Financial Accounting_ A Business Perspective_ 8e - Salstrom by pptfiles

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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

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

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

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)?
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

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

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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