Financial Accounting_ A Business Perspective_ 8e - Salstrom

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					Managerial Accounting:
A Decision Focus, 8e



                Chapter 5: Cost-
                Volume-Profit
                Analysis
                                         Chapter 5




Importance of CVP Analysis

l   Understanding the relationship between
    costs, revenue, and volume
l   Short-run decision making
l   Planning
                                                     Chapter 5




Cost Behavior Patterns

l   Cost behavior means how a cost will react
    to changes in the level of business activity.
    –   Total variable costs change when activity changes.
    –   Total fixed costs remain unchanged when activity
        changes.
                                                         Chapter 5




Total Variable Cost Example

                                        Your total long
                                        distance telephone bill
 Total Long Distance




                                        is often based on how
   Telephone Bill




                                        many minutes you talk.




                       Minutes Talked
                                                          Chapter 5




Variable Cost Per Unit Example

 The cost per long
 distance minute talked
 may be constant. For




                          Telephone Charge
 example, 10 cents per



                              Per Minute
 minute.




                                             Minutes Talked
                                                        Chapter 5




    Total Fixed Cost Example

                                         Your monthly basic
                                         telephone bill is
                                         probably unchanged
                                         as you make more
Telephone Bill
Monthly Basic




                                         local calls.




                 Number of Local Calls
                                                                    Chapter 5




Fixed Cost Per Unit Example

 The average cost per




                           Monthly Basic Telephone
 local call decreases
 as more local calls are




                              Bill per Local Call
 made.




                                                     Number of Local Calls
                         Chapter 5




Cost Behavior Patterns
                                                 Chapter 5




Mixed Costs

l   Contain both fixed and variable components.
l   Example: monthly electric utility charge
    –   Fixed service fee
    –   Variable charge per kilowatt hour used
                              Chapter 5




Mixed Costs


Total                    Variable
Cost                     Portion


                          Fixed
                         Portion
              Activity
                                          Chapter 5




     Step Costs
 Total cost increases to a
new higher cost for the next
  higher range of activity.




                                          Cost
Total cost remains
 constant within a
  narrow range of
      activity.
                               Activity
                                            Chapter 5




Curvilinear Costs

                         Costs that increase
                         when activity increases,
                         but in a non-linear
                         manner.
 Total Cost




              Activity
                                                         Chapter 5




The Linearity Assumption
and the Relevant Range
                        A straight line closely approximates a
                        curvilinear variable cost line within the
                                     relevant range.
             Relevant
Total Cost




              Range
                                 Accountant’s Straight-Line
                                  Approximation (constant
                                    unit variable cost)


                  Activity
                                     Chapter 5




Two Methods for Analyzing Costs
l   Scatter Diagram
l   High-Low Method

Objective:
    y = a + bx
       where:
            y = total cost
            a = fixed cost
            b = unit variable cost
            x = number of units
                                                                 Chapter 5




                             Scatter Diagram
Draw a line through the plotted data points so that about an equal
         numbers of points fall above and below the line.
 1,000’s of Dollars


                      20
                                              * ** *
   Total Cost in




                                 * *
                                             **
                      10       * *

                      0
                           0       1      2      3       4
                           Activity, 1,000’s of Units Produced
                                                                 Chapter 5




                            Scatter Diagram
                           s in cost      $8,000
Slope =                               =             = $2.00 per unit
                           s in units   4,000 units
1,000’s of Dollars


                     20
                                             * ** * s in cost
  Total Cost in




                                * *
                                            **      = $8,000
                     10       * *                          Total cost =
                                                            $10,000 +
                                s in units = 4,000        $2.00 per unit
                     0
                          0       1      2      3       4
                          Activity, 1,000’s of Units Produced
                                                         Chapter 5




           The High-Low Method




                         s in cost      $3,600
Ê Unit variable cost =              =           = $.90
                         s in units     $4,000
Ë Fixed cost = Total cost – Total variable cost
  Fixed cost = $9,700 – ($.90 per unit × 9,000 units)
  Fixed cost = $9,700 – $8,100 = $1,600
Ì Total cost = Fixed cost + Variable cost (Y = a + bx)
  Y = $1,600 + $0.90x
                                              Chapter 5




Cost-Volume-Profit Analysis
        Objective:                   Uses:
 Determine the effects       Cost-volume-profit
 that changes in selling     analysis may be used
 prices, costs, and/or       to analyze a number of
 volume will have on         situations such as
 profits in the short run.
                             changing sales price,
                             changing variable cost,
                             or changing fixed cost.
                                                        Chapter 5




Cost-Volume-Profit Chart
                                                        Sales
Costs and Revenue



                     Break-even Point
                                               Income
    in Dollars




                                                   Total costs


                    Loss


                           Units of Activity
                                             Chapter 5




Cost-Volume-Profit Analysis




 Contribution margin is amount by which revenue
  Contribution margin is amount by which revenue
 exceeds variable costs of producing the revenue.
 exceeds variable costs of producing the revenue.
                                            Chapter 5




Cost-Volume-Profit Analysis




  Contribution margin goes to cover fixed costs.
  Contribution margin goes to cover fixed costs.

     After covering fixed costs, any remaining
     After covering fixed costs, any remaining
    contribution margin contributes to income.
    contribution margin contributes to income.
                                               Chapter 5




Cost-Volume-Profit Analysis




  How much contribution margin does OK
  How much contribution margin does OK
 need to cover its fixed costs (break even)?
 need to cover its fixed costs (break even)?
              Answer $30,000
              Answer $30,000
                                          Chapter 5




Finding the Break-Even Point

  Break-even (BE) Computation


                     Fixed costs
   BEunits =
               Unit contribution margin
                                              Chapter 5




 Finding the Break-Even Point

The break-even formula may also be expressed in
                  sales dollars:

                        Fixed costs
         BE$ =
                 Contribution margin ratio




                 CMR = contribution margin
                  as a percentage of sales.
                                Chapter 5




Finding the Breakeven Point




                              CMR
                                                     Chapter 5




CVP Analysis Example

l   Tulip Co. sells its plant cartons at $5.00 per unit. If
    fixed costs are $200,000 and variable costs are
    $3.00 per unit, how many units must be sold to
    break even?

l       a. 100,000 units
l       b. 40,000 units
l       c. 200,000 units
l       d. 66,667 units
                                                     Chapter 5




CVP Analysis Example (Answer)

l   Tulip Co. sells its plant cartons at $5.00 per unit. If
    fixed costs are $200,000 and variable costs are
    $3.00 per unit, how many units must be sold to
    break even?

l       a. 100,000 units
l       b. 40,000 units
                            Fixed costs         $200,000
l       c. 200,000 units Unit contribution = $5.00 – $3.00
l       d. 66,667 units
                                             = 100,000 units
                                                 Chapter 5




CVP Analysis Example 2

l   Use the CMR formula to determine the amount of
    sales revenue Tulip Co. needs to break even. Fixed
    costs, unit sales price, and unit variable cost are
    unchanged.

l      a.   $200,000
l      b.   $300,000
l      c.   $400,000
l      d.   $500,000
                                                   Chapter 5




CVP Analysis Example 2 (Answer)

l   Use the CMR formula to determine the amount of
    sales revenue Tulip Co. needs to break even. Fixed
    costs, unit sales price, and unit variable cost are
    unchanged.

l      a.   $200,000
l      b.   $300,000
l      c.   $400,000   CMR = ($5.00 – $3.00) ÷ $5.00 = .40
l      d.   $500,000   BE$ = $200,000 ÷ .40 = $500,000
                                                       Chapter 5




  Calculating Break-Even for
   a Multiproduct Company




                               The CMR is a function of the
                                sales mix of the products.

BE$ = Fixed costs ÷ CMR
BE$ = Fixed costs ÷ CMR
BE$ = 27,000 ÷ .45 = $60,000
BE$ = 27,000 ÷ .45 = $60,000
                                               Chapter 5




Margin of Safety

        Excess of current sales over the
          break-even volume of sales.

 Margin of safety = Total sales – Break-even sales

  May also be expressed as a percentage of sales.
                                               Chapter 5




   Calculating Sales Volume
  Needed for Desired Income
Add desired income to fixed costs in the
 numerator of the break-even equation.


                Fixed costs + Desired income
 BEunits   =
                   Unit contribution margin

                Fixed costs + Desired income
 BE$       =
                  Contribution margin ratio
                                                     Chapter 5




CVP Example 3

l   Tulip Co. sells its plant cartons at $5.00 per unit. If
    fixed costs are $200,000 and variable costs are
    $3.00 per unit, how many units must be sold to
    earn income of $40,000?

l       a. 100,000 units
l       b. 120,000 units
l       c. 80,000 units
l       d. 200,000 units
                                                       Chapter 5




CVP Example 3

l   Tulip Co. sells its plant cartons at $5.00 per unit. If
    fixed costs are $200,000 and variable costs are
    $3.00 per unit, how many units must be sold to
    earn income of $40,000?

l       a. 100,000 units     Fixed costs + Desired income
l       b. 120,000 units           Unit contribution
l       c. 80,000 units      $200,000 + $40,000
                                                = 120,000 units
                               $5.00 – $3.00
l       d. 200,000 units
                                           Chapter 5




Cost-Volume-Profit Analysis
Assumptions

Ê Linearity in the relevant range
  – Unit sales price remains constant.
  – Unit variable cost remains constant.
Ë Total fixed costs remain constant.
Ì In multiproduct situations, product
  mix is known and does not change.
Í All costs may be classified as either
  fixed or variable.

				
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