Chapter 19: Cost-Volume-Profit Analysis Questions Addressed by Cost-Volume-Profit Analysis Cost Behavior Variable Cost Fixed Cost Mixed Costs High-low

• Chapter 19: Cost-Volume-Profit Analysis• Questions Addressed by Cost-Volume-Profit

Analysis• Cost Behavior• Variable Cost• Fixed Cost• Mixed Costs• High-low Method

• Stair-Step Costs• Curvilinear Costs• Cost Behavior Summary• Cost-Volume-Profit Relationships• Contribution Margin Income Statement• Contribution Margin Ratio• Cost-Volume-Profit (CVP) Analysis• Computing Break-Even Point

• Formula for Computing Break-Even Sales in Units & In Dollar

• Preparing a CVP Graph• Computing Sales Needed to Achieve Target

Operating Income • What is our Margin of Safety?• What Change in Operating Income Do We

Anticipate?

Sales Mix ConsiderationsChapter

19

Sales Mix Considerations

Cascade Company sold 8,000 units of Product A and 2,000 units of Product B during the past year. Cascade Company’s fixed costs are $200,000. Other relevant data are as follows:

Sales $ 90 $140 Variable costs 70 95 Contribution margin $ 20 $ 45 Sales mix 80% 20%

Products A B

Sales $ 90 $140 Variable costs 70 95 Contribution margin $ 20 $ 45 Sales mix 80% 20%

Sales Mix ConsiderationsSales Mix Considerations Sales Mix ConsiderationsSales Mix Considerations

Products A B

Product contribution margin $16 $ 9

$25

Fixed costs, $200,000Fixed costs, $200,000


Products A BProduct contribution

margin $16 $ 9

$25

Break-even sales unitsBreak-even sales units

$200,000

$25




margin $16 $ 9

$25

Break-even sales unitsBreak-even sales units

$200,000

$25


= 8,000 units



margin $16 $ 9

$25

A:A: 8,000 units x Sales Mix (80%) = 6,400

B:B: 8,000 units x Sales Mix (20%) = 1,600

PROOFPROOF

Product A Product B Total

Sales:6,400 units x $90 $576,000 $576,0001,600 units x $140 $224,000 224,000Total sales $576,000 $224,000 $800,000

Variable costs:6,400 x $70 $448,000 $448,0001,600 x $95 $152,000 152,000Total variable costs $448,000 $152,000 $600,000

Contribution margin $128,000 $ 72,000 $200,000

Fixed costs 200,000Income from operations $ 0Break-even point

Margin of Safety

Margin of Safety =Sales – Sales at break-even point

Sales

The margin of safety indicates the possible decrease in sales that may occur

before an operating loss results.

Margin of Safety =$250,000 – $200,000

$250,000

Margin of Safety = 20%

Operating LeverageOperating Leverage

Both companies have the same contribution margin.Both companies have the same contribution margin.


Jones Inc. Wilson Inc.

Contribution margin

Income from operations

Sales $400,000 $400,000Variable costs 300,000 300,000Contribution margin $100,000 $100,000Fixed costs 80,000 50,000Income from operations $ 20,000 $ 50,000Contribution margin ? ?

Contribution margin



$100,000

$20,000= 5.0 Jones Inc.:


5.0

Sales $400,000 $400,000Variable costs 300,000 300,000Contribution margin $100,000 $100,000Fixed costs 80,000 50,000Income from operations $ 20,000 $ 50,000Contribution margin ?

Contribution margin



= 5.0

$100,000

$20,000Jones Inc.


Sales $400,000 $400,000Variable costs 300,000 300,000Contribution margin $100,000 $100,000Fixed costs 80,000 50,000Income from operations $ 20,000 $ 50,000Contribution margin 5.0 ?

Contribution margin



= 2.0$100,000Wilson Inc.:

Capitalintensive?

Laborintensive?

2.0


Sales $400,000 $400,000Variable costs 300,000 300,000Contribution margin $100,000 $100,000Fixed costs 80,000 50,000Income from operations $ 20,000 $ 50,000Contribution margin 5.0

$50,000

Assumptions of Cost-Volume-Profit AnalysisAssumptions of Cost-Volume-Profit AnalysisAssumptions of Cost-Volume-Profit AnalysisAssumptions of Cost-Volume-Profit Analysis

1. Total sales and total costs can be represented by straight lines.

2. Within the relevant range of operating activity, the efficiency of operations does not change.

3. Costs can be accurately divided into fixed and variable components.

4. The sales mix is constant.5. There is no change in the inventory quantities

during the period.

The reliability of cost-volume-profit analysis depends upon several assumptions.

Business Applications of CVP

Total Per Unit PercentSales (500 bikes) 250,000$ 500$ 100%Less: variable expenses 150,000 300 60%Contribution margin 100,000$ 200$ 40%

Less: fixed expenses 80,000 Operating income 20,000$


Consider the following information developed by the accountant at CyclCo, a bicycle retailer:


Should CyclCo spend $12,000 on advertising to increase sales by 10 percent?

Total Per Unit PercentSales (500 bikes) 250,000$ 500$ 100%Less: variable expenses 150,000 300 60%Contribution margin 100,000$ 200$ 40%

Less: fixed expenses 80,000 Operating income 20,000$

500 550Bikes Bikes

Sales 250,000$ 275,000$ Less: variable expenses 150,000 165,000 Contribution margin 100,000$ 110,000$ Less: fixed expenses 80,000 92,000 Operating income 20,000$ 18,000$

550 × $300

$80K + $12K

No, income is decreased.

550 × $500


Should CyclCo spend $12,000 on advertising to increase sales by 10 percent?

500Bikes

Sales 250,000$ Less: variable expenses 150,000 Contribution margin 100,000$ Less: fixed expenses 80,000 Operating income 20,000$

Now, in combination with the advertising, CyclCo is considering a 10 percent price reduction that willincrease sales by 25 percent. What is the income effect?


500 625Bikes Bikes


625 × $300

$80K + $12K

Income is decreased even more.

625 × $450

Now, in combination with the advertising, CyclCo is considering a 10 percent price reduction that willincrease sales by 25 percent. What is the income effect?

1.25 × 500


500Bikes

Sales 250,000$ Less: variable expenses 150,000 Contribution margin 100,000$ Less: fixed expenses 80,000 Operating income 20,000$

Business Applications of CVPNow, in combination with advertising and a price cut, CyclCo

will replace $50,000 in sales salaries with a $25 per bike commission, increasing sales by 50 percent above the

original 500 bikes. What is the effect on income?

500 750Bikes Bikes


The combination of advertising, a price cut,and change in compensation increases income.

750 × $325

$92K - $50K

750 × $450

Business Applications of CVPNow, in combination with advertising and a price cut, CyclCo

will replace $50,000 in sales salaries with a $25 per bike commission, increasing sales by 50 percent above the

original 500 bikes. What is the effect on income?

1.5 × 500

Different products with different contribution margins.

Determining semivariablecost elements.

Complying with theassumptions of CVP analysis.

Additional Considerations in CVP

CVP Analysis When a Company Sells Many Products

Sales mix is the relative combination in whicha company’s different products are sold.

Different products have different selling prices, costs, and contribution margins.

If CyclCo sells bikes and carts, howwill we deal with break-even analysis?

Sales mix is the relative combination in whicha company’s different products are sold.

Different products have different selling prices, costs, and contribution margins.

If CyclCo sells bikes and carts, howwill we deal with break-even analysis?


CyclCo provides us with the following information:

Bikes Carts TotalSales 250,000$ 100% 300,000$ 100% 550,000$ 100%Var. exp. 150,000 60% 135,000 45% 285,000 52%Contrib. margin 100,000$ 40% 165,000$ 55% 265,000$ 48%

Fixed exp. 170,000 Net income 95,000$


The overall contribution margin ratio is:

$265,000 $550,000

= 48% (rounded)


Fixed exp. 170,000 Net income 95,000$

CVP Analysis When a Company Sells Many ProductsBreak-even in sales dollars is:

$170,000 .48

= $354,167 (rounded)


Fixed exp. 170,000 Operating income 95,000$

The High-Low MethodOwlCo recorded the following production activity and maintenance

costs for two months:

Using these two levels of activity, compute: the variable cost per unit. the total fixed cost. total cost formula.

Units Cost

High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$

Units Cost


Unit variable cost = = = $0.90 per unitin cost

in units$3,600 4,000

The High-Low Method

Units Cost


Unit variable cost = = = $0.90 per unit

Fixed cost = Total cost – Total variable cost

in costin units

$3,600 4,000

The High-Low Method

Units Cost




Fixed cost = $9,700 – ($0.90 per unit × 9,000 units)

Fixed cost = $9,700 – $8,100 = $1,600

in costin units

$3,600 4,000

The High-Low Method

Units Cost




Fixed cost = $9,700 – ($0.90 per unit × 9,000 units)

Fixed cost = $9,700 – $8,100 = $1,600 Total cost = $1,600 + $.90 per unit

in costin units

$3,600 4,000

The High-Low Method

The High-Low MethodQuestion 1

If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the variable portion of sales commission per unit sold?

a. $.08 per unitb. $.10 per unit c. $.12 per unitd. $.125 per unit








$4,000 ÷ 40,000 units = $.10 per unit

Units Cost

High level 120,000 14,000$Low level 80,000 10,000 Change 40,000 4,000$


If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is

the fixed portion of the sales commission?

a. $ 2,000b. $ 4,000 c. $10,000d. $12,000

If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is

the fixed portion of the sales commission?

a. $ 2,000b. $ 4,000 c. $10,000d. $12,000

If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the fixed portion of the sales commission?

a. $ 2,000

b. $ 4,000

c. $10,000

d. $12,000

If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the fixed portion of the sales commission?

a. $ 2,000

b. $ 4,000

c. $10,000

d. $12,000

Total cost = Total fixed cost + Total variable cost

$14,000 = Total fixed cost +($.10 × 120,000 units)

Total fixed cost = $14,000 - $12,000

Total fixed cost = $2,000


Assumptions Underlying CVP Analysis

A limited range of activity, called the relevant range, where CVP relationships are linear. – Unit selling price remains constant.– Unit variable costs remain constant.– Total fixed costs remain constant.

Sales mix remains constant. Production = sales (no inventory changes).

End of Chapter 19

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Chapter 19: Cost-Volume-Profit Analysis Questions Addressed by Cost-Volume-Profit Analysis Cost Behavior Variable Cost Fixed Cost Mixed Costs High-low