Chapter 18

Identify how changes in volume affect costs

VariableFixed Mixed Copyright (c) 2009 Prentice Hall. All rights reserved3

 Total variable costs change in direct proportion to changes in the volume of activity ◦ If activity increases, so does the cost  Unit variable cost remains constant Copyright (c) 2009 Prentice Hall. All rights reserved4 Units produced Direct materials cost per unit Total direct materials cost 100$25$2, $255, $257, $2510, $2512,500

Copyright (c) 2009 Prentice Hall. All rights reserved5

 Do not change over wide ranges in volume  Examples: ◦ Straight-line depreciation ◦ Salaries  Fixed cost per unit is inversely proportional to activity ◦ The more activity, the less the fixed cost per unit Copyright (c) 2009 Prentice Hall. All rights reserved6

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 Have both a fixed and variable component  Example: ◦ Utilities that charge a set fee per month, plus a charge for usage Copyright (c) 2009 Prentice Hall. All rights reserved8

9 Variable Fixed

 Method to separate mixed costs into variable and fixed components  Select the highest level and the lowest level of activity over a period of time 10Copyright (c) 2009 Prentice Hall. All rights reserved

Calculate variable cost per unit Calculate total fixed costs Create equation to show cost behavior Copyright (c) 2009 Prentice Hall. All rights reserved11

Copyright (c) 2009 Prentice Hall. All rights reserved12 Change in total cost Change in activity Total mixed cost Total variable cost Variable cost per unit Total fixed costs minus #2 #1

Copyright (c) 2009 Prentice Hall. All rights reserved13 Number of units Variable cost per unit Total mixed cost Total fixed costs

Copyright (c) 2009 Prentice Hall. All rights reserved14 Variable cost per unit Change in total cost Change in activity $4,400 - $4, Variable cost per unit $0.80 per inspection

Copyright (c) 2009 Prentice Hall. All rights reserved15 Total fixed costs Total mixed cost minus Total variable cost $4,000 minus 900 inspections x $0.80 Total fixed costs $3,280 Total fixed costs

Copyright (c) 2009 Prentice Hall. All rights reserved16 Number of inspections $0.80 per inspection Total mixed cost $3,280 $0.80 per inspection 1,000 inspections $3,280 $4,080

 Band of volume: ◦ Where total fixed costs remain constant and variable cost per unit remains constant  Outside the relevant range, costs can differ 17Copyright (c) 2009 Prentice Hall. All rights reserved

Use CVP analysis to compute breakeven points

Costs can be classified as fixed or variable. Volume is only factor that affects costs. Fixed costs don’t change. 19Copyright (c) 2009 Prentice Hall. All rights reserved

 Sales level at which operating income is zero ◦ Sales above breakeven result in a profit ◦ Sales below breakeven result in a loss  Two methods: ◦ Income statement approach ◦ Contribution margin approach 20Copyright (c) 2009 Prentice Hall. All rights reserved

21 Sales – Variable costs – Fixed costs = Operating income Selling price per unit x units sold Variable cost per unit x units sold Fixed costs Operating income Set to zero Solve for units sold

Copyright (c) 2009 Prentice Hall. All rights reserved22 Sales revenue per unit Variable costs per unit Contribution margin per unit Fixed costs Contribution margin per unit Breakeven point in units

Copyright (c) 2009 Prentice Hall. All rights reserved23 Sales revenue Contribution margin ratio Contribution margin Fixed costs Contribution margin ratio Breakeven point in sales dollars

Use CVP analysis for profit planning, and graph the CVP relations

Copyright (c) 2009 Prentice Hall. All rights reserved25 Fixed costs + Desired operating income Contribution margin ratio Target sales in dollars

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29 Breakeven point Profit Loss

Use CVP methods to perform sensitivity analysis

 Management tool to predict how changes in sale prices, cost or volume affects profits  “What if?” analysis 31Copyright (c) 2009 Prentice Hall. All rights reserved

32 Change selling price Change in variable costs Change in fixed costs All would impact breakeven point

Copyright (c) 2009 Prentice Hall. All rights reserved33 CauseEffectResult ChangeContribution margin Breakeven point Selling price increasesIncreaseDecrease Selling price decreasesDecreaseIncrease Variable cost per unit increasesDecreaseIncrease Variable cost per unit decreasesIncreaseDecrease Fixed costs increaseNo effectIncrease Fixed costs decreaseNo effectDecrease

 Excess of expected sales over breakeven sales  Cushion company can absorb without incurring a loss Copyright (c) 2009 Prentice Hall. All rights reserved34 Expected sales in units Breakeven sales in units Margin of safety in units Expected sales in dollars Breakeven sales in dollars Margin of safety in dollars

Copyright (c) 2009 Prentice Hall. All rights reserved35 Sales price per unit Variable costs per unit Contribution margin per unit Fixed costs Contribution margin per unit Breakeven point in units $230$70$160 $112,000 $ students

Copyright (c) 2009 Prentice Hall. All rights reserved36 Decreased Sales price per unit Variable costs per unit Decreased Contribution margin per unit Fixed costs Contribution margin per unit New Breakeven point in units $200 $70 $130 $112,000 $ students

Copyright (c) 2009 Prentice Hall. All rights reserved37 Sales price per unit Decreased variable costs per unit Increased Contribution margin per unit Fixed costs Contribution margin per unit New Breakeven point in units $50 $180 $112,000 $ students $230

Copyright (c) 2009 Prentice Hall. All rights reserved38 Sales price per unit Variable costs per unit Contribution margin per unit Decreased fixed costs Contribution margin per unit Breakeven point in units $230$70$160 $102,000 $ students

Calculate the breakeven point for multiple product lines or services

 Selling prices and variable costs differ for each product ◦ Different contribution to profits  Weighted-average contribution margin computed  Sales mix provides weights ◦ Combination of products that make up total sales Copyright (c) 2009 Prentice Hall. All rights reserved40

 Calculate weighted average contribution margin per unit Copyright (c) 2009 Prentice Hall. All rights reserved41 Product AProduct BTotal Sales price per unit $100$150 Variable cost per unit Contribution margin per unit 4290 Sales mix per unit 538 Contribution margin Weighted average contribution margin$60 A company has two products with the sales prices and variable costs per unit indicated in the table The sales mix weight is multiplied by the product’s contribution margin Last year, the company sold 5,000 units of A and 3,000 units of B. This results in a sale mix of 5:3 The sales mix weights are added as well as the products’ contribution margins $480 divided by 8 results in a weighted average contribution margin of $60

 Calculate breakeven point for the package of products Copyright (c) 2009 Prentice Hall. All rights reserved42 Fixed costs Weighted average contribution margin per unit $600,000 $60 10,000 units assumed

 Calculate the breakeven point for each product line ◦ Multiply the package breakeven point by each product line’s proportion of the sales mix Copyright (c) 2009 Prentice Hall. All rights reserved43 Breakeven point Product A 10,000 x 5/86,250 units Breakeven point Product B 10,000 x 3/83,750 units