Chapter 6 Cost-Volume-Profit Analysis and Relevant Costing
Jan 05, 2016
Chapter 6
Cost-Volume-Profit Analysis and Relevant Costing
1. How is breakeven point computed and what does it
represent?
2. How do costs, revenues, and contribution margin
interact with changes in an activity base (volume)?
Learning Objectives
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3. How does cost-volume-profit (CVP) analysis in single-
product and multiproduct firms differ?
4. What are the underlying assumptions of CVP analysis
and how do these assumptions create a short-run
managerial perspective?
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Continuing . . . Learning Objectives
5. How do quality decisions affect the components of CVP
analysis?
6. What constitutes relevance in a decision-making
situation?
C6
Continuing . . . Learning Objectives
7. How can management best utilize a scarce
resource?
8. What is the relationship between sales mix and
relevant costing problems?
Continuing . . . Learning Objectives
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9. How can pricing decisions be used to
maximize profit?
10. How can product margin be used to determine
whether a product line should be retained or
eliminated?
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Continuing . . . Learning Objectives
11. How are breakeven and profit-volume graphs
prepared? (Appendix 1)
12. What are the differences between absorption and
variable costing? ( Appendix 2)
13. Why is linear programming a valuable tool for
managers? (Appendix 3)
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Continuing . . . Learning Objectives
The Breakeven Point (BEP)
The level of activity, in units or dollars, at which
REVENUES = COSTS
Basic Assumption: Relevant Range
Company is operating within the relevant
range of activity specified in determining the revenue
and cost information used.
Total$
Activity Level
RelevantRange
Basic Assumption: Revenue
Total revenue fluctuates in direct proportion to level of activity or volume. On a per unit basis, the selling
price remains constant.
Total$
Activity Level
Basic Assumption: Variable Costs
Total variable costs fluctuate in direct proportion to level of activity or volume. On a per unit basis,
variable costs remain constant.
Total$
Activity Level
Basic Assumption: Fixed Costs
Total fixed costs remain constant relative to activity level changes. Per-unit fixed costs decrease as
volume increases and increase as volume decreases.
Total$
Activity Level
Basic Assumption: Mixed Costs
Mixed costs must be separated into variable and fixed elements.
Total$
Activity Level
Cost Behavior Example
Selling price per ice bucket $40
Variable production cost per ice bucket $20Variable selling cost per ice bucket 4Total variable cost per ice bucket $24
Fixed production costs $100,000Fixed selling and administrative costs 20,000
Contribution Margin Per Unit
Contribution margin per unit equals selling price per unit less variable cost per unit.
sp -vc = cm
$40 - $24 = $16
Contribution Margin Ratio
Contribution margin ratio is per-unit contribution margin divided by selling price, or total contribution margin divided by total sales dollars.
cm/sp=cm%
$16 / $40 = 40%
Breakeven Point
Breakeven point is the point at which profits are
zero because total revenues equal total costs, or
Total revenues = Total variable costs + Total fixed costs
Continuing . . . Breakeven Point
Total fixed costs In units = ---------------------
CM per unit
Total fixed costs In sales dollars = ---------------------
CM ratio
Continuing . . . Breakeven Point
$120,000 In units = ----------- = 7,500 ice buckets
$16
$120,000 In sales dollars = ----------- = $300,000
.40
CVP Analysis: Fixed Amount of
Profit Before Taxes (PBT)
Total fixed costs + PBTIn units = ------------------------------
CM per unit
Total fixed costs + PBTIn sales dollars = ------------------------------
CM ratio
CVP Analysis: Fixed Amount of
Profit Before Taxes (PBT)
$120,000 + $64,000In units = ------------------------ = 11,500 buckets
$16
$120,000 + $64,000In sales dollars = ------------------------ = $460,000
.40
CVP Analysis: Variable Amount
of Profit Before Taxes
Assume PUBT desired is 25% on sales
Therefore, PUBT = .25 ($40) = $10
Total fixed costsSales in units = ---------------------------
CM per unit - PUBT
$120,000Sales in units = --------------- = 20,000 ice buckets
$16 - $6
CVP Analysis: Variable Amount
of Profit Before Taxes
Assume PUBT desired is 25% on sales
Therefore, PUBT = .25 ($40) = $10
Total fixed costsSales in $ = ---------------------
CM% - PUBT%
$120,000Sales in $ = --------------- = $800,000 .40 - .25
Income Statement
Dollars Percentages
Sales $800,000 100%
Variable costs 480,000 60%
Contribution margin $320,000 40%
Fixed costs 120,000 15%
Income $200,000 25%======= ==
CVP Analysis - Multiple Products
Ice ServingBuckets Sets
Selling price $40 $24Variable cost 24 12Contribution margin $16 $12
Contribution margin ratio 40.0% 50.0%Sales mix* 80.6% 19.4%
*5:2 ratio
Continuing . . . CVP Analysis -
Multiple Products
Ice ServingBuckets Sets
Contribution margin ratio 40.0% 50.0%
Sales mix* 80.6% 19.4%
Weighted contribution margin 32.2% 9.7%
Contribution margin ratio per bag 41.9%
*5:2 ratio
Continuing . . . CVP Analysis -
Multiple Products
Total fixed costs BEP in sales dollars = -----------------------
CM ratio per bag
($120,000 + $30,000*) BEP in sales dollars = ----------------------------
.419
= $357,995
*$30,000 of additional fixed cost is incurred to produce both units
Scarce Resource -- Machine Hours
Ice Juice Crushers Extractors
Selling price per unit $15 $12Variable production cost per unit: Direct materials $3 $3 Direct labor 4 2 Variable overhead 3 1Total variable cost 10 6Unit contribution margin $5 $6Units of output per machine hour 30 20Contribution margin per machine hour $150 $120
Sales Mix Decisions
How many of each product?
Relevant Costs in
Product Line Decisions
• Revenues associated with product• Variable costs associated with product• Avoidable fixed costs • Consider product margin
Revenues - Variable costs - Avoidable fixed costs
Exhibit 6-12: Partial Product Line
Income Statement
ElectricSkillet
Sales $75,000Total direct variable expenses 43,750Total contribution margin $31,250Total fixed expenses* 39,500Net loss ($8,250)
*Fixed expenses:Avoidable fixed expenses $25,000Unavoidable fixed expenses 4,500Allocated common costs 10,000 Total $39,500
Exhibit 6-13: Product Margin for
the Electric Skillet Product Line
Electric
Skillet
Sales $75,000
Total direct variable expenses 43,750
Total contribution margin $31,250
Avoidable fixed expenses 25,000
Product margin $6,250
CVP Graph
Total$
Volume
Total Costs
Total RevenuesBEP
Profit-Volume Graph
BEP
Fixed Costs
Volume
Profit or Loss
Total$
Absorption Costing
• Also known as full costing• Treats costs of all manufacturing components as
inventoriable, or product, costs– Direct materials
– Direct labor
– Variable factory overhead
– Fixed factory overhead
• Presents expenses on income statement according to functional classifications
– Cost of goods sold
– Selling expenses
– Administrative expenses
Variable Costing
• Also known as direct costing
• Includes only variable production costs as inventoriable, or product, costs
– Direct materials
– Direct labor
– Variable factory overhead
• Fixed factory overhead costs treated as period expenses
• Income statement separates costs by cost behavior– May also present expenses by functional classifications within
behavioral categories
Absorption Costing
Income Statement
Sales XXXCost of Goods Sold:
Beginning inventory XXXCost of goods manufactured XXX Cost of goods available XXXEnding inventory XXX
Cost of goods sold XXXGross Margin XXXOperating Expenses:
Selling XXXAdministrative XXX XXX
Income before Taxes XXX
Variable Costing
Income StatementSales XXXCost of Goods Sold:
Beginning inventory XXXCost of goods manufactured XXX Cost of goods available XXXEnding inventory XXX
Variable cost of goods sold XXXProduct Contribution Margin XXXVariable Selling Expense XXXTotal Contribution Margin XXXFixed Expenses:
Factory XXXSelling XXXAdministrative XXX XXX
Income before Taxes XXX
Absorption Costing vs. Variable
Costing Income Statements
Absorption Costing Variable Costing:
Sales $60,000 Sales $60,000
Cost of sales 30,000 Variable costs:
Gross profit $30,000 Cost of sales 30,000
Operating expenses: Operating expenses 6,000
Variable $6,000 Total variable costs $36,000
Fixed 20,000 Contribution margin: $24,000
Total operating expenses $26,000 Fixed costs 20,000
Income $4,000 Income $4,000
Linear Programming
• Used to solve problems with one objective and multiple limiting factors
• Objective
• Constraints
– Resource
– Demand
– Technical product requirements
– Non-negativity
• Optimal solution
• Simplex