Summary
Highlights
Cost-Volume-Profit (CVP) analysis systematically examines relationships among cost, cost drivers, and profit. The contribution margin income statement classifies expenses based on behavior—variable or fixed—unlike traditional income statements. This statement highlights the contribution margin, which is sales minus variable costs, before deducting fixed costs to arrive at profit.
Variable costs change in total as the level of activity changes (e.g., direct materials, direct labor). Fixed costs remain constant in total regardless of changes in activity level (e.g., depreciation, rent, insurance). The contribution margin represents the portion of sales revenue available to cover fixed costs and contribute to profit.
The contribution margin is the difference between sales and variable costs. For example, if a product sells for 10 pesos and has a variable cost of 5 pesos, the contribution margin per unit is 5 pesos. The contribution margin ratio (CM ratio) is the contribution margin as a percentage of sales, calculated by dividing the total contribution margin by total sales, or contribution margin per unit by selling price per unit.
The break-even point is the sales volume level (in pesos or units) where total revenue equals total cost, resulting in neither profit nor loss. An illustration with "Straight Show Incorporation" demonstrates how to prepare a contribution margin income statement and introduces the concept with a selling price of 25 pesos, variable cost of 15 pesos, fixed cost of 100,000 pesos, and average monthly sales of 11,000 units.
The break-even point in pesos can be calculated by multiplying the break-even point in units by the selling price per unit (10,000 units * 25 pesos = 250,000 pesos). Alternatively, it can be found using the formula: Fixed Costs / Contribution Margin Ratio. With a 40% CM ratio (10/25), 100,000 pesos divided by 40% also gives 250,000 pesos. At the break-even point, profit is zero, meaning contribution margin equals fixed costs.
To calculate the break-even point in units, we use the formula: Fixed Costs / Contribution Margin Per Unit. Using the example, with fixed costs of 100,000 pesos and a contribution margin per unit of 10 pesos (25 selling price - 15 variable cost), the break-even point is 10,000 units.