CHAPTER 9

Break-Even Point and
Cost-Volume-Profit Analysis

QUESTIONS

1. The variable costing income statement classifies costs by the way they behave. Variable costs are deducted from revenues to determine contribution margin and then fixed costs are deducted from contribution margin to determine operating profit. Break-even analysis involves a study of fixed costs, variable costs and revenues to determine the volume at which total costs equal total revenues. Hence, variable costing provides the variable and fixed cost classification needed to compute break-even. The absorption costing income statement uses a functional classification--manufacturing and nonmanufacturing costs--to compute gross profit and then operating income respectively. A functional classification requires cost to be classified based on the reason it was incurred, i.e., selling, administrative, or production. This classification does not separate variable from fixed costs and is therefore not useful in computing breakeven.

2. The break-even point is the starting point for CVP analysis because before a company can earn profits, it must first cover all of its variable and fixed costs; the point at which all costs are just covered is the break-even point. The formula approach requires solving for the exact break-even using the following algebraic equation: R(X)– V(X) – FC = 0; where R is revenue per unit, X is volume, V is variable cost per unit, and FC is fixed cost.

The graph approach provides a visual relationship between revenues and costs. The break-even point is where the total revenue line intersects the total cost line on the traditional or cost-volume-profit graph or where the profit line intersects the x-axis on the profit-volume graph. Unlike the formula approach, the graph approach does not provide a precise solution because exact points cannot be