Smeal College of Business Managerial Accounting: B A 521Pennsylvania State University Professor HuddartCost-Volume-Profit Analysis1. The Basic Idea• Variable costs are a multiple of sales ($ or units).• Total contribution margin is the difference between sales dollars andvariable 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) andgross margin (GM). Variable marketing and administrative expenses aresubtracted to get CM (but not GM), and fixed manufacturing overheadis 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 − CoGScSteven Huddart, 1995–2009. All rights reserved. www.personal.psu.edu/sjh11B A 521 Cost-Volume-Profit Analysis3. Schema: The CVP ChartStep 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, passenger-mile, patient-day).(Units × Sales Price) − (Units × Unit variable cost) − Fixed Costs =Operating IncomeAsk the questions: What is pre-determined in the equation? What isunknown in the equation?3.1 Assumptions• volume is the only driver• linearity• single product or constant product mix3.2 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 multi-product setting where product mix can vary.• Identifying all of the relevant costs for a CVP analysis (or any costingtechnique) can be tricky.Page 2Cost-Volume-Profit Analysis B A 5213.3 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 3B A 521 Cost-Volume-Profit AnalysisComponents of Gross Margin for aGrocery Store∗Sales 100Cost of Goods Sold 75Gross Margin 25Labor 15Refrigeration 3Heat and Light 1Rent 322Operating Profit 3Taxes 1.5Net Income 1.5∗Data are based on information from the Food Marketing Institute, 1750 K Street,N.W., Washington, DC 20006.Page