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# Chapter 20 Cost-Volume-Profit Analysis

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1. Chapter 20Cost-Volume-Profit Analysis

2. Learning Objectives • Determine how changes in volume affect costs • Calculate operating income using contribution margin and contribution margin ratio • Use cost-volume-profit (CVP) analysis for profit planning

3. Learning Objectives • Use CVP analysis to perform sensitivity analysis • Use CVP analysis to calculate margin of safety, operating leverage, and multiproduct breakeven points

4. Learning Objective 1 Determine how changes in volume affect costs

5. How Do Costs Behave When There Is a Change in Volume? • Some costs change as the volume of sales increases or decreases. Other costs are not affected by changes in volume. • Different types of costs are: • Variable costs • Fixed costs • Mixed costs

6. Variable Costs • Variable costs remain constant per unit but change in total as volume changes.

7. Variable Costs

8. Fixed Costs

9. Fixed Costs

10. Fixed Costs

11. Mixed Costs • Mixed costs have both fixed and variable components.

12. Mixed Costs

13. High-Low Method • A method to separate mixed costs into variable and fixed components is the high-low method.

14. High-Low Method • Use three steps to separate the variable and fixed costs. • Step 1: Identify the highest and lowest levels of activity and calculate the variable cost per unit.

15. High-Low Method • Now that we have calculated the variable costs per unit, we can calculate the portion of the mixed costs that relates to the fixed costs. • Step 2: Calculate the total fixed costs.

16. High-Low Method • Using the variable costs per unit and the fixed costs per unit, we can determine the total mixed costs at various levels of productivity. • Step 3: Create and use an equation to show the behavior of a mixed cost.

17. Relevant Range and Relativity • The relevant range is the range of volume where total fixed costs and variable costs per unit remain constant.

18. Learning Objective 2 Calculate operating income using contribution margin and contribution margin ratio

19. What Is Contribution Margin, And How Is It Used to Compute Operating Income? • A traditional income statement classifies costs by function: • Product costs • Period costs • A contribution margin income statement classifies costs by behavior: • Variable costs • Fixed costs

20. Contribution Margin • The difference between net sales revenue and variable costs is the contribution margin. • It is called contribution margin because it is the amount that contributes to covering fixed costs.

21. Unit Contribution Margin • The contribution margin can be expressed as a unit amount. • Note: The terms unit contribution margin and contribution margin per unit are used interchangeably.

22. Contribution Margin Ratio • A third way to express contribution margin is as a ratio. • Contribution margin ratio is the ratio of contribution margin to net sales revenue.

23. Contribution Margin Income Statement

24. Learning Objective 3 Use cost-volume-profit (CVP) analysis for profit planning

25. How Is Cost-Volume-Profit (CVP) Analysis Used? • Managers use information about cost behavior to make business decisions. • Cost-volume-profit (CVP) analysis is a planning tool that looks at the relationships among costs and volume and how they affect profits (or losses).

26. Assumptions • The price per unit does not change as volume changes. • Managers can classify each cost as variable, fixed, or mixed. • The only factor that affects total costs is change in volume, which increases or decreases variable and mixed costs. • Fixed costs do not change. • There are no changes in inventory levels.

27. Target Profit—Three Approaches • CVP analysis can be used to estimate the amount of sales needed to achieve a target profit. • There are three methods of estimated sales required to make a profit: • Equation approach • Contribution margin approach • Contribution margin ratio approach

28. The Equation Approach • An equation can be used to estimate the number of units a company needs to sell to achieve target profit or total sales revenue.

29. The Equation Approach • If Smart Touch Learning desires a target profit of \$6,000, using the equation approach, it finds it needs to sell 80 units.

30. The Contribution Margin Approach • The contribution margin approach is a shortcut method of computing the required sales in units. • The equation approach is rewritten to derive the following equation:

31. Contribution Margin Ratio Approach • The contribution margin ratio approach computes required sales in terms of sales dollars rather than in units.

32. Breakeven Point—A Variation of Target Profit • The breakeven point calculation is a variation of the target profit calculation. • The breakeven point is the point at which total revenues equal total costs. • The same three approaches used for target profit can be used to determine the breakeven point.

33. Breakeven Point—A Variation of Target Profit

34. CVP Graph—A Graphic Portrayal

35. Learning Objective 4 Use CVP analysis to perform sensitivity analysis

36. How Is CVP Analysis Used for Sensitivity Analysis? • Managers can use CVP relationships to conduct sensitivity analysis. • Sensitivity analysis is a “what if” technique that estimates profit or loss results if sales price, cost, volume, or underlying assumptions change.

37. Changes in the Sales Price • If the sales price changes from \$500 to \$475, the number of units needed to breakeven increases from 54 to 60.

38. Changes in Variable Costs • If one of Smart Touch Learning’s suppliers raises prices and variable costs increase from \$275 to \$285, the number of units needed to break even increases from 54 to 56.

39. Changes in Fixed Costs • If Smart Touch Learning’s fixed costs increase from \$12,000 to \$15,000, the number of units needed to break even increases from 54 to 67.

40. How Is CVP Analysis Used for Sensitivity Analysis?

41. Learning Objective 5 Use CVP analysis to calculate margin of safety, operating leverage, and multiproduct breakeven points

42. What Are Some Other Ways CVP Analysis Can Be Used? • CVP analysis can be used for estimating target profits and breakeven points, as well as sensitivity analysis. • Three additional applications of CVP are: • Margin of safety • Operating leverage • Sales mix

43. Margin of Safety • Margin of safety is the excess of expected sales over breakeven sales. • Used to evaluate the risk of current operations and their plans for the future.

44. Operating Leverage • The cost structure of a company is the proportion of fixed costs to variable costs. • Operating leverage predicts the effects that fixed costs will have on changes in operating income when sales volume changes. • The degree of operating leverage can be measured by dividing the contribution margin by the operating income.

45. Operating Leverage • For Company A, the percentage change in operating income will be 2.5 times the percentage change in sales.

46. Sales Mix • Most companies sell more than one product. • Sales price and variable costs differ for each product. • Sales mix, or product mix, is the combination of products that make up total sales.

47. Sales Mix