COST-VOLUME-PROFIT ANALYSIS
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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 Copyright 2015 by McGraw-Hill Education (Asia). All rights reserved.
2 22-2 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?
3 22-3 C 1 FIXED COSTS Monthly Basic Telephone Bill Number of Local Calls Monthly Basic Telephone Bill per Local Call Number of Local Calls Total fixed costs remain constant as activity increases. Cost per call declines as activity increases.
4 22-4 C 1 VARIABLE COSTS Total Costs Cost per Minute Minutes Talked Total variable costs increase as activity increases. Minutes Talked Cost per Minute is constant as activity increases.
5 22-5 C 1 MIXED COSTS 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. Total Utility Cost Total mixed cost Activity (Kilowatt Hours) Variable Cost per KW Fixed Monthly Utility Charge
6 22-6 C 1 A comparison of cost behavior Fixed Costs Per unit Total At zero volume changes with volume Variable Costs does not change with volume Mixed Costs Total Costs partly changes with volume partly changes with volume Fixed, within a range of volume Changes with volume partly changes with volume partly changes with volume Fixed amount No Cost Fixed component of the cost Fixed component of the cost
7 22-7 C 1 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.
8 22-8 C 1 CURVILINEAR COSTS Costs that increase when activity increases, but in a nonlinear manner.
9 22-9 P 1 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.
10 22-10 P 1 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 * * * * * * * * * * Estimated fixed cost = 10, Activity, 1,000 s of Units Produced
11 22-11 P 1 SCATTER DIAGRAMS Unit Variable Cost = Slope = Δ in cost Δ in units Total Cost in 1,000 s of Dollars * * * * Horizontal distance is the change in activity * * * * * * Vertical distance is the change in cost. Activity, 1,000 s of Units Produced
12 22-12 P 1 THE HIGH-LOW METHOD The following relationships between units produced and total cost are observed: Using these two levels of activity, compute: ❶ the variable cost per unit. ❷ the total fixed cost.
13 22-13 P 1 THE HIGH-LOW METHOD Units ❶ Variable cost per unit is determined as follows: Cost High activity level - December 67,500 $ 29,000 Low activity level - January 17,500 20,500 Change in activity 50,000 $ 8,500 ❷ Fixed costs are determined as follows: Total cost = $17,525 + $0.17 per unit produced
14 22-14 P 1 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.
15 22-15 A 1 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.
16 A 1 CONTRIBUTION MARGIN AND ITS MEASURES Total Unit Sales Revenue (2,000 units) $ 200,000 $ 100 Less: Variable costs 140, Contribution margin $ 60,000 $ 30 Less: Fixed costs 24,000 Net income $ 36,000 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.
17 A 1 CONTRIBUTION MARGIN AND ITS MEASURES Total Unit Sales Revenue (2,000 units) $ 200,000 $ 100 Less: Variable costs 140, Contribution margin $ 60,000 $ 30 Less: Fixed costs 24,000 Net income $ 36,000 Contribution margin ratio = Contribution margin per unit Sales price per unit Contribution margin ratio = $30 per unit $100 per unit = 30%
18 P 2 COMPUTING THE BREAK-EVEN POINT Total Unit Sales Revenue (2,000 units) $ 200,000 $ 100 Less: Variable costs 140, Contribution margin $ 60,000 $ 30 Less: Fixed costs 24,000 Net income $ 36,000 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
19 22-19 P 2 COMPUTING THE BREAK-EVEN POINT We have just seen one of the basic CVP relationships the break-even computation. Break-even point in units = Fixed costs Contribution margin per unit Unit sales price less unit variable cost ($30 in previous example)
20 22-20 P 2 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
21 22-21 P 3 PREPARING A CVP CHART
22 22-22 P 3 MAKING ASSUMPTIONS IN COST-VOLUME-PROFIT ANALYSIS ❶ 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. ❷ Production = sales (no inventory changes).
23 22-23 P 3 WORKING WITH CHANGES IN ESTIMATES Total Unit Sales Revenue (2,000 units) $ 200,000 $ 100 Less: Variable costs 140, Contribution margin $ 60,000 $ 30 Less: Fixed costs 24,000 Net income $ 36,000 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 $105 $70 = 686 units
24 22-24 C 2 COMPUTING INCOME FROM SALES AND COSTS Income (pretax) = Sales Variable costs Fixed costs Rydell 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 Rydell expect? Income (pretax) = Sales Variable costs Fixed costs = [1,500 units $100] [1,500 units $70] $24,000 = $21,000
25 22-25 C 2 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
26 C 2 COMPUTING SALES (DOLLARS) FOR A TARGET NET INCOME To convert target net income to before-tax income, use the following formula: Before-tax income = Target net income 1 - tax rate
27 C 2 COMPUTING SALES (DOLLARS) FOR A TARGET NET INCOME Rydell 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 Rydell s target pretax income? Pretax income = Target net income 1 - tax rate $9,000 Pretax income = = $12,
28 C 2 COMPUTING SALES (DOLLARS) FOR A TARGET NET INCOME Rydell 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 Rydell will need to earn $12,000 of pretax income? Dollar sales = Fixed costs + Target pretax income Contribution margin ratio $24,000 + $12,000 Dollar sales = = $120,000 30%
29 22-29 C 2 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 = Fixed costs + Target pretax income Contribution margin per unit $24,000 + $12,000 Unit sales = = 1,200 units $30 per unit
30 C 2 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 Rydell s sales are $100,000 and break-even sales are $80,000, what is the margin of safety percentage? Margin of safety $100,000 - $80,000 = = 20% percentage $100,000
31 22-31 C 2 USING SENSITIVITY ANALYSIS Rydell 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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