copyright 2008 mcgraw-hill ppts t/a management accounting: information for managing and creating...
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Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-1
Chapter 18
Cost volume profit analysis
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-2
Cost volume profit (CVP) analysis
• A technique used to determine the effects of changes in an organisation’s sales volume on its costs, revenue and profit
• Can be used in profit-seeking organisations and not-for-profit organisations
• Not confined to profit-seeking enterprises• Commonly used in many not-for-profit situations
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-3
The break-even point
• The volume of sales where the total revenues and expenses are equal, and the operation breaks even
• At this level of sales, there is no profit or loss• Can be calculated for an entire organisation or
individual projects
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
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Formulas
ratiomargin on contributiUnit
costs Fixed =Rands) sales(in point even -Break
margin oncontributi Unit
costs Fixed =units) (in point even-Break
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
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Terminology
• Contribution margin (or variable costing) statement– A profit report where costs are reported by cost behaviour
and a contribution margin is calculated– Fixed and variable costs are separated
• Total contribution margin– The difference between the total sales revenue and the
total variable costs– The amount available to cover fixed costs and then
contribute to profits
continued
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
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Terminology
• Unit contribution margin– The difference between the sales price per unit and the
variable cost per unit
• Contribution margin ratio– The unit contribution margin divided by the unit sales
price– The proportion of each sales Rand available to cover
fixed costs and earn a profit
• Contribution margin percentage– The contribution margin ratio multiplied by 100– The percentage of each sales Rand available to cover
fixed costs and earn a profit
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
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Projected revenues & costs at a theatre company (CTC)
Revenue
Price per ticket R 100.00Variable costs per ticket
Royalties R 18.75Theatre rental 16.25
R 35.00
Fixed costs of the play
Creative:
Director R 30,000Stage designer 25,000Lighting designer 12,500Extra artistic staff 5,000Actors 350,000
Pre-production:
Sets and props R 60,000Wardrobe 25,000Freight 7,500Stage management 89,000Set up and demolish stage 20,000
R 624,000
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
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Break-even number of tickets
fixed costsunit contribution margin
R 624,000R 65
= 9,600
=
Break-even point (in units) =
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
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Break-even point (in Rands)
• Unit Contribution margin = R100 – R35 = R65• Unit contribution margin as % of selling price =
R65/R100 = 0.65. Also called the unit contribution margin ratio.
R 624,0000.65
= R 960,000
Break-even point (in sales Rands) =fixed costs
unit contribution margin ratio
=
Break-even point (in Rands) =fixed costs
unit contribution margin/unit sales price
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-10
Cost-volume-profit graph for CTC
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-11
Profit volume (PV) graph
• Shows the total amount of profit or loss at different sales volumes
• The graph intercepts the vertical axis at the amount equal to the fixed costs
• The break-even point is the point at which the line crosses the horizontal axis
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-12
Profit volume graph, CTC production of Calypso
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
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Target net profit
• A desired profit level determined by management • Can be used within the break-even formula
marginon contributiUnit
profit target + expenses Fixed = volumesalesTarget
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-14
Target net profit
• Assume that the target profit for the theatre company is R70 000 (we will use R70 005 to avoid rounding differences)
R 624,000 + R 70,005R 65
= 10,677 units
=
Target sales volume (in units) =fixed costs + target profitunit contribution margin
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-15
Using CVP analysis for management decision making
• Common applications include– Safety margin– Changes in fixed expenses– Changes in the unit contribution margin– Multiple changes in key variables
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-16
Safety margin
• Difference between the budgeted sales revenue and the break-even sales revenue
• Gives a feel for how close projected operations are to the break-even point
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
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Changes in fixed costs
• When estimates of fixed costs are revised, the break-even point will change– Percentage change in fixed expenses will lead to a
similar increase in the break-even point (in units or Rands)
• Different fixed costs may apply to different levels of sales/production volume– More than one break-even point
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
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Changes in the unit contribution margin• Change in unit variable expenses
– Changes the unit contribution margin– A new break-even point– An increase in unit variable expenses will increase the
break-even point
• Change in sales price– Changes the unit contribution margin– A new break-even point– An increase in unit price will lower the break-even point
continued
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-19
Change in variable cost per ticketOriginal estimate New estimate
Variable costs per ticket R 35.00 R 41.25
Unit contribution margin per ticket R 65.00 R 58.75
R 624,000 R 624,000R 65.00 R 58.75
Break-even point (units ie. No. of tickets) = 9,600 10,622 [rounded-up]
Price x R 100.00 R 100.00
Break-even point (Rands) R 960,000 R 1,062,200 *
Break-even calculation
* If we use a contribution margin of 0.5875, then B/E (Rands) = R664000/0.5875 = R1062128 (slight difference due to rounding)
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
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Change in selling price & fixed costs
R 100.00 R 90.00
Sales revenue:
Currently 10,032 x R 100.00 R 1,003,200
New 12,500 x R 90.00 R 1,125,000
Less Variable costs:
Currently 10,032 x R 35.00 R 351,120
New 12,500 x R 35.00 R 437,500
Total contribution margin R 652,080 R 687,500
Less Fixed costs of the play R 624,000 R 650,000
Profit R 28,080 R 37,500
Ticket price
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-21
Cost volume profit graph with step-fixed costs, CTC production of Calypso
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-22
Multiple changes in key variables
• May involve– Increasing unit prices – Increasing selling prices– Undertaking a new advertising campaign– Leasing a new office
• An incremental approach to analysis– Focuses on the differences in the total contribution
margin, fixed expenses and profits under the two alternatives
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-23
CVP analysis with multiple products
• Sales mix– The relative proportions of each type of product sold by
the organisation
• Weighted average unit contribution margin – The average of the products’ unit contribution margins,
weighted by the sales mix
margin oncontributi unit average Weighted
expenses Fixed=point even-Break
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
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CVP Analysis with multiple products
• Weighted average unit contribution margin = (R90 x 75%) + (R50 x 25%) = R80
• Break-even
R 624,000R 80.00
= 7,800 tickets
fixed costsweighted average unit contribution margin
=
Break-even point =
Seat type Unit ticket price Unit variable costUnit contribution
marginNumber of seats
in theatreA R 125 R 35 R 90 495
B R 85 R 35 R 50 165
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-25
Profit volume graph with multiple products, CTC production of Calypso
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-26
Including income taxes in CVP analysis
margin oncontributi unit
)-(1
tax after profit net target + costs Fixed
=
profittax -after target earn to required volume Sales
t
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-27
Assumptions underlying CVP analysis
• The behaviour of total revenue is linear• The behaviour of total costs is linear over a
relevant range– Costs can be categorised as fixed, variable or
semivariable– Labour productivity, production technology and market
conditions do not change– There are no capacity changes during the period under
consideration
continued
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-28
Assumptions underlying CVP analysis
• For both variable and fixed costs, sales volume is the only cost driver
• The sales mix remains constant over the relevant range
• In manufacturing firms, the levels of inventory at the beginning and end of the period are the same– Thus, the number of units produced and sold during a
period are equal
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-29
CVP analysis and long-term decisions
• CVP analysis is usually regarded as a short-term or tactical decision tool
• Classification of costs as variable or fixed is usually based on cost behaviour over the short term
• The financial impact of long-term decisions is best analysed using capital budgeting techniques– Takes into account the time value of money
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-30
Treating CVP analysis with caution
• CVP analysis is merely a simplified model• The usefulness of CVP analysis may be greater in
less complex smaller firms, or stand-alone projects• For larger firms, CVP analysis can be valuable as
a decision tool for the planning stages of new projects and ventures
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-31
An activity-based approach to CVP analysis
• ABC categorises activities as facility, product, batch or unit costs– Facility, product and batch activities are non-volume
activity costs
unit per costs-unit per price Selling
costs levelfacility and product batch, Total=point even-Break
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
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Limiting assumptions of CVP analysis using activity-based costs• Total batch level costs are dependent on the batch
size and the break-even/target production level• Management may change the batch size at certain
production volume levels and this will change the break-even volume
• More complex models are needed where there are multiple products
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
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Including customer-related costs in CVP analysis
• Some ABC systems include customer-related costs– Order level
– Customer level
– Market level
– Facility level
costs) levelfacility costs levelmarket
costs levelcustomer costs levelorder costs levelproduct
costs levelbatch costs level(unit - revenue sales Profit
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-34
Sensitivity analysis and CVP analysis
• Sensitivity analysis– An approach that examines how an outcome may
change due to variations in the predicted data or underlying assumptions
• Can be run using spreadsheet software, such as Excel
• Goal seek approaches– The analyst specifies the outcome, and the software
specifies the necessary inputs
• What-if analysis– The analyst specifies changes in assumptions and data
to examine the effect of these changes on the outputscontinued
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-35
Simple sensitivity analysis at KubiliTime
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Customer-related costs at KubiliTime Pty Ltd
Activity levelCost per
activity (cost) driver
Volume of activity (cost)
drivers
Estimated cost
Order R 7.50 15,000 112,500
Customer R 30.00 8,000 240,000
Market R 47,500 1 47,500
Facility 744,000
Total cost 1,144,000
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
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Profit model for KubiliTime under activity-based costing
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
18-38
Real life
• CVP analysis in the hotel sector– High occupancy rates– Lower fixed costs, IT & internet bookings has reduced
the break-even occupancy rate
• Reducing the break-even cost of mining gold at Gold Fields, was one of the reasons for the failed take-over attempt by Harmony of Gold Fields
MinesBreakeven price per
kg under GF management
Breakeven price per kg under HAR management
Breakeven price in $ per oz. under GF
management
Breakeven price in $ per oz. under HAR
managementDriefontein
9# R 97,382 R 82,775 $432 $3685# R 85,057 R 72,298 $378 $321
Kloof
Kea R 89,056 R 75,698 $395 $336EBA R 86,198 R 73,268 $383 $325
Copyright 2008 McGraw-Hill PPTs t/a Management Accounting: Information for managing and creating value 1e Slides prepared by Kim Langfield-Smith, Carlos Correia & Colin Smith
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Real life• Break-even at ATMS
– Decision to install an ATM driven by its break-even– Revenue depends on fees from the different types of transactions. Estimate the mix of
transactions to determine the revenue mix– Fixed costs include installation, rent & depreciation and planned maintenance– Variable costs include paper, replacing deposit envelopes, variable component of communications
costs and costs of physical cash management
• Break-even of a major radiation medicine centre– Advanced radiation and diagnostic equipment at cost of $96m– Revenue mix and number of patients– International and local patients
• Break-even in the airline industry– Break-even of A380 increased from 270 to 420 planes for the Airbus Co.– Boeing’s Dreamliner uses less fuel than comparable planes resulting in over 700 orders– Both the A380 and the Dreamliner have been subject to delays which increases the break-even
number of planes– Break-even load factor is about 70% but SAA moved from the Boeing 747 to the A340 as SAA
estimated that this would reduce the break-even load factor from 70% to 55% at the time.
• Break-even for wine producers in South Africa– Production cost (in 2001) amounted to R9933 per hectare. If a farm achieves a recovery of 773
litres of wine per ton of grapes and if the farm was producing 10 tons per hectare, then the cost of production was about R1.28 per litre
– Add cellar costs of R0.93 per litre– Yet the average selling price for bulk wine was about R1.25 per litre at the time.– Break-even depends on the yield of grapes per hectare– For branded bottled wines, we need to take into account the bottling costs, the marketing costs,
storage and financing costs