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CHAPTER 4CHAPTER 4CHAPTER 4CHAPTER 4
Cost-Volume-Profit AnalysisCost-Volume-Profit Analysis
Variable Costs
Fixed Costs
Mixed Costs
Step Costs
Common Cost Behavior Patterns
Common Cost Behavior Patterns
Variable CostsVariable Costs
Costs that change in proportion to changes in volume or activity
At restaurants, food costs vary with the number of customers served
For airlines, fuel costs vary with the number of miles flown
Example Activity increases by 10% Cost increases by 10%
Variable CostsVariable Costs
Fixed CostsFixed Costs
Do not change in response to changes in activity level Typical fixed costs are depreciation,
supervisory salaries, and building maintentance
Example Activity increases by 10% Costs remain unchanged
Fixed CostsFixed Costs
Fixed CostsFixed Costs
Discretionary Fixed Costs Management can easily change Advertising, Research and
Development
Committed Fixed Costs Cannot be easily changed Rent, Insurance
Fixed CostsFixed Costs
Mixed CostsMixed Costs
Contain variable and fixed cost elements
Example Salesperson with base salary (fixed) Receives commission on sales
(variable)
Mixed CostsMixed Costs
Step CostsStep Costs
Fixed cost for a specific range
Increases to higher level when upper bound of range is exceeded
Example Company adds third production shift Costs increase to include supervisory
costs
Step CostsStep Costs
Direct LaborDirect Labor
Cost Estimation MethodsCost Estimation Methods
Account Analysis
Scattergraphs
High-Low Method
Regression Analysis
Account AnalysisAccount Analysis
Most common approach
Requires professional judgment of management
Management classifies costs as fixed and variable
Account AnalysisAccount Analysis
Costs are then estimated Variable cost per unit Total fixed costs
Account AnalysisAccount Analysis
Estimates used to find total production costs at various production levels
ScattergraphsScattergraphs
Utilization of cost information from previous periods
Weekly, monthly, or quarterly cost reports
Plot the costs at specific activity levels
ScattergraphsScattergraphs
High-Low MethodHigh-Low Method
Utilization of cost information from previous periods
Connect straight line from lowest activity level to highest activity level
High-Low MethodHigh-Low Method
High-Low MethodHigh-Low Method
Cost Estimations Variable cost equals the slope of the
line Fixed cost equals the intercept of
cost axis
Estimates used to find total production costs at various production levels
Regression AnalysisRegression Analysis
Statistical technique
Estimates the slope and intercept of a cost equation
Typically spreadsheet programs are utilized
Regression AnalysisRegression Analysis
The Relevant RangeThe Relevant Range
Limitation of estimates
Accuracy expected only for production levels within range
Difficult to assess costs outside the relevant range
The Relevant RangeThe Relevant Range
Cost-Volume-Profit AnalysisCost-Volume-Profit Analysis
Equation Abbreviations
x = Quantity of units produced and sold
SP = Selling price per unit VC = Variable cost per unitTFC = Total fixed cost
Cost-Volume-Profit AnalysisCost-Volume-Profit Analysis
The Profit Equation
Profit = SP(x) – VC(x) – TFC
Fundamental to CVP analysis
Cost-Volume-Profit AnalysisCost-Volume-Profit Analysis
Break-Even Point Number of units sold that allow the
company to neither a profit nor a loss
$0 = SP(x) – VC(x) – TFC
Margin of Safety Difference between expected sales
and break-even sales
Break-Even PointBreak-Even Point
Cost-Volume-Profit AnalysisCost-Volume-Profit Analysis
Contribution Margin (CM) Difference between selling price
and variable cost per unit
Profit = (SP – VC)(x) – TFC
OR
Profit = CM per unit(x) - TFC
Cost-Volume-Profit AnalysisCost-Volume-Profit Analysis
Contribution Margin Ratio Contribution of every sales dollar to
covering fixed cost
CM Ratio = SP – VC SP
Profit Equation (utilizing CM Ratio)
Sales($) = Profit + TFC CM Ratio
Cost-Volume-Profit AnalysisCost-Volume-Profit Analysis
“What If” Analysis Utilize profit equation to determine
impact of managerial decisions
Change in Fixed and Variable Costs
Change in Selling Price
Cost-Volume-Profit AnalysisCost-Volume-Profit Analysis
Taxes in CVP Analysis Profit Formula without Tax
Considerations
Before Tax Profit = SP(x) – VC(x) – TFC
Profit Formula with Tax Considerations
After Tax Profit = [SP(x) – VC(x) – TFC](1-t)
Break-EvenBreak-Even
Gabby’s Wedding Cakes creates elaborate wedding cakes. Each cake sells for $500. The variable cost of baking the cakes is $200 and the fixed cost per month is $6,000
1. Calculate the break-even point for a month.
2. How many cakes must be sold to earn a monthly profit of $9,000?
Break-Even Pointx = (Profit + TFC) / CM per Unitx = ($0 + $6,000) / $300x = 20 cakes
What if monthly profit is $9,000?x = ($9,000 + $6,000) / $300x = 50 cakes
Multiproduct AnalysisMultiproduct Analysis
Contribution Margin Approach Used if products are similar
Identify number of units needed to be sold to break even
Calculate weighted average contribution margin based on expected units sold
Multiproduct AnalysisMultiproduct Analysis
Contribution Margin Ratio Approach Products are substantially different
Identify dollar amount of sales needed to break even
Calculate total CM Ratio and use to determine break-even point
Assumptions in CVP Analysis
Assumptions in CVP Analysis
Costs can be accurately separated into fixed and variable components
Fixed costs remain fixed
Variable costs per unit do not change
Operating LeverageOperating Leverage
Level of fixed versus variable costs in a company
High level of fixed costs has a high operating leverage
Typically have large fluctuations in profit when sales fluctuate
OutsourcingOutsourcing
ConstraintsConstraints
Constraints on how many items can be produced
Shortage of space, equipment, or labor
Utilize contribution margin per unit to analyze situations
Decisions that Increase Sales or Production
Decisions that Increase Sales or Production
Rhetorix, Inc. produces stereo speakers. The selling price per pair of speakers is $800. The variable cost of production is $300 and the fixed cost per month is $50,000.
1. Calculate the contribution margin associated with a pair of speakers.
2. Calculate the contribution margin ratio for Rhetorix associated with a pair of speakers.
Contribution MarginCM = SP – VCCM = $800 - $300CM = $500
If the company sells five more speakers than planned, what is the expected effect on profit of selling the additional speakers?Expected Effect = $500 * 5 units = $2,500
Contribution Margin RatioCM Ratio = (SP – VC)/SP = ($800 - $300)/$800
= 62.5%
If the company has sales that are $5,000 higher than expected, what is the expected effect on profit?Expected Effect = 62.5% * $5,000 = $3,125
1. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Contribution Margin per unit is?a. $65b. $75c. $175d. $30
1. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Contribution margin per unit is?a. $65b. $75c. $175d. $30
2. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Break-Even Point is?
a. 1,000 units
b. 1,083 units
c. 2,000 units
d. None of these
2. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Break-Even Point is?
a. 1,000 units
b. 1,083 units
c. 2,000 units
d. None of these
3. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. The Margin of Safety is?a. $264,000b. $384,000c. $143,000d. $121,000
3. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. The Margin of Safety is?a. $264,000b. $384,000c. $143,000d. $121,000
4. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. What is profit expected to be?
Answer here: _________________
4. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. What is profit expected to be?
Answer here: $143,000
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