Week 6 Chapters 5 and 6

7/28/2019 Week 6 Chapters 5 and 6

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Cost-Volume-Profit Analyses


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Learning Objectives

After studying this chapter, you should be able to:

[1] Distinguish between variable and fixed costs.

[2] Explain the significance of the relevant range.

[3] Explain the concept of mixed costs.

[4] List the five components of cost-volume-profit analysis.

[5] Indicate what contribution margin is and how it can be expressed.

[6] Identify the three ways to determine the break-even point.

[7] Give the formulas for determining sales required to earn target netincome.

[8] Define margin of safety, and give the formulas for computing it.


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Mixed costs contains both variable and fixed costselements.

What is the behaviour of mixed costs? Changes in totalbut not proportionately with changes in the level ofactivity.

E.g. utility charge: Flat rate plus usage charge or rental


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Can we use mixed costs for CVP? Yes, but we mustseparate the fixed costs from the variable cost.

How do we do that? By an analysis known as High-lowmethod.

Step 1: Variable cost/unit=change in TC/(H-L ActivityLevel)

Step 2: Fixed cost= Total costs Total variable costs ateither high/low activity level answer is the same.

Equation :

Mixed costs = Fixed costs (Step2) + Vc per unit (Step1)


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Componentsof CVP

UnitSellingPrices

Variablecost per

unit

Totalfixedcosts

Salesmix

Level ofActivity


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Behavior of both costs and revenues is linear throughout

the relevant range of the activity index.

All costs can be classified as either variable or fixed with

reasonable accuracy.

Changes in activity are the only factors that affect costs.

All units produced are sold.

When more than one type of product is sold, the sales mix

will remain constant.


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For internal use only

Classifies costs as variable and expenses so as to showCM and then net income. Example below:


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Revenue remainingafter deductingvariable costs

ContributionMargin(CM)

CM per unit= USP-UVC

CM ratio= CM perunit / USP

Method


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BreakEven

Analysis

Net Income = Zero

Total costs=Totalrevenue

CM=FixedCosts


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1. Mathematical Equation:

SP(x)= VC(x) +F C + NI : Net Income=Zero

X= units: $$$= units x selling price(SP)

2. CM technique:

Break even in units= FC + NI/ CM per unit Break even in dollars= FC + NI / CM ratio

3. Graphic Presentation page 217 5th edition


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What is it? Is a tool to help management understand howfar sales could change before company start operating ata net loss.

How do you calculate it:

MOS in dollars= Actual(expected) sales- BE Sales

MOS ratio= MOS in dollars / Actual (exp.) sales

The higher the sales dollars or percentages, the greaterthe MOS


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Learning Objectives

After studying this chapter, you should be able to:

[1] Describe the essential features of a cost-volume-profit income

statement.

[2] Apply basic CVP concepts.

[3] Explain the term sales mix and its effects on break-even sales.

[4] Determine sales mix when a company has limited resources.

[5] Understand how operating leverage affects profitability.


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Sales mix is the relative proportion in which the company sellsits products.

If a companys unit sales are 80% printers and 20%

computers, its sales mix is 80% to 20%. Sales mix is important because different products often

have very different contribution margins.

Breakeven in $$ Breakeven in Units


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Looking at the Formula You are to gather two pieces of information:Step 1: Fixed Costs = Fixed costs of MOH +Fixed Costs Periodexpenses

Step 2: Calculate Weighted Average Unit CM= ((USP-UVC prdA )x

(Sales prdA/Total Sales) ) + ((USP-UVC prdB )x (Sales prdB /TotalSales)


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After you receive TOTAL Break-even point in Units THENyou calculate Break-even point in units per product.

HOW?

1. Total Break-even units x Sales mix % Prd A= BEUnits

Prd A

2. Total Break-even units x Sales mix %Prd B= BEUnitsPrd B


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The calculation of break-even point in units workswell if the company has only a few products Butwhat if there is a large quantity of products?

When there are many products, calculate the break-even point in terms of sales dollars fordivisions or

productlines, NOTindividual products.


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Step one: Fixed costs

Step two: Calculate: Weighted-Average CM Ratio

Illustration 6-16


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Here we consider the Sales Dollars ($$$)

CM Ratio = (Sales Dollars- V. costs Dollars) / SalesDollars

Sales Mix Percentage: Total Sales Revenue Dollars /

Prdx Sales Revenue

Relationship between products and Net Income?

Greater if more higher-contribution margin units are soldthan lower-contribution margin units.

Illustration 6-16


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All companies have limited resourceswhether it be floor

space, raw materials, direct labor hours, etc.

Limited resources force management to decide whichproducts to sell to maximize net income.

To determine the appropriate sales mix, compute thecontribution margin per unit of limited resource:

Product with the higher CM per unit of Limited resource

will be the product managemt should produce more of.


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What is Cost structure? Cost Structure is the relative

proportion of fixed versus variable costs that a companyincurs.

Why is it important?

1. It has an Effect on CM Ratio

It has an Effect on Break-even point in Dollars


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What is Operating leverage? It refers to the extent that

net income reacts to a given change in sales. What is the effect on income levels?

Higher fixed costs relative to variable costs causea company to have higher operating leverage.

When sales revenues are increasing, highoperating leverage means that profits will increaserapidly a good thing.

When sales revenues are declining, too muchoperating leverage can have devastatingconsequences.


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New Waves earnings would go up (or down) by

about two times (5.33 2.67 = 1.99) as much asVargos with an equal increase in sales.

Illustration 6-25


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Announcement:

MST details are on Moodle.

TUESDAY 23/04/2013 at 4pm Fiji time Venue: Contact your respective SAS at the earliest.

Assignment due Tuesday April 9th 2013.

Documents

Week 6 Chapters 5 and 6