12-1 chapter 12 managerial accounting and cost — volume — profit relationships mcgraw-hill/irwin...

12-1

CHAPTER 12

Managerial Accounting and

Cost—Volume—Profit Relationships

McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

12-2

Decision Making

Strategic, Operational,and Financial (Planning)

Planning and Control Cycle

Executing operational

activities (Managing)

Performance analysis: Plans vs.

actual results (Controlling)

L O 1

Implement Plans

Rev

isit

Pla

ns

Data collection and Performance Feedback

12-3

Managerial Accounting versus Financial Accounting

Managerial accountingsupports the internal

planning (future-oriented)decisions made by

management.

Financial accounting hasmore of a scorekeeping,

historical orientationthat provides information

to owners and othersoutside the organization.

L O 2

12-4

Managerial Financial Accounting Accounting

Service perspective Internal to managers External to investorsand creditors

Time Frame Present and Future Historical perspective

Breadth of concern Micro - Individual unitsof organization

Reporting frequency Frequent and timely - Monthly - a week or and promptness one day after period ends more after period ends

Degree of precision Relevance more important High accuracy desired - than reliability reliability very important

Reporting standards Must follow GAAPand prescribed formats

None imposed

Macro - Entire organization

Managerial Accounting versus Financial Accounting

L O 2

12-5

How a cost will react to changes in the level of

business activity.

– Total variable costs change when activity changes.

– Total fixed costs remain unchanged when activity changes.

How a cost will react to changes in the level of

business activity.

– Total variable costs change when activity changes.

– Total fixed costs remain unchanged when activity changes.

Relationship of Total Costto Volume of Activity

L O 3

12-6

Total Fixed Cost

Your monthly basic telephone billprobably does not change when

you make more local calls.

Number of Local Calls

Mon

thly

Bas

ic

Tel

epho

ne B

ill

L O 4

12-7

Fixed Cost per Unit

Number of Local Calls

Mon

thly

Bas

ic T

elep

hone

B

ill p

er L

ocal

Cal

l

The average cost per local call decreasesas more local calls are made.

L O 4

12-8

Total Variable Cost

Your total long distance telephone bill is based on how many minutes you talk.

Minutes Talked

Tot

al L

ong

Dis

tanc

eT

elep

hone

Bill

L O 5

12-9

Variable Cost Per Unit

Minutes Talked

Per

Min

ute

Tel

epho

ne C

harg

e

The cost per long distance minute talked is constant. For example, 10 cents per minute.

L O 5

12-10

Relationship of Total Costto Volume of Activity

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remainsas activity level changes. the same over wide ranges

of activity.

Fixed Total fixed cost remains Fixed cost per unit goesthe same even when the down as activity level goes up.

activity level changes.

L O 5

12-11

Relationship of Total Costto Volume of Activity

Fixed costs are usually characterized by:

a. Unit costs that remain constant.

b. Total costs that increase as activity decreases.

c. Total costs that increase as activity increases.

d. Total costs that remain constant.

Fixed costs are usually characterized by:

a. Unit costs that remain constant.

b. Total costs that increase as activity decreases.

c. Total costs that increase as activity increases.

d. Total costs that remain constant.

L O 5

12-12

Fixed costs are usually characterized by:

a. Unit costs that remain constant.

b. Total costs that increase as activity decreases.

c. Total costs that increase as activity increases.

d. Total costs that remain constant.

Fixed costs are usually characterized by:

a. Unit costs that remain constant.

b. Total costs that increase as activity decreases.

c. Total costs that increase as activity increases.

d. Total costs that remain constant.

Relationship of Total Costto Volume of Activity

L O 5

12-13

Variable costs are usually characterized by:

a. Unit costs that decrease as activityincreases.

b. Total costs that increase as activity decreases.

c. Total costs that increase as activity increases.

d. Total costs that remain constant.

Variable costs are usually characterized by:

a. Unit costs that decrease as activityincreases.

b. Total costs that increase as activity decreases.

c. Total costs that increase as activity increases.

d. Total costs that remain constant.

Relationship of Total Costto Volume of Activity

L O 5

12-14

Variable costs are usually characterized by:

a. Unit costs that decrease as activityincreases.

b. Total costs that increase as activity decreases.

c. Total costs that increase as activity increases.

d. Total costs that remain constant.

Variable costs are usually characterized by:

a. Unit costs that decrease as activityincreases.

b. Total costs that increase as activity decreases.

c. Total costs that increase as activity increases.

d. Total costs that remain constant.

Relationship of Total Costto Volume of Activity

LO 5

12-15

Activity

To

tal

Co

st

Economist’sCurvilinear Cost

Function

Relationship of Total Costto Volume of Activity

L O 5

12-16

Activity

To

tal

Co

st

Economist’sCurvilinear Cost

Function

Accountant’s Straight-Line Approximation (constant

unit variable cost)

Relationship of Total Costto Volume of Activity

L O 5

12-17

RelevantRange

Activity

To

tal

Co

st

Economist’sCurvilinear Cost

Function

Accountant’s Straight-Line Approximation (constant

unit variable cost)

Relationship of Total Costto Volume of Activity

A straight line closely

approximates a curvilinear variable cost line within the

relevant range.

A straight line closely

approximates a curvilinear variable cost line within the

relevant range.

L O 5

12-18

Fixed Costs andthe Relevant Range

Example: Office space is available at a rental rate of

$30,000 per year in increments of 1,000 square feet. As the business grows

more space is rented, increasing the total cost.

Continue

L O 5

12-19

Fixed Costs andthe Relevant Range

Ren

t C

ost

in

T

ho

usa

nd

s o

f D

oll

ars

0 1,000 2,000 3,000 Rented Area (Square Feet)

0

30

60

90

Relevant

Range

Total cost doesn’t change for a wide

range of activity, but then jumps to a new higher cost for the

next higher range of activity.

Total cost doesn’t change for a wide

range of activity, but then jumps to a new higher cost for the

next higher range of activity.

L O 5

12-20

Typical variable costs• Raw materials

• Direct labor

• Factory utilities

• Sales commissions

• Shipping costs

Typical fixed costs• Real estate taxes

• Insurance

• Supervisory salaries

• Depreciation

• Advertising

Relationship of Total Costto Volume of Activity

L O 5

12-21

A semivariable cost has both fixed and

variablecomponents.

Consider thefollowing electric utility example.

Relationship of Total Costto Volume of Activity

L O 5

12-22

Semivariable Costs

Fixed Monthly

Utility Charge

Variable

Utility Charge

Activity (Kilowatt Hours)

To

tal

Uti

lity

Co

st

X

Y

Total semivariable cost

L O 5

12-23

Semivariable Costs

Fixed Monthly

Utility Charge

Variable

Utility Charge

Activity (Kilowatt Hours)

To

tal

Uti

lity

Co

st

X

Y

Total semivariable cost

The total semivariable cost line can be expressed as an equation: Y = a + bX

Where: Y = the total semivariable cost

a = the total fixed cost (thevertical intercept of the line)

b = the variable cost per unit ofactivity (the slope of the line)

X = the level of activity

L O 5

12-24

Semivariable Costs

Fixed Monthly

Utility Charge

Variable

Utility Charge

Activity (Kilowatt Hours)

To

tal

Uti

lity

Co

st

X

Y

Total semivariable cost Y = a + bX

L O 5

12-25

Estimating Cost Behavior Patterns

The high-low method isused to determine the fixedand variable components

of a semivariable cost.

L O 6

12-26

The High-low Method

Beetle Co. recorded the following productionactivity and maintenance costs for two months:

Using these two levels of activity, compute: the variable cost per unit; the fixed cost; and then express the costs in equation form Y = a + bX.

Cost Units

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

L O 6

12-27

Unit variable cost =Change in costChange in units

The High-low MethodL O 6

Cost Units

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

12-28

Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit

The High-low MethodL O 6

Cost Units

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

12-29

Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit Fixed cost = Total cost – Total variable cost

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

Fixed cost = $9,700 – $8,100 = $1,600

The High-low MethodL O 6

Cost Units

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

12-30

Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit Fixed cost = Total cost – Total variable cost

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

Fixed cost = $9,700 – $8,100 = $1,600 Total cost = Fixed cost + Variable cost (Y = a + bX) Y = $1,600 + $0.90X

The High-low MethodL O 6

Cost Units

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

12-31

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

a. $0.08 per unit

b. $0.10 per unit

c. $0.12 per unit

d. $0.125 per unit

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

a. $0.08 per unit

b. $0.10 per unit

c. $0.12 per unit

d. $0.125 per unit

The High-low MethodL O 6

12-32

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

a. $0.08 per unit

b. $0.10 per unit

c. $0.12 per unit

d. $0.125 per unit

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

a. $0.08 per unit

b. $0.10 per unit

c. $0.12 per unit

d. $0.125 per unit

The High-low MethodL O 6

Cost Units

High level 14,000$ 120,000

Low level (10,000) (80,000)

Change 4,000$ 40,000

$4,000 ÷ 40,000 units = $0.10 per unit

12-33

The High-low MethodL O 6

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

a. $ 2,000

b. $ 4,000

c. $10,000

d. $12,000

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

a. $ 2,000

b. $ 4,000

c. $10,000

d. $12,000

12-34

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

a. $ 2,000.

b. $ 4,000

c. $10,000

d. $12,000

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

a. $ 2,000.

b. $ 4,000

c. $10,000

d. $12,000

Total cost = $14,000 = $10,000Total variable cost = ($0.10 × 120,000 units) = (.10 X 80,000 units)

= $12,000 = $8,000Total fixed cost = Total cost - Total variable cost =

= $14,000 - $12,000 = $10,000 - $8,000Total fixed cost = $2,000 = $2,000

Total cost = Total fixed cost + Total variable cost =

or y = a + bX =

y = $2,000 + $12,000 = $2,000 + 8,000y = $14,000 = $10,000

The High-low MethodL O 6

12-35

Let’s put our

knowledge of cost

behavior to work by

preparing a

contribution margin

format income

statement.

A Modified IncomeStatement Format

L O 7

12-36

Used primarily forexternal reporting.

Used primarily bymanagement.

The Contribution Margin FormatL O 7

Both formats report the same Operating income!

12-37

The Contribution Margin Format

Total Unit

Sales Revenue 100,000$ 50$

Less: Variable costs 60,000 30

Contribution margin 40,000$ 20$

Less: Fixed costs 30,000

Net income 10,000$

The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs

and provides for income.

L O 8

12-38

Contribution margin ratioContribution margin ratio

The Contribution Margin FormatL O 9

12-39

At Evans, each $1.00 increase in sales revenue results in a total contribution margin increase of

40¢.

If sales increase by $60,000, what will be the If sales increase by $60,000, what will be the increase in total contribution margin?increase in total contribution margin?

$60,000 $60,000 × 0.40 = $24,000× 0.40 = $24,000

At Evans, each $1.00 increase in sales revenue results in a total contribution margin increase of

40¢.

If sales increase by $60,000, what will be the If sales increase by $60,000, what will be the increase in total contribution margin?increase in total contribution margin?

$60,000 $60,000 × 0.40 = $24,000× 0.40 = $24,000

The Contribution Margin FormatL O 9

12-40

What is income if sales increase by 2,000 units? What is income if sales increase by 2,000 units?

Contribution Margin in ActionL O 9

12-41

Note that fixed expenses do not increase when sales volume increases.

Note that fixed expenses do not increase when sales volume increases.

Contribution Margin in ActionL O 9

12-42

What is the effect on income if a $1.00 per unitprice cut results in a 4,000 unit increase in volume?

What is the effect on income if a $1.00 per unitprice cut results in a 4,000 unit increase in volume?

Contribution Margin in ActionL O 9

12-43

Contribution margin is increased without anincrease in fixed expenses, so income increases.

Contribution margin is increased without anincrease in fixed expenses, so income increases.

Contribution Margin in ActionL O 9

12-44

Contribution Margin in Action

What is the effect on income if a $1.00 per unitprice cut, combined with a $10,000 increase inadvertising, results in an 8,000 unit increase

in volume?

What is the effect on income if a $1.00 per unitprice cut, combined with a $10,000 increase inadvertising, results in an 8,000 unit increase

in volume?

L O 9

12-45

Contribution Margin in Action

Contribution margin is increased more than the $10,000 increase in fixed expenses, so income increases.

Contribution margin is increased more than the $10,000 increase in fixed expenses, so income increases.

L O 9

12-46

Multiple Products andSales Mix Considerations

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

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

A change in the sales mix will result in a different contribution margin ratio.

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

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

A change in the sales mix will result in a different contribution margin ratio.

L O 10

12-47

Multiple Products andSales Mix Considerations

Lawnmowers TotalSales 250,000$ 100% 300,000$ 100% 550,000$ 100%Variable expense 150,000 60% 135,000 45% 285,000 52%Contribution margin 100,000$ 40% 165,000$ 55% 265,000$ 48%

Fixed expense 170,000 Operating income 95,000$

Lawn tractors

Jones Company provides uswith the following information:

L O 10

Both products have the same sales volume of 1,000 units

However, each product has a different contribution margin ratio

12-48

Multiple Products andSales Mix Considerations

Lawnmowers TotalSales 250,000$ 100% 300,000$ 100% 550,000$ 100%Variable expense 150,000 60% 135,000 45% 285,000 52%Contribution margin 100,000$ 40% 165,000$ 55% 265,000$ 48%

Fixed expense 170,000 Operating income 95,000$

Lawn tractors

$265,000

$550,000

= 48% (rounded)

Jones Company provides uswith the following information:

L O 10

Average total contribution margin ratio provided from all products

How will average total contribution margin change if Jones sold 1,500 lawn tractors, all other factors held constant?

12-49

Multiple Products andSales Mix Considerations

Lawnmowers TotalSales 250,000$ 100% $450,000 100% 700,000$ 100%Variable expense 150,000 60% 202,500 45% 352,500 50%Contribution margin 100,000$ 40% $247,500 55% 347,500$ 50%

Fixed expense 170,000 Operating income 177,500$

Lawn tractors

L O 10

$347,500

$700,000

= 50% (rounded)

Average total contribution margin ratio provided from all products

How will average total contribution margin change if Jones sold 1,500 lawn tractors, all other factors held constant?

Due to selling more product with a higher CM ratio

Increases

12-50

Break-Even Point Analysis

How many units must Evans sell to cover its fixed costs (break even)?

Answer: $30,000 ÷ $4 per unit = 7,500 units

How many units must Evans sell to cover its fixed costs (break even)?

Answer: $30,000 ÷ $4 per unit = 7,500 units

L O 11

12-51

Break-Even Point Analysis

We have just seen one of the basic CVP relationships – the break-even computation.

Break-even point in units = Fixed costs

Contribution margin per unit

Unit sales price less unit variable cost($4 for Evans company)

L O 11

12-52

Break-Even Point Analysis

The break-even formula may also be expressed in sales dollars.

Break-even point in dollars = Fixed costs

Contribution margin ratio

Unit sales price Unit variable cost

L O 11

12-53

Break-Even Point Analysis

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to

break even?

a. 100,000 units

b. 40,000 units

c. 200,000 units

d. 66,667 units

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to

break even?

a. 100,000 units

b. 40,000 units

c. 200,000 units

d. 66,667 units

L O 11

12-54

Break-Even Point Analysis

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per

unit, how many units must be sold to break even?

a. 100,000 units

b. 40,000 units

c. 200,000 units

d. 66,667 units

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per

unit, how many units must be sold to break even?

a. 100,000 units

b. 40,000 units

c. 200,000 units

d. 66,667 units Unit contribution = $5.00 - $3.00 = $2.00

Fixed costsUnit contribution =

$200,000$2.00 per unit

= 100,000 units

L O 11

12-55

Break-Even Point Analysis

Use the contribution margin ratio formula to determine the amount of sales revenue ABC must

have to break even. All information remains unchanged: fixed costs are $200,000; unit sales

price is $5.00; and unit variable cost is $3.00.

a. $200,000

b. $300,000

c. $400,000

d. $500,000

Use the contribution margin ratio formula to determine the amount of sales revenue ABC must

have to break even. All information remains unchanged: fixed costs are $200,000; unit sales

price is $5.00; and unit variable cost is $3.00.

a. $200,000

b. $300,000

c. $400,000

d. $500,000

L O 11

12-56

Break-Even Point Analysis

Use the contribution margin ratio formula to determine the amount of sales revenue ABC must

have to break even. All information remains unchanged: fixed costs are $200,000; unit sales

price is $5.00; and unit variable cost is $3.00.

a. $200,000

b. $300,000

c. $400,000

d. $500,000

Use the contribution margin ratio formula to determine the amount of sales revenue ABC must

have to break even. All information remains unchanged: fixed costs are $200,000; unit sales

price is $5.00; and unit variable cost is $3.00.

a. $200,000

b. $300,000

c. $400,000

d. $500,000

Unit contribution = $5.00 - $3.00 = $2.00

Contribution margin ratio = $2.00 ÷ $5.00 = .40

Break-even revenue = $200,000 ÷ .4 = $500,000

L O 11

12-57

Break-Even Point Analysis

Break-even formulas may be adjusted to show the sales volume needed to earn

any amount of operating income.

Break-even formulas may be adjusted to show the sales volume needed to earn

any amount of operating income.

Unit sales = Fixed costs + Desired incomeContribution margin per unit

Dollar sales = Fixed costs + Desired income

Contribution margin ratio

L O 11

12-58

Break-Even Point Analysis

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to earn operating income of $40,000?

a. 100,000 units

b. 120,000 units

c. 80,000 units

d. 200,000 units

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to earn operating income of $40,000?

a. 100,000 units

b. 120,000 units

c. 80,000 units

d. 200,000 units

L O 11

12-59

Break-Even Point Analysis

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to earn operating income of $40,000?

a. 100,000 units

b. 120,000 units

c. 80,000 units

d. 200,000 units

ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to earn operating income of $40,000?

a. 100,000 units

b. 120,000 units

c. 80,000 units

d. 200,000 units = 120,000 units

Unit contribution = $5.00 - $3.00 = $2.00

Fixed costs + Target income Unit contribution

$200,000 + $40,000 $2.00 per unit

L O 11

12-60

Break-Even Graph

Total expense

Volume in Units

Co

sts

and

Rev

enu

ein

Do

llar

s

Total fixed expense

Break-even point

Profit

Loss

Revenue

Total variable expense

L O 11

12-61

Operating Leverage

A measure of how sensitive net income is to percentage changes in sales.

With high leverage, a small percentage increase in revenue can produce a much larger percentage increase in income.

A measure of how sensitive net income is to percentage changes in sales.

With high leverage, a small percentage increase in revenue can produce a much larger percentage increase in income.

L O 12

12-62

Operating Leverage

If revenues increase by 20 percent,what is the percentage increase in income?

If revenues increase by 20 percent,what is the percentage increase in income?

L O 12

12-63

Operating Leverage

80 percent increase in income

Operating leverage resulted in the operating incomeincreasing proportionately more than the increase in revenue.

Operating leverage resulted in the operating incomeincreasing proportionately more than the increase in revenue.

20 percent increase in revenue

L O 12

12-64

End of Chapter 12