Unformatted text preview: ACC 202 Intro to Management Accounting
Chapter 6: CostVolumeProfit Relationships obj 1 Learning Objectives Understand CVP ("What if?") Analysis: how changes in activity affect CM and net income. Prepare & interpret a CVP graph Compute & interpret: CM ratio Break even & target sales $'s & units Margin of safety Degree of operating leverage Key Assumptions of CVP Analysis Selling price is constant. Costs are linear. In multiproduct companies, the sales mix is constant. In manufacturing companies, inventories do not change (units produced = units sold). CostVolumeProfit Analysis Contribution Margin (CM) is the amount remaining from sales revenue after variable expenses have been deducted. CostVolumeProfit Analysis CM is used first to cover fixed expenses. Any remaining CM contributes to net income. Sales, variable expenses, and contribution margin can also be expressed on a per unit basis. If Racing sells an additional bicycle, $200 additional CM will be generated to cover fixed expenses and profit. The Contribution Approach The Contribution Approach
Each month Racing must generate at least $80,000 in total CM to break even. If Racing sells 400 units in a month, it will be operating at the breakeven point. The Contribution Approach The Contribution Approach
If Racing sells one more bike (401 bikes), net operating income will increase by $200. The Contribution Approach
To estimate profits at a particular sales volume multiply the number of units sold above breakeven by the contribution margin per unit. If Racing sells 430 bikes, its net income will be ????? The Contribution Approach
To estimate profits at a particular sales volume multiply the number of units sold above breakeven by the contribution margin per unit. CVP Graphing Steps
Racing developed contribution margin income statements at 300, 400, and 500 units sold. We will use this information to prepare the CVP graph.
Income 300 units Sales $ 150,000 Less: variable expenses 90,000 Contribution margin $ 60,000 Less: fixed expenses 80,000 Net operating income $ (20,000) Income 400 units $ 200,000 120,000 $ 80,000 80,000 $ Income 500 units $ 250,000 150,000 $ 100,000 80,000 $ 20,000 CVP Graphing Steps Dollars In a CVP graph, unit volume is usually represented on the horizontal (X) axis and dollars on the vertical (Y) axis. Units CVP Graphing Steps Dollars Fixed Expenses Units CVP Graphing Steps Dollars Total Expenses Fixed Expenses Units CVP Graphing Steps
Total Sales
Dollars Total Expenses Fixed Expenses Units CVP Graphing Steps
Breakeven point (400 units or $200,000 in sales)
Dollars rofi P t rea A os s L rea A Units Contribution Margin Ratio
The contribution margin ratio is:
Total CM CM Ratio = Total sales For Racing Bicycle Company the ratio is:
$80,000 = 40% $200,000 Each $1.00 increase in sales results in a total contribution margin increase of 40. Contribution Margin Ratio
Or, in terms of units, the contribution margin ratio is:
Unit CM CM Ratio = Unit selling price For Racing Bicycle Company the ratio is: $200 = 40% $500 Contribution Margin Ratio
400 Bikes Sales $ 200,000 Less: variable expenses 120,000 Contribution margin 80,000 Less: fixed expenses 80,000 Net operating income $ 500 Bikes $ 250,000 150,000 100,000 80,000 $ 20,000 A $50,000 increase in sales revenue results in a $20,000 increase in CM. ($50,000 40% = $20,000) Quick Check Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. 2,100 cups are sold each month on average. What is the CM Ratio for Coffee Klatch? a. 1.319 b. 0.758 c. 0.242 d. 4.139 Changes in Fixed Costs & Sales Volume What is the profit impact if Racing can increase unit sales from 500 to 540 by increasing the monthly advertising budget by $10,000? Changes in Fixed Costs & Sales Volume
$80,000 + $10,000 advertising = $90,000 Sales increased by $20,000, but net income decreased by $2,000. Changes in Fixed Costs & Sales Volume The Shortcut Solution (incremental analysis)
Increase in CM (40 units X $200) Increase in advertising expenses Decrease in net operating income $ 8,000 10,000 $ (2,000) Changes in Variable Costs & Sales Volume What is the profit impact if Racing can use higher quality raw materials, thus increasing variable costs per unit by $10, to generate an increase in unit sales from 500 to 580? Changes in Variable Costs & Sales Volume
580 units $310 variable cost/unit = $179,800 Sales increase by $40,000, and net income increases by $10,200. Changes in Fixed Costs, Sales Price & Volume What is the profit impact if Racing: (1) cuts its selling price $20 per unit, (2) increases advertising by $15,000 & (3) increases sales from 500 to 650 units Changes in Fixed Costs, Sales Price & Volume Sales increase by $62,000, fixed costs increase by $15,000, & net income increases by $2,000. Change in Variable Cost, Fixed Cost & Sales Volume
What is the profit impact if Racing: (1)pays a $15 sales commission per bike sold instead of paying salespersons flat salaries that currently total $6,000 per month, and (2) increases unit sales from 500 to 575? Change in Variable Cost, Fixed Cost & Sales Volume Sales increase by $37,500, variable costs increase by $31,125, but fixed expenses decrease by $6,000. Change in Regular Sales Price
If Racing has an opportunity to sell 150 bikes to a wholesaler without disturbing sales to other customers or fixed expenses, what price would it quote to the wholesaler if it wants to increase monthly profits by $3,000? Change in Regular Sales Price
$ 3,000 150 bikes = Variable cost per bike = Selling price required = $ 20 per bike 300 per bike $ 320 per bike 150 bikes $320 per bike = $ 48,000 Total variable costs = 45,000 Increase in net income = $ 3,000 Practice: Exercise 612 BreakEven Analysis Breakeven analysis can be approached in three ways: 1. CVP Equation method 1. Alternative method 1. Contribution margin method CVP Equation Method
Profits = (Sales Variable expenses) Fixed expenses OR Sales = Variable expenses + Fixed expenses + Profits At the breakeven point profits equal zero BreakEven Analysis
Information from Racing Bicycle Company: Total Sales (500 bikes) $ 250,000 Less: variable expenses 150,000 Contribution margin $ 100,000 Less: fixed expenses 80,000 Net operating income $ 20,000 Per Unit $ 500 300 $ 200 Percent 100% 60% 40% CVP Equation Method
Calculate the breakeven point in units:
Sales = Variable expenses + Fixed expenses + Profits $500Q = $300Q + $80,000 + $0 Where: Q = Number of bikes sold $500 = Unit selling price $300 = Unit variable expense $80,000 = Total fixed expense CVP Equation Method
Calculate the breakeven point in units:
Sales = Variable expenses + Fixed expenses + Profits $500Q = $300Q + $80,000 + $0 $500Q  $300Q = $80,000 $200Q = $80,000 Q = $80,000 $200 per bike Q = 400 bikes CVP Equation Method
The equation to calculate the breakeven point in sales dollars.
Sales = Variable expenses + Fixed expenses + Profits X = 0.60X + $80,000 + $0
Where: X = Total sales dollars 0.60 = Variable expenses as a % of sales $80,000 = Total fixed expenses CVP Equation Method
The equation to calculate the breakeven point in sales dollars.
Sales = Variable expenses + Fixed expenses + Profits X = 0.60X + $80,000 + $0 X 0.6X = $80,000 0.40X = $80,000 X = $80,000 0.40 X = $200,000 Alternative Method
Plug the given info into a contribution format income statement: Sales < VC > CM < FC > Profit P/U 500 300 % Total < 80K > 0 Alternative Method
What must total CM be to break even? Sales < VC > CM < FC > Profit P/U 500 300 % Total < 80K > 0 Alternative Method
What must total CM be to break even? Sales < VC > CM < FC > Profit P/U 500 300 % Total 80K < 80K > 0 Alternative Method
What is CM per unit? Sales < VC > CM < FC > Profit P/U 500 300 % Total 80K <80K > 0 Alternative Method
What is CM per unit? Sales < VC > CM < FC > Profit P/U 500 300 200 % Total 80K < 80K > 0 Alternative Method
What is CM Ratio? Sales < VC > CM < FC > Profit P/U 500 300 200 % Total 80K < 80K > 0 Alternative Method
What is CM Ratio? Sales < VC > CM < FC > Profit P/U 500 300 200 % 100% 60% 40% Total 80K < 80K > 0 Alternative Method
What is break even sales? Sales < VC > CM < FC > Profit P/U 500 300 200 % 100% 60% 40% Total 80K < 80K > 0 Contribution Margin Method
The contribution margin method has two key equations.
Breakeven point = in units sold Breakeven point in total sales dollars = Fixed expenses Unit contribution margin Fixed expenses CM ratio Alternative Method
Break even sales = $80K / 40% = $200K Sales < VC > CM < FC > Profit P/U 500 300 200 % Total 100% 200K 60% < 120K > 40% 80K < 80K > 0 Contribution Margin Method
Calculate the breakeven point in total sales dollars at Racing.
Breakeven point in total sales dollars = Fixed expenses CM ratio $80,000 = $200,000 breakeven sales 40% Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. 2,100 cups are sold each month on average. What is the breakeven sales in units? a. 872 cups Quick Check b. 3,611 cups c. 1,200 cups d. 1,150 cups Quick Check Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. 2,100 cups are sold each month on average. What is the breakeven sales in dollars? a. $1,300 b. $1,715 c. $1,788 d. $3,129 Target Profit Analysis Use the equation and contribution margin methods to calculate the sales volume needed to achieve a target profit. Racing Bicycle Company wants to know how many bikes must be sold to earn a profit of $100,000. The CVP Equation Method
Sales = Variable expenses + Fixed expenses + Profits $500Q = $300Q + $80,000 + $100,000 $200Q = $180,000 Q = 900 bikes The Contribution Margin Approach
Unit sales to attain = the target profit Fixed expenses + Target profit Unit contribution margin $80,000 + $100,000 = 900 bikes $200/bike Quick Check Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. How many cups of coffee would have to be sold to attain target profits of $2,500 per month? a. 3,363 cups b. 2,212 cups c. 1,150 cups d. 4,200 cups The Margin of Safety:
The excess of budgeted (or actual) sales over the breakeven volume of sales.
Margin of safety = Total sales  Breakeven sales Look at Racing Bicycle Company and determine the margin of safety. The Margin of Safety
Assume Racing Bicycle Company has actual sales of $250,000. We determined breakeven sales were $200,000. The margin of safety therefore is $50,000. ($250,000 $200,000 = $50,000)
Breakeven sales 400 units Sales $ 200,000 Less: variable expenses 120,000 Contribution margin 80,000 Less: fixed expenses 80,000 Net operating income $ Actual sales 500 units $ 250,000 150,000 100,000 80,000 $ 20,000 The Margin of Safety
The margin of safety can be expressed as 20% of sales. ($50,000 $250,000)
Breakeven sales 400 units Sales $ 200,000 Less: variable expenses 120,000 Contribution margin 80,000 Less: fixed expenses 80,000 Net operating income $ Actual sales 500 units $ 250,000 150,000 100,000 80,000 $ 20,000 The Margin of Safety
The margin of safety can be expressed in terms of the number of units sold. The margin of safety at Racing is $50,000, and each bike sells for $500.
Margin of $50,000 = = 100 bikes Safety in units $500 Quick Check Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. 2,100 cups are sold each month on average. What is the margin of safety in units? a. 3,250 cups b. 950 cups c. 1,150 cups d. 2,100 cups Cost Structure and Profit Stability
Cost structure refers to the relative proportion of fixed and variable costs in an organization. Managers often have some latitude in determining their organization's cost structure. Cost Structure and Profit Stability
There are advantages and disadvantages to high fixed cost (or low variable cost) and low fixed cost (or high variable cost) structures.
An advantage of a high fixed cost structure is that income will be higher in good years compared to companies A disadvantage of a high fixed with lower proportion of cost structure is that income fixed costs. will be lower in bad years compared to companies with lower proportion of fixed costs. Operating Leverage:
Measures how sensitive net income is to percentage changes in sales.
Degree of Contribution margin = operating leverage Net income Operating Leverage
At Racing, the degree of operating leverage is 5.
Actual sales 500 Bikes Sales $ 250,000 Less: variable expenses 150,000 Contribution margin 100,000 Less: fixed expenses 80,000 Net income $ 20,000 $100,000 = 5 $20,000 Operating Leverage
With an operating leverage of 5, if Racing increases its sales by 10%, net operating income would increase by 50%.
Percent increase in sales Degree of operating leverage Percent increase in profits
10% 5 50% Here's the verification! Operating Leverage 10% increase in sales from $250,000 to $275,000 . . . . . . results in a 50% increase in income from $20,000 to $30,000. Quick Check Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. 2,100 cups are sold each month on average. What is the operating leverage? a. 2.21 b. 0.45 c. 0.34 d. 2.92 Quick Check At Coffee Klatch the average selling price of a cup of coffee is $1.49, the average variable expense per cup is $0.36, and the average fixed expense per month is $1,300. 2,100 cups are sold each month on average. If sales increase by 20%, by how much should net operating income increase? a. 30.0% b. 20.0% c. 22.1% d. 44.2% Verify Increase in Profit
Actual sales 2,100 cups Sales $ 3,129 Less: Variable expenses 756 Contribution margin 2,373 Less: Fixed expenses 1,300 Net operating income $ 1,073 % change in sales % change in net operating income Increased sales 2,520 cups $ 3,755 907 2,848 1,300 $ 1,548 20.0% 44.2% Structuring Sales Commissions
Companies generally compensate salespeople by paying them either a commission based on sales or a salary plus a sales commission. Commissions based on sales dollars can lead to lower profits in a company. Let's look at an example. Structuring Sales Commissions
Pipeline Inc. produces two types of surfboards: XR7 Turbo selling price $100 selling price $150 CM $25 CM $18 The sales force at Pipeline Inc. is compensated by commissions based on sales dollars. Which product will the sales force try to sell? Structuring Sales Commissions
If you were on the sales force at Pipeline, would you push hard to sell the Turbo even though the XR7 earns a higher CM per unit? Eliminate this type of conflict, by basing commissions on contribution margin rather than on selling price. The Concept of Sales Mix Sales mix is the relative proportion in which a company's products are sold. Different products have different selling prices, cost structures, and contribution margins. Let's assume Racing Bicycle Company sells bikes and carts and that the sales mix between the two products remains the same. Multiproduct BreakEven Analysis
Racing Bicycle Co. information: $265,000 = 48.2% (rounded) $550,000 Multiproduct BreakEven Analysis
Breakeven sales Fixed expenses = CM Ratio $170,000 = 48.2% = $352,697 Class Practice
Compute Break Even Point for a Multiproduct Company ...
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 Spring '08
 WOOLLEN
 Accounting, Contribution Margin, Sales, Coffee Klatch

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