Cost-Volume-Profit Analysis Chapter 18 PowerPoint Editor: Beth Kane, MBA, CPA Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Wild, Shaw, and Chiappetta Financial & Managerial Accounting 6th Edition Wild, Shaw, and Chiappetta Financial & Managerial Accounting 6th Edition

18-C1: Fixed Costs 2

Identifying Cost Behavior Cost-volume-profit analysis is used to answer questions such as: – How much does income increase if we install a new machine to reduce labor costs? – What is the change in income if selling prices decline and sales volume increases? – How will income change if we change the sales mix of our products or services? – What sales volume is needed to earn a target income? C 1 3

Fixed Costs C 1 4

Variable Costs C 1 5

Mixed Costs C 1 6

Step-Wise Costs Total cost increases to a new higher cost for the next higher range of activity, but remains constant within a range of activity. C 1 7

Curvilinear Costs Costs that increase when activity increases, but in a nonlinear manner. C 1 8

NEED-TO-KNOW Determine whether each of the following is best described as a fixed, variable, mixed, step-wise, or curvilinear cost with respect to product units. Rubber used to manufacture tennis balls$0.50 per tennis ballVariable cost Depreciation (straight-line method) Electricity cost Supervisory salaries A salesperson’s commission is 7% for sales of up to $100,000, and 10% of sales for sales above $100,000 $0 $1,000 $2,000 $3,000 $4,000 $5,000 $6,000 02,0004,0006,0008,00010,000 Total Cost Units Produced $0.50 per tennis ball-Variable C 1 9

NEED-TO-KNOW Determine whether each of the following is best described as a fixed, variable, mixed, step-wise, or curvilinear cost with respect to product units. Rubber used to manufacture tennis balls$0.50 per ballVariable cost Depreciation (straight-line method)$2,000 per monthFixed cost Electricity cost Supervisory salaries A salesperson’s commission is 7% for sales of up to $100,000, and 10% of sales for sales above $100,000 $0 $500 $1,000 $1,500 $2,000 $2,500 02,0004,0006,0008,00010,000 Total Cost Units Produced $2,000 per month-Fixed C 1 10

NEED-TO-KNOW Determine whether each of the following is best described as a fixed, variable, mixed, step-wise, or curvilinear cost with respect to product units. Rubber used to manufacture tennis balls$0.50 per ballVariable cost Depreciation (straight-line method)$2,000 per monthFixed cost Electricity cost$500 + $0.10 per ballMixed cost Supervisory salaries A salesperson’s commission is 7% for sales of up to $100,000, and 10% of sales for sales above $100,000 $0 $200 $400 $600 $800 $1,000 $1,200 $1,400 $1,600 02,0004,0006,0008,00010,000 Total Cost Units Produced $500 + $0.10 per unit-Mixed C 1 11

NEED-TO-KNOW Determine whether each of the following is best described as a fixed, variable, mixed, step-wise, or curvilinear cost with respect to product units. Rubber used to manufacture tennis balls$0.50 per ballVariable cost Depreciation (straight-line method)$2,000 per monthFixed cost Electricity cost$500 + $0.10 per ballMixed cost Supervisory salaries 4,000 units per shift$5,000 per mo. per supervisorStep-wise cost A salesperson’s commission is 7% for sales of up to $100,000, and 10% of sales for sales above $100,000 $0 $2,000 $4,000 $6,000 $8,000 $10,000 $12,000 $14,000 $16,000 02,0004,0006,0008,00010,000 Units Produced $5,000 per supervisor per month-Step-wise Total Cost C 1 12

NEED-TO-KNOW Determine whether each of the following is best described as a fixed, variable, mixed, step-wise, or curvilinear cost with respect to product units. Rubber used to manufacture tennis balls$0.50 per ballVariable cost Depreciation (straight-line method)$2,000 per monthFixed cost Electricity cost$500 + $0.10 per ballMixed cost Supervisory salaries 4,000 units per shift$5,000 per mo. per supervisorStep-wise cost Curvilinear costA salesperson’s commission is 7% for sales of up to $100,000, and 10% of sales for sales above $100,000 $0 $5,000 $10,000 $15,000 $20,000 $25,000 $30,000 $0$50,000$100,000$150,000$200,000$250,000$300,000 Sales $ Sales Commissions-Curvilinear Total Cost C 1 13

18-P1: Measuring Cost Behavior 14

Measuring Cost Behavior The objective is to classify all costs as either fixed or variable. We will look at three methods: 1.Scatter diagrams. 2.The high-low method. 3.Least–squares regression. A scatter diagram is a plot of cost data points on a graph. It is almost always helpful to plot cost data to be able to observe a visual picture of the relationship between cost and activity. P 1 15

Scatter Diagrams P 1 16

The High-Low Method The following relationships between units produced and total cost are observed: Using these two levels of activity, compute:  the variable cost per unit.  the total fixed cost. P 1 17

The High-Low Method Total cost = $17,525 + $0.17 per unit produced P 1 18

The objective of the cost analysis remains the same: determination of total fixed cost and the variable unit cost. Least-Squares Regression Least-squares regression is usually covered in advanced cost accounting courses. It is commonly used with spreadsheet programs or calculators. P 1 19

Comparison of Cost Estimation Methods P 1 20

NEED-TO-KNOW Using the information below, use the high-low method to determine the cost equation (total fixed costs plus variable costs per unit). Activity Level Units Produced Total Cost Lowest1,600$9,800 Highest4,00017,000 Variable Cost =$7,200 2,400 $3per unit produced Fixed Costs (at high point)Total cost = Fixed costs + $3 per unit $17,000 = Fixed costs + ($3 x 4,000) $5,000 = Fixed costs Fixed Costs (at low point)Total cost = Fixed costs + $3 per unit $9,800 = Fixed costs + ($3 x 1,600) $5,000 = Fixed costs Cost at high point - Cost at low point Units at high point - Units at low point ($17,000 - $9,800) (4, ,600) Total costs = $5,000 + $3 per unit P 1 21

NEED-TO-KNOW $0 $2,000 $4,000 $6,000 $8,000 $10,000 $12,000 $14,000 $16,000 $18, ,0001,5002,0002,5003,0003,5004,0004,500 Total Cost Units Produced Total Cost Slope = Variable Cost $3 per unit y-intercept = Fixed Costs $5,000 (1,600 units, $9,800) (4,000 units, $17,000) (0 units, $5,000) = $5,000 + $3 per unit P 1 22

18-A1: Contribution Margin and Its Measures 23

Contribution Margin and Its Measures A 1 24

18-P2: Computing the Break- Even Point 25

Using Break-Even Analysis The break-even point (expressed in units of product or dollars of sales) is the unique sales level at which a company earns neither a profit nor incurs a loss. P 2 26

Computing the Break-Even Point P 2 27

P 2 Computing the Margin of Safety 28

NEED-TO-KNOW A manufacturer predicts fixed costs of $400,000 for the next year. Its one product sells for $170 per unit, and it incurs variable costs of $150 per unit. The company predicts total sales of 25,000 units for the next year. 1. Compute the contribution margin per unit. 2. Compute the break-even point (in units). 3. Compute the margin of safety (in dollars). Contribution margin per unit, or unit contribution margin, is the amount by which a product’s unit selling price exceeds its total variable cost per unit. Sales $170 per unit Variable costs 150 per unit Contribution margin $ 20 per unit $20 per unit P 2 29

NEED-TO-KNOW A manufacturer predicts fixed costs of $400,000 for the next year. Its one product sells for $170 per unit, and it incurs variable costs of $150 per unit. The company predicts total sales of 25,000 units for the next year. 1. Compute the contribution margin per unit. 2. Compute the break-even point (in units). 3. Compute the margin of safety (in dollars). Break-even point in units = Fixed costs Contribution margin per unit $400,000 $20 per unit 20,000 units to break-even Unitsper unitTotal Sales20,000$170$3,400,000 Variable costs20,000$1503,000,000 Contribution margin$20400,000 Fixed costs400,000 Net income$0 $20 per unit 20,000 units P 2 30

NEED-TO-KNOW A manufacturer predicts fixed costs of $400,000 for the next year. Its one product sells for $170 per unit, and it incurs variable costs of $150 per unit. The company predicts total sales of 25,000 units for the next year. 1. Compute the contribution margin per unit. 2. Compute the break-even point (in units). 3. Compute the margin of safety (in dollars). The excess of expected sales over the break-even sales level is called a company’s margin of safety $20 per unit 20,000 units Unitsper unitTotal Expected sales25,000$170$4,250,000 Break-even sales20,000$1703,400,000 Margin of safety$850,000 P 2 31

18-P3: Preparing a Cost-Volume- Profit Chart 32

Preparing a CVP Chart P 3 33

Working with Changes in Estimates P 3 34

18-C2: Applying Cost-Volume- Profit Analysis 35

Computing Income from Sales and Costs C 2 36

Computing Sales for a Target Income C 2 37

Computing Sales for a Target Income C 2 38

Computing Sales for a Target Income C 2 39

NEED-TO-KNOW A manufacturer predicts fixed costs of $502,000 for the next year. Its one product sells for $180 per unit, and it incurs variable costs of $126 per unit. Its target income (pretax) is $200, Compute the contribution margin ratio. 2. Compute the dollar sales needed to yield the target income. 3. Compute the unit sales needed to yield the target income. The contribution margin ratio is the percent of a unit’s selling price that exceeds total unit variable cost. Contribution margin ratio = Contribution margin per unit Selling price per unit $180 - $126 $54 $180 $180 30% per unitRatio Sales$180100% Variable costs 12670% Contribution margin$5430% C 2 40

NEED-TO-KNOW Dollar sales to achieve target income = Fixed costs + Pretax Income Contribution margin ratio $502,000 + $200, $2,340,000 A manufacturer predicts fixed costs of $502,000 for the next year. Its one product sells for $180 per unit, and it incurs variable costs of $126 per unit. Its target income (pretax) is $200, Compute the contribution margin ratio. 2. Compute the dollar sales needed to yield the target income. 3. Compute the unit sales needed to yield the target income. 30% per unitRatioTotal Sales$180100%$2,340,000 Variable costs$12670%1,638,000 Contribution margin$5430%702,000 Fixed costs502,000 Net income$200,000 $2,340,000 C 2 41

NEED-TO-KNOW Break-even point in units = Fixed costs Contribution margin per unit A manufacturer predicts fixed costs of $502,000 for the next year. Its one product sells for $180 per unit, and it incurs variable costs of $126 per unit. Its target income (pretax) is $200, Compute the contribution margin ratio. 2. Compute the dollar sales needed to yield the target income. 3. Compute the unit sales needed to yield the target income. 30% $2,340,000 Units to yield target income = Fixed costs + target (pretax) income Contribution margin per unit $502,000 + $200,000 $702,000 $180 - $126 $54 13,000 units Unitsper unitTotal Sales13,000$180$2,340,000 Variable costs13,000$1261,638,000 Contribution margin$54702,000 Fixed costs502,000 Net income$200,000 13,000 units (or $2,340,000 / $180) C 2 42

Using Sensitivity Analysis C 2 43

18-P4: Computing a Multiproduct Break-Even Point 44

Computing a Multiproduct Break-Even Point The CVP formulas can be modified for use when a company sells more than one product.  The unit contribution margin is replaced with the 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. P 4 45

Computing a 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 = Continue P 4 46

Hair-Today offers three cuts as shown below. Annual fixed costs are $192,000. Compute the break-even point in composite units and in number of units for each haircut at the given sales mix. Computing a Multiproduct Break-Even Point P 4 47

Computing a Multiproduct Break-Even Point P 4 48

Computing a Multiproduct Break-Even Point P 4 49

Break-even point in composite units Fixed costs Contribution margin per composite unit = Break-even point in composite units $192,000 $64.00 per composite unit = Break-even point in composite units = 3,000 composite units Computing a Multiproduct Break-Even Point P 4 50

Computing a Multiproduct Break-Even Point P 4 51

Multiproduct Break-Even Income Statement P 4 52

NEED-TO-KNOW The sales mix of a company’s two products, X and Y, is 2:1. Unit variable costs for both products are $2, and unit selling prices are $5 for X and $4 for Y. The company has $640,000 of fixed costs. 1. What is the contribution margin per composite unit? 2. What is the break-even point in composite units? 3. How many units of X and how many units of Y will be sold at the break-even point? Selling price per composite unitUnitsper unitTotal Product X2$5$10 Product Y1$44 Total3$14 Variable cost per composite unitUnitsper unitTotal Product X2$2$4 Product Y1$22 Total3$6 Contribution margin per composite unit ($14 - $6)$8 P 4 53

NEED-TO-KNOW The sales mix of a company’s two products, X and Y, is 2:1. Unit variable costs for both products are $2, and unit selling prices are $5 for X and $4 for Y. The company has $640,000 of fixed costs. 1. What is the contribution margin per composite unit? 2. What is the break-even point in composite units? 3. How many units of X and how many units of Y will be sold at the break-even point? $8 Break-even point in composite units = Fixed costs Contribution margin per composite unit $640,000 $8 per composite unit 80,000 composite units to break even 80,000 composite units P 4 54

NEED-TO-KNOW The sales mix of a company’s two products, X and Y, is 2:1. Unit variable costs for both products are $2, and unit selling prices are $5 for X and $4 for Y. The company has $640,000 of fixed costs. 1. What is the contribution margin per composite unit? 2. What is the break-even point in composite units? 3. How many units of X and how many units of Y will be sold at the break-even point? $8 80,000 composite units Units of each product at break-evenTotal Product X80,000 composite units x 2 units per composite unit160,000 Product Y80,000 composite units x 1 unit per composite unit80, ,000 Total SalesUnitsper unitTotal Product X160,000$5$800,000 Product Y80,000$4320,000 Total240,000$1,120,000 Total Variable CostsUnitsper unitTotal Product X160,000$2$320,000 Product Y80,000$2160,000 Total240,000$480,000 Composite unitsper unitTotal Sales$14$1,120,000 Variable costs$6480,000 Contribution margin$8640,000 Fixed costs640,000 Net income$0 80,000 P 4 55

Global View Over 90 percent of German companies surveyed report their cost accounting systems focus on contribution margin. This focus helps German companies like Volkswagen control costs and plan their production levels. 56

18-A2: Degree of Operating Leverage 57

Degree of Operating Leverage A measure of the extent to which fixed costs are being used in an organization. A measure of how a percentage change in sales will affect profits. A 2 58

If Rydell increases sales by 10 percent, what will the percentage increase in income be? Operating Leverage A 2 59

Appendix 18A: Using Excel to Estimate Least-Squares Regression 60

End of Chapter 18 61