11-1 Visit UMT online at ACCT125© 2006 UMT ACCOUNTING FUNDAMENTALS FOR MANAGERS University of Management and Technology 1901 North Fort Myer Drive Arlington, VA Voice: (703) Fax: (703) Website:
11-2 Visit UMT online at ACCT125© 2006 UMT Carl S. Warren Survey of Accounting (2 nd ed.) © 2004 South-Western
Visit UMT online at ACCT125© 2006 UMT Task Force Clip Art included in this electronic presentation is used with the permission of New Vision Technology of Nepean Ontario, Canada.
11-4 Visit UMT online at ACCT125© 2006 UMT Chapter 11 Cost Behavior and Cost-Volume- Profit Analysis
Visit UMT online at ACCT125© 2006 UMT ContinuedContinued Learning Objectives 1.Classify costs according to their behavior as variable costs, fixed costs, or mixed costs. 2.Compute the contribution margin, the contribution margin ratio, and the unit contribution margin, and explain how they can be useful to managers. After studying this chapter, you should be able to:
Visit UMT online at ACCT125© 2006 UMT ContinuedContinued Learning Objectives 3.Using the unit contribution margin, determine the break- even point and the volume necessary to achieve a target profit. 4.Using a cost-volume-profit chart and a profit-volume chart, determine the break-even point and the volume necessary to achieve a target profit.
Visit UMT online at ACCT125© 2006 UMT Learning Objectives 5.Calculate the break-even point for a business selling more than one product. 6.Compute the margin of safety and the operating leverage, and explain how managers use these concepts. 7.List the assumptions underlying cost-volume-profit analysis.
Visit UMT online at ACCT125© 2006 UMT 1 Classify costs according to their behavior as variable costs, fixed costs, or mixed costs. Learning Objective
Visit UMT online at ACCT125© 2006 UMT Cost Behavior Cost behavior refers to the manner in which a cost changes as a related activity changes. Knowing how costs behave is useful to management for predicting profits and for analyzing ways to control costs. To understand cost behavior, we need two factors: Identify the activities that cause costs to be incurred. These are called activity bases or activity drivers. Specify the range of activity over the which changes in costs are of interest This range is called the relevant range.
Visit UMT online at ACCT125© 2006 UMT Cost Behavior To illustrate: Hospital administrators must plan and control food costs. To understand why food costs change, the activity that causes food costs to be incurred must be understood. In the case of hospital food, feed patients is a major driver. However, the total patients is not a good indicator because many of them are out-patients. So tracking the in-patient population is a good activity base or activity driver for studying food costs. Then the food costs can be studied over the varying number of patients in hospital, the relevant range.
Visit UMT online at ACCT125© 2006 UMT Cost Behavior When examining cost behavior, three of the most common classifications are Variable Costs These are costs that vary in direct proportion to changes in the level of activity: The more output, the greater the variable costs. VC are the costs for producing each unit of output and include at least labor and materials. Fixed Costs These costs remain the same regardless of the number of units produced (or other measure of output). FC usually are long-term and can only be recovered over the life cycle of the property, plant, or equipment. Mixed Costs These costs have characteristics of both fixed and variable costs. For example, these costs could follow a step function, where they are fixed over some range of output and then increase to a new plateau when output rises beyond the given range.
Visit UMT online at ACCT125© 2006 UMT Variable Costs Total Variable Cost Graph Total Costs $300,000 $250,000 $200,000 $150,000 $100,000 $50, Unit Variable Cost Graph $20 $15 $10 $5 0 Cost per Unit ,000 $ 50,000 $10 10, , , , , , , , , , Units Total Cost Produced Cost per Unit Units Produced (000)
Visit UMT online at ACCT125© 2006 UMT Variable Costs Total Variable Cost Graph Total Costs $300,000 $250,000 $200,000 $150,000 $100,000 $50, Unit Variable Cost Graph $20 $15 $10 $5 0 Cost per Unit ,000 $ 50,000 $10 10, , , , , , , , , , Units Total Cost Produced Cost per Unit Units Produced (000)
Visit UMT online at ACCT125© 2006 UMT Variable Costs Total Variable Cost Graph Total Costs $300,000 $250,000 $200,000 $150,000 $100,000 $50, Unit Variable Cost Graph $20 $15 $10 $5 0 Cost per Unit ,000 $ 50,000 $10 10, , , , , , , , , , Units Total Cost Produced Cost per Unit Units Produced (000)
Visit UMT online at ACCT125© 2006 UMT Fixed Costs Total Fixed Cost Graph Total Costs 0 Unit Fixed Cost Graph Cost per Unit 50,000 $75,000 $ ,000 75, ,000 75, ,000 75, ,000 75, ,000 75, Units Total Cost Produced Cost per Unit Units Produced (000) $150,000 $125,000 $100,000 $75,000 $50,000 $25, $1.50 $1.25 $1.00 $.75 $.50 $
Visit UMT online at ACCT125© 2006 UMT Fixed Costs Total Fixed Cost Graph Total Costs 0 Unit Fixed Cost Graph Cost per Unit 50,000 $75,000 $ ,000 75, ,000 75, ,000 75, ,000 75, ,000 75, Units Total Cost Produced Cost per Unit $150,000 $125,000 $100,000 $75,000 $50,000 $25, $1.50 $1.25 $1.00 $.75 $.50 $ Units Produced (000)
Visit UMT online at ACCT125© 2006 UMT Fixed Costs Total Fixed Cost Graph Total Costs 0 Unit Fixed Cost Graph Cost per Unit 50,000 $75,000 $ ,000 75, ,000 75, ,000 75, ,000 75, ,000 75, Units Total Cost Produced Cost per Unit $150,000 $125,000 $100,000 $75,000 $50,000 $25, $1.50 $1.25 $1.00 $.75 $.50 $ Units Produced (000)
Visit UMT online at ACCT125© 2006 UMT Mixed Costs Total Mixed Cost Graph Total Costs 0 Total Machine Hours (000) $40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5, Mixed costs are usually separated into their fixed and variable components for management analysis. Mixed costs are sometimes called semi-variable or semi-fixed costs.
Visit UMT online at ACCT125© 2006 UMT Mixed Costs: High-Low Method Actual costs incurred June1,000$45,550 July1,50052,000 August2,10061,500 September1,80057,500 October75041,250 ProductionTotal UnitsCost Highest level Lowest level Difference ProductionTotal UnitsCost Highest and lowest levels
Visit UMT online at ACCT125© 2006 UMT Mixed Costs: High-Low Method Actual costs incurred ProductionTotal UnitsCost Highest level2,100$61,500 Lowest level Difference ProductionTotal UnitsCost Highest and lowest levels June1,000$45,550 July1,50052,000 August2,10061,500 September1,80057,500 October75041,250
Visit UMT online at ACCT125© 2006 UMT Mixed Costs: High-Low Method Actual costs incurred ProductionTotal UnitsCost Highest level2,100$61,500 Lowest level75041,250 Difference ProductionTotal UnitsCost Highest and lowest levels June1,000$45,550 July1,50052,000 August2,10061,500 September1,80057,500 October75041,250
Visit UMT online at ACCT125© 2006 UMT Mixed Costs: High-Low Method Actual costs incurred ProductionTotal UnitsCost Variable cost per unit Difference in total cost Difference in production = Highest level2,100$61,500 Lowest level75041,250 Difference1,350$20,250 ProductionTotal UnitsCost Highest and lowest levels 1 June1,000$45,550 July1,50052,000 August2,10061,500 September1,80057,500 October75041,250
Visit UMT online at ACCT125© 2006 UMT Mixed Costs: High-Low Method Actual costs incurred June1,000$45,550 July1,50052,000 August2,10061,500 September1,80057,500 October75041,250 ProductionTotal UnitsCost Variable cost per unit Difference in total cost Difference in production $20,250 1,350 units === ProductionTotal UnitsCost Highest and lowest levels 1 $15 Highest level2,100$61,500 Lowest level75041,250 Difference1,350$20,250
Visit UMT online at ACCT125© 2006 UMT Mixed Costs: High-Low Method Actual costs incurred June1,000$45,550 July1,50052,000 August2,10061,500 September1,80057,500 October75041,250 ProductionTotal UnitsCost Variable cost per unit Difference in total cost Difference in production $20,250 1,350 units $15 === Total cost =– Fixed cost Highest level2,100$61,500 Lowest level75041,250 Difference1,350$20,250 ProductionTotal UnitsCost Highest and lowest levels Variable cost per unit x Units of production 1 2
Visit UMT online at ACCT125© 2006 UMT Mixed Costs: High-Low Method Actual costs incurred June1,000$45,550 July1,50052,000 August2,10061,500 September1,80057,500 October75041,250 ProductionTotal UnitsCost Variable cost per unit Difference in total cost Difference in production $20,250 1,350 units $15 == = Total cost =– Fixed cost Highest level2,100$61,500 Lowest level75041,250 Difference1,350$20,250 ProductionTotal UnitsCost Highest and lowest levels Variable cost per unit x Units of production Highest level: $61,500 =– ( $15 x 2,100 ) = $30,
Visit UMT online at ACCT125© 2006 UMT Mixed Costs: High-Low Method Actual costs incurred June1,000$45,550 July1,50052,000 August2,10061,500 September1,80057,500 October75041,250 ProductionTotal UnitsCost Variable cost per unit Difference in total cost Difference in production $20,250 1,350 units $15 === Total cost =– Fixed cost Highest level2,100$61,500 Lowest level75041,250 Difference1,350$20,250 ProductionTotal UnitsCost Highest and lowest levels Variable cost per unit x Units of production Highest level: $61,500 =– ( $15 x 2,100 ) = $30,000 Lowest level: $41,250 =– ( $15 x 750 ) = $30,
Visit UMT online at ACCT125© 2006 UMT Mixed Costs: High-Low Method Actual costs incurred June1,000$45,550 July1,50052,000 August2,10061,500 September1,80057,500 October75041,250 ProductionTotal UnitsCost Variable cost per unit Difference in total cost Difference in production $20,250 1,350 units $15 === Total cost =– Fixed cost Highest level2,100$61,500 Lowest level75041,250 Difference1,350$20,250 ProductionTotal UnitsCost Highest and lowest levels Variable cost per unit x Units of production Highest level: $61,500 =– ( $15 x 2,100 ) = $30,000 Lowest level: $41,250 =– ( $15 x 750 ) = $30,
Visit UMT online at ACCT125© 2006 UMT Variable Costs Total Fixed Costs Total Units Produced Total Costs Unit Fixed Costs Total Units Produced Per Unit Cost Total Variable Costs Total Units Produced Unit Variable Costs Total Units Produced Total Costs Per Unit Cost Fixed Costs
Visit UMT online at ACCT125© 2006 UMT Variable Costs Total Fixed Costs Total Units Produced Total Costs Unit Fixed Costs Total Units Produced Per Unit Cost Total Variable Costs Total Units Produced Unit Variable Costs Total Units Produced Total Costs Per Unit Cost Fixed Costs Used for planning. Remains the same regardless of activity level. $10 per unit $75,000 total
Visit UMT online at ACCT125© 2006 UMT Compute the contribution margin, the contribution margin ratio, and the unit contribution margin, and explain how they can be useful to managers. 2 Learning Objective
Visit UMT online at ACCT125© 2006 UMT Cost-Volume-Profitability Cost-volume-profitability analysis is the systematic examination of the relationships among selling prices, sales and production volumes, costs (fixed and variable), expenses, and profits. CVP analysis provide valuation information to inform decision-making. CVP can inform Price setting Selecting the product mix Choosing between marketing strategies Analyzing effects of changes in costs on levels of profits
Visit UMT online at ACCT125© 2006 UMT Contribution Margin The contribution margin is the excess of sales revenue over variable costs. The contribution margin of each unit sold helps pay the fixed costs of the firm. Note that if the variable costs are not covered by the sales price, then the firm is losing money on every unit…a situation that cannot be corrected by selling more units. Once the fixed costs have been covered, the contribution margin represents income from operations. Assuming the sales price is a little more than variable costs, then firm should continue to produce the goods on the reasoning that the fixed costs will not “disappear” so any additional revenue helps keep the company in business.
Visit UMT online at ACCT125© 2006 UMT Sales (50,000 units) $1,000,000 Variable costs 600,000 Contribution margin $400,000 Fixed costs 300,000 Income from operations $100,000 Contribution Margin Income Statement Total The contribution margin is available to cover the fixed costs and income from operations. Sales Variable costs Fixed costs Income from operations
Visit UMT online at ACCT125© 2006 UMT Contribution Margin Income Statement Sales (50,000 units) $1,000,000 $20 100% Variable costs 600, % Contribution margin $400,000 $ 8 40% Fixed costs 300,000 Income from operations $100,000 Total Per Unit Percent The statement can be extended to include per unit dollars and percentage numbers.
Visit UMT online at ACCT125© 2006 UMT Sales (50,000 units) $1,000,000 $20 100% Variable costs 600, % Contribution margin $400,000 $ 8 40% Fixed costs 300,000 Income from operations $100,000 Contribution Margin Income Statement Total Per Unit Percent Sales Sales Variable Variablecosts Fixed Fixedcosts Incomefrom operations operations =++ Sales Sales Variable VariablecostsContributionmargin –=
Visit UMT online at ACCT125© 2006 UMT Contribution Margin Income Statement Total Per Unit Percent Unit Contribution Margin Contribution Margin Ratio Sales (50,000 units) $1,000,000 $20 100% Variable costs 600, % Contribution margin $400,000$ 8 40% Fixed costs 300,000 Income from operations $100,000 The contribution margin can be expressed three ways: 1. Total contribution margin in dollars. 2. Unit contribution margin (dollars per unit). 3. Contribution margin ratio (percentage). The contribution margin can be expressed three ways: 1. Total contribution margin in dollars. 2. Unit contribution margin (dollars per unit). 3. Contribution margin ratio (percentage).
Visit UMT online at ACCT125© 2006 UMT Using the unit contribution margin, determine the break- even point and the volume necessary to achieve a target profit. 3 Learning Objective
Visit UMT online at ACCT125© 2006 UMT Contribution Margin Ratio & Unit Contribution Margin The contribution margin ratio, also called the profit-volume ratio, indicates the percentage of each sales dollar that can be used to cover the fixed costs. Equals (Sales – Variable Costs) ÷ Sales. The unit contribution margin is the number of dollars from each unit of sales that can be used to cover fixed costs. The contribution margin ratio is useful in setting business policy and decision-making when forecasts are made in terms of sales dollars. The unit contribution margin is most useful when sales forecasts are made in terms of units sold.
Visit UMT online at ACCT125© 2006 UMT Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $300,000 $ 8 40% Fixed costs 300,000 Income from operations $ 0 Calculating the Break-Even Point Total Per Unit Percent At the break-even point, fixed costs and the contribution margin are equal.
Visit UMT online at ACCT125© 2006 UMT Calculating the Break-Even Point Total Per Unit Percent Break-even Break-evensales Fixedcosts =/ Contributionmargin Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 300,000 $ 8 40% Fixed costs 300,000 Income from operations $ 0 /or Divide by either: $8 per unit or 40%
Visit UMT online at ACCT125© 2006 UMT Calculating the Break-Even Point Total Per Unit Percent Break-even Break-evensales Fixedcosts = / Contributionmargin Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 300,000 $ 8 40% Fixed costs 300,000 Income from operations $ 0 or What is the break-even sales in units?
Visit UMT online at ACCT125© 2006 UMT Calculating the Break-Even Point Total Per Unit Percent Break-even Break-evensales Fixedcosts =/ Contributionmargin Break-even sales = $300,000 / $8 = 37,500 units Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 300,000 $ 8 40% Fixed costs 300,000 Income from operations $ 0 What is the break-even sales in dollars? /or
Visit UMT online at ACCT125© 2006 UMT Calculating the Break-Even Point Total Per Unit Percent Break-even Break-evensales Fixedcosts =/ Contributionmargin Break-even sales = $300,000 / $8 = 37,500 units Break-even sales = $300,000 / 40% = $750,000 Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 300,000 $ 8 40% Fixed costs 300,000 Income from operations $ 0 /or
Visit UMT online at ACCT125© 2006 UMT Calculating a Planned Sales Level Total Per Unit Percent Plannedsales Fixe d Target costs profit Fixe d Target costs profit =/ Contributionmargin Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 400,000 $ 8 40% Fixed costs 300,000 Income from operations $ 100,000 + /or Fixed costs plus the target profit equals the required total contribution margin.
Visit UMT online at ACCT125© 2006 UMT Calculating a Planned Sales Level Total Per Unit Percent Plannedsales Fixed Target costs profit =/ Contributionmargin Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 400,000 $ 8 40% Fixed costs 300,000 Income from operations $ 100,000 + /or $8 per unit or 40%
Visit UMT online at ACCT125© 2006 UMT Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 400,000 $ 8 40% Fixed costs 300,000 Income from operations $ 100,000 Calculating a Planned Sales Level Total Per Unit Percent Plannedsales Fixed Target costs profit =/ Contributionmargin + /or What is the planned sales level in units?
Visit UMT online at ACCT125© 2006 UMT Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 400,000 $ 8 40% Fixed costs 300,000 Income from operations $ 100,000 Calculating a Planned Sales Level Plannedsales Fixed Target costs profit =/ Contributionmargin Planned sales = ($300,000 + $100,000) / $8 = 50,000 units + What is the planned sales level in dollars? Total Per Unit Percent /or
Visit UMT online at ACCT125© 2006 UMT Calculating a Planned Sales Level Total Per Unit Percent Plannedsales Fixed Target costs profit =/ Contributionmargin Planned sales = ($300,000 + $100,000) / $8 = 50,000 units + Planned sales = ($300,000 + $100,000) / 40% = $1,000,000 /or $1,000,000 Sales (50,000 units) $1,000,000 $20 100% Variable costs 600, % Contribution margin $ 400,000 $ 8 40% Fixed costs 300,000 Income from operations $ 100,000
Visit UMT online at ACCT125© 2006 UMT Using a cost-volume- profit chart and a profit-volume chart, determine the break- even point and the volume necessary to achieve a target profit. 4 Learning Objective
Visit UMT online at ACCT125© 2006 UMT Cost-Volume-Profit Analysis CFP analysis uses simple mathematical equations to determine The number of units to achieve break-even. The number of units to achieve a given profit level. The formula for determining the break-even point is as follows: Notice that break-even is reported in terms of the number of units, not sales revenue in dollars.
Visit UMT online at ACCT125© 2006 UMT Cost-Volume-Profit Chart Sales and Costs ($000) 0 Units of Sales (000) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs$100,000 Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs$100,000 Total Sales
Visit UMT online at ACCT125© 2006 UMT Cost-Volume-Profit Chart Sales and Costs ($000) 0 Units of Sales (000) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs$100,000 Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs$100,000 Total Sales Variable Costs 60%
Visit UMT online at ACCT125© 2006 UMT 100% 60% 40% 100% 60% 40% Cost-Volume-Profit Chart Sales and Costs ($000) 0 Units of Sales (000) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs$100,000 Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs$100,000 Total Sales Variable Costs Contribution Margin 40% 60%
Visit UMT online at ACCT125© 2006 UMT Cost-Volume-Profit Chart Sales and Costs ($000) 0 Units of Sales (000) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs$100,000 Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs$100,000 Total Costs Total Sales Fixed Costs Variable Costs
Visit UMT online at ACCT125© 2006 UMT Cost-Volume-Profit Chart Sales and Costs ($000) 0 Units of Sales (000) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs$100,000 Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs$100,000 Total Costs Total Sales
Visit UMT online at ACCT125© 2006 UMT Cost-Volume-Profit Chart Sales and Costs ($000) 0 Units of Sales (000) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs$100,000 Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs$100,000 Operating Loss Area Operating Profit Area Total Costs Total Sales
Visit UMT online at ACCT125© 2006 UMT Cost-Volume-Profit Chart Sales and Costs ($000) 0 Units of Sales (000) Break-Even Point Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs $100,000 Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs $100,000 Total Costs Total Sales $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50
Visit UMT online at ACCT125© 2006 UMT Cost-Volume-Profit Chart Sales and Costs ($000) 0 Units of Sales (000) Break-Even Point Unit selling price$ 50 Unit variable cost30 Unit contribution margin$20 Total fixed costs$100,000 Unit selling price$ 50 Unit variable cost30 Unit contribution margin$20 Total fixed costs$100,000 Total Costs Total Sales $100,000 $20 = 5,000 units $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50
Visit UMT online at ACCT125© 2006 UMT Cost-Volume-Profit Chart (Break-Even) Sales and Costs ($000) 0 Units of Sales (000) Break-Even Point Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs $100,000 Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs $100,000 Operating Loss Area Operating Profit Area Total Costs Total Sales $100,000 $20 = 5,000 units $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50
Visit UMT online at ACCT125© 2006 UMT Revised Cost-Volume-Profit Chart Sales and Costs ($000) 0 Units of Sales (000) Revised Break- Even Point Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs$80,000 Unit selling price$ 50 Unit variable cost30 Unit contribution margin$ 20 Total fixed costs$80,000 Operating Loss Area Operating Profit Area Total Costs Total Sales $80,000 $20 = 4,000 units $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50
Visit UMT online at ACCT125© 2006 UMT Profit-Volume Chart Operating Profit (Loss) $000’s $100 $75 $50 $25 $ 0 $(25) $(50) $(75) $(100) Sales (10,000 units x $50) $500,000 Variable costs (10,000 units x $30) 300,000 Contribution margin (10,000 units x $20) $200,000 Fixed costs 100,000 Operating profit $100,000 Sales (10,000 units x $50) $500,000 Variable costs (10,000 units x $30) 300,000 Contribution margin (10,000 units x $20) $200,000 Fixed costs 100,000 Operating profit $100,000 Units of Sales (000’s) Relevant range is 10,000 units.
Visit UMT online at ACCT125© 2006 UMT Profit-Volume Chart Operating Profit (Loss) $000’s $100 $75 $50 $25 $ 0 $(25) $(50) $(75) $(100) Sales (10,000 units x $50) $500,000 Variable costs (10,000 units x $30) 300,000 Contribution margin (10,000 units x $20) $200,000 Fixed costs 100,000 Operating profit $100,000 Sales (10,000 units x $50) $500,000 Variable costs (10,000 units x $30) 300,000 Contribution margin (10,000 units x $20) $200,000 Fixed costs 100,000 Operating profit $100,000 Units of Sales (000’s) Maximum profit within the relevant range. Maximum loss is equal to the total fixed costs.
Visit UMT online at ACCT125© 2006 UMT Profit-Volume Chart Operating Profit (Loss) $000’s $100 $75 $50 $25 $ 0 $(25) $(50) $(75) $(100) Sales (10,000 units x $50) $500,000 Variable costs (10,000 units x $30) 300,000 Contribution margin (10,000 units x $20) $200,000 Fixed costs 100,000 Operating profit $100,000 Sales (10,000 units x $50) $500,000 Variable costs (10,000 units x $30) 300,000 Contribution margin (10,000 units x $20) $200,000 Fixed costs 100,000 Operating profit $100,000 Profit Line Units of Sales (000’s) Operating Profit Operating Loss
Visit UMT online at ACCT125© 2006 UMT Profit-Volume Chart Operating Profit (Loss) $000’s $100 $75 $50 $25 $ 0 $(25) $(50) $(75) $(100) Sales (10,000 units x $50) $500,000 Variable costs (10,000 units x $30) 300,000 Contribution margin (10,000 units x $20) $200,000 Fixed costs 100,000 Operating profit $100,000 Sales (10,000 units x $50) $500,000 Variable costs (10,000 units x $30) 300,000 Contribution margin (10,000 units x $20) $200,000 Fixed costs 100,000 Operating profit $100,000 Profit Line Units of Sales (000’s) Operating Profit Operating Loss Break-Even Point
Visit UMT online at ACCT125© 2006 UMT Calculate the break-even point for a business selling more than one product. 5 Learning Objective
Visit UMT online at ACCT125© 2006 UMT Sales Mix Considerations Sales $ 90 $140 Variable costs Contribution margin $ 20 $ 45 Sales mix 80% 20% Contribution margin Contribution margin Products A B What is the average contribution for each product?
Visit UMT online at ACCT125© 2006 UMT Sales Mix Considerations Sales $ 90 $140 Variable costs Contribution margin $ 20 $ 45 Sales mix x 80% x 20% Product contribution $ 16 $ 9 Contribution margin Contribution margin Products AB What is the total product contribution?
Visit UMT online at ACCT125© 2006 UMT Sales Mix Considerations Sales $ 90 $140 Variable costs Contribution margin $ 20 $ 45 Sales mix x 80% x 20% Product contribution $ 16 $ 9 Total product contribution$ 25 Contribution margin Contribution margin Break-even sales units Break-even sales units Products AB Total fixed costs $200,000 Product contribution $25 What is the break-even sales units?
Visit UMT online at ACCT125© 2006 UMT Sales Mix Considerations Sales $ 90 $140 Variable costs Contribution margin $ 20 $ 45 Sales mix x 80% x 20% Product contribution $ 16 $ 9 Total product contribution $ 25 Contribution margin Contribution margin Break-even sales units Break-even sales units Products AB Total fixed costs $200,000 Product contribution $25 Break-even sales units 8,000 Product A units (80%) 6,400 Product B units (20%) 1,600 = 8,000 units
Visit UMT online at ACCT125© 2006 UMT Sales Mix Considerations Sales $ 90 $ 140 Variable costs Contribution margin $ 20 $ 45 Sales mix 60% 40% Contribution margin Contribution margin Products AB If the sales mix is 60% for product A and 40% for product B, what is the break-even sales units?
Visit UMT online at ACCT125© 2006 UMT Sales Mix Considerations Sales $ 90 $140 Variable costs Contribution margin $ 20 $ 45 Sales mix x 60% x 40% Product contribution $ 12 $ 18 Total product contribution $ 30 Contribution margin Contribution margin Break-even sales units Break-even sales units Products AB Total fixed costs $200,000 Product contribution $30 Break-even sales units 6,667 Product A units (60%) 4,000 Product B units (40%) 2,667 = 6,667 units
Visit UMT online at ACCT125© 2006 UMT Compute the margin of safety and the operating leverage, and explain how managers use these concepts. 6 Learning Objective
Visit UMT online at ACCT125© 2006 UMT Margin of Safety The margin of safety is the difference between the current sales revenues and the sales at break-even. It indicates the possible in decrease in sales that can be absorbed before an operating loss results. The margin of safety can be expressed in units or in terms of sales revenue.
Visit UMT online at ACCT125© 2006 UMT Margin of Safety Sales – Sales at break-even point Sales Sales – Sales at break-even point Sales Dollars Units Sales $250,00010,000 Break-even sales 200,000 8,000 Excess $ 50,000 2,000
Visit UMT online at ACCT125© 2006 UMT Margin of Safety Sales – Sales at break-even point Sales Sales – Sales at break-even point Sales Dollars Units A Sales $250,00010,000 Break-even sales 200,000 8,000 Excess $ 50,000 2,000 Actual sales level.
Visit UMT online at ACCT125© 2006 UMT Margin of Safety Sales – Sales at break-even point Sales Sales – Sales at break-even point Sales Dollars Units A B Sales $250,00010,000 Break-even sales 200,000 8,000 Excess $ 50,000 2,000 Margin of safety (B/A) Excess of actual sales over the break-even sales. What is the margin of safety as a percentage?
Visit UMT online at ACCT125© 2006 UMT Margin of Safety Sales – Sales at break-even point Sales Sales – Sales at break-even point Sales Margin of safety indicates the decrease in sales that may occur before an operating loss results. Dollars Units A B Sales $250,00010,000 Break-even sales 200,000 8,000 Excess $ 50,000 2,000 Margin of safety (B/A)20% Margin of safety expressed in units.
Visit UMT online at ACCT125© 2006 UMT Operating Leverage Operating leverage is an indicator of the relative mix of the business’ variable costs and fixed costs. Since the difference between contribution margin and income from operations is the fixed cost, companies with high fixed costs have high operating leverage. Also, firms that have a “network” business in which services are provided over a network that moves either goods or information have high operating leverage.
Visit UMT online at ACCT125© 2006 UMT Operating Leverage Contribution margin Operating income Contribution margin Operating income Sales $400,000 $400,000 Variable costs 300, ,000 Contribution margin $100,000 $100,000 Fixed costs 80,000 50,000 Income from operations $20,000$ 50,000 Jones Inc. Wilson Inc. Operating leverage is a measure of the relative mix of variable costs and fixed costs.
Visit UMT online at ACCT125© 2006 UMT Operating Leverage Contribution margin Operating income Contribution margin Operating income Sales $400,000 $400,000 Variable costs 300, ,000 Contribution margin $100,000 $100,000 Fixed costs 80,000 50,000 Income from operations $20,000$ 50,000 Jones Inc. Wilson Inc. A Operating leverage is a measure of the relative mix of variable costs and fixed costs. Both companies have the same contribution margin.
Visit UMT online at ACCT125© 2006 UMT Operating Leverage Contribution margin Operating income Contribution margin Operating income Sales $400,000 $400,000 Variable costs 300, ,000 Contribution margin $100,000 $100,000 Fixed costs 80,000 50,000 Income from operations $20,000$ 50,000 Operating leverage (A/B) Jones Inc. Wilson Inc.A B Operating leverage is a measure of the relative mix of variable costs and fixed costs. What is the operating leverage?
Visit UMT online at ACCT125© 2006 UMT Operating Leverage Contribution margin Operating income Contribution margin Operating income Sales $400,000 $400,000 Variable costs 300, ,000 Contribution margin $100,000 $100,000 Fixed costs 80,000 50,000 Income from operations $20,000$ 50,000 Operating leverage (A/B) Jones Inc. Wilson Inc.A B Operating leverage is a measure of the relative mix of variable costs and fixed costs. What do these numbers mean? 5 2
Visit UMT online at ACCT125© 2006 UMT Operating Leverage Contribution margin Operating income Contribution margin Operating income Sales $400,000 $400,000 Variable costs 300, ,000 Contribution margin $100,000 $100,000 Fixed costs 80,000 50,000 Income from operations $20,000$ 50,000 Operating leverage (A/B) Jones Inc. Wilson Inc. A B Operating leverage is a measure of the relative mix of variable costs and fixed costs. Capital intensive? Labor intensive? 5 2
Visit UMT online at ACCT125© 2006 UMT List the assumptions underlying cost- volume-profit analysis. 7 Learning Objective
Visit UMT online at ACCT125© 2006 UMT Assumptions of Cost-Volume-Profit Analysis 1.Total sales and total costs can be represented by straight lines. 2.Within the relevant range of operating activity, the efficiency of operations does not change. 3.Costs can be accurately divided into fixed and variable components. 4.The sales mix is constant. 5.There is no change in the inventory quantities during the period. The reliability of cost-volume-profit analysis depends upon several assumptions.