chapter 9 break-even point and cost-volume profit analysis cost accounting foundations and...
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Chapter 9
Break-Even Point and
Cost-Volume Profit Analysis
Cost AccountingFoundations and Evolutions
Kinney and RaibornSeventh Edition
COPYRIGHT © 2009 South-Western, a part of Cengage Learning. South-Western is a trademark used herein
under license.
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Learning Objectives (1 of 2)
• Explain why variable costing is more useful than absorption costing for break-even and cost-volume-profit analysis
• Calculate the break-even point using formulas, graphs, and income statements
• Explain how companies use cost-volume-profit analysis in decision making
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Learning Objectives (2 of 2)
• Explain break-even and cost-volume-profit analysis for single-product and multiproduct environments
• Describe how businesses use margin of safety and operating leverage concepts
• List the underlying assumptions of cost-volume-profit analysis
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Variable Costing and CVP
• Variable costing– Separates costs into fixed and variable
components– Shows fixed costs in lump-sum amounts, not
on a per-unit basis– Does not allow for deferral/release of fixed
costs to/from inventory when production and sales volumes differ
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Equations
• Break-even point Total Revenues = Total Costs
Total Revenues - Total Costs = Zero Profit
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Equations
Contribution Margin (CM)Sales Price - Variable Cost = CM per unit
Revenue - Total Variable Costs = CM in total
Contribution Margin Ratio (CM%)
Sales Price – Variable Cost
Sales Price
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Traditional CVP Graph
Total$
Activity Level
Total Costs
Total Revenues
BEP
Loss
Profit
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Profit-Volume Graph
$
Activity Level
Fixed Costs
BEP
ProfitLoss
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Income Statement Approach
Sales
Less Total variable costs
Contribution Margin
Less Total fixed costs
Profit before taxes
Income taxes
Profit after taxes
B/E
$ 150,000
(50,000)
$ 100,000
(100,000)
-0-
Target Profit
$ 240,000
(80,000)
$ 160,000
(100,000)
60,000
(24,000)
$ 36,000
Proof of CVP and/or graph solutions
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Incremental Analysis
• Focuses only on factors that change from one option to another
• Changes in revenues, costs, and/or volume
• Break-even point increases when– fixed costs increase– sales price decreases– variable costs increase
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Multiproduct Cost-Volume-Profit Analysis
• Assumes a constant product sales mix
• Contribution margin is weighted on the quantities of each product included in the “bag” of products
• Contribution margin of the product making up the largest proportion of the bag has the greatest impact on the average contribution margin of the product mix
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Multiproduct Cost-Volume-Profit Analysis
Multiproduct Cost-Volume-Profit Analysis
3 2Sales mix
Contribution
margin per unit$2 $1
FC = $8,000
“The Bag” --Three units of Product 1 for every two units of Product 2
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Multiproduct Cost-Volume-Profit Analysis
Multiproduct Cost-Volume-Profit Analysis
3 2Sales mix
Contribution
margin per unit$2 $1
$80003($2) + 2($1) = 1,000 “bags”
Breakeven
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Multiproduct Cost-Volume-Profit Analysis
Multiproduct Cost-Volume-Profit Analysis
3 2Sales mix
x 1,000 3,000
x 1,000 2,000
Breakeven “bag”Breakeven units
To break even sell 3,000 units of first product and 2,000 units of second product
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Margin of Safety• How far the company is operating from its
break-even point
• Budgeted (or actual) sales after the break-even point
• The amount that sales can drop before reaching the break-even point
• Measure of the amount of “cushion” against losses
• Indication of risk
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Margin of Safety• Units
Actual units - break-even units• Dollars
Actual sales dollars - break-even sales dollars• Percentage
Margin of Safety in units or dollarsActual unit sales or dollar sales
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Operating Leverage
• Relationship of variable and fixed costs
• Effect on profits when volume changes
• Cost structure strongly influences the impact that a change in volume has on profits
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Operating Leverage
High Operating Leverage• Low variable costs• High fixed costs• High contribution margin • High break-even point• Sales after break-even
have greater impact on profits
Low Operating Leverage• High variable costs• Low fixed costs• Low contribution margin• Low break-even point• Sales after break-even
have lesser impact on profits
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Cost-Volume-Profit Assumptions• Company is operating within the relevant range
• Revenue and variable costs per unit are constant
• Total contribution margin increases proportionally with increases in unit sales
• Total fixed costs remain constant
• Mixed costs are separated into variable and fixed elements
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Cost-Volume-Profit Assumptions• No change in inventory (production equals
sales)
• No change in capacity
• Sales mix remains constant
• Anticipated price level changes included in formulas
• Labor productivity, production technology, and market conditions remain constant
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Questions
• What is the difference between absorption and variable costing?
• How do companies use cost-volume-profit analysis?
• What are the underlying assumptions of cost-volume-profit analysis?
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Potential Ethical Issues
• Ignoring relevant range in setting assumptions about cost behavior
• Using absorption (fixed manufacturing) costs as part of variable costs for CVP analysis
• Using improper assumptions about cost and volume relationships
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Potential Ethical Issues
• Assuming constant sales mix while ignoring demand for individual products
• Using CVP analysis to improperly support cost management strategies
• Visually distorting break-even graphs
• Using irrelevant information in incremental analysis