cost accounting - week 9

8/17/2019 Cost Accounting - Week 9

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WEEK NINECOST-VOLUME-PROFIT RELATIONSHIPS

REFERENCES:

MANAGERIAL ACCOUNTING, MCGRAW HILLINTERNATIONAL EDITION, 11TH EDITIONGARRISON / NOREEN / BREWER

Cost Accounting


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Learning Objectives

Prepared by: Deva Djohan, BCom

2

1. Explain how changes in activity affect contribution marginand net operating income.

2. Prepare and interpret a costvolumeprofit !"#P$ graph.

%. &se the contribution margin ratio !"' ratio$ to compute

changes in contribution margin and net operating incomeresulting from changes in sales volume.

(. )how the effects on contribution margin of changes in variablecosts* fixed costs* selling price* and volume.

+. "ompute brea,even point in unit sales and sales dollars.

-. etermine the level of sales needed to achieve a desired targetprofit.


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/ntroduction


3

Cost-Volume-Proft Analysis is one of the mostpowerful tools that managers have at their command.

/t is a vital tool in many business decisions i.e. 0hat products and services to offer.

0hat pricing policy to follow.

0hat mar,eting strategy to employ.

0hat basic cost structure to use.


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/ntroduction


4

Cost-Volume-Proft Analysis also helpsmanagers understand the relationship among cost* volume*and profit by focusing on interactions among the followingfive elements Price of products

#olume or level of activity

Per unit variable costs

otal fixed costs

'ix of products sold


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he 3asics of "#P 4nalysis


5

he contribution income statement emphasi5es the behaviorof costs and therefore is extremely helpful to a manager in judging the impact on profits of changes in selling price*

cost* or volume.


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"ontribution /ncome )tatement

ACOUSTIC CONCEPTS, INC.

Contribution Income Statement

For the Month of June

Total Per Unit

Sales (400 speakers) !00"000 250

#ess var$able e%penses (&0"000) !50

Con'r$b'$on mar$n 40"000 !00

#ess *$%ed e%penses 35"000

Net operatin income !".###

Prepared by: Deva Djohan, BCom &


7/30

"ontribution 'argin


+

he amount remaining from sales revenue after variableexpenses have been deducted.

/t is the amount available to cover fixed expenses and thento provide profits for the period.

/f enough goods are sold to generate sufficient contributionmargin* then all of the fixed expenses will be covered andthe company will brea, even for the month 6 that is* it willshow neither profit nor loss but just cover its costs.


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"#P 7elationships in 8raphic 9orm


he relationships among revenue* cost* profit* and volumecan be expressed graphically by preparing a costvolumeprofit !"#P$ graph.

4 "#P graph highlights "#P relationships over wide ranges ofactivity and can give managers a perspective that can beobtained in no other way.


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Preparing the "#P 8raph


-

/n "#P graph !sometimes called a break-even chart $* unit volume is commonly represented on the hori5ontal !:$ axisand dollars on the vertical !;$ axis.


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Preparing the "#P 8raph


!0

Three steps in preparing "#P graph

1. raw a parallel line to the volume axis to represent totalfixed expense.

2. "hoose some volume of unit sales and plot the pointrepresenting total expenses !fixed and variable$ at theactivity that you have selected.

%. 4gain choose some volume of units sales and plot thepoint representing total sales dollars at the activity level you have selected.


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"#P 8raph


!!

Volume o speakers

sold

D o l l a r

A m o u n t


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"ontribution 'argin 7atio !"' 7atio$


!2

/n this section* we show how the contribution margin ratiocan be used in costvolumeprofit calculations.

he contribution margin as a percentage of sales is referredas the cont!"#t!on $%&!n %t!o 'CM %t!o() hisratio is computed as follow

"' ratio < "ontribution margin

)ales


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Total Per Unit Percent of Sale$

Sales (400 speakers) !00"000 250 !00.

#ess var$able e%penses (&0"000) !50 &0.

Con'r$b'$on mar$n 40"000 !00 40.

#ess *$%ed e%penses 35"000

Net operatin income !".###

Prepared by: Deva Djohan, BCom !3


14/30



!4

he "' ratio is extremely useful since it shows how thecontribution margin will be affected by a change in totalsales.

o illustrate* notice that 4coustic "oncepts has a "' ratio of(=>. his means that for each dollar increase in sales* totalcontribution margin will increase by (= cents !?1 sales x"' ratio of (=>$. @et operating income will also increase

by (=>* assuming that fixed costs do not change.


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)ome 4pplications of "#P "oncepts

he following illustrationsare to show how the "#Pconcepts can be used in

planning and decisionma,ing.

7ecall the following is the basic data for 4coustic

"oncepts.




Per UnitPercent of

Sale$

Sales (400 speakers) 250 !00.

#ess var$able e%penses !50 &0.

Con'r$b'$on mar$n !00 40.

Prepared by: Deva Djohan, BCom !5


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"hanges in 9ixed "osts and )ales #olume


!&

4coustic "oncepts is currently selling (== spea,ers permonth !monthly sales of ?1==*===$. he sales managerfeels that a ?1=*=== increase in the monthly advertising budget would increase monthly sales by ?%=*=== to a total

of +2= units.

)hould the advertising budget be increasedA


17/30

"hanges in 9ixed "osts and )ales #olume

/nremen'al on'r$b'$on mar$n:

30,000 % 40. C1 ra'$o !%&,###

#ess $nremen'al adver'$s$n e%pense !%#,###

Increa$e' net operatin income !&,###

Prepared by: Deva Djohan, BCom !+


18/30

"hanges in #ariable "osts and )ales #olume


!

'anagement is considering the use of higherBualitycomponents* which would increase variable costs !andthereby reduce the contribution margin$ by ?1= perspea,er.

Cowever* the sales manager predicts that the higher overallBuality would increase the sales to (D= spea,er per month.

)hould the higherBuality components be usedA


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"hanges in #ariable "osts and )ales #olume

%pe'ed 'o'al on'r$b'$on mar$n $'h h$her al$'y omponen's:

40 speakers % -0 per speaker 43,200

Presen' 'o'al on'r$b'$on mar$n

400 speakers % !00 per speaker 40,000

Increa$e in total contribution marin !(,#

Prepared by: Deva Djohan, BCom !-


20/30

"hanges in 9ixed "osts* )ales Price )ales #olume


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o increase sales* the sales manager would li,e to cut theselling price by ?2= per spea,er and increase theadvertising budget by ?1+*=== per month.

he sales manager believes that if these two steps are ta,en*unit sales will increase by +=> to -== spea,ers per month.

)hould the changes be madeA


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"hanges in 9ixed "osts* )ales Price )ales #olume

%pe'ed 'o'al on'r$b'$on mar$n $'h loer sell$n pr$e:

&00 speakers % 0 per speaker 4,000

Presen' 'o'al on'r$b'$on mar$n

400 speakers % !00 per speaker 40,000

/nremen'al on'r$b'$on mar$n ,000

Chanes $n *$%ed e%penses:

#ess $nremen'al adver'$s$n e%pense !5,000

)e'uction in net operatin income *!+,###

Prepared by: Deva Djohan, BCom 2!


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3rea,Even 4nalysis


22

"#P analysis is sometimes referred to simply as brea,evenanalysis. his is unfortunate because brea,even analysis isonly one element of "#P analysis 6 although an importantelement.

3rea,even analysis is designed to answer Buestions such as*how far could sales drop before the company begins to losemoneyA


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3rea,Even "omputations


23

3rea,even is defined as the level of sales at which thecompanyFs profit is 5ero.

he brea,even point can be computed using either theequation method or the contribution margin method 6 thetwo methods are eBuivalent.


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he EBuation 'ethod


24

Profits < !)ales 6 #ariable expenses$ 6 9ixed expenses

Rearranging:

)ales < #ariable expenses G 9ixed expenses G Profits

?2+=H < ?1+=H G ?%+*=== G ?=

?2+=H ?1+=H < ?%+*===

?1==H < ?%+*===

H < ?%+*=== I 1==

H < %+= spea,ers


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he EBuation 'ethod


25

he brea,even in total sales dollar* :* can also be computedas follows


: < =.-=: G ?%+*=== G ?=

: 6 =.-=: < ?%+*===

=.(=: < ?%+*===

: < ?%+*=== I =.(=

: < ?DJ*+==


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he "ontribution 'argin 'ethod


2&

4 shortcut version of the eBuation method.

he approach centers on the idea discussed earlier thateach unit sold provides a certain amount of contributionmargin that goes toward covering fixed costs.


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he "ontribution 'argin 'ethod


2+

3rea,even point in units sold

< 9ixed expenses

&nit contribution margin

3rea,even point in total sales dollars

< 9ixed expenses

"' 7atio


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arget Profit 4nalysis


2

"#P formulas can be used to determine the sales volumeneeded to achieve a target profit.

)uppose 4coustic "oncepts would li,e to earn a target profitof ?(=*=== per month. Cow many spea,ers would have to be soldA


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he "#P EBuation


2-


?2+=H < ?1+= H G ?%+*=== G ?(=*===

?1==H < ?J+*===

H < ?J+*=== I 1==

H < J+= spea,ers

hus* the target profit can be achieved by selling J+= spea,ers per

month* which represents ?1DJ*+== in total sales !?2+= perspea,er x J+= spea,ers$.


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he "ontribution 'argin 4pproach


30

&nits sales to attain the target profit

< 9ixed expenses G arget profit

&nit contribution margin

ollar sales to attain target profit

< 9ixed expenses G arget profit

"' 7atio

cost accounting - week 9

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