Transcript Slide 1

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.
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IDENTIFYING COST BEHAVIOR
Cost-volume-profit analysis is used to answer questions
such as:
 What sales volume is needed to earn a target income?
 What is the change in income if selling prices decline
and sales volume increases?
 How much does income increase if we install a new
machine to reduce labor costs?
 What is the income effect if we change the sales mix
of our products or services?
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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.
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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.
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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
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C1
STEP-WISE COSTS
Total cost increases to a new higher cost for the next
higher range of activity, but remains constant within a
range of activity.
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C1
CURVILINEAR COSTS
Costs that increase when activity
increases, but in a nonlinear manner.
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P1
MEASURING COST BEHAVIOR
The objective is to classify all costs as either fixed
or variable. We will look at three methods:
1. Scatter diagrams.
2. The high-low method.
3. Least–squares regression.
A scatter diagram is a plot of cost data points on a
graph. It is almost always helpful to plot cost data to
be able to observe a visual picture of the relationship
between cost and activity.
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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
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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.
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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.
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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
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P1
LEAST-SQUARES REGRESSION
Least-squares regression is usually covered
in advanced cost accounting courses. It is
commonly used with spreadsheet programs
or calculators.
The objective of the cost
analysis remains the
same: determination of
total fixed cost and the
variable unit cost.
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A1
USING BREAK-EVEN ANALYSIS
The break-even point (expressed in
units of product or dollars of sales) is the
unique sales level at which a company
earns neither a profit nor incurs a loss.
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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.
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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%
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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
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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)
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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
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P3
PREPARING A CVP CHART
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MAKING ASSUMPTIONS IN
COST-VOLUME-PROFIT ANALYSIS
P3
 A limited range of activity called the relevant
range, where CVP relationships are linear.

Unit selling price remains constant.

Unit variable costs remain constant.

Total fixed costs remain constant.
 Production = sales (no inventory changes).
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P3
WORKING WITH CHANGES
IN ESTIMATES
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
What happens to the break-even point if management can
increase the sales price to $105, with no changes in fixed or
variable costs?
Break-even point in units =
Break-even point in units =
Fixed costs
Contribution margin per unit
$24,000
= 686 units
$105 – $70
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C2
COMPUTING INCOME
FROM SALES AND COSTS
Income (pretax) = Sales – Variable costs – Fixed costs
Ridwan expects to sell 1,500 units at $100 each next
month. Fixed costs are $24,000 per month and the unit
variable cost is $70. What amount of income should
Ridwan expect?
Income (pretax) = Sales – Variable costs – Fixed costs
= [1,500 units × $100] – [1,500 units × $70] – $24,000
= $21,000
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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
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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
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C2
COMPUTING SALES (DOLLARS) FOR A
TARGET NET INCOME
Ridwan has a monthly target net income of $9,000. The
unit selling price is $100. Monthly fixed costs are
$24,000, the unit variable cost is $70, and the tax rate is
25 percent.
What is Ridwan’s target pretax income?
Pretax income =
Pretax income =
Target net income
1 - tax rate
$9,000
1 - .25
=
$12,000
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C2
COMPUTING SALES (DOLLARS) FOR A
TARGET NET INCOME
Ridwan has a monthly target after-tax income of $9,000.
The unit selling price is $100. Monthly fixed costs are
$24,000, the unit variable cost is $70, and the tax rate is
25 percent. Let’s compute the sales revenue that Ridwan
will need to earn $12,000 of pretax income?
Dollar sales =
Dollar sales =
Fixed costs + Target pretax income
Contribution margin ratio
$24,000 + $12,000
30%
= $120,000
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C2
COMPUTING SALES (UNITS) FOR A
TARGET NET INCOME
The formula for computing dollar sales may be
used to compute unit sales by substituting
contribution per unit in the denominator.
Unit sales =
Unit sales =
Fixed costs + Target pretax income
Contribution margin per unit
$24,000 + $12,000
$30 per unit
= 1,200 units
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C2
COMPUTING THE MARGIN OF SAFETY
Margin of safety is the amount by which sales can drop
before the company incurs a loss. Margin of safety may
be expressed as a percentage of expected sales.
Margin of safety
percentage
=
Expected sales - Break-even sales
Expected sales
If Ridwan’s sales are $100,000 and break-even sales are
$80,000, what is the margin of safety percentage?
Margin of safety
percentage
$100,000 - $80,000
=
= 20%
$100,000
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C2
USING SENSITIVITY ANALYSIS
Ridwan Company is considering buying a new machine
that would increase monthly fixed costs from $24,000 to
$30,000, but decrease unit variable costs from $70 to $60.
The $100 per unit selling price would remain unchanged.
What is the new break-even point in dollars?
Revised Break-even
point in dollars
=
Revised fixed costs
Revised contribution margin ratio
Revised Break-even
point in dollars
=
$30,000
40%
= $75,000
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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.
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P4
COMPUTING A MULTIPRODUCT
BREAK-EVEN POINT
The resulting break-even formula
for composite unit sales is:
Break-even point
in composite units
=
Fixed costs
Contribution margin
per composite unit
Consider the following example:
Continue
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P4
COMPUTING A MULTIPRODUCT
BREAK-EVEN POINT
Hair-Today offers three cuts as shown below. Annual fixed
costs are $192,000. Compute the break-even point in
composite units and in number of units for each haircut at the
given sales mix.
Selling Price
Variable Cost
Unit Contribution
Sales Mix Ratio
Haircuts
Basic
Ultra
Budget
$ 20.00 $ 32.00 $ 16.00
13.00
18.00
8.00
$ 7.00 $ 14.00 $ 8.00
4
2
1
A 4:2:1 sales mix means that if there are 500 budget cuts,
then there will be 1,000 ultra cuts, and 2,000 basic cuts.
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P4
COMPUTING A MULTIPRODUCT
BREAK-EVEN POINT
Step 1: Compute contribution margin per
composite unit.
Basic
Selling Price
$20.00
Variable Cost
13.00
Unit Contribution
$7.00
Sales Mix Ratio
×4
Weighted Contribution $ 28.00
Haircuts
Ultra
Budget
$32.00
$16.00
18.00
8.00
$14.00
$8.00
×2
×1
+ $ 28.00 + $ 8.00 = $ 64.00
Contribution margin per composite unit
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P4
COMPUTING A MULTIPRODUCT
BREAK-EVEN POINT
Step 2: Compute break-even point in
composite units.
=
Fixed costs
Contribution margin
per composite unit
Break-even point
in composite units
=
$192,000
$64.00 per
composite unit
Break-even point
in composite units
=
3,000 composite units
Break-even point
in composite units
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P4
COMPUTING A MULTIPRODUCT
BREAK-EVEN POINT
Step 3: Determine the number of each haircut
that must be sold to break-even.
Sales Composite
Product Mix
Cuts
Haircuts
Basic
4
×
3,000
= 12,000
Ultra
2
×
3,000
=
6,000
Budget
1
×
3,000
=
3,000
Total
21,000
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P4
MULTIPRODUCT BREAK-EVEN
INCOME STATEMENT
Step 4: Verify the results.
Basic
Selling Price
$ 20.00
Variable Cost
13.00
Unit Contribution
$
7.00
Sales Volume
×
12,000
Total Contribution
$ 84,000
Fixed Costs
Income
Haircuts
Ultra
$ 32.00
18.00
$ 14.00
×
6,000
$ 84,000
Budget
$ 16.00
8.00
$
8.00
×
3,000
$ 24,000
Combined
$192,000
192,000
$
0
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GLOBAL VIEW
Over 90 percent of German companies
surveyed report their cost accounting systems
focus on contribution margin. This focus helps
German companies like Volkswagen control
costs and plan their production levels.
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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
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A2
OPERATING LEVERAGE
Ridwan Company
Sales (1,200 units)
Less: variable expenses
Contribution margin
Less: fixed expenses
Pretax income
Contribution margin
Net income
$120,000
84,000
36,000
24,000
$ 12,000
= Degree of operating leverage = $36,000
$12,000
= 3.0
If Ridwan increases sales by 10 percent, what will the
percentage increase in income be?
Percent increase in sales
Degree of operating leverage
Percent increase in pretax income
10%
×
3
30%
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APPENDIX 22A: USING EXCEL TO
ESTIMATE LEAST-SQUARES REGRESSION
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END OF CHAPTER 22