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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 — CostVolumeProfit (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 156166. . .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 rearranged! For example at some points the book states the Proﬁt Equation is: Contribution Margin — Fixed Costs = Proﬁt same thing! The BreakEven Point CostVolumeProﬁt (CVP) analysis  examines the interrelationship of sales activity, sales prices,
costs, and proﬁts in planning and decisionmaking situations. What does it mean to “break even”? Breakevenpoint— (HAL numb” 90', 0N“ 90“
eﬁUai, I} Why is this important? I .
FMg’kg 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 breakeven?
(Hint —— use the proﬁt equation!) (to ~ (0 5 5’ ‘
mace/r, a (gmo TOM“ Prove it! Sometimes management prefers that the breakeven point be expressed in sales dollars instead of sales units. So what is our breakeven point in sales dollars (aka what is the breakeven 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 breakeven 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 selfexplanatory.)
(<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
contributionmargin percentage (or contributionmargin 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 contributionmargin 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 71 CVP Graph Observations What is along the x—axis? VDiUML ‘ What is along the yaxis? lokt’l 5/ Where does the Revenue Line intersect the yaxis? O ., Where does the Expense Line intersect the yaxis? t/ {2096 , l‘OY‘ml P’ “A win“
Where do both lines intersect? B rec. it / 02m go) A Y Exhibit 73 ProﬁtVolume Graph . Observations q What is along the xaxis? V50” °’ What is along the y—axis‘? “9 'r‘vi St A. V
Where does the Proﬁt Line intersect the yaxis? ~ 41 I. 4“ 4"! {eéi 3’”
Where both the Proﬁt line intersect the xaxis? {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  iTcztatrrevanuefmm' 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 emsmes wt»
12 .300 «W «I
10,006 WWWww—d/
Rdevam range m. w. vima 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 breakeven? (Then, prove that you are right.) \Sx' .oS‘X ~IO>< "SX —— '\'77(l0 =~‘ “(JWK, ‘240 =0
Ms‘ W ‘3‘“) )4: 3Q\.l?.">C What is our breakeven 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 contributionmargin ratio (contributionmargin 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 contributionmargin 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 contributionmargin ratio? 9;: _: gm This was a target net proﬁt problem. What effect does income taxes have on your breakeven 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 perunit 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 breakeven 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‘eW“ 9&1“ rename: Margin of Safety Margin of Safety  A costvolumeproﬁt (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 tshirts. They only make one type of tshirt. You are the company’s CFO. Hoops for Horns Inc. currently has the following cost information: Sales volume 100,000 tshirts per year
Sales price $25 Variable Expenses per tshirt $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 laborintensive 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 aftertax income of $73,500. How many units of each
product do they need to sell to reach their aftertax 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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 Spring '08
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 Managerial Accounting, Contribution Margin

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