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Chapter 22 COST-VOLUME-PROFIT ANALYSIS PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. 22 - 2 Number of Local Calls Total fixed costs remain constant as activity increases. Monthly Basic Telephone Bill per Local Call FIXED COSTS Monthly Basic Telephone Bill C1 Number of Local Calls Cost per call declines as activity increases. 22 - 3 C1 Total Costs Cost per Minute VARIABLE COSTS Minutes Talked Total variable costs increase as activity increases. Minutes Talked Cost per Minute is constant as activity increases. 22 - 4 C1 MIXED COSTS Total Utility Cost Mixed costs contain a fixed portion that is incurred even when the facility is unused, and a variable portion that increases with usage. Utilities typically behave in this manner. Variable Cost per KW Activity (Kilowatt Hours) Fixed Monthly Utility Charge 22 - 5 P1 SCATTER DIAGRAMS Draw a line through the plotted data points so that about equal numbers of points fall above and below the line. Total Cost in 1,000’s of Dollars 20 * ** * ** * * * * 10 Estimated fixed cost = 10,000 0 0 1 2 3 4 5 Activity, 1,000’s of Units Produced 6 22 - 6 P1 SCATTER DIAGRAMS Δ in cost Δ in units Unit Variable Cost = Slope = Total Cost in 1,000’s of Dollars 20 * ** * ** * * * * 10 Horizontal distance is the change in activity. 0 0 1 2 3 4 Activity, 1,000’s of Units Produced 5 6 Vertical distance is the change in cost. 22 - 7 P1 THE HIGH-LOW METHOD The following relationships between units produced and total cost are observed: Using these two levels of activity, compute: the variable cost per unit. the total fixed cost. 22 - 8 P1 THE HIGH-LOW METHOD High activity level - December Low activity level - January Change in activity Units 67,500 17,500 50,000 Cost $ 29,000 20,500 $ 8,500 Variable cost per unit is determined as follows: Fixed costs are determined as follows: Total cost = $17,525 + $0.17 per unit produced 22 - 9 A1 CONTRIBUTION MARGIN AND ITS MEASURES Sales Revenue (2,000 units) Less: Variable costs Contribution margin Less: Fixed costs Net income Total $ 200,000 140,000 $ 60,000 24,000 $ 36,000 Unit $ 100 70 $ 30 Contribution margin is the amount by which revenue exceeds the variable costs of producing the revenue. Total contribution margin is $60,000 and the contribution margin per unit sold is $30. 22 - 10 A1 CONTRIBUTION MARGIN AND ITS MEASURES Sales Revenue (2,000 units) Less: Variable costs Contribution margin Less: Fixed costs Net income Contribution margin ratio Contribution margin ratio Total $ 200,000 140,000 $ 60,000 24,000 $ 36,000 Unit $ 100 70 $ 30 = Contribution margin per unit Sales price per unit = $30 per unit $100 per unit = 30% 22 - 11 P2 COMPUTING THE BREAK-EVEN POINT Sales Revenue (2,000 units) Less: Variable costs Contribution margin Less: Fixed costs Net income Total $ 200,000 140,000 $ 60,000 24,000 $ 36,000 Unit $ 100 70 $ 30 How much contribution margin must Rydell Company have to cover its fixed costs (break-even)? Answer: $24,000 How many units must Rydell sell to cover its fixed costs (break-even)? Answer: $24,000 ÷ $30 per unit = 800 units 22 - 12 P2 COMPUTING THE BREAK-EVEN POINT We have just seen one of the basic CVP relationships – the break-even computation. Fixed costs Break-even point in units = Contribution margin per unit Unit sales price less unit variable cost ($30 in previous example) 22 - 13 P2 COMPUTING THE BREAK-EVEN POINT The break-even formula may also be expressed in sales dollars. Break-even point in dollars = Fixed costs Contribution margin ratio Unit contribution margin Unit sales price 22 - 14 C2 COMPUTING SALES FOR A TARGET INCOME Break-even formulas may be adjusted to show the sales volume needed to earn any amount of income. Unit sales = Fixed costs + Target pretax income Contribution margin per unit Dollar sales = Fixed costs + Target pretax income Contribution margin ratio 22 - 15 C2 COMPUTING SALES (DOLLARS) FOR A TARGET NET INCOME To convert target net income to before-tax income, use the following formula: Target net income Before-tax income = 1 - tax rate 22 - 16 P4 COMPUTING A MULTIPRODUCT BREAK-EVEN POINT The CVP formulas can be modified for use when a company sells more than one product. The unit contribution margin is replaced with the contribution margin for a composite unit. A composite unit is composed of specific numbers of each product in proportion to the product sales mix. Sales mix is the ratio of the volumes of the various products. 22 - 17 A2 DEGREE OF OPERATING LEVERAGE A measure of the extent to which fixed costs are being used in an organization. A measure of how a percentage change in sales will affect profits. Contribution margin Pretax income = Degree of operating leverage 22 - 18 END OF CHAPTER 22