1 Brenda Mallouk Management Accounting One Cost Volume Profit Analysis
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Management Accounting One
Cost Volume Profit Analysis
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Variable Cost Behaviour
Increases Decreases
Total Variable Cost
Increases Proportionately
Decreases Proportionately
Variable Cost Per Unit
Remains Constant Remains Constant
When activity . . .
$
Units
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Fixed Cost Behaviour
Increases Decreases
Total Fixed Cost Remains constant Remains Constant
Fixed Cost Per Unit Decreases Increases
When activity . . . .
$
Units
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Jabot Cosmetics makes and sells scent holders. The company normally produces and sells between 20,000 and 23,000 holders per year. The following cost data were drawn from the company’s accounting records.
Number of Units 20,000 21,000 22,000 23,000
Total Costs Incurred Fixed $ 45,000 Variable 100,000 Total Costs $145,000 Cost Per Unit Fixed $ 2.25 Variable 5.00 Total Cost Per Unit $ 7.25
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Lumpy Costs
A cost which shifts upwards when an activitychanges by a certain interval or “step”.
$
Activity Measure
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Mixed Costs
A cost that has both a variable and a fixed component
Does not fluctuate in direct proportion to changes in activity
Does not remain constant with changes inactivity
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Mixed Cost
FixedPortion
Mixed(Semi-Variable)Expenses
VariablePortion
$145.00
$217.00
$ 72.00
Rent a truck -- base cost $145 kilometer charge $0.12 600 km driven
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The Pasta Palace is a fast food restaurant that operates a chain of restaurants across the country. Each restaurant employs 8 people. The manager is paid a salary plus a bonus equal to 2 percent of sales. The other employees -- two cooks, one cleaner and four waitstaff are paid salaries. Each manager has a budget of $1,000 per month for advertising cost.
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Classify each of the following total costs incurred by PastaPalace as being fixed, variable or mixed:
a. The cooks’ salary at a particular location, relative tothe number of customers
b. The cooks’ salary relative to the number of restaurantsc. The cost of cups, plates, spoons, etc. relative to the
number of customersd. The cost of cups, plates, spoons, etc. relative to the
number of restaurantse. The manager’s compensation relative to the number of
customersf. Waitstaff salaries relative to the number of restaurantsg. Advertising costs relative to the number of customers
for a particular restaurant.h. Advertising costs relative to the number of
restaurants.
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Analyzing Mixed Costs Using the High Low
Method
Has advantage of objectivity
Solely dependent on two observations
Simple and fast
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Steps in Using the High-Low Method
1. Identify the high and low cost-volume points
2. Compute the variable rate by using the followingformula:
Variable rate = High cost – Low cost High activity – Low activity
3. Compute the fixed rate by using the followingformula and inserting the variable rate computedabove and either the high activity or the low activity level
Total cost = Fixed cost + (Activity level x variable rate)
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TotalSales (500 units) 250,000$ Less: variable expenses 150,000 Contribution margin 100,000 Less: fixed expenses 80,000 Net income 20,000$
Jeff's Computers
Pentium Five Model
Contribution Statement
Contribution margin (CM) is the difference between the sales revenue and the variable costs. It is the amount
available to cover fixed costs and profit.
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Contribution Margin Ratio
ContributionMargin Ratio
= Sales - Variable Costs / Sales
= ($250,000 - $150,000) / $250,000
= 40%
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Determining the Break-Even Point
Break-Even Volumein Units
= Fixed Costs Contribution Margin Per Unit
For Jeff’s Pentium Five model computer the break-even volume in
units is:$80,000 $200
= 400 computers
Contribution Margin Per Unit $ 500 - $300 = $200
The break-even point in units can be determined using the following equation:
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Estimating the Sales Volume Necessary to Attain a Target
Profit
Sales Volumein Units
= Fixed Costs + Desired Profit Contribution Margin Per Unit
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Estimating the Effects of Changes in Sales Price
The new contribution per unit would be $160 ($460 -$300).
Break-Even Volumein Units =
Fixed Costs
Contribution Margin Per Unit
Break-Even Volumein Units =
Break-Even Volumein Units = 500 units
Competition is forcing consideration of a drop in selling price. What is the impact on break-even of a drop in selling price from $500 to $460 per unit?
$80,000
$160
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Dollars
Cost-Volume-Profit Graph
-
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
- 100 200 300 400 500 600 700 800
Break-even point
Units
Profit Area
Loss Area
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Margin of Safety
The number of units (or sales dollars) by which actual sales can fall below budgeted sales before a loss is incurred.
Margin of safety =Budgeted Sales - Break-even sales
Budgeted Sales
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Operating Leverage
A measure of the extent to which fixed
costs are being used in an organization.
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$100,000 $20,000
= 5
Operating Leverage
CM Net Income =
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Short Cut for ChangesShort Cut for Changes
If sales are increased by 10%, profits If sales are increased by 10%, profits will increase by 50%will increase by 50%
Operating Leverage
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CVP LimitationsSelling price is constant
throughout the entire relevant range.
Costs are linear throughout the entire relevant range.
In multi-product companies, the sales mix is constant.
In manufacturing companies, inventories do not change (units produced = units sold).
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Income Effects of Alternative Inventory Costing Methods
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The Effect of Cost Structureon Profit Stability
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The Effect of Cost Structureon Profit Stability
VariableCosts
FixedCosts
What happenswhen the
number of unitssold increases or increases?
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The income increase is greaterin the All Fixed Company.
Increased Sales
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The income decrease is greaterin the All Fixed Company.
Decreased Sales
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Absorption Costing
Product Cost Includes
• Direct Material• Direct Labour• Manufacturing Overhead
Variable
Fixed
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Absorption Costing
Direct MaterialDirect LabourVariable Mfg. O/HFixed Mfg. O/H
Work-in-ProcessInventory
Finished Goods Inventory
Costs are expensed on the income
statement as cost of goods sold at the
When costs are incurred
time of sale of product
Asset
Asset
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Variable Costing (Direct)
Includes only variable manufacturing costs inwork in process and finished goods inventories and in cost of goods sold
Expenses all fixed costs in the period in which they are incurred
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Variable Costing
Direct MaterialDirect LabourVariable Mfg. O/H
Work-in Process Inventory
Finished Goods Inventory
Expense on Income Statement
Total FixedMfg. O/H
When costs are incurred
When Sold
Asset Asset
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Net Income RelationshipsIF
# of units produced > # of units sold, then NI under variable costing < NI under absorption costing Why?
# of units produced < # units sold, then NIunder variable costing > NI under absorption costing
Why?
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Net Income Reconciliation
(NI AC - NI VC) = ( I* X FOR)
*Inventory
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Let’s compare absorption and
variable costing.
The Motive to Overproduce – Absorption Costing
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The Motive to Overproduce – Absorption Costing
Newman Manufacturing Company incurs the followingcosts to produce 2,000 units of inventory:
Newman Manufacturing Company incurs the followingcosts to produce 2,000 units of inventory:
What happens to costsif Newman increases production.
What happens to costsif Newman increases production.
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Compute income at the three levelof production if Newman sells 2,000 units.
Compute income at the three levelof production if Newman sells 2,000 units.
The Motive to Overproduce – Absorption Costing
2,000 3,000 4,000
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The Motive to Overproduce – Absorption Costing
Level of Production 2000 3000 4000Sales @ $20 per unit × 2,000 units 40,000$ 40,000$ 40,000$ Cost of Goods Sold $15 per unit × 2,000 units 30,000 $13 per unit × 2,000 units 26,000 $12 per unit × 2,000 units 24,000 Gross Margin 10,000$ 14,000$ 16,000$
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Variable Costing
Net income is not affected by production increases.Net income is not affected by production increases.
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Conclusions
1) Under variable costing, income is correlatedwith sales and not influenced by production
2) Under absorption costing, income is affected byproduction as well as sales
3) Income is the same when production = sales4) Production > sales, income is under
absorption costing
5) Sales > production, income under variable costing
Difference due to inventory levels