4 Cost Volume Profit (CVP) Analysis
Learning Objectives LO
LO1 Identify the purposes of cost volume profit analysis
LO2 Explain how the contribution margin income statement is used for cost volume profit analysis
LO3 Apply cost volume profit analysis to show the effects on net operating income from changes in variable costs, fixed costs, selling price, and sales volume
LO4 Calculate the breakeven point in sales dollars and units sold
LO5 Calculate target profit in sales dollars and units sold
Purposes of cost volume profit (CVP) analysis LO1
Cost volume profit (CVP) analysis helps managers make many important decisions about what products and services to offer, what prices to charge, what marketing strategy to use, and what cost structure to maintain. Cost structure is the type and proportion of fixed and variable costs in relation to the organization’s total costs. The primary purpose of cost volume profit analysis is to estimate how profits are affected by the following five factors:
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- Selling prices
- Sales volume
- Unit variable costs
- Total fixed costs
- Mix of products sold
Check Your Understanding LO1
CVP analysis using the contribution margin income statement LO2
Cost volume profit (CVP) analysis is based on cost behavior. Cost behavior is how a cost reacts to changes in production or sales quantity. Cost behavior is discussed in detail in Chapter 1. To recap, cost behavior is classified as variable, fixed, or mixed.
Variable cost—cost is the same per unit but the total changes depending on quantity
Fixed cost—cost is the same in total regardless of quantity but the per unit cost changes depending on quantity
Mixed cost—cost has both a variable and a fixed component
Cost behavior must be considered to estimate how profits are affected by changes in sales prices, sales volume, unit variable costs, total fixed costs, and the mix of products sold. The contribution margin income statement classifies costs on the basis of cost behavior. For this reason, it is an essential tool for cost volume profit analysis. The contribution margin income statement is covered in detail in Chapter 1. In this chapter, cost volume profit analysis using the contribution margin income statement is introduced.
Video Illustration 4-1: Discussion of CVP and the contribution margin income statement LOs1,2
Kinsley Shuck, the founder of Kinsley’s Koncepts, designed a radical new toy that can be programmed to perform various tasks. The programmable toy was an immediate success, and sales grew to the point that Kinsley moved the company’s headquarters out of her garage and into a rented manufacturing space. Kinsley sold 500 toys in the first year of operation. The contribution margin income statement for Kinsley’s Koncepts first year of operations is presented in Exhibit 4-1.
Exhibit 4-1 Contribution margin income statement and video explanation
CVP analysis when sales quantity changes LO3
The contribution margin represents the margin that an organization can make or l