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Revised Summer 2010
Page 1 of 16
CHAPTER 6
COST-VOLUME-PROFIT
RELATIONSHIPS
Key Terms and Concepts to Know
Contribution Income Statement:
Separates expenses into variable and fixed.
Sales
–
variable expenses = contribution margin.
Contribution margin
–
fixed expenses = net income (loss).
Same revenue and net income (loss) as absorption income statement.
Contribution Margin:
The amount of sales available to cover fixed expenses with any remaining
contribution margin providing profits.
If the contribution margin is not sufficient to cover fixed expenses, there will be a
net loss for the period.
Contribution Margin Ratio:
Sales, variable expenses and contribution margin are all variable, and therefore
may be expressed as a percent of revenue.
The contribution margin ratio is calculated as the contribution margin dollars as a
percent of sales dollars.
In a company producing a single product, this relationship applies to either total
sales dollars and total contribution margin or per-unit sales dollars and
contribution margin dollars.
In a company producing multiple products, each product will have its own unique
contribution margin ratio, with the contribution margin for the entire company
calculated only for total contribution margin dollars as a percent of total sales
dollars.
The variable expense ratio is the complement to the contribution margin ratio.
It
represents the percent of sales dollars not included in the contribution margin
ratio.
Break Even Point:
At the breakeven point:
o
Operating income
= 0
o
Total revenue = total expenses

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Revised Summer 2010
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o
Fixed expenses = contribution margin
Target Profit:
Rather than setting operating income = 0, target profit calculations assume a
certain operating income and calculate the sales dollars and units sold necessary
to achieve it.
The same equations are used as to calculate the breakeven point, except that a
non-zero operating income term is included in the numerator.
Margin of Safety:
The margin of safety is the excess of budgeted or actual sales over the break
even volume of sales.
It is expressed as both the dollar amount of the difference and as a percent of
budgeted or actual sales.
Operating Leverage:
Operating leverage quantifies, at a given level of sales, the percent change
in
operating income caused by a percent change
in sales.
Leverage calculations are a two-step process:
o
First, calculate the Degree of Leverage or Leverage Factor
Degree of Leverage
=
Contribution Margin
Operating Income
o
Second,
Percent change in
operating income
=
Degree of Leverage
x
Operating Income
Key Topics to Know
Breakeven Equations
The breakeven point is expressed in sales dollars and units sold.
The link
between the two is selling price per unit, meaning that breakeven units sold x
selling price per unit = breakeven sales.
The breakeven equations are:

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