12.1 Based On Accounting Profit

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Problem. A project has a fixed cost of $30,000, variable costs of $4.00 per unit, and generates sales

revenue of $6.00 per unit. What is the break-even point in unit sales, where accounting profit exactly

equals zero, and what is the intuition for it?

Solution Strategy. First, we solve for the break-even point in unit sales using the formula. Second, we

use Excel's Solver to back solve for the break-even point using the income statement. Lastly, we will

determine the sensitivity of costs, revenues, and accounting profits to unit sales. This will allow us to

graphically illustrate the intuition of the break-even point.

FIGURE 12.1 Spreadsheet for Break-Even Analysis - Based On Accounting Profit.

How To Build This Spreadsheet Model.

1. Inputs. Enter the inputs into the range B4:B6.

2. Break-Even Point using the Formula. The formula is: Break-Even Point = Fixed Costs / (Sales

Revenue/Unit - Variable Costs/Unit). In cell B9, enter =B4/(B5-B6) We see that the Break-Even

Point is 15,000 units.

3. Back solve for the Break-even Point using the Income Statement. Create the Income

Statement using these simple steps.

o Unit Sales. Enter a trial value for the break-even point. In cell B12, enter 12000

o Sales Revenue = (Sales Revenue/Unit) * (Unit Sales). In cell B13, enter =B12*B5

o Variable Costs = (Variable Costs/Unit) * (Unit Sales). In cell B14, enter =B12*B6

o Gross Margin = Sales Revenue - Variable Costs. In cell B15, enter =B13-B14

o Fixed Costs = input value for Fixed Costs. In cell B16, enter =B4

o Accounting Profit = Gross Margin - Fixed Costs. In cell B17, enter =B15-B16

Then call up Excel's Solver from Excel’s main menu by clicking on Tools and then Solver. (If

you don't see Solver on the Tools Menu, then click on Tools | Add-Ins, check the Solver Add-In

box, and click on OK.) Set-up the Solver dialog box by entering Accounting Profit in cell B17 as

the Set Target Cell. In the Equal to row, click on the option button for Value of and enter 0 in the

adjacent box. Enter Unit Sales in cell B12 as the By Changing Cell. See the figure below.

FIGURE 12.2 Solver dialog box.

Then run Solver by clicking on the Solve button. By trial and error, the Solver adjusts the value of

Unit Sales in cell B12 until the Accounting Profit in cell B17 equals zero (within a very small

error tolerance). This results in an Break-even Point of 15,000, where Accounting Profit equals

zero. Your results may differ by a slight amount depending on Solver's error tolerance. This

verifies that the Break-Even Point is 15,000 units.

4. Create A List of Input Values and An Output Formula. Create a list of input values for Unit

Sales (0, 5,000, 10,000, etc.) in the range C21:G21. Create output formulas that reference the

pieces of the accounting profit calculation. Specifically:

o for Fixed Cost, enter =B16 in cell B22

o for Variable Costs, enter =B14 in cell B23

o for Total Costs, enter =B16+B14 in cell B24

o for Sales Revenue, enter =B13 in cell B25

o for Accounting Profit, enter =B17 in cell B26

FIGURE 12.3 Spreadsheet for Sensitivity of Costs, Revenues, and Accounting Profits to Unit Sales.

5. Data Table. Select the range B21:G26 for the Data Table. This range includes both the list of

input values at the top of the data table and the output formulas on the side of the data table. Then

choose Data Table from the main menu and a Table dialog box pops up. Enter the cell address

B12 (Unit Sales) in the Row Input Cell and click on OK.

6. Graph the Data Table Results. Highlight the data table C21:G26 and then choose Insert

Chart from the main menu. Select an XY(Scatter) chart type and make other selections to

complete the Chart Wizard.

The graph shows visually that the Break-Even Point is 15,000 units. The graph illustrates two equivalent

intuitions for this result. First, the Break-Even Point is where the Sales Revenue line (in blue) crosses

Total Costs line (in red). Second, the Break-Even Point is where Accounting Profit (in orange) hits zero

and thus decisively switches from negative to positive.

Problem. A project has a fixed cost of $30,000, variable costs of $4.00 per unit, and generates sales

revenue of $6.00 per unit. What is the break-even point in unit sales, where accounting profit exactly

equals zero, and what is the intuition for it?

Solution Strategy. First, we solve for the break-even point in unit sales using the formula. Second, we

use Excel's Solver to back solve for the break-even point using the income statement. Lastly, we will

determine the sensitivity of costs, revenues, and accounting profits to unit sales. This will allow us to

graphically illustrate the intuition of the break-even point.

FIGURE 12.1 Spreadsheet for Break-Even Analysis - Based On Accounting Profit.

How To Build This Spreadsheet Model.

1. Inputs. Enter the inputs into the range B4:B6.

2. Break-Even Point using the Formula. The formula is: Break-Even Point = Fixed Costs / (Sales

Revenue/Unit - Variable Costs/Unit). In cell B9, enter =B4/(B5-B6) We see that the Break-Even

Point is 15,000 units.

3. Back solve for the Break-even Point using the Income Statement. Create the Income

Statement using these simple steps.

o Unit Sales. Enter a trial value for the break-even point. In cell B12, enter 12000

o Sales Revenue = (Sales Revenue/Unit) * (Unit Sales). In cell B13, enter =B12*B5

o Variable Costs = (Variable Costs/Unit) * (Unit Sales). In cell B14, enter =B12*B6

o Gross Margin = Sales Revenue - Variable Costs. In cell B15, enter =B13-B14

o Fixed Costs = input value for Fixed Costs. In cell B16, enter =B4

o Accounting Profit = Gross Margin - Fixed Costs. In cell B17, enter =B15-B16

Then call up Excel's Solver from Excel’s main menu by clicking on Tools and then Solver. (If

you don't see Solver on the Tools Menu, then click on Tools | Add-Ins, check the Solver Add-In

box, and click on OK.) Set-up the Solver dialog box by entering Accounting Profit in cell B17 as

the Set Target Cell. In the Equal to row, click on the option button for Value of and enter 0 in the

adjacent box. Enter Unit Sales in cell B12 as the By Changing Cell. See the figure below.

FIGURE 12.2 Solver dialog box.

Then run Solver by clicking on the Solve button. By trial and error, the Solver adjusts the value of

Unit Sales in cell B12 until the Accounting Profit in cell B17 equals zero (within a very small

error tolerance). This results in an Break-even Point of 15,000, where Accounting Profit equals

zero. Your results may differ by a slight amount depending on Solver's error tolerance. This

verifies that the Break-Even Point is 15,000 units.

4. Create A List of Input Values and An Output Formula. Create a list of input values for Unit

Sales (0, 5,000, 10,000, etc.) in the range C21:G21. Create output formulas that reference the

pieces of the accounting profit calculation. Specifically:

o for Fixed Cost, enter =B16 in cell B22

o for Variable Costs, enter =B14 in cell B23

o for Total Costs, enter =B16+B14 in cell B24

o for Sales Revenue, enter =B13 in cell B25

o for Accounting Profit, enter =B17 in cell B26

FIGURE 12.3 Spreadsheet for Sensitivity of Costs, Revenues, and Accounting Profits to Unit Sales.

5. Data Table. Select the range B21:G26 for the Data Table. This range includes both the list of

input values at the top of the data table and the output formulas on the side of the data table. Then

choose Data Table from the main menu and a Table dialog box pops up. Enter the cell address

B12 (Unit Sales) in the Row Input Cell and click on OK.

6. Graph the Data Table Results. Highlight the data table C21:G26 and then choose Insert

Chart from the main menu. Select an XY(Scatter) chart type and make other selections to

complete the Chart Wizard.

The graph shows visually that the Break-Even Point is 15,000 units. The graph illustrates two equivalent

intuitions for this result. First, the Break-Even Point is where the Sales Revenue line (in blue) crosses

Total Costs line (in red). Second, the Break-Even Point is where Accounting Profit (in orange) hits zero

and thus decisively switches from negative to positive.