Chapter 7 - Cost-volume-profit analysis. After completing this chapter, you should be able to: Compute a break-even point using the contribution-margin approach and the equation approach; compute the contribution-margin ratio and use it to find the break-even point in sales dollars; prepare a cost-volume-profit (CVP) graph and explain how it is used;...
Chapter Cost-Volume-Profit Analysis Copyright © 2014 McGraw-Hill Education All rights reserved No reproduction or distribution without the prior written consent of McGraw-Hill Education The Break-Even Point The break-even point is the point in the volume of activity where the organization’s revenues and expenses are equal Sales $ 250,000 Less: variable expenses 150,000 Contribution margin 100,000 Less: fixed expenses 100,000 Net income $ - 72 Equation Approach Sales revenue – Variable expenses – Fixed expenses = Profit Unit Sales sales × volume price in units Unit Sales variable × volume expense in units ($500 × X) – ($300 × X) – $80,000 = $0 ($200X) – $80,000 = $0 X = 400 surf boards 73 Contribution-Margin Approach Consider the following information developed by the accountant at Curl, Inc.: For each additional surf board sold, Curl generates $200 in contribution margin Sales (500 surf boards) Less: variable expenses Contribution margin Less: fixed expenses Net income Total $250,000 150,000 $100,000 80,000 $ 20,000 Per Unit $ 500 300 $ 200 Percent 100% 60% 40% 74 Contribution-Margin Approach Fixed expenses Unit contribution margin Sales (500 surf boards) Less: variable expenses Contribution margin Less: fixed expenses Net income $80,000 $200 Break-even point = (in units) Total $250,000 150,000 $100,000 80,000 $ 20,000 Per Unit $ 500 300 $ 200 Percent 100% 60% 40% = 400 surf boards 75 Contribution-Margin Approach Here is the proof! Sales (400 surf boards) Less: variable expenses Contribution margin Less: fixed expenses Net income 400 × $500 = $200,000 Total $200,000 120,000 $ 80,000 80,000 $ - Per Unit $ 500 300 $ 200 Percent 100% 60% 40% 400 × $300 = $120,000 76 Contribution Margin Ratio Calculate the break-even point in sales dollars rather than units by using the contribution margin ratio Contribution margin Sales Fixed expense CM Ratio = CM Ratio Break-even point = (in sales dollars) 77 Graphing Cost-Volume-Profit Relationships Viewing CVP relationships in a graph gives managers a perspective that can be obtained in no other way Consider the following information for Curl, Inc.: 78 Cost-Volume-Profit Graph 450,000 400,000 350,000 Dollars 300,000 250,000 200,000 150,000 es s n x pe e l Tota Fixed expenses 100,000 50,000 100 200 300 400 Units 500 600 700 800 79 Cost-Volume-Profit Graph 450,000 400,000 350,000 Dollars 300,000 250,000 200,000 150,000 es s n x pe e l Tota Fixed expenses 100,000 50,000 100 200 300 400 Units 500 600 700 800 710 Applying CVP Analysis Safety Margin The difference between budgeted sales revenue and break- even sales revenue The amount by which sales can drop before losses occur 716 CVP Analysis with Multiple Products For a company with more than one product, sales mix is the relative combination in which a company’s products are sold Different products have different selling prices, cost structures, and contribution margins Let’s assume Curl sells surfboards and sail boards and see how we deal with break-even analysis 717 CVP Analysis with Multiple Products Curl provides us with the following: information: 718 CVP Analysis with Multiple Products Weightedaverage unit contribution margin $200 × 62.5% $550 × 37.5% 719 CVP Analysis with Multiple Products Break-even point Break-even Fixed expenses = point Weighted-average unit contribution margin Break-even = point $170,000 $331.25 Break-even = 514 combined unit sales point 720 CVP Analysis with Multiple Products Break-even point Break-even point = 514 combined unit sales 721 Assumptions Underlying CVP Analysis Selling price is constant throughout the entire relevant range Costs are linear over the relevant range In multi-product companies, the sales mix is constant In manufacturing firms, inventories not change (units produced =units sold) 722 CVP Relationships and the Income Statement A Traditional Format ACCUTIME COMPANY Income Statement For the Year Ended December 31, 20x1 Sales Less: Gross margin Less: Operating expenses: Selling expenses Administrative expenses Net income $500,000 380,000 $120,000 $35,000 35,000 70,000 $50,000 723 CVP Relationships and the Income Statement B Contribution Format ACCUTIME COMPANY Income Statement For the Year Ended December 31, 20x1 Sales Less: Variable expenses: Variable manufacturing Variable selling Variable administrative Contribution margin Less: Fixed expenses: Fixed manufacturing Fixed selling Fixed administrative Net income $500,000 $280,000 15,000 5,000 $100,000 20,000 30,000 300,000 $200,000 150,000 $50,000 724 Cost Structure and Operating Leverage The Thecost coststructure structureof of an anorganization organizationis isthe therelative relative proportion proportionof of its itsfixed fixedand andvariable variablecosts costs Operating Operatingleverage leverageis: is: the theextent extentto towhich whichan anorganization organizationuses usesfixed fixedcosts costsin inits itscost cost structure structure greatest greatestin incompanies companiesthat thathave haveaahigh highproportion proportionof of fixed fixedcosts costs in inrelation relationto tovariable variablecosts costs 725 Measuring Operating Leverage Operating leverage factor = Contribution margin Net income $100,000 = $20,000 726 Measuring Operating Leverage A A measure measureof of how how aapercentage percentagechange changein insales saleswill will affect affect profits profits If If Curl Curl increases increasesits itssales salesby by 10%, 10%, what whatwill will be bethe the percentage percentageincrease increasein innet netincome? income? Percent increase in sales Operating leverage factor × Percent increase in profits 10% 50% 727 CVP Analysis, Activity-Based Costing, and Advanced Manufacturing Systems An activity-based costing system provides a much more complete picture of cost-volume-profit relationships and, thus, it provides better information to managers Break-even = Fixed costs point Unit contribution margin 728 A Move Toward JIT and Flexible Manufacturing Overhead costs like setup, inspection, and material handling are fixed with respect to sales volume, but they are not fixed with respect to other cost drivers This is the fundamental distinction between a traditional CVP analysis and an activity-based costing CVP analysis 729 Effect of Income Taxes Income taxes affect a company’s CVP relationships To earn a particular after-tax net income, a greater before-tax income will be required Target after-tax net income - t Before-tax = net income 730 ... percentageincrease increasein innet netincome? income? Percent increase in sales Operating leverage factor × Percent increase in profits 10% 50% 7? ? 27 CVP Analysis, Activity-Based Costing, and Advanced Manufacturing... fundamental distinction between a traditional CVP analysis and an activity-based costing CVP analysis 7? ?29 Effect of Income Taxes Income taxes affect a company’s CVP relationships To earn a particular... margin ratio Contribution margin Sales Fixed expense CM Ratio = CM Ratio Break-even point = (in sales dollars) 7? ?7 Graphing Cost-Volume-Profit Relationships Viewing CVP relationships in a graph