EXAMPLE: If the activity level is 45,000 miles, the If the activity level is 45,000 miles, the estimated maintenance costs would be $8,000
estimated maintenance costs would be $8,000
fixed costs and $49,500 variable ($1.10 × 45,000 fixed costs and $49,500 variable ($1.10 × 45,000
miles) for a total of $57,500.
miles) for a total of $57,500.
SO 3: Explain the concept of mixed costs.
SO 3: Explain the concept of mixed costs.
Chapter
Mixed costs consist of a:
Mixed costs consist of a:
a.a. Variable cost element and a fixed cost Variable cost element and a fixed cost element.
element.
b. b. Fixed cost element and a semi-variable cost Fixed cost element and a semi-variable cost element.
element.
c. c. Relevant cost element and a fixed cost Relevant cost element and a fixed cost element.
element.
d. d. Variable cost element and a relevant cost Variable cost element and a relevant cost element
element.
Let’s Review Let’s Review Let’s Review Let’s Review
SO 3: Explain the concept of mixed costs.
SO 3: Explain the concept of mixed costs.
Chapter
Cost-Volume-Profit Analysis Cost-Volume-Profit Analysis Cost-Volume-Profit Analysis Cost-Volume-Profit Analysis
CVP Analysis - the study of the
CVP Analysis - the study of the effects of changes in costs and volume on a on a
company’s profits.
company’s profits.
Important in profit planning.
Important in profit planning.
A critical factor in setting:
A critical factor in setting:
selling prices,selling prices,
determining product mix, and determining product mix, and
maximizing use of production facilities.
maximizing use of production facilities.
SO 4: List the five components of cost-volume-profit analysis.
SO 4: List the five components of cost-volume-profit analysis.
Chapter
Cost-Volume-Profit Analysis Cost-Volume-Profit Analysis Cost-Volume-Profit Analysis Cost-Volume-Profit Analysis
CVP analysis considers the interrelationships CVP analysis considers the interrelationships
among five basic components:
among five basic components:
SO 4: List the five components of cost-volume-profit analysis.
SO 4: List the five components of cost-volume-profit analysis.
Illustration 5-9
Chapter
Assumptions Underlying CVP Analysis Assumptions Underlying CVP Analysis Assumptions Underlying CVP Analysis Assumptions Underlying CVP Analysis
Behavior of both costs and revenues is
Behavior of both costs and revenues is linear throughout the
throughout the relevant range of the activity of the activity index.
index.
Costs can be classified accurately as either
Costs can be classified accurately as either variable or fixed.
Changes in
Changes in activity are the only factors that affect are the only factors that affect costs
costs.. All units
All units produced are sold.
When more than one type of product is sold, the When more than one type of product is sold, the sales mix will remain constant.
SO 4: List the five components of cost-volume-profit analysis.
SO 4: List the five components of cost-volume-profit analysis.
Chapter
One of the following is
One of the following is NOTNOT involved in CVP analysis. involved in CVP analysis.
That factor is:
That factor is:
a.a. Sales mix.Sales mix
b. Unit selling prices.
c. Fixed costs per unit.
d. Volume or level of activity.
Let’s Review Let’s Review Let’s Review Let’s Review
SO 4: List the five components of cost-volume-profit analysis.
SO 4: List the five components of cost-volume-profit analysis.
Chapter
CVP Income Statement CVP Income Statement CVP Income Statement CVP Income Statement
Classifies costs and expenses as fixed or variable.
Reports contribution margin in the body of the statement.
Contribution margin – Amount of revenue remaining
after deducting all variable costs.
Reports the same net
income as a traditional income statement.income statement.
A statement for internal use only.
SO 5: Indicate what contribution margin is and how it can be expressed.
SO 5: Indicate what contribution margin is and how it can be expressed.
Chapter 5-34
CVP Income Statement - Example CVP Income Statement - Example CVP Income Statement - Example CVP Income Statement - Example
Vargo Video Company produces a DVD player/recorder.
Vargo Video Company produces a DVD player/recorder.
Relevant data for June 2010:
Relevant data for June 2010:
SO 5: Indicate what contribution margin is and how it can be expressed.
SO 5: Indicate what contribution margin is and how it can be expressed.
Illustration 5-11 Illustration 5-10
Chapter
Contribution Margin Per Unit Contribution Margin Per Unit Contribution Margin Per Unit Contribution Margin Per Unit
Contribution margin is the amount available
Contribution margin is the amount available to cover fixed costs and to contribute to income.
The formula for
The formula for contribution margin per unit and the and the
computation of the contribution margin per unit for Vargo computation of the contribution margin per unit for Vargo Video are:
Video are:
Thus, for every DVD player sold, Vargo Video has $200 to Thus, for every DVD player sold, Vargo Video has $200 to cover fixed costs and contribute to net income.
cover fixed costs and contribute to net income.
SO 5: Indicate what contribution margin is and how it can be expressed.
SO 5: Indicate what contribution margin is and how it can be expressed.
Illustration 5-12
Chapter
CVP Income Statement – Contribution Margin Effect CVP Income Statement – Contribution Margin Effect CVP Income Statement – Contribution Margin Effect CVP Income Statement – Contribution Margin Effect
Since Vargo Video has fixed costs of $200,000, it must sell Since Vargo Video has fixed costs of $200,000, it must sell 1,000 DVD players ($200,000 ÷ $200) before it can earn any 1,000 DVD players ($200,000 ÷ $200) before it can earn any net income.
net income.
Vargo’s CVP income statement, assuming a zero net income is:
Vargo’s CVP income statement, assuming a zero net income is:
SO 5: Indicate what contribution margin is and how it can be expressed.
SO 5: Indicate what contribution margin is and how it can be expressed.
Illustration 5-13
Chapter
CVP Income Statement – Contribution Margin Effect CVP Income Statement – Contribution Margin Effect CVP Income Statement – Contribution Margin Effect CVP Income Statement – Contribution Margin Effect
For every DVD player that Vargo sells above 1,000 units, net For every DVD player that Vargo sells above 1,000 units, net income increases by the amount of the contribution margin, income increases by the amount of the contribution margin,
$200.
$200.
Vargo’s CVP income statement, assuming 1001 units sold is:
Vargo’s CVP income statement, assuming 1001 units sold is:
SO 5: Indicate what contribution margin is and how it can be expressed.
SO 5: Indicate what contribution margin is and how it can be expressed.
Illustration 5-14
Chapter
Contribution Margin Ratio Contribution Margin Ratio Contribution Margin Ratio Contribution Margin Ratio
Shows the percentage of each sales dollar available to apply Shows the percentage of each sales dollar available to apply toward fixed costs and profits
toward fixed costs and profits.
The contribution margin ratio is the contribution margin per unit divided by the unit selling price. For Vargo Company, the he computation is:
computation is:
In this case, the contribution margin ratio of 40% means In this case, the contribution margin ratio of 40% means
that $ 0.40 of each sales dollar is available to apply to fixed that $ 0.40 of each sales dollar is available to apply to fixed costs and contribute to net income.
costs and contribute to net income.
SO 5: Indicate what contribution margin is and how it can be expressed.
SO 5: Indicate what contribution margin is and how it can be expressed.
Illustration 5-15
Chapter
Contribution Margin Ratio Contribution Margin Ratio Contribution Margin Ratio Contribution Margin Ratio
As shown below, the contribution margin ratio
helps to determine the effect of changes in sales on net income.
SO 5: Indicate what contribution margin is and how it can be expressed.
SO 5: Indicate what contribution margin is and how it can be expressed.
Illustration 5-16
Chapter
Contribution margin:
Contribution margin:
a.a. Is revenue remaining after deducting variable Is revenue remaining after deducting variable costs.
costs.
b. b. May be expressed as contribution margin per May be expressed as contribution margin per unit.
unit.
c. c. Is selling price less cost of goods sold.Is selling price less cost of goods sold.
d. d. Both a and b above. Both a and b above.
Let’s Review Let’s Review Let’s Review Let’s Review
SO 5: Indicate what contribution margin is and how it can be expressed.
SO 5: Indicate what contribution margin is and how it can be expressed.
Chapter
Break-Even Analysis Break-Even Analysis Break-Even Analysis Break-Even Analysis
A key relationship in CVP analysis is the level of activity at A key relationship in CVP analysis is the level of activity at which
which total revenue equals total costs (both fixed and (both fixed and variable).
variable).
This level of activity is called the break-even point.
At this volume of sales, the company will realize no income, but At this volume of sales, the company will realize no income, but will also suffer no loss.
will also suffer no loss.
Can be computed or derived:
Can be computed or derived:
from a mathematical equation, by using contribution margin, or
from a cost-volume profit (CVP) graph..
The break-even point can be expressed either in sales units or in sales dollars.
SO 6: Identify the three ways to determine the break-even point.
SO 6: Identify the three ways to determine the break-even point.
Chapter 5-42
Break-Even Analysis: Mathematical Equation Break-Even Analysis: Mathematical Equation Break-Even Analysis: Mathematical Equation Break-Even Analysis: Mathematical Equation
Break-even occurs where total sales equal variable costs plus fixed costs; i.e., net income is zero.
The formula for the
The formula for the break-even point in unitsin units and and the computation for Vargo Video are:
the computation for Vargo Video are:
To find
To find sales dollarssales dollars required to break-even: required to break-even:
1,000 units × $500 = $500,000 (break-even sales dollars).
1,000 units × $500 = $500,000 (break-even sales dollars).
SO 6: Identify the three ways to determine the break-even point.
SO 6: Identify the three ways to determine the break-even point.
Illustration 5-18
Chapter
Break-Even Analysis:
Break-Even Analysis:
Contribution Margin Technique Contribution Margin Technique Break-Even Analysis: Break-Even Analysis:
Contribution Margin Technique Contribution Margin Technique
At the break-even point, contribution margin must equal total fixed costs.
(Contribution Margin = Total revenues – Variable costs) The break-even point (BEP) can be computed using either contribution margin per unit or contribution margin ratio.
SO 6: Identify the three ways to determine the break-even point.
SO 6: Identify the three ways to determine the break-even point.
Chapter
Contribution Margin Technique Contribution Margin Technique Contribution Margin Technique Contribution Margin Technique
When the contribution margin per unit is used, the formula to compute the BEP in units for Vargo Video is:
When the BEP in dollars is desired, contribution margin ratio is used in the following formula for Vargo Video:
SO 6: Identify the three ways to determine the break-even point.
SO 6: Identify the three ways to determine the break-even point.
Illustration 5-19
Illustration 5-20
Chapter
Break-Even Analysis: Graphic Presentation Break-Even Analysis: Graphic Presentation Break-Even Analysis: Graphic Presentation Break-Even Analysis: Graphic Presentation
A cost-volume profit (CVP) graph shows the
relationships between costs, volume and profits.
To construct a CVP graph:
To construct a CVP graph:
Plot the total-sales line starting at the zero activity level,
Plot the total fixed cost using a horizontal line,
Plot the total-cost line (starts at the fixed-cost line at zero activity), Determine the break-even point from
the intersection of the total-cost line and the total-sales line..
SO 6: Identify the three ways to determine the break-even point.
SO 6: Identify the three ways to determine the break-even point.
Chapter
Break-Even Analysis: Graphic Presentation Break-Even Analysis: Graphic Presentation Break-Even Analysis: Graphic Presentation Break-Even Analysis: Graphic Presentation
SO 6: Identify the three ways to determine the break-even point.
SO 6: Identify the three ways to determine the break-even point.
Illustration 5-21
Chapter
Gossen Company is planning to sell 200,000 pliers for Gossen Company is planning to sell 200,000 pliers for
$4 per unit. The contribution margin ratio is 25
$4 per unit. The contribution margin ratio is 25 percent. If Gossen will break even at this level of percent. If Gossen will break even at this level of
sales, what are the fixed costs?
sales, what are the fixed costs?
a.a. $100,000.$100,000 b. $160,000.
c. $200,000.
d. $300,000.
Let’s Review Let’s Review Let’s Review Let’s Review
SO 6: Identify the three ways to determine the break-even point.
SO 6: Identify the three ways to determine the break-even point.
Chapter 5-48
Break-Even Analysis: Target Net Income Break-Even Analysis: Target Net Income Break-Even Analysis: Target Net Income Break-Even Analysis: Target Net Income
Rather than just breaking even, management usually sets an income objective called “target net income.” Indicates sales or units necessary to achieve this specified level of income.
Can be determined from each of the approaches used Can be determined from each of the approaches used
to determine break-even sales/units:
to determine break-even sales/units:
From a mathematical equation, By using contribution margin, or
From a cost-volume profit (CVP) graph . .
Expressed either in sales units or in sales dollars.
SO 7: Give the formulas for determining sales required SO 7: Give the formulas for determining sales required to earn target net income.
to earn target net income.
Chapter 5-49
Break-Even Analysis: Target Net Income Break-Even Analysis: Target Net Income Break-Even Analysis: Target Net Income Break-Even Analysis: Target Net Income
Mathematical Equation
Using the basic formula for the
Using the basic formula for the break-even point, simply include the desired net income as a factor.
The computation for Vargo Video is as follows:
The computation for Vargo Video is as follows:
SO 7: Give the formulas for determining sales required to SO 7: Give the formulas for determining sales required to earn target net income.
earn target net income.
Illustration 5-23
Chapter 5-50
Break-Even Analysis: Target Net Income Break-Even Analysis: Target Net Income Break-Even Analysis: Target Net Income Break-Even Analysis: Target Net Income
Contribution Margin Technique Contribution Margin Technique
To determine the required sales in units for Vargo Video:
To determine the required sales in dollars for Vargo Video:
SO 7: Give the formulas for determining sales required to SO 7: Give the formulas for determining sales required to earn target net income.
earn target net income.
Illustration 5-25 Illustration 5-24
Chapter
The mathematical equation for computing required The mathematical equation for computing required
sales to obtain target net income is:
sales to obtain target net income is:
Required sales = ? Required sales = ?
a.a. Variable costs + Target net income.Variable costs + Target net income
b. Variable costs + Fixed costs + Target net income.
c. Fixed costs + Target net income.
d. No correct answer is given.
Let’s Review Let’s Review Let’s Review Let’s Review
SO 7: Give the formulas for determining sales required to SO 7: Give the formulas for determining sales required to earn target net income.
earn target net income.
Chapter
Break-Even Analysis: Margin of Safety Break-Even Analysis: Margin of Safety Break-Even Analysis: Margin of Safety Break-Even Analysis: Margin of Safety
Difference between actual or expected sales and sales at the break-even point.
Measures the “cushion” that management has,
allowing it to break-even even if expected sales fail to materialize.
May be expressed in dollars or as a ratio.
To determine the margin of safety in dollars for Vargo Video assuming that actual/expected sales are
$750,000:
SO 8: Define margin of safety, and give the formulas for computing it.
SO 8: Define margin of safety, and give the formulas for computing it.
Illustration 5-26
Chapter
Break-Even Analysis: Margin of Safety Break-Even Analysis: Margin of Safety Break-Even Analysis: Margin of Safety Break-Even Analysis: Margin of Safety
Margin of Safety Ratio Margin of Safety Ratio
Computed by dividing the margin of safety in dollars by the actual or expected sales.
To determine the margin of safety ratio for Vargo Video assuming that actual/expected sales are
$750,000:
The higher the dollars or the percentage, the greater the margin of safety.
SO 8: Define margin of safety, and give the formulas for computing it.
SO 8: Define margin of safety, and give the formulas for computing it.
Illustration 5-27
Chapter
Marshall Company had actual sales of $600,000 when Marshall Company had actual sales of $600,000 when break-even sales were $420,000. What is the margin break-even sales were $420,000. What is the margin
of safety ratio?
of safety ratio?
a.a. 25%.25%
b. 30%.
c. 33 1/3%.
d. 45%.
Let’s Review Let’s Review Let’s Review Let’s Review
SO 8: Define margin of safety, and give the formulas for SO 8: Define margin of safety, and give the formulas for computing it.
computing it.
$600 - $420 = $180
$180 ÷ $600 = 30%
Chapter
All All About You About You All All About You About You
A Hybrid Dilemma
Hybrid vehicles typically cost
$3,000 to $5,000 more than conventional vehicles.
The most fuel efficient
hybrids can save about $660 per year in fuel costs.
Each gallon of gas not burned reduces carbon dioxide
emissions by 19 pounds.
Chapter
All All About You About You All All About You About You
A Hybrid Dilemma What do you think?
Do you think that making the investment in a hybrid car will slow the cash outflow from your wallet due to high gas prices and save your feet?
Because of the premium charged for hybrid cars,
would you ever break-even on your investment?
Chapter 5-57
Chapter Review - Brief Exercise 5-4 Chapter Review - Brief Exercise 5-4 Chapter Review - Brief Exercise 5-4 Chapter Review - Brief Exercise 5-4
Markowis Company accumulates the following data concerning a Markowis Company accumulates the following data concerning a
mixed cost, using miles as the activity level.
mixed cost, using miles as the activity level.
Miles
Miles TotalTotal MilesMiles TotalTotal Driven
Driven CostCost DrivenDriven CostCost
January 8,000 $14,150$14,150 MarchMarch 8,5008,500 $15,000$15,000 February
February 7,5007,500 $13,600$13,600 AprilApril 8,2008,200 $14,490$14,490 Compute the variable and fixed cost elements using the high- low method.
High Level of Activity: March $15,000 8,500 miles
Low Level of Activity: February 13,600 7,500 miles
Difference $ 1,400 1,000
miles Step 1:
Variable Cost per Unit = $1,400 ÷ 1,000 miles
= $1.40 variable cost per mile
Chapter 5-58
Chapter Review - Brief Exercise 5-4 Chapter Review - Brief Exercise 5-4 Chapter Review - Brief Exercise 5-4 Chapter Review - Brief Exercise 5-4
High Level of Activity:
High Level of Activity: MarchMarch $15,000$15,000 8,500 miles8,500 miles Low Level of Activity:
Low Level of Activity: FebruaryFebruary 13,600 13,600 7,500 miles 7,500 miles Difference
Difference $ 1,400$ 1,400 1,000 miles 1,000 miles Step 1
Step 1: :
Variable Cost per Unit = $1,400 ÷ 1,000 miles Variable Cost per Unit = $1,400 ÷ 1,000 miles
= $1.40 variable = $1.40 variable cost per mile
cost per mile Step 2:
Step 2:
HighHigh LowLow
Total Cost:
Total Cost: $15,000 $15,000 $13,600
$13,600
Variable Cost:
Variable Cost:
8,500 × $1.408,500 × $1.40 11,900 11,900
7,500 × $1.407,500 × $1.40
10,500 10,500
Total Fixed Costs
Total Fixed Costs $ 3,100 $ 3,100 $ $ 3,100
3,100