Chapter%205 - 2:11—15 UNIVERSITY OF TEXAS AT AUSTIN...

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Unformatted text preview: 2:11—15 UNIVERSITY OF TEXAS AT AUSTIN MCCOMBS SCHOOL OF BUSINESS ‘ ACC 312 — Spring 2011 Fundamentals of Managerial Accounting Instructor - Brian Lendecky, MPA, CPA (copyright © 2011 Brian Lendecky) Tuesday and Thursday, February 8 & 10, 2011 Chapter 5 — Cost-Volume-Profit (CVP) Analysis Profit Eguation In Chapter 4 we learned about the cost equation: total variable costs + total fixed costs = total costs Stated another way. . .. (unit variable cost)(volume of activity) + total fixed costs = total costs If we just add revenue, we now have the profit equation: Revenues — Variable Costs — Fixed Costs = Profit Since revenue and variable costs are both variable the profit equation can also be stated as: (sales 55 per unit)(units sold) — (variable cost per unit)(units sold) — fixed costs = profit I counted around 7 equations used in this chapter from pages 156-166. . .unit contribution margin approach, contribution margin ratio approach, blah, blah, blah. Pretty confusing if you ask me! There is really only one equation you need to know ...... ..THE PROFIT EQUATION. All the other equations in the book are the Profit Equation, just re-arranged! For example at some points the book states the Profit Equation is: Contribution Margin — Fixed Costs = Profit same thing! The Break-Even Point Cost-Volume-Profit (CVP) analysis - examines the interrelationship of sales activity, sales prices, costs, and profits in planning and decision-making situations. What does it mean to “break even”? Break-evenpoint— (HAL numb” 90', 0N“ 90“ efiUai, I} Why is this important? I . FMg’k-g fioC/Si’ir00 ‘19" ("NH qskjodrnqp ‘Lj‘w (“V/o & ’ / ef—t. new basin“ WNW” gamma, *0 Cf . (NMQA PQJUULf cam-(3 Lypmgc} (Lrt/ / Example - Seattle Contemporary Theater First step for CVP analysis, is to break out all your costs into fixed or variable. Ticket Price $ 1 6 Variable Expenses per audience member (city fee, printing playbills, etc.) $10 Fixed Costs per month (theater rental, salaries, insurance, advertising, etc.) $48,000 How many tickets does Seattle Contemporary Theater have to sell per month to break-even? (Hint —— use the profit equation!) (to ~ (0 5 5’ ‘ mace/r, a (gmo TOM“ Prove it! Sometimes management prefers that the break-even point be expressed in sales dollars instead of sales units. So what is our break-even point in sales dollars (aka what is the break-even revenues) per month, not units? gt 17/900 Review question from Chapter 4. . ..What is the contribution margin? lZzUcMc, / 6‘61"“ C95? So, what is the unit contribution margin for our Seattle Contemporary Theater example above? ((a\(O =6 In order to break-even do you have to cover just your variable expenses? Or BOTH your variable and fixed expenses? So, why is it called contribution margin? (If you think about it, it is kind of self-explanatory.) (<9! 0/003 Q hum) w e. 3%, ll‘L LON-("lacked {'0 (Oder [v :4 ‘KJ Co; +5. ‘30 NOV” +1” @‘xefi (6965 are, amazok, In the Seattle Contemporary Theater example, how many tickets do we have to sell per month before all the fixed costs are “paid off” and we start turning a profit? What else does the unit contribution margin tell us? id EUUJ Haw" ML 960/ we, [A we,“ cor {)(Dczilr (or decfeeszlmf 1°93 :7 fl; Many times the contribution margin is expressed as a percentage of sales dollars. This is called the contribution-margin percentage (or contribution-margin ratio). Contribution Margin Ratio = Contribution Margin / Revenue It could also be stated as Contribution Margin Ratio = (Revenue — Variable Costs) / Revenue What is Seattle Contemporary Theaters contribution-margin ratio? @ZACQ 6’ /( b 5 T? 'g ‘70 So, for every dollar that is sold, how much gets contributed to “paying off” fixed expenses? <3; .37 5’ In some industries CM ratios are high (furniture), some are low (grocery store). Let’s look at what we just learned in a graph format. Exhibit 7-1 CVP Graph Observations What is along the x—axis? VDiUML ‘ What is along the y-axis? l-okt’l 5/ Where does the Revenue Line intersect the y-axis? O ., Where does the Expense Line intersect the y-axis? t/ {2096 , l‘OY‘ml P’ “A win“ Where do both lines intersect? B rec. it / 02m go) A Y Exhibit 7-3 Profit-Volume Graph . Observations q What is along the x-axis? V50” °’ What is along the y—axis‘? “9 'r‘vi St A. V Where does the Profit Line intersect the y-axis? ~ 41 I. 4“ 4"! {eéi 3’” Where both the Profit line intersect the x-axis? {4 r09 '1 at/M foil “7r Let’s review everything we’ve learned so far, by making up our own example! Try and do this without looking at the notes above! Let’s throw a party! $600 (per month) Pmfit area “30 - iTcztatrrevanue-fmm' ticketsaies = 1:30 > E Breakfiven pew: Tom; WU ‘ 8,036 tickms 0:“ expenses _ I V , _ $138.9{30mf samfi v 130 ' QM W m m m W M m m w m M W W m m A. E . ( 120 f 1 1 O A um " Tatai fixed ems-mes wt» 12 .300 «W «I 10,006 WWWww—d/ Rdevam range m. w. vim-a 6.000 m». w. 4,0530 WW 0 2.000 83300 Volume {tickets Boss in me month} Aficofi 96 E 2me 339m 9:20} ngg amwméghm “mama “fiat”, , _ cm 590“ ow. om EEQE E3 000% Class example — ACC 312 Party, Inc. Variable Expenses: I _ S. ‘ wrist lawn — d .0 r I r ‘ I ‘0 \N/rx‘mk‘l (“N «H? Lit» 303%“ 1'0 (0 Dumps (UM pro "l’w‘a'b‘ )/ S COPS : S‘O Fixed Expenses: Bflq‘fl’k Roomn i: Q (GCQC) by: $100 [lgudqv pen} ; Wristband Sales Price l 5’ How many wristbands do we have to sell to break-even? (Then, prove that you are right.) \Sx' .oS‘X ~IO>< "SX —-— '\'77(l0 =~‘ “(J-WK, ‘240 =0 Ms‘ W ‘3‘“) )4: 3Q\.l?.">C What is our break-even point in dollars, not units? gm, .tsm What is our unit contribution margin? @/ 24cm 5 26"“70/7’ / For every wristband we sell, how much do we increase our profits? § 4 . Ht 9 What is our contribution-margin ratio (contribution-margin percentage)? Target Profit Are we happy just breaking even? NO. (Lid, (000 [Mg/tag. Example - Seattle Contemporm Theater Seattle Contemporary Theater wants to make a profit of $3,600 per month. Ticket Price $16 Variable Expenses per audience member (city fee, printing playbills, etc.) $10 Fixed Costs per month (theater rental, salaries, insurance, advertising, etc.) $48,000 How many tickets does Seattle Contemporary Theater have to sell per month to reach their target net profit? (Hint — use the profit equation! !) x: 3% HM t“ W“ Prove it! (9(g600> _ {OCQQmB \qgoooz them v <Z<POOQ "KW : 3600 (Note — I recommend calculating the solution as shown above, however I did want to share with you the way I personally solved this question the first time I saw it.) ’zeoa/é r Co 06 Mflre/ uni-"Asa What is the target profit point in sales dollars? ("87on What is the unit contribution margin? ((5 What is the contribution-margin ratio? G/l(0 : 37.3% Effect of Income Taxes on Target Net Profit Very old saying - What are two things you HAVE to do in life? pea,“ 0! ml {’79 m - Example — AccuTime Company AccuTime Company wants to make a profit of $30,000 at the end of 2009. Sales Price per unit $25 Variable Expenses per unit $16 Fixed Costs $150,000 Tax Rate 40% How many units does AccuTime have to sell to reach their target net profit? ZS>4* (fox ~ ($0600 ; Wfibm .QJ('ZS’7<- (bX—D—ooacD : 7.0990 (ix—($000: Same X: 2272?, '21 Prove it! Revenue - Variable Expenses - Fixed Expenses Income before Taxes - Income Tax Expense Net Profit What is the target profit point in sales dollars (aka revenue)? §g~§§§ §.§ What is the unit contribution margin? ‘l What is the contribution-margin ratio? 9;: _: gm This was a target net profit problem. What effect does income taxes have on your break-even point? \Qona. No +k+<34 or\ “212?” P/“m' 31., Applying CVP Analysis Now that you know the Profit Equation, you can use CVP analysis to answer what if” questions (called sensitivity analysis). Example — Wake Up Inc. Wake Up Inc. makes alarm clocks. They only make one alarm clock, Clock X. You are the company’s CFO. Wake Up Inc. currently has the following cost information: Variable Expenses per clock $10 Total Fixed Expenses per month $48,000 Tax Rate 20% The VP of Marketing gives you the following options and wants you to pick what is best for the company. Option 1 - If we sell Clock X for $16, we can sell 10,000 clocks a month. Option 2 - If we sell Clock X for $19, we can sell 6,000 clocks a month. But, if we only need to make 6,000 clocks we can rent a smaller building and therefore will save $10,000 in rent per month. SQGCWQ v (0000033 - £61600) :. 51600 _<g(‘tc«(<m» ~ mews — 3&me : Quick Review — CVP Analysis What is “contribution margin”? (Remember, CM can be stated in total dollars or on a per-unit basis.) Qawmeb v V4 MW. e 05 V5 What is the profit equation? . Q11 a]? fiwwv» var; «All. @0995 ' Kad)‘ cefiks ‘5 0% How do you calculate a company’s break-even point? Rode/too) / V‘Lf {Risk (08 i5 — CIX.(AA (03b : a How do you calculate how many units have to be sold to obtain a target net income? Randy»; , vm'aw c051,; - C(‘XLQR ($38: in «If 40'1" (Mama. U How does the above profit equation change if, for example, there is a 30% tax rate? (WCAUQ ’ WWW; Lé’fl'9. wgbm : Pmték New term. . . .What is the Margin of Safety? \ L CLgk/H‘QA gOhw 30')! 54h! Fatima—v. and We bek‘e-W“ 9&1“ rename: Margin of Safety Margin of Safety - A cost-volume-profit (CVP) relation that allows firms to evaluate risk by considering the amount by which expected sales exceeds breakeven sales. Example — Hoops for Horns Inc. Hoops for Horns Inc. makes 2011 Final Four t-shirts. They only make one type of t-shirt. You are the company’s CFO. Hoops for Horns Inc. currently has the following cost information: Sales volume 100,000 t-shirts per year Sales price $25 Variable Expenses per t-shirt $10 Total Fixed Expenses per year $1,200,000 Tax Rate 20% What is Hoop>s< for Horns Inc’s breakeven point? ’< , 25' (Wee) ~ (chemise) «— 1,100,090 ~ 0 X 1: / 00;) Prove it: Revenue lSmOOO 30, 000 (Lg) - Variable Expenses (O @0000 $0000 C 1° 3 — Fixed Expenses 4100000 Income before Taxes 0 - Income Tax Expense 0 Net Profit 0 The margin of safety lets Hoops for Horns Inc. know how much “cushion” they have between their current sales volume and the breakeven sales volume. This cushion lets them know how much of a fluctuation in demand can occur before they lose money. Margin of safety = current sales volume — breakeven sales volume current sales volume The margin of safety can also be expressed in revenue dollars (it gives you the same answer): Margin of safety = current revenue — breakeven revenue current revenue What is Hoops for Horns Inc.’s margin of safety? m Cofi‘cfl ~ $0090 ,. 194%) ( 006w In general, the higher the margin of safety, the lower the risk of a net loss should actual sales fall short of expectations. ‘ The margin of safety can also be used to calculate the percent change in profit that results from any given percent change in sales, using the following equation: Percent change in profit before taxes = (Percent change in sales volume)(1 / margin of safety) If Hoops for Horns Inc.’s sales increased by 5%, how much would before tax profit increase? (Same answer for decreases) (USO/.1) £1590 Prove it: y I ’— (\°> ‘ 11000633 (000005153, (0900000)» (200000 (0.8000087 ' “93900 Zfooooo- 1,000000 ~ \,ZooO©® 2(013000 p. (090005, \200000 339.30 Vom— selom We WSW WW 775‘mo/3owoo fi l .75 Cost Structure and Operating Leverage Cost structure of an organization — TZKL rglafiUq, pC‘o?of{»,‘g,\ 0Q, 1M4) Wfabte (<3. I: So. . . ..An automated manufacturing plant usually has a high proportion of fixed costs. So. . ...A labor-intensive manufacturing plant usually has a high proportion of variable costs. An organization’s cost structure has a significant effect on the way that profits fluctuate in response to changes in sales volume. The greater the proportion of fixed costs, the greater the impact on profit from a change in sales revenue. I think this is best explained in a graph. Company A, B, and C each sold 1,000 widgets this year. Each company makes the exact same widget, you cannot tell them apart. Their income statements are: Company A Company B Company C (Manual) (Middle) (Automated) Sales $500,000 $500,000 $500,000 Variable Expenses $400,000 $300 000 $ 50 000 Contribution Margin $100,000 $200,000 $450,000 Fixed Expenses $ 50,000 $150,000 $400,000 Net Income $50,000 $50,000 $50,000 500k 400k 300k 200k 100k Net Income 0 I 1000 1250 1500 1750 2000 <100k> xx” ’1’ Units sold <200k> , <300k> ,z ’ ’ <400k> ” <500k> OperatingLeverage— TkL flaw/k .10 dunk an orjma‘zJHotx 08M (2;de c49ng . . m id‘s (at WWW High Operating Leverage —- a company With a high proportion of fixed costs compared to variable costs. (Therefore a HIGH contribution margin.) Low Operating Leverage — a company with a low proportion of fixed costs compared to variable costs. (Therefore a LOW contribution margin.) Which company’s net income will be affected more by a change (either up or down) in sales revenue, one that has a high operating leverage or one with a low operating leverage? (away C. Which company is that in our graph above? 0 An accountant can measure the risk arising from having more fixed costs. This is called the operating leverage: Operating Leverage = Fixed Costs / Total Costs Let’s look again at companies A, B, and C from the last page. i r What is A’s operating leverage? 30300 / qgoOaf) :: /6{ r _ ’— ‘ y I What is B’s operating leverage? iii/0°04, 90000 ’— /3 ' What is C’s operating leverage? \lOOOOO/ q 9000 L V? 9 , <3 % g fil Sales Mix Most companies sell more than one product. SalesMix— TLW “\Ay‘wo, “cede,” DC and, $394, 06’ (produc/l' éolA. Again, I think the book makes this topic look much harder than it really is. On pages 172 they talk about using the weighted unit contribution margin method and then on page 174 they talk about solving the same problem using the weighted contribution margin ratio method. It’s so confusingl! Again, all you need is the PROFIT EQUATION! ! !! Example Mount Carmel Company sells only two products, Product A and Product B. Product A Product B Total Selling price $40 $50 Variable cost per unit $24 $40 Total fixed costs $840,000 Mount Carmel sells two units of Product A for each unit it sells of Product B. Mount Carmel faces a tax rate of 30%. Mount Carmel desires a net after-tax income of $73,500. How many units of each product do they need to sell to reach their after-tax income target? WKQQQMQOKH hizfilsoo «(.6007 (m) ~(m‘>@0>0 Jams) =4sz £647 ((620 tfl’éleofl 30490” :7 X: 67309 Vfotloclr A T 49000 pookabi' B 5: ZlfOO ' 49000} + mfizls’m‘) -gqmo = 7 Assumptions underlying CVP Analysis Everything we have learned about CVP analysis is based on some underlying assumptions. 1. Revenues and variable costs increase proportionally with sales volume. (aka the behavior of revenues and variable costs is linear within the relevant range.) 2. Selling prices, unit variable costs, and fixed costs are known with certainty. 3. The sales mix remains constant over the relevant range. 4. Inventory levels at the beginning and end of the accounting period are the same. (aka we assume the number of units sold equals the number of units produced.) 5. CVP analysis does not take into account the time value of money. 6. There is plenty of capacity for the organization in question. ...
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This note was uploaded on 06/07/2011 for the course ACC 312 taught by Professor Welsh during the Spring '08 term at University of Texas at Austin.

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Chapter%205 - 2:11—15 UNIVERSITY OF TEXAS AT AUSTIN...

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