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Cost-Volume-Profit Relationships UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee
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Dr. Fred BarbeeACCT 202 - UAA - Fall 20042 Introduction We have learned... –How to identify costs as fixed, variable, and mixed; –How each of these behave when changes take place; and –How to separate them into their component parts.
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Dr. Fred BarbeeACCT 202 - UAA - Fall 20043 Introduction Understanding these relationships help managers to; –Predict future conditions (planning); and –Explain, evaluate, and act on past results (control)
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Dr. Fred BarbeeACCT 202 - UAA - Fall 20044 Introduction Today we will focus on gaining an understanding of how... –Costs –Volume, and –Profits Interact
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Dr. Fred BarbeeACCT 202 - UAA - Fall 20045 Cost-Volume-Profit (CVP) CVP is the systematic examination of the relationships among... –Selling prices, –Volume of Sales and Production –Cost, –Expenses, and –Profits
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Output Sales Price Variable Costs Fixed Costs Total Revenues Total Cost Operating Income Total Revenue Total Cost Operating Income What happens here? As changes occur here. Graphically 4 Output Sales Price Variable Costs Fixed Costs
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Dr. Fred BarbeeACCT 202 - UAA - Fall 20047 CVP - For-Profit Firms How many photocopies must the College Avenue Copy Shop produce to earn a profit of $20,000? At what sales volume will Burger King’s total costs and total revenues equal?
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Dr. Fred BarbeeACCT 202 - UAA - Fall 20048 CVP - For-Profit Firms What will happen to profits in Joe’s Diner if... –There is a 20% increase in the cost of food; and –A 10% increase in the selling price of meals?
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Dr. Fred BarbeeACCT 202 - UAA - Fall 20049 CVP - Not-For-Profit Firms How many meals can the Salvation Army serve with an annual budget of $150,000? How many tickets must be sold for the benefit concert to raise $15,000?
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200410 CVP is Useful in... Choice of product lines Pricing of products Developing marketing strategies Utilization of productive facilities
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200411 Traditional Statement Costs are grouped by functional classifications - such as: –Production, –Selling & Administration With both fixed and variable costs being included in each category.
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Sales$xxx COGS(xx) Gross Margin$xxx Selling Exp.(xx) Net Income $xxx Admin. Exp(xx) Production FC & VC Selling FC & VC Administrative FC & VC
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200413 Contribution Format The focus of the contribution format income statement is the contribution margin... Contribution Margin = Net Sales - Variable Costs
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200414 Contribution Format I/S Groups costs by behavior: –Fixed, and –Variable Rather than into the functional categories of production, marketing and administration.
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Sales$xxx Variable Costs(xx) Cont. Margin$xxx Fixed Costs(xx) Net Income $xxx
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Income Statements... Sales$xxx COGS(xx) Gross Margin$xxx Operating Exp(xx) TraditionalContribution Format Net Income $xxx Sales$xxx Variable Costs(xx) Cont. Margin$xxx Fixed Costs(xx) Net Income $xxx
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Sourdough Alaska, Inc. Sales $900,000 Cost of Sales Direct Materials $100,000 Direct Labor 160,000 Mfg. Overhead 100,000 361,000 VC=$55,000 FC=$45,000 Marketing Costs Variable 18,000 Fixed 82,000 100,000 Admin. Costs (Fixed) $150,000
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Sourdough Alaska, Inc. Traditional Income Statement For Year Ended December 31, 2002 Sourdough Alaska, Inc. Traditional Income Statement For Year Ended December 31, 2002 Sales $900,000 100% Cost of Sales Direct Materials $100,000 Direct Labor 160,000 Mfg. Overhead 100,000 360,000 40% Gross Margin $540,000 60% Marketing/Admin Costs Marketing Costs $100,000 Administrative Costs 150,000 250,000 Net Income $290,000
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200419 What if... You were asked to project the effect on net income of: –A 20% increase in sales volume; –With no change in selling prices. How would you go about doing it?
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Sourdough Alaska, Inc. Contribution Format Income Statement For Year Ended December 31, 2002 Sourdough Alaska, Inc. Contribution Format Income Statement For Year Ended December 31, 2002 Sales $900,000 100% Cost of Sales Direct Materials $100,000 Direct Labor 160,000 Mfg. Overhead 55,000 Variable Mkt. Exp 18,000 $333,000 37% Contribution Martin $567,000 63% Fixed Costs Manufacturing 45,000 Marketing 82,000 Administrative 150,000 277,000 Net Income $290,000
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200421 NOW... What if... You were asked to project the effect on net income of: –A 20% increase in sales volume; –With no change in selling prices. How would you go about doing it?
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Sourdough Alaska, Inc. Projected Increase in Net Income For Year Ended December 31, 2002 Sourdough Alaska, Inc. Projected Increase in Net Income For Year Ended December 31, 2002 Sales ($900,000 x 120%) $1,080,000 Contribution Margin 688,400 Projected Net Income 403,400 Less: VC: ($333,000 x 120%) 399,600 Less: Fixed Costs 277,000 Less Original NI Projection 290,000 Projected Increase in Net Income $113,400
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200423 2 Can be computed two ways: –The equation method –The contribution margin method Breakeven Analysis
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200424 2 Can be computed in two forms: Breakeven Analysis –Number of units required to break even; or –Sales dollars required to break even.
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The Equation Method Exhaustion Unlimited – An Illustration
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200426 Exhaustion Unlimited Exhaustion Unlimited makes and distributes high end exercise equipment. One of their best selling products is an exercise bike – Model IMATRD-1
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Per BikePercent SP$500100% VC30060% CM$20040% Fixed Costs = $80,000
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The equation method centers on the contribution approach to the income statement. Sales$xxx Variable Costs(xx) Contribution Margin$xxx Fixed Costs(xx) Net Operating Income$xxx
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At breakeven profit = 0 The equation becomes:
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Use our BE Equation; and Let X = BE Point in Bikes Sales = VC + FC $500X = $300X + $80,000 $200X = $80,000 X = 400 Bikes Sales FCVC
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Use our BE Equation; and Let X = BE Point in Sales $ Sales = VC + FC 1X =.6X + $80,000.4X = $80,000 X = $200,000 Sales FCVC
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Exhaustion Unlimited Income Statement For Year Ended 12/31/01 Sales (400 x $500)$200,000 VC (400 x $300)120,000 CM$80,000 FC80,000 Net Income$-0-
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The Unit Contribution Method Exhaustion Unlimited – An Illustration
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200434 Unit-Contribution Method Is a variation of the equation method. The method may be just a bit more intuitive than the equation method.
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200435 The approach centers on the idea that each unit sold provides a certain amount of CM that goes toward covering fixed costs. Unit-Contribution Method
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200436 The Formula... Unit-Contribution Method Fixed Expenses =BEP Unit Contribution Margin
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Fixed Costs Unit CM BEP in Units
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Fixed Costs CM % BEP in $
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200439 Unit Contribution Method Let’s look at a series of income statements that graphically point out the concept of a contribution margin.
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Exhaustion Unlimited Income Statement 1 Bike2 Bikes400 Bikes401 Bikes Sales$500$1,000$200,000$200,500 VC300600120,000$120,300 CM$200$400$80,000$80,200 FC80,000 NI($79,800)($79,600)$-0-$200
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Break-Even Analysis Target Net Profit Analysis
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200442 Target Net Profit Analysis A firm’s targeted NI is the amount of income the firm wishes to make... –Pre-Tax OI; or –After-Tax NI
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200443 Target Net Profit Analysis Recall the BE formula:
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200444 Target Net Profit Analysis Using data from Exhaustion Unlimited. Assume the firm wants to make a before-tax profit of $40,000.
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Per BikePercent SP$500100% VC30060% CM$20040% Fixed Costs = $80,000
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Use our BE Equation; and Let X = BE Point in Bikes Sales = VC + FC + Profits $500X = $300X + $80,000 + $40,000 $200X = $120,000 X = 600 Bikes Sales FCVC Desired Profit
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Use our BE Equation; and Let X = BE Point in Sales $ Sales = VC + FC + Profits 1X =.6X + $80,000 + $40,000.4X = $12,000 X = $300,000 Sales FCVC Desired Profit
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Exhaustion Unlimited Income Statement For Year Ended 12/31/01 Sales (600 x $500)$300,000 VC (600 x $300)180,000 CM$120,000 FC80,000 Net Income$40,000
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Target Before-Tax Profit Analysis The Unit Contribution Method
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200450 The Formula... Unit-Contribution Method Fixed Expenses =BEP Unit Contribution Margin Add Targeted Before-Tax OI (TI) to the Fixed Expenses Fixed Expenses +TI =BEP Unit Contribution Margin Add Targeted Before-Tax OI (TI) to the Fixed Expenses
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Fixed Costs Unit CM BEP in Units Desired BT OI (TI)
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Fixed Costs CM % BEP in $ Desired BT OI
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Target Net Profit Analysis What About Taxes?
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The equation becomes: Remember this? Profit = Taxes At breakeven profit = 0
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200455 Tax Effects...
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200456 Net Income OI = ------------------ (1 – TR) This, then, is our handy-dandy formula to calculate an after- tax net income (ATNI).
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200457 Target Net Profit Analysis Back to Exhaustion Unlimited Assume management wants $40,000 after taxes Tax Rate = 30%
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Sales = VC + FC + ATNI SalesFC VC Targeted ATNI
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Sales = VC + FC + ATNI Bikes
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200461 Limiting Assumptions CVP assumes a linear revenue and cost function. CVP analysis assumes a relevant range. CVP assumes that production equals sales.
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Dr. Fred BarbeeACCT 202 - UAA - Fall 200462 Limiting Assumptions Sales mix remains constant. Sales prices and costs are known with certainty.
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