Transcript CHAPTER 21
21-1 CHAPTER 21 COST-VOLUME-PROFIT ANALYSIS 21-2 Cost-Volume-Profit Analysis You must understand the relationships between costs, volume and “profit” i.e., costs, volume and revenues The concept is also known as “Break-Even Analysis” Focuses on short-run decision making i.e, time frame during which a company can’t change effects of certain past decisions Long-run decision making is covered in Chapter 26 21-3 Cost-Volume-Profit Analysis Assumptions Throughout the relevant range (range of activity where cost behavior assumptions are valid) Unit sales price remains constant Unit variable cost remains constant Total fixed cost remains constant All costs may be classified as either fixed or variable 21-4 Cost Behavior Patterns Cost behavior means how a cost will react to changes in the level of business activity. Fixed Costs and Variable Costs react differently. 21-5 Cost Behavior Patterns Fixed Costs Total fixed costs remain constant over wide ranges of activity/volume. Per unit fixed costs decrease as volume level increases. Example: basic monthly telephone charge Total cost is unchanged regardless of number of local calls. Cost per local call decreases as number of local calls increases. 21-6 Total Fixed Cost Example Monthly Basic Telephone Bill Your monthly basic telephone bill is probably unchanged as you make more local calls. Number of Local Calls 21-7 Per Unit Fixed Cost Example Monthly Basic Telephone Bill per Local Call The average cost per local call decreases as more local calls are made. Number of Local Calls 21-8 Cost Behavior Patterns Variable Costs Total variable costs increase and decrease in proportion to increases and decreases in volume. Per unit variable costs remain constant over wide ranges of volume. Example: long distance telephone charges Total cost will increase as a function of minutes talked. Cost per minute remains unchanged. 21-9 Total Variable Cost Example Total Long Distance Telephone Bill Your total long distance telephone bill is based on how many minutes you talk. Minutes Talked 21-10 Per Unit Variable Cost Example Per Minute Telephone Charge The cost per long distance minute talked is constant. For example, 10 cents per minute. Minutes Talked 21-11 Cost Behavior Patterns Summary of Variable and Fixed Cost Behavior Cost In Total Per Unit Variable Total variable cost changes as activity level changes. Variable cost per unit remains the same over wide ranges of activity. Total fixed cost remains the same even when the activity level changes. Fixed cost per unit goes down as activity level goes up. Fixed 21-12 Cost Behavior Question Fixed costs are usually characterized by: a. Unit costs that remain constant. b. Total costs that increase as activity decreases. c. Total costs that increase as activity increases. d. Total costs that remain constant. 21-13 Cost Behavior Question Fixed costs are usually characterized by: a. Unit costs that remain constant. b. Total costs that increase as activity decreases. c. Total costs that increase as activity increases. d. Total costs that remain constant. 21-14 Cost Behavior Question Variable costs are usually characterized by: a. Unit costs that decrease as activity increases. b. Total costs that increase as activity decreases. c. Total costs that increase as activity increases. d. Total costs that remain constant. 21-15 Cost Behavior Question Variable costs are usually characterized by: a. Unit costs that decrease as activity increases. b. b. Total costs that increase as activity decreases. c. Total costs that increase as activity increases. d. Total costs that remain constant. 21-16 Cost Behavior Patterns Mixed Costs Contains fixed portion incurred even when facility is unused and a variable portion which increases with usage. Example: monthly electric utility charge Fixed service fee Variable charge per kilowatt hour used 21-17 Cost Behavior Patterns Mixed Costs Total Cost $ Activity/Volume Level 21-18 Cost Behavior Patterns Mixed Costs Total Cost $ Variable Portion Fixed Portion Activity/Volume Level 21-19 Cost Behavior Patterns Step Costs Definition: Constant fixed cost over a range of activity with an increase at a certain level to a new, higher fixed cost. Example: A supervisor’s salary is $30,000 for a process that produces 10,000 units. When volume increased beyond 10,000 units, a second process was added with a second supervisor, increasing total salaries to $60,000. 21-20 Cost Behavior Patterns Salaries in Thousands of Dollars Step Costs 60 30 0 0 10 20 Activity in Thousands 21-21 Cost Behavior Patterns Curvilinear Costs Total Cost Costs that increase when activity increases, but in a non-linear manner Activity 21-22 Cost Behavior Patterns Relevant Range Definition: Range of activity where the cost behavior assumptions are valid Total fixed costs remain constant. Per unit variable costs remain unchanged. The cost behavior assumptions discussed earlier allow us to use linear relationships. How does this differ from what you learned in your economics course? 21-23 Cost Behavior Patterns Relevant Range Economics (Economies of Scale) Extremely wide range assumed e.g., 0 to 8 Accounting Relatively narrow range assumed e.g., 40,000 units to 100,000 units The Linearity Assumption and the Relevant Range Total Cost Economist’s Curvilinear Total Cost Function Activity 21-24 The Linearity Assumption and the Relevant Range 21-25 Total Cost Economist’s Curvilinear Total Cost Function Accountant’s Straight-Line Approximation (constant unit variable cost) Activity The Linearity Assumption and the Relevant Range 21-26 Total Cost A straight line closely approximates a curvilinear variable cost line within the relevant range. Relevant Range Accountant’s Straight-Line Approximation (constant unit variable cost) Activity 21-27 Fixed Costs and Relevant Range Example: Office space is available at a rental rate of $30,000 per year in increments of 1,000 square feet. As the business grows more space is rented, increasing the total cost. 21-28 Rent Cost in Thousands of Dollars Fixed Costs and Relevant Range Relevant 90 Range Relevant 60 30 00 Range Relevant Range Total cost doesn’t change for a wide range of activity, and then jumps to a new higher cost for the next higher range of activity. 1,000 2,000 3,000 Rented Area (Square Feet) 21-29 Fixed Costs and Relevant Range How does this type of fixed cost differ from a step cost? 21-30 Fixed Costs and Relevant Range How does this type of fixed cost differ from a step cost? Step costs can be adjusted more quickly and . . . The width of the activity steps is much wider for the fixed cost. 21-31 Methods for Analyzing Costs We will separate a mixed cost into its fixed and variable components. 21-32 Methods for Analyzing Costs Two methods will be used: Scatter Diagram High-low method 21-33 Scatter Diagram Total Cost in 1,000’s of Dollars A scatter diagram of past cost behavior is helpful in analyzing mixed costs. 20 10 * * * * * ** * ** Plot the data points on a graph (total cost vs. activity). 0 0 1 2 3 4 Activity, 1,000’s of Units Produced 21-34 Scatter Diagram Total Cost in 1,000’s of Dollars Draw a line through the plotted data points so that about an equal numbers of points fall above and below the line. 20 10 * * * * * ** * ** 0 0 1 2 3 4 Activity, 1,000’s of Units Produced 21-35 Scatter Diagram Total Cost in 1,000’s of Dollars Where line intercepts with cost axis is total fixed cost. 20 10 Review regression analysis calculations from your statistics class and bring your scientific calculator to the next test. * * * * * ** * ** Estimated fixed cost = $10,000 0 0 1 2 3 4 Activity, 1,000’s of Units Produced 21-36 Methods for Analyzing Costs Now, the High-low method (You are responsible for knowing how to use it.) 21-37 Analyzing Mixed Costs High-Low Method Objective: To separate total cost into fixed and variable portions. Step 1 - Calculate variable cost per unit. . V.C./unit = in cost ÷ in units Step 2 - Calculate total variable cost at either high or low volume level and subtract it from total cost at the same volume level to determine total fixed cost at any level. 21-38 The High-Low Method WiseCo recorded the following production activity and maintenance costs for two months: High activity level Low activity level Change Units 9,000 5,000 4,000 Cost $ 9,700 6,100 $ 3,600 Using these two levels of activity, compute: the variable cost per unit the total fixed cost 21-39 The High-Low Method High activity level Low activity level Change Unit variable cost = Units 9,000 5,000 4,000 Cost $ 9,700 6,100 $ 3,600 in cost $3,600 in units = $4,000 = $.90 21-40 The High-Low Method High activity level Low activity level Change Units 9,000 5,000 4,000 Cost $ 9,700 6,100 $ 3,600 in cost $3,600 Unit variable cost = in units = $4,000 = $.90 Fixed cost = Total cost – Total variable cost 21-41 The High-Low Method High activity level Low activity level Change Units 9,000 5,000 4,000 Cost $ 9,700 6,100 $ 3,600 in cost $3,600 Unit variable cost = in units = $4,000 = $.90 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 21-42 The High-Low Method Choosing the low activity level will give the same result. 21-43 The High-Low Method High activity level Low activity level Change Units 9,000 5,000 4,000 Cost $ 9,700 6,100 $ 3,600 in cost $3,600 Unit variable cost = = = $.90 in units $4,000 Fixed cost = Total cost – Total variable cost Fixed cost = $6,100 – ($.90 per unit × 5,000 units) Fixed cost = $6,100 – $4,500 = $1,600 21-44 Cost-Volume-Profit Analysis Now that we understand cost behavior, let’s turn our attention to cost-volumeprofit analysis. 21-45 Cost-Volume-Profit Analysis Objective Determine the effects that changes in selling prices, costs, and/or volume will have on profits in the short run. 21-46 Costs and Revenue in Dollars Cost-Volume-Profit Chart Sales Break-even Point Income Total costs Loss Units of Activity 21-47 Profit Equations At any point on the cost-volume-profit chart the following relationships are valid: Net income = Revenue – Total costs Variable costs + Fixed costs Contribution Margin = Revenue – Variable costs 21-48 The Cost-Volume-Profit Chart 240 Relevant sales volume range 220 - . 200 180 Sales 160 140 120 - Break-even point Total costs 100 80 Variable costs 60 - - - - - - - - 1 2 3 4 5 6 7 Units (000) 8 9 10 11 - - 0 - 20 - Fixed costs - 40 - 12 21-49 Cost-Volume-Profit Analysis Let’s look at the OK Company example. 21-50 Cost-Volume-Profit Analysis Sales Revenue (2,000 units) Less: Variable costs Contribution margin Total $ 100,000 60,000 $ 40,000 Unit $ 50 30 $ 20 Contribution margin is amount by which revenue exceeds variable costs of producing the revenue. 21-51 Cost-Volume-Profit Analysis Sales Revenue (2,000 units) Less: Variable costs Contribution margin Less: Fixed costs Total $ 100,000 60,000 $ 40,000 30,000 Unit $ 50 30 $ 20 Contribution margin goes to cover fixed costs and ... 21-52 Cost-Volume-Profit Analysis Sales Revenue (2,000 units) Less: Variable costs Contribution margin Less: Fixed costs Net income Total $ 100,000 60,000 $ 40,000 30,000 $ 10,000 Unit $ 50 30 $ 20 Contribution margin goes to cover fixed costs and … after covering fixed costs, any remaining contribution margin contributes to net income. 21-53 Cost-Volume-Profit Analysis Sales Revenue (2,000 units) Less: Variable costs Contribution margin Less: Fixed costs Net income Total $ 100,000 60,000 $ 40,000 30,000 $ 10,000 Unit $ 50 30 $ 20 How much contribution margin does OK need to cover its fixed costs (i.e., break even)? 21-54 Cost-Volume-Profit Analysis Sales Revenue (2,000 units) Less: Variable costs Contribution margin Less: Fixed costs Net income Total $ 100,000 60,000 $ 40,000 30,000 $ 10,000 Unit $ 50 30 $ 20 How much contribution margin does OK need to cover its fixed costs (i.e., break even)? Answer $30,000 21-55 Cost-Volume-Profit Analysis Sales Revenue (2,000 units) Less: Variable costs Contribution margin Less: Fixed costs Net income Total $ 100,000 60,000 $ 40,000 30,000 $ 10,000 How many units must OK sell to cover its fixed costs (break even)? Unit $ 50 30 $ 20 21-56 Cost-Volume-Profit Analysis Sales Revenue (2,000 units) Less: Variable costs Contribution margin Less: Fixed costs Net income Total $ 100,000 60,000 $ 40,000 30,000 $ 10,000 How many units must OK sell to cover its fixed costs (break even)? $30,000 ÷ $20 per unit = 1,500 units Unit $ 50 30 $ 20 21-57 Cost-Volume-Profit Analysis Sales Revenue (1,500 units) Less: Variable costs Contribution margin Less: Fixed costs Net income Total $ 75,000 45,000 30,000 30,000 $ 0 How many units must OK sell to cover its fixed costs (break even)? $30,000 ÷ $20 per unit = 1,500 units Unit $ 50 30 $ 20 PR O O F 21-58 Cost-Volume-Profit Analysis We have just seen one of the basic costvolume-profit relationships, the break-even computation in units. Fixed costs Break-even units = Contribution margin per unit Contribution margin per unit is sales price per unit less variable cost per unit. Conceptually, it represents the amount of each sales dollar which “contributes” to fixed costs and profit (net income). 21-59 Finding the Break-Even Point Break-even (BE) Computation BEunits = Fixed costs Contribution margin per unit 21-60 Cost-Volume-Profit Analysis The break-even formula may also be expressed in sales dollars. Fixed costs Break-even dollars = Contribution margin ratio rate The contribution margin rate is computed either by dividing contribution margin per unit by selling price per unit or by dividing total contribution margin by total revenues. Conceptually, the contribution margin rate represents the percentage of each sales dollar which “contributes” to fixed costs and profit (net income). 21-61 Finding the Break-Even Point The break-even formula may also be expressed in sales dollars: BE$ = Fixed costs Contribution margin rate CMR = contribution margin as a percentage of sales. OK’s CMR 21-62 Finding the Break-Even Point Sales Revenue (1,500 units) Less: Variable costs Contribution margin Total $ 75,000 45,000 30,000 Unit Percent $ 50 100% 30 60% $ 20 40% OK’s contribution margin per unit is $20. OK’s CMR is 40% or $20/$50. 21-63 Cost-Volume-Profit Analysis Question 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? a. 100,000 units b. 40,000 units c. 200,000 units d. 66,667 units 21-64 Cost-Volume-Profit Analysis Question 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? a. 100,000 units a. $200,000 Fixed costs = $5.00 – $3.00 b. b. 40,000 unitsUnit contribution c. 200,000 units = 100,000 units c. d. 66,667 units 21-65 Cost-Volume-Profit Analysis Question Use the CMR formula to determine the amount of sales revenue Tulip Co. needs to break even. Fixed costs ($200,000), unit sales price ($5), and per unit variable cost ($3) are unchanged. a. b. c. d. $200,000 $300,000 $400,000 $500,000 21-66 Cost-Volume-Profit Analysis Question Use the CMR formula to determine the amount of sales revenue Tulip Co. needs to break even. Fixed costs ($200,000), unit sales price ($5), and per unit variable cost ($3) are unchanged. a. b. c. d. $200,000 $300,000 $400,000 $500,000 CMR = ($5.00 – $3.00) ÷ $5.00 = .40 BE$ = $200,000 ÷ .40 = $500,000 Calculating Break-Even for a Multiproduct Company Sales Less: Variable costs Contribution margin Less: Fixed costs Income Product 1 Product 2 Amount % Amount % $ 20,000 100% $ 80,000 100% 15,000 75% 40,000 50% 4000 $ 5,000 25% $ 40,000 50% Total $ 100,000 55,000 $ 45,000 27,000 $ 18,000 21-67 % 100% 55% 45% 21-68 Cost-Volume-Profit Analysis Desired Income Break-even formulas may be adjusted to show the sales volume needed to earn any amount of income. Add desired income to fixed costs in the numerator. No other changes are needed. BEunits = Fixed costs + Desired income Contribution margin per unit BE$ = Fixed costs + Desired income Contribution margin rate 21-69 Cost-Volume-Profit Analysis Question 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? a. 100,000 units b. 120,000 units c. 80,000 units d. 200,000 units 21-70 Cost-Volume-Profit Analysis Question 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? Fixed costs + Desired income a. 100,000 units Unit contribution b. 120,000 units $200,000 + $40,000 = 120,000 units $5.00 – $3.00 c. 80,000 units d. 200,000 units 21-71 Margin of Safety Excess of current sales over the break-even volume of sales. (i.e., the amount by which sales may decline before reaching break-even sales.) Margin of safety = Current sales – Break-even sales Let’s calculate the margin of safety for OK Company. 21-72 Margin of Safety Current sales Breakeven sales Margin of safety Sales Revenue Less: Variable costs Contribution margin Less: Fixed costs Net income $ 100,000 - 75,000 $ 25,000 Break-even Sales 1,500 Units $ 75,000 45,000 30,000 30,000 $ 0 Current Sales 2,000 Units $ 100,000 60,000 40,000 30,000 $ 10,000 21-73 Margin of Safety The margin of safety may also be expressed as a percentage of current sales. Sales Revenue Less: Variable costs Contribution margin Less: Fixed costs Net income Break-even Sales 1,500 Units $ 75,000 45,000 30,000 30,000 $ 0 Current Sales 2,000 Units $ 100,000 60,000 40,000 30,000 $ 10,000 21-74 Margin of Safety Margin of safety percentage = = = Current sales - Break-even sales Current sales $100,000 $75,000 $100,000 25% Sales Revenue Less: Variable costs Contribution margin Less: Fixed costs Net income Break-even Sales 1,500 Units $ 75,000 45,000 30,000 30,000 $ 0 Current Sales 2,000 Units $ 100,000 60,000 40,000 30,000 $ 10,000 21-75 THE END