BreakEven Point and CostVolumeProfit Analysis


 Ralph Stuart Golden
 3 years ago
 Views:
Transcription
1 9 BreakEven Point and CostVolumeProfit Analysis Objectives After completing this chapter, you should be able to answer the following questions: LO.1 LO.2 LO.3 LO.4 LO.5 LO.6 What is the breakeven point (BEP) and why is it important? How is the BEP determined and what methods are used to identify BEP? What is costvolumeprofit (CVP) analysis and how do companies use CVP information in decision making? How do breakeven and CVP analysis differ for singleproduct and multiproduct firms? How are margin of safety and operating leverage concepts used in business? What are the underlying assumptions of CVP analysis? ZTS/ISTOCKPHOTO.COM 381
2 382 Chapter 9 BreakEven Point and CostVolumeProfit Analysis Introduction Corporate managers have a goal of maximizing shareholder wealth. However, given that no obvious, single course of action leads to fulfillment of that goal, managers must choose a specific course of action and develop plans and controls to pursue that course. Because planning is future oriented, uncertainty exists and information helps reduce that uncertainty. Controlling is making actual performance align with plans, and information is necessary in that process. Much of the information managers use to plan and control reflects relationships among product cost, selling prices, and sales volumes. Changing one of these essential components in the mix will cause changes in other components. For example, a company manager would want to estimate whether an increase in advertising expenditures for a particular product would be justified by the increase in product sales volume and contribution margin that would be generated. This chapter focuses on understanding how cost, volume, and profit interact. Understanding these relationships helps in predicting future conditions (planning) as well as in explaining, evaluating, and acting on results (controlling). Before generating profit, a company must first reach its breakeven point, which means that it must generate sufficient sales revenue to cover all cost. Then, by linking cost behavior and sales volume, managers can use the costvolumeprofit model to plan and control. The chapter also presents the concepts of margin of safety and degree of operating leverage. Information provided by these models helps managers focus on the implications that volume changes would have on organizational profitability. LO.1 What is the breakeven point (BEP) and why is it important? BreakEven Point As discussed in Chapter 3, absorption costing is the traditional approach to product costing and is primarily used for external reporting. Alternatively, variable costing is more commonly used for internal purposes because it makes cost behavior more transparent than does absorption costing. The variable costing presentation separates variable from fixed cost and facilitates the use of this chapter s models: breakeven point, costvolumeprofit, margin of safety, and degree of operating leverage. A variable costing budgeted income statement for Sesame Company is presented in Exhibit 9 1. Sesame Company manufactures a highquality line of desk clocks. Product specifications have been established for several years and will continue at least until model year In addition to the traditional income statement information, perunit amounts are shown for sales revenue, variable cost, and contribution margin. The company has a total variable production cost of 62.5 percent, a variable selling expense of 10 percent, and a contribution margin ratio of 27.5 percent. These Sesame Company data are used throughout this chapter to illustrate breakeven and costvolumeprofit computations. A company s breakeven point (BEP) is that level of activity, in units or dollars, at which total revenue equal total cost. Thus, at BEP, the company generates neither a profit nor a loss on operating activities. Companies, however, do not wish merely to break even on operations. The BEP is calculated to establish a point of reference. Knowing BEP, managers are better able to set sales goals that should result in profits from operations rather than losses. Finding the BEP first requires understanding company revenues and cost. A short summary of revenue and cost assumptions is presented at this point to provide a foundation for BEP calculation and costvolumeprofit (CVP) analysis. These assumptions, and some challenges to them, are discussed in more detail at the end of the chapter.
3 Chapter 9 BreakEven Point and CostVolumeProfit Analysis 383 Exhibit 9 1 Sesame Company Budgeted Income Statement for 2010 Total Per Unit Percentage Sales (600,000 units) $24,000,000 $ Variable cost Production $15,000,000 $ Selling 2,400, Total variable cost (17,400,000) (29.00) (72.5) Contribution margin $ 6,600,000 $ Fixed cost Production $ 3,200,000 Selling and administrative 1,200,000 Total fixed cost (4,400,000) Income before income tax $ 2,200,000 Relevant range: The company is assumed to be operating within the relevant range of activity specified in determining the revenue and cost information used in each of the following assumptions. 1 Revenue: Revenue per unit is assumed to remain constant; fluctuations in perunit revenue for factors such as quantity discounts are ignored. Thus, total revenue fluctuates in direct proportion to level of activity or volume. Variable cost: On a perunit basis, variable costs are assumed to remain constant. Therefore, total variable cost fluctuates in direct proportion to level of activity or volume. Variable production costs include direct material, direct labor, and variable overhead; variable selling costs include charges for items such as commissions and shipping. Variable administrative costs can exist in areas such as purchasing; however, in the illustrations that follow, administrative costs are assumed to be fixed. Fixed cost: Total fixed costs are assumed to remain constant, and, as such, perunit fixed cost decreases as volume increases. (Perunit fixed cost increases as volume decreases.) Fixed costs include both fixed manufacturing overhead and fixed selling and administrative expenses. Mixed cost: Mixed costs are separated into their variable and fixed elements before they are used in BEP or CVP analysis. Any method (such as regression analysis or the high low method) that validly separates these costs in relation to one or more predictors can be used. An important measure in breakeven analysis is contribution margin (CM), which can be defined on either a perunit or a total basis. CM per unit equals selling price per unit minus total variable cost per unit, which includes production, selling, and administrative cost. Unit contribution margin is constant because revenue and variable cost have been defined as being constant per unit. Total CM is the difference between total revenue and total variable cost for all units sold. This amount fluctuates in direct proportion to sales volume. On either a perunit or a total basis, CM indicates the amount of revenue remaining after all variable costs have been covered. 2 This amount contributes to the coverage of fixed cost and the generation of profit. 1 As discussed in Chapter 2, the relevant range is the range of activity over which a variable cost will remain constant per unit and a fixed cost will remain constant in total. 2 Contribution margin refers to the total contribution margin. Product contribution margin is the difference between revenues and total variable product cost included in cost of goods sold.
4 384 Chapter 9 BreakEven Point and CostVolumeProfit Analysis LO.2 How is the BEP determined and what methods are used to identify BEP? Identifying the BreakEven Point Breakeven calculations can be demonstrated using the formula, graph, and income statement approaches. Data needed to compute the breakeven point and perform CVP analysis are given in the income statement shown in Exhibit 9 1 for Sesame Company. Formula Approach to Breakeven The formula approach to breakeven analysis uses an algebraic equation to calculate the BEP. In this analysis, sales volume, rather than production activity, is the focus of the relevant range. The equation represents the variable costing income statement and shows the relationships among revenue, fixed cost, variable cost, volume, and profit as follows: R(X) VC(X) FC P where R revenue (selling price) per unit X volume (number of units) R(X) total revenue VC variable cost per unit VC(X) total variable cost FC total fixed cost P total profit Because this equation is simply a formulaic representation of an income statement, P can be set equal to zero to solve for the breakeven point. At the point where P $0, total revenues are equal to total cost, and breakeven point (BEP) in units can be found by solving the equation for X. R(X) VC(X) FC $0 R(X) VC(X) FC (R VC)(X) FC X FC (R VC) X FC CM Breakeven volume equals total fixed cost divided by contribution margin per unit (revenue per unit minus the variable cost per unit). Using the information in Exhibit 9 1 for Sesame Company ($40 selling price per clock, $29 variable cost per clock, and $4,400,000 of total fixed cost), the BEP for the company is calculated as $40(X) $29(X) $4,400,000 $0 $40(X) $29(X) $4,400,000 $11(X) $4,400,000 X $4,400,000 $11 X 400,000 clocks BEP can be expressed in either units or dollars of revenue. One way to convert a unit BEP to dollars is to multiply the number of units by the selling price per unit. For Sesame, the BEP in sales dollars is $16,000,000 (400,000 clocks $40 per clock). Another method of computing BEP in sales dollars requires the computation of a contribution margin ratio (CM%), which is calculated as contribution margin divided by revenue. This ratio indicates what proportion of revenue remains after variable cost has been deducted from sales or that portion of the revenue dollar that can be used to cover fixed cost and provide profit. The CM% can be calculated using either perunit, or total, revenue and variable cost information. Dividing total fixed cost by the CM% gives the BEP in sales dollars.
5 Chapter 9 BreakEven Point and CostVolumeProfit Analysis 385 For Sesame Company, the breakeven sales dollars are X FC [(R VC) R] X $4,400,000 [($40 $29) $40] X $4,400,000 ($11 $40) X $4,400, X $16,000,000 BEP in units can be determined by dividing the BEP in sales dollars by the unit selling price, or X = $16,000,000 $40 X = 400,000 clocks The CM% allows the BEP to be determined even if unit selling price and unit variable cost are not known. Subtracting the contribution margin ratio from 100 percent gives the variable cost ratio (VC%), which represents variable cost as a proportion of revenue. 3 Graphing Approach to Breakeven Although solutions to BEP problems can be determined using equations, sometimes the information is more effectively conveyed to managers in a visual format. Exhibit 9 2 (p. 386) graphically presents each income statement item for Sesame Company s original budgeted data (see Exhibit 9 1), providing visual representations of revenue, cost, and contribution margin behaviors. The graphs presented in Exhibit 9 2 illustrate individual behaviors, but are not very useful for determining the relationships among the income statement amounts. A breakeven chart can be prepared to graph the relationships among revenue, volume, and cost. The BEP on a breakeven chart is located at the point where the total cost and total revenue lines intersect. Two approaches to graphing can be used in preparing breakeven charts: the traditional approach and the profitvolume graph approach. Traditional Approach The traditional approach breakeven graph shows the relationships among revenue, cost, and profit/loss. This graph does not show contribution margin. A traditional breakeven graph for Sesame Company is prepared by completing the following steps. Step 1: As shown in Exhibit 9 3 (p. 386), label each axis and graph the total cost and fixed cost lines. The fixed cost line is drawn parallel to the xaxis (volume). The variable cost line begins where the fixed cost line intersects the yaxis. The slope of the variable cost line is the perunit variable cost ($29). The resulting line represents total cost. The distance between the fixed cost and the total cost lines represents total variable cost at each activity level. Step 2: Chart the revenue line, beginning at $0. The BEP is located at the intersection of the revenue line and the total cost line. The vertical distance to the right of the BEP and between the revenue and total cost lines represents profit; the distance between the revenue and total cost lines to the left of the BEP represents loss. If exact readings could be taken on the graph in Exhibit 9 4 (p. 387), the breakeven point for Sesame Company would be $16,000,000 of sales, or 400,000 clocks. 3 Derivation of the contribution margin ratio formula is as follows: Sales [(VC%)(Sales)] FC (1 VC%)Sales FC Sales FC (1 VC%) because (1 VC%) CM% then Sales FC CM% where VC% variable cost ratio or variable cost as a percentage of sales, CM% contribution margin ratio or contribution margin as a percentage of sales Thus, the VC% plus the CM% is equal to 100 percent.
6 386 Chapter 9 BreakEven Point and CostVolumeProfit Analysis Exhibit 9 2 Sesame Company Graphing Presentation of Income Statement Items 20,000,000 Relevant Range Relevant Range 16,000,000 TR Revenue (in $) 12,000,000 Variable Cost (in $) 14,500,000 11,600,000 8,700,000 TVC 300, , ,000 Number of Clocks 300, , ,000 Number of Clocks Contribution Margin (in $) 5,500,000 4,400,000 3,300,000 Relevant Range TR TCM TVC Fixed Cost (in $) 4,400,000 Relevant Range TFC 300, , ,000 Number of Clocks 300, , ,000 Number of Clocks TR Total Revenue TCM Total Contribution Margin TVC Total Variable Cost TFC Total Fixed Cost Note: Linear functions are always assumed for total revenue, total variable cost, and total fixed cost. These functions are reflected in the basic assumptions given on pp Exhibit 9 3 Sesame Company Graph of Total and Variable Cost $18,900,000 Total Cost Cost $4,400,000 Total Fixed Cost 0 300,000 Number of Clocks 500,000
7 Chapter 9 BreakEven Point and CostVolumeProfit Analysis 387 Exhibit 9 4 Sesame Company Traditional Approach of Graphing Breakeven $20,000,000 Contribution Margin Area Total Revenue Total Cost Total Variable Cost $16,000,000 $4,400, ,000 Number of Clocks 500,000 ProfitVolume Graph The profitvolume (PV) graph provides a depiction of the amount of profit or loss associated with each sales level. The horizontal, or x, axis on the PV graph represents sales volume; the vertical, or y, axis represents dollars of profit or loss. Amounts shown above the xaxis are positive and represent profits; amounts shown below the xaxis are negative and represent losses. Two points can be located on the graph: total fixed cost and breakeven point. Total fixed cost is shown on the yaxis below the sales volume line as a negative amount. If no products were sold, the fixed cost would still be incurred and a loss of that amount would result. Location of the BEP in units may be determined algebraically and is shown at the point where the profit line intersects the xaxis; at that point, there is no profit or loss. The amount of profit or loss for any sales volume can be read from the yaxis. The slope of the profit (diagonal) line is determined by the unit contribution margin ($11), and the points on the line represent the contribution margin earned at each volume level. The line shows that no profit is earned until total contribution margin covers total fixed cost. The PV graph for Sesame Company is shown in Exhibit 9 5 (p. 388). Total fixed cost is $4,400,000, and the breakeven point is 400,000 clocks. The diagonal line reflects the original Exhibit 9 1 income statement data indicating a profit of $2,200,000 at a sales volume of 600,000 clocks. Clocks sold at BEP 400,000 Sales $ 16,000,000 Total variable cost (11,600,000) Contribution margin $ 4,400,000 Total fixed cost (4,400,000) Profit before tax $ 0
8 388 Chapter 9 BreakEven Point and CostVolumeProfit Analysis Exhibit 9 5 Sesame Company ProfitVolume Graph $4,400,000 $3,300,000 Profit/Loss $2,200,000 $1,100,000 0 $1,100,000 $2,200,000 $3,300,000 $4,400,000 PROFIT BEP LOSS Number of Clocks (in thousands) Total Fixed Cost The graphing approach to breakeven provides a detailed visual display of the BEP. It does not, however, provide a precise solution because exact points cannot be determined on a graph. A definitive computation of the BEP can be found algebraically using the formula approach or a computer software application. A third approach to illustrating breakeven is the income statement approach. Income Statement Approach LO.3 What is costvolumeprofit (CVP) analysis and how do companies use CVP information in decision making? The income statement approach to finding BEP allows accountants to prepare budgeted statements using available revenue and cost information. Income statements can also be used to prove the accuracy of computations made using the BEP formulas or graphs. Because the formula, graphing, and income statement approaches are based on the same relationships, each should align with the other. Following is the income statement proving the prior calculations of the BEP for Sesame Company. Because the profit before tax is $0, the income statement supports the breakeven point determinations of the other methods. The BEP provides a starting point for planning future operations. Managers want to earn operating profit rather than simply cover costs. Substituting an amount other than zero for the profit (P) term in the breakeven formula converts breakeven analysis to costvolumeprofit analysis. CVP Analysis Because profit cannot be achieved until the BEP is reached, the starting point of CVP analysis is the breakeven point. Examining shifts in cost and volume and the resulting effects on profits is called costvolumeprofit (CVP) analysis. CVP analysis can be used to calculate the sales volume necessary to achieve a target profit, stated as either a fixed or variable amount on a before or aftertax basis. Managers use CVP analysis to effectively plan and control by concentrating on the relationships among revenues, cost, volume changes, taxes, and profit. The CVP model can be expressed mathematically or graphically. The CVP model considers all costs, regardless of whether they are product, period, variable, or fixed. The analysis is usually performed on a
9 Chapter 9 BreakEven Point and CostVolumeProfit Analysis 389 companywide basis. The same basic CVP model and calculations can be applied to a single or multiproduct business. CVP analysis requires substitution of known amounts in the formula to solve for an unknown amount. The formula mirrors the income statement when known amounts are used for selling price per unit, variable cost per unit, volume of units, and fixed cost to find the amount of profit generated under given conditions. Because CVP analysis is concerned with relationships among the elements affecting continuing operations, in contrast with nonrecurring activities and events, profits as used in this chapter refer to operating profits before extraordinary and other nonoperating, nonrecurring items. The following quote indicates the pervasive utility of the CVP model: Cost Volume Profit analysis (CVP) is one of the most hallowed, and yet one of the simplest, analytical tools in management accounting. [CVP] allows managers to examine the possible impacts of a wide range of strategic decisions [in] such crucial areas as pricing policies, product mixes, market expansions or contractions, outsourcing contracts, idle plant usage, discretionary expense planning, and a variety of other important considerations in the planning process. Given the broad range of contexts in which CVP can be used, the basic simplicity of CVP is quite remarkable. Armed with just three inputs of data sales price, variable cost per unit, and fixed cost a managerial analyst can evaluate the effects of decisions that potentially alter the basic nature of a firm. 4 CORBIS/JUPITER IMAGES An important application of CVP analysis allows managers to set a desired target profit and focus on the relationships between it and other known income statement amounts to find an unknown. One common unknown in such applications is the sales volume that is needed to generate a particular profit amount. Selling price is generally not as commonly unknown as volume because selling price is often market determined and is not a management decision variable. Additionally, because selling price and volume are often directly related and because certain costs are considered fixed, managers can use CVP to determine how high variable cost can be while allowing the company to produce a desired amount of profit. Variable cost can be affected by modifying product specifications or material quality as well as by being more efficient or effective in the production, service, and/or distribution processes. The following examples continue using the Sesame Company data with different amounts of target profit. A product's selling price is often marketrelated rather than being a management decision variable. Fixed Amount of Profit Because contribution margin represents the sales dollars remaining after variable cost is covered, each dollar of CM generated by product sales goes first to cover fixed cost and then to produce profits. After the BEP is reached, each dollar of CM is a dollar of beforetax profit. Before Tax Profit can be treated in the breakeven formula as an additional cost to be covered. Inclusion of a target profit changes the breakeven formula to a CVP equation. 4 Flora Guidry, James O. Horrigan, and Cathy Craycraft, CVP Analysis: A New Look, Journal of Managerial Issues (Spring 1998), pp. 74ff.
10 390 Chapter 9 BreakEven Point and CostVolumeProfit Analysis R(X) VC(X) FC PBT where PBT fixed amount of profit before tax. R(X) VC(X) FC PBT X (FC PBT) (R VC) or X (FC PBT) CM Assume that Sesame s management desires a $3,300,000 beforetax profit. The calculations in Exhibit 9 6 show that to achieve this profit before tax, the company must sell 700,000 clocks and generate $28,000,000 of revenue. Exhibit 9 6 Sesame Company CVP Analysis Fixed Amount of Profit before Tax In units: Profit before tax (PBT) desired $3,300,000 R(X) VC(X) FC PBT CM(X) FC PBT ($40 $29)X $4,400,000 $3,300,000 $11X $7,700,000 X $7,700,000 $11 700,000 clocks In sales dollars: Sales (FC PBT) CM% Sales $7,700, * Sales $28,000,000 *From Exhibit 9 1. After Tax In choosing a target profit amount, managers must recognize that income tax represents a significant influence on business decision making. A company wanting a particular amount of profit after tax must first determine, given the applicable tax rate, the amount of profit that must be earned on a beforetax basis. The CVP formulas that designate a fixed aftertax profit amount are as follows: PBT [(TR)(PBT)] PAT and R(X) VC(X) FC [(TR)(PBT)] PAT where PBT fixed amount of profit before tax PAT fixed amount of profit after tax TR tax rate PAT is further defined so that it can be integrated into the original CVP formula: PBT (1 TR) PAT or PBT PAT (1 TR)
11 Chapter 9 BreakEven Point and CostVolumeProfit Analysis 391 Substituting into the formula, R(X) VC(X) FC PBT R(X) VC(X) FC PBT (R VC)(X) FC [PAT (1 TR)] CM(X) FC [PAT (1 TR)] Assume Sesame Company managers set an earnings target of $3,300,000 after tax and the company s average tax rate is 25 percent. The number of clocks (800,000) and dollars of sales ($32,000,000) needed to achieve that target are calculated in Exhibit 9 7. Exhibit 9 7 Sesame Company CVP Analysis Fixed Amount of Profit after Tax In units: PAT desired $3,300,000; tax rate 25% PBT PAT (1 TR) PBT $3,300,000 (1 0.25) PBT $3,300, PBT $4,400,000 CM(X) FC PBT $11X $4,400,000 $4,400,000 $11X $8,800,000 X $8,800,000 $11 X 800,000 clocks In sales dollars: Sales (FC PBT) CM ratio Sales ($4,400,000 $4,400,000) Sales $8,800, Sales $32,000,000 Specific Amount of Profit per Unit Managers may want to conduct an analysis of profit on a perunit basis. As in the prior examples, profit can be stated on either a beforetax or an aftertax basis. For these alternatives, the CVP formula must be adjusted to recognize that profit is related to volume of activity. Before Tax In this situation, the adjusted CVP formula for computing the necessary unit sales volume to earn a specified amount of profit before tax per unit is where P u BT amount of profit per unit before tax Solving for X (volume) gives the following: R(X) VC(X) FC P u BT(X) R(X) VC(X) P u BT(X) FC CM(X) P u BT(X) FC X FC (CM P u BT) The perunit profit is treated in the CVP formula as if it were an additional variable cost to be covered. This treatment effectively adjusts the original contribution margin and
12 392 Chapter 9 BreakEven Point and CostVolumeProfit Analysis contribution margin ratio. When setting the desired profit as a percentage of selling price, the profit percentage cannot exceed the contribution margin ratio. If it does, an infeasible problem is created because the adjusted contribution margin is negative. In such a case, the variable cost ratio plus the desired profit percentage would exceed 100 percent of the selling price, and such a condition cannot exist. Assume that Sesame s president wants to know what level of sales (in clocks and dollars) would be required to earn a 15 percent beforetax profit on sales. This rate of return translates into a set amount of profit per unit of $6. The calculations shown in Exhibit 9 8 provide the answers to these questions. Exhibit 9 8 Sesame Company CVP Analysis Set Amount of Profit per Unit before Tax In units: P u BT desired 15% of sales revenue P u BT 0.15($40) P u BT $6 CM(X) P u BT(X) FC $11X $6X $4,400,000 $5X $4,400,000 X 880,000 clocks In sales dollars, the following relationships exist: Per Clock Percentage Selling price $ Variable cost (29) (72.5) Set amount of profit before tax (6) (15.0) Adjusted contribution margin ratio $ Sales FC Adjusted CM%* Sales $4,400, Sales $35,200,000 *It is not necessary to have perunit data; all computations can be made with percentage information only. After Tax Adjusting the CVP formula to determine unit profit on an aftertax basis involves stating profit in relation to both the volume and the tax rate. Algebraically, the formula is: where P u AT amount of profit per unit after tax R(X) VC(X) FC {(TR)[P u BT(X)]} P u AT(X) P u AT is further defined so that it can be integrated into the original CVP formula: P u AT(X) P u BT(X) {(TR)[P u BT(X)]} P u AT(X) P u BT(X)[(1 TR)] P u BT(X) [P u AT (1 TR)](X)
13 Chapter 9 BreakEven Point and CostVolumeProfit Analysis 393 Thus, the following relationship exists: R(X) VC(X) FC [P u AT (1 TR)](X) CM(X) FC P u BT(X) CM(X) P u BT(X) FC X FC (CM P u BT) Sesame s managers want to earn an aftertax profit of 10 percent of revenue and the company has a 25 percent tax rate. The necessary sales in units and dollars are given in Exhibit 9 9. Exhibit 9 9 Sesame Company CVP Analysis Set Amount of Profit per Unit after Tax In units: P u AT desired 10% of revenue; tax rate 25% P u AT 0.10($40) P u AT $4 P u BT $4 ( ) P u BT $ P u BT $5.33 (rounded) CM(X) P u BT(X) FC $11.00X $5.33X $4,400,000 $5.67X $4,400,000 X $4,400,000 $5.67 X 776,014 clocks (rounded) Per Clock Percentage Selling price $ Variable cost (29.00) (72.50) Set amount of profit before tax (5.33) (13.33) (rounded) Adjusted contribution margin $ Sales FC Adjusted CM ratio Sales $4,400, Sales $31,051,517 (rounded) Exhibit 9 10 (p. 394) proves each of the computations made in Exhibits 9 6 through 9 9 for Sesame Company. The answers provided by breakeven or CVP analysis are valid only in relation to specific selling price and cost relationships. Changes that occur in the company s selling price or cost structure will cause a change in the BEP or in the sales needed to obtain a desired profit. However, the effects of revenue and cost changes on a company s BEP or sales volume can be determined through incremental analysis. Incremental Analysis for ShortRun Changes The breakeven point can increase or decrease, depending on revenue and cost changes. Other things being equal, the BEP will increase if there is an increase in the total fixed cost or a decrease in the unit (or percentage) contribution margin. A decrease in contribution margin could arise because of a reduction in selling price, an increase in variable cost per
14 394 Chapter 9 BreakEven Point and CostVolumeProfit Analysis Exhibit 9 10 Sesame Company s Income Statement Approach to CVP Proof of Computations Previous computations: Breakeven point: 400,000 clocks Fixed profit ($255,000) before tax: 700,000 clocks Fixed profit ($3,300,000) after tax: 800,000 clocks Set amount of profit (15% on revenues) before tax: 880,000 clocks Set amount of profit (10% on revenues) after tax: 776,014 clocks R $40 per clock; VC $29 per clock; FC $4,400,000 Tax rate 25% for Exhibits 9 3 and 9 5 Clocks Sold Basic Data 400,000 Exh ,000 Exh ,000 Exh ,000 Exh ,014 Sales $16,000,000 $28,000,000 $32,000,000 $35,200,000 $31,040,560 Total variable cost (11,600,000) (20,300,000) (23,200,000) (25,520,000) (22,504,406) Contribution margin $ 4,400,000 $ 7,700,000 $ 8,800,000 $ 9,680,000 $ 8,536,154 Total fixed cost (4,400,000) (4,400,000) (4,400,000) (4,400,000) (4,400,000) Profit before tax $ 0 $ 3,300,000 $ 4,400,000 $ 5,280,000 a $ 4,136,154 Tax (25%) (1,100,000) (1,034,039) Profit after tax (NI) $ 3,300,000 $ 3,102,115 b a Desired profit before tax 15% on revenue; 0.15 $35,200,000 $5,280,000. b Desired profit after tax 10% on revenue; 0.10 $31,040,560 $3,104,056 (differs from $3,102,115 only because of rounding error). unit, or a combination of the two. The BEP will decrease if total fixed cost decreases or unit (or percentage) contribution margin increases. A change in the BEP will also cause a shift in total profit or loss at any level of activity. Incremental analysis is a process that focuses only on factors that change from one course of action or decision to another. In CVP situations, incremental analysis is focused on changes occurring in revenue, cost, and/or volume. Following are some examples of changes that could occur in a company and the incremental computations that can be used to determine the effects of those changes on the BEP or on profit. In most situations, incremental analysis is sufficient to determine the feasibility of contemplated changes, and a complete income statement need not be prepared. The basic facts presented for Sesame Company in Exhibit 9 1 are continued. All of the following examples use beforetax information to simplify the computations. Aftertax analysis would require the application of the (1 tax rate) adjustment to all profit figures. Case 1 Sesame Company wants to earn a beforetax profit of $2,750,000. How many clocks must the company sell to achieve that profit? The incremental analysis relative to this question addresses the number of clocks above the BEP that must be sold. Because each dollar of contribution margin after BEP is a dollar of profit, the incremental analysis focuses only on the profit desired: $2,750,000 $11 250,000 clocks above BEP
15 Chapter 9 BreakEven Point and CostVolumeProfit Analysis 395 Because the BEP has already been computed as 400,000 clocks, the company must sell a total of 650,000 clocks. Case 2 Sesame Company estimates that spending an additional $425,000 on advertising will result in an additional 50,000 clocks being sold. Should the company incur this extra fixed cost? The contribution margin from the additional clocks must first cover the additional fixed cost before additional profits can be generated. Increase in contribution margin (50,000 clocks $11 CM per clock) $550,000 Increase in fixed cost (425,000) Net incremental benefit $125,000 Because there is a net incremental profit of $125,000, the company should undertake the advertising campaign. An alternative computation is to divide the additional fixed cost of $425,000 by the $11 contribution margin. The result indicates that 38,636 clocks (rounded) would be required to cover the additional cost. Because the company expects to sell 50,000 clocks, the remaining 11,364 clocks would produce $11 of profit per clock, or $125,004. Case 3 Sesame Company estimates that reducing a clock s selling price to $37.50 will result in an additional 90,000 clocks per year being sold. Should the company reduce the clock s selling price? Budgeted sales volume, given in Exhibit 9 1, is 600,000 clocks. If the selling price is reduced, the contribution margin per unit will decrease to $8.50 per clock ($37.50 SP $29.00 VC). Sales volume will increase to 690,000 clocks (600,000 90,000). Total new contribution margin (690,000 clocks $8.50 CM per clock) $5,865,000 Total fixed cost (unchanged) (4,400,000) New profit before tax $1,465,000 Current budgeted profit before tax (from Exhibit 9 1) (2,200,000) Net incremental loss $ (735,000) Because the reduction in sales price will cause profit to decrease by $735,000, Sesame Company should not reduce the clock s selling price. The company, however, might want to investigate the possibility that a reduction in price could, in the long run, increase demand to more than the additional 90,000 clocks per year and, thus, make the price reduction a profitable action. Case 4 Sesame Company has an opportunity to sell 100,000 clocks to a nonrecurring customer for $27 per clock. The clocks will be packaged and sold using the customer s own logo. Packaging cost will increase by $1 per clock, but the company will not incur any of the current variable selling cost. If Sesame accepts the job, it will pay a $30,000 commission to the salesperson calling on this customer. This sale will not interfere with budgeted sales and is within the company s relevant range of activity. Should Sesame make this sale? The new variable cost per clock is $26 ($25 total budgeted variable production cost $1 additional variable packaging cost $0 variable selling cost). The $27 selling price minus the
16 396 Chapter 9 BreakEven Point and CostVolumeProfit Analysis $26 new total variable cost provides a contribution margin of $1 per clock sold to the nonrecurring customer. Total additional contribution margin (100,000 clocks $1 CM per clock) $100,000 Additional fixed cost (commission) related to this sale (30,000) Net incremental benefit $ 70,000 The total CM generated by the sale more than covers the additional fixed cost. Thus, the sale produces incremental profit and, therefore, should be made. However, as with all proposals, this one should be evaluated on the basis of its longrange potential. Is the commission a onetime payment? Will the customer possibly return in future years to buy additional clocks? Will such sales affect regular business in the future? Is the sales price to the new customer a legal one? 5 If all of these questions can be answered yes, Sesame should seriously consider this opportunity. In addition, referral business by the new customer could also increase sales. The incremental approach is often used to evaluate alternative pricing strategies in economic downturns. In such stressful times, companies must confront the reality that they might be unable to sell a normal volume of goods at normal prices. With this understanding, companies can choose to maintain normal prices and sell a lower volume of goods or reduce prices and attempt to maintain market share and normal volume. LO.4 How do breakeven and CVP analysis differ for singleproduct and multiproduct firms? CVP Analysis in a Multiproduct Environment Companies typically produce and sell a variety of products, some of which may be related (such as bats and baseballs or sheets, towels, and bedspreads). To perform CVP analysis in a multiproduct company, one must assume either that the product sales mix stays constant as total sales volume changes or that the average contribution margin ratio stays constant as total sales volume changes. The constant mix assumption can be referred to as the bag (or basket ) analogy. The analogy is that the sales mix represents a bag of products that are sold together. For example, when some product A is sold, set amounts of products B and C are also sold. Use of an assumed constant sales mix allows a weighted average contribution margin ratio to be computed for the bag of products being sold. Without the assumption of a constant sales mix, BEP cannot be calculated, nor can CVP analysis be used effectively. 6 In a multiproduct company, the CM% is weighted by the quantities of each product included in the bag. This weighting process means that the CM% of the product composing the largest proportion of the bag has the greatest impact on the average contribution margin of the product mix. Suppose that, because of the success of its desk clocks, Sesame management is considering the production of clock wallmounting kits. The vice president of marketing estimates that, for every three clocks sold, the company will sell one clock wallmounting kit. Therefore, the bag of products has a 3:1 product ratio. Sesame will incur an additional $514,000 in fixed plant asset cost (depreciation, insurance, and so forth) to support a higher relevant range of production. Exhibit 9 11 provides relevant company information and shows the breakeven computations. Breakeven occurs at sales of 126,000 bags of product, which contain 378,000 clocks and 126,000 wallmounting kits. 5 The RobinsonPatman Act addresses the legal ways in which companies can price their goods for sale to different purchasers. 6 After the constant percentage contribution margin in a multiproduct firm has been determined, all situations regarding profit points can be treated in the same manner as they were earlier in the chapter. One must remember, however, that the answers reflect the bag assumption.
17 Chapter 9 BreakEven Point and CostVolumeProfit Analysis 397 Exhibit 9 11 Sesame Company CVP Analysis Multiple Products Clocks Clock WallMounting Kits Product Cost Information (Percentage) (Percentage) Selling price $ $ Total variable cost (29) (72.5) (4) (40) Contribution margin $ $ 6 60 Total fixed cost (FC) $4,400,000 previous $514,000 additional $4,914,000 Clocks Clock Wall Mounting Kits Total Percentage Number of products per bag 3 1 Revenue per product $40 $10 Total revenue per "bag" $120 $10 $ Variable cost per product (29) (4) Total variable cost per "bag" (87) (4) (91) (70) Contribution margin product $11 $ 6 Contribution margin "bag" $ 33 $ 6 $ BEP in units (where B number of "bags" of products) CM(B) FC $39B $4,914,000 B 126,000 bags Note: Each "bag" consists of 3 clocks and 1 clock wallmounting kit; therefore, it will take 378,000 clocks and 126,000 clock wallmounting kits to break even, assuming the constant 3:1 mix. BEP in sales dollars (where S$ sales dollars; CM% weighted average CM per "bag") S$ FC CM% S$ $4,914, S$ $16,380,000 Note: The breakeven sales dollars also represent the assumed constant sales mix of $120 of clocks to $10 of clock wallmounting kits to represent a 92.3% (rounded) to 7.7% (rounded) ratio. Thus, the company must have $15,120,000 ($16,380, %) in sales of clocks and $1,260,000 in sales of clock wallmounting kits to break even. Proof of these computations using the income statement approach: Clocks Clock WallMounting Kits Total Sales $15,120,000 $1,260,000 $16,380,000 Variable cost (10,962,000) (504,000) (11,466,000) Contribution margin $ 4,158,000 $ 756,000 $ 4,914,000 Fixed cost (4,914,000) Income before tax $ 0
18 398 Chapter 9 BreakEven Point and CostVolumeProfit Analysis Any shift in the product sales mix will change the weighted average CM% and BEP. If the sales mix shifts toward a product with a lower dollar contribution margin, the BEP will increase and profits will decrease unless there is a corresponding increase in total revenues. A shift toward higher dollar contribution margin products without a corresponding decrease in revenues will cause a lower BEP and increase profits. The financial results shown in Exhibit 9 12 indicate that a shift toward the product with the lower dollar contribution margin (clock wallmounting kits) causes a higher BEP and lower profits. This exhibit assumes that Sesame sells 126,000 bags of product (the breakeven level in Exhibit 9 11), but the mix was not in the exact proportions assumed in Exhibit Instead of a 3:1 ratio, the sales mix was 2.5 clocks to 1.5 clock wallmounting kits. A loss of $315,000 resulted because Sesame sold a higher proportion of the clock wallmounting kits, which have a lower unit contribution margin than the clocks. Exhibit 9 12 Sesame Company s Effects of Product Mix Shift Clocks Clock Wall Mounting Kits Total Percentage Number of products per bag Revenue per product $40 $10 Total revenue per bag $ $15 $ Variable cost per product (29) (4) Total variable cost per bag (72.50) (6) (78.50) (68.3) Contribution margin product $11 $ 6 Contribution margin "bag" $ $ 9 $ BEP in units (where B number of bags of products) CM(B) FC $36.50B $4,914,000 B 134,631 bags (rounded up) Actual results: 126,000 bags with a sales mix ratio of 2.5 clocks to 1.5 clock wallmounting kits; thus, the company sold 315,000 clocks and 189,000 clock wallmounting kits. 315,000 Clocks 189,000 Clock WallMounting Kits Total Sales $12,600,000 $1,890,000 $14,490,000 Variable cost (9,135,000) (756,000) (9,891,000) Contribution margin $ 3,465,000 $1,134,000 $ 4,599,000 Fixed cost (4,914,000) Net loss $ (315,000)
19 Chapter 9 BreakEven Point and CostVolumeProfit Analysis 399 Managing Risk of CVP Relationships CVP relationships can be formally analyzed using standard metrics to evaluate risk/reward relationships at existing sales levels or prospective sales levels. Two of these metrics are margin of safety and degree of operating leverage. LO.5 How are margin of safety and operating leverage concepts used in business? Margin of Safety When making decisions about business opportunities and changes in sales mix, managers often consider the margin of safety (MS), which is the excess of budgeted or actual sales over breakeven sales. The MS is the amount that sales can drop before reaching the BEP and, thus, provides a measure of the amount of cushion against losses. The MS can be expressed in units, in dollars, or as a percentage (MS%). The following formulas are applicable: Margin of safety in units Actual sales in units Breakeven sales in units Margin of safety in $ Actual sales in $ Breakeven sales in $ Margin of safety % Margin of safety in units Actual unit sales or MS% Margin of safety in $ Actual sales $ The BEP for Sesame based on the Exhibit 9 1 data is 400,000 units or $16,000,000 of sales. The company s budgeted income statement presented in Exhibit 9 1 shows sales for 2010 of $24,000,000 for 600,000 clocks. Sesame s MS is quite high because the company is operating far above its BEP (see Exhibit 9 13). Exhibit 9 13 Sesame Company s Margin of Safety In units: 600,000 actual 400,000 BEP 200,000 clocks In sales $: $24,000,000 actual sales $16,000,000 BEP sales $8,000,000 As a percentage: 200, , % or $8,000,000 $24,000, % MS calculations allow management to determine how close to a danger level the company is operating and, as such, provide an indication of risk. The lower the MS, the more carefully management must watch revenue and control cost to avoid operating losses. At low margins of safety, managers are less likely to take advantage of opportunities that, if incorrectly analyzed or forecasted, could send the company into a loss position. Operating Leverage Another measure that is closely related to the MS and provides useful management information is the company s degree of operating leverage. The relationship between a company s variable and fixed costs is reflected in its operating leverage. Typically, highly laborintensive organizations have high variable cost and low fixed cost; these organizations have low operating leverage. (An exception to this rule is a sports team, which is highly labor intensive, but its labor cost is fixed rather than variable.)
20 400 Chapter 9 BreakEven Point and CostVolumeProfit Analysis Conversely, organizations that are highly capital intensive or automated have cost structures that include low variable and high fixed cost, providing high operating leverage. Because variable cost is low relative to selling price, the contribution margin is high. However, high fixed cost means that BEP also tends to be high. If the market predominantly sets selling prices, volume has the primary impact on profitability. As companies become more automated, they face this type of cost structure and become more dependent on volume increases to raise profits. Thus, a company s cost structure strongly influences the degree to which its profits respond to sales volume changes. Companies with high operating leverage have high contribution margin ratios. Although such companies must establish fairly high sales volumes to initially cover fixed cost, once that cost is covered, each unit sold after breakeven adds significantly to profits. Thus, a small increase in sales can have a major impact on a company s profits. The degree of operating leverage (DOL) measures how a percentage change in sales from the current level will affect company profits. In other words, DOL indicates how sensitive the company s profit is to sales volume increases and decreases. The computation for DOL follows. DOL CM Profit before tax This calculation assumes that fixed costs do not increase when sales increase. Assume that Sesame Company is currently selling 600,000 clocks. The income statement in Exhibit 9 14 reflects this sales level and shows that the company has a DOL of If Sesame increases sales by 20 percent, the 60 percent change in profits equals the DOL multiplied by the percentage change in sales or ( %). If sales decrease by the same 20 percent, the impact on profits is a negative 60 percent. These amounts are confirmed in Exhibit Exhibit 9 14 Sesame Company s Degree of Operating Leverage Current (600,000 clocks) 20 Percent Increase (720,000 clocks) 20 Percent Decrease (480,000 clocks) Sales $24,000,000 $28,800,000 $19,200,000 Variable cost ($29.00 per clock) (17,400,000) (20,880,000 (13,920,000) Contribution margin $ 6,600,000 $ 7,920,000 $ 5,280,000 Fixed cost (4,400,000) (4,400,000) (4,400,000) Profit before tax $ 2,200,000 $ 3,520,000 a $ 880,000 b Degree of operating leverage Contribution margin Profit before tax ($6,600,000 $2,200,000) 3.00 ($7,920,000 $3,520,000) 2.25 ($5,280, ,000) 6.00 a Profit increase $3,520,000 $2,200,000 $1,320,000 (or 60.00% of the original profit). b Profit decrease $880,000 $2,200,000 ($1,320,000) (or 60% of the original profit). The DOL decreases as sales move upward from the BEP. Thus, when the margin of safety is low, the degree of operating leverage is high. In fact, at the BEP, the DOL is infinite because any increase from zero is an infinite percentage change. If a company is operating close to BEP, each percentage increase in sales can make a dramatic impact on net income. As sales increase from the breakeven point, margin of safety increases but the
21 Chapter 9 BreakEven Point and CostVolumeProfit Analysis 401 degree of operating leverage declines. The relationship between the MS percentage (MS%) and DOL is as follows: MS% 1 DOL DOL 1 MS% This relationship is proved in Exhibit 9 15 using the 600,000clock sales level information for Sesame. Therefore, if one of the two measures is known, the other can be easily calculated. Exhibit 9 15 Sesame Company s Margin of Safety and Degree of Operating Leverage Relationship Breakeven sales 400,000 units; Current sales 600,000 units Margin of safety % Margin of safety in units Actual sales in units [(600, ,000) 600,000] 0.33, or 33% (rounded) Degree of operating leverage Contribution margin Profit before tax $6,600,000 $2,200,000 3 Margin of safety (1 DOL) (1 3) 0.33, or 33% (rounded) Degree of operating leverage (1 MS%) (1 0.33) 3 (rounded) Underlying Assumptions of CVP Analysis CVP analysis is a shortrun model that focuses on relationships among selling price, variable cost, fixed cost, volume, and profit. This model is a useful planning tool that can provide information about the impact on profit when changes are made in the cost structure or in the sales level. Although limiting the accuracy of the results, several important but necessary assumptions are made in the CVP model. These assumptions follow: LO.6 What are the underlying assumptions of CVP analysis? 1. All revenue and variable cost behavior patterns are constant per unit and linear within the relevant range. 2. Total contribution margin (total revenue total variable cost) is linear within the relevant range and increases proportionally with output. This assumption follows directly from assumption Total fixed cost is constant within the relevant range. This assumption, in part, indicates that no capacity additions will be made during the period under consideration. 4. Mixed costs can be accurately separated into fixed and variable elements. Although accuracy of separation can be questioned, reliable estimates can be developed from the use of regression analysis or the high low method (as discussed in Chapter 3). 5. Sales and production are equal; thus, there is no material fluctuation in inventory levels. This assumption is necessary because fixed cost can be allocated to inventory at a different rate each year. Thus, variable costing information must be available. Because CVP and variable costing both focus on cost behavior, they are distinctly compatible with one another. 6. In a multiproduct firm, the sales mix remains constant. This assumption is necessary so that a weighted average contribution margin and CM% can be computed.
Summary. Chapter Five. Cost Volume Relations & Break Even Analysis
Summary Chapter Five Cost Volume Relations & Break Even Analysis 1. Introduction : The main aim of an undertaking is to earn profit. The cost volume profit (CVP) analysis helps management in finding out
More informationChapter 6 CostVolumeProfit Relationships
Chapter 6 CostVolumeProfit Relationships Solutions to Questions 61 The contribution margin (CM) ratio is the ratio of the total contribution margin to total sales revenue. It can be used in a variety
More informationCHAPTER 22 COSTVOLUMEPROFIT ANALYSIS
CHAPTER 22 COSTVOLUMEPROFIT ANALYSIS Related Assignment Materials Student Learning Objectives Conceptual objectives: C1. Describe different types of cost behavior in relation to production and sales
More informationChapter. CostVolumeProfit Relationships
Chapter 6 CostVolumeProfit Relationships 62 LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. Explain how changes in activity affect contribution margin. 2. Compute the contribution
More informationAccounting Building Business Skills. Learning Objectives: Learning Objectives: Paul D. Kimmel. Chapter Fourteen: Costvolumeprofit Relationships
Accounting Building Business Skills Paul D. Kimmel Chapter Fourteen: Costvolumeprofit Relationships PowerPoint presentation by Kate WynnWilliams University of Otago, Dunedin 2003 John Wiley & Sons Australia,
More informationAccounting 610 2C CostVolumeProfit Relationships Page 1
Accounting 610 2C CostVolumeProfit Relationships Page 1 I. OVERVIEW A. The managerial accountant uses analytical tools to advise line managers in decision making functions. CVP (CVP) analysis provides
More informationAssumptions of CVP Analysis. Objective 1: Contribution Margin Income Statement. Assumptions of CVP Analysis. Contribution Margin Example
Assumptions of CVP Analysis CostVolumeProfit Analysis Expenses can be classified as either variable or fixed. CVP relationships are linear over a wide range of production and sales. Sales prices, unit
More informationExhibit 7.5: Graph of Total Costs vs. Quantity Produced and Total Revenue vs. Quantity Sold
244 13. 7.5 Graphical Approach to CVP Analysis (BreakEven Chart) A breakeven chart is a graphical representation of the following on the same axes: 1. Fixed costs 2. Total costs at various levels of
More informationCostVolumeProfit Analysis
CostVolumeProfit Analysis Costvolumeprofit (CVP) analysis is used to determine how changes in costs and volume affect a company's operating income and net income. In performing this analysis, there
More informationManagerial Accounting Prof. Dr. Vardaraj Bapat Department of School of Management Indian Institute of Technology, Bombay
Managerial Accounting Prof. Dr. Vardaraj Bapat Department of School of Management Indian Institute of Technology, Bombay Lecture  26 Cost Volume Profit Analysis Dear participations in our early session,
More informationCOST DATA FOR SHORTRUN TACTICAL DECISION MAKING
COST DATA FOR SHORTRUN TACTICAL DECISION MAKING To decide on the acceptance or rejection of a special order from a supplier, marginal costing and contribution analysis should be applied. The company may
More informationPart Five. Cost Volume Profit Analysis
Part Five Cost Volume Profit Analysis COST VOLUME PROFIT ANALYSIS Study of the effects of changes of costs and volume on a company s profits A critical factor in management decisions Important in profit
More informationModule 12 : Cost Volume Profit Analysis. Lecture 1 : Cost Volume Profit Analysis
Module 12 : Cost Volume Profit Analysis Lecture 1 : Cost Volume Profit Analysis Objectives In this lecture you will learn the following Cost Volume Profit (CVP) Introduction. Fixed costs. Variable costs.
More informationCost VOLUME RELATIONS & BREAK EVEN ANALYSIS
1. Introduction The cost volume profit (CVP) analysis helps management in finding out the relationship of costs and revenues to profit. Cost depends on various factors like Volume of production Product
More informationCosting For DecisionMaking Break Even Analysis. Breakeven even Analysis
Costing For DecisionMaking Break Even Analysis CHAPTER 18 Introduction CVP Analysis Behaviour of Fixed and Variable Costs CVP Analysis and Breakeven even Analysis Breakeven even Analysis Breakeven
More informationPart II Management Accounting DecisionMaking Tools
Part II Management Accounting DecisionMaking Tools Chapter 7 Chapter 8 Chapter 9 CostVolumeProfit Analysis Comprehensive Business Budgeting Incremental Analysis and Decisionmaking Costs Chapter 10
More informationApplications of Linear Equations. Chapter 5
52 Applications of Linear Equations Chapter 5 53 After completing this chapter, you will be able to: > Solve two linear equations in two variables > Solve problems that require setting up two linear
More informationChapter 6: BreakEven & CVP Analysis
HOSP 1107 (Business Math) Learning Centre Chapter 6: BreakEven & CVP Analysis One of the main concerns in running a business is achieving a desired level of profitability. Costvolume profit analysis
More informationChapter 25 CostVolumeProfit Analysis Questions
Chapter 25 CostVolumeProfit Analysis Questions 1. Costvolumeprofit analysis is used to accomplish the first step in the planning phase for a business, which involves predicting the volume of activity,
More informationThe term marginal cost refers to the additional costs incurred in providing a unit of
Chapter 4 Solutions Question 4.1 A) Explain the following The term marginal cost refers to the additional costs incurred in providing a unit of product or service. The term contribution refers to the amount
More informationChapter 6. Chapter 61. Basics of CostVolumeProfit Analysis. Basics of CostVolumeProfit Analysis. CostVolumeProfit Relationships
Chapter 61 Chapter 6 CostVolumeProfit Relationships McGrawHill /Irwin The McGrawHill Companies, Inc., 2007 Basics of CostVolumeProfit Analysis Contribution Margin (CM) is the amount remaining from
More informationBreakeven, Leverage, and Elasticity
Breakeven, Leverage, and Elasticity Dallas Brozik, Marshall University Breakeven Analysis Breakeven analysis is what management is all about. The idea is to compare where you are now to where you might
More informationC 6  ACRONYMS notesc6.doc Instructor s Supplemental Information Written by Professor Gregory M. Burbage, MBA, CPA, CMA, CFM
C 6  ACRONYMS notesc6.doc Instructor s Supplemental Information ACRONYMS (ABBREVIATIONS) FOR USE WITH MANAGERIAL ACCOUNTING RELATING TO COSTVOLUMEPROFIT ANALYSIS. CM Contribution Margin in total dollars
More informationCOSTVOLUMEPROFIT RELATIONSHIPS
TM 51 COSTVOLUMEPROFIT RELATIONSHIPS Costvolumeprofit (CVP) analysis is concerned with the effects on net operating income of: Selling prices. Sales volume. Unit variable costs. Total fixed costs.
More informationCost Behavior and CostVolumeProfit Analysis QUESTIONS
Chapter 18 Cost Behavior and CostVolumeProfit Analysis QUESTIONS 1. A variable cost is one that varies proportionately with the volume of activity. For example, direct materials and direct labor (when
More informationFinancial Analysis, Modeling, and Forecasting Techniques. Course #5710B/QAS5710B Course Material
Financial Analysis, Modeling, and Forecasting Techniques Course #5710B/QAS5710B Course Material TECHNIQUES OF FINANCIAL ANALYSIS, MODELING, AND FORECASTING Delta Publishing Company Copyright 2011 by DELTA
More informationFinancial Analysis, Modeling, and Forecasting Techniques
Financial Analysis, Modeling, and Forecasting Techniques Course #5710A/QAS5710A Course Material Financial Analysis, Modeling, and Forecasting Techniques (Course #5710A/QAS5710A) Table of Contents PART
More informationBreakeven analysis. On page 256 of It s the Business textbook, the authors refer to an alternative approach to drawing a breakeven chart.
Breakeven analysis On page 256 of It s the Business textbook, the authors refer to an alternative approach to drawing a breakeven chart. In order to survive businesses must at least break even, which
More informationThe following purposes are served by analysis of costvolumeprofit relationship : i. To forecast profit fairly accurately. ii. iii. iv.
1. CVP analysis and purposes: Profit per unit of a product depends on its selling price and cost of sales. Total profit depends on sales volume which in turn depends inter alia on selling price. By and
More informationCHAPTER LEARNING OBJECTIVES. Identify common cost behavior patterns.
c04.qxd 6/2/06 2:53 PM Page 124 CHAPTER 4 LEARNING OBJECTIVES 1 2 3 4 5 6 Identify common cost behavior patterns. Estimate the relation between cost and activity using account analysis and the highlow
More informationBreakeven Analysis. Thus, if we assume that price and AVC are constant, (1) can be rewritten as follows TFC AVC
Breakeven Analysis An enterprise, whether or not a profit maximizer, often finds it useful to know what price (or output level) must be for total revenue just equal total cost. This can be done with a
More informationMANAGERIAL ACCOUNTING 7e Al L. Hartgraves Wayne J. Morse
MANAGERIAL ACCOUNTING 7e Al L. Hartgraves Wayne J. Morse Learning Objective 1 CHAPTER 3 Cost Volume Profit Analysis and Planning Identify the uses and limitations of traditional cost volume profit analysis.
More informationHouse Published on www.jpsdir.com
I. Cost  Volume  Profit (Break  Even) Analysis A. Definitions 1. Cost  Volume  Profit (CVP) Analysis: is a means of predicting the relationships among revenues, variable costs, and fixed costs at
More informationVariable Costs. Breakeven Analysis. Examples of Variable Costs. Variable Costs. Mixed
Breakeven Analysis Variable Vary directly in proportion to activity: Example: if sales increase by 5%, then the Variable will increase by 5% Remain the same, regardless of the activity level Mixed Combines
More informationBREAKEVEN ANALYSIS. In your business planning, have you asked questions like these?
BREAKEVEN ANALYSIS In your business planning, have you asked questions like these? How much do I have to sell to reach my profit goal? How will a change in my fixed costs affect net income? How much do
More informationCostVolumeProfit Analysis
CostVolumeProfit Analysis CostVolumeProfit Assumptions and Terminology 1 Changes in the level of revenues and costs arise only because of changes in the number of product (or service) units produced
More information11.3 BREAKEVEN ANALYSIS. Fixed and Variable Costs
385 356 PART FOUR Capital Budgeting a large number of NPV estimates that we summarize by calculating the average value and some measure of how spread out the different possibilities are. For example, it
More informationChapter. Breakeven analysis (CVP analysis)
Chapter 5 Breakeven analysis (CVP analysis) 1 5.1 Introduction Costvolumeprofit (CVP) analysis looks at how profit changes when there are changes in variable costs, sales price, fixed costs and quantity.
More informationThe Profit Function: A Pedagogical Improvement For Teaching Operating Breakeven Analysis
The Profit Function: A Pedagogical Improvement For Teaching Operating Breakeven Analysis Bruce D. Bagamery, Central Washington University  Lynnwood Abstract This paper presents a graphical approach for
More informationBASIC CONCEPTS AND FORMULAE
12 Marginal Costing BASIC CONCEPTS AND FORMULAE Basic Concepts 1. Absorption Costing: a method of costing by which all direct cost and applicable overheads are charged to products or cost centers for finding
More informationBreakEven and Leverage Analysis
CHAPTER 6 BreakEven and Leverage Analysis After studying this chapter, you should be able to: 1. Differentiate between fixed and variable costs. 2. Calculate operating and cash breakeven points, and
More informationProfessional Development Programme on Enriching Knowledge of the Business, Accounting and Financial Studies (BAFS) Curriculum
Professional Development Programme on Enriching Knowledge of the Business, Accounting and Financial Studies (BAFS) Curriculum Course 1 : Contemporary Perspectives on Accounting Unit 8 : Cost Accounting
More informationCostVolumeProfit Analysis
Chapter 6 Notes Page 1 CostVolumeProfit Analysis Understanding the relationship between a firm s costs, profits and its volume levels is very important for strategic planning. When you are considering
More informationChapter 5 Revenue & Cost Analysis
Chapter 5 Revenue & Cost Analysis 1. General Cost data are subject to great misunderstanding than are value data. The main reason: although the various categories of costs have precise meaning to the accountant,
More informationQuantitative Marketing Analysis
Quantitative Marketing Analysis CLASS 2 09.16.13 Revenue (sales) Income Statement Sections 5 Expenses Cost of goods sold (FC and VC) Operating expenses (generally FC) Profit 1 EXHIBIT 2.4: PRO FORMA INCOME
More informationIn this chapter, you will learn to use costvolumeprofit analysis.
2.0 Chapter Introduction In this chapter, you will learn to use costvolumeprofit analysis. Assumptions. When you acquire supplies or services, you normally expect to pay a smaller price per unit as the
More informationModule 4: Cost behaviour and costvolumeprofit analysis
Page 1 of 28 Module 4: Cost behaviour and costvolumeprofit analysis Required reading Chapter 5, pages 187213 Chapter 6, pages 230253 Appendix 6A, pages 256258 Overview The way in which a cost responds
More informationManagement Accounting Fundamentals
Management Accounting Fundamentals Module 4 Cost behaviour and costvolumeprofit analysis Lectures and handouts by: Shirley Mauger, HB Comm, CGA Part 1 2 3 Module 4  Table of Contents Content 4.1 Variable
More informationCHAPTER 3 COSTVOLUMEPROFIT ANALYSIS
CHAPTER 3 COSTVOLUMEPROFIT ANALYSIS NOTATION USED IN CHAPTER 3 SOLUTIONS SP: Selling price VCU: Variable cost per unit CMU: Contribution margin per unit FC: Fixed costs TOI: Target operating income 31
More informationCostVolumeProfit Analysis
HOSP 2110 (Management Acct) Learning Centre CostVolumeProfit Analysis The basic principles of CVP analysis were covered in business math. CVP analysis can be done both graphically, through plotting the
More informationCostVolumeProfit. Managerial Accounting Fifth Edition Weygandt Kimmel Kieso. Page 52
51 CostVolumeProfit Managerial Accounting Fifth Edition Weygandt Kimmel Kieso 52 study objectives 1. Distinguish between variable and fixed costs. 2. Explain the significance of the relevant range.
More information01 In any business, or, indeed, in life in general, hindsight is a beautiful thing. If only we could look into a
01 technical costvolumeprofit relevant to acca qualification paper F5 In any business, or, indeed, in life in general, hindsight is a beautiful thing. If only we could look into a crystal ball and find
More informationAnswers to Text Questions and Problems. Chapter 22. Answers to Review Questions
Answers to Text Questions and Problems Chapter 22 Answers to Review Questions 3. In general, producers of durable goods are affected most by recessions while producers of nondurables (like food) and services
More informationHelena Company reports the following total costs at two levels of production.
Chapter 22 Helena Company reports the following total costs at two levels of production. 10,000 Units 20,000 Units Direct materials $20,000 $40,000 Maintenance 8,000 10,000 Direct labor 17,000 34,000 Indirect
More informationCHAPTER II LITE RATURE STUDY
CHAPTER II LITE RATURE STUDY 2.1. Cost Terminology Based on Charles T.Horngren (2009: 53), cost is a resource sacrificed or forgone to achieve a specific objective. A cost is usually measured as the monetary
More informationManagerial accounting
Managerial accounting Concept of Cost COST definition and classifications In general, cost means the amount of expenditure (actual or notional) incurred on, or attributable to a given thing. However, the
More informationCOST & BREAKEVEN ANALYSIS
COST & BREAKEVEN ANALYSIS http://www.tutorialspoint.com/managerial_economics/cost_and_breakeven_analysis.htm Copyright tutorialspoint.com In managerial economics another area which is of great importance
More informationvolumeprofit relationships
Slide 1.3.1 1. Accounting for decision making 1.3 Costvolume volumeprofit relationships Slide 1.3.2 Introduction This chapter examines one of the most basic planning tools available to managers: cost
More informationINCORPORATION OF LEARNING CURVES IN BREAKEVEN POINT ANALYSIS
Delhi Business Review Vol. 2, No. 1, January  June, 2001 INCORPORATION OF LEARNING CURVES IN BREAKEVEN POINT ANALYSIS Krishan Rana Suneel Maheshwari Ramchandra Akkihal T HIS study illustrates that a
More informationYou and your friends head out to a favorite restaurant
19 CostVolumeProfit Analysis Learning Objectives 1 Identify how changes in volume affect costs 2 Use CVP analysis to compute breakeven points 3 Use CVP analysis for profit planning, and graph the CVP
More informationQWhat Does CHAPTER. Managerial Accounting and CostVolumeProfit Relationships. It Mean?
12 CHAPTER Managerial Accounting and CostVolumeProfit When asked by a marketing or production manager what a certain item or activity costs, the management accountant who asks Why do you want to know?
More informationNumber of Workers Number of Chairs 1 10 2 18 3 24 4 28 5 30 6 28 7 25
Intermediate Microeconomics Economics 435/735 Fall 0 Answers for Practice Problem Set, Chapters 68 Chapter 6. Suppose a chair manufacturer is producing in the short run (with its existing plant and euipment).
More informationCostVolumeProfit Analysis:
4 CostVolumeProfit Analysis: A Managerial Planning Tool After studying Chapter 4, you should be able to: 1 Determine the breakeven point in number of units and in total sales dollars. 2 Determine the
More informationEconomics 101 Fall 2013 Answers to Homework 5 Due Tuesday, November 19, 2013
Economics 101 Fall 2013 Answers to Homework 5 Due Tuesday, November 19, 2013 Directions: The homework will be collected in a box before the lecture. Please place your name, TA name and section number on
More informationCHAPTER 9 BREAKEVEN POINT AND COSTVOLUMEPROFIT ANALYSIS
CHAPTER 9 BREAKEVEN POINT AND COSTVOLUMEPROFIT ANALYSIS 11. a. Breakeven in units = $90,000 ($70 $40) = 3,000 units b. In dollars breakeven = 3,000 $70 = $210,000 12. a. Breakeven point in rings
More informationSession 07. CostVolumeProfit Analysis
Session 07 CostVolumeProfit Analysis Programme : Executive Diploma in Business & Accounting (EDBA 2014) Course : Cost Analysis in Business Lecturer : Mr. Asanka Ranasinghe BBA (Finance), ACMA, CGMA Contact
More informationDOWNLOAD FREE TEXT BOOKS AT BOOKBOON.COM
DOWNLOAD FREE TEXT BOOKS AT BOOKBOON.COM Introduction Nikolaos Tsorakidis, Huron University, London Sophocles Papadopoulos, Huron University, London Michael Zerres, Universität Hamburg Christopher Zerres,
More informationRevenue Structure, Objectives of a Firm and. BreakEven Analysis.
Revenue :The income receipt by way of sale proceeds is the revenue of the firm. As with costs, we need to study concepts of total, average and marginal revenues. Each unit of output sold in the market
More informationChapter3D CVP ANALYSIS AND OPERATING LEVERAGE. BSNL, India For Internal Circulation Only 1
Chapter3D CVP ANALYSIS AND OPERATING LEVERAGE BSNL, India For Internal Circulation Only 1 CVP ANALYSIS AND OPERATING LEVERAGE Introduction: Cost Volume Profit analysis is a study of the interrelationship
More informationIn following this handout, sketch appropriate graphs in the space provided.
Dr. McGahagan Graphs and microeconomics You will see a remarkable number of graphs on the blackboard and in the text in this course. You will see a fair number on examinations as well, and many exam questions,
More information12 Marginal Costing. 12.1 Definitions
12 Marginal Costing Learning Objectives When you have finished studying this chapter, you should be able to Understand the difference between absorption costing and marginal costing Understand the concept
More informationPART TWO. management accounting
PART TWO management accounting CHAPTER TWELVE Management accounting, cost volume profit examined and applied Learning objectives After studying this chapter you should be able to: 1. Explain the need
More informationPart Three. Cost Behavior Analysis
Part Three Cost Behavior Analysis Cost Behavior Cost behavior is the manner in which a cost changes as some related activity changes An understanding of cost behavior is necessary to plan and control costs
More informationNet Present Value and Capital Budgeting. What to Discount
Net Present Value and Capital Budgeting (Text reference: Chapter 7) Topics what to discount the CCA system total project cash flow vs. tax shield approach detailed CCA calculations and examples project
More information2. CostVolumeProfit Analysis
CostVolumeProfit Analysis Page 1 2. CostVolumeProfit Analysis Now that we have discussed a company s cost function, learned how to identify its fixed and variable costs. We will now discuss a manner
More informationDUKE UNIVERSITY Fuqua School of Business. FINANCE 351  CORPORATE FINANCE Problem Set #1 Prof. Simon Gervais Fall 2011 Term 2.
DUKE UNIVERSITY Fuqua School of Business FINANCE 351  CORPORATE FINANCE Problem Set #1 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Two years ago, you put $20,000 dollars in a savings account earning
More informationCost Concepts and Behavior
Chapter 2 Cost Concepts and Behavior McGrawHill/Irwin Copyright 2011 by The McGrawHill Companies, Inc. All rights reserved. Learning Objectives L.O. 1 Explain the basic concept of cost. L.O. 2 Explain
More informationMGT402  Cost & Management Accounting Glossary For Final Term Exam Preparation
MGT402  Cost & Management Accounting Glossary For Final Term Exam Preparation Glossary Absorption costing : Includes all manufacturing costs  including direct materials, direct labor, and both variable
More informationLecture 2. Marginal Functions, Average Functions, Elasticity, the Marginal Principle, and Constrained Optimization
Lecture 2. Marginal Functions, Average Functions, Elasticity, the Marginal Principle, and Constrained Optimization 2.1. Introduction Suppose that an economic relationship can be described by a realvalued
More informationMANAGEMENT ACCOUNTING CostVolumeProfit Analysis
MANAGEMENT ACCOUNTING CostVolumeProfit Analysis Zofia KrokoszKrynke, Ph.D., MBA zofia.krokoszkrynke@pwr.edu.pl Wroclaw University of Technology, Building B4 Room 521 http://www.ioz.pwr.edu.pl/pracownicy/krokosz/
More informationCHAPTER 3 COSTVOLUMEPROFIT ANALYSIS
316 (10 min.) CVP computations. CHAPTER 3 COSTVOLUMEPROFIT ANALYSIS Variable Fixed Total Operating Contribution Contribution Revenues Costs Costs Costs Income Margin Margin % a. $2,000 $ 500 $300 $
More informationPractical Business Application of Break Even Analysis in Graduate Construction Education
Journal of Construction Education Spring 1999, Vol. 4, No. 1, pp. 2637 Copyright 1999 by the Associated Schools of Construction 15228150/99/$3.00/Educational Practice Manuscript Practical Business Application
More informationThe term used for the relative proportion in which a company's products are sold is:
The term used for the relative proportion in which a company's products are sold is: profit ~ Your answer is correct. breakeven sales price The correct answer Is shown. In order to convert the margin
More informationLimited factor and breakeven analysis
Chapter 7 Limited factor and breakeven analysis Syllabus Content D  Marginal costing and decisionmaking 15% Contribution concept. Limiting factor analysis. Breakeven charts, profit/volume graphs, breakeven
More informationRevision point: Fixed costs are those that do not change with changes in production levels, e.g. rent.
SECTION ONE BREAKEVEN ANALYSIS Breakeven point What is meant by the term break even? A firm breaks even when income is sufficiently high to exactly cover total costs therefore neither a profit nor a
More informationManagement Accounting Theory of Cost Behavior
Management Accounting 63 Management Accounting Theory of Cost Behavior Management accounting contains a number of decision making tools that require the conversion of all operating costs and expenses into
More informationChapter 011 Project Analysis and Evaluation
Multiple Choice Questions 1. Forecasting risk is defined as the: a. possibility that some proposed projects will be rejected. b. process of estimating future cash flows relative to a project. C. possibility
More informationMath 1314 Lesson 8 Business Applications: Break Even Analysis, Equilibrium Quantity/Price
Math 1314 Lesson 8 Business Applications: Break Even Analysis, Equilibrium Quantity/Price Three functions of importance in business are cost functions, revenue functions and profit functions. Cost functions
More information6. Financial Planning. Breakeven. Operating and Financial Leverage.
6. Financial Planning. Breakeven. Operating and Financial Leverage. Financial planning primarily involves anticipating the impact of operating, investment and financial decisions on the firm s future
More informationSolutions to Homework Problems for CVP! Cost Volume Profit by David Albrecht
Solutions to Homework Problems for CVP! Cost Volume Profit by David Albrecht Solution to Problem #26 CVP analysis using CM per unit. The controller of Stardust Furniture Company has determined the following
More informationIdentify how changes in volume affect costs
Chapter 18 Identify how changes in volume affect Total variable change in direct proportion to changes in the volume of activity Unit variable cost remains constant Units produced 3 5 Total direct materials
More informationIt is important to know the following assumptions in CVP analysis before we can use it effectively.
CostVolumeProfit analysis (Relevant to AAT Examination Paper 3 Management Accounting) Li Tak Ming, Andy, Deputy Head, Department of Business Administration, Hong Kong Institute of Vocational Education
More informationCE2451 Engineering Economics & Cost Analysis. Objectives of this course
CE2451 Engineering Economics & Cost Analysis Dr. M. Selvakumar Associate Professor Department of Civil Engineering Sri Venkateswara College of Engineering Objectives of this course The main objective of
More informationCHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA
CHAPTER 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA Basic 1. To calculate the payback period, we need to find the time that the project has recovered its initial investment. After two years, the
More informationMathinCTE Lesson Plan: Marketing
MathinCTE Lesson Plan: Marketing Lesson Title: BreakEven Point Lesson 01 Occupational Area: Marketing Ed./Accounting CTE Concept(s): Math Concepts: Lesson Objective: Fixed Costs, Variable Costs, Total
More informationCosting and BreakEven Analysis
W J E C B U S I N E S S S T U D I E S A L E V E L R E S O U R C E S. 28 Spec. Issue 2 Sept 212 Page 1 Costing and BreakEven Analysis Specification Requirements Classify costs: fixed, variable and semivariable.
More informationAnswers to Text Questions and Problems in Chapter 8
Answers to Text Questions and Problems in Chapter 8 Answers to Review Questions 1. The key assumption is that, in the short run, firms meet demand at preset prices. The fact that firms produce to meet
More informationMath 1314 Lesson 8: Business Applications: Break Even Analysis, Equilibrium Quantity/Price
Math 1314 Lesson 8: Business Applications: Break Even Analysis, Equilibrium Quantity/Price Cost functions model the cost of producing goods or providing services. Examples: rent, utilities, insurance,
More informationNotes on indifference curve analysis of the choice between leisure and labor, and the deadweight loss of taxation. Jon Bakija
Notes on indifference curve analysis of the choice between leisure and labor, and the deadweight loss of taxation Jon Bakija This example shows how to use a budget constraint and indifference curve diagram
More information