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CHAPTER
3
CostVolumeProfit
Analysis
Overview
This chapter explains a planning tool called
costvolumeprofit (CVP) analysis
. CVP
analysis examines the behavior of total
revenues, total costs, and operating income
(profit) as changes occur in the output level,
selling price, variable cost per unit, and/or fixed
costs of a product or service. The reliability of
the results from CVP analysis depends on the
reasonableness
of
the
assumptions.
The
Appendix to the chapter gives additional
insights about CVP analysis; it illustrates
decision models and uncertainty.
Review Points
1.
CVP analysis is based on several
assumptions including:
a.
Changes in the level of revenues and costs
arise only because of changes in the number
of product (or service) units produced and
sold (that is, the number of output units is
the only driver of revenues and costs).
b.
Total costs can be separated into a fixed
component that does not vary with the
output level and a component that is
variable with respect to the output level.
c.
When represented graphically, the behaviors
of both total revenues and total costs are
linear (straight lines) in relation to the
output level within the relevant range (and
time period).
d.
The analysis either covers a single product
or assumes that the proportion of different
products when multiple products are sold
will remain constant as the level of total
units sold changes.
2.
Even though CVP assumptions simplify
realworld situations, many companies have
found CVP relationships can be helpful in
making decisions about strategic and longrange
planning, as well as decisions about product
features and pricing. Managers, however, must
always assess whether the simplified CVP
relationships generate sufficiently accurate
predictions of how total revenues and total costs
behave. If decisions can be significantly
improved, managers should choose a more
complex approach that, for example, uses
multiple cost drivers and nonlinear cost
functions.
3.
Because managers want to avoid
operating losses, they are interested in the
breakeven point
calculated using CVP analysis.
The breakeven point is the quantity of output
sold at which total revenues equal total costs.
There is neither a profit nor a loss at the
breakeven point. To illustrate, assume a
company sells 2,000 units of its only product for
$50 per unit, variable cost is $20 per unit, and
fixed costs are $60,000 per month. Given these
conditions, the company is operating at the
breakeven point:
Revenues, 2,000
×
$50
$100,000
Deduct:
Variable costs, 2,000
×
$20
40,000
Fixed costs
60,000
Operating income
$
0
The breakeven point can be expressed two ways:
2,000 units
and
$100,000 of revenues
.
4.
Under CVP analysis, the income
statement above is reformatted to show a key
line item,
contribution margin
:
Revenues, 2,000
×
$50
$100,000
Variable costs, 2,000
×
$20
40,000
Contribution margin
60,000
Fixed costs
60,000
Operating income
$
0
This format, called the
contribution income
statement
, is used extensively in this chapter
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 Fall '09
 SIEBERT
 Cost Accounting

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