Using CVP Analysis Example Suppose the management anticipates selling 3,200 pairs of pants. Management is considering an advertising campaign that would cost $10,000. It is anticipated that the advertising will increase sales to 4,000 units. Should the business advertise?

Using CVP Analysis Example 3,200 pairs of pants sold with no advertising: Contribution margin $89,600 Fixed costs 84,000 Operating income $ 5,600 4,000 pairs of pants sold with advertising: Contribution margin $112,000 Fixed costs 94,000 Operating income $ 18,000

Using CVP Analysis Example Instead of advertising, management is considering reducing the selling price to $61 per pair of pants. It is anticipated that this will increase sales to 4,500 units. Should management decrease the selling price per pair of pants to $61?

Using CVP Analysis Example 3,200 pairs of pants sold with no change in the selling price: Operating income = $5,600 4,500 pairs of pants sold at a reduced selling price: Contribution margin: (4,500 × $19) $85,500 Fixed costs 84,000 Operating income $ 1,500

Sensitivity Analysis and Uncertainty Example Assume that the Pants Shop can sell 4,000 pairs of pants. Fixed costs are $84,000. Contribution margin ratio is 40%. At the present time the business cannot handle more than 3,500 pairs of pants.

Sensitivity Analysis and Uncertainty Example To satisfy a demand for 4,000 pairs, management must acquire additional space for $6,000. Should the additional space be acquired? Revenues at breakeven with existing space are $84,000 ÷ .40 = $210,000. Revenues at breakeven with additional space are $90,000 ÷ .40 = $225,000

Sensitivity Analysis and Uncertainty Example Operating income at $245,000 revenues with existing space = ($245,000 × .40) – $84,000 = $14,000. (3,500 pairs of pants × $28) – $84,000 = $14,000

Sensitivity Analysis and Uncertainty Example Operating income at $280,000 revenues with additional space = ($280,000 × .40) – $90,000 = $22,000. (4,000 pairs of pants × $28 contribution margin) – $90,000 = $22,000

Apply CVP analysis to a company producing different products. Learning Objective 6 Apply CVP analysis to a company producing different products.

Effects of Sales Mix on Income Pants Shop Example Management expects to sell 2 shirts at $20 each for every pair of pants it sells. This will not require any additional fixed costs.

Effects of Sales Mix on Income Contribution margin per shirt: $20 – $9 = $11 What is the contribution margin of the mix? $28 + (2 × $11) = $28 + $22 = $50

Effects of Sales Mix on Income $84,000 fixed costs ÷ $50 = 1,680 packages 1,680 × 2 = 3,360 shirts 1,680 × 1 = 1,680 pairs of pants Total units = 5,040

Effects of Sales Mix on Income What is the breakeven in dollars? 3,360 shirts × $20 = $ 67,200 1,680 pairs of pants × $70 = 117,600 $184,800

Effects of Sales Mix on Income What is the weighted-average budgeted contribution margin? Pants: 1 × $28 + Shirts: 2 × $11 = $50 ÷ 3 = $16.667

Effects of Sales Mix on Income The breakeven point for the two products is: $84,000 ÷ $16.667 = 5,040 units 5,040 × 1/3 = 1,680 pairs of pants 5,040 × 2/3 = 3,360 shirts

Effects of Sales Mix on Income Sales mix can be stated in sales dollars: Pants Shirts Sales price $70 $40 Variable costs 42 18 Contribution margin $28 $22 Contribution margin ratio 40% 55%

Effects of Sales Mix on Income Assume the sales mix in dollars is 63.6% pants and 36.4% shirts. Weighted contribution would be: 40% × 63.6% = 25.44% pants 55% × 36.4% = 20.02% shirts 45.46%

Effects of Sales Mix on Income Breakeven sales dollars is $84,000 ÷ 45.46% = $184,778 (rounding). $184,778 × 63.6% = $117,519 pants sales $184,778 × 36.4% = $ 67,259 shirt sales

Adapt CVP analysis to situations in which a product has more Learning Objective 7 Adapt CVP analysis to situations in which a product has more than one cost driver.

Multiple Cost Drivers Example Suppose that the business will incur an additional cost of $10 for preparing documents associated with the sale of pants to various customers. Assume that the business sells 3,500 pants to 100 different customers. What is the operating income from this sale?

Multiple Cost Drivers Example Revenues: 3,500 × $70 $245,000 Variable costs: Pants: 3,500 × $42 147,000 Documents: 100 × $10 1,000 Total 148,000 Contribution margin 97,000 Fixed costs 84,000 Operating income $ 13,000

Multiple Cost Drivers Would the operating income of the Pants Shop be lower or higher if the business sells pants to more customers? The cost structure depends on two cost drivers: 1. Number of units 2. Number of customers

Learning Objective 8 Distinguish between contribution margin and gross margin.

Contribution Margin versus Gross Margin Contribution income statement emphasizes contribution margin. Financial accounting income statement emphasizes gross margin.

End of Chapter 3