2. ©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones6 - 1 Chapter 6 Business Decisions Using Cost Behavior

3. ©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones6 - 2 Learning Objective 1 Describe the differences between a functional income statement and a contribution income statement.

4. 6 - 3©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Functional Income Statement An income statement that separates product and period costs is called a functional income statement. The traditional income statement separates costs as either product separates costs as either product costs (COGS) or period costs (selling and administrative).

5. 6 - 4©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones The Contribution Income Statement The contribution income statement classifies costs by its behavior. Variable Fixed

6. 6 - 5©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Review of Functional Format Purchase cost: $7.20 Selling price: $12.00 Selling expenses: $9,500 Administrative expenses: $7,900 3,000 T-shirts sold

7. 6 - 6©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Income Statement Using the Functional Format BEACHSIDE T-SHIRT SHOP Income Statement For the Year Ended December 31, 2003 Sales$ 36,000 Cost of goods sold 21,600 Gross profit$ 14,400 Operating expenses: Selling expenses$9,500 Selling expenses$9,500 Administrative expenses 7,900 17,400 Administrative expenses 7,900 17,400 Operating gain/(loss)($ 3,000)

8. 6 - 7©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Income Statement Using the Functional Format BEACHSIDE T-SHIRT SHOP Income Statement For the Year Ended December 31, 2003 Sales$ 36,000 Cost of goods sold 21,600 Gross profit$ 14,400 Operating expenses: Selling expenses$9,500 Selling expenses$9,500 Administrative expenses 7,900 17,400 Administrative expenses 7,900 17,400 Operating gain/(loss)($ 3,000) Period cost Product cost

9. 6 - 8©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Income Statement Using the Functional Format The functional format income statement emphasizes gross profit or margin. Revenues – Cost of goods sold =Grossprofit Grossprofit –Operatingexpenses =Operatingincome

10. ©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones6 - 9 Learning Objective 2 Determine per unit amounts for sales, variable cost, and the contribution margin.

11. 6 - 10©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Beachside Cost Behavior The expenses for Beachside have the following behavior patterns: Cost of goods sold: all variable Selling expense: 40% variable, 60% fixed Administrative expense: $6,300 fixed, $1,600 variable

12. 6 - 11©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Beachside Cost Behavior Cost of goods sold per unit: $7.20 Selling expenses per unit: 40% variable × $9,500 ÷ 3,000 $1.27 Administrative expenses per unit: $1,600 ÷ 3,000 $0.53 Total variable expenses per unit $9.00

13. 6 - 12©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Income Statement Using the Contribution Format Revenues – Variable cost of goods sold – Variable operating expense = Contributionmargin – Fixed operating costOperatingincome/(loss) =

14. 6 - 13©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Income Statement Using the Contribution Format Sales (3,000 @ $12)$ 36,000 Variable cost: Cost of goods sold$21,600 Cost of goods sold$21,600 Variable selling expense ($9,500 × 40%) 3,800 Variable selling expense ($9,500 × 40%) 3,800 Variable admin. expense ($7,900 – $6,300) 1,600 27,000 Variable admin. expense ($7,900 – $6,300) 1,600 27,000 Contribution margin (sales less total variable cost)$ 9,000 Fixed cost: Fixed selling expense ($9,500 × 60%)$ 5,700 Fixed selling expense ($9,500 × 60%)$ 5,700 Fixed administrative expense 6,300 –12,000 Fixed administrative expense 6,300 –12,000 Operating income/(loss)($ 3,000) BEACHSIDE T-SHIRT SHOP Contribution Income Statement For the Year Ended December 31, 2003

15. 6 - 14©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Contribution Margin for Beachside What is the Beachside’s contribution margin per unit? Contribution margin per unit = Selling price – Variable expenses per unit $12 – $9 = $3 contribution margin per unit What is the total contribution margin when 3,000 units are sold? 3,000 × $3 = $9,000

16. ©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones6 - 15 Learning Objective 3 Determine the contribution margin ratio and explain its importance as a management tool.

17. 6 - 16©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Condensed Contribution Income Statement Sales in units 3,000 1 Sales$36,000$12.00100 Variable cost–27,000 – 9.00–75 Contribution margin$ 9,000$ 3.00 25 Fixed cost–12,000 Operating loss$ (3,000) BEACHSIDE T-SHIRT SHOP Contribution Income Statement For the Year Ended December 31, 2003 Per % of Total Unit Sales

18. 6 - 17©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Contribution Margin Ratio Contribution margin ratio (or contribution margin percentage) is the contribution margin per unit divided by the selling price. What is Beachside’s contribution margin ratio (CM%)? $3 ÷ $12 = 25%

19. 6 - 18©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Using the Contribution Margin This means that for any dollar increase in sales, there should be an increase in income equal to 25% of the dollar increase in sales. Each additional unit sold adds $3.00 to profits.

20. ©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones6 - 19 Learning Objective 4 Prepare and analyze a contribution income statement for a merchandising firm.

21. 6 - 20©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Predicting Profits Using the Contribution Income Statement Assume no changes in selling price and variable or fixed costs. Beachside expects to sell 7,500 units in 2005.

22. 6 - 21©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Condensed Contribution Income Statement Sales in units 7,500 1 Sales$90,000$12.00100% Variable cost–67,500 – 9.00–75% Contribution margin$22,500$ 3.00 25% Fixed cost–12,000 Operating income$10,500 BEACHSIDE T-SHIRT SHOP Projected Contribution Income Statement For the Year Ended December 31, 2005 Per % of Total Unit Sales

23. ©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones6 - 22 Learning Objective 5 Describe cost-volume-profit (CVP) analysis and explain its importance as a management tool.

24. 6 - 23©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Cost-Volume-Profit Analysis Cost-volume-profit analysis (CVP) is the study of the relationships is the study of the relationships among selling prices, costs, and volumes, and the impact that changes in those factors have upon profits.

25. 6 - 24©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Cost-Volume-Profit Formulas To determine the required sales in dollars to achieve a target profit. (Total fixed cost + Target profit) Contribution margin ratio

26. 6 - 25©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Cost-Volume-Profit Formulas To determine the required sales in units to achieve a target profit. (Total fixed cost + Target profit) Contribution margin per unit

27. 6 - 26©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Breakeven The break-even point is the sales volume that results in neither a profit nor a loss. What is the breakeven in dollars for Beachside? ($12,000 + $0) ÷ 25% = $48,000 sales to break even.

28. 6 - 27©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Breakeven What is the breakeven in units for Beachside? ($12,000 +$0) ÷ $3.00 = 4,000 t-shirts to break even.

29. ©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones6 - 28 Learning Objective 6 Use CVP analysis to determine the amount of sales required to break even or to earn a target profit.

30. 6 - 29©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Determining Sales Required to Meet a Profit Objective For Beachside to earn $27,000: For Beachside to earn $27,000: ($12,000 + $27,000) ÷ 25% = $156,000 in sales dollars (Total fixed cost + Target profit) Contribution margin ratio

31. 6 - 30©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Determining Units Required to Meet a Profit Objective For Beachside to earn $27,000: For Beachside to earn $27,000: ($12,000 + $27,000) ÷ $3.00 = 13,000 T-shirts (Total fixed cost + Target profit) Contribution margin per unit

32. 6 - 31©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones CVP Graph – Beachside T-Shirt Shop Sales & Costs T-Shirts Sold Sales Cost Profit Break-even point Loss

33. ©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones6 - 32 Learning Objective 7 Use CVP to perform sensitivity analysis.

34. 6 - 33©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Sensitivity Analysis Sensitivity analysis is applied to assess the changes in the CVP analysis when changes are made in the basic parameters (price, volume, etc.). It is also called “what-if” analysis.

35. 6 - 34©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Condensed Contribution Income Statement Sales in units 11,286 1 Sales$135,432$12.00100% Variable cost–101,574 – 9.00–75% Contribution margin$ 33,858$ 3.00 25% Fixed cost – 12,000 Operating income$ 21,858 BEACHSIDE T-SHIRT SHOP Contribution Income Statement For the Year Ended December 31, 2005 Per % of Total Unit Sales

36. 6 - 35©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Change in Selling Price If the only change is in the selling price, then the contribution margin also changes in the same direction by the same amount.

37. 6 - 36©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Change in Selling Price Example Lets assume that Beachside decreases the price from $12 to $11. This results in a decrease in the CMU from $3 to $2, and a decrease in the CM% from 25% to 18.1818%. What is the required sales in dollars to make a $27,000 profit?

38. 6 - 37©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Change in Selling Price Example For Beachside to earn $27,000: ($12,000 + $27,000) ÷ 18.1818% = $214,500 sales dollars What is the required sales in units to make a $27,000 profit? ($12,000 + $27,000) ÷ $2.00 = 19,500 T-shirts

39. 6 - 38©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Change in Variable Cost and Fixed Cost Cost of goods sold: $7.20 Selling expenses: $3,800 ÷ 3,000 = $1.27 Administrative expenses: $1,600 ÷ 3,000 = $.53 Total variable expense or cost per unit = $9.00

40. 6 - 39©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Change in Variable Cost and Fixed Cost Example Assume the purchase price of T-shirts decreases from $7.20 to $6.00. This results in a decrease in variable cost from $9.00 to $7.80. The new contribution margin ratio is: ($11.00 selling price – $7.80) ÷ $11 = 0.29091

41. 6 - 40©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Change in Variable Cost and Fixed Cost Example In addition, Beachside can reduce fixed costs from $12,000 to $9,000. ($9,000 + $27,000) ÷ 29.091% = $123,750 sales dollars What is the required sales in dollars to make a $27,000 profit?

42. 6 - 41©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Change in Variable Cost and Fixed Cost Example What is the required sales in units to make a $27,000 profit? ($9,000 + $27,000) ÷ $3.20 = 11,250 T-shirts

43. 6 - 42©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Multiple Products and CVP Companies that sell more than one product can use CVP analysis.

44. 6 - 43©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Sales$500,000100% Variable cost 315,000 63% Contribution margin$185,000 37% Fixed cost 143,000 Operating income$ 42,000 Multiple Products and CVP MARGARET’S FRAME FACTORY Contribution Income Statement For the Year Ended December 31, 2003 % of Total Sales

45. 6 - 44©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones Break-Even Point in a Multiproduct Situation What is the required sales in dollars? ($143,000 + $0) ÷ 37% = $386,486 What is the required sales in dollars to make $80,000 profit? ($143,000 + $80,000) ÷ 37% = $602,703

46. 6 - 45©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones CVP Assumptions 1. All costs are either fixed or variable. 2. Fixed costs remain fixed throughout the relevant range. the relevant range. 3. Variable costs per unit do not change. 4. Selling price per unit remains the same. 5. The average contribution margin ratio in a multiple product company remains the same. multiple product company remains the same.

47. ©2004 Prentice Hall Business Publishing Introduction to Management Accounting, 2/e Werner/Jones6 - 46 End of Chapter 6