Cost-Volume-Profit Understand the assumptions underlying cost-volume-profit (CVP) analysis. Cost-Volume-Profit Assumptions and Terminology 1. Changes in the level of revenues and costs arise only...

Cost-Volume-Profit


Understand the assumptions


underlying cost-volume-profit


(CVP) analysis.

Cost-Volume-Profit Assumptions
and Terminology
1. Changes in the level of revenues and costs arise
only because of changes in the number of product
(or service) units produced and sold.
2. Total costs can be divided into a fixed component
and a component that is variable with respect to
the level of output.
3. When graphed, the behavior of total revenues
and total costs is linear (straight-line) in relation
to output units within the relevant range
(and time period).
4. The unit selling price, unit variable costs, and
fixed costs are known and constant.
5. The analysis either covers a single product or
assumes that the sales mix when multiple
products are sold will remain constant as the
level of total units sold changes.
6. All revenues and costs can be added and
compared without taking into account the time
value of money.
Operating income
= Total revenues from operations
– Cost of goods sold and operating costs
(excluding income taxes)
Net income = Operating income – Income taxes

Learning Objective 2


Explain the features


of CVP analysis.

Essentials of Cost-Volume-Profit
(CVP) Analysis Example
Assume that the Pants Shop can purchase pants
for $32 from a local factory; other variable costs
amount to $10 per unit.
The local factory allows the Pants Shop to
return all unsold pants and receive a full $32
refund per pair of pants within one year.
The average selling price per pair of pants is $70
and total fixed costs amount to $84,000.
Essentials of Cost-Volume-Profit
(CVP) Analysis Example
How much revenue will the business receive if
2,500 units are sold?
2,500
×
$70 = $175,000
How much variable costs will the business incur?
2,500
×
$42 = $105,000
$175,000 – 105,000 – 84,000 = ($14,000)
$175,000 – 105,000 – 84,000 = ($14,000)
Essentials of Cost-Volume-Profit
(CVP) Analysis Example
What is the contribution margin per unit?
$70 – $42 = $28 contribution margin per unit
What is the total contribution margin when
2,500 pairs of pants are sold?
2,500
×
$28 = $70,000