12-1 CHAPTER 12 Managerial Accounting and Cost — Volume — Profit Relationships McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

12-2 Decision Making Strategic, Operational, and Financial (Planning) Planning and Control Cycle Executing operational activities (Managing) Performance analysis: Plans vs. actual results (Controlling) L O 1 Implement Plans Revisit Plans Data collection and Performance Feedback

12-3 Managerial Accounting versus Financial Accounting Managerial accounting supports the internal planning (future-oriented) decisions made by management. Financial accounting has more of a scorekeeping, historical orientation that provides information to owners and others outside the organization. L O 2

12-4 Managerial Accounting versus Financial Accounting L O 2

12-5 How a cost will react to changes in the level of business activity. –Total variable costs change when activity changes. –Total fixed costs remain unchanged when activity changes. How a cost will react to changes in the level of business activity. –Total variable costs change when activity changes. –Total fixed costs remain unchanged when activity changes. Relationship of Total Cost to Volume of Activity L O 3

12-6 Total Fixed Cost Your monthly basic telephone bill probably does not change when you make more local calls. Number of Local Calls Monthly Basic Telephone Bill L O 4

12-7 Fixed Cost per Unit Number of Local Calls Monthly Basic Telephone Bill per Local Call The average cost per local call decreases as more local calls are made. L O 4

12-8 Total Variable Cost Your total long distance telephone bill is based on how many minutes you talk. Minutes Talked Total Long Distance Telephone Bill L O 5

12-9 Variable Cost Per Unit Minutes Talked Per Minute Telephone Charge The cost per long distance minute talked is constant. For example, 10 cents per minute. L O 5

12-10 Relationship of Total Cost to Volume of Activity L O 5

12-11 Relationship of Total Cost to Volume of Activity Fixed costs are usually characterized by: a.Unit costs that remain constant. b.Total costs that increase as activity decreases. c.Total costs that increase as activity increases. d.Total costs that remain constant. Fixed costs are usually characterized by: a.Unit costs that remain constant. b.Total costs that increase as activity decreases. c.Total costs that increase as activity increases. d.Total costs that remain constant. L O 5

12-12 Fixed costs are usually characterized by: a.Unit costs that remain constant. b.Total costs that increase as activity decreases. c.Total costs that increase as activity increases. d.Total costs that remain constant. Fixed costs are usually characterized by: a.Unit costs that remain constant. b.Total costs that increase as activity decreases. c.Total costs that increase as activity increases. d.Total costs that remain constant. Relationship of Total Cost to Volume of Activity L O 5

12-13 Variable costs are usually characterized by: a.Unit costs that decrease as activity increases. b.Total costs that increase as activity decreases. c.Total costs that increase as activity increases. d.Total costs that remain constant. Variable costs are usually characterized by: a.Unit costs that decrease as activity increases. b.Total costs that increase as activity decreases. c.Total costs that increase as activity increases. d.Total costs that remain constant. Relationship of Total Cost to Volume of Activity L O 5

12-14 Variable costs are usually characterized by: a.Unit costs that decrease as activity increases. b.Total costs that increase as activity decreases. c.Total costs that increase as activity increases. d.Total costs that remain constant. Variable costs are usually characterized by: a.Unit costs that decrease as activity increases. b.Total costs that increase as activity decreases. c.Total costs that increase as activity increases. d.Total costs that remain constant. Relationship of Total Cost to Volume of Activity LO 5

12-15 Activity Total Cost Economist’s Curvilinear Cost Function Relationship of Total Cost to Volume of Activity L O 5

12-16 Activity Total Cost Economist’s Curvilinear Cost Function Accountant’s Straight-Line Approximation (constant unit variable cost) Relationship of Total Cost to Volume of Activity L O 5

12-17 Relevant Range Activity Total Cost Economist’s Curvilinear Cost Function Accountant’s Straight-Line Approximation (constant unit variable cost) Relationship of Total Cost to Volume of Activity A straight line closely approximates a curvilinear variable cost line within the relevant range. L O 5

12-18 Fixed Costs and the Relevant Range Example: Office space is available at a rental rate of $30,000 per year in increments of 1,000 square feet. As the business grows more space is rented, increasing the total cost. Continue L O 5

12-19 Fixed Costs and the Relevant Range Rent Cost in Thousands of Dollars 0 1,000 2,000 3,000 Rented Area (Square Feet) Relevant Range Total cost doesn’t change for a wide range of activity, but then jumps to a new higher cost for the next higher range of activity. L O 5

12-20 Typical variable costs Raw materials Direct labor Factory utilities Sales commissions Shipping costs Typical fixed costs Real estate taxes Insurance Supervisory salaries Depreciation Advertising Relationship of Total Cost to Volume of Activity L O 5

12-21 A semivariable cost has both fixed and variable components. Consider the following electric utility example. Relationship of Total Cost to Volume of Activity L O 5

12-22 Semivariable Costs Fixed Monthly Utility Charge Variable Utility Charge Activity (Kilowatt Hours) Total Utility Cost X Y Total semivariable cost L O 5

12-23 Semivariable Costs Fixed Monthly Utility Charge Variable Utility Charge Activity (Kilowatt Hours) Total Utility Cost X Y Total semivariable cost L O 5

12-24 Semivariable Costs Fixed Monthly Utility Charge Variable Utility Charge Activity (Kilowatt Hours) Total Utility Cost X Y Total semivariable cost Y = a + bX L O 5

12-25 Estimating Cost Behavior Patterns The high-low method is used to determine the fixed and variable components of a semivariable cost. L O 6

12-26 The High-low Method Beetle Co. recorded the following production activity and maintenance costs for two months: Using these two levels of activity, compute:  the variable cost per unit;  the fixed cost; and then  express the costs in equation form Y = a + bX. L O 6

12-27  Unit variable cost = Change in cost Change in units The High-low Method L O 6

12-28  Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit The High-low Method L O 6

12-29  Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit  Fixed cost = Total cost – Total variable cost Fixed cost = $9,700 – ($0.90 per unit × 9,000 units) Fixed cost = $9,700 – $8,100 = $1,600 The High-low Method L O 6

12-30  Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit  Fixed cost = Total cost – Total variable cost Fixed cost = $9,700 – ($0.90 per unit × 9,000 units) Fixed cost = $9,700 – $8,100 = $1,600  Total cost = Fixed cost + Variable cost (Y = a + bX) Y = $1,600 + $0.90X The High-low Method L O 6

12-31 If sales salaries and commissions are $14,000 when 120,000 units are sold and $10,000 when 80,000 units are sold, what is the variable portion of sales salaries and commission? a. $0.08 per unit b. $0.10 per unit c. $0.12 per unit d. $0.125 per unit If sales salaries and commissions are $14,000 when 120,000 units are sold and $10,000 when 80,000 units are sold, what is the variable portion of sales salaries and commission? a. $0.08 per unit b. $0.10 per unit c. $0.12 per unit d. $0.125 per unit The High-low Method L O 6

12-32 If sales salaries and commissions are $14,000 when 120,000 units are sold and $10,000 when 80,000 units are sold, what is the variable portion of sales salaries and commission? a. $0.08 per unit b. $0.10 per unit c. $0.12 per unit d. $0.125 per unit If sales salaries and commissions are $14,000 when 120,000 units are sold and $10,000 when 80,000 units are sold, what is the variable portion of sales salaries and commission? a. $0.08 per unit b. $0.10 per unit c. $0.12 per unit d. $0.125 per unit The High-low Method L O 6 $4,000 ÷ 40,000 units = $0.10 per unit

12-33 The High-low Method L O 6 If sales salaries and commissions are $14,000 when 120,000 units are sold and $10,000 when 80,000 units are sold, what is the fixed portion of sales salaries and commissions? a. $ 2,000 b. $ 4,000 c. $10,000 d. $12,000 If sales salaries and commissions are $14,000 when 120,000 units are sold and $10,000 when 80,000 units are sold, what is the fixed portion of sales salaries and commissions? a. $ 2,000 b. $ 4,000 c. $10,000 d. $12,000

12-34 If sales salaries and commissions are $14,000 when 120,000 units are sold and $10,000 when 80,000 units are sold, what is the fixed portion of sales salaries and commissions? a. $ 2,000. b. $ 4,000 c. $10,000 d. $12,000 If sales salaries and commissions are $14,000 when 120,000 units are sold and $10,000 when 80,000 units are sold, what is the fixed portion of sales salaries and commissions? a. $ 2,000. b. $ 4,000 c. $10,000 d. $12,000 The High-low Method L O 6

12-35 Let’s put our knowledge of cost behavior to work by preparing a contribution margin format income statement. A Modified Income Statement Format L O 7

12-36 Used primarily for external reporting. Used primarily by management. The Contribution Margin Format L O 7 Both formats report the same Operating income!

12-37 The Contribution Margin Format The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs and provides for income. L O 8

12-38 Contribution margin ratio The Contribution Margin Format L O 9

12-39 At Evans, each $1.00 increase in sales revenue results in a total contribution margin increase of 40¢. If sales increase by $60,000, what will be the increase in total contribution margin? $60,000 × 0.40 = $24,000 At Evans, each $1.00 increase in sales revenue results in a total contribution margin increase of 40¢. If sales increase by $60,000, what will be the increase in total contribution margin? $60,000 × 0.40 = $24,000 The Contribution Margin Format L O 9

12-40 What is income if sales increase by 2,000 units? Contribution Margin in Action L O 9

12-41 Note that fixed expenses do not increase when sales volume increases. Contribution Margin in Action L O 9

12-42 What is the effect on income if a $1.00 per unit price cut results in a 4,000 unit increase in volume? Contribution Margin in Action L O 9

12-43 Contribution margin is increased without an increase in fixed expenses, so income increases. Contribution Margin in Action L O 9

12-44 Contribution Margin in Action What is the effect on income if a $1.00 per unit price cut, combined with a $10,000 increase in advertising, results in an 8,000 unit increase in volume? L O 9

12-45 Contribution Margin in Action Contribution margin is increased more than the $10,000 increase in fixed expenses, so income increases. L O 9

12-46 Multiple Products and Sales Mix Considerations Sales mix is the relative combination in which a company’s different products are sold. Different products have different selling prices, costs, and contribution margins. A change in the sales mix will result in a different contribution margin ratio. Sales mix is the relative combination in which a company’s different products are sold. Different products have different selling prices, costs, and contribution margins. A change in the sales mix will result in a different contribution margin ratio. L O 10

12-47 Multiple Products and Sales Mix Considerations Jones Company provides us with the following information: L O 10 Both products have the same sales volume of 1,000 units However, each product has a different contribution margin ratio

12-48 Multiple Products and Sales Mix Considerations $265,000 $550,000 = 48% (rounded) Jones Company provides us with the following information: L O 10 Average total contribution margin ratio provided from all products How will average total contribution margin change if Jones sold 1,500 lawn tractors, all other factors held constant?

12-49 Multiple Products and Sales Mix Considerations L O 10 $347,500 $700,000 = 50% (rounded) Average total contribution margin ratio provided from all products How will average total contribution margin change if Jones sold 1,500 lawn tractors, all other factors held constant? Due to selling more product with a higher CM ratio Increases

12-50 Break-Even Point Analysis How many units must Evans sell to cover its fixed costs (break even)? Answer: $30,000 ÷ $4 per unit = 7,500 units How many units must Evans sell to cover its fixed costs (break even)? Answer: $30,000 ÷ $4 per unit = 7,500 units L O 11

12-51 Break-Even Point Analysis We have just seen one of the basic CVP relationships – the break-even computation. Break-even point in units = Fixed costs Contribution margin per unit Unit sales price less unit variable cost ($4 for Evans company) L O 11

12-52 Break-Even Point Analysis The break-even formula may also be expressed in sales dollars. Break-even point in dollars = Fixed costs Contribution margin ratio Unit sales price Unit variable cost L O 11

12-53 Break-Even Point Analysis ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to break even? a. 100,000 units b. 40,000 units c. 200,000 units d. 66,667 units ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to break even? a. 100,000 units b. 40,000 units c. 200,000 units d. 66,667 units L O 11

12-54 Break-Even Point Analysis ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to break even? a. 100,000 units b. 40,000 units c. 200,000 units d. 66,667 units ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to break even? a. 100,000 units b. 40,000 units c. 200,000 units d. 66,667 units Unit contribution = $ $3.00 = $2.00 Fixed costs Unit contribution = $200,000 $2.00 per unit = 100,000 units L O 11

12-55 Break-Even Point Analysis Use the contribution margin ratio formula to determine the amount of sales revenue ABC must have to break even. All information remains unchanged: fixed costs are $200,000; unit sales price is $5.00; and unit variable cost is $3.00. a. $200,000 b. $300,000 c. $400,000 d. $500,000 Use the contribution margin ratio formula to determine the amount of sales revenue ABC must have to break even. All information remains unchanged: fixed costs are $200,000; unit sales price is $5.00; and unit variable cost is $3.00. a. $200,000 b. $300,000 c. $400,000 d. $500,000 L O 11

12-56 Break-Even Point Analysis Use the contribution margin ratio formula to determine the amount of sales revenue ABC must have to break even. All information remains unchanged: fixed costs are $200,000; unit sales price is $5.00; and unit variable cost is $3.00. a. $200,000 b. $300,000 c. $400,000 d. $500,000 Use the contribution margin ratio formula to determine the amount of sales revenue ABC must have to break even. All information remains unchanged: fixed costs are $200,000; unit sales price is $5.00; and unit variable cost is $3.00. a. $200,000 b. $300,000 c. $400,000 d. $500,000 Unit contribution = $ $3.00 = $2.00 Contribution margin ratio = $2.00 ÷ $5.00 =.40 Break-even revenue = $200,000 ÷.4 = $500,000 L O 11

12-57 Break-Even Point Analysis Break-even formulas may be adjusted to show the sales volume needed to earn any amount of operating income. Unit sales = Fixed costs + Desired income Contribution margin per unit Dollar sales = Fixed costs + Desired income Contribution margin ratio L O 11

12-58 Break-Even Point Analysis ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to earn operating income of $40,000? a. 100,000 units b. 120,000 units c. 80,000 units d. 200,000 units ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to earn operating income of $40,000? a. 100,000 units b. 120,000 units c. 80,000 units d. 200,000 units L O 11

12-59 Break-Even Point Analysis ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to earn operating income of $40,000? a. 100,000 units b. 120,000 units c. 80,000 units d. 200,000 units ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to earn operating income of $40,000? a. 100,000 units b. 120,000 units c. 80,000 units d. 200,000 units = 120,000 units Unit contribution = $ $3.00 = $2.00 Fixed costs + Target income Unit contribution $200,000 + $40,000 $2.00 per unit L O 11

12-60 Break-Even Graph Total expense Volume in Units Costs and Revenue in Dollars Total fixed expense Break-even point Profit Loss Revenue Total variable expense L O 11

12-61 Operating Leverage  A measure of how sensitive net income is to percentage changes in sales.  With high leverage, a small percentage increase in revenue can produce a much larger percentage increase in income.  A measure of how sensitive net income is to percentage changes in sales.  With high leverage, a small percentage increase in revenue can produce a much larger percentage increase in income. L O 12

12-62 Operating Leverage If revenues increase by 20 percent, what is the percentage increase in income? L O 12

12-63 Operating Leverage 80 percent increase in income Operating leverage resulted in the operating income increasing proportionately more than the increase in revenue. 20 percent increase in revenue L O 12

12-64 End of Chapter 12