Cost-Volume-Profit Analysis

Objective 1 Identify how changes in volume affect costs.

Variable Fixed Mixed Types of Costs

Minutes Talked Total Long Distance Telephone Bill Total variable costs change when activity changes. Your total long distance telephone bill is based on how many minutes you talk. Raw materials are the typical example of Variable Cost. Total Variable Cost

Minutes Talked Per Minute Telephone Charge Variable Cost Per Unit ( UVC) Variable costs per unit do not change as activity increases. The cost per long distance minute talked is constant. For example, 10 cents per minute.

Variable Costs Example $24 – $18 – $12 – $6 – – Volume (Thousands of passengers) Total Variable Costs (thousands)

Volume Total Fixed Cost Total fixed costs remain unchanged when activity changes. Insurance Premium for the Plant. Rent of the office Total Fixed Cost

Mixed Costs Contain fixed portion that is incurred even when facility is unused & variable portion that increases with usage. Example: monthly electric utility charge Fixed service fee Variable charge per kilowatt hour used

Total mixed cost Variable Utility Charge Activity (Kilowatt Hours) Total Utility Cost Fixed Monthly Utility Charge Mixed Costs

Objective 2 Use CVP analysis to compute breakeven point.

Assumptions of CVP Analysis Expenses can be classified as either variable or fixed. CVP relationships are linear over a wide range of production and sales. Sales prices, unit variable cost, and total fixed expenses will not vary within the relevant range.

Assumptions of CVP Analysis Volume is the only cost driver. The relevant range of volume is specified. Inventory levels will be unchanged. The sales mix remains unchanged during the period.

Computing Break-Even Point The unique sales level at which a company earns neither a profit nor incurs a loss. Sales – Variable Costs – Fixed Costs = 0

Breakeven Point Example Let’s look back at Luis and Tom’s manufacturing, assuming that the fixed cost are $90,000.

Objective 3 Use CVP analysis for profit planning and graph the cost-volume-profit relations

Volume in Units Costs and Revenue in Dollars Total fixed costs Ê Plot total fixed costs on the vertical axis. Preparing a CVP Chart Total costs Draw the total cost line with a slope equal to the unit variable cost.

Volume in Units Costs and Revenue in Dollars Total fixed costs Preparing a CVP Chart Total costs Sales Starting at the origin, draw the sales line with a slope equal to the unit sales price. Break- even Point

Various Sales Levels Example What operating income is expected when sales are _____ units?

Target Operating Income Example Suppose that our business would be content with operating income of _________________. How many units must be sold?

Objective 4 Use CVP method to perform sensitivity analysis.

Change in Sales Price Example Suppose that the sales price per device is _____ rather than ____ What is the revised breakeven sales in units?

Change in Variable Costs Example Suppose that variable expenses per device are ____ instead of ____ Other factors remain unchanged.

Change in Fixed Costs Example Suppose that fixed costs increased by $30,000. What are the new fixed costs? What is the new breakeven point?

Margin of Safety Example Excess of expected sales over breakeven sales.

E22-7 Fixed expense Break even point Profit Loss Break even in units = 1,200,000 Break even in $ = 1,200,000 x 24 = $28,800,000

Effect of sales mix on CVP analysis.

Computing Multiproduct Break-Even Point Unit contribution margin is replaced with contribution margin for a composite unit. A composite unit is composed of specific numbers of each product in proportion to the product sales mix. Sales mix is the ratio of the volumes of the various products.

Computing Multiproduct Break-Even Point The resulting break-even formula for composite unit sales is: Break-even point in composite units Fixed costs Contribution margin per composite unit =

Computing Multiproduct Break-Even Point A company sells windows and doors. They sell 4 windows for every door.

Step 1: Compute contribution margin per composite unit. Computing Multiproduct Break-Even Point

Break-even point in composite units Fixed costs Contribution margin per composite unit = Step 2: Compute break-even point in composite units. Computing Multiproduct Break-Even Point

Break-even point in composite units Fixed costs Contribution margin per composite unit = Break-even point in composite units 900, per composite unit = Step 2: Compute break-even point in composite units. Computing Multiproduct Break-Even Point Break-even point in composite units = 2,000 composite units

Step 3: Determine the number of windows and doors that must be sold to break even. Computing Multiproduct Break-Even Point

Step 4: Verify the results. Multiproduct Break-Even Income Statement

Contribution Margin & Gross Margin Manufacturing Sector Pages Contribution Margin Format Revenues1,000 Variable costs: Manufacturing250 Non-manufacturing Contribution margin480 Fixed costs: Manufacturing160 Non-manufacturing Operating income182 Gross Margin Format Revenues1,000 Cost of goods sold ( )410 Gross margin590 Non-manufacturing ( )408 Operating income182