Smeal College of Business Pennsylvania State University Managerial Accounting B A 521 Professor Huddart Cost Volume Profit Analysis 1 The Basic Idea Variable costs are a multiple of sales or units Total contribution margin is the difference between sales dollars and variable costs Volume i e the number of units is the only driver CVP analysis has the virtue of being quick and easy 2 Terminology There are two distinctions between contribution margin CM and gross margin GM Variable marketing and administrative expenses are subtracted to get CM but not GM and fixed manufacturing overhead is subtracted to get GM but not CM CoGS or Cost of Goods Sold usually includes some fixed costs CM sales all variable costs gross profit GM sales CoGS c Steven Huddart 1995 2009 All rights reserved www personal psu edu sjh11 B A 521 3 Cost Volume Profit Analysis Schema The CVP Chart Step 1 Decide on the purpose Step 2 In light of the purpose categorize data as fixed or variable Step 3 For variable costs define the unit e g sales dollar passengermile patient day Units Sales Price Units Unit variable cost Fixed Costs Operating Income Ask the questions What is pre determined in the equation What is unknown in the equation 3 1 Assumptions volume is the only driver linearity single product or constant product mix 3 2 Caveats CVP is valid only in the relevant range Deciding which costs are fixed and which are variable can be tricky CVP will not work if multiple drivers are appropriate e g in a multiproduct setting where product mix can vary Identifying all of the relevant costs for a CVP analysis or any costing technique can be tricky Page 2 Cost Volume Profit Analysis 3 3 B A 521 Modifications What do we do when there are multiple products How do changes in product mix affect the break even point How does taxation affect CVP analysis Net income operating income taxes Page 3 B A 521 Cost Volume Profit Analysis Components of Gross Margin for a Grocery Store Sales Cost of Goods Sold Gross Margin 100 75 25 Labor Refrigeration Heat and Light Rent 15 3 1 3 22 Operating Profit Taxes Net Income 3 1 5 1 5 Data are based on information from the Food Marketing Institute 1750 K Street N W Washington DC 20006 Page 4