C H A P T E R 2 Analyzing Cost-Volume- Profit Relationships Analyzing Cost-Volume- Profit Relationships

Learning Objective 1 Understand the key factors involved in cost-volume- profit (C-V-P) analysis and why it is such an important tool in management decision making.

CVP - What Questions Does It Answer?

CVP Key Variables äRevenues–Price x Quantity äFixed costs– Independent of volume äVariable costs– Dependent upon volume äVolume– Level of activity äProduct mix– Different products äEfficiency & quality of production äCombinations of above

Learning Objective 2 Explain and analyze the basic cost behavior patterns—variable, fixed, mixed, and stepped.

What are Variable Costs? Units Produced Total Cost

Define Relevant Range and Curvilinear Costs Relevant range: Curvilinear costs:

Define Fixed Costs Total Cost Units Produced

Fixed Costs are Used to Calculate Break-Even What does break-even mean? What is the formula for break-even?

Define Stepped Costs

Define Mixed Costs Production Volume Cost Variable Fixed

Learning Objective 3 Analyze mixed costs using the scattergraph and high-low methods.

What is the Scattergraph (Visual- Fit) Method? Cost Volume of Activity Regression Line

Variable costs per unit are equal to the slope of the regression line. Variable Costs Scattergraph (Visual-Fit) Cost Volume of Activity Fixed costs are represented by the intersection of the regression line and the vertical axis. Fixed Costs

Define the High-Low Method

Cost Volume of Activity Step 1: High-Low Method

Cost Volume of Activity High-Low Method Step 2:

Step 3: High-Low Method Cost Volume of Activity Rise Run Variable Cost per Unit =

High-Low Method Step 4:

Learning Objective 4 Perform C-V-P analyses, and describe the effects potential changes in C-V-P variables have on company profitability.

Sales revenue –Variable costs =Contribution margin –Fixed costs =Profit Contribution Margin Approach Contribution margin is the portion of sales revenue available to cover fixed costs and provide a profit.

Contribution Margin Approach If a computer sells for $2,000 with variable costs of $800 per computer and fixed costs of $350,000 per year: What is the total contribution margin on 500 computers?

Contribution Margin Approach If a computer sells for $2,000 with variable costs of $800 per computer and fixed costs of $350,000 per year: What is the total contribution margin on 500 computers? What is the contribution margin per unit?

Contribution Margin Approach If a computer sells for $2,000 with variable costs of $800 per computer and fixed costs of $350,000 per year: What is the total contribution margin on 500 computers? What is the contribution margin per unit? What is the contribution margin ratio?

Contribution Margin Approach If a computer sells for $2,000 with $800 variable costs per computer and $350,000 fixed costs per year: What is the total contribution margin on 500 computers? What is the contribution margin per unit? What is the contribution margin ratio? What is the total dollar profit after one year?

The Break-Even Point Example: How many computers will the store have to sell in order to break even if one computer sells for $2,000, costs $800 to make (variable cost), and fixed costs are $350,000? Sales price x units Variable cost x units Independent of units Target Income

Sales price x units Variable cost x units Costs independent of units Zero for break-even OR OR etc. Multiple Variable Changes

Assume prior year profits of $250,000 for The Store. This year the price of our $2,000 computers is reduced by 15 percent due to a decrease in variable costs from $800 to $700 per computer and a decrease in fixed costs from $350,000 to $325,000. What would be the effect on target income (or profit) assuming the production of 500 computers?

Learning Objective 5 Visualize C-V-P relationships using graphs.

The Graphic Approach Identify the Break-Even Point, Revenue Line, Total Cost Line, and Fixed Costs Revenue & Cost Number of Computers Sold

Learning Objective 6 Identify the limiting assumptions of C-V-P analysis, and explain the issues of quality and time relative to C-V-P analysis decisions.

What are the Limiting Assumptions of C-V-P Analysis?

How Do Quality & Time Affect C-V-P Decisions?

Expanded Material Learning Objective 7 Analyze mixed costs using the least squares method.

Identify the Parts of the Least Squares Method Equation

Least Squares Method For Example: Month Computers Produced Total Cost Jan.500 $ 750,000 Feb ,000 Mar ,000 April 1,000 1,100,000 May450420,000 Using least squares regression output: a = Y-intercept= total fixed costs= $49, b = slope= variable cost rate= $ 1, Using least squares regression output: a = Y-intercept= total fixed costs= $49, b = slope= variable cost rate= $ 1,036.45

Expanded Material Learning Objective 8 Explain the effects of sales mix on profitability.

Sales Mix Sales revenue $5,000100%$25,000100% $30,000100% Less variable costs 3,000 60% 20,000 80% 23,000 77% Contribution margin $2,00040%$ 5,00020% $ 7,00023% Sales mix 17% 83% 100% Can Openers Microwaves Total Amount % Amount % Amount % Product Revenue Total Revenue = 5,000 30,000 = 17%

Sales Mix To maximize profit in a company with multiple products, management should emphasize products with the highest contribution margin ratio. Which product should they choose? Can Openers Microwaves Total Amount % Amount % Amount % Sales revenue $5,000100%$25,000100%$30,000100% Less variable costs 3,000 60% 20,000 80% 23,000 77% Contribution margin $2,00040%$ 5,00020%$ 7,00023% Sales mix 17% 83% 100%

Expanded Material Learning Objective 9 Describe how fixed and variable costs differ in manufacturing, service, merchandising, and e- commerce organizations, and illustrate these differences with the operating leverage concept.

Define Operating Leverage

Now what happens to net income if sales are increased by 20 percent? Net income increases Operating Leverage For example: Assume the following data. Total Per UnitRatio Sales revenue$1,000,000$2,000100% Less variable costs 400, % Contribution margin$ 600,000$1,20060% Less fixed costs 450,000 Net income$ 150,000 What happens to net income if sales are increased by 20 percent? Decrease fixed costs to $300,000. What is the operating leverage (no sales increase)? Operating leverage = Net income increases What is the operating leverage? Operating leverage =

Chapter 2 of Managerial Accounting is Completed