chapter 5 powerpoint
DESCRIPTION
lectureTRANSCRIPT
Slide 1PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 5
In order to analyze the relationship between costs-volume-profit, we must classify costs as
Variable
Fixed
increase as
activity increases.
Minutes Talked
Total Costs
C 1
Total variable costs increase as activity increases. For most people, the total land-line long distance telephone bill is based on the number of minutes talked. As such, there’s a direct relationship between the number of minutes talked and your total bill.
The cost per minute talked on your land-line is normally constant. For example, your service may charge five cents per minute. Talking more or less minutes will not change the per minute charge, so on a per unit basis, variable costs remain unchanged.
22 - *
C 1
We begin our study of cost behavior with fixed costs. Your basic land-line telephone has a monthly connect charge that remains constant regardless of the number of local calls that you might make. The monthly charge that is independent of call activity is a fixed cost.
Fixed costs per unit decline as activity increases. Dividing your monthly connect fee by more local calls reduces the cost per call by spreading the fixed amount over a higher number of calls. For example, if your monthly connect charge is $20 and you make 40 local calls in a month, your cost per local call is $0.50. If you make 100 local calls in a month, your cost per local call is $0.20.
22 - *
MIXED COSTS
Mixed costs contain a fixed portion that is incurred even when the facility is unused, and a variable portion that increases with
usage. Utilities typically behave in this manner.
C 1
Fixed Monthly
Utility Charge
Cost per KW
Activity (Kilowatt Hours)
Total Utility Cost
Total mixed cost
Mixed costs have both a fixed and variable component. For example, utility bills often contain fixed and variable cost components. The fixed portion of the utility bill is constant regardless of kilowatt hours consumed. This cost represents the minimum cost that is incurred to have the service ready and available for use. The variable portion of the bill varies in direct proportion to the consumption of kilowatt hours.
Here we see a graph with utility cost on the vertical axis and kilowatt hours on the horizontal axis. Notice that the fixed monthly charge is the same at all levels of kilowatt usage, even the zero level of usage. The variable cost, which rises as more kilowatt hours are used, is added to the fixed cost to obtain the total mixed cost.
22 - *
Outside the relevant range, cost behavior may be different.
All fixed costs are only fixed within a relevant range.
22 - *
Net Income= Total Sales – Total Costs
22 - *
Contribution margin is the amount by which revenue exceeds the variable costs of producing the revenue.
CONTRIBUTION MARGIN AND ITS MEASURES
Total contribution margin is $60,000 and the contribution margin per unit sold is $30.
A 1
In manufacturing companies, volume of activity usually refers to the number of units produced. We then classify a cost as either fixed or variable, depending on whether total cost changes as the number of units produced changes. Once we separate costs by behavior, we can then compute a product’s contribution margin.
We’re going to concentrate exclusively on the contribution format income statement for our break-even analysis. Contribution margin is the amount remaining after we deduct all our variable expenses from sales revenue. In this example, contribution margin can be expressed as a total amount, $60,000, or as an amount per unit, $30. Each unit sold contributes $30 toward covering Rydell’s fixed costs and providing for profits.
Sheet1
Total
Unit
Contribution margin per unit
Sales price per unit
The contribution margin ratio is equal to the unit contribution margin divided by the unit sales price. In this example, the contribution margin ratio is 30 percent, resulting from dividing the $30 per unit contribution margin by the $100 unit sales price.
Sheet1
Total
Unit
Based on the Illustration on page 5, determine the following:
Total Variable Cost
Based on the Illustration on page 5, determine the following:
Total Variable Cost ($34,000)
Total Fixed Cost ($14,000)
Contribution Margin per unit (16,000/500=$32 per Unit)
Contribution Margin Ratio (32/100=32%)
22 - *
BREAK-EVEN ANALYSIS
The break-even point (expressed in units of product or dollars of sales) is the unique sales level at which a company earns neither a profit nor incurs a loss.
A 1
Break-even analysis is a special case of cost-volume-profit analysis. The break-even point is the level of sales where a company’s income is exactly equal to zero. At break-even, total costs equal total revenues.
22 - *
($30 in previous example)
We have just seen one of the basic CVP relationships – the break-even computation.
COMPUTING THE BREAK-EVEN POINT
Contribution margin per unit
The results of the previous question can be expressed in equation form as seen on your screen. The break-even point in units is equal to total fixed costs divided by the unit contribution margin. Rydell’s fixed costs are $24,000 per month. Rydell breaks even for the month when it sells 800 footballs ($24,000 ÷ $30 per unit), using the formula on your screen.
22 - *
$52,500/6=8,750 units
Contribution Margin per unit (10-4=6)
22 - *
The break-even formula may also be expressed in sales dollars.
COMPUTING THE BREAK-EVEN POINT
Contribution margin ratio
The break-even point in sales dollars is equal to total fixed costs divided by the contribution margin ratio. The contribution margin ratio is equal to the unit contribution margin divided by the unit sales price. In the earlier example, the contribution margin ratio is 30 percent, resulting from dividing the $30 per unit contribution margin by the $100 unit sales price. You might want to refer back to the example to verify these numbers. The contribution margin ratio tells us that 30 cents of each sales dollar contributes to covering fixed costs and providing for income.
22 - *
Your Turn-Change in Selling Price
Find the break-even point in units and dollars for the illustration at the top of page 7
22 - *
FOR A TARGET INCOME
Break-even formulas may be adjusted to show the sales volume needed to earn any amount of income.
Unit sales =
Contribution margin per unit
Contribution margin ratio
C 2
We can adjust the break-even formulas that we used earlier to incorporate target pretax income. Recall that we calculated break-even by dividing fixed costs by contribution. When we incorporate pretax income, contribution must cover the fixed cost as well as provide for income. To adapt the break-even formulas for pretax income, we add the desired amount of pretax income to the numerator.
Let’s see if we can use these formulas to answer a question.
22 - *
Sales in Units for a target net income of $22,000?
(12,000+22,000)/2=17,000 units
22 - *
(12,000+22,000)/.4=$85,000
COMPUTING THE MARGIN OF SAFETY
Margin of safety is the amount by which sales can drop before the company incurs a loss.
C 2
Margin of Safety can be calculated in terms of a # of units or sales dollars.
The margin of safety is the excess of expected sales (or actual sales) over the break-even sales. It’s the amount by which expected sales can drop before the company begins to incur losses. We can also express the margin of safety as a percent of sales. The margin of safety percentage is equal to the margin of safety in dollars divided by the expected sales in dollars.
If Rydell’s sales are $100,000 and break-even sales are $80,000, what is the margin of safety percentage?
The margin of safety in dollars is equal to actual sales of $100,000 less the break-even sales of $80,000. The margin of safety percentage is equal to the $20,000 and actual sales are $100,000, so the margin of safety percentage is 20 percent ($20,000 divided by $100,000).
22 - *
Margin of Safety in units=Expected Sales in unit-Breakeven (units)
22 - *
Margin of Safety in Units
925-575=350 units
$4,162.50-2,587.50=$1,575
Constant Selling Price
Constant Total Fixed Cost
22 - *
22 - *
The CVP formulas can be modified for use when a company sells more than one product.
The unit contribution margin is replaced with the contribution margin for a composite unit.
A composite unit is composed of specific numbers of each product in proportion to the product sales mix.
Sales mix is the ratio of the volumes of the various products.
COMPUTING A MULTIPRODUCT
BREAK-EVEN POINT
P 4
To this point, we’ve assumed that a company sells a single product. We can extend the cost-volume-profit relationships to cover multiproduct companies. Instead of unit contribution margin for one unit, we will have a composite unit contribution for all units. The composite unit contribution margin is dependent on the sales mix of the products sold.
22 - *
Less: Variable costs140,000 70
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 5
In order to analyze the relationship between costs-volume-profit, we must classify costs as
Variable
Fixed
increase as
activity increases.
Minutes Talked
Total Costs
C 1
Total variable costs increase as activity increases. For most people, the total land-line long distance telephone bill is based on the number of minutes talked. As such, there’s a direct relationship between the number of minutes talked and your total bill.
The cost per minute talked on your land-line is normally constant. For example, your service may charge five cents per minute. Talking more or less minutes will not change the per minute charge, so on a per unit basis, variable costs remain unchanged.
22 - *
C 1
We begin our study of cost behavior with fixed costs. Your basic land-line telephone has a monthly connect charge that remains constant regardless of the number of local calls that you might make. The monthly charge that is independent of call activity is a fixed cost.
Fixed costs per unit decline as activity increases. Dividing your monthly connect fee by more local calls reduces the cost per call by spreading the fixed amount over a higher number of calls. For example, if your monthly connect charge is $20 and you make 40 local calls in a month, your cost per local call is $0.50. If you make 100 local calls in a month, your cost per local call is $0.20.
22 - *
MIXED COSTS
Mixed costs contain a fixed portion that is incurred even when the facility is unused, and a variable portion that increases with
usage. Utilities typically behave in this manner.
C 1
Fixed Monthly
Utility Charge
Cost per KW
Activity (Kilowatt Hours)
Total Utility Cost
Total mixed cost
Mixed costs have both a fixed and variable component. For example, utility bills often contain fixed and variable cost components. The fixed portion of the utility bill is constant regardless of kilowatt hours consumed. This cost represents the minimum cost that is incurred to have the service ready and available for use. The variable portion of the bill varies in direct proportion to the consumption of kilowatt hours.
Here we see a graph with utility cost on the vertical axis and kilowatt hours on the horizontal axis. Notice that the fixed monthly charge is the same at all levels of kilowatt usage, even the zero level of usage. The variable cost, which rises as more kilowatt hours are used, is added to the fixed cost to obtain the total mixed cost.
22 - *
Outside the relevant range, cost behavior may be different.
All fixed costs are only fixed within a relevant range.
22 - *
Net Income= Total Sales – Total Costs
22 - *
Contribution margin is the amount by which revenue exceeds the variable costs of producing the revenue.
CONTRIBUTION MARGIN AND ITS MEASURES
Total contribution margin is $60,000 and the contribution margin per unit sold is $30.
A 1
In manufacturing companies, volume of activity usually refers to the number of units produced. We then classify a cost as either fixed or variable, depending on whether total cost changes as the number of units produced changes. Once we separate costs by behavior, we can then compute a product’s contribution margin.
We’re going to concentrate exclusively on the contribution format income statement for our break-even analysis. Contribution margin is the amount remaining after we deduct all our variable expenses from sales revenue. In this example, contribution margin can be expressed as a total amount, $60,000, or as an amount per unit, $30. Each unit sold contributes $30 toward covering Rydell’s fixed costs and providing for profits.
Sheet1
Total
Unit
Contribution margin per unit
Sales price per unit
The contribution margin ratio is equal to the unit contribution margin divided by the unit sales price. In this example, the contribution margin ratio is 30 percent, resulting from dividing the $30 per unit contribution margin by the $100 unit sales price.
Sheet1
Total
Unit
Based on the Illustration on page 5, determine the following:
Total Variable Cost
Based on the Illustration on page 5, determine the following:
Total Variable Cost ($34,000)
Total Fixed Cost ($14,000)
Contribution Margin per unit (16,000/500=$32 per Unit)
Contribution Margin Ratio (32/100=32%)
22 - *
BREAK-EVEN ANALYSIS
The break-even point (expressed in units of product or dollars of sales) is the unique sales level at which a company earns neither a profit nor incurs a loss.
A 1
Break-even analysis is a special case of cost-volume-profit analysis. The break-even point is the level of sales where a company’s income is exactly equal to zero. At break-even, total costs equal total revenues.
22 - *
($30 in previous example)
We have just seen one of the basic CVP relationships – the break-even computation.
COMPUTING THE BREAK-EVEN POINT
Contribution margin per unit
The results of the previous question can be expressed in equation form as seen on your screen. The break-even point in units is equal to total fixed costs divided by the unit contribution margin. Rydell’s fixed costs are $24,000 per month. Rydell breaks even for the month when it sells 800 footballs ($24,000 ÷ $30 per unit), using the formula on your screen.
22 - *
$52,500/6=8,750 units
Contribution Margin per unit (10-4=6)
22 - *
The break-even formula may also be expressed in sales dollars.
COMPUTING THE BREAK-EVEN POINT
Contribution margin ratio
The break-even point in sales dollars is equal to total fixed costs divided by the contribution margin ratio. The contribution margin ratio is equal to the unit contribution margin divided by the unit sales price. In the earlier example, the contribution margin ratio is 30 percent, resulting from dividing the $30 per unit contribution margin by the $100 unit sales price. You might want to refer back to the example to verify these numbers. The contribution margin ratio tells us that 30 cents of each sales dollar contributes to covering fixed costs and providing for income.
22 - *
Your Turn-Change in Selling Price
Find the break-even point in units and dollars for the illustration at the top of page 7
22 - *
FOR A TARGET INCOME
Break-even formulas may be adjusted to show the sales volume needed to earn any amount of income.
Unit sales =
Contribution margin per unit
Contribution margin ratio
C 2
We can adjust the break-even formulas that we used earlier to incorporate target pretax income. Recall that we calculated break-even by dividing fixed costs by contribution. When we incorporate pretax income, contribution must cover the fixed cost as well as provide for income. To adapt the break-even formulas for pretax income, we add the desired amount of pretax income to the numerator.
Let’s see if we can use these formulas to answer a question.
22 - *
Sales in Units for a target net income of $22,000?
(12,000+22,000)/2=17,000 units
22 - *
(12,000+22,000)/.4=$85,000
COMPUTING THE MARGIN OF SAFETY
Margin of safety is the amount by which sales can drop before the company incurs a loss.
C 2
Margin of Safety can be calculated in terms of a # of units or sales dollars.
The margin of safety is the excess of expected sales (or actual sales) over the break-even sales. It’s the amount by which expected sales can drop before the company begins to incur losses. We can also express the margin of safety as a percent of sales. The margin of safety percentage is equal to the margin of safety in dollars divided by the expected sales in dollars.
If Rydell’s sales are $100,000 and break-even sales are $80,000, what is the margin of safety percentage?
The margin of safety in dollars is equal to actual sales of $100,000 less the break-even sales of $80,000. The margin of safety percentage is equal to the $20,000 and actual sales are $100,000, so the margin of safety percentage is 20 percent ($20,000 divided by $100,000).
22 - *
Margin of Safety in units=Expected Sales in unit-Breakeven (units)
22 - *
Margin of Safety in Units
925-575=350 units
$4,162.50-2,587.50=$1,575
Constant Selling Price
Constant Total Fixed Cost
22 - *
22 - *
The CVP formulas can be modified for use when a company sells more than one product.
The unit contribution margin is replaced with the contribution margin for a composite unit.
A composite unit is composed of specific numbers of each product in proportion to the product sales mix.
Sales mix is the ratio of the volumes of the various products.
COMPUTING A MULTIPRODUCT
BREAK-EVEN POINT
P 4
To this point, we’ve assumed that a company sells a single product. We can extend the cost-volume-profit relationships to cover multiproduct companies. Instead of unit contribution margin for one unit, we will have a composite unit contribution for all units. The composite unit contribution margin is dependent on the sales mix of the products sold.
22 - *
Less: Variable costs140,000 70