1. Previous Lecture Chapter 19: Cost-Volume-Profit Analysis
Questions Addressed by Cost-Volume-Profit Analysis
Cost Behavior
Variable Cost
Fixed Cost
Mixed Costs
High-low Method

2. Previous Lecture Stair-Step Costs Curvilinear Costs
Cost Behavior Summary
Cost-Volume-Profit Relationships
Contribution Margin Income Statement
Contribution Margin Ratio
Cost-Volume-Profit (CVP) Analysis
Computing Break-Even Point

3. Previous Lecture
Formula for Computing Break-Even Sales in Units & In Dollar
Preparing a CVP Graph
Computing Sales Needed to Achieve Target Operating Income
What is our Margin of Safety?
What Change in Operating Income Do We Anticipate?

4. Sales Mix Considerations
Chapter 19 2

5. Sales Mix Considerations

6. Cascade Company sold 8,000 units of Product A and 2,000 units of Product B during the past year. Cascade Company’s fixed costs are $200,000. Other relevant data are as follows:
Sales $ 90 $140
Variable costs
Contribution margin $ 20 $ 45
Sales mix 80% 20%
Products
A B

7. Sales Mix Considerations
Products
A B
Sales $ 90 $140
Variable costs
Contribution margin $ 20 $ 45
Sales mix 80% 20%
Product contribution
margin $16 $ 9
$25
Fixed costs, $200,000

8. Sales Mix Considerations
Products
A B
Product contribution
margin $16 $ 9
$25
Break-even sales units
$200,000
$25
Fixed costs, $200,000

9. Sales Mix Considerations
Products
A B
Product contribution
margin $16 $ 9
$25
Break-even sales units
$200,000
$25
= 8,000 units
Fixed costs, $200,000

10. Sales Mix Considerations
Products
A B
Product contribution
margin $16 $ 9
$25
A: 8,000 units x Sales Mix (80%) = 6,400
B: 8,000 units x Sales Mix (20%) = 1,600

11. Break-even point PROOF Product A Product B Total Sales:
6,400 units x $90 $576,000 $576,000
1,600 units x $140 $224, ,000
Total sales $576,000 $224,000 $800,000
Variable costs:
6,400 x $70 $448,000 $448,000
1,600 x $95 $152, ,000
Total variable costs $448,000 $152,000 $600,000
Contribution margin $128,000 $ 72,000 $200,000
Fixed costs ,000
Income from operations $
Break-even point
PROOF

12. Margin of Safety

13. Sales – Sales at break-even point
Margin of Safety =
Margin of Safety =
$250,000 – $200,000
$250,000
Margin of Safety = 20%
The margin of safety indicates the possible decrease in sales that may occur before an operating loss results.

14. Operating Leverage

15. Operating Leverage Contribution margin Income from operations
Jones Inc. Wilson Inc.
Sales $400,000 $400,000
Variable costs 300, ,000
Contribution margin $100,000 $100,000
Fixed costs , ,000
Income from operations $ 20,000 $ 50,000
Contribution margin ? ?
Both companies have the same contribution margin.
Contribution margin
Income from operations

16. Income from operations
Operating Leverage
Jones Inc. Wilson Inc.
Sales $400,000 $400,000
Variable costs 300, ,000
Contribution margin $100,000 $100,000
Fixed costs , ,000
Income from operations $ 20,000 $ 50,000
Contribution margin ?
5.0
Contribution margin
Income from operations
$100,000
Jones Inc.:
= 5.0
$20,000

17. Income from operations
Operating Leverage
Jones Inc. Wilson Inc.
Sales $400,000 $400,000
Variable costs 300, ,000
Contribution margin $100,000 $100,000
Fixed costs , ,000
Income from operations $ 20,000 $ 50,000
Contribution margin ?
$100,000
$20,000
Jones Inc.
Contribution margin
Income from operations
= 5.0

18. Income from operations
Operating Leverage
Jones Inc. Wilson Inc.
Sales $400,000 $400,000
Variable costs 300, ,000
Contribution margin $100,000 $100,000
Fixed costs , ,000
Income from operations $ 20,000 $ 50,000
Contribution margin 5.0
2.0
Capital
intensive?
Labor
intensive?
Contribution margin
Income from operations
$100,000
Wilson Inc.:
= 2.0
$50,000

19. Assumptions of Cost-Volume-Profit Analysis
The reliability of cost-volume-profit analysis depends upon several assumptions.
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.

20. Business Applications of CVP

21. Business Applications of CVP
Consider the following information developed by the accountant at CyclCo, a bicycle retailer:

22. Business Applications of CVP
Should CyclCo spend $12,000 on advertising to increase sales by 10 percent?

23. Business Applications of CVP
Should CyclCo spend $12,000 on advertising to increase sales by 10 percent?
550 × $500
550 × $300
$80K + $12K
No, income is decreased.

24. Business Applications of CVP
Now, in combination with the advertising, CyclCo is considering a 10 percent price reduction that will increase sales by 25 percent. What is the income effect?

25. Business Applications of CVP
Now, in combination with the advertising, CyclCo is considering a 10 percent price reduction that will increase sales by 25 percent. What is the income effect?
1.25 × 500
625 × $450
625 × $300
$80K + $12K
Income is decreased even more.

26. Business Applications of CVP
Now, in combination with advertising and a price cut, CyclCo will replace $50,000 in sales salaries with a $25 per bike commission, increasing sales by 50 percent above the original 500 bikes. What is the effect on income?

27. Business Applications of CVP
Now, in combination with advertising and a price cut, CyclCo will replace $50,000 in sales salaries with a $25 per bike commission, increasing sales by 50 percent above the original 500 bikes. What is the effect on income?
1.5 × 500
750 × $450
750 × $325
$92K - $50K
The combination of advertising, a price cut, and change in compensation increases income.

28. Additional Considerations in CVP
Different products with different contribution margins.
Determining semivariable cost elements.
Complying with the assumptions of CVP analysis.

29. CVP Analysis When a Company Sells Many Products
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.
If CyclCo sells bikes and carts, how will we deal with break-even analysis?

30. CVP Analysis When a Company Sells Many Products
CyclCo provides us with the following information:

31. CVP Analysis When a Company Sells Many Products
The overall contribution margin ratio is:
$265,000
$550,000
= 48% (rounded)

32. CVP Analysis When a Company Sells Many Products
Break-even in sales dollars is:
$170,000
.48
= $354,167 (rounded)

33. The High-Low Method
OwlCo recorded the following production activity and maintenance costs for two months:
Using these two levels of activity, compute:
the variable cost per unit.
the total fixed cost.
total cost formula.

34. The High-Low Method Unit variable cost = = = $0.90 per unit
in cost in units
$3,600 4,000

35. The High-Low Method
Unit variable cost = = = $0.90 per unit
Fixed cost = Total cost – Total variable cost
in cost in units
$3,600 4,000

36. The High-Low Method Unit variable cost = = = $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
in cost in units
$3,600 4,000

37. The High-Low Method in cost in units $3,600 4,000
Unit variable cost = = = $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 = $1,600 + $.90 per unit
in cost in units
$3,600 4,000

38. The High-Low Method Question 1
If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the variable portion of sales commission per unit sold?
a. $.08 per unit
b. $.10 per unit
c. $.12 per unit
d. $.125 per unit

39. The High-Low Method Question 1
If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the variable portion of sales commission per unit sold?
a. $.08 per unit
b. $.10 per unit
c. $.12 per unit
d. $.125 per unit
$4,000 ÷ 40,000 units = $.10 per unit

40. The High-Low Method Question 2
If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the fixed portion of the sales commission?
a. $ 2,000
b. $ 4,000
c. $10,000
d. $12,000

41. The High-Low Method Question 2
If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the fixed portion of the sales commission?
a. $ 2,000
b. $ 4,000
c. $10,000
d. $12,000

42. Assumptions Underlying CVP Analysis
A limited range of activity, called the relevant range, where CVP relationships are linear.
Unit selling price remains constant.
Unit variable costs remain constant.
Total fixed costs remain constant.
Sales mix remains constant.
Production = sales (no inventory changes).

43. End of Chapter 19