chapter 19: cost-volume-profit analysis questions addressed by cost-volume-profit analysis cost...
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• Chapter 19: Cost-Volume-Profit Analysis• Questions Addressed by Cost-Volume-Profit
Analysis• Cost Behavior• Variable Cost• Fixed Cost• Mixed Costs• High-low Method
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• 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
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• 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?
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Sales Mix ConsiderationsChapter
19
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Sales Mix Considerations
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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 70 95 Contribution margin $ 20 $ 45 Sales mix 80% 20%
Products A B
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Sales $ 90 $140 Variable costs 70 95 Contribution margin $ 20 $ 45 Sales mix 80% 20%
Sales Mix ConsiderationsSales Mix Considerations Sales Mix ConsiderationsSales Mix Considerations
Products A B
Product contribution margin $16 $ 9
$25
Fixed costs, $200,000Fixed costs, $200,000
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Sales Mix ConsiderationsSales Mix Considerations Sales Mix ConsiderationsSales Mix Considerations
Products A BProduct contribution
margin $16 $ 9
$25
Break-even sales unitsBreak-even sales units
$200,000
$25
Fixed costs, $200,000Fixed costs, $200,000
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Sales Mix ConsiderationsSales Mix Considerations Sales Mix ConsiderationsSales Mix Considerations
Products A BProduct contribution
margin $16 $ 9
$25
Break-even sales unitsBreak-even sales units
$200,000
$25
Fixed costs, $200,000Fixed costs, $200,000
= 8,000 units
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Sales Mix ConsiderationsSales Mix Considerations Sales Mix ConsiderationsSales Mix Considerations
Products A BProduct contribution
margin $16 $ 9
$25
A:A: 8,000 units x Sales Mix (80%) = 6,400
B:B: 8,000 units x Sales Mix (20%) = 1,600
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PROOFPROOF
Product A Product B Total
Sales:6,400 units x $90 $576,000 $576,0001,600 units x $140 $224,000 224,000Total sales $576,000 $224,000 $800,000
Variable costs:6,400 x $70 $448,000 $448,0001,600 x $95 $152,000 152,000Total variable costs $448,000 $152,000 $600,000
Contribution margin $128,000 $ 72,000 $200,000
Fixed costs 200,000Income from operations $ 0Break-even point
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Margin of Safety
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Margin of Safety =Sales – Sales at break-even point
Sales
The margin of safety indicates the possible decrease in sales that may occur
before an operating loss results.
Margin of Safety =$250,000 – $200,000
$250,000
Margin of Safety = 20%
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Operating LeverageOperating Leverage
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Both companies have the same contribution margin.Both companies have the same contribution margin.
Operating LeverageOperating Leverage
Jones Inc. Wilson Inc.
Contribution margin
Income from operations
Sales $400,000 $400,000Variable costs 300,000 300,000Contribution margin $100,000 $100,000Fixed costs 80,000 50,000Income from operations $ 20,000 $ 50,000Contribution margin ? ?
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Contribution margin
Income from operations
Jones Inc. Wilson Inc.
$100,000
$20,000= 5.0 Jones Inc.:
Operating LeverageOperating Leverage
5.0
Sales $400,000 $400,000Variable costs 300,000 300,000Contribution margin $100,000 $100,000Fixed costs 80,000 50,000Income from operations $ 20,000 $ 50,000Contribution margin ?
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Contribution margin
Income from operations
Jones Inc. Wilson Inc.
= 5.0
$100,000
$20,000Jones Inc.
Operating LeverageOperating Leverage
Sales $400,000 $400,000Variable costs 300,000 300,000Contribution margin $100,000 $100,000Fixed costs 80,000 50,000Income from operations $ 20,000 $ 50,000Contribution margin 5.0 ?
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Contribution margin
Income from operations
Jones Inc. Wilson Inc.
= 2.0$100,000Wilson Inc.:
Capitalintensive?
Laborintensive?
2.0
Operating LeverageOperating Leverage
Sales $400,000 $400,000Variable costs 300,000 300,000Contribution margin $100,000 $100,000Fixed costs 80,000 50,000Income from operations $ 20,000 $ 50,000Contribution margin 5.0
$50,000
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Assumptions of Cost-Volume-Profit AnalysisAssumptions of Cost-Volume-Profit AnalysisAssumptions of Cost-Volume-Profit AnalysisAssumptions of Cost-Volume-Profit Analysis
1. Total sales and total costs can be represented by straight lines.
2. Within the relevant range of operating activity, the efficiency of operations does not change.
3. Costs can be accurately divided into fixed and variable components.
4. The sales mix is constant.5. There is no change in the inventory quantities
during the period.
The reliability of cost-volume-profit analysis depends upon several assumptions.
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Business Applications of CVP
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Total Per Unit PercentSales (500 bikes) 250,000$ 500$ 100%Less: variable expenses 150,000 300 60%Contribution margin 100,000$ 200$ 40%
Less: fixed expenses 80,000 Operating income 20,000$
Business Applications of CVP
Consider the following information developed by the accountant at CyclCo, a bicycle retailer:
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Business Applications of CVP
Should CyclCo spend $12,000 on advertising to increase sales by 10 percent?
Total Per Unit PercentSales (500 bikes) 250,000$ 500$ 100%Less: variable expenses 150,000 300 60%Contribution margin 100,000$ 200$ 40%
Less: fixed expenses 80,000 Operating income 20,000$
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500 550Bikes Bikes
Sales 250,000$ 275,000$ Less: variable expenses 150,000 165,000 Contribution margin 100,000$ 110,000$ Less: fixed expenses 80,000 92,000 Operating income 20,000$ 18,000$
550 × $300
$80K + $12K
No, income is decreased.
550 × $500
Business Applications of CVP
Should CyclCo spend $12,000 on advertising to increase sales by 10 percent?
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500Bikes
Sales 250,000$ Less: variable expenses 150,000 Contribution margin 100,000$ Less: fixed expenses 80,000 Operating income 20,000$
Now, in combination with the advertising, CyclCo is considering a 10 percent price reduction that willincrease sales by 25 percent. What is the income effect?
Business Applications of CVP
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500 625Bikes Bikes
Sales 250,000$ 281,250$ Less: variable expenses 150,000 187,500 Contribution margin 100,000$ 93,750$ Less: fixed expenses 80,000 92,000 Operating income 20,000$ 1,750$
625 × $300
$80K + $12K
Income is decreased even more.
625 × $450
Now, in combination with the advertising, CyclCo is considering a 10 percent price reduction that willincrease sales by 25 percent. What is the income effect?
1.25 × 500
Business Applications of CVP
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500Bikes
Sales 250,000$ Less: variable expenses 150,000 Contribution margin 100,000$ Less: fixed expenses 80,000 Operating income 20,000$
Business Applications of CVPNow, in combination with advertising and a price cut, CyclCo
will replace $50,000 in sales salaries with a $25 per bike commission, increasing sales by 50 percent above the
original 500 bikes. What is the effect on income?
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500 750Bikes Bikes
Sales 250,000$ 337,500$ Less: variable expenses 150,000 243,750 Contribution margin 100,000$ 93,750$ Less: fixed expenses 80,000 42,000 Operating income 20,000$ 51,750$
The combination of advertising, a price cut,and change in compensation increases income.
750 × $325
$92K - $50K
750 × $450
Business Applications of CVPNow, in combination with advertising and a price cut, CyclCo
will replace $50,000 in sales salaries with a $25 per bike commission, increasing sales by 50 percent above the
original 500 bikes. What is the effect on income?
1.5 × 500
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Different products with different contribution margins.
Determining semivariablecost elements.
Complying with theassumptions of CVP analysis.
Additional Considerations in CVP
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CVP Analysis When a Company Sells Many Products
Sales mix is the relative combination in whicha company’s different products are sold.
Different products have different selling prices, costs, and contribution margins.
If CyclCo sells bikes and carts, howwill we deal with break-even analysis?
Sales mix is the relative combination in whicha company’s different products are sold.
Different products have different selling prices, costs, and contribution margins.
If CyclCo sells bikes and carts, howwill we deal with break-even analysis?
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CVP Analysis When a Company Sells Many Products
CyclCo provides us with the following information:
Bikes Carts TotalSales 250,000$ 100% 300,000$ 100% 550,000$ 100%Var. exp. 150,000 60% 135,000 45% 285,000 52%Contrib. margin 100,000$ 40% 165,000$ 55% 265,000$ 48%
Fixed exp. 170,000 Net income 95,000$
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CVP Analysis When a Company Sells Many Products
The overall contribution margin ratio is:
$265,000 $550,000
= 48% (rounded)
Bikes Carts TotalSales 250,000$ 100% 300,000$ 100% 550,000$ 100%Var. exp. 150,000 60% 135,000 45% 285,000 52%Contrib. margin 100,000$ 40% 165,000$ 55% 265,000$ 48%
Fixed exp. 170,000 Net income 95,000$
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CVP Analysis When a Company Sells Many ProductsBreak-even in sales dollars is:
$170,000 .48
= $354,167 (rounded)
Bikes Carts TotalSales 250,000$ 100% 300,000$ 100% 550,000$ 100%Var. exp. 150,000 60% 135,000 45% 285,000 52%Contrib. margin 100,000$ 40% 165,000$ 55% 265,000$ 48%
Fixed exp. 170,000 Operating income 95,000$
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The High-Low MethodOwlCo 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.
Units Cost
High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$
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Units Cost
High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$
Unit variable cost = = = $0.90 per unitin cost
in units$3,600 4,000
The High-Low Method
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Units Cost
High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$
Unit variable cost = = = $0.90 per unit
Fixed cost = Total cost – Total variable cost
in costin units
$3,600 4,000
The High-Low Method
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Units Cost
High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$
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 costin units
$3,600 4,000
The High-Low Method
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Units Cost
High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$
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 costin units
$3,600 4,000
The High-Low Method
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The High-Low MethodQuestion 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 unitb. $.10 per unit c. $.12 per unitd. $.125 per unit
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 unitb. $.10 per unit c. $.12 per unitd. $.125 per unit
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The High-Low MethodQuestion 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 unitb. $.10 per unit c. $.12 per unitd. $.125 per unit
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 unitb. $.10 per unit c. $.12 per unitd. $.125 per unit
$4,000 ÷ 40,000 units = $.10 per unit
Units Cost
High level 120,000 14,000$Low level 80,000 10,000 Change 40,000 4,000$
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The High-Low MethodQuestion 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. $ 2,000b. $ 4,000 c. $10,000d. $12,000
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. $ 2,000b. $ 4,000 c. $10,000d. $12,000
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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
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
Total cost = Total fixed cost + Total variable cost
$14,000 = Total fixed cost +($.10 × 120,000 units)
Total fixed cost = $14,000 - $12,000
Total fixed cost = $2,000
The High-Low MethodQuestion 2
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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).
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End of Chapter 19