Unformatted text preview: ,000 X $800)
Contribution margin
Fixed costs 1 ,200,000 Net income  What would happen if Leyland sold 2,000 units?
Sales (2,000 X $2,000) * Variable costs (2,000 X $800)
Contribution margin
Fixed costs 1 ,200,000 Net income $1,200,000
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20 BreakEven and Target Income Cost Analysis What would happen if Leyland sold only 500 units?
Total
Sales (500 X $2,000) * P er Unit Ratio $ 1,000,000 $2,000 100% 4 00,000 8 00 40% $ 600,000 $1,200 60% Variable costs (500 X $800)
Contribution margin
Fixed costs 1 ,200,000 Net income $ (600,000) Notice that changes in volume only impact certain amounts within the “total column.” Volume
changes did not impact fixed costs, or change the per unit or ratio calculations. By reviewing the
data on the previous page, also note that 1,000 units achieved breakeven net income. At 2,000 units,
Leyland managed to achieve a $1,200,000 net income. Conversely, 500 units resulted in a $600,000
loss. 3.3 Graphic Presentation
Leyland’s management would probably find the following chart very handy. Dollars are represented
on the vertical axis and units on the horizontal: Be sure to examine this chart, taking note of the following items: The total sales line starts at “0”
and rises $2,000 for each additional unit. The total cost line starts at $1,200,000 (reflecting the fixed
cost), and rises $800 for each additional unit (reflecting the addition of variable cost). “Breakeven”
results where sales equal total costs. At any given point, the width of the loss area (in red) or profit
area (in green) is the difference between sales and total costs. Download free ebooks at bookboon.com
21 BreakEven and Target Income Cost Analysis 3.4 BreakEven Calculations
As they say, a picture is worth a thousand words, and that is certainly true for the CVP graphic just
presented. However, everyone is not an artist, and you may find it more precise to do a little algebra
to calculate the breakeven point. Consider that:
Breakeven results when:
Sales = Total Variable Costs + Total Fixed Costs
For Leyland, the math turns out this way:
(Units X $2,000) = (Units X $800) + $1,200,000
Solving:
Step a: (Units X $2,000) = (Units X $800) + $1,200,000
Step b: (Units X $1,200) = $1,200,000
Step c: Units = 1,000
Now, it is possible to “jump to step b” above by dividing the fixed costs by the contribution margin
per unit. Thus, a breakeven short cut is: e Graduate Programme
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Download free ebooks at bookboon.com 22 BreakEven and Target Income Cost Analysis BreakEven Point in Units = Total Fixed Costs / Contribution Margin Per Unit
1,000 Units = $1,200,000 / $1,200
Sometimes, you may want to know the breakeven point in dollars of sales (rather than units). This
approach is especially useful for companies with more than one product, where those products all
have a similar contribution margin ratio:
BreakEven Point in Sales = Total Fixed Costs / Contribution Margin Ratio
$2,000,000 = $1,200,000 / 0.60 3.5 Target Income Calculations
Breaking even is not a bad thing, but hardly a satisfactory outcome for most businesses. Instead, a
manager may be more interested in learning the necessary sales level to achieve a targeted profit.
The approach to solving this problem is to treat the “target income” like an added increment of fixed
costs. In other words, the margin must cover the fixed costs and the desired profit:
Target Income results when:
Sales = Total Variable Costs + Total Fixed Costs + Target Income
Assume Leyland wants to know the level of sales to reach a $600,000 income:
(Units X $2,000) = (Units X $800) + $1,200,000 + $600,000
Solving:
Step a: (Units X $2,000) = (Units X $800) + $1,200,000 + $600,000
Step b: (Units X $1,200) = $1,800,000
Step c: Units = 1,500
Again, it is possible to “jump to step b” by dividing the fixed costs and target income by the per unit
contribution margin:
Units to Achieve a Target Income
=
(Total Fixed Costs + Target Income) / Contribution Margin Per Unit
1,500 Units = $1,800,000 / $1,200
If you want to know the dollar level of sales to achieve a target net income:
Sales to Achieve a Target Income
=
(Total Fixed Costs + Target Income) / Contribution Margin Ratio
$3,000,000 = $1,800,000 / 0.60
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23 BreakEven and Target Income Cost Analysis 3.6 Critical Thinking About CVP
CVP is more than just a mathematical tool to calculate values like the breakeven point. It can be
used for critical evaluations about business viability.
For instance, a manager should be aware of the “margin of safety.” The margin of safety is the
degree to which sales exceed the breakeven point. For Leyland, the degree to which sales exceed
$2,000,000 (its breakeven point)...
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 Fall '13
 CuongVu
 Management, Cost Accounting, Contribution Margin, Download free eBooks

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