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## Cost-Volume-Profit Analysis

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**Objective 1**• Identify how changes in volume affect costs.**Types of Costs**Variable Fixed Mixed**Total Variable Cost**• Total variable costs changewhen activity changes. • Your total long distancetelephone bill is basedon how many minutesyou talk. • Raw materials are the typical example of Variable Cost. Total Long DistanceTelephone Bill Minutes Talked**Variable Cost Per Unit ( UVC)**Variable costs per unit do not changeas activity increases. The cost per long distanceminute talked is constant.For example, 10cents per minute. Per MinuteTelephone Charge Minutes Talked**Variable Costs Example**Total Variable Costs (thousands) $24 – $18 – $12 – $6 – – – – – 0 1 2 3 4 5 Volume (Thousands of passengers)**Total Fixed Cost**Total fixed costs remain unchangedwhen activity changes. • Insurance Premium for the Plant . • Rent of the office Total Fixed Cost Volume**Mixed Costs**• Contain fixed portion that is incurred even when facility is unused & variable portion that increases with usage. • Example: monthly electric utility charge • Fixed service fee • Variable charge per kilowatt hour used**Mixed Costs**Total mixed cost VariableUtilityCharge Total Utility Cost FixedMonthlyUtilityCharge Activity (Kilowatt Hours)**Objective 2**• Use CVP analysis to compute breakeven point.**Assumptions of CVP Analysis**• Expenses 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 Analysis**• Volume 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.**Computing Break-Even Point**The unique sales level at which a company earns neither a profit nor incurs a loss. Sales – Variable Costs – Fixed Costs = 0**Breakeven Point Example**Let’s look back at Luis and Tom’s manufacturing, assuming that the fixed cost are $90,000.**Objective 3**• Use CVP analysis for profit planning and graph the cost-volume-profit relations**Preparing a CVP Chart**• Plot total fixed costs on the vertical axis. Total fixed costs Total costs Costs and Revenuein Dollars Draw the total cost line with a slopeequal to the unit variable cost. Volume in Units**Sales**Break-even Point Preparing a CVP Chart Starting at the origin, draw the sales line with a slope equal to the unit sales price. Total fixed costs Total costs Costs and Revenuein Dollars Volume in Units**Various Sales Levels Example**• What operating income is expected when sales are _____ units?**Target Operating Income Example**• Suppose that our business would be content with operating income of _________________. • How many units must be sold?**Objective 4**• Use CVP method to perform sensitivity analysis.**Change in Sales Price Example**• Suppose that the sales price per device is _____ rather than ____ • What is the revised breakeven sales in units?**Change in Variable Costs Example**• Suppose that variable expenses per device are ____ instead of ____ • Other factors remain unchanged.**Change in Fixed Costs Example**• Suppose that fixed costs increased by $30,000. • What are the new fixed costs? • What is the new breakeven point?**Margin of Safety Example**• Excess of expected sales over breakeven sales.**Break even in units = 1,200,000**Break even in $ = 1,200,000 x 24 = $28,800,000 E22-7 Profit Loss Break even point Fixed expense**Computing MultiproductBreak-Even Point**• Unit 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 Point**The resulting break-even formulafor composite unit sales is: Fixed costsContribution marginper composite unit Break-even pointin composite units =**Computing MultiproductBreak-Even Point**A company sells windows and doors. They sell 4 windows for every door.**Computing MultiproductBreak-Even Point**Step 1: Compute contribution margin per composite unit.**Computing MultiproductBreak-Even Point**Step 2: Compute break-even point in composite units. FixedcostsContributionmarginper composite unit Break-evenpointin compositeunits =**Fixed costsContribution marginper composite unit**Break-even pointin composite units = 900,000 450 per composite unit Break-even pointin composite units = Break-even pointin composite units = 2,000 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.**Multiproduct Break-EvenIncome Statement**Step 4: Verify the results.**Contribution Margin & Gross Margin**Manufacturing Sector Contribution Margin Format Revenues 1,000 Variable costs: Manufacturing 250 Non-manufacturing 270 520 Contribution margin 480 Fixed costs: Manufacturing 160 Non-manufacturing 138 298 Operating income 182 Gross Margin Format Revenues 1,000 Cost of goods sold (250+160) 410 Gross margin 590 Non-manufacturing (270+138) 408 Operating income 182 Pages 8 - 82