Accounting 2120

1. Accounting 2120 Chapter 21 –Cost-Volume-Profit Analysis

2. Cost Behavior • Fixed costs - costs that stay the same in total with changes in activity • Variable costs - costs that change in total with changes in activity • Mixed - costs that have some fixed and some variable behavior; you must split these costs into variable and fixed costs • Step-wise costs – costs go up by steps. Ex: salaries (at some point, you will have to hire another worker) • Curvilinear costs – costs increase in a curved direction • Relevant range – point where cost behavior assumptions hold true

3. In Total Variable - changes directly Fixed - stays same These relationships hold over the relevant range. Per unit Variable - stays same Fixed - changes inversely Cost Behavior

4. Variable Costs • Assume $30 unit • Volume Per unitTotal cost • 100 units $30 ? • 200 units $30 ? • 300 units $30 ?

5. Fixed Costs • Assume $3000 in total • Volume Per unitTotal cost • 100 units ? $3,000 • 200 units ? $3,000 • 300 units ? $3,000

6. Measuring Cost Behavior • Scatter Diagrams • High-low method • Least squares regression

7. High-low Method • Method used to separate the variable and fixed costs in a mixed cost • Procedure • Find the highest activity and the lowest activity • Subtract the lowest from the highest activity • The difference represents the variable part of the activity • Determine the variable cost per unit • Apply the variable cost per unit to either the low or the high amount and subtract this amount from the total cost • The difference is the fixed cost. • You now have a cost formula: Total cost = fixed cost in total + variable cost per unit

8. Cost-Volume-Profit Analysis • Procedure that examines changes in costs -- variable and fixed-- and volume levels and the resulting effects on net income. • Used for planning -- to determine effects of anticipated changes in revenues, variable costs, fixed costs and volume • Used for controlling -- what happens to net income when changes occur

9. Contribution Margin • Contribution margin = Sales – variable costs • Example: Billy Bob’s Bicycles (Sales of 200 bikes) Sales Revenues $100,000 Var. Costs 40,000 Contr. Margin 60,000 Less Fixed costs 30,000 Net Income $30,000

10. Contribution Margin • Per unit • Sales Price per unit - var. costs per unit • Tells us how much in $ is contributed to firm • Ratio • CM per unit/Sales price per unit • Tells us what % of each dollar is contributed to the firm

11. Contribution Margin • CM in total = $60,000 • CM per unit = • $100,000/200 bikes = $500 sales price per bike • $ 40,000/200 bikes = $200 var.costs per bike • $ 60,000/200 bikes = $300 CM per bike • CM Ratio = • $300/$500 = 60% OR • $60,000/$100,000 = 60%

12. Break-even Analysis • Contribution Margin Method • 1) Determine the CM per unit • $500 - $200 = $300 • 2) Calculate how many units must be sold to break even by the following formula: • Fixed costs $30,000 = 100 bikes • CM per unit $300

13. Break-even Analysis • In Sales Dollars • B.E. in units x Sales price per unit • OR • Fixed Costs • CM ratio • = $30,000/.60 = $50,000

14. Cost-Volume-Profit Relationships • Break-even point = point where total costs = total revenues; no profit • Costs = Fixed + variable • Revenues • Revenue per unit = fixed costs in total + variable cost per unit • Rev(x) = Fixed + Var(x) • Solve for x

15. Sensitivity Analysis • A change in any of the variables will yield a new break-even point. • Sales prices • Increase (decrease) – increased (decreased) break-even point • Fixed costs • Increase (decrease) – increased (decreased) break-even point • Variable costs • Increase (decrease) – increased (decreased) break-even point

16. CM Income Statement • Costs arranged by behavior • Sales • Less variable costs • Equal contribution margin • Less fixed costs • Equal operating income • End up with the same operating income as a traditional income statement

17. Margin of safety • Tells us the amount sales dollars can drop before we have a net loss • Therefore, it is the difference between current sales and break-even sales dollars

18. Target Profit AnalysisAdd desired profit to fixed costs • Fixed costs + Before-tax Profit: • $30,000 + $60,000 • $300 • = $90,000/300 = • 300 bikes

19. Before-tax Income • Net income = Before-tax income • 1- Tax rate

20. C-V-P in a Multiproduct Environment • Sales Mix - more than one product sold • Ratio of each product sold to total • Example: Pizza Hut sells pizza, breadsticks, etc. • How many pizzas sold per breadsticks? • Assume four pizzas to one breadstick • Sales mix = 4P + 1B • This equation is called a “basket” of goods

21. C-V-P in a Multiproduct Environment • Breakeven/Target Profit analysis for multiproducts - use the CM per basket of goods • Example: Assume the CM for pizzas is $4 and the CM for breadsticks is $2, equation would be: • 4P ($4) + 1B ($2) = $18 CM per basket of goods • Proceed as usual with break-even analysis

22. C-V-P for MultiproductsBasket of Goods Approach • Example: Fixed costs = $90,000 • Break-even point = $90,000/18 CM • = 5,000 baskets of goods • 1 basket = 4 P + 1B, therefore • Break-even is 4 x 5000 = 20,000 pizzas and 1 x 5000 = 5,000 breadsticks • All analysis is based on baskets of goods!!!

23. C-V-P for Multiproducts Weighted Average Approach • Can weight the basket of goods to get a weighted average CM per unit • (4/5 x $4) + (1/5 x $2) = $3.60 • $90,000/ $3.60 = 25,000 baskets of goods • 25,000 x 4/5 = 20,000 pizzas • 25,000 x 1/5 = 5,000 breadsticks

24. Company 1 - Pizza Pizza Sales $200,000 -Var. costs 150,000 CM 50,000 -Fixed costs 20,000 Oper. Income 30,000 Company 2 - Pizza oven manufacturers Sales $200,000 -Var. costs 50,000 CM 150,000 -Fix. costs 120,000 Oper. income 30,000 Cost Structure- Operating Leverage

25. Cost Structure • What is CM ratio for each company? • Company 1 = 50,000/200,000 • Company 2 = 150,000/200,000 • Which company is riskier? • Operating Leverage = Contribution Margin Net Income • Higher operating leverage, more risky company

26. Homework • Problems 21-4B, 21-7B*, BTN 21-7 • DUE WITH EXAM, FRIDAY, MAY 23