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ACCT 2302 Fundamentals of Accounting II Spring 2011 Lecture 6 Professor Jeff Yu
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Review: Cost Behavior True Variable Cost (a=0, b>0) Total cost: Y=bX, increases with X Unit cost: Y/X=b, constant Fixed Cost ( a>0, b=0) Total cost: Y=a, constant Unit cost: Y/X=a/X, decreases with X Mixed Cost ( a>0, b>0) Total cost: Y=a+bX, increases with X Unit cost: Y/X=a/X + b, decreases with activity level X.
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(1) Select the highest- & the lowest- activity levels: X h, X l (2) Fit a line through the two data points: (X h, Y h ), (X l, Y l ) Y h =a + bX h b=(Y h - Y l )/(X h - X l ) Y l =a + bX l a= ? The slope of the line: b = Variable Cost per unit The intercept of the line: a = Total Fixed Cost Review: Cost Function & High-low Method Cost Function: Y = a + bX
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Used primarily for external reporting Used primarily for Managerial Decision making The Contribution Format Income Statement
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The contribution format emphasizes cost behavior. Contribution Margin (CM) covers fixed costs and then contributes to net operating income. The Contribution Format Income Statement
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Q: Prepare a contribution margin format income statement for August. Example JulyAugust Sales in units11,00010,000 Sales$165,000$150,000 Cost of goods sold 72,600 66,000 Gross margin 92,400 84,000 Selling and administrative expenses: Rent12,000 Sales commissions13,20012,000 Maintenance expenses13,50013,000 Clerical expense 16,000 15,000 Total S&A expense 54,700 52,000 Net operating income$ 37,700$ 32,000 Comparative income statements for Boggs Co. for the last two months are presented below (assume all costs are either fixed, true variable or mixed):
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The 2010 income statement for Janna Company is as follows: Sales$1,600,000 Less: Cost of goods sold $1,200,000 Gross Margin$ 400,000 Less: Selling expenses$ 196,000 Administrative expenses$ 98,000 Net Income$ 106,000 The price of the product is $50 per unit and CGS is entirely variable. Variable selling expenses are $5.5 per unit. The remaining selling expenses are fixed. Variable administrative expenses are 2% of CGS. The remaining administrative expenses are fixed. Q: (1) What is the contribution margin for year 2010? (2) Let X be the number of units sold, what is the cost function for total S&A expenses? Practice Problem
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Break-even point is the amount of units needed to be sold to make the company’s revenues equal to expenses (NOI = 0). Chapter 6: CVP Analysis
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Sales – Variable Expenses – Fixed Expenses = NOI Unit price Units sold × VC Per Unit Units Sold × At the break-even point, NOI=0. $$$ $0 or target Profit Break-even Point: The Equation Method
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Contribution Margin = NOI + Fixed Expenses Once the Break-even Point has been reached, NOI will increase by contribution margin per unit for each additional unit sold. At the Break-even Point, NOI = 0, Contribution Margin = Fixed Expenses. Break-even Point: Contribution Margin Method
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Consider Razor Inc, a scooter manufacturer. For each additional scooter sold, Razor Inc. generates $200 in contribution margin. Example Q: calculate the break-even point in units for Razor Inc.
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We can calculate the break-even point in sales dollars rather than in units using the Contribution-Margin (CM) ratio. Break Even Point in Sales Dollars What is the break-even point in Sales Dollars for Razor Inc.? CM = Fixed Expenses at the break-even point
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Target Profit: CM Approach Original formula: Target profit modification: We can determine the number of scooters that Razor must sell to earn a target profit of $100,000 by slightly modifying the break-even point formula:
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Sales revenue – Variable expenses – Fixed expenses = NOI ($500 × X)($300 × X)––$80,000 = $100,000 ($200X)= $180,000 X = 900 units Target Profit: Equation Approach
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Asphalt is a gravel making firm. Gravel is made by crushing stones. The variable cost of making gravel is estimated to be $15 per ton. The fixed costs of operating the gravel making plant for the year are $100,000. The sales price of gravel is $25 per ton. Q: (1)How many tons of gravel must Asphalt sell to break even? (2)What is the break-even point in sales dollars for Asphalt? (3)How many units you have to sell if the target profit is $100,000? (4)What will the NOI be if 11,000 tons of gravel are sold? Practice Problem
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For Next Class Continue covering Chapter 6. Complete assigned readings. Attempt the assigned HW problems.
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Homework Problem 1 Units SoldUnit Price VC per unit CM per unit Total CMTotal fixed costs NOI 120,000$30$720,000$640,000 100,000$6$4$320,000 80,000$9$160,000$40,000 Fill in the blanks of the following table:
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In 2010, Voltar Co. sold 20,000 units of a special telephone at $60 each, variable expenses were $900,000 and fixed expenses were $240,000. Q:(1) Compute its CM ratio and variable expense ratio. (2) Compute its break-even point in units and sales dollars. (3) How many units have to be sold to earn a profit of $90,000 in 2011? Homework Problem 2
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Air Safety Systems manufactures a component used in aircraft radar systems. The firm’s fixed costs are $4,000,000 per year. The variable cost per unit is $2,000 and the sales price is $3,000 per component. The company sold 5,000 components in 2010. Q: (1) What is the breakeven point in units? (2) What is the breakeven point in units if fixed costs increase 10%? (3) What if sales price and VC per unit both decrease 10%, while other things remain unchanged? The sales manager believes that reducing sales price to $2,500 per unit will increase the sales volume to 7,500 components. (4) What will the new break-even point in units be? Should the change be made? Homework Problem 3
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