Cost-Volume-Profit AnalysisChapter 22

Objective 1Identify how changes in volume affect costs.

VariableFixedMixedTypes of Costs

Minutes TalkedTotal Long Distance Telephone BillTotal variable costs change when activity changes.Your total long distance telephone bill is based on how many minutes you talk.Total Variable Cost

Minutes TalkedPer Minute Telephone ChargeVariable Cost Per Unit Variable costs per unit do not change as activity increases. The cost per long distance minute talked is constant. For example, 10 cents per minute.

Variable Costs ExampleConsider Grand Canyon Railway.Assume that breakfast costs Grand Canyon Railway $3 per person.If the railroad carries 2,000 passengers, it will spend $6,000 for breakfast services.

Variable Costs Example012345$24

$18

$12

$6

Volume(Thousands of passengers)Total Variable Costs(thousands)

Number of Local CallsMonthly Basic Telephone BillTotal fixed costs remain unchanged when activity changes.Your monthly basic telephone bill probably does not change when you make more local calls.Total Fixed Cost

Mixed CostsContain fixed portion that is incurred even when facility is unused & variable portion that increases with usage.Example: monthly electric utility chargeFixed service feeVariable charge per kilowatt hour used

Total mixed costVariable Utility ChargeActivity (Kilowatt Hours) Total Utility CostFixed Monthly Utility ChargeMixed Costs

Relevant Range...is a band of volume in which a specific relationship exists between cost and volume.Outside the relevant range, the cost either increases or decreases.A fixed cost is fixed only within a given relevant range and a given time span.

Relevant RangeFixed CostsVolume in Units$160,000

$120,000

$80,000

$40,000 0 5,000 10,000 15,000 20,000 25,000

Relevant Range

Objective 2Use CVP analysis to compute breakeven point.

Assumptions of CVP AnalysisExpenses can be classified as either variable or fixed.CVP relationships are linear over a wide range of production and sales.Sales prices, unit variable cost, and total fixed expenses will not vary within the relevant range.

Assumptions of CVP AnalysisVolume is the only cost driver.The relevant range of volume is specified.Inventory levels will be unchanged.The sales mix remains unchanged during the period.

Contribution Margin Income StatementSales- Variable CostsContribution Margin- Fixed CostsOperating Income

Contribution Margin ExampleLuis and Tom manufacture a device that allows users to take a closer look at icebergs from a ship.The usual price for the device is $100.Variable costs are $70 per unit.They receive a proposal from a company in Newfoundland to sell 20,000 units at a price of $85.

Contribution Margin ExampleThere is sufficient capacity to produce the order.How do we analyze this situation?$85 $70 = $15 contribution margin.$15 20,000 units = $300,000 (total increase in contribution margin)

Contribution Margin Income StatementSales (20,000 x $85)$1,700,000Variable costs (20,000 x $70)(1,400,000)Contribution margin$300,000

Computing Break-Even PointThe unique sales level at which a company earns neither a profit nor incurs a loss.

Sales Variable Costs Fixed Costs = 0

Breakeven Point ExampleLets look back at Luis and Toms manufacturing, assuming that the fixed cost are $90,000.

Objective 3Use CVP analysis for profit planning and graph the cost-volume-profit relations

Volume in UnitsCosts and Revenue in DollarsTotal fixed costs Plot total fixed costs on the vertical axis.Preparing a CVP ChartTotal costs Draw the total cost line with a slope equal to the unit variable cost.

Volume in UnitsCosts and Revenue in DollarsTotal fixed costsPreparing a CVP ChartTotal costsStarting at the origin, draw the sales line with a slope equal to the unit sales price.

Various Sales Levels ExampleWhat operating income is expected when sales are _____ units?

Target Operating Income ExampleSuppose that our business would be content with operating income of _________________.How many units must be sold?

Objective 4Use CVP method to perform sensitivity analysis.

Change in Sales Price ExampleSuppose that the sales price per device is _____ rather than ____What is the revised breakeven sales in units?

Change in Variable Costs ExampleSuppose that variable expenses per device are ____ instead of ____Other factors remain unchanged.

Change in Fixed Costs ExampleSuppose that fixed costs increased by $30,000.What are the new fixed costs?What is the new breakeven point?

Margin of Safety ExampleExcess of expected sales over breakeven sales.

E22-7 Fixed expenseBreak even pointProfitLossBreak even in units = 1,200,000Break even in $ = 1,200,000 x 24 = $28,800,000

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02400

12002600

24002800

36003000

48003200

60003400

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Total Expense

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(in thousands)

Atlanta Braves

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Data Chart

0.050100150200250

Revenues0.0$1,200$2,400$3,600$4,800$6,000

Total Expense$2,400$2,600$2,800$3,000$3,200$3,400

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Atlanta Braves

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Effect of sales mix on CVP analysis.

Computing MultiproductBreak-Even PointUnit contribution margin is replaced with contribution margin for a composite unit.A composite unit is composed of specific numbers of each product in proportion to the product sales mix.Sales mix is the ratio of the volumes of the various products.

Computing MultiproductBreak-Even PointThe resulting break-even formula for composite unit sales is:Break-even point in composite unitsFixed costs Contribution margin per composite unit=

Computing MultiproductBreak-Even Point A company sells windows and doors. They sell 4 windows for every door.

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WindowsDoors

Selling Price$200$500

Variable Cost$125$350

Unit Contribution$75$150

Sales Mix Ratio41

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Step 1: Compute contribution margin per composite unit.Computing MultiproductBreak-Even Point

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WindowsDoors

Selling Price$200$500

Variable Cost$125$350

Unit Contribution$75$150

Sales Mix Ratio

Composite C/M

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Break-even point in composite unitsFixed costs Contribution margin per composite unit=Step 2: Compute break-even point in composite units.Computing MultiproductBreak-Even Point

Step 2: Compute break-even point in composite units.Computing MultiproductBreak-Even Point

Step 3: Determine the number of windows and doors that must be sold to break even.Computing MultiproductBreak-Even Point

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SalesComposite

ProductMixUnitsUnits

Window42,000=8,000

Door12,000=2,000

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Step 4: Verify the results.Multiproduct Break-EvenIncome Statement

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WindowsDoorsCombined

Selling Price$200$500

Variable Cost125.00350.00

Unit Contribution$75.00$150.00

Sales Volume8,0002,000

Total Contribution$600,000$300,000$900,000

Fixed Costs900,000

Income$ 0

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