17-1 HANSEN & MOWEN Cost Management ACCOUNTING AND CONTROL

17-2 Cost-Volume-Profit Analysis 17

17-3 Sales (72,500 $40)$2,900,000 Less: Variable expenses 1,740,000 Contribution margin$1,160,000 Less: Fixed expenses 800,000 Operating income$ 360,000 The Break-Even Point in Units 1

= ($40 x Units) – ($24 x Units) – $800,000 Operating Income Approach 0 = ($16 x Units) – $800,000 ($16 x Units) = $800,000 Units = 50,000 $1,740,000 ÷ 72,500 The Break-Even Point in Units 1 Proof Sales (50,000 $40)$2,000,000 Less: Variable expenses 1,200,000 Contribution margin$ 800,000 Less: Fixed expenses 800,000 Operating income$ 0 Proof Sales (50,000 $40)$2,000,000 Less: Variable expenses 1,200,000 Contribution margin$ 800,000 Less: Fixed expenses 800,000 Operating income$ 0

17-5 Number of units Contribution Margin Approach = $800,000 / $16 per unit = 50,000 units The Break-Even Point in Units 1 = $800,000 / ($40 - $24)

17-6 $424,000 $1,224,000 Units The Break-Even Point in Units 1 Target Income as a Dollar Amount = ($40 x Units) – ($24 x Units) – $800,000 = $16 x Units = 76,500 Proof Sales (76,500 $40)$3,060,000 Less: Variable expenses 1,836,000 Contribution margin$1,224,000 Less: Fixed expenses 800,000 Operating income$ 424,000 Proof Sales (76,500 $40)$3,060,000 Less: Variable expenses 1,836,000 Contribution margin$1,224,000 Less: Fixed expenses 800,000 Operating income$ 424,000

($40)(Units)= ($40 x Units) – ($24 x Units) – $800,000 $6 x Units= ($40 x Units) – ($24 x Units) – $800,000 $6 x Units= ($16 x Units) – $800,000 $10 x Units= $800,000 Units= 80,000 More-Power Company wants to know the number of sanders that must be sold in order to earn a profit equal to 15 percent of sales revenue. The Break-Even Point in Units 1 Target Income as a Percentage of Sales Revenue

17-8 Net income = Operating income – (Tax rate x Operating income) = Operating income (1 – Tax rate) Or Operating income = Net income (1 – Tax rate) After-Tax Profit Targets The Break-Even Point in Units 1 = Operating income – Income taxes

17-9 $487,500 = Operating income – 0.35(Operating income) $487,500 = 0.65(Operating income) $750,000 = Operating income More-Power Company wants to achieve net income of $487,500 and its income tax rate is 35 percent. Units = ($800,000 + $750,000)/$16 Units = $1,550,000/$16 Units = 96,875 After-Tax Profit Targets The Break-Even Point in Units 1

17-10 Break-Even Point in Sales Dollars 2 Revenue Equal to Variable Cost Plus Contribution Margin

17-11 Sales$2,900,000 Less: Variable expenses 1,740,000 Contribution margin$1,160,000 Less: Fixed expenses 800,000 Operating income$ 360,000 Sales$2,900,000 Less: Variable expenses 1,740,000 Contribution margin$1,160,000 Less: Fixed expenses 800,000 Operating income$ 360,000 The following More-Power Company contribution margin income statement is shown for sales of 72,500 sanders. Sales$2,900,000100% Less: Variable expenses 1,740,000 60% Contribution margin$1,160,00040% Less: Fixed expenses 800,000 Operating income$ 360,000 Sales$2,900,000100% Less: Variable expenses 1,740,000 60% Contribution margin$1,160,00040% Less: Fixed expenses 800,000 Operating income$ 360,000 To determine the break-even in sales dollars, the contribution margin ratio must be determined ($1,160,000 ÷ $2,900,000). Break-Even Point in Sales Dollars 2

17-12 Operating income = Sales – Variable costs – Fixed Costs 0 =Sales – (Variable cost ratio x Sales) – Fixed costs 0 =Sales (1 – Variable cost ratio) – Fixed costs 0 =Sales (1 –.60) – $800,000 Sales(0.40) =$800,000 Sales =$2,000,000 Break-Even Point in Sales Dollars 2

17-13 Break-Even Point in Sales Dollars 2 Impact of Fixed Costs on Profit

17-14 Break-Even Point in Sales Dollars 2 Impact of Fixed Costs on Profit

17-15 Break-Even Point in Sales Dollars 2 Impact of Fixed Costs on Profit

17-16 How much sales revenue must More-Power generate to earn a before-tax profit of $424,000? Sales = ($800,000) + $424,000/0.40 = $1,224,000/0.40 = $3,060,000 Break-Even Point in Sales Dollars 2 Profit Targets

17-17 Regular Mini- Sander Sander Total Sales$3,000,000$1,800,000$4,800,000 Less: Variable expenses 1,800, ,000 2,700,000 Contribution margin$1,200,000$ 900,000$2,100,000 Less: Direct fixed expenses 250, , ,000 Product margin$ 950,000$ 450,000$1,400,000 Less: Common fixed exp. 600,000 Operating income$ 800,000 Multiple-Product Analysis 3

17-18 Regular sander break-even units = Fixed costs/(Price – Unit variable cost) = $250,000/$16 = 15,625 units Mini-sander break-even units = Fixed costs/(Price – Unit variable cost) = $450,000/$30 = 15,000 units Multiple-Product Analysis 3

17-19 Income Statement: Break-Even Solution Multiple-Product Analysis 3

17-20 Profit or Loss Loss (40, $100) I = $5X - $100 Break-Even Point (20, $0) $100— 80— 60— 40— 20— 0— - 20— - 40— -60— -80— -100— | | | | | | | | | | Units Sold (0, -$100) 4 Graphical Representation of CVP Relationships Profit- Volume Graph

17-21 Revenue Units Sold $ | | | | | | | | | | | | Total Revenue Total Cost 100) Profit ($100) Loss Break-Even Point (20, $200) Fixed Expenses ($100) Variable Expenses ($200, or $5 per unit) 4 Graphical Representation of CVP Relationships Cost-Volume-Profit Graph Profit Region

17-22 Assumptions of C-V-P Analysis 1.The analysis assumes a linear revenue function and a linear cost function. 2.The analysis assumes that price, total fixed costs, and unit variable costs can be accurately identified and remain constant over the relevant range. 3.The analysis assumes that what is produced is sold. 4.For multiple-product analysis, the sales mix is assumed to be known. 5.The selling price and costs are assumed to be known with certainty. 4 Graphical Representation of CVP Relationships

17-23 $ Units Total Cost Total Revenue Relevant Range 4 Graphical Representation of CVP Relationships Cost and Revenue Relationships

Changes in the CVP Variables Alternative 1: If advertising expenditures increase by $48,000, sales will increase from 72,500 units to 75,000 units. Summary of the Effects of the First Alternative

17-25 Alternative 2: A price decrease from $40 per sander to $38 would increase sales from 72,500 units to 80,000 units. Summary of the Effects of the Second Alternative 5 Changes in the CVP Variables

17-26 Alternative 3: Decreasing price to $38 and increasing advertising expenditures by $48,000 will increase sales from 72,500 units to 90,000 units. Summary of the Effects of the Third Alternative 5 Changes in the CVP Variables

17-27 Margin of Safety Assume that a company has a break-even volume of 200 units and the company is currently selling 500 units. Current sales500 Break-even volume200 Margin of safety (in units)300 Break-even point in dollars: Current revenue$350,000 Break-even volume 200,000 Margin of safety (in dollars)$150,000 5 Changes in the CVP Variables

17-28 Operating Leverage AutomatedManualSystem Sales (10,000 units)$1,000,000$1,000,000 Less: Variable expenses 500, ,000 Contribution margin$ 500,000$ 200,000 Less: Fixed expenses 375, ,000 Operating income$ 125,000$ 100,000 Unit selling price$100$100 Unit variable cost5080 Unit contribution margin5020 $500,000 ÷ $125,000 = DOL of 4 $200,000 ÷ $200,000 = DOL of 2 5 Changes in the CVP Variables

17-29 What happens to profit in each system if sales increase by 40 percent? 5 Changes in the CVP Variables

17-30 AutomatedManualSystem Sales (14,000 units)$1,400,000$1,400,000 Less: Variable expenses 700,000 1,120,000 Contribution margin$ 700,000$ 280,000 Less: Fixed expenses 375, ,000 Operating income$ 325,000$ 180,000 Automated system—40% x 4 = 160% $125,000 x 160% = $200,000 increase $125,000 + $200,000 = $325,000 Manual system—40% x 2 = 80% $100,000 x 80% = $80,000 $100,000 + $80,000 = $180,000 5 Changes in the CVP Variables

17-31 Total cost = Fixed costs + (Unit variable cost x Number of units) + (Setup cost x Number of setups) + (Engineering cost x Number of engineering hours) The ABC Cost Equation Operating income = Total revenue – [Fixed costs + (Unit variable cost x Number of units) + (Setup cost x Number of setups) + (Engineering cost x Number of engineering hours)] Operating Income 6 CVP Analysis and Activity-Based Costing

17-32 Break-even units = [Fixed costs + (Setup cost x Number of setups) + (Engineering cost x Number of engineering hours)]/(Price – Unit variable cost) Break-Even in Units Differences Between ABC Break-Even and Convention Break-Even The fixed costs differ The numerator of the ABC break-even equation has two nonunit-variable cost terms 6 CVP Analysis and Activity-Based Costing

17-33 Data about Variables Cost Driver Unit Variable Cost Level of Cost Driver Units sold$ 10-- Setups1,00020 Engineering hours301,000 Other data: Total fixed costs (conventional) $100,000 Total fixed costs (ABC)50,000 Unit selling price20 6 CVP Analysis and Activity-Based Costing Example Comparing Convention and ABC Analysis

17-34 Units to be sold to earn a before-tax profit of $20,000: Units= (Targeted income + Fixed costs)/(Price – Unit variable cost) =($20,000 + $100,000)/($20 – $10) =$120,000/$10 =12,000 units 6 CVP Analysis and Activity-Based Costing Example Comparing Convention and ABC Analysis Same data using the ABC: Units= ($20,000 + $50,000 + $20,000 + $30,000/($20 – $10) =$120,000/$10 =12,000 units

17-35 Suppose that marketing indicates that only 10,000 units can be sold. A new design reduces direct labor by $2 (thus, the new variable cost is $8). The new break-even is calculated as follows: Units = Fixed costs/(Price – Unit variable cost) = $100,000/($20 – $8) = 8,333 units Example Comparing Convention and ABC Analysis 6 CVP Analysis and Activity-Based Costing

17-36 The projected income if 10,000 units are sold is computed as follows: Sales ($20 x 10,000)$200,000 Less: Variable expenses ($8 x 10,000) 80,000 Contribution margin$120,000 Less: Fixed expenses 100,000 Operating income$ 20,000 6 CVP Analysis and Activity-Based Costing Example Comparing Convention and ABC Analysis

17-37 Suppose that the new design requires a more complex setup, increasing the cost per setup from $1,000 to $1,600. Also, suppose that the new design requires a 40 percent increase in engineering support. The new cost equation is given below: Total cost = $50,000 + ($8 x Units) + ($1,600 x Setups) + ($30 x Engineering hours) 6 CVP Analysis and Activity-Based Costing Example Comparing Convention and ABC Analysis

17-38 The break-even point using the ABC equation is calculated as follows: Units =[$50,000 + ($1,600 x 20) + ($30 x 1,400)]/($20 – $8) = $124,000/$12 =10,333 This is more than the firm can sell! 6 CVP Analysis and Activity-Based Costing Example Comparing Convention and ABC Analysis

17-39 End of Chapter 17