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1. Cost-Volume-Profit Analysis Chapter 21

2. Objective 1 Identify how changes in volume affect costs

3. Cost Behavior • How costs change in response to changes in a cost driver • Cost driver - any factor whose change makes a difference in a related total cost • Volume (units or dollars) - most prominent cost driver in cost-volume-profit (CVP) analysis

4. Cost Behavior • Variable costs • Fixed costs • Mixed costs

5. Total Variable Costs

6. Variable Cost Per Unit • Variable costs per unit do not changeas activity increases

7. Total Fixed Costs

8. Mixed Costs

9. Mixed Costs Variable Fixed

10. E21-14 _____ 1. Oil filter _____ 2. Building rent _____ 3. Oil _____ 4. Wages of maintenance worker _____ 5. Television _____ 6. Manager’s salary _____ 7. Cash register _____ 8. Equipment V F V V F F F F

11. E21-15 a

12. E21-15 b

13. E21-15 c

14. High-Low Method • Method to separate mixed costs into variable and fixed components • Select the highest level and the lowest level of activity over a period of time

15. High-Low Method – E21-16 Step 1: Calculate variable cost/unit = Δ total cost / Δ volume of activity (\$4,000-\$3,600) ÷ (1,000-600) \$400 ÷ 400 = \$1

16. High-Low Method Step 2: Calculate total fixed costs = Total mixed cost – Total variable cost \$4,000 – (\$1 * 1,000) = \$3,000 or \$3,600 – (\$1 * 600) = \$3,000

17. High-Low Method Step 3: Create and use an equation to show the behavior of a mixed cost Total mixed cost = \$1x + \$3,000 = (\$1 * 900) + \$3,000 = \$3,900

18. Relevant Range • Band of volume: Where total fixed costs remain constant and variable cost per unit remains constant • Outside the relevant range, the cost either increases or decreases

19. Objective 2 Use CVP analysis to compute breakeven point

20. Assumptions • Expenses can be classified as either variable or fixed • The only factor that affects costs is change in volume

21. Breakeven Point • Sales level at which operating income is zero • Sales above breakeven result in a profit • Sales below breakeven result in a loss

22. Income Statement Approach Contribution Margin Income Statement Sales - Variable Costs Contribution Margin - Fixed Costs Operating Income

23. Contribution Margin Approach Breakeven units sold = Fixed costs + Operating income Contribution margin per unit

24. Contribution Margin Ratio Contribution margin ÷ Sales revenue Breakeven sales dollars = Fixed costs + Operating income Contribution margin ratio

25. E21-17 1. Contribution margin ÷ Sales revenue \$187,500 ÷ \$312,500 = 60%

26. E21-17 2. Aussie Travel Contribution Margin Income Statement Three Months Ended March 31, 2007 Sales revenue \$250,000 \$360,000 Variable Costs (40%) (100,000)(144,000) Contribution Margin (60%) \$150,000 \$216,000 Fixed Costs (170,000)(170,000) Operating Income \$(20,000) \$46,000

27. E21-17 2. Breakeven sales dollars = Fixed costs + Operating income Contribution margin ratio \$170,000 + \$0 .60 \$283,333

28. E21-18 1. Contribution margin = Sales–Variable costs = \$1.70 - \$0.85 = \$0.85 2. Breakeven units sold = Fixed costs + Operating income Contribution margin per unit (\$85,000 + \$0) / \$0.85 = 100,000 units 100,000 units x \$1.70 = \$170,000

29. Objective 3 Use CVP analysis for profit planning and graph relations

30. Plan Profits Example: The following information is available for Conte Company Sale price per unit \$30 Variable costs per unit 21 Total fixed costs \$180,000 Target operating income \$90,000 How many units must be sold to meet the targeted operating income?

31. Plan Profits Sales – variable costs – fixed costs = operating income \$30x – \$21x - \$180,000 = \$90,000 \$9x = \$270,000 x = 30,000 units

32. Preparing a CVP Chart Step 1: • Choose a sales volume • Plot point for total sales revenue • Draw sales revenue line from origin

33. Preparing a CVP Chart Step 2: Draw the fixed cost line

34. Preparing a CVP Chart

35. Preparing a CVP Chart Step 3: Draw the total cost line ( fixed plus variable)

36. Preparing a CVP Chart

37. Preparing a CVP Chart Step 4: Identify the breakeven point and the areas of operating income and loss

38. Preparing a CVP Chart Breakeven point Profit Loss

39. Profit E21-21 Breakeven point Total Costs Fixed Costs Revenues

40. Objective 4 Use CVP methods to perform sensitivity analysis

41. Sensitivity Analysis • “What if” analysis • What if the sales price changes? • What if costs change?

42. E21-22 Sale price per student \$200 Variable costs per student 120 Total fixed costs \$50,000 1. Contribution margin per unit: \$200 – 120 = \$80 Breakeven point: \$50,000 ÷ \$80 = 625 students

43. E21-22 Sale price per student \$180 Variable costs per student 120 Total fixed costs \$50,000 2. Contribution margin per unit: \$180 – 120 = \$60 Breakeven point: \$50,000 ÷ \$60 = 833 students

44. E21-22 Sale price per student \$200 Variable costs per student 110 Total fixed costs \$50,000 2. Contribution margin per unit: \$200 – 110 = \$90 Breakeven point: \$50,000 ÷ \$90 = 556 students

45. E21-22 Sale price per student \$200 Variable costs per student 120 Total fixed costs \$40,000 1. Contribution margin per unit: \$200 – 120 = \$80 Breakeven point: \$40,000 ÷ \$80 = 500 students

46. Margin of Safety • Excess of expected sales over breakeven sales • Drop in sales that the company can absorb before incurring a loss

47. E21-23 Margin of safety = Expected sales – breakeven sales Expected sales: Sales – variable costs – fixed costs = operating income 1x - .70x - \$9,000 = \$12,000 .30x = \$21,000 x = \$70,000

48. E21-23 Margin of safety = Expected sales – breakeven sales Breakeven sales: Sales – variable costs – fixed costs = operating income 1x - .70x - \$9,000 = \$0 .30x = \$9,000 x = \$30,000

49. E21-23 Margin of safety = Expected sales – breakeven sales = \$70,000 - \$30,000 = \$40,000