COST-VOLUME- PROFIT ANALYSIS

Transcription

1 COST-VOLUME- PROFIT ANALYSIS Chapter 13 Cost-Volume-Profit Relationships Cost-volume-profit (CVP) analysis is used to answer questions such as: How much must I sell to earn my desired income? How will income be affected if I reduce selling prices to increase sales volume? What will happen to profitability if I expand capacity? To explain how fixed, variable, and semivariable costs respond to changes in the volume of business activity. LO1 Monthly Basic Telephon ne Bill Fixed Costs Total fixed costs remain unchanged when activity changes. Number of Local Calls Your monthly basic telephone bill probably does not change when you make more local l calls.

2 Fixed Costs Fixed costs per unit decline as activity increases. Your average cost per local call decreases as more local calls are made. Mont thly Bas sic Tele ephone Bill per Local Call Number of Local Calls Variable Costs Total variable costs change when activity i changes. Tota al Long Distan nce Telepho one Bill Minutes Talked Your total long distance telephone bill is based on how many minutes you talk Variable Costs Variable costs per unit do not change as activity increases. Semivariable Costs (Mixed Costs) Mixed costs contain a fixed portion that is incurred even when facility is unused, and a variable portion that increases with usage. e The cost per long distance minute talked is constant. For example, 10 cents per minute. Per Minute Tele ephone e Charg Minutes Talked Example: monthly electric utility charge Fixed service fee Variable charge per kilowatt hour used

3 Semivariable Costs (Mixed Costs) Cost Behavior Summary Total Utility Cost Slope is variable cost per unit of activity. Variable Utility Charge Fixed Monthly Utility Charge Per Unit Total Summary of Variable and Fixed Cost Behavior Variable Costs Remains the same even when activity level changes. Changes as activity level changes. Fixed costs Dereases as activity level increases. Remains the same over wide ranges of activity. Activity it (Kilowatt Hours) Economies of Scale Recall our earlier telephone example. To explain how economies of scale can reduce unit costs. LO2 Fixed costs per unit decline as activity increases. Monthly Basic Telepho one Bill per Loc cal Call Number of Local Calls

4 Economies of Scale Economies of scale are most apparent in business with high fixed costs. Economies of Scale Economies of scale are most apparent in business with high fixed costs. Utility Companies Steel Mills Number Fixed Costs of Flights Fixed Cost per Month per Month per Flight $ 100,000,000 1,000 $ 100,000 $ 100,000,000 2,000 $ 50,000 $ 100,000,000 4,000 $ 25,000 $ 100,000,000 8,000 $ 12,500 Oil Refineries Airlines Airlines Stair-Step Step Costs Stair-Step Step Costs Total cost remains constant within a narrow range of activity. Total cost increases to a new higher cost for the next thigher h range of activity. Cost Cost Activity Activity

5 Curvilinear Costs Curvilinear Cost Function Total C ost Relevant Range Volume of Output A straight line closely (constant unit variable cost) approximates a curvilinear variable cost line within the relevant range. To prepare a cost-volume-profit graph. LO Preparing a CVP Graph Preparing a CVP Graph Starting at the origin, draw the total revenue line with a slope equal to the unit sales price. Revenue Draw the total cost line with a slope equal to the unit variable cost. Revenue e Co osts an nd Rev venue in Dollars Total fixed cost extends horizontally from the vertical axis. Total fixed cost venue s nd Rev Dollars osts an in D Co Break- even Point Loss Profit Total cost Total fixed cost Volume in Units Volume in Units

6 To compute the contribution margin and explain its usefulness. Computing Break-Even Point The break-even even point (expressed in units of product or dollars of sales) is the unique sales level at which a company neither earns a profit nor incurs a loss. LO4 Computing Break-Even Point Formula for Computing Finding Break-Even the Break-Even Sales (in Units) Point Total Unit Sales Revenue (2,000 units) $ 100,000 $ 50 Less: Variable costs 60, Contribution margin $ 40,000 $ 20 Less: Fixed costs 30,000 Operating income $ 10,000 We have just seen one of the basic CVP relationships the break-even even computation. Fixed costs Break-even even point in units = Contribution margin per unit How many units must tthis company How How Contribution much many much contribution units ti margin must i margin is this margin amount company must must by this which this sell hcompany revenue to cover have exceeds have to the cover to variable cover its its fixed fixed costs of costs producing (break (break even)? the even)? revenue. sell its fixed to cover costs its (break fixed even)? costs Answer: $30, Answer: $30,000 (break $20 even)? per unit = 1,500 units Unit sales price less unit variable cost ($20 in previous example)

7 Formula for Computing Break-Even Sales (in Dollars) Computing Break-Even Sales The break-even formula may also be expressed in sales dollars. Fixed costs Break-even point in dollars = Contribution margin ratio Unit sales price Unit variable cost ABC Co. sells product XYZ 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, units c. 200,000 units d. 66,667 units Computing Break-Even Sales ABC Co. sells product XYZ 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, units Unit contribution = $ $3.00 = $2.00 c. 200,000 units d. 66,667 units Fixed costs Unit contribution = $200,000 $2.00 per unit = 100,000 units Computing Break-Even Sales Use the contribution ti margin ratio formula to determine the amount of sales revenue ABC must have to break even. All information remains unchanged: fixed costs are $200,000; unit sales price is $5.00; and unit variable cost is $3.00. a. $200, b. $300,000 c. $400,000 d. $500,

8 Computing Break-Even Sales Use the contribution ti margin ratio formula to determine the amount of sales revenue ABC must have to break even. All information remains unchanged: fixed costs are $200,000; unit sales price is $5.00; and unit variable cost is $3.00. Unit contribution = $ $3.00 = $2.00 a. $200, Contribution margin ratio = $2.00 $5.00 =.40 b. $300,000 Break-even even revenue = $200, =$500 $500, c. $400,000 d. $500, Determine the sales volume required to earn a desired level of operating income. LO5 Computing Sales Needed to Achieve Target Operating Income Computing Sales Needed to Achieve Target Operating Income Break-even formulas may be adjusted to show the sales volume needed to earn any amount of operating income. ABC Co. sells product XYZ 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 operating income of $40,000? Unit sales = Dollar sales = Fixed costs + Target income Contribution margin per unit Fixed costs + Target income Contribution margin ratio a. 100, units b. 120,000 units c. 80,000 units d. 200,000 units

9 Computing Sales Needed to Achieve Target Operating Income What is our Margin of Safety? ABC Co. sells product XYZ 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 operating income of $40,000? Unit contribution = $ $3.00 = $2.00 a. 100, units Fixed costs + Target income b. 120,000 units Unit contribution c. 80,000 units $200,000 + $40,000 = 120,000 units d. 200,000 units $2.00 per unit Margin of safety is the amount by which sales may decline before reaching break-even sales: Margin of safety = Actual sales - Break-even sales Margin of safety provides a quick means of estimating operating income at any level of sales: Operating Margin Contribution Income = of safety margin ratio What is our Margin of Safety? ADM contribution margin ratio is 40 percent. If sales are $100,000 and break-even sales are $80,000, what is operating income? Operating Margin Contribution Income = of safety margin ratio To use the contribution margin to estimate the change in operating income caused by a change in sales volume. Operating Income = $20, = $8,000 LO6

10 What Change in Operating Income Do We Anticipate? Once break-even is reached, every additional dollar of contribution margin becomes operating income: Change in Change in Contribution operating income = sales volume margin ratio ADM expects sales to increase by $15,000 and has a contribution margin ratio of 40%. How much will operating income increase? To use CVP relationships to evaluate a new marketing strategy. Change in operating income = $15, = $6,000 LO Business Applications of CVP Consider the following information developed by the accountant at Speedo, a bicycle retailer: Business Applications of CVP Should Speedo spend $12,000 on advertising to increase sales by 10 percent? Total Per Unit Percent Sales (500 bikes) $ 250,000 $ % Less: variable expenses 150, % Contribution margin $ 100,000 $ % Less: fixed expenses 80,000 Operating income $ 20,000 Total Per Unit Percent Sales (500 bikes) $ 250,000 $ % Less: variable expenses 150, % Contribution margin $ 100,000 $ % Less: fixed expenses 80,000 Operating income $ 20,000

11 Business Applications of CVP Should Speedo spend $12,000 on advertising to increase sales by 10 percent? $500 Bikes Bikes Sales $ 250,000 $ 275,000 Less: variable expenses 150, $ ,000 Contribution margin $ 100,000 $ 110,000 Less: fixed expenses 80,000 92,000 Operating income $ 20,000 $80K + $12K $ 18,000 Business Applications of CVP Now, in combination with the advertising, Speedo is considering a 10 percent price reduction that will increase sales by 25 percent. What is the income effect? 500 Bikes Sales $ 250,000 Less: variable expenses 150,000 Contribution margin $ 100,000 Less: fixed expenses 80,000 Operating income $ 20,000 No, income is decreased Business Applications of CVP Now, in combination with the advertising, Speedo is considering a 10 percent price reduction that will increase sales by 25 percent. What is the income effect? Bikes Bikes Sales $ 250, $450 $ 281,250 Less: variable expenses 150, ,500 Contribution margin $ 100, $300 $ 93,750 Less: fixed expenses 80,000 92,000 Operating income $ 20,000 $80K + $12K $ 1,750 Business Applications of CVP Now, in combination with advertising and a price cut, Speedo will replace $50, in sales salaries with a $25 per bike commission, increasing sales by 50 percent above the original 500 bikes. What is the effect on income? 500 Bikes Sales $ 250,000 Less: variable expenses 150,000 Contribution margin $ 100,000 Less: fixed expenses 80,000 Operating income $ 20,000 Income is decreased even more.

12 Business Applications of CVP Now, in combination with advertising and a price cut, Speedo will replace $50, in sales salaries with a $25 per bike commission, increasing sales by 50 percent above the original 500 bikes. What is the effect on income? Bikes Bikes Sales $ 250, $450 $ 337,500 Less: variable expenses 150, ,750 Contribution margin $ 100, $325 $ 93,750 Less: fixed expenses 80,000 42,000 Operating income $ 20,000 $92K - $50K $ 51,750 The combination of advertising, a price cut, and change in compensation increases income. Additional Considerations in CVP Different products with different contribution margins. Determining semivariable cost elements. Complying with the assumptions of CVP analysis CVP Analysis When a Company Sells Many Products To use CVP when a company sells multiple products. Sales mix is the relative combination in which a company s different products are sold. Different products have different selling prices, costs, and contribution margins. If Speedo sells bikes and carts, how will we deal with break-even even analysis? LO8

13 CVP Analysis When a Company Sells Many Products CVP Analysis When a Company Sells Many Products Speedo provides us with the following information: Bikes Carts Total Sales $ 250, % $ 300, % $ 550, % Var. exp. 150, % 135,000 45% 285,000 52% Contrib. margin $ 100,000 40% $ 165,000 55% $ 265,000 48% Fixed exp. 170,000 Net income $ 95,000 The overall contribution margin ratio is: Bikes Carts Total Sales $ 250, % $ 300, % $ 550, % Var. exp. 150, % 135,000 45% 285,000 52% Contrib. margin $ 100,000 40% $ 165,000 55% $ 265,000 48% Fixed exp. 170,000 Net income $ 95,000 $265,000 = 48% (rounded) $550,000 CVP Analysis When a Company Sells Many Products Break-even in sales dollars is: Bikes Carts Total Sales $ 250, % $ 300, % $ 550, % Var. exp. 150, % 135,000 45% 285,000 52% Contrib. margin $ 100,000 40% $ 165,000 55% $ 265,000 48% Fixed exp. 170,000 Operating income $ 95,000 To determine semivariable cost elements. $170, = $354,167 (rounded).48 LO9

14 The High-Low Method Matrix, Inc. recorded the following production activity and maintenance costs for two months: Units Cost High activity level 9,000 $ 9,700 Low activity level 5,000 6,100 Change 4,000 $ 3,600 The High-Low Method Units Cost High activity level 9,000 $ 9,700 Low activity level 5,000 6,100 Change 4,000 $ 3,600 in cost $3,600 Unit variable cost = = = $0.90 per unit in units 4,000 Using these two levels of activity, compute: the variable cost per unit. the total fixed cost. total cost formula. The High-Low Method The High-Low Method Units Cost High activity level 9,000 $ 9,700 Low activity level 5,000 6,100 Change 4,000 $ 3,600 in cost $3,600 Unit variable cost = = = $0.90 per unit in units 4,000 Fixed cost = Total cost Total variable cost Units Cost High activity level 9,000 $ 9,700 Low activity level 5,000 6,100 Change 4,000 $ 3,600 in cost $3,600 Unit variable cost = = = $0.90 per unit in units 4,000 Fixed cost = Total cost Total variable cost Fixed cost = $9,700 ($0.90 per unit 9,000 units) Fixed cost = $9,700 $8,100 = $1,600

15 The High-Low Method The High-Low Method Units Cost High activity level 9,000 $ 9,700 Low activity level 5,000 6,100 Change 4,000 $ 3,600 in cost $3,600 Unit variable cost = = = $0.90 per unit in units 4,000 Fixed cost = Total cost Total variable cost Fixed cost = $9,700 ($0.90 per unit 9,000 units) Fixed cost = $9,700 $8,100 = $1,600 Total cost = $1,600 +$90 $.90 per unit If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the variable portion of sales commission per unit sold? a. $.08 per unit b. $.10 per unit c. $.12 per unit d. $.125 per unit The High-Low Method The High-Low Method If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the variable portion of sales commission per unit sold? a. $.08 per unit b. $.10 per unit c. $.12 per unit Units Cost High level l 120, $ 14,000 Low level 80,000 10,000 Change 40,000 $ 4,000 $4,000 40,000 units d. $.125 per unit = $.10 per unit If sales commissions are $10,000 when 80, units are sold and $14,000 when 120,000 units are sold, what is the fixed portion of the sales commission? a. $ 2,000 b. $ 4,000 c. $10,000 d. $12,000

16 The High-Low Method Assumptions Underlying CVP Analysis If sales commissions are $10,000 when 80, units are sold and $14,000 when 120,000 units are sold, what is the fixed portion of the sales commission? Total cost = Total fixed cost + Total variable cost a. $ 2,000 $14,000 = Total fixed cost + b. $ 4,000 Total fixed cost = $14,000 - $12,000 c. $10,000 Total fixed cost = $2,000 d. $12,000 ($ ,000 units) 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. Sales mix remains constant. Production = sales (no inventory changes). Ethics, Fraud, and Corporate Governance End of Chapter Some industries, such as the airline industry are characterized by high fixed costs, namely investments in equipment. The Sarbanes-Oxley Act requires public companies to disclose material changes in these fixed costs within four business days after they occur.