Chapter 6

1. Chapter 6 Cost-Volume-Profit Analysis and Variable Costing

2. Introduction • Cost-Volume-Profit Analysis (CVP) focuses on the following factors: • The prices of products or services • The volume of products or services produced and sold • The per-unit variable costs • The total fixed costs • The mix of products or services produced

3. The Contribution Margin Income Statement The Contribution Margin Income Statement is structured by behavior rather than by function. Sales - All Variable Costs = Contribution Margin Contribution Margin - All Fixed Costs = Net Income

4. Income Statements TRADITIONAL CONTRIBUTION MARGIN Sales Less: Cost of Goods Sold: Variable Costs Fixed Costs Total Cost of Goods Sold Gross Profit Less: S&A Costs: Variable Costs Fixed Costs Total S&A Costs Net Income $1,000 350 150 $ 500 $ 500 $ 50 250 $ 300 $ 200 Sales Less: Variable Costs: Manuf. Costs S&A Costs Total Variable Costs Contribution Margin Less: Fixed Costs: Manuf. Costs S&A Costs Total Fixed Costs Net Income $1,000 $350 50 $400 $600 $150 250 $400 $200

5. Contribution Margin Ratio Contribution Margin Ratio = Contribution Margin (in $) Sales (in $)

6. Changes in Price and Volume If the manager changes the sales price resulting in a change in sales volume, what will be the impact on net income? Raising the sales price may decrease sales volume but the impact on total sales revenue may be offset by the increase in sales price. Decreasing the sales price may increase the sales volume without increasing total sales revenue.

7. Changes in Cost, Price and Volume Changes can be made to cost, price and volume at the same time. Changes in one variable almost always impact one or both of the other variables.

8. Break-Even Analysis Break-Even Point: the level of sales where contribution margin just covers fixed costs and consequently net income is equal to zero.

9. Break-Even Analysis Fixed Costs Contribution Margin Per Unit Break-Even (units) = Break-Even (Sales $) Fixed Costs Contribution Margin Ratio =

10. Break-Even Calculations with Multiple Products The calculation of “average” contribution margin is really a weighted average. Fixed Costs Weighted Average Contribution Margin Per Unit Break-Even Point =

11. Break-Even Calculations Using Activity-Based Costing When using Activity-Based-Costing, costs are classified as unit, batch, product, or facility level instead of variable or fixed. Break-Even (units) = Fixed Costs + Batch-level costs + Product-level costs Contribution Margin Per Unit

12. Target Profit Analysis(Before and After Tax) To determine the sales units required to achieve a Target Profit before taxes: Sales Volume = Fixed Costs + Target Profit (before taxes) Contribution Margin Per Unit

13. Assumptions of CVP Analysis • Selling price is constant throughout the relevant range. • Costs are linear throughout the relevant range. • The sales mix used to calculate the weighted average contribution margin is constant. • The amount of inventory is constant.

14. Cost Structure and Operating Leverage Operating Leverage: The measure of the proportion of fixed costs in a company’s cost structure. It is used as an indicator of how sensitive profit is to changes in sales volume.

15. Cost Structure and Operating Leverage Contribution Margin Net Income Operating Leverage = Multiply Operating Leverage x % increase in Sales = % increase in Net Income

16. Variable Costing for Decision Making The only difference between absorption and variable costing is the treatment of fixed overhead. Absorption Costing: Fixed Overhead is treated as a product cost and expensed when the product is sold. Variable Costing: Fixed Overhead is treated as a period cost and expensed as incurred.

17. Differences Between Absorption and Variable Costing • When units sold equal units produced, net income is the same under both costing methods. • When units produced exceed units sold, absorption costing will report higher net income than variable costing. • When units sold exceed units produced, variable costing will report higher net income than absorption costing.

18. End of Chapter Six I’m ready! Bring on the costs!