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Chapter 7

# Chapter 7 Cost-Volume-Profit Relationships.docx

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University of Waterloo

Accounting & Financial Management

AFM 102

Tom Vance

Fall

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07– Cost-Volume-ProfitRelationships
Chapter 7: Cost-Volume-Profit Relationships
CVP analysis is a powerful tool that helps managers understand the relationships among cost, volume, and
profit
focuses on: prices of products, volume/level of activity, per unit variable cost, TFC and mix of products sold
The Basicsof Cost-Volume-Profit (CVP)Analysis
Contribution Margin
the amount remaining from sales revenue after variable expense have be deducted
break-even point: the level of sales at which profit is zero
total sales equals total expenses
total contribution margin equals total fixed expenses
sales – variable expenses – fixed expenses = 0
once the break-even point has been reached, operating income will increase by the unit contribution margin
for each additional unit sold
if sales are zero, the company’s loss would equal the fixed costs
CVP Relationships in Graphic Form
cost-volume-profit graph: the relationships among revenues, costs and level of activity in an organization
presented in graphic form
Preparing the CVP Graph
sometimes called the break-even chart
unit volume on the x-axis and $ on the y-axis
total fixed cost is a horizontal line
total variable cost has slope equal to per unit variable cost and crosses the origin
total costs cuts the y-axis with the total fixed cost and has the same slope has total variable cost
total revenue has slope equal to price per unit and crosses the origin
break-even point is where the total revenue and total expenses cross
profit is the area above the break-even point (between total rev. and total exp) and loss is the area below
ContributionMargin(CM) Ratio
contribution (CM) ratio: the contribution margin as a percentage of total sales
contributionmargin
CMratio sales
Break-Even Analysis
Break-Even Computations
X = break-even point in units sold
equation method: a method of computing break-even sales using the contribution format income statement
profit = (sales – variable expenses) – fixed expenses
sales = variable expenses + fixed expenses + profits
$salesX = $varX + $fix + 0
X = ($fix)/($sales - $var)
variable expense ratio: the ratio of var. exp. to sales dollars [var.exp/sales]
page 1 of 3 07– Cost-Volume-ProfitRelationships
contribution margin method: a method of computing the break-even point in which fixed expenses are
divided by the contribution margin per unit
X = fixed exp/unit contribution margin
Target Operating Profit Analysis
CVP Equation: X = (var exp + fixed exp + target profit) / (sales per unit – var per unit)
contribution margin approach: X = (fixed exp + target profit) / unit contribution margin
After-TaxAnalysis
income after tax = before-tax profit – taxes
= B – t(B)
= B(1 – t)
B = income after tax / (1 – t)
The Marginof Safety
margin of safety: the excess of budgeted (or actual) sales over the break-even volume of sales
margin of safety = total budgeted (or actual) sales –

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