CHAPTER 2 Analyzing CostVolume Profit Relationships Learning Objective

CHAPTER 2 Analyzing Cost-Volume. Profit Relationships

Learning Objective 1 Understand the key factors involved in cost-volumeprofit (C-V-P) analysis and why it is such an important tool in management decision making.

CVP - What Questions Does It Answer?

CVP Key Variables ä ä ä ä Revenues – Price x Quantity Fixed costs – Independent of volume Variable costs – Dependent upon volume Volume – Level of activity Product mix – Different products Efficiency & quality of production Combinations of above

Learning Objective 2 Explain and analyze the basic cost behavior patterns—variable, fixed, mixed, and stepped.

What are Variable Costs? Total Cost Units Produced

Define Relevant Range and Curvilinear Costs Relevant range: Curvilinear costs:

Define Fixed Costs Total Cost Units Produced

Fixed Costs are Used to Calculate Break-Even What does break-even mean? What is the formula for break-even?

Define Stepped Costs

Define Mixed Costs Variable Cost Fixed Production Volume

Learning Objective 3 Analyze mixed costs using the scattergraph and high-low methods.

What is the Scattergraph (Visual. Fit) Method? Cost Regression Line Volume of Activity

Scattergraph (Visual-Fit) Variable costs per unit are equal to the slope of the regression line. Cost Fixed costs are represented by the intersection of the regression Variable line and the Costs vertical axis. Fixed Costs Volume of Activity

Define the High-Low Method

High-Low Method Cost Step 1: Volume of Activity

High-Low Method Cost Step 2: Volume of Activity

High-Low Method Step 3: Cost Rise Run Volume of Activity = Variable Cost per Unit

High-Low Method Step 4:

Learning Objective 4 Perform C-V-P analyses, and describe the effects potential changes in C-V-P variables have on company profitability.

Contribution Margin Approach Contribution margin is the portion of sales revenue available to cover fixed costs and provide a profit. – = Sales revenue Variable costs Contribution margin Fixed costs Profit

Contribution Margin Approach If a computer sells for $2, 000 with variable costs of $800 per computer and fixed costs of $350, 000 per year: What is the total contribution margin on 500 computers?

Contribution Margin Approach If a computer sells for $2, 000 with variable costs of $800 per computer and fixed costs of $350, 000 per year: What is the total contribution margin on 500 computers? What is the contribution margin per unit?

Contribution Margin Approach If a computer sells for $2, 000 with variable costs of $800 per computer and fixed costs of $350, 000 per year: What is the total contribution margin on 500 computers? What is the contribution margin per unit? What is the contribution margin ratio?

Contribution Margin Approach If a computer sells for $2, 000 with $800 variable costs per computer and $350, 000 fixed costs per year: What is the total contribution margin on 500 computers? What is the contribution margin per unit? What is the contribution margin ratio? What is the total dollar profit after one year?

The Break-Even Point Sales price x units Variable cost x units Independent of units Target Income Example: How many computers will the store have to sell in order to break even if one computer sells for $2, 000, costs $800 to make (variable cost), and fixed costs are $350, 000?

Multiple Variable Changes Sales price x units Variable cost x units Costs independent of units OR OR etc. Zero for break-even

Multiple Variable Changes Assume prior year profits of $250, 000 for The Store. This year the price of our $2, 000 computers is reduced by 15 percent due to a decrease in variable costs from $800 to $700 per computer and a decrease in fixed costs from $350, 000 to $325, 000. What would be the effect on target income (or profit) assuming the production of 500 computers?

Learning Objective 5 Visualize C-V-P relationships using graphs.

The Graphic Approach Identify the Break-Even Point, Revenue Line, Total Cost Line, and Fixed Costs Revenue & Cost Number of Computers Sold

Learning Objective 6 Identify the limiting assumptions of C-V-P analysis, and explain the issues of quality and time relative to C-V-P analysis decisions.

What are the Limiting Assumptions of C-V-P Analysis?

How Do Quality & Time Affect C-V-P Decisions?

Expanded Material Learning Objective 7 Analyze mixed costs using the least squares method.

Identify the Parts of the Least Squares Method Equation

Least Squares Method For Example: Month Jan. Feb. Mar. April May Computers Produced 500 800 650 1, 000 450 Total Cost $ 750, 000 900, 000 600, 000 1, 100, 000 420, 000 Using least squares regression output: a = Y-intercept b = slope = total fixed costs = variable cost rate = $49, 211. 82 = $ 1, 036. 45

Expanded Material Learning Objective 8 Explain the effects of sales mix on profitability.

Sales Mix Can Openers Amount % Sales revenue $5, 000 100% Less variable costs 3, 000 60% Contribution margin $2, 000 40% Sales mix Microwaves Amount % $25, 000 100% 20, 000 80% $ 5, 000 20% 17% Product Revenue Total Revenue 83% = 5, 000 30, 000 Total Amount % $30, 000 100% 23, 000 77% $ 7, 000 23% 100% = 17%

Sales Mix To maximize profit in a company with multiple products, management should emphasize products with the highest contribution margin ratio. Which product should they choose? Can Openers Amount % Sales revenue $5, 000 100% Less variable costs 3, 000 60% Contribution margin $2, 000 40% Sales mix 17% Microwaves Amount % $25, 000 100% 20, 000 80% $ 5, 000 20% 83% Total Amount % $30, 000 23, 000 $ 7, 000 100% 77% 23% 100%

Expanded Material Learning Objective 9 Describe how fixed and variable costs differ in manufacturing, service, merchandising, and ecommerce organizations, and illustrate these differences with the operating leverage concept.

Define Operating Leverage

Operating Leverage For example: Assume the following data. Sales revenue Less variable costs Contribution margin Less fixed costs Net income Total $1, 000 400, 000 $ 600, 000 450, 000 $ 150, 000 Per Unit $2, 000 800 $1, 200 Ratio 100% 40% 60% What is the operating leverage? Operating leverage = What happens to net income if sales are increased by 20 percent? Net income increases Decrease fixed costs to $300, 000. Operating leverage = What is the operating leverage (no sales increase)? Now what happens to net income if Net income increases sales are increased by 20 percent?

Chapter 2 of Managerial Accounting is Completed