Accounting: The Language of Business - Vol. 1 (Part 123)

"What is meat for one is not for another--no accounting for fancy." - Abigail Adams 

 Cost Behavior and Cost-Volume-Profit Analysis ️(Part E)

by

Charles Lamson

Graphic Approach to Cost-Volume-Profit Analysis

Cost volume profit analysis can be presented graphically as well as in equation form. Many managers prefer the graphic format because the income or loss from operations (operating profit or loss) for different levels of sales can readily be determined. Next, we describe two graphic approaches that managers find useful.

Cost-Volume-Profit (Break Even) Chart

A cost-volume-profit chart, sometimes called a break-even chart, may assist management in understanding relationships among costs, sales, and operating profit or loss. To illustrate, the cost-volume-profit chart in Exhibit 5 is based on the following data:

EXHIBIT 5 Cost-Volume-Profit Chart

We constructed the cost volume profit chart in Exhibit 5 as follows: 

1. Volume expressed in units of sales as indicated along the horizontal axis. The range of volume shown on the horizontal axis should reflect the relevant range in which the business expects to operate. Dollar amounts representing total sales and costs are indicated along the vertical axis.

2.  A sales line is plotted by beginning at 0 on the left corner of the graph. A second point is determined by multiplying any units of sales on the horizontal access by the unit sales price of $50. For example, for 10,000 units of sales, the total sales would be $500,000 (10,000 units * $50). The sales line is drawn upward to the right from 0 through the $500,000 point.

3.  A cost line is plotted by beginning with total fixed costs, $100,000, on the vertical axis. A second point is determined by multiplying any units of sales on the horizontal axis by the unit variable costs and adding the fixed costs. For example, for 10,000 units of sales, the total estimated costs would be $400,000 [(10,000 units * $30) + $100,000]. The cost line is drawn upward to the right from $100,000 on the vertical axis through the $400,000 point.

4.  Horizontal and vertical lines are drawn at the intersection point of the sales and cost lines, which is the break even point, and the areas representing operating profit and operating loss are identified.

In Exhibit 5, the dotted lines drawn from the intersection point of the total sales line and the total cost line identify the break-even point in total sales dollars and units. The break-even point is $250,000 of sales, which represents a sales volume of 5,000 units. Operating profits will be earned when sales levels are to the right of the break-even point (operating profit area). Operating losses will be incurred when sales levels are to the left of the break-even point (operating loss area).

Changes in the unit selling price, total fixed costs, and unit variable costs can be analyzed by using a cost-volume-profit chart. Using the data in Exhibit 5, assume that a proposal to reduce fixed costs by $20,000 is to be evaluated. In this case, the total fixed cost would be $80,000 ($100,000 - $20,000). As shown in exhibit 6, the total cost line should be redrawn, starting at the $80,000 point (total fixed costs) on the vertical axis. A second point is determined by multiplying any units of sales on the horizontal axis by the unit variable costs and adding the fixed costs. For example, for 10,000 units of sales, the total estimated costs would be $380,000 [(10,000 units * $30) + $80,000]. The cost line is drawn upward to the right from $80,000 on the vertical axis through the $380,000 point. The revised cost-volume-profit chart in Exhibit 6 indicates that the break-even point decreases to $200,000 or 4,000 units of sales. 

EXHIBIT 6 Revised Cost-Volume-Profit Chart

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 838-839*

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