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Cost-Volume-Profit RelationshipsUAA ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee

ACCT 202 - UAA - Fall 2004

IntroductionWe have learned . . .How to identify costs as fixed, variable, and mixed; How each of these behave when changes take place; andHow to separate them into their component parts.

ACCT 202 - UAA - Fall 2004

IntroductionUnderstanding these relationships help managers to;Predict future conditions (planning); and Explain, evaluate, and act on past results (control)

ACCT 202 - UAA - Fall 2004

IntroductionToday we will focus on gaining an understanding of how . . .CostsVolume, andProfitsInteract

ACCT 202 - UAA - Fall 2004

Cost-Volume-Profit (CVP)CVP is the systematic examination of the relationships among . . .Selling prices,Volume of Sales and ProductionCost,Expenses, andProfits

ACCT 202 - UAA - Fall 2004

Total RevenuesTotalCostOperatingIncomeTotal RevenueTotal CostOperating IncomeWhat happens here?As changes occur here.Graphically4OutputSales PriceVariable CostsFixed Costs

ACCT 202 - UAA - Fall 2004

CVP - For-Profit FirmsHow many photocopies must the College Avenue Copy Shop produce to earn a profit of $20,000?At what sales volume will Burger Kings total costs and total revenues equal?

ACCT 202 - UAA - Fall 2004

CVP - For-Profit FirmsWhat will happen to profits in Joes Diner if . . .There is a 20% increase in the cost of food; andA 10% increase in the selling price of meals?

ACCT 202 - UAA - Fall 2004

CVP - Not-For-Profit FirmsHow many meals can the Salvation Army serve with an annual budget of $150,000?How many tickets must be sold for the benefit concert to raise $15,000?

ACCT 202 - UAA - Fall 2004

CVP is Useful in . . .Choice of product linesPricing of productsDeveloping marketing strategiesUtilization of productive facilities

ACCT 202 - UAA - Fall 2004

Traditional StatementCosts are grouped by functional classifications - such as:Production,Selling & AdministrationWith both fixed and variable costs being included in each category.

ACCT 202 - UAA - Fall 2004

ProductionFC & VCSellingFC & VCAdministrativeFC & VC

ACCT 202 - UAA - Fall 2004

Contribution FormatThe focus of the contribution format income statement is the contribution margin . . .Contribution Margin = Net Sales - Variable Costs

ACCT 202 - UAA - Fall 2004

Contribution Format I/S Groups costs by behavior:Fixed, andVariableRather than into the functional categories of production, marketing and administration.

ACCT 202 - UAA - Fall 2004

Variable Costs(xx)Fixed Costs(xx)

ACCT 202 - UAA - Fall 2004

Income Statements . . .TraditionalContribution Format

ACCT 202 - UAA - Fall 2004

Sourdough Alaska, Inc.

ACCT 202 - UAA - Fall 2004

Sourdough Alaska, Inc.Traditional Income StatementFor Year Ended December 31, 2002

ACCT 202 - UAA - Fall 2004

What if . . .You were asked to project the effect on net income of:A 20% increase in sales volume;With no change in selling prices.How would you go about doing it?

ACCT 202 - UAA - Fall 2004

Sourdough Alaska, Inc.Contribution Format Income StatementFor Year Ended December 31, 2002Net Income$290,000

ACCT 202 - UAA - Fall 2004

NOW . . . What if . . .You were asked to project the effect on net income of:A 20% increase in sales volume;With no change in selling prices.How would you go about doing it?

ACCT 202 - UAA - Fall 2004

Sourdough Alaska, Inc.Projected Increase in Net IncomeFor Year Ended December 31, 2002

ACCT 202 - UAA - Fall 2004

Breakeven AnalysisCan be computed two ways:The equation methodThe contribution margin method

2

ACCT 202 - UAA - Fall 2004

Breakeven AnalysisCan be computed in two forms:2Number of units required to break even; orSales dollars required to break even.

ACCT 202 - UAA - Fall 2004

The Equation Method

Exhaustion Unlimited An Illustration

ACCT 202 - UAA - Fall 2004

Exhaustion UnlimitedExhaustion Unlimited makes and distributes high end exercise equipment.One of their best selling products is an exercise bike Model IMATRD-1

ACCT 202 - UAA - Fall 2004

Per BikePercent SP$500100%VC30060%CM$20040%Fixed Costs = $80,000

ACCT 202 - UAA - Fall 2004

The equation method centers on the contribution approach to the income statement.

Sales$xxxVariable Costs(xx)Contribution Margin$xxxFixed Costs(xx)Net Operating Income$xxx

ACCT 202 - UAA - Fall 2004

At breakeven profit = 0The equation becomes:

ACCT 202 - UAA - Fall 2004

Use our BE Equation; andLet X = BE Point in BikesSalesFCVC

Sales = VC + FC

$500X = $300X + $80,000

$200X = $80,000

X = 400 Bikes

ACCT 202 - UAA - Fall 2004

Use our BE Equation; andLet X = BE Point in Sales $SalesFCVC

Sales = VC + FC

1X = .6X + $80,000

.4X = $80,000

X = $200,000

ACCT 202 - UAA - Fall 2004

Exhaustion UnlimitedIncome StatementFor Year Ended 12/31/01Sales (400 x $500)$200,000VC (400 x $300)120,000CM$80,000FC80,000Net Income$-0-

ACCT 202 - UAA - Fall 2004

The Unit Contribution MethodExhaustion Unlimited An Illustration

ACCT 202 - UAA - Fall 2004

Unit-Contribution MethodIs a variation of the equation method.The method may be just a bit more intuitive than the equation method.

ACCT 202 - UAA - Fall 2004

The approach centers on the idea that each unit sold provides a certain amount of CM that goes toward covering fixed costs.Unit-Contribution Method

ACCT 202 - UAA - Fall 2004

The Formula . . .Unit-Contribution Method

Fixed Expenses=BEPUnit Contribution Margin

ACCT 202 - UAA - Fall 2004

Fixed CostsUnit CMBEP in Units

ACCT 202 - UAA - Fall 2004

Fixed CostsCM %BEP in $

ACCT 202 - UAA - Fall 2004

Unit Contribution MethodLets look at a series of income statements that graphically point out the concept of a contribution margin.

ACCT 202 - UAA - Fall 2004

Exhaustion UnlimitedIncome Statement1 Bike2 Bikes400 Bikes401 BikesSales$500$1,000$200,000$200,500VC300600120,000$120,300CM$200$400$80,000$80,200FC80,00080,00080,00080,000NI($79,800)($79,600)$-0-$200

ACCT 202 - UAA - Fall 2004

Break-Even Analysis

Target Net Profit Analysis

ACCT 202 - UAA - Fall 2004

Target Net Profit AnalysisA firms targeted NI is the amount of income the firm wishes to make . . .Pre-Tax OI; orAfter-Tax NI

ACCT 202 - UAA - Fall 2004

Target Net Profit AnalysisRecall the BE formula:

ACCT 202 - UAA - Fall 2004

Target Net Profit AnalysisUsing data from Exhaustion Unlimited.Assume the firm wants to make a before-tax profit of $40,000.

ACCT 202 - UAA - Fall 2004

Per BikePercent SP$500100%VC30060%CM$20040%Fixed Costs = $80,000

ACCT 202 - UAA - Fall 2004

Use our BE Equation; andLet X = BE Point in BikesSalesFCVCDesired Profit

Sales = VC + FC + Profits

$500X = $300X + $80,000 + $40,000

$200X = $120,000

X = 600 Bikes

ACCT 202 - UAA - Fall 2004

Use our BE Equation; andLet X = BE Point in Sales $SalesFCVCDesired Profit

Sales = VC + FC + Profits

1X = .6X + $80,000 + $40,000

.4X = $12,000

X = $300,000

ACCT 202 - UAA - Fall 2004

Exhaustion UnlimitedIncome StatementFor Year Ended 12/31/01Sales (600 x $500)$300,000VC (600 x $300)180,000CM$120,000FC80,000Net Income$40,000

ACCT 202 - UAA - Fall 2004

Target Before-Tax Profit AnalysisThe Unit Contribution Method

ACCT 202 - UAA - Fall 2004

The Formula . . .Unit-Contribution MethodAdd Targeted Before-Tax OI (TI) to the Fixed ExpensesAdd Targeted Before-Tax OI (TI) to the Fixed Expenses

Fixed Expenses=BEPUnit Contribution Margin

Fixed Expenses +TI=BEPUnit Contribution Margin

ACCT 202 - UAA - Fall 2004

Fixed CostsUnit CMBEP in UnitsDesired BT OI (TI)

ACCT 202 - UAA - Fall 2004

Fixed CostsCM %BEP in $Desired BT OI

ACCT 202 - UAA - Fall 2004

Target Net Profit AnalysisWhat About Taxes?

ACCT 202 - UAA - Fall 2004

At breakeven profit = 0The equation becomes:Remember this?

ACCT 202 - UAA - Fall 2004

Tax Effects . . .

ACCT 202 - UAA - Fall 2004

Net Income OI = ------------------ (1 TR)This, then, is our handy-dandy formula to calculate an after-tax net income (ATNI).

ACCT 202 - UAA - Fall 2004

Target Net Profit AnalysisBack to Exhaustion UnlimitedAssume management wants $40,000 after taxesTax Rate = 30%

ACCT 202 - UAA - Fall 2004

Sales = VC + FC + ATNI SalesFCVCTargeted ATNI

ACCT 202 - UAA - Fall 2004

Sales = VC + FC + ATNI Bikes

ACCT 202 - UAA - Fall 2004

Bikes

ACCT 202 - UAA - Fall 2004

Limiting AssumptionsCVP assumes a linear revenue and cost function.CVP analysis assumes a relevant range.CVP assumes that production equals sales.

ACCT 202 - UAA - Fall 2004

Limiting AssumptionsSales mix remains constant.Sales prices and costs are known with certainty.

ACCT 202 - UAA - Fall 2004

Cost-Volume-Profit RelationshipsDr. Fred BarbeeCost-Volume-Profit RelationshipsThe conc

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