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CHAPTER 3: COST-VOLUME-PROFIT ANALYSIS

Document Type

: Book Summary

Source

: Cost Accounting: A Managerial Emphasis 15th Edition by Charles T
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Datar, and Madhav V
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One of the
important concept mainly used in the CVP analysis is the contribution margin concept
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It
indicates why operating income changes as the number of units sold changes
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This modified form provides another way to calculate contribution
margin through the following formula: Contribution margin per unit × Number of units

sold
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When companies sell multiple products, instead of expressing contribution margin in
dollars per unit, they can express it as a percentage called contribution margin

percentage (ratio), whose formula is calculated by dividing contribution margin by
revenue
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It is a useful tool for
calculating how a change in revenues changes contribution margin
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Besides that, by rearranging terms in the
equation defining contribution margin percentage, we can get another way to calculate
contribution margin (which is Contribution margin percentage × Revenues (in dollars)),
and if we multiply contribution margin percentage with change in revenues, we get the
formula to calculate Change in contribution margin
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The equation method and the
contribution method are most useful when managers want to determine operating
income at a few specific sales levels
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There are four cost-volume-profit assumptions, as follows:


Changes in revenues and costs arise only because of changes in the number of
product units sold;



Total costs can be separated into a fixed component and a variable component ;



When represented graphically, the behaviors of total revenues and total costs are
linear in relation to units sold within a relevant range; and



Selling price, variable cost per unit, and total fixed costs are known and constant
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BEP can be
calculated using below formula
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In practice, management accountants usually calculate the BEP directly in terms of
revenues using contribution margin percentages (see below formula)
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To do this, they can use below formulas
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To calculate target net income, we can use below formula
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Learning Objective 4

: Explain How Managers Use CVP Analysis to Make Decisions

A manager can also use CVP analysis to make other strategic decisions, such as decision
to advertise, decision to reduce the selling price, and decision to determine the target
price
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Analyzing differences allows managers to get to the heart of CVP analysis and
sharpens their intuition by focusing only on the revenues and costs that will change as a
result of a decision
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Managers can
use CVP analysis to evaluate how the operating income of their companies will be

affected if the outcomes they predict are not achieved
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Learning Objective 5

: Explain How Sensitivity Analysis Helps Managers Cope with
Uncertainty

Sensitivity analysis is a “what-if” technique managers use to examine how an outcome
will change if the original predicted data are not achieved or if an underlying assumption
changes
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One aspect of the sensitivity analysis is margin of safety,
whose formulas are as follows
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It is a
simple approach to recognizing uncertainty, which is the possibility that an actual
amount will deviate from an expected amount
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For that decision, managers can use the CVP analysis to help them evaluate
various fixed-cost/variable-cost structures
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It measures the risk-return tradeoff across alternative cost
structures
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Organizations with a high
proportion of fixed costs in their cost structures have high operating leverage
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The degree of operating leverage at a given level of sales
helps managers calculate the effect of sales fluctuations on operating income
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Learning Objective 7

: Apply CVP Analysis to a Company Producing Multiple
Products

Sales mix is the quantities (or proportion) of various products (or services) that constitute
a company’s total unit sales
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In general, for any given total quantity
of units sold, as the sales mix shifts toward units with lower contribution margins, the
lower operating income will be
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Learning Objective 8

: Apply

CVP

Analysis

in

Service

and

Not-for-Profit

Organizations
To apply CVP analysis in service and not-for-profit organizations, we need to focus on
measuring their output, which is different from the tangible units sold by manufacturing
and merchandising companies
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While, contribution margin indicates how
much of a company’s revenues are available to cover fixed costs
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