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Chapter 22

Chapter 22. Cost-Volume-Profit Analysis. Objective 1. Identify how changes in volume affect costs. Types of Costs. Variable. Fixed. Mixed. Total Variable Cost. Total variable costs change when activity changes.

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Chapter 22

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  1. Chapter 22 Cost-Volume-Profit Analysis

  2. Objective 1 • Identify how changes in volume affect costs.

  3. Types of Costs Variable Fixed Mixed

  4. Total Variable Cost • Total variable costs changewhen activity changes. Your total long distancetelephone bill is basedon how many minutesyou talk. Total Long DistanceTelephone Bill Minutes Talked

  5. Variable Cost Per Unit Variable costs per unit do not changeas activity increases. The cost per long distanceminute talked is constant.For example, 10cents per minute. Per MinuteTelephone Charge Minutes Talked

  6. Variable Costs Example Consider Grand Canyon Railway. • Assume that breakfast costs Grand Canyon Railway $3 per person. • If the railroad carries 2,000 passengers, it will spend $6,000 for breakfast services.

  7. Variable Costs Example Total Variable Costs (thousands) $24 – $18 – $12 – $6 – – – – – 0 1 2 3 4 5 Volume (Thousands of passengers)

  8. Total Fixed Cost Total fixed costs remain unchangedwhen activity changes. Your monthly basictelephone bill probablydoes not change whenyou make more local calls. Monthly Basic Telephone Bill Number of Local Calls

  9. Mixed Costs • Contain fixed portion that is incurred even when facility is unused & variable portion that increases with usage. • Example: monthly electric utility charge • Fixed service fee • Variable charge per kilowatt hour used

  10. Mixed Costs Total mixed cost Variable Utility Charge Total Utility Cost Fixed MonthlyUtility Charge Activity (Kilowatt Hours)

  11. Relevant Range... …is a band of volume in which a specific relationship exists between cost and volume. • Outside the relevant range, the cost either increases or decreases. • A fixed cost is fixed only within a given relevant range and a given time span.

  12. Relevant Range $160,000 – $120,000 – $80,000 – $40,000 – – – Fixed Costs Relevant Range 0 5,000 10,000 15,000 20,000 25,000 Volume in Units

  13. Objective 2 • Use CVP analysis to compute breakeven point.

  14. Assumptions of CVP 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 variable cost, and total fixed expenses will not vary within the relevant range.

  15. Assumptions of CVP Analysis • Volume is the only cost driver. • The relevant range of volume is specified. • Inventory levels will be unchanged. • The sales mix remains unchanged during the period.

  16. Contribution Margin Income Statement Sales - Variable Costs Contribution Margin - Fixed Costs Operating Income

  17. Contribution Margin Example • Luis and Tom manufacture a device that allows users to take a closer look at icebergs from a ship. • The usual price for the device is $100. • Variable costs are $70 per unit. • They receive a proposal from a company in Newfoundland to sell 20,000 units at a price of $85.

  18. Contribution Margin Example • There is sufficient capacity to produce the order. • How do we analyze this situation? • $85 – $70 = $15 contribution margin. • $15 × 20,000 units = $300,000 (total increase in contribution margin)

  19. Contribution Margin Income Statement Sales (20,000 x $85) $1,700,000 Variable costs (20,000 x $70) (1,400,000) Contribution margin $300,000

  20. Computing Break-Even Point The unique sales level at which a company earns neither a profit nor incurs a loss. Sales – Variable Costs – Fixed Costs = 0

  21. Breakeven Point Example Let’s look back at Luis and Tom’s manufacturing, assuming that the fixed cost are $90,000.

  22. Objective 3 • Use CVP analysis for profit planning and graph the cost-volume-profit relations

  23. Preparing a CVP Chart • Plot total fixed costs on the vertical axis. Total fixed costs Total costs Costs and Revenuein Dollars Draw the total cost line with a slopeequal to the unit variable cost. Volume in Units

  24. Sales Break-even Point Preparing a CVP Chart Starting at the origin, draw the sales line with a slope equal to the unit sales price. Total fixed costs Total costs Costs and Revenuein Dollars Volume in Units

  25. Various Sales Levels Example • What operating income is expected when sales are _____ units?

  26. Target Operating Income Example • Suppose that our business would be content with operating income of _________________. • How many units must be sold?

  27. Objective 4 • Use CVP method to perform sensitivity analysis.

  28. Change in Sales Price Example • Suppose that the sales price per device is _____ rather than ____ • What is the revised breakeven sales in units?

  29. Change in Variable Costs Example • Suppose that variable expenses per device are ____ instead of ____ • Other factors remain unchanged.

  30. Change in Fixed Costs Example • Suppose that fixed costs increased by $30,000. • What are the new fixed costs? • What is the new breakeven point?

  31. Margin of Safety Example • Excess of expected sales over breakeven sales.

  32. E22-7 Break even in units = 1,200,000 Break even in $ = 1,200,000 x 24 = $28,800,000 Profit Loss Break even point Fixed expense

  33. Effect of sales mix on CVP analysis.

  34. Computing MultiproductBreak-Even Point • Unit contribution margin is replaced with contribution margin for a composite unit. • A composite unit is composed of specific numbers of each product in proportion to the product sales mix. • Sales mix is the ratio of the volumes of the various products.

  35. Computing MultiproductBreak-Even Point The resulting break-even formulafor composite unit sales is: Fixed costsContribution marginper composite unit Break-even pointin composite units =

  36. Computing MultiproductBreak-Even Point A company sells windows and doors. They sell 4 windows for every door.

  37. Computing MultiproductBreak-Even Point Step 1: Compute contribution margin per composite unit.

  38. Computing MultiproductBreak-Even Point Step 2: Compute break-even point in composite units. Fixed costsContribution marginper composite unit Break-even pointin composite units =

  39. Fixed costsContribution marginper composite unit Break-even pointin composite units = $900,000 $450 per composite unit Break-even pointin composite units = Break-even pointin composite units = 2,000 composite units Computing MultiproductBreak-Even Point Step 2: Compute break-even point in composite units.

  40. Computing MultiproductBreak-Even Point Step 3: Determine the number of windows and doors that must be sold to break even.

  41. Multiproduct Break-EvenIncome Statement Step 4: Verify the results.

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