chapter 6-1 chapter 6 cost–volume– profit analysis: additional issues managerial accounting,...

Chapter 6-1

CHAPTER CHAPTER 66

COST–VOLUME–COST–VOLUME–PROFIT ANALYSIS: PROFIT ANALYSIS: ADDITIONAL ISSUESADDITIONAL ISSUES

Managerial Accounting, Fifth Edition

Chapter 6-2

Preview of ChapterPreview of ChapterPreview of ChapterPreview of Chapter

The relationship between a company’s fixed and variable The relationship between a company’s fixed and variable costs can have a huge impact on its profitability.costs can have a huge impact on its profitability.

The current trend is toward companies with cost structures The current trend is toward companies with cost structures dominated by fixed costs.dominated by fixed costs.

This has significantly increased theThis has significantly increased thevolatility of many companies’ net income.volatility of many companies’ net income.

Thus, the use of CVP analysis has additional uses in making Thus, the use of CVP analysis has additional uses in making sound business decisions.sound business decisions.

Chapter 6-3

Basic ConceptsBasic ConceptsBasic ConceptsBasic Concepts

CVP is so important, management often wants the information reported in a special format income statement.The CVP income statement is for internal use only, classifies costs and expenses as fixed or variable, reports a contribution margin in the body of the statement.

Contribution margin – amount of revenue remaining after deducting all variable costs.

The contribution margin is often reported as a total amount and on a per unit basis.

SO 1: Describe the essential features ofSO 1: Describe the essential features ofa cost-volume-profit income statement.a cost-volume-profit income statement.

Chapter 6-4

Basic Computations – A ReviewBasic Computations – A ReviewBasic Computations – A ReviewBasic Computations – A Review

Break-Even Analysis:Break-Even Analysis:Desossa Music Player’s CVP income statement shows that Desossa Music Player’s CVP income statement shows that total CM (sales minus variable expenses) is $175,000 and total CM (sales minus variable expenses) is $175,000 and the company’s CM per unit is $50. The Contribution the company’s CM per unit is $50. The Contribution margin ratio (contribution margin divided by sales) is margin ratio (contribution margin divided by sales) is 41.67% ($50 / $120). Desossa’s breakeven point in units 41.67% ($50 / $120). Desossa’s breakeven point in units (using contribution margin per unit) or in dollars (using (using contribution margin per unit) or in dollars (using contribution margin ratio) are calculated as follows:contribution margin ratio) are calculated as follows:

Fixed cost ÷ Contribution margin per unit = Break-even point in units$94,500 ÷ $50 = 1,890 units Fixed cost ÷ Contribution margin ratio = Break-even point in dollars$94,500 ÷ .4167 = $226,800

Chapter 6-5

E6-2 – page 279 in textE6-2 – page 279 in text

In the month of June, Paula’s Beauty Salon gave 3500 In the month of June, Paula’s Beauty Salon gave 3500 haircuts, shampoos and permanents at an average haircuts, shampoos and permanents at an average price of $30. During the month fixed costs were $16,800 price of $30. During the month fixed costs were $16,800 and variable cost were 80% of sales.and variable cost were 80% of sales.

Instructions:Instructions:

a)a) Determine the contribution margins in dollars, per unit Determine the contribution margins in dollars, per unit and as a ratio.and as a ratio.

b)b) Using the contribution margin technique, compute the Using the contribution margin technique, compute the breakeven point in dollars and in units.breakeven point in dollars and in units.

c)c) Compute the margin of safety in dollars and as a ratio.Compute the margin of safety in dollars and as a ratio.

Chapter 6-6

Contribution Margin in dollars , units and Contribution Margin in dollars , units and ratiosratios

Contribution margin in dollars equals to sales in dollars Contribution margin in dollars equals to sales in dollars minus the variable cost in dollars. ($Sales – $VC = $CM ) minus the variable cost in dollars. ($Sales – $VC = $CM )

Contribution margin per unit equals the units selling price Contribution margin per unit equals the units selling price minus the unit variable cost. (Unit Sales – Unit VC = minus the unit variable cost. (Unit Sales – Unit VC = CM/unit)CM/unit)

Contribution margin ratio equals the CM per unit divided by Contribution margin ratio equals the CM per unit divided by the unit selling pricethe unit selling price

Sales: 3,500 X $30 = 105,000Sales: 3,500 X $30 = 105,000 Variable cost: 105,000 X .8 = $84,000Variable cost: 105,000 X .8 = $84,000 $CM: 105,000 – 84,000 = 21,000$CM: 105,000 – 84,000 = 21,000 CM/unit: $30 - $24 = $6 (CM/unit: $30 - $24 = $6 (UVC: $84,000 / UVC: $84,000 /

3500 = $24)3500 = $24)

CM ratio: $6/$30 = .20 or 20%CM ratio: $6/$30 = .20 or 20%

Chapter 6-7

Break even in Dollars and Break even in Dollars and Units – Units –

Break Even points in Break Even points in DollarsDollars: Fixed Cost : Fixed Cost divided by divided by Contribution Margin Contribution Margin Ratio Ratio

Break Even points in Break Even points in Units: Units: Fixed Cost Fixed Cost divided by divided by Contribution margin Contribution margin per unit.per unit.

$16,800 (Fixed Cost) / 20% (CM ratio) = $16,800 (Fixed Cost) / 20% (CM ratio) = $84,000$84,000

$16,800 /$6 (CM/unit) = 2,800 units$16,800 /$6 (CM/unit) = 2,800 units

Chapter 6-8

Basic Computations – A ReviewBasic Computations – A ReviewBasic Computations – A ReviewBasic Computations – A Review

Target Net IncomeTarget Net Income

Once a company achieves break-even sales, a sales goal Once a company achieves break-even sales, a sales goal can be set that will result in a target net income.can be set that will result in a target net income.

Assuming Paula’s target net income is $18,000, required Assuming Paula’s target net income is $18,000, required sales in units and dollars to achieve this are:sales in units and dollars to achieve this are:

16,800 + 18,000 / $6 = 5800 16,800 + 18,000 / $6 = 5800 units units

(Fixed cost plus Target Net Income divided by Contribution (Fixed cost plus Target Net Income divided by Contribution Margin per unit = Required sales in units)Margin per unit = Required sales in units)

16,800 + 18,000 / .20 = $174,00016,800 + 18,000 / .20 = $174,000

(Fixed cost plus Target Net Income divided by the CM ratio (Fixed cost plus Target Net Income divided by the CM ratio = Required Sales in dollars.)= Required Sales in dollars.)

SO 2: Apply basic CVP concepts.SO 2: Apply basic CVP concepts.

Chapter 6-9

ExampleExample

Assuming Desossa’s management has a target net Assuming Desossa’s management has a target net income of $100,000, the required sales in units and income of $100,000, the required sales in units and dollars to achieve its target net income are calculated as dollars to achieve its target net income are calculated as follows:follows:

($94,500 + $100,000) ÷ $50 = 3,890 units

(Fixed cost + Target net income)

/ Contribution Margin per unit = Required

Sales in units

($94,500 + $100,000) ÷ .4167 =$466,762

(Fixed cost + Target net income)

/ Contribution Margin ratio = Required

Sales in dollars

Chapter 6-10

Basic Computations: Margin of SafetyBasic Computations: Margin of SafetyBasic Computations: Margin of SafetyBasic Computations: Margin of Safety

Remember from Chapter 5, the margin of safety Remember from Chapter 5, the margin of safety tells us how far sales tells us how far sales can dropcan drop before the before the company will operate at a loss.company will operate at a loss.

The margin of safety can be expressed The margin of safety can be expressed in dollars in dollars or as a ratio.or as a ratio.

Assuming Desossa’s sales are $420,000:Assuming Desossa’s sales are $420,000:Actual (expected) sales – Break-even sales = Margin of safety in dollars$420,000 – $226,800 = $193,200

Margin of safety in dollars ÷ Actual (expected) sales =Margin of safety

ratio$193,200 ÷ $420,000 = 46%

Chapter 6-11

Margin of Safety in Dollars and Units – E Margin of Safety in Dollars and Units – E 6-2 continued 6-2 continued

Sales (Actual or Expected) minus Break Even Sales (Actual or Expected) minus Break Even Sales equals Sales equals Margin of Safety in DollarsMargin of Safety in Dollars

Margin of Safety in Dollars divided by the Sales Margin of Safety in Dollars divided by the Sales (Actual or Expected) equals (Actual or Expected) equals Margin of Safety Margin of Safety RatioRatio

$105,000 (Sales) - $84,000 (BE) = $105,000 (Sales) - $84,000 (BE) = $21,000$21,000

$21,000 / 105,000 = 20%$21,000 / 105,000 = 20%

Chapter 6-12

To better understand how CVP analysis works, let’s To better understand how CVP analysis works, let’s assume that shipping costs have increased assume that shipping costs have increased significantly causing the unit variable cost to significantly causing the unit variable cost to increase by 10%, what effect will this have on increase by 10%, what effect will this have on Desossa’s break-even point?Desossa’s break-even point?

Answer: A 10% increase in variable costs increases the per unit variable cost to $77 [$70 + ($70 X 10%)]. The new contribution

margin per unit is therefore $43 ($120 – $77). Thus the new break-even point in

units is calculated as follows:

CVP – Changes in Business CVP – Changes in Business EnvironmentEnvironment

CVP – Changes in Business CVP – Changes in Business EnvironmentEnvironment

Fixed cost ÷ Contribution margin per unit = Break-even point in units$94,500 ÷ $43 = 2,198 units.

Chapter 6-13

Sales MixSales MixSales MixSales Mix

When a company sells more than one When a company sells more than one product:product:

It is important to understandIt is important to understandits sales mix.its sales mix.

The The sales mixsales mix is the relative percentage is the relative percentage in which a company sells its products.in which a company sells its products.

If a company’s unit sales are 80%If a company’s unit sales are 80% printers and 20% computers, its printers and 20% computers, its sales mix is 80% to 20%.sales mix is 80% to 20%.

Sales mix is important because Sales mix is important because different products often have very different products often have very different contribution margins.different contribution margins.

SO 3: Explain the term sales mix and its effects on break-even sales.SO 3: Explain the term sales mix and its effects on break-even sales.

Chapter 6-14

Break-Even Sales in UnitsBreak-Even Sales in UnitsBreak-Even Sales in UnitsBreak-Even Sales in Units

A company can compute break-even sales for a mix of two or more products by determining the:

Weighted-average unit contribution margin of all

products.

The weighted-average unit contribution margin is the sum of the weighted contribution margin of each product.


Chapter 6-15

Break-Even Sales in Units – BE 6-7 & 6-Break-Even Sales in Units – BE 6-7 & 6-88


Information for Bruno Corporation sells three different models of mosquito “zapper.”

Model A12 sells for $50 and has variable cost of $40Model B22 sells for $100 and has a variable cost of $70Model C124 sells for $400 and has a variable cost of $300

a)What is the weighted average unit contribution margin?b)If the company has a fixed cost of 199,500 how many units of each model must the company sell in order to break even?


Chapter 6-16



Model A12 sells for $50 and has variable cost of $40Model B22 sells for $100 and has a variable cost of $70Model C124 sells for $400 and has a variable cost of $300a)What is the weighted average unit contribution margin?

Model A12: 10 X .60 = $6.00Model B22: 30 X .25 = $7.50Model C124: 100 X.15 = $15.00

Total $28.50


Weighted-average contribution margin: CM

multiplied by the sales mix

Chapter 6-17



Model A12 sells for $50 and has variable cost of $40Model B22 sells for $100 and has a variable cost of $70Model C124 sells for $400 and has a variable cost of $300 b) If the company has a fixed cost of 199,500 how many units of each model must the company sell in order to break even?

199,500 / $28.50 = 7,000

Model A12 7,000 X .60 = 4,200Model B22 7,000 X .25 = 1,750Model C124 7,000 X .15 = 1,050

Breakeven: fixed cost divided by the Weighted-

average CM

Multiply the # of units by the sales mix in order to reach the number of units for each products in

the mix

Chapter 6-18

Break-Even Sales in DollarsBreak-Even Sales in DollarsBreak-Even Sales in DollarsBreak-Even Sales in Dollars

The calculation of break-even point in units works well if the company has only a few products.

Consider 3M which has over 30,000 different products:

3M would need to calculate 30,000 different unit contribution margins.

When there are many products, calculate the break-even point in terms of sales dollars for divisions or product lines, NOT individual products.SO 3: Explain the term sales mix and its effects on break-even sales.SO 3: Explain the term sales mix and its effects on break-even sales.

Chapter 6-19

Break-Even Sales in Dollars - ExampleBreak-Even Sales in Dollars - ExampleBreak-Even Sales in Dollars - ExampleBreak-Even Sales in Dollars - Example

Compute sales mix as a percentage of total dollar sales rather than units sold,

andCompute the contribution margin ratio rather than the contribution margin per unit.


Chapter 6-20

Chapter Review - Brief Exercise 6-9 Chapter Review - Brief Exercise 6-9 Chapter Review - Brief Exercise 6-9 Chapter Review - Brief Exercise 6-9

Presto Candle Supply makes candles. The sales mix Presto Candle Supply makes candles. The sales mix (as a percent of total dollar sales) of its three product (as a percent of total dollar sales) of its three product lines is as follows: birthday candles, 30%; standard lines is as follows: birthday candles, 30%; standard tapered candles, 50%; and large scented candles, tapered candles, 50%; and large scented candles, 20%. The contribution margin ratio of each candle 20%. The contribution margin ratio of each candle type is shown below.type is shown below.

Candle TypeCandle Type Contribution Margin Contribution Margin RatioRatio BirthdayBirthday 10% 10%

Standard taperedStandard tapered 20% 20%Large scentedLarge scented 45% 45%

What is the weighted-average contribution margin ratio?

Chapter 6-21

Chapter Review - Brief Exercise 6-9 Chapter Review - Brief Exercise 6-9 Chapter Review - Brief Exercise 6-9 Chapter Review - Brief Exercise 6-9

Type of CandlesType of Candles CMR Sales Mix CMR Sales MixBirthday 10% × 30% = 3%Standard tapered 20% × 50% = 10%Large scented45% × 20% = 9% Weighted Average Contribution Margin Ratio22%

If the company’s fixed costs are $440,000 per year, what is the If the company’s fixed costs are $440,000 per year, what is the dollar amount of each type of candle that must be sold to break dollar amount of each type of candle that must be sold to break even? even?

Step 1:Step 1: Fixed Costs: Fixed Costs:$440,000 ÷ WACMR 22% = $ BEP = $2,000,000$440,000 ÷ WACMR 22% = $ BEP = $2,000,000

Step 2:Step 2:Birthday candles $2,000,000 × 30% = $ 600,000Standard tapered $2,000,000 × 50% =1,000,000Large scented$2,000,000 × 20% = 400,000

Chapter 6-22

Net income will be:Net income will be:

a.a. Greater if more higher-contribution margin Greater if more higher-contribution margin units are sold than lower-contribution margin units are sold than lower-contribution margin unitsunits.

b. Greater if more lower-contribution margin units are sold than higher-contribution margin units.

c. Equal as long as total sales remain equal, regardless of which products are sold.

d. Unaffected by changes in the mix of products sold.

Let’s ReviewLet’s ReviewLet’s ReviewLet’s Review

SO 3: Explain the term sales mix and its effects on break-even SO 3: Explain the term sales mix and its effects on break-even sales.sales.

Chapter 6-23

Sales Mix with Limited Resources (BE Sales Mix with Limited Resources (BE 6-11)6-11)

Sales Mix with Limited Resources (BE Sales Mix with Limited Resources (BE 6-11)6-11)

All companies have limited resources whether it be floor space, raw materials, direct labor hours, etc.

Limited resources force management to decide which Limited resources force management to decide which products to sell to maximize net income.products to sell to maximize net income.

Example: In Larissa Company, data concerning two products are:

Contribution margin per unit – Product A $10, Product B $12;

Machine house required for one unit – Product A 2hrs, Product B 3hrs.

Compute the contribution margin per unit of limited resource for each product

Chapter 6-24

Sales Mix with Limited Resources – BE 6-Sales Mix with Limited Resources – BE 6-1111

Sales Mix with Limited Resources – BE 6-Sales Mix with Limited Resources – BE 6-1111

Product B seems to be more profitable since it has the higher contribution margin per unit, but they require more machine hours to produce than Product A.

To determine the appropriate sales mix, compute the contribution margin per unit of limited resource:contribution margin per unit of limited resource:

Product A $10 / 2 hours = 5Product A $10 / 2 hours = 5

Product B $12 / 3 hours = 4Product B $12 / 3 hours = 4

((contribution margin per unit / machine hours)contribution margin per unit / machine hours)

Product A has the higher contribution margin per unit of Product A has the higher contribution margin per unit of limited resources. Management would likely produce limited resources. Management would likely produce more of these instead of Product B – depending on more of these instead of Product B – depending on demand… or increase machine capacitydemand… or increase machine capacity

Chapter 6-25

Contribution Margin per unit of Contribution Margin per unit of limited resourceslimited resources

When a company has limited resources (e.g., When a company has limited resources (e.g., floor space, raw materials, direct labor hours), floor space, raw materials, direct labor hours), management must decide which products to management must decide which products to make and sell in order to maximize net make and sell in order to maximize net income. Assume that Seth Inc. has limited income. Assume that Seth Inc. has limited machine capacity which is 2,600 hours per machine capacity which is 2,600 hours per month. Relevant data consist of the following:month. Relevant data consist of the following:

TablesTablesChairsChairs

Contribution margin per unitContribution margin per unit $40$40 $10$10

Machine hours required per unitMachine hours required per unit 8 8 .16.16

Chapter 6-26

The contribution margin per unit of limited The contribution margin per unit of limited resource is calculated as follows:resource is calculated as follows:

TablesTables ChairsChairs

Contribution margin Contribution margin

per unit (a)per unit (a) $40 $40 $10 $10

Machine hours required (b)Machine hours required (b) .8 .8 .16 .16


per unit ofper unit of

limited resource (a/b)limited resource (a/b) $50 $50 $62.50 $62.50

Chapter 6-27

If Seth Inc. increases machine capacity If Seth Inc. increases machine capacity hours by 400 hours per month, it would hours by 400 hours per month, it would be better to use the hours to produce be better to use the hours to produce more chairs.more chairs.

Tables Tables Chairs Chairs

Machine hours (a)Machine hours (a) 400 400 400 400


per unit ofper unit of

limited resource (b)limited resource (b) $ 50$ 50 $ 62.50$ 62.50


[(a) X (b)][(a) X (b)] $20,000$20,000 $25,000$25,000

Chapter 6-28

If the contribution margin per unit is $15 and it margin per unit is $15 and it takes 3.0 machine hours to produce the unit, the takes 3.0 machine hours to produce the unit, the contribution margin per unit of limited resource is:contribution margin per unit of limited resource is:

a.a. $25$25.

b. $5.

c. $4.

d. No correct answer is given.


SO 4: Determine the sales mix when a company has limited SO 4: Determine the sales mix when a company has limited resources.resources.

Chapter 6-29

Cost Structure and Operating LeverageCost Structure and Operating LeverageCost Structure and Operating LeverageCost Structure and Operating Leverage

Cost StructureCost Structure is the relative proportion of fixed versus variable costs that a company incurs.

May have a significant effect on profitability.

Thus, a company must Thus, a company must carefully choose its carefully choose its cost structure.cost structure.

SO 5: Understand how operating leverage affects SO 5: Understand how operating leverage affects profitability.profitability.

Chapter 6-30

Operating LeverageOperating LeverageOperating LeverageOperating Leverage

Operating leverageOperating leverage refers to the extent that net income reacts to a given change in sales.

Higher fixed costs relative to variable costs cause a company to have higher operating leverage.

When sales revenues are increasing, high operating leverage means that profits will increase rapidly – a good thing.

When sales revenues are declining, too much operating leverage can have devastating consequences.

SO 5: Understand how operating leverage affects profitability.SO 5: Understand how operating leverage affects profitability.

Chapter 6-31

The degree of operating leverage:The degree of operating leverage:

a.a. Can be computed by dividing total contribution margin by net income.

b. Provides a measure of the company’s earnings volatility.

c. Affects a company’s break-even point.

d. All of the above.


SO 5: Understand how operating leverage affects profitability.SO 5: Understand how operating leverage affects profitability.

Chapter 6-32

ANY QUESTIONS?ANY QUESTIONS?

chapter 6-1 chapter 6 cost–volume– profit analysis: additional issues managerial accounting,...

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