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