Principles of Managerial Accounting

Chapter 6

Cost-Volume-Profit (CVP) Analysis CVP is used to predict the impact

on profits with changes: Selling price Variable cost per unit Sales volume Total fixed costs.

Contribution Margin Contribution margin:

Sales minus variable costs. (Contribution to fixed costs and profits.)

Contribution margin ratio: Contribution margin/sales

Break-even point – the point when sales equals Fixed plus Variable costs (zero profit)

Break-even point Break-even – equation method

To determine quantity: Sales(selling price per unit) = Variable

cost (per unit) + Fixed cost

To determine break-even in Sales Dollars:

Sales = Variable cost per unit + Fixed Costs

Break-even point—Contribution Margin method Break-even in units = Fixed

expenses/Unit contribution margin in dollars

Break-even in dollars = Fixed expenses/contribution margin ratio

Margin of Safety The amount by which sales can

drop before losses begin to be incurred. In dollars

Total budgeted or actual sales – Break-even sales in dollars

In Percentage form: Margin of safety in dollars/Total budgeted

or actual sales

Operating Leverage The measure of how sensitive net

income is to a given percentage change in sales

Degree of operating leverage = Contribution margin/net income

The higher the degree of operating leverage, the larger the increase in net income.

Assumptions: Unit selling price is constant Costs are linear and can be

accurately divided into variable and fixed elements

Sales mix is constant in multi-product companies

In manufacturing companies, inventories do not change