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C H A P T E R

2. C H A P T E R . Analyzing Cost-Volume- Profit Relationships. Learning Objective 1. Understand the key factors involved in cost-volume-profit (C-V-P) analysis and why it is such an important tool in management decision making. CVP. CVP - What Questions Does It Answer?.

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C H A P T E R

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  1. 2 • C H A P T E R Analyzing Cost-Volume- Profit Relationships

  2. Learning Objective 1 • Understand the key factors involved in cost-volume-profit (C-V-P) analysis and why it is such an important tool in management decision making. CVP

  3. CVP - What Questions Does It Answer?

  4. CVP Key Variables • Revenues – Price x Quantity • Fixed costs – Independent of volume • Variable costs – Dependent upon volume • Volume – Level of activity • Product mix – Different products • Efficiency & quality of production • Combinations of above

  5. Learning Objective 2 Explain and analyze the basic cost behaviorpatterns—variable,fixed,mixed,andstepped.

  6. What are Variable Costs? Total Cost Units Produced

  7. Define Relevant Range and Curvilinear Costs Relevant range: Curvilinear costs:

  8. Define Fixed Costs Total Cost UnitsProduced

  9. Fixed Costs are Used to Calculate Break-Even • What does break-even mean? • What is the formula for break-even?

  10. Define Stepped Costs

  11. Variable Cost Fixed ProductionVolume Define Mixed Costs

  12. Learning Objective 3 • Analyze mixed costs using the scattergraph and high-low methods.

  13. Regression Line What is the Scattergraph (Visual-Fit) Method? Cost Volume of Activity

  14. Scattergraph (Visual-Fit) Variable costs per unit are equal to the slope of the regression line. Fixed costs are represented by the intersection of the regression line and the vertical axis. Cost Variable Costs Fixed Costs Volume of Activity

  15. Define the High-Low Method

  16. Step 1: High-Low Method Cost Volume of Activity

  17. Step 2: High-Low Method Cost Volume of Activity

  18. Step 3: High-Low Method Cost Variable Cost per Unit Rise = Run Volume of Activity

  19. High-Low Method • Step 4:

  20. Learning Objective 4 • Perform C-V-P analyses, and describe the effects potential changes in C-V-P variables have on company profitability.

  21. Contribution Margin Approach Contribution margin is the portion of sales revenue available to cover fixed costs and provide a profit. Sales revenue – Variable costs = Contribution margin – Fixed costs = Profit

  22. Contribution Margin Approach If a computer sells for $2,000 with variable costs of $800 per computer and fixed costs of $350,000 per year: What is the total contribution margin on 500 computers?

  23. Contribution Margin Approach If a computer sells for $2,000 with variable costs of $800 per computer and fixed costs of $350,000 per year: What is the total contribution margin on 500 computers? What is the contribution margin per unit?

  24. Contribution Margin Approach If a computer sells for $2,000 with variable costs of $800 per computer and fixed costs of $350,000 per year: What is the total contribution margin on 500 computers? What is the contribution margin per unit? What is the contribution margin ratio?

  25. Contribution Margin Approach If a computer sells for $2,000 with $800 variable costs per computer and $350,000 fixed costs per year: What is the total contribution margin on 500 computers? What is the contribution margin per unit? What is the contribution margin ratio? What is the total dollar profit after one year?

  26. Sales price x units Variable cost x units Independent of units Target Income The Break-Even Point Example:How many computers will the store have to sell in order to break even if one computer sells for $2,000, costs $800 to make (variable cost), and fixed costs are $350,000?

  27. Multiple Variable Changes Costs independent of units Sales price x units Variable cost x units Zero for break-even Revenue = Variable costs + Fixed costs + Target profits OR Revenue - Variable costs - Fixed costs = Target profits OR Revenue - Variable costs - Target profits = Fixed costs etc.

  28. Multiple Variable Changes Assume prior year profits of $250,000 for The Store. This year the price of our $2,000 computers is reduced by 15 percent due to a decrease in variable costs from $800 to $700 per computer and a decrease in fixed costs from $350,000 to $325,000. What would be the effect on target income (or profit) assuming the production of 500 computers?

  29. Learning Objective 5 Visualize C-V-P relationships using graphs.

  30. Revenue & Cost The Graphic ApproachIdentify the Break-Even Point, Revenue Line, Total Cost Line, and Fixed Costs Number of Computers Sold

  31. Learning Objective 6 • Identify the limiting assumptions of C-V-P analysis, and explain the issues of quality and time relative to C-V-P analysis decisions.

  32. What are the Limiting Assumptionsof C-V-P Analysis?

  33. How Do Quality & Time Affect C-V-P Decisions?

  34. Expanded MaterialLearning Objective 7 • Analyze mixed costs using the least squares method.

  35. Identify the Parts of the Least Squares Method Equation Y = a + bx

  36. Least Squares Method Y = a + bX For Example: Month Computers ProducedTotal Cost Jan. 500 $ 750,000 Feb. 800 900,000 Mar. 650 600,000 April 1,000 1,100,000 May 450 420,000 Using least squares regression output: a = Y-intercept = total fixed costs = $49,211.82 b = slope = variable cost rate = $ 1,036.45

  37. Expanded MaterialLearning Objective 8 • Explain the effects of sales mix on profitability. Multiple Products?

  38. Can Openers Microwaves Total Amount % Amount % Amount % = = Product Revenue Total Revenue 5,000 30,000 17% Sales Mix Sales revenue $5,000 100% $25,000 100% $30,000 100% Less variable costs 3,000 60% 20,000 80% 23,000 77% Contribution margin $2,000 40% $ 5,000 20% $ 7,000 23% Sales mix 17% 83% 100%

  39. Sales Mix To maximize profit in a company with multiple products, management should emphasize products with the highest contribution margin ratio. Which product should they choose? Can Openers Microwaves Total Amount % Amount % Amount % Sales revenue $5,000 100% $25,000 100% $30,000 100% Less variable costs 3,000 60% 20,000 80% 23,000 77% Contribution margin $2,000 40% $ 5,000 20% $ 7,000 23% Sales mix 17% 83% 100%

  40. Expanded MaterialLearning Objective 9 • Describe how fixed and variable costs differ in manufacturing, service, merchandising, and e-commerce organizations, and illustrate these differences with the operating leverage concept.

  41. Define Operating Leverage

  42. Operating Leverage For example: Assume the following data. Total Per Unit Ratio Sales revenue $1,000,000 $2,000 100% Less variable costs 400,000 800 40% Contribution margin $ 600,000 $1,200 60% Less fixed costs 450,000 Net income $ 150,000 Operating leverage = What is the operating leverage? What happens to net income if sales are increased by 20 percent? Net income increases Decrease fixed costs to $300,000. What is the operating leverage (no sales increase)? Operating leverage = Now what happens to net income if sales are increased by 20 percent? Net income increases

  43. Chapter 2 of Managerial Accounting is Completed Even if your on the right track, you'll get run over if you just sit there. Will Rogers, Jr.

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