Cost-Volume-Profit Analysis

1. Cost-Volume-Profit Analysis UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee

2. Introduction • We have learned . . . • How to identify costs as fixed, variable, and mixed; • How each of these behave when changes take place; and • How to separate them into their component parts.

3. Introduction • Understanding these relationships help managers to; • Predict future conditions (planning); and • Explain, evaluate, and act on past results (control)

4. Introduction Today we will focus on gaining an understanding of how . . . • Costs • Volume, and • Profits Interact

5. Cost-Volume-Profit (CVP) • CVP is the systematic examination of the relationships among . . . • Selling prices, • Volume of Sales and Production • Cost, • Expenses, and • Profits

6. Output Sales Price Variable Costs Fixed Costs Graphically As changes occur here. What happens here? Total Revenues Total Revenue Output Sales Price Total Cost Total Cost Variable Costs Operating Income Fixed Costs Operating Income 4

7. CVP - For-Profit Firms • How many photocopies must the College Avenue Copy Shop produce to earn a profit of $20,000? • At what sales volume will Burger King’s total costs and total revenues equal?

8. CVP - For-Profit Firms • What will happen to profits in Joe’s Diner if . . . • There is a 20% increase in the cost of food; and • A 10% increase in the selling price of meals?

9. CVP - Not-For-Profit Firms • How many meals can the Salvation Army serve with an annual budget of $150,000? • How many tickets must be sold for the benefit concert to raise $15,000?

10. CVP - Not-For-Profit Firms • Given current tuition rates and projected enrollments, how much money must UAA obtain from other sources?

11. CVP is Useful in . . . • Choice of product lines • Pricing of products • Developing marketing strategies • Utilization of productive facilities

12. Traditional Statement • Costs are grouped by functional classifications - such as: • Production, • Selling & Administration • With both fixed and variable costs being included in each category.

13. Sales $xxx COGS (xx) Gross Margin $xxx Selling Exp. Admin. Exp (xx) (xx) Net Income $xxx Absorption-Costing I/S Production FC & VC Selling FC & VC Administrative FC & VC

14. Contribution Format • The focus of the contribution format income statement is the contribution margin . . . Contribution Margin = Net Sales - Variable Costs

15. Contribution Format I/S • Groups costs by behavior: • Fixed, and • Variable • Rather than into the functional categories of production, marketing and administration.

16. Sales $xxx Cont. Margin $xxx Net Income $xxx Variable-Costing I/S Variable Costs (xx) Fixed Costs (xx)

17. Sales $xxx Sales $xxx COGS (xx) Variable Costs (xx) Gross Margin $xxx Cont. Margin $xxx Operating Exp (xx) Fixed Costs (xx) Net Income $xxx Net Income $xxx Income Statements . . . Traditional Contribution Format

18. Sales $900,000 Cost of Sales Direct Materials $100,000 Direct Labor 160,000 Mfg. Overhead 100,000 361,000 VC=$55,000 FC=$45,000 Marketing Costs Variable 18,000 Fixed 82,000 100,000 Admin. Costs (Fixed) $150,000 Sourdough Alaska, Inc.

19. Sales $900,000 100% Cost of Sales Direct Materials $100,000 Direct Labor 160,000 Mfg. Overhead 100,000 360,000 40% Gross Margin $540,000 60% Marketing/Admin Costs Marketing Costs $100,000 Administrative Costs 150,000 250,000 Net Income $290,000 Sourdough Alaska, Inc. Traditional Income Statement For Year Ended December 31, 2001

20. Sourdough Alaska, Inc. Traditional Income Statement For Year Ended December 31, 2001 Note functional grouping of costs Sales $900,000 100% Cost of Sales Direct Materials $100,000 Production Direct Labor 160,000 Mfg. Overhead 100,000 360,000 40% Gross Margin $540,000 60% Marketing/Admin Costs Marketing Costs $100,000 Marketing & Admin. Administrative Costs 150,000 250,000 Net Income $290,000

21. What if . . . • You were asked to project the effect on net income of: • A 20% increase in sales volume; • With no change in selling prices. • How would you go about doing it?

22. Sourdough Alaska, Inc. Traditional Income Statement For Year Ended December 31, 2001 Sales $900,000 100% Includes: $55,000 VC $45,000 FC Cost of Sales Includes: $18,000 VC $82,000 FC Direct Materials $100,000 Direct Labor 160,000 Mfg. Overhead 100,000 360,000 40% Gross Margin $540,000 60% Marketing/Admin Costs All Fixed Marketing Costs $100,000 Administrative Costs 150,000 250,000 Net Income $290,000

23. Sales $900,000 100% Cost of Sales Direct Materials $100,000 Direct Labor 160,000 Mfg. Overhead Variable Mkt. Exp 18,000 55,000 $333,000 37% Contribution Martin $567,000 63% Fixed Costs Manufacturing Marketing 45,000 82,000 Administrative 150,000 277,000 Sourdough Alaska, Inc. Contribution Format Income Statement For Year Ended December 31, 2001 Net Income $290,000

24. Sales $900,000 100% Cost of Sales Direct Materials $100,000 Direct Labor 160,000 Mfg. Overhead Variable Mkt. Exp 18,000 55,000 $333,000 37% Contribution Martin $567,000 63% Fixed Costs Manufacturing Marketing 45,000 82,000 Administrative 150,000 277,000 Sourdough Alaska, Inc. Contribution Format Income Statement For Year Ended December 31, 2001 Now, costs are grouped by BEHAVIOR Variable Fixed Net Income $290,000

25. NOW . . . What if . . . • You were asked to project the effect on net income of: • A 20% increase in sales volume; • With no change in selling prices. • How would you go about doing it?

26. Sales ($900,000 x 120%) $1,080,000 Less: VC: ($333,000 x 120%) 399,600 Contribution Margin 688,400 Less: Fixed Costs 277,000 Projected Net Income 403,400 Less 1997 Net Income 290,000 Projected Increase in Net Income $113,400 Sourdough Alaska, Inc. Projected Increase in Net Income For Year Ended December 31, 2001

27. Sales ($900,000 x 120%) $1,080,000 Less: VC: ($333,000 x 120%) 399,600 Contribution Margin 688,400 Less: Fixed Costs 277,000 Projected Net Income 403,400 Less 1997 Net Income 290,000 Projected Increase in Net Income $113,400 Sourdough Alaska, Inc. Projected Increase in Net Income For Year Ended December 31, 2001 Variable costs change Fixed costs do not change

28. Is this stuff usable?

29. Break-Even Analysis

30. The Equation Method Exhaustion Unlimited – An Illustration

31. Exhaustion Unlimited Info

32. Exhaustion Unlimited Info Use this info to get the BEP in # of units.

33. Sales $xxx Variable Costs (xx) Contribution Margin $xxx Fixed Costs (xx) Net Income $xxx • The equation method centers on the contribution approach to the income statement. Profit = Sales - VC - FC Sales = Profit + VC + FC

34. Sales = Profit + VC + FC • At breakeven profit = 0 Sales = Profit + VC + FC • The equation becomes: BES = VC + FC

35. Use our BE Equation; and • Let X = BE Point in Bikes Sales VC FC

36. Exhaustion Unlimited Info Use this info to get the BEP in Sales $$$ CMR

37. Use our BE Equation; and • Let X = BE Point in Sales $ Sales VC FC

38. The Equation Method OK . . . But Does It Work?

40. Break-Even Analysis The Unit-Contribution Method

41. Unit-Contribution Method • Is a variation of the equation method. • The method may be just a bit more intuitive than the equation method.

42. Unit-Contribution Method • The approach centers on the idea that each unit sold provides a certain amount of CM that goes toward covering fixed costs.

43. Unit-Contribution Method • The Formula . . .

44. Use this info to get the BEP in # of units.

45. Fixed Costs BEP in Units Unit CM

46. Use this info to get the BEP in Sales $$$

47. Fixed Costs BEP in $ CM %

48. Unit Contribution Method • Let’s look at a series of income statements that graphically point out the concept of a contribution margin.

50. Break-Even Analysis Target Net Profit Analysis