Chapter 7 Learning Objectives

LO7-1 Compute a break-even point using the contribution-margin approach and the equation approach.
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LO7-1 Compute a break-even point using the contribution-margin approach and the equation approach.
These two approaches result in the same general formula for computing the break-even point (in units). Under the equation approach, the profit equation is specified as follows: Sales revenue - Variable expenses - Fixed expenses = Profit. When this equation is manipulated, the contribution-margin approach to the break-even point results, as follows: Break-even point (in units) = Fixed expenses divided by Unit contribution margin.
LO7-2 Compute the contribution-margin ratio and use it to find the break-even point in sales dollars.
The contribution-margin ratio is defined as follows: Unit contribution margin divided by Unit sales price. The break-even point (in sales dollars) can be computed as follows: Fixed expenses divided by Contribution-margin ratio.
LO7-3 Prepare a cost-volume-profit (CVP) graph and explain how it is used.
A cost-volume-profit graph show the break-even point (in sales dollars) as the intersection of the total revenue line and the total expense line. The graph can be used to help management understand how changes in the volume of activity affect cost and profit.
LO7-4 Apply CVP analysis to determine the effect on profit of changes in fixed expenses, variable expenses, sales prices, and sales volume.
Management can use the break-even equation to predict the effects on the break-even point of changes in any component of the equation, for example, sales price, unit variable cost, fixed cost, and so forth. Such prediction can help management in making a variety of operational decisions.
LO7-5 Compute the break-even point and prepare a profit-volume graph for a multiproduct enterprise.
Break-even analysis in a multiproduct firm is accomplished by computing a weighted-average contribution margin, which is based on the expected sales mix. The same break-even formulas are used as in a single-product analysis, except that the unit contribution margin is replaced by the weighted-average contribution margin. This analysis is limited by the assumption of a constant sales mix across the range of total sales volume.
LO7-6 List and discuss the key assumptions of CVP analysis.
CVP analysis involves several key assumptions, which follow: (1) Total revenue is linear (i.e., a straight line) with respect to changes in the volume of activity. (2) Total expense is linear (i.e., a straight line) with respect to changes in the volume of activity. An implication of this assumption is that the efficiency and productivity of the production process remains constant. (3) The sales mix remains constant over the relevant range. (4) The beginning and ending inventory levels are the same in a manufacturing firm.
LO7-7 Prepare and interpret a contribution income statement.
Cost-volume-profit relationships are important enough to operating managers that some firms prepare a contribution income statement. This income-statement format separates fixed and variable expenses and computes the aggregate contribution margin. This statement format helps managers discern the effects on profit from changes in volume. The contribution income statement also discloses an organization's cost structure, which is the relative proportion of its fixed and variable costs.
LO7-8 Explain the role of cost structure and operating leverage in CVP relationships.
An organization's cost structure is the relative proportions of its fixed and variable costs. The extent to which an organization uses fixed costs in its cost structure is called operating leverage. Firms with high operating leverage tend to have higher break-even points, other things being equal.
LO7-9 Understand the implications of activity-based costing for CVP analysis.
Activity-based costing (ABC) provides a richer description of an organization's cost behavior and CVP relationships than is provided by a traditional costing system. An ABC cost-volume-profit analysis recognizes that some costs that are fixed with respect to sales volume may not be fixed with respect to other important cost drivers. In many cases, management can benefit substantially from such an improved understanding of cost behavior and CVP relationships.
LO7-10 Be aware of the effects of advanced manufacturing technology on CVP relationships.
Companies with advanced manufacturing technology tend to have higher fixed costs, lower variable costs, and higher break-even points.
LO7-11 Understand the effect of income taxes on CVP analysis (appendix).