Chapter 5

# Chapter 5 - Chapter 5 Cost-Volume-Profit Relationships...

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Chapter 5 Cost-Volume-Profit Relationships Suggested Homework: E5-1 thru E5-17

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Basics of Cost-Volume-Profit Analysis Contribution Margin (CM) is the amount remaining from sales revenue after variable expenses have been deducted. CM is used first to cover fixed expenses. Any remaining CM contributes to net operating income.
The Contribution Approach 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.

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The Contribution Approach Each month, Racing must generate at least \$80,000 in total CM to break even.
The Contribution Approach If Racing sells 400 units 400 units in a month, it will be operating at the break-even point .

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The Contribution Approach If Racing sells one more bike ( 401 bikes 401 bikes ), net operating income will increase by \$200 .
The Contribution Approach We do not need to prepare an income statement to estimate profits at a particular sales volume. Profits = # of units sold above break- even * contribution margin per unit. If Racing sells 430 bikes, its net income will be \$6,000 (30 bikes above break-even * \$200 = \$6,000)

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CVP Relationships in Graphic Form The relationship among revenue, cost, profit and volume can be expressed graphically by preparing a CVP graph. 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 400 units 500 units Sales 150,000 \$ 200,000 \$ 250,000 \$ Less: variable expenses 90,000 120,000 150,000 Contribution margin 60,000 \$ 80,000 \$ 100,000 \$ Less: fixed expenses 80,000 80,000 80,000 Net operating income (20,000) \$ - \$ 20,000 \$
CVP Graph Units Dollars In a CVP graph, unit volume is usually represented on the horizontal (X) axis and dollars on the vertical (Y) axis.

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CVP Graph Units Dollars Fixed Expenses
CVP Graph Dollars Units Fixed Expenses Total Expenses

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CVP Graph Fixed Expenses Dollars Total Expenses Total Sales Units
CVP Graph Dollars Units Break-even point Break-even point (400 units or \$200,000 in sales) (400 units or \$200,000 in sales) Profit Area Loss Area

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Contribution Margin Ratio The contribution margin ratio is: For Racing Bicycle Company the ratio is: Total CM Total sales CM Ratio = Each \$1.00 increase in sales results in a total contribution margin increase of 40¢. = 40% \$80,000 \$200,000
Contribution Margin Ratio Or, in terms of units , the contribution margin ratio is: For Racing Bicycle Company the ratio is: \$200 \$500 = 40% Unit CM Unit selling price CM Ratio =

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400 Bikes 500 Bikes Sales 200,000 \$ 250,000 \$ Less: variable expenses 120,000 150,000 Contribution margin 80,000 100,000 Less: fixed expenses 80,000 80,000 Net operating income - \$ 20,000 \$ Contribution Margin Ratio 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?

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Chapter 5 - Chapter 5 Cost-Volume-Profit Relationships...

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