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Cost-Volume-Profit Analysis

Lecture 16. Cost-Volume-Profit Analysis. Break-even formulas may be adjusted to show the sales volume needed to earn any amount of operating income. Computing Sales Needed to Achieve Target Operating Income. Fixed costs + Target income. Unit sales =. Contribution margin per unit.

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Cost-Volume-Profit Analysis

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  1. Lecture 16 Cost-Volume-Profit Analysis

  2. Break-even formulas may be adjusted to show the sales volume needed to earnany amount of operating income. Computing Sales Needed to Achieve Target Operating Income Fixed costs + Target income Unit sales = Contribution margin per unit Fixed costs + Target income Dollar sales = Contribution margin ratio

  3. Computing Sales Needed to Achieve Target Operating Income ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to earn operating income of $40,000? a. 100,000 units b. 120,000 units c. 80,000 units d. 200,000 units

  4. Unit contribution = $5.00 - $3.00 = $2.00 Fixed costs + Target income Unit contribution $200,000 + $40,000 $2.00 per unit = 120,000 units Computing Sales Needed to Achieve Target Operating Income ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to earn operating income of $40,000? a. 100,000 units b. 120,000 units c. 80,000 units d. 200,000 units

  5. Margin of safety is the amount by which sales may decline before reaching break-even sales: Margin of safety provides a quick means of estimating operating income at any level of sales: Margin of safety = Actual sales - Break-even sales Operating Margin Contribution Income of safety margin ratio = × What is our Margin of Safety?

  6. Oxco’s contribution margin ratio is 40 percent. If sales are $100,000 and break-even sales are $80,000, what is operating income? Operating Margin Contribution Income of safety margin ratio = × Operating Income = $20,000 × .40 = $8,000 What is our Margin of Safety?

  7. Once break-even is reached, every additional dollar of contribution margin becomes operating income: Oxco expects sales to increase by $15,000. How much will operating income increase? Change in Change in Contributionoperating income sales volume margin ratio = × Change in operating income = $15,000 × .40 = $6,000 What Change in Operating Income Do We Anticipate?

  8. Business Applications of CVP

  9. Consider the following information developed by the accountant at CyclCo, a bicycle retailer: Business Applications of CVP

  10. Should CyclCo spend $12,000 on advertising to increase sales by 10 percent? Business Applications of CVP

  11. $80K + $12K Business Applications of CVP Should CyclCo spend $12,000 on advertising to increase sales by 10 percent? 550 × $500 550 × $300 No, income is decreased.

  12. Business Applications of CVP Now, in combination with the advertising, CyclCo is considering a 10 percent price reduction that willincrease sales by 25 percent. What is the income effect?

  13. $80K + $12K Business Applications of CVP Now, in combination with the advertising, CyclCo is considering a 10 percent price reduction that willincrease sales by 25 percent. What is the income effect? 1.25 × 500 625 × $450 625 × $300 Income is decreased even more.

  14. Business Applications of CVP Now, in combination with advertising and a price cut, CyclCowill replace $50,000 in sales salaries with a $25 per bike commission, increasing sales by 50 percent above the original 500 bikes. What is the effect on income?

  15. Different products with different contribution margins. • Determining semivariablecost elements. • Complying with theassumptions of CVP analysis. Additional Considerations in CVP

  16. Sales mix is the relative combination in whicha company’s different products are sold. Different products have different selling prices, costs, and contribution margins. If CyclCo sells bikes and carts, howwill we deal with break-even analysis? CVP Analysis When a Company Sells Many Products

  17. CyclCo provides us with the following information: CVP Analysis When a Company Sells Many Products

  18. The overall contribution margin ratio is: CVP Analysis When a Company Sells Many Products $265,000 $550,000 = 48% (rounded)

  19. Break-even in sales dollars is: CVP Analysis When a Company Sells Many Products $170,000 .48 = $354,167 (rounded)

  20. OwlCo recorded the following production activity and maintenance costs for two months: Using these two levels of activity, compute: the variable cost per unit. the total fixed cost. total cost formula. The High-Low Method

  21. The High-Low Method $3,600 4,000 in costin units • Unit variable cost = = = $0.90 per unit

  22. The High-Low Method $3,600 4,000 in costin units • Unit variable cost = = = $0.90 per unit • Fixed cost = Total cost – Total variable cost

  23. The High-Low Method $3,600 4,000 in costin units • Unit variable cost = = = $0.90 per unit • Fixed cost = Total cost – Total variable cost • Fixed cost = $9,700 – ($0.90 per unit × 9,000 units) • Fixed cost = $9,700 – $8,100 = $1,600

  24. The High-Low Method $3,600 4,000 in costin units • Unit variable cost = = = $0.90 per unit • Fixed cost = Total cost – Total variable cost • Fixed cost = $9,700 – ($0.90 per unit × 9,000 units) • Fixed cost = $9,700 – $8,100 = $1,600 • Total cost = $1,600 + $.90 per unit

  25. If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the variable portion of sales commission per unit sold? a. $.08 per unit b. $.10 per unit c. $.12 per unit d. $.125 per unit The High-Low MethodQuestion 1

  26. If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the variable portion of sales commission per unit sold? a. $.08 per unit b. $.10 per unit c. $.12 per unit d. $.125 per unit The High-Low MethodQuestion 1 $4,000 ÷ 40,000 units = $.10 per unit

  27. If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is thefixedportion of the sales commission? a. $ 2,000 b. $ 4,000 c. $10,000 d. $12,000 The High-Low MethodQuestion 2

  28. The High-Low MethodQuestion 2 If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is thefixedportion of the sales commission? a. $ 2,000 b. $ 4,000 c. $10,000 d. $12,000

  29. A limited range of activity, called therelevant range, where CVP relationships are linear. Unit selling price remains constant. Unit variable costs remain constant. Total fixed costs remain constant. Sales mix remains constant. Production = sales (no inventory changes). Assumptions Underlying CVP Analysis

  30. Source: Adopted from McGraw-Hill/Irvin

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