Variable costs and contribution margin may be expressed as a percentage of revenue. This
percentage is called the contribution margin ratio:

Total contribution margin

Contribution margin ratio =
Total revenues
Contribution margin per unit
=
Selling price per unit

Example 1 Contribution Margin and Contribution Margin Ratio

Facts: Alpha Co. sells 20,000 units per year of its single product at a sales price of $100 per
unit. The variable manufacturing costs are $45 per unit and the variable selling costs are
$15 per unit. The annual fixed costs are $600,000.
Required:
1. Calculate the contribution margin per unit.
2. Calculate the total contribution margin.
3. Calculate the contribution margin ratio.
4. Calculate operating income.
Solution:

1.
Contribution
 Selling price per unit  Total variable costs per unit
margin per unit

 $100  ($45 + $15)

 $100  $60

 $40 per unit

2.
Total
 Contribution margin per unit  Number of units
contribution margin

 $40 per unit  20,000 units

 $800, 000

Or:

Total  $100 sales   $60 total variable 

   20,000 units     20,000 units 
contribution margin  price per unit   costs per unit 
 $2,000,000  $1, 200, 000

 $800, 000

(continued)

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 1 C.1. Cost-Volume-Profit Analysis PART 2 UNIT 3

(continued)

3.
Total contribution margin
Contribution margin ratio =
Total sales
$800,000
=
$2,000,000
= 40%
Or:
Contribution margin per unit
Contribution margin ratio =
Sales price per unit
$40
=
$100
= 40%

4.
Operating income = Total contribution margin – Total fixed costs
= $800,000 – $600,000
= $200,000

LOS 2C1b 1.3.4 Effects of Output Level on Profits

Contribution margin analysis can be used to assess the effect of various levels of production on
operating income.

Example 2 Calculating Operating Income at Different Operating Levels

Facts: Production for Falcon Co. is currently 4,000 units. The sales price per unit and
the variable costs per unit are $120 and $50, respectively. Total annual fixed costs are
$140,000. These relationships are constant for production levels up to 10,000 units.
Required: Determine operating income for sales of 2,000, 4,000, 6,000, 8,000, and 10,000 units.
Solution:
Units sold 2,000 4,000 6,000 8,000 10,000
Sales @ $120/unit $240,000 $480,000 $720,000 $960,000 $1,200,000
Less: variable cost
@ $50/unit (100,000) (200,000) (300,000) (400,000) (500,000)
CM @ $70 $140,000 $280,000 $420,000 $560,000 $ 700,000
Less: total fixed costs (140,000) (140,000) (140,000) (140,000) (140,000)
Operating income $ 0 $140,000 $280,000 $420,000 $ 560,000

3–8 Module 1 C.1. Cost-Volume-Profit

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2 Breakeven Analysis and Target Profit Computation LOS 2C1f

Breakeven analysis determines the sales required (in dollars or units) to achieve zero profit
or loss from operations. After breakeven is achieved, each additional unit sold will increase
pretax income by the amount of the contribution margin per unit. Note that pretax income is
not taxable income for federal income tax purposes. In determining the amount in revenues
required to break even, management must estimate both fixed costs overall and variable costs
on a per-unit basis.

Example 3 Breakeven Analysis

Facts: The following information is applicable to Green Grass Industries and will be used
for all of the examples in the next several sections:
yySales price per unit of $125 and variable costs per unit of $50. The contribution margin
per unit is $75 ($125 – $50) and the contribution margin ratio is 60% ($75—/—$125).
yyFixed costs of $150,000.
yyDesired pretax profit of $60,000, a tax rate of 40%, and desired after-tax profit
of $36,000.
yyPotential unit sales of 2,500 at the current sales price, and a maximum of 3,000 in unit
sales to reach market saturation.

2.1 Breakeven Point in Units

The breakeven point in units is determined by dividing breakeven sales revenue by the unit
selling price:

Revenues to breakeven
Units to breakeven =
Unit selling price

The breakeven point in units can also be calculated by dividing the unit contribution margin into
total fixed costs.

Total fixed costs

Breakeven point in units =
Contribution margin per unit

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1 C.1. Cost-Volume-Profit Analysis PART 2 UNIT 3

Illustration 2 Calculating the Formula for Breakeven in Units

This formula for breakeven point in units can be derived by starting with the fact that at the
breakeven point, sales revenue is equal to total costs:

Breakeven point sales = Total costs at the breakeven point

It is given that:

Sales price
Breakeven point sales   Breakeven units
per unit

Total costs at the  Variable cost Breakeven

    Fixed costs
breakeven point  per unit units 

Using substitution:

Sales price  Variable cost Breakeven

 Breakeven units     Fixed costs
per unit  per unit units 

Therefore:

 Breakeven Sales price   Variable cost Breakeven

 units      Fixed costs
 per unit   per unit units 

 Sales price Variable cost 

Breakeven units     Fixed costs
 per unit per unit 

Total fixed costs

Breakeven units 
Sales price per unit  Variable cost per unit
Total fixed costs

Contribution margin per unit

Example 3 Breakeven Analysis (continued)

Facts: The same as the first part of Example 3.

Required: Calculate Green Grass' breakeven point in units.
Solution: Breakeven point in units = $150,000 / $75 = 2,000 units
The company will need to sell 2,000 units in order to recover its variable costs of $50 per
unit and its total fixed costs of $150,000.

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2.2 Breakeven Point in Dollars

There are two approaches to computing breakeven in sales dollars.
1. Contribution Margin per Unit: Compute the breakeven point in units using the contribution
margin per unit, and then multiply those breakeven units by the selling price per unit:

Breakeven point in dollars = Unit price × Breakeven point (in units)

Example 3 Breakeven Analysis (continued)

Facts: The same as the first part of Example 3.

Required: Calculate Green Grass' breakeven point in dollars, using breakeven units.
Solution: Breakeven point in dollars = $125 × 2,000 units = $250,000
The company will need sales of $250,000 in order to cover total variable costs of
$100,000 (2,000 units × $50 per unit) and total fixed costs of $150,000.

2. Contribution Margin Ratio: Divide total fixed costs by the contribution margin ratio
(i.e., the contribution margin as a percentage of revenue per unit or unit price):

Total fixed costs

Breakeven point in dollars =
Contribution margin ratio

Example 3 Breakeven Analysis (continued)

Facts: The same as the first part of Example 3.

Required: Calculate Green Grass' breakeven point in dollars, using the contribution
margin ratio.
Solution: Breakeven point in dollars = $150,000 / 60% = $250,000

2.3 Required Sales Volume for Target Profit LOS 2C1l

Breakeven analysis can be extended to calculate the unit sales or sales dollars required to
produce a targeted profit. Although profit figures are most relevant on an after-tax basis, the
amount that must be added to the breakeven computation in order to calculate the required
sales dollars/units must be a before-tax profit amount. This is done for the purposes of
maintaining consistency with the pretax sales and pretax cost figures used in the calculation.

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1 C.1. Cost-Volume-Profit Analysis PART 2 UNIT 3

Pass Key

Pretax profit can be calculated from after-tax profit using the following formula:

After-tax income
Pretax profit =
1 – Tax rate

2.3.1 Sales Units Needed to Obtain a Desired Profit

The formula is modified to treat the desired net income before taxes as another fixed cost.

Sales (units) = (Fixed cost + Pretax profit) / Contribution margin per unit

Example 3 Breakeven Analysis (continued)

Facts: The same as the first part of Example 3.

Required: Calculate Green Grass' unit sales needed in order to achieve its desired pretax
profit of $60,000.
Solution: Sales (units) = ($150,000 + $60,000) / $75 = 2,800 units
Green Grass must sell 2,800 units in order to cover its fixed and variable costs and
to achieve its desired pretax profit of $60,000.

2.3.2 Sales Dollars Needed to Obtain a Desired Profit

There are two approaches to computing the sales dollars needed to achieve a desired profit.

1. Summation of Total Costs and Profits

Sales dollars = Variable costs + Fixed costs + Pretax profit

Example 3 Breakeven Analysis (continued)

Facts: The same as the first part of Example 3.

Required: Calculate Green Grass' sales (in dollars) needed in order to achieve its desired
pretax profit.
Solution: Total variable costs = 2,800 units × $50 per unit = $140,000
Sales (dollars) = $140,000 + $150,000 + $60,000 = $350,000
Green Grass must have sales of $350,000 in order to cover its variable and fixed costs and
achieve its desired $60,000 pretax profit.

3–12 Module 1 C.1. Cost-Volume-Profit

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1 3 C.1. Cost-Volume-Profit Analysis

2. Contribution Margin Ratio

Fixed cost + Pretax profit

Sales =
Contribution margin ratio

Example 3 Breakeven Analysis (continued)

Facts: The same as the first part of Example 3.

Required: Calculate Green Grass' sales (in dollars) needed in order to achieve its desired
pretax profit.
Solution: Sales (dollars) = ($150,000 + $60,000)—/60% = $350,000

2.4 Predicting Profits Based on Volume

After breakeven has been achieved, each additional unit sold will increase net income by the
amount of the contribution margin per unit.

Example 3 Breakeven Analysis (continued)

Facts: The same as the first part of Example 3.

Required: Calculate Green Grass' profit if the company sells 2,500 units.
Solution: Profit = Units above the breakeven point × Contribution margin per unit
= 500 × $75 = $37,500.
The breakeven point calculated earlier was 2,000 units. For every unit sold above 2,000,
the company will book a $75 profit. If it sells 2,500 units, that is 500 additional units above
breakeven; those 500 units will provide a total profit of $37,500.

2.5 Setting Selling Prices Based on Assumed Volume

This analysis also may be used to derive a per-unit selling price necessary to cover all costs and
the desired pretax profit given a specific volume limit.

Sale price per unit = (Fixed costs + Variable costs + Pretax profit) / Number of units sold

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 1 C.1. Cost-Volume-Profit Analysis PART 2 UNIT 3

Example 3 Breakeven Analysis (continued)

Facts: The same as the first part of Example 3.

Required: Calculate Green Grass' per-unit sales price needed to produce its desired pretax
profit given the market saturation level of 3,000 units.
Solution: Per-unit sales price = [$150,000 + (3,000 units × $50 per unit) + $60,000]—/—3,000
= $120 per unit.
If the company can sell 3,000 units at $120 per unit, it will cover all fixed costs, variable
costs, and the desired pretax profit.

LOS 2C1h 3 Breakeven Analysis With Sales of Multiple Products

When breakeven analysis is used with multiple products, the units sold to achieve breakeven
depends on the sales mix (also called revenue mix) because each product in the mix likely has a
different contribution margin per unit.

Pass Key

There is no unique, single breakeven point for a company selling multiple products. Each
time the sales mix changes, a new breakeven point results because each product has
a different contribution margin. Selling more of relatively higher contribution margin
products results in a lower breakeven point.

3.1 Calculation of Breakeven Point Using Multiple Products

The calculation of the breakeven point for a given sales mix is a two-step procedure. If the
company sells a small number of products, the use of weighted averages for all products is
appropriate. If there is a wide range of products, the firm should segregate products into
product lines or product groups.

3.1.1 Multiproduct Breakeven Point in Units

y Step 1: Calculate the weighted average contribution margin in dollars. To do so, calculate
each product's contribution margin per unit, multiply that contribution margin by the ratio
of each product's units sold relative to total units sold, and add the results.
y Step 2: Calculate the breakeven point (in units), as follows:

Total fixed costs

Breakeven point in units =
Weighted contribution margin (dollars) per unit

3–14 Module 1 C.1. Cost-Volume-Profit

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3.1.2 Multiproduct Breakeven Point in Dollars

y Step 1: Calculate the weighted average contribution margin ratio by adding the weighted
contribution margin in dollars and dividing it by the total sales dollars.
y Step 2: Calculate the breakeven point (in dollars), as follows:

Total fixed costs

Breakeven point in sales dollars =
Weighted contribution margin ratio

3.2 Breakeven Point and Effects of Changes in Sales Mix

A change in the sales mix will result in a change in the breakeven point. When competitive,
economic, or other market conditions are expected to change during the period, managers
may wish to change sales mix assumptions to examine how changes in mix affect breakeven
and profit. Changes to the company's use of variable costs versus fixed costs will change the
contribution margin, contribution margin ratio, breakeven point, and profit forecasts.

Example 4 Breakeven Point Effects of Changes in Sales Mix LOS 2C1g

Facts: A company sells two products, Fix and Brix. Following are the revenues and costs
budgets for the coming year:

Fix Brix
Budgeted sales in units 50,000 150,000
Unit selling price $20 $10
Direct materials per unit $ 2 $ 1
Direct labor per unit $ 3 $ 2
Variable overhead per unit $ 2 $ 2

Fixed overhead is budgeted for the year at $600,000.

Required:
1. Calculate breakeven in dollars and units. Assume that the company will maintain the
sales mix as budgeted.
2. Calculate breakeven in dollars and units. Assume that the direct materials cost per unit
of Fix increases from $2 to $3.
3. Calculate breakeven in dollars and units. Assume that the quantity sold of Brix is
200,000 units instead of 150,000 units.

(continued)

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1 C.1. Cost-Volume-Profit Analysis PART 2 UNIT 3

(continued)

Solution:
1. Assume that the company will maintain the sales mix as budgeted:
Breakeven (dollars):
Fix Brix
Contribution margin per unit (CM/unit = SP/unit – VC/unit) $13 $5
CM ratio (CM/unit ÷ SP/unit) 65% 50%
Total sales dollars (Q × SP per unit) $1,000,000 $1,500,000
Product mix ratio based on sales dollars (Each product's
sales dollars ÷ Total sales dollars) 40% 60%
Product mix ratio in units (Each product's Q ÷ Total Q 25% 75%
of both)
Variable overhead per unit $2 $2
Weighted average CM ratio = Sum of each product's contribution margin ratio × That
product's mix ratio (based on sales dollars)
Weighted average CM ratio = (65% × 40%) + (50% × 60%) = 56%

Total fixed costs

Breakeven point (sales dollars) =
Weighted average contribution margin ratio
$600,000
=
56%
= $1,071,429 (rounded)

yyFix = 40% Fix's product mix ratio based on total sales dollars × $1,071,429 BEP in total
sales dollars = $428,572 (rounded) Fix sales to achieve BEP
yyBrix = 60% Brix's product mix ratio based on total sales dollars × $1,071,429 BEP in
total sales dollars = $642,857 (rounded) Brix sales to achieve BEP
Breakeven Point (units):
Weighted average per unit CM (in dollars) = Sum of each product's mix ratio (based on
units sold) x That product's per-unit contribution margin in dollars
Weighted average CM per unit = (25% × $13) + (75% × $5) = $7 weighted average CM
per unit

Total fixed costs

Breakeven point (unit) =
Weighted average contribution margin per unit
$600,000
=
$7
= 85,714 units (rounded)

(continued)

3–16 Module 1 C.1. Cost-Volume-Profit

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PART 2 UNIT
1 3 C.1. Cost-Volume-Profit Analysis

(continued)

yyFix = 25% product mix ratio based on units sold × 85,714 BE total units = 21,429
(rounded) Fix units to be sold to achieve BE
yyBrix = 75% product mix ratio based on units sold × 85,714 BE total units = 64,286
(rounded) Brix units to be sold to achieve BE
2. Assume that the direct materials cost per unit of Fix increases from $2 to $3:

Breakeven (dollars):
Fix Brix
Budgeted sales in units (Q) 50,000 150,000
Product mix ratio in units (Each product's Q ÷ Total Q 25% 75%
of both)
Unit selling price (SP) $20 $10
Direct materials per unit (DM) $ 3 $ 1
Direct labor per unit (DL) $ 3 $ 2
Variable overhead per unit (VOH) $ 2 $ 2
Total variable cost per unit (VC per unit = DM per unit + DL
per unit + VOH per unit) $ 8 $ 5
Contribution margin per unit (CM per unit = SP per unit –
VC per unit) $12 $ 5
CM ratio (CM per unit ÷ SP per unit) 60% 50%
Total sales dollars (Q × SP per unit) $1,000,000 $1,500,000
Product mix ratio based on sales dollars (Each product's
sales dollars ÷ Total sales dollars) 40% 60%

Weighted average CM ratio = Sum of each product's contribution margin ratio × That
product's mix ratio (based on sales dollars)
Weighted average CM ratio = (60% × 40%) + (50% × 60%) = 54%

Total fixed cost

Breakeven point (dollars) =
Weighted average contribution margin ratio
$600,000
=
54%
= $1,111,111 (rounded)

yyFix = 40% product mix ratio based on total sales dollars × $1,111,111 BEP in total
sales = $444,444 (rounded) Fix sales to achieve BEP
yyBrix = 60% product mix ratio based on total sales dollars × $1,111,111 BEP in total
sales = $666,667 (rounded) Brix sales to achieve BEP

(continued)

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1 C.1. Cost-Volume-Profit Analysis PART 2 UNIT 3

(continued)

Breakeven Point (units):

Weighted average CM per unit = Sum of each product's mix ratio (based on units sold)
× That product's unit contribution margin in dollars
Weighted average CM per unit = (25% × $12) + (75% × $5) = $6.75 weighted average CM
per unit

Total fixed costs

Breakeven point (units) =
Weighted average contribution margin per unit
$600,000
=
$6.75
= 88,889 (rounded) units

yyFix = 25% product mix based on units sold × 88,889 BEP total units = 22,223
(rounded) Fix units to be sold to achieve BEP.
yyBrix = 75% product mix based on units sold × 88,889 BEP total units = 66,667
(rounded) Brix units to be sold to achieve BEP.
As the contribution margin per unit of Fix decreases, the number of units needed to
break even increases.
3. Assume that the quantity sold of Brix is 200,000 units instead of 150,000 units:

Breakeven (dollars):
Fix Brix
Budgeted sales in units (Q) 50,000 200,000
Product mix ratio in units (Each product's Q ÷ Total Q of both) 20% 80%
Unit selling price (SP) $20 $10
Direct materials per unit (DM) $2 $1
Direct labor per unit (DL) $3 $2
Variable overhead per unit (VOH) $2 $2
Total variable cost per unit (VC per unit = DM per unit +
DL per unit + VOH per unit) $7 $5
Contribution margin per unit (CM per unit = SP per unit – VC
per unit) $13 $5
CM ratio (CM per unit ÷ SP per unit) 65% 50%
Total sales dollars (Q × SP per unit) $1,000,000 $2,000,000
Product mix ratio based on sales dollars (Each product's sales
dollars ÷ Total sales dollars) ⁄
13 ⁄
23

(continued)

3–18 Module 1 C.1. Cost-Volume-Profit

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PART 2 UNIT
1 3 C.1. Cost-Volume-Profit Analysis

(continued)

Weighted average CM ratio = Sum of each product's contribution margin ratio × That
product's mix ratio (based on sales dollars)
Weighted average CM ratio = (65% × 1⁄ 3) + (50% × 2⁄ 3) = 55%

Total fixed cost

Breakeven point (dollars) =
Weighted average contribution margin ratio
$600,000
=
55%
= $1,090,909 (rounded)

yyFix = 1⁄ 3 Fix's product mix ratio based on total sales dollars × $1,090,909 BEP in total
sales dollars = $363,636 (rounded) Fix sales to achieve BEP.
yyBrix = 2⁄ 3 Brix's product mix ratio based on total sales dollars × $1,090,909 BEP in
total sales dollars = $727,273 (rounded) Brix sales to achieve BEP.
Breakeven Points (units):
Weighted average CM per unit = Sum of each product mix ratio (based on units sold) ×
That product's unit contribution margin in dollars
The weighted average contribution margin per unit = (20% × $13) + (80% × $5) = $6.60

Total fixed cost

Breakeven (units) =
Weighted average contribution margin per unit
$600,000
=
$6.60
= $90,909 (rounded) units

yyFix = 20% product mix based on units sold × 90,909 BEP total units = 18,182
(rounded) Fix units to be sold to achieve BEP.
yyBrix = 80% product mix based on units sold × 90,909 BEP total units = 72,728
(rounded) Brix units to be sold to achieve BEP. Note: As the product with lower
contribution margin per unit constitutes a larger percentage of the sales mix, all else
equal, the number of units needed to break even has increased.

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 1 C.1. Cost-Volume-Profit Analysis PART 2 UNIT 3

4 CVP Analytical Tools

Managers may also use CVP analysis to forecast the effects of many types of operating changes
and to determine whether a firm has an operating cushion that can absorb sudden downturns
in the economy. When managers have this type of information, they are better able to make
operational decisions.

LOS 2C1j 4.1 Sensitivity Analysis

Managers use sensitivity analysis to model uncertainties. When sensitivity analysis is used in CVP
analysis, models test the sensitivity of operating income to changes in underlying assumptions
such as volume changes, sales price changes, or cost structure changes.

Illustration 3 Sensitivity Analysis

A company produces and sells widgets. The sales price per unit is $22 and variable costs
per unit are $9.50. Fixed costs for the year are estimated to be $100,000. The company
currently sells 10,000 units each year. The manager wants to analyze the change in
operating income that will result from changes in volume or an increase in variable cost
per unit.
Total sales revenue (10,000 units × $22/per unit) $220,000
Less: variable costs (10,000 units × $9.50 per unit) (95,000)
Total contribution margin (10,000 units × $12.50 CM per unit; CM per
unit = $22 selling price per unit – $9.50 variable costs per unit) 125,000
Less: fixed costs (100,000)
Operating income $ 25,000

Contribution margin per unit is $12.50 per unit; therefore, for every one-unit change in
sales volume there is a $12.50 change in operating income.
yyIf sales volume increases by 1,000 units: $12.50 contribution margin per unit × 1,000
additional units sold = $12,500 increase in operating income.
yyIf sales volume decreases by 1,000 units: $12.50 contribution margin per unit × 1,000
additional units sold = $12,500 decrease in operating income.
To determine how many units that sales would have to decline before profits fall to
$0 (breakeven):
$25,000 current operating income ÷ $12.50 CM per unit = 2,000 decline in unit sales
If variable costs per unit increase by $1, the contribution margin per unit decreases to
$11.50 and operating income falls by $10,000: 10,000 units × $1/unit decrease in the
contribution margin.
To find by how much sales price per unit would have to decline (or variable costs per unit
increase) before profits fall to $0 (breakeven):
$25,000 operating income ÷ 10,000 units = $2.50 per unit
Therefore, the sales price per unit could fall by $2.50 per unit or variable costs could
increase by $2.50 per unit (or some combination of the two) to breakeven.

3–20 Module 1 C.1. Cost-Volume-Profit

© Becker Professional Education Corporation. Analysis
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PART 2 UNIT
1 3 C.1. Cost-Volume-Profit Analysis

4.2 Margin of Safety LOS 2C1i

The margin of safety is the excess of sales over breakeven sales. A decline in sales will not lead
to losses as long as the decline is within the margin of safety.

4.2.1 Sales Dollars

The margin of safety expressed in dollars is calculated as follows:

Margin of safety (in dollars) = Total sales (in dollars) – Breakeven sales (in dollars)

4.2.2 Percentage
The margin of safety also can be expressed as a percentage of sales, as indicated below:

Margin of safety in dollars

Margin of safety ratio =
Total sales

Illustration 4 Margin of Safety

Draft Co. incurs annual fixed costs of $220,000. The company produces and sells a single
product at a price of $180 per unit with variable cost of $60 per unit. The company expects
to sell 3,000 units in the coming year.
yyCM ratio = CM per unit ÷ Selling price per unit = ($180 – $60) ÷ $180 = 66.67%
yyBreakeven sales (dollars) = Fixed costs / CM ratio = $220,000 / 66.7% = $330,000
yyBreakeven sales in units: $330,000 breakeven (dollars) ÷ $180 sales price per unit = 1,834
units (rounded up)
yyExpected sales = 3,000 units × $180 sales price per unit = $540,000
yyMargin of safety = Expected sales – Breakeven sales = $540,000 – $330,000 = $210,000
yyMargin of safety ratio = Margin of safety / Total sales - $210,000 / $540,000 = 39%

(continued)

© Becker Professional Education Corporation. All rights reserved. Module 1 3–21 C.

 1 C.1. Cost-Volume-Profit Analysis PART 2 UNIT 3

(continued)

$990,000

$880,000
es
e nu
Rev
$770,000

$660,000
Margin of safety

$550,000
ts
l cos
Tota
$440,000

$330,000
s
cost
able
Vari
$220,000
Fixed costs

$110,000

Quantity
0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500 5,000

Quantity to BE

The graph illustrates the breakeven sales point, relative to the production costs and total
2C_Margin
revenues. The margin of safety is the area on the of Safetythat is to the right of the BEP point
graph
and that is between the Revenues line and the Total Costs line.

LOS 2C1k 4.3 Decision Making Using CVP

Managers can use CVP to compare how revenues, costs, and contribution margins change and
select the alternatives that maximize operating income.

Example 5 Decision Analysis Using CVP

Facts: A college operates a print shop that offers copying services to students for $0.15 per
copy. The machines are leased from a supplier. Labor and paper cost $0.07 per copy.
The supplier who provides the copying machines makes two offers to the college:
yyOffer No. 1: Pay a fixed monthly lease of $1,400.
yyOffer No. 2: Pay a fixed monthly fee of $200 plus an additional $20 for every 500
copies made.

(continued)

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© Becker Professional Education Corporation. Analysis
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PART 2 UNIT
1 3 C.1. Cost-Volume-Profit Analysis

(continued)

Required:
1. Calculate the breakeven point in units if offer No. 1 is accepted.
2. Calculate the breakeven point in units if offer No. 2 is accepted.
3. Calculate the level of sales volume at which the college will be indifferent between the
two offers.
4. Which option should the college select if estimated sales volume is 40,000 copies
per month?
Solution:
1. Sales price per copy $0.15
Variable cost per copy (0.07)
Contribution margin per copy $0.08

Fixed costs
Breakeven point =
Contribution margin per copy
$1,400
=
$0.08
= 17,500 copies

2. Sales price per copy $0.15

Variable cost per copy (0.11) (0.07) paper and labor + $20 / 500 copies
additional variable (costs in lease)
Contribution margin per copy $0.04

Fixed costs
Breakeven point =
Contribution margin per copy
$200
=
$0.04
= 5,000 copies

(continued)

© Becker Professional Education Corporation. All rights reserved. Module 1 3–23 C.

1 C.1. Cost-Volume-Profit Analysis PART 2 UNIT 3

(continued)
3. The indifference point occurs when the numbers of copies sold generate the same cost
under either option.
Total cost of offer No. 1 = Total cost of offer No. 2
$1,400 fixed costs + $0.07 variable costs × Number of copies = $200 fixed costs +
$0.11 variable costs × the number of copies
$1,400 + $0.07N = $200 + $0.11N
$1,200 = $0.04N
N = 30,000 copies
At sales volume of 30,000 copies, the cost under either option is identical.
4. If the print shop expects to sell 40,000 copies, offer No. 1 will be the better option.
yy Offer No. 1: (40,000 copies × $0.07 VC per copy) + $1,400 fixed costs = $4,200
yy Offer No. 2: (40,000 copies × $0.11 VC per copy) + $200 fixed costs = $4,600

Question 1 MCQ-12494

A retailer sells a product throughout its stores for $30 per unit. Fixed costs include rent of
$60,000, salaries of $200,000, and other fixed costs of $100,000. Each unit's wholesale cost
is $16.50. A salesperson is paid a 5 percent sales commission in addition to the fixed salary
that the salesperson receives and that is included in the total annual salaries listed above.
What is the annual breakeven point in units?
a. 12,000 units
b. 20,000 units
c. 21,819 units
d. 30,000 units

Question 2 MCQ-12495

A retailer sells a product throughout its stores for $30 for each unit. Fixed costs include
rent of $60,000, salaries of $200,000, and other fixed costs of $100,000. Each unit's whole
cost is $16.50. The salesperson receives a 5 percent sales commission in addition to the
fixed salary that the salesperson receives and that is included in the total annual salaries
listed above. If the company expects to sell 35,000 units next year, what is the estimated
operating income?
a. $112,500
b. $60,000
c. $0
d. $(60,000)

3–24 Module 1 C.1. Cost-Volume-Profit

© Becker Professional Education Corporation. Analysis
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PART 2 UNIT
1 3 C.1. Cost-Volume-Profit Analysis

Question 3 MCQ-12496

A company produces three products, X, Y, and Z, with a contribution margin of $6, $4, and
$3, respectively. Management estimates sales of 300,000 units next year: 100,000 units
of X; 150,000 units of Y; and 50,000 units of Z. How many units of Y must be sold to break
even if the sales mix is maintained and if fixed costs for the year are $112,500?
a. 25,000 units
b. 12,500 units
c. 8,334 units
d. 4,167 units

Question 4 MCQ-12497

A retailer sells a product throughout its stores for $30 for each unit. Fixed costs include rent
of $60,000, salaries of $200,000, and other fixed costs of $100,000. Each unit's wholesale
cost is $16.50. A salesperson receives a 5 percent sales commission in addition to a fixed
salary, and that is included in the total annual salaries listed above. If the company expects
to sell 35,000 units next year, what is the margin of safety?
a. $1,050,000
b. $900,000
c. $150,000
d. $0

© Becker Professional Education Corporation. All rights reserved. Module 1 3–25 C.

1 C.1. Cost-Volume-Profit Analysis PART 2 UNIT 3

NOTES

3–26 Module 1 C.1. Cost-Volume-Profit

© Becker Professional Education Corporation. Analysis
All rights reserved.