Transcript Chapter title - METU | Middle East Technical University

Decision Making and CVP
EMBA 5412
Fall 2007
Decision-Making Process
Set goals and
objectives
Gather
information
Evaluate
alternatives
Plan and
implement
Get feedback
and revise
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Strategic Decision Making
Strategic Planning
Company policies and plans to reflect
how to reach the company goals.
Answers the following two major questions:
What are the
ways of
achieving?
What to we want
to accomplish?
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Managerial Accounting
• Process of
–
–
–
–
–
Identifying
Measuring
Analyzing
Interpreting
Communicating
information in pursuit of a company’s goals
– Managerial accountants – business
partners/consultants in companies
– Provides information to managers
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Cost Management Perspective
• Provide highest quality service/goods with
lowest possible cost
• Objectives:
– Determine cost of resources consumed in company’s
activities
– Eliminate non-value added activities as much as
possible
– Determine efficiency and effectiveness of all major
activities
– Identify and evaluate new activities that can improve
the performance of the company
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Strategic Cost Management
• Value chain
– Get raw materials and other resources
– Research and development – including quality assessment
– Product design
– Production
– Marketing
– Distribution
– Customer service
• Should understand the value chain
• Cost drivers in activities
• Managing the cost relationships to a company’s advantage –
strategic cost management
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Exh.
1.2
The Value Chain
R&
D
Desig
n
Supply
Production Marketing
Distribution
Customer
service
Value of
products
and
services
Support services
•Accounting
•Human resources
•Legal services
•Information systems
•Telecommunications
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Primary processes
7
Exh.
1.1
Strategic Position of a Company and its missions
• New market potential
• Be early entrant
• Achieve growth
• Capture market share
High
Return
Hold
Medium
Harvest
Low
Divest
Build
• Continuing market
• Maintain growth
• Be a major player
• Protect market share
• Continuing market
• Maintain cash flow
• Maintain volume
• Cut costs
• Declining market
• Exit at lowest cost
• Minimize losses
• Find a buyer quickly
Risk
Low
Medium
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High
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Types of
Costs
The opportunity cost is the monetary amount
associated with the next best use of the
resource.
• differential costs- (benefits) – costs or
benefits that change between/among
alternatives
• Irrelevant costs -Costs that don’t change are
irrelevant to the decision
• Choose the alternatives where differential
benefits exceed differential costs
• Opportunity costs
• Sunk costs
• Controllable /avoidable costs/discretionary
costs
Costs that have already been incurred and cannot be
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changed no matter what action
is 2007
taken in the future.
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Cost Definitions
Fixed Costs: Costs incurred when there is
no production.
Marginal cost: cost of producing (and
selling) one more unit = variable costs
after the initial production stage
Average cost: Total costs divided by
number of units produced
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Cost Definitions
TC = FC + (VC Q) for Q in relevant range
Total costs (TC) are a linear function of quantity (Q) produced over a
relevant range.
Variable Cost (VC): Cost to produce one more unit. Variable cost is a
linear approximation of marginal opportunity costs.
Fixed Cost (FC): Predicted total costs with no production (Q=0).
Relevant Range: Range of production quantity (Q) where a constant
variable cost is a reasonable approximation of opportunity cost.
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Cost Curve
Total Cost –Mixed Cost
Y
Total Cost
Variable Cost per unit or marginal cost
Average Cost
Fixed Cost
X
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Cost Drivers
• Cost driver: units of physical activity most highly
associated with total costs in an activity center
Examples of cost drivers:
–
–
–
–
Quantity produced
Direct labor hours
Number of set-ups
Number of orders processed
• Different activity drivers might be used for different
decisions
• Costs could be fixed, variable, or mixed in different
situations
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Cost Estimation Example
•
•
•
In each month, Exclusive
Billiards produces between 4 to
10 pool tables. The plant
operates on 40-hr shift to
produce up to seven tables.
Producing more than seven
tables requires the craftsmen to
work overtime. Overtime work is
paid at a higher hourly wage.
The plant can add overtime
hours and produce up to 10
tables per month. The following
table contains the total cost of
producing between 4 and 10
pool tables.
Required: a. compute average
cost per pool table for 4 to 10
tables
Estimate fixed costs per month.
Pool Tables Total Cost
4
5
6
7
8
9
10
62800
66000
69200
72400
75800
79200
82600
Pool Tables Total Cost Variable Cost
Average Cost
4
62.800
15.700
5
66.000
3.200
13.200
6
69.200
3.200
11.533
7
72.400
3.200
10.343
8
75.800
3.400
9.475
9
79.200
3.400
8.800
10
82.600
3.400
8.260
FC=
FC=
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TC
VC
66.000 4 x 3200= 12800
50.000
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Format of Income Statement
Financial Accounting (traditional – required for financial
statements and tax )
Sales Revenue
- Cost of goods sold (product costs)
= Gross profit
- General, selling, administrative, and taxes (period costs)
= Net income
Decision Making( useful for managers – internal oriented)
Revenue
- Variable costs (product and selling and administration)
= Contribution margin
- Fixed costs and taxes( product and selling and administration)
= Net income
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Income Statement Example
FM Manufacturing Company has sales of TL 1.800.000 for the first quarter of 2008.
In selling 6.000 units of gadgets the company incurred the following costs:
Variable
Fixed
Cost of Goods Sold
750.000
540.000
Selling Expenses
95.000
60.000
Administrative Expenses
80.000
65.000
Prepare a traditional and a CVP income statement for the first quarter of 2008.
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Income Statement Example
Traditional Income Statement
FM Manufacturing Income Statement
For the first Quarter 2008
Sales
1.800.000 TL
Cost of Goods Sold
(1.290.000)
Gross Margin
510.000
Selling Expenses
(155.000)
Administrative Expenses
(145.000)
Net Income Before Tax
210.000 TL
CVP Income Statement
FM Manufacturing Income Statement
For the first Quarter 2008
Sales (5000 units)
1.800.000 TL
Variable Costs:
Production Costs
750.000
Selling Expenses
95.000
Administrative Expenses
80.000
Total Variable Costs
925.000
Contribution Margin
875.000
Fixed Costs:
Production Costs
540.000
Selling Expenses
60.000
Administrative Expenses
65.000
Total Fixed Costs
665.000
Net Income Before Tax
210.000 TL
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CVP definitions
Cost-Volume-Profit (C-V-P) analysis is very useful
for production and marketing decisions.
Contribution margin equals price per unit minus
variable cost per unit: CM = (P – VC).
Total contribution margin equals total revenue
minus total variable costs: (CM Q) = (P - VC)
Q.
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COST VOLUME PROFIT ANALYSIS
• HELPFUL TO UNDERSTAND THE RELATIONSHIP
AMONG VARIABLE COSTS, FIXED COSTS AND
PROFIT
• BASIC ASSUMPTIONS:
– SELLING PRICE IS CONSTANT
– COSTS ARE LINEAR AND CAN BE DIVIDED INTO FIXED
AND VARIABLE
– FIXED ELEMENT CONSTANT OVER THE RELEVANT
RANGE
– UNIT VARIABLE COST CONSTANT OVER THE RELEVANT
RANGE
– SALES MIX IS CONSTANT
– INVENTORIES STAY AT THE SAME LEVEL
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Basics of Cost-Volume-Profit Analysis
CVP Income Statement
FM Manufacturing Income Statement
For the first Quarter 2008
Sales (5000 units)
1.800.000 TL
Variable Costs:
Production Costs
750.000
Selling Expenses
95.000
Administrative Expenses
80.000
Total Variable Costs
925.000
Contribution Margin
875.000
Fixed Costs:
Production Costs
540.000
Selling Expenses
60.000
Administrative Expenses
65.000
Total Fixed Costs
665.000
Net Income Before Tax
210.000 TL
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CM is used first to
cover fixed
expenses. Any
remaining CM
contributes to net
operating income.
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The Contribution Approach
Sales, variable expenses, and contribution margin can also be expressed on a
per unit basis. If FM sells an additional gadget, TL 175 additional CM will be
generated to cover fixed expenses and profit.
FM Manufacturing Income Statement
For the first Quarter 2008
Sales (5000 units)
1.800.000 TL
Variable Costs:
Production Costs
750.000
Selling Expenses
95.000
Administrative Expenses
80.000
Total Variable Costs
925.000
Contribution Margin
875.000
Fixed Costs:
Production Costs
540.000
Selling Expenses
60.000
Administrative Expenses
65.000
Total Fixed Costs
665.000
Net Income Before Tax
210.000 TL
Per Unit
selling price
360 TL
Unit Cost
Unit Sell. Exp
Unit Adm. Exp
variable cost per unit (vcu)
contribution margin per unit (cmu)
150 TL
19 TL
16 TL
185 TL
175 TL
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The Contribution Approach
CVP Income Statement
FM Manufacturing Income Statement
For the first Quarter 2008
Sales (5000 units)
1.800.000 TL
Variable Costs:
Production Costs
750.000
Selling Expenses
95.000
Administrative Expenses
80.000
Total Variable Costs
925.000
Contribution Margin
875.000
Fixed Costs:
Production Costs
540.000
Selling Expenses
60.000
Administrative Expenses
65.000
Total Fixed Costs
665.000
Net Income Before Tax
210.000 TL
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Each month FM
must generate at
least TL 665.000
in total CM to
break even.
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The Contribution Approach
If FM sells 3800 units in a quarter, it will
be operating at the break-even point.
CVP Income Statement
FM Manufacturing Income Statement
For the first Quarter 2008
Sales (5000 units)
1.368.000 TL
Variable Costs:
Production Costs
570.000
Selling Expenses
72.200
Administrative Expenses
60.800
Total Variable Costs
703.000
Contribution Margin
665.000
Fixed Costs:
Production Costs
540.000
Selling Expenses
60.000
Administrative Expenses
65.000
Total Fixed Costs
665.000
Net Income Before Tax
0 TL
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The Contribution Approach
If FM sells one more gadget (3801 gadgets), net
operating income will increase by TL 175.
CVP Income Statement
FM Manufacturing Income Statement
For the first Quarter 2008
Sales (5000 units)
1.368.360 TL
Variable Costs:
Production Costs
570.150
Selling Expenses
72.219
Administrative Expenses
60.816
Total Variable Costs
703.185
Contribution Margin
665.175
Fixed Costs:
Production Costs
540.000
Selling Expenses
60.000
Administrative Expenses
65.000
Total Fixed Costs
665.000
Net Income Before Tax
175 TL
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The Contribution Approach
We do not need to prepare an income statement
to estimate profits at a particular sales volume.
Simply multiply the number of units sold above
break-even by the contribution margin per unit.
If FM sells 4000
gadgets, its net
income will be
35.000 TL.
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Break-Even Analysis
Break-even analysis can be
approached in two ways:
1. Equation method
2. Contribution margin method
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EQUATION METHOD-1
SALES= VARIABLE COSTS+FIXED COSTS + PROFIT
p*q= vcu *q + FC + ¶
p= price;
q=quantity sold (in terms of units)
vcu=variable cost per unit = VC/ q;(includes both manufacturing and selling and
administrative)
FC= total fixed costs;
¶= profit
AT BREAKEVEN PROFIT = 0
p*q=vcu *q +FC
q * (p-vcu) = FC
BREAKEVEN in units sold: (q)
q= FC ÷ (p - vcu) OR q=FC ÷ cmu
Breakeven Sales amount = selling price x breakeven quantity
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EQUATION METHOD-2
Sales = (Variable Cost Ratio x Sales) + Fixed Costs + Profit
VCR = Variable Cost Ratio
FC = total fixed costs (both manufacturing, and selling and
administrative)
AT BREAKEVEN PROFIT = 0
Sales = (Sales x VCR) + FC + 0
Therefore
Sales amount (monetary terms) at breakeven point is
Sales (breakeven)= FC ÷ (1-VCR)
BREAKEVEN in units sold= Sales (breakeven) ÷ selling price
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Sensitivity Analysis
EFFECT OF CHANGE IN FIXED COSTS?
EFFECT OF CHANGE IN VARIABLE COSTS?
EFFECT OF CHANGE IN SELLING PRICE?
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Break-Even Analysis
Here is the information from FM Company:
Cost and price information
Selling Price (p)
Per Unit
TL
360 100,00%
Variable Manufacturing Cost
150
Variable Selling Expense
19
Variable Administrative Expense
16
Variable Cost per Unit (vcu)
185
Contribution Margin per Unit (cmu)
175
Total Fixed Costs
TL 665.000
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51,39%
48,61%
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Equation Method-1
We can calculate the break-even point as follows:
Sales = Variable expenses + Fixed expenses + Profits
360q = 185q + 665.000 + 0
Where:
q = Number of gadgets sold
TL 360 = Unit selling price
TL 185 = Unit variable expense
TL 665.000 = Total fixed expense
Breakeven units = q= 3800 gadgets
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Equation Method-2
The equation can be modified to calculate
the break-even point in sales dollars.
Sales = Variable expenses + Fixed expenses + Profits
X = 0,5139X + 665.000 + 0
Where:
X
= Total sales amount
0,5139
= Variable expenses as a % of sales
TL 665.000 = Total fixed expenses
Breakeven Sales amount = Sales (BE) = TL 1.368.000*
*rounding error might occur
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Reconciliation of the Equation
Method 1 and 2
From equation method 1:
Breakeven units:
3800 gadgets x price 360= TL 1.368.000 =
sales amount at breakeven
From equation 2:
Breakeven sales amount:
1.368.000 ÷ TL 360 per unit= 3800 gadgets
= breakeven units
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CONTRIBUTION MARGIN RATIO
CMR= CONTRIBUTION MARGIN RATIO
= CM / SALES OR cmu/p
VCR = VARIABLE COST RATIO
= VC/SALES OR vcu/p
CM= SALES - TOTAL VC
VC= SALES – CM (variable costs include both manufacturing and selling and
administrative variable costs)
cmu =CONTRIBUTION MARGIN PER UNIT= p - vcu=CM/q
CM = total contribution margin
vcu= variable cost (manufacturing and selling and administrative per unit)
p= selling price
cmu = contribution margin per unit
CMR +VCR= 1
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Contribution Margin Method
The contribution margin method has
two key equations.
Break-even point
=
in units sold
Break-even point in
total sales dollars =
Fixed expenses
Unit contribution margin
Fixed expenses
CM ratio
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Contribution Margin Method
Let’s use the contribution margin method to calculate
the breakeven sales amount at FM Company.
Break-even point in
total sales dollars =
Fixed expenses
CM ratio
TL 665.000
= TL 1.368.000 break-even sales
48,61%
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PROFIT ANALYSIS
• AT BREAKEVEN PROFIT = 0
• BEFORE BREAKEVEN LOSS; AFTER
BREAKEVEN PROFIT
• CM COVERS FIXED COST UPTO BREAKEVEN
POINT
• AFTER BREAKEVEN POINT INCREASE IN CM
WILL INCREASE NET INCOME
• CM = FC + INCOME BEFORE TAX
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Basic Analysis using CVP
• EFFECT OF CHANGE IN FIXED COSTS?
• EFFECT OF CHANGE IN VARIABLE COSTS?
• EFFECT OF CHANGE IN SELLING PRICE?
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Target Profit Analysis
The equation and contribution margin methods
can be used to determine the sales volume
needed to achieve a target profit.
Suppose FM Company wants to know how
many gadgets must be sold to earn a
before tax profit of TL100,000.
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The CVP Equation Method
Sales = Variable expenses + Fixed expenses + Profits
360q = 185q + 665.000 + 100.000
Where:
q = Number of gadgets sold
TL 360 = Unit selling price
TL 185 = Unit variable expense
TL 665.000 = Total fixed expense
TL 100.000 = profit BEFORE tax
Target income units = q= 4372*gadgets
*rounded up
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The Contribution Margin Approach
Unit sales to attain
=
the target profit
Fixed expenses + Target profit
Unit contribution margin
TL 665.000 + TL100,000 = 4372
TL175 per gadget
gadgets
Or
TL 100.000 ÷ TL 175 = 572 more units after the
breakeven point need to be sold
3800+572= 4372 gadgets
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Target Income –after tax profit
Assume that FM Company’s tax rate is 20%; and the
company wants an after-tax income of TL 100.000. How
many units must it sell?
After tax TL 100.000 ÷0.8 (after tax percent of
net income) = Before Tax income of TL
125.000
Then the company needs to sell after
breakeven
TL 125.000 ÷ TL 175 = 715*(rounded up) more units
3800(breakeven )+715(units after breakeven) =
4515 gadgets
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The Margin of Safety
• The margin of safety is the excess of
budgeted (or actual) sales over the breakeven amount of sales.
• The margin of safety can also be expressed
as
– % of sales
– Units
Margin of safety = Total sales - Break-even sales
MoS TL = ACTUAL OR BUDGETED SALES - BREAKEVEN SALES $
MoS % = MoS TL / ACTUAL OR BUDGETED SALES
MoS units = MoS TL / selling price
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The Margin of Safety FM Company
FM Manufacturing Income Statement
For the first Quarter 2008
Sales units
Sales
Variable Costs:
Production Costs
Selling Expenses
Administrative Expenses
Total Variable Costs
Contribution Margin
Fixed Costs:
Production Costs
Selling Expenses
Administrative Expenses
Total Fixed Costs
Net Income Before Tax
CURRENT
SALE
5.000
1.800.000 TL
BREAKEVEN
750.000
95.000
80.000
925.000
875.000
570.000
72.200
60.800
703.000
665.000
540.000
60.000
65.000
665.000
210.000 TL
540.000
60.000
65.000
665.000
0
3.800
1.368.000
Margin of safety = 1.800.000 - 1.368.000= TL 432.000
MoS % =
MoS units =
432.000 ÷ 1.800.000= 24%
432.000 ÷ 360 = 1200 gadgets
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Cost Structure and Profit
Stability
Cost structure refers to the relative proportion
of fixed and variable costs in an organization.
Managers often have some latitude in
determining their organization’s cost structure.
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Operating Leverage
• The effect of cost structure on operating
income
• Higher operating leverage – very
sensitive to changes in sales volume
Degree of
Contribution margin
=
operating leverage
Operating income
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Operating Leverage
At FM, the degree of operating leverage is.
FM Manufacturing Income Statement
For the first Quarter 2008
Sales units
Sales
Variable Costs:
Production Costs
Selling Expenses
Administrative Expenses
Total Variable Costs
Contribution Margin
Fixed Costs:
Production Costs
Selling Expenses
Administrative Expenses
Total Fixed Costs
Net Income Before Tax
CURRENT
SALE
5.000
1800000
750.000
95.000
80.000
925.000
875.000
540.000
60.000
65.000
665.000
210.000
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TL 875.000 =4,17
TL 210.000
If sales increase by
10% income is going
increase by 41,67%
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Cost Structure and Profitability
• High variable costs lead to lower CM and less
vulnerable in crisis time
• High fixed costs cause higher breakeven point; after the
breakeven point profits increase faster than the high
variable cost company
• Degree of operating leverage effects:
– For a given % change in sales, income will increase by (%
increase in sales *degree of operating leverage)
– Degree of operating leverage decreases as the sales move
away from the breakeven point
– If variable costs are high degree of operating leverage low; and
vice versa
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Structuring Sales Commissions
Companies generally compensate
salespeople by paying them either a
commission based on sales or a salary plus a
sales commission. Commissions based on
sales dollars can lead to lower profits in a
company.
Let’s look at an example.
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Structuring Sales Commissions
Pipeline Unlimited produces two types of surfboards,
the XR7 and the Turbo. The XR7 sells for $100 and
generates a contribution margin per unit of $25. The
Turbo sells for $150 and earns a contribution margin
per unit of $18.
The sales force at Pipeline Unlimited is
compensated based on sales commissions.
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Structuring Sales Commissions
If you were on the sales force at Pipeline, you would
push hard to sell the Turbo even though the XR7
earns a higher contribution margin per unit.
To eliminate this type of conflict, commissions can
be based on contribution margin rather than on
selling price alone.
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The Concept of Sales Mix
• Sales mix is the relative proportion in
which a company’s products are sold.
• Different products have different selling
prices, cost structures, and contribution
margins.
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Multiple Products Example
• Let’s assume Han sells synthetic fiber filled and
dawn feather sleeping bags. Then we’ll calculate a
break-even point that encompasses both products
and their cost-price parameters.
Description
Synthetic
Dawn Feather
Total sold
Total
Sales
250.000
300.000
550.000
% of
Total
45,5% (250000 ÷ 550000)
54,5% (300000 ÷ 550000)
100,0%
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Multiple Products Example
Cost other related information
Description
Synthetic
Dawn Feather
Total sold
Fixed Costs
Number
Selling
Unit
Unit
of
price
variable contribution sleeping
cost
margin
bags
500 TL
300 TL
200 TL
500
1.000
450
550
300
800
TL 170.000
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Multiple Products Example
Description
Synthetic
Daw n Feather
Selling
Unit
Unit
Sales Mix
price variable contribution Contribution
%
cost
margin
Margin Ratio (amount)
500 TL
300 TL
1.000
450
200 TL
550
Weighted CMR
40,00%
45,50%
55,00%
54,50%
48,18%
Breakeven Sales Amount =
TL 170.000 ÷ 48.18% = TL 352.880
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Multiple Products Example
At Breakeven Han needs to sell of each product
Synthetic
Dawn Feather
* rounded up to the next whole unit
Sale Amount
Number of
Breakeven Sale of Each
Selling
bags to be
Sales mix
Amount TL
Product TL
Price TL sold*
45,50%
352.880
160.560
500
322,00
54,50%
192.320
1.000
193,00
Or we can use the following method
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Multiple Products Example
Weighted-average unit contribution
margin
Contribution
Weighted
Description
% of total
margin
contribution
Synthetic
200
62,5%
125
Dawn Feather
550
37,5%
206,25
Weighted-average contribution margin
331
TL 200 × 62.5%
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Multiple Products Example
The break-even point is 514 combined units. We can use the sales
mix to find the number of units of each
product that must be sold to break even.
Break-even
Fixed expenses
=
point
Weighted-average unit contribution margin
Break-even
=
point
170,000
331.25
Break-even
= 514 combined units
point
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Multiple Products Example
Combined
break-even
sales
514
Product
Synthe tic
Daw n Fe athe r
Total units
% of
total
62,5%
37,5%
Individual
sales
321
193
514
The break-even point of 514 units is valid
only for the sales mix of 62.5% and 37.5%.
Sales amount to break even:
There is a slight
difference between
the results of the
approaches due to
rounding.
Number of
Selling
bags to be Total
Price TL sold
Sales
500
321,00 160.500
1.000
193,00 193.000
353.500
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In Class – Multiple Customers
Cali sells PROD 1.0 which is a top electronic spreadsheet product.
Now, the company is coming up with the new version –PROD 2.0.
The company offers the new version at substantially lower prices to
customers who has PROD 1.0 (upgrade customers).
Cali plans to sell 200.000 units of PROD 2.0 and wants to have a net
income of TL 7.000.000 after tax. Current tax rate is 20%.
The expected sales mix in units is 60% new customers; and 40%
upgrade customers.
Cali management wants to know:
• What the expected breakeven in units and TLs for PROD 2.0 at
60/40 sales mix.
• Whether they will be able to attain its target income with the
expected sales level and sales mix.
• What the optimal sales mix is.
Relevant information appear in the following slide.
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In Class – Multiple Customers
Cali Cost and Revenue
Information
New
Customer
Selling Price
Variable Costs:
Production Costs
Selling Expenses
Total Variable Costs
Contribution Margin
Fixed Costs:
Production Costs
Selling Expenses
Administrative Expenses
Total Fixed Costs
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Upgrade
Customers
210
120
25
65
90
120
25
15
40
80
9.000.000
3.000.000
2.000.000
14.000.000
9.000.000
3.000.000
2.000.000
14.000.000
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Solution to CALI
Modeling Multiple Cost Drivers
An insight from activity-based
costing: costs may be a
function of multiple activities,
not merely sales volume.
Some costs
treated as fixed
(when sales
volume is the only
activity) may now
be considered
variable.
Total Cost =
(Unit variable cost × Sales units)
+ (Batch cost × Batch activity)
+ (Product cost × Product activity)
+ (Customer cost × Customer activity)
+ (Facility cost × Facility activity)
Mugan 2007
63
Multiple Cost Drivers
• Variable costs may arise from multiple cost
drivers or activities. A separate variable
cost needs to be calculated for each
driver. Examples include:
– Customer or patient count
– Passenger miles
– Patient days
– Student credit-hours
– Set-up Costs – number of setups
Mugan 2007
64
Multiple Cost Drivers
EMBA Company produces a single product with
the following costs:
Selling price: TL 200
Variable production costs per product TL 120
Variable gift wrapping costs TL 10 per customer
Fixed costs TL 4500
Determine the breakeven sales.
Mugan 2007
65
Multiple Cost Drivers
Operating Income = Sales
– (Variable production cost x number of units sold)
- ( Variable gift wrapping cost x number of customers)
- Fixed Costs
Rev/Cost per
unit/customer
(TL)
Sales
Variable Production costs
Variable Packaging costs
Total Variable Costs
Contribution margin
Fixed Costs
Operating Income
Number of
products sold
150
200
120
10
Number of
Total Rev/
Customers Cost (TL)
150
30.000
18.000
1500
30.000
18.000
1.500
19.500
10.500
4.500
6.000
If EMBA sells 150 products to 100 customers?
Mugan 2007
66
Multiple Cost Drivers
Rev/Cost per
unit/customer
(TL)
Sales
Variable Production costs
Variable Packaging costs
Total Variable Costs
Contribution margin
Fixed Costs
Operating Income
Number of
products sold
150
200
120
10
Number of
Total Rev/
Customers Cost (TL)
100
30.000
18.000
1000
30.000
18.000
1.000
19.000
11.000
4.500
6.500
Number of units sold is NOT the only determinant of operating
income; there are two cost drivers
– the number of units sold; and – the number of customers
Mugan 2007
67
Multiple Cost Drivers
• There is no unique breakeven point
Rev/Cost per
unit/customer
(TL)
Sales
Variable Production costs
Variable Packaging costs
Total Variable Costs
Contribution margin
Fixed Costs
Operating Income
Number of
products sold
60
200
120
10
Rev/Cost per
unit/customer
(TL)
Sales
Variable Production costs
Variable Packaging costs
Total Variable Costs
Contribution margin
Fixed Costs
Operating Income
Number of
Total Rev/
Customers Cost (TL)
30
12.000
7.200
12.000
7.200
300
7.500
4.500
4.500
0
300
Number of
products sold
57
200
120
10
Mugan 2007
Number of
Customers
Total Rev/
Cost (TL)
6
11.400
6.840
60
11.400
6.840
60
6.900
4.500
4.500
0
68
In Class – CVP multiple cost drivers
Sade Comp is a distributor of special dolls. For 2008,
Seyda, the manager, plans to purchase the dolls for TL
30 each and sell them for TL 45 each. Sade’s fixed costs
are expected to be TL 240.000. Seyda’s only other costs
will be variable costs of TL 60 per shipment for each
customer regardless of the number of dolls in the order.
Seyda wants to know:
How much operating income will be if she sell 40,000 dolls
in 1.000 shipments? 800 shipments?
She estimates that she can make 500 shipments in 2008.
She wants to know how many dolls she needs to sell to
breakeven.
Is this the only breakeven point? Can she have other
breakeven points if she can make more or less
shipments?
Mugan 2007
69
Solution to Sade Company
USING CVP with Absorption
Costing
• Poli Company produces and sells coffee mugs. Cost and
revenue related information is provided below.
Selling price per unit
variable manufacturing, cost per unit
Fixed Manufacturing Costs
Variable selling and administrative costs
Fixed Selling and Administrative costs
Contribution Margin per unit
Mugan 2007
13
6
100.000
2
0
5
71
USING CVP with Absorption
Costing
Determine the break-even point under
contribution approach.
Breakeven for Variable Costing:
Fixed Costs: manuf and selling
Contribution Margin per unit
Breakeven units
Mugan 2007
100.000
5
20000
72
USING CVP with Absorption Costing
• If the company uses absorption costing and wants to determine the
breakeven point, three cases arise.
Case 1 sales = production
inventory beginning - units
inventory ending - units
production units
sales units
contribution margin per unit
fixed manufacturing costs
fixed manufacturing costs per unit-current
fixed manufacturing costs per unit-previous period
unit sold from inventory
fixed cost absorbed in units sold
fixed cost absorbed in inventories-beginning
fixed cost absorbed in inventories-ending
total fixed manufacturing costs
breakeven units
Mugan 2007
10.000
10.000
25.000
25.000
5
100.000
4
4
0
100.000
40.000
40.000
100.000
20.000
73
USING CVP with Absorption Costing
• Let’s prove: at 20,000 units – sales=production
Absorption Income Statement
Case 1 sales = production
Sales
Cost of Goods Sold:
Variable Manuf Costs
Fixed Manuf Costs
Gross Margin
Selling and Administrative Costs
Variable
Fixed
Net Income Before Tax
Variable Costing Income Statement
Case 1 sales = production
260.000 Sales
Variable Costs:
120.000
Manufacturing
100.000
Selling, administrative
220.000
40.000 Contribution Margin
Fixed Costs:
40.000
Manufacturing
0
Selling, administrative
40.000
260.000
120.000
40.000
160.000
100.000
100.000
0
100.000
0 Net Income Before Tax
Mugan 2007
0
74
USING CVP with Absorption Costing
Case 2 sales < production
inventory beginning - units
inventory ending - units
production units
sales units
contribution margin per unit
fixed manufacturing costs
fixed manufacturing costs per unit-current
fixed manufacturing costs per unit-previous period
unit sold from inventory
fixed cost absorbed in units sold
fixed cost absorbed in inventories-beginning
fixed cost absorbed in inventories-ending
total fixed manufacturing costs
breakeven units
Mugan 2007
10.000
15.000
25.000
20.000
5
100.000
4
4
(5.000)
80.000
40.000
60.000
80.000
16.000
75
USING CVP with Absorption Costing
Absorption Income Statement
at breakeven per absorption
Case 2 sales < production
Sales
Cost of Goods Sold:
Variable Manuf Costs
Fixed Manuf Costs
Gross Margin
Selling and Administrative Costs
Variable
Fixed
Variable Costing Income Statement
at breakeven per absorption
Case 2 sales < production
208.000 Sales
Variable Costs:
96.000
Manufacturing
80.000
Selling, administrative
176.000
32.000 Contribution Margin
Fixed Costs:
32.000
Manufacturing
0
Selling, administrative
32.000
Net Income Before Tax
0 Net Income Before Tax
208.000
96.000
32.000
128.000
80.000
100.000
0
100.000
(20.000)
Amount of fixed manufacturing costs
absorbed in the units sold
Amount of fixed manufacturing costs
absorbed in the increase in ending
Muganinventory
2007
76
USING CVP with Absorption
Costing
Case 3 sales > production
inventory beginning - units
inventory ending - units
production units
sales units
contribution margin per unit
fixed manufacturing costs
fixed manufacturing costs per unit-current
fixed manufacturing costs per unit-previous period
unit sold from inventory
fixed cost absorbed in units sold
fixed cost absorbed in inventories-beginning
fixed cost absorbed in inventories-ending
total fixed manufacturing costs
breakeven units
Mugan 2007
10.000
5.000
25.000
30.000
5
100.000
4
4
5.000
120.000
40.000
20.000
120.000
24.000
77
USING CVP with Absorption Costing
Absorption Income Statement
at breakeven per absorption
Case 3 sales > production
Sales
Cost of Goods Sold:
Variable Manuf Costs
Fixed Manuf Costs
Gross Margin
Selling and Administrative Costs
Variable
Fixed
Variable Costing Income Statement
at breakeven per absorption
Case 3 sales > production
312.000 Sales
Variable Costs:
144.000
Manufacturing
120.000
Selling, administrative
264.000
48.000 Contribution Margin
Fixed Costs:
48.000
Manufacturing
0
Selling, administrative
48.000
Net Income Before Tax
Amount of fixed manufacturing costs
absorbed in the units sold
312.000
144.000
48.000
192.000
120.000
100.000
0
100.000
0 Net Income Before Tax
Amount of fixed manufacturing costs
Mugan
2007
absorbed
in the increase in ending
inventory
20.000
78
With fixed selling and admin costs
Case 1 sales = production
inventory beginning - units
inventory ending - units
production units
sales units
contribution margin per unit
fixed manufacturing costs
fixed manufacturing costs per unit-current
fixed manufacturing costs per unit-previous period
unit sold from inventory
fixed cost absorbed in units sold
fixed cost absorbed in inventories-beginning
fixed cost absorbed in inventories-ending
total fixed manufacturing costs
fixed selling and administrative
TOTAL FIXED COSTS
breakeven units
Case 1 sales = production
Case 1 sales = production
Absorption Income Statement
Variable Income Statement
Sales
286.000 Sales
Cost of Goods Sold:
Variable Costs:
Variable Manuf Costs
132.000 Manufacturing
Fixed Manuf Costs
100.000 Selling, administrative
232.000
Gross Margin
54.000 Contribution Margin
10.000
10.000
25.000
25.000
5
100.000
4
4 Selling and Administrative Costs
Fixed Costs:
0 Variable
44.000 Manufacturing
100.000 Fixed
10.000 Selling, administrative
40.000
54.000
40.000
100.000 Net Income Before Tax
0 Net Income Before Tax
10.000
110.000
22.000
Mugan 2007
286.000
132.000
44.000
176.000
110.000
100.000
10.000
110.000
0
79
With fixed selling and admin costs
Case 2 sales < production
Case 2 sales < production
Absorption Income Statement
Sales
Cost of Goods Sold:
Variable Manuf Costs
Fixed Manuf Costs
Case 2 sales < production
Variable Income Statement
234.000 Sales
234.000
Variable Costs:
108.000 Manufacturing
108.000
80.000 Selling, administrative
36.000
188.000
144.000
46.000 Contribution Margin
90.000
inventory beginning - units
10.000
inventory ending - units
15.000
production units
25.000
sales units
20.000
contribution margin per unit
5
fixed manufacturing costs
100.000 Gross Margin
fixed manufacturing costs per unit-current
4
fixed manufacturing costs per unit-previous period
4 Selling and Administrative Costs
Fixed Costs:
unit sold from inventory
(5.000) Variable
36.000 Manufacturing
fixed cost absorbed in units sold
80.000 Fixed
10.000 Selling, administrative
fixed cost absorbed in inventories-beginning
40.000
46.000
fixed cost absorbed in inventories-ending
60.000
total fixed manufacturing costs
80.000 Net Income Before Tax
0 Net Income Before Tax
fixed selling and administrative
10.000
TOTAL FIXED COSTS
90.000
breakeven units
18.000
Mugan 2007
100.000
10.000
110.000
(20.000)
80
With fixed selling and admin costs
Case 3 sales > production
inventory beginning - units
inventory ending - units
production units
sales units
contribution margin per unit
fixed manufacturing costs
fixed manufacturing costs per unit-current
fixed manufacturing costs per unit-previous period
unit sold from inventory
fixed cost absorbed in units sold
fixed cost absorbed in inventories-beginning
fixed cost absorbed in inventories-ending
total fixed manufacturing costs
fixed selling and administrative
TOTAL FIXED COSTS
breakeven units
Case 3 sales > production
Absorption Income Statement
Sales
Cost of Goods Sold:
Variable Manuf Costs
Fixed Manuf Costs
Case 3 sales > production
Variable Income Statement
338.000 Sales
338.000
Variable Costs:
156.000 Manufacturing
156.000
120.000 Selling, administrative
52.000
276.000
208.000
62.000 Contribution Margin
130.000
10.000
5.000
25.000
30.000
5
100.000 Gross Margin
4
4 Selling and Administrative Costs
Fixed Costs:
5.000 Variable
52.000 Manufacturing
120.000 Fixed
10.000 Selling, administrative
40.000
62.000
20.000
120.000 Net Income Before Tax
0 Net Income Before Tax
10.000
130.000
26.000
Mugan 2007
100.000
10.000
110.000
20.000
81