Download - Cost-Volume-Profit Relationships UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee

Cost-Volume-Profit Relationships

UAA – ACCT 202 Principles of Managerial

Accounting Dr. Fred Barbee

Dr. Fred Barbee ACCT 202 - UAA - Fall 2004 2

Introduction

• We have learned . . .

– How to identify costs as fixed, variable, and mixed;

– How each of these behave when changes take place; and

– How to separate them into their component parts.


Introduction

• Understanding these relationships help managers to;

– Predict future conditions (planning); and

– Explain, evaluate, and act on past results (control)


Introduction

Today we will focus on gaining an understanding of how . . .– Costs

– Volume, and

– Profits

Interact


Cost-Volume-Profit (CVP)

• CVP is the systematic examination of the relationships among . . .

– Selling prices,

– Volume of Sales and Production

– Cost,

– Expenses, and

– Profits

Output

Sales Price

Variable Costs

Fixed Costs

Total Revenues

TotalCost

OperatingIncome

Total Revenue

Total Cost

Operating Income

What happens here?

As changes occur here.Graphically

4

Output

Sales Price

Variable Costs

Fixed Costs


CVP - For-Profit Firms

• How many photocopies must the College Avenue Copy Shop produce to earn a profit of $20,000?

• At what sales volume will Burger King’s total costs and total revenues equal?


CVP - For-Profit Firms

• What will happen to profits in Joe’s Diner if . . .

– There is a 20% increase in the cost of food; and

– A 10% increase in the selling price of meals?


CVP - Not-For-Profit Firms

• How 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?


CVP is Useful in . . .

• Choice of product lines

• Pricing of products

• Developing marketing strategies

• Utilization of productive facilities


Traditional Statement

• Costs are grouped by functional classifications - such as:– Production,– Selling & Administration

• With both fixed and variable costs being included in each category.

Sales $xxx

COGS (xx)

Gross Margin $xxx

Selling Exp. (xx)

Net Income $xxx

Admin. Exp (xx)

ProductionFC & VC

SellingFC & VC

AdministrativeFC & VC


Contribution Format

• The focus of the contribution format income statement is the contribution margin . . .

Contribution Margin = Net Sales - Variable Costs


Contribution Format I/S

• Groups costs by behavior:– Fixed, and– Variable

• Rather than into the functional categories of production, marketing and administration.

Sales $xxx

Variable Costs (xx)

Cont. Margin $xxx

Fixed Costs (xx)

Net Income $xxx

Income Statements . . .

Sales $xxx

COGS (xx)

Gross Margin $xxx

Operating Exp (xx)

Traditional Contribution Format

Net Income $xxx

Sales $xxx

Variable Costs (xx)

Cont. Margin $xxx

Fixed Costs (xx)

Net Income $xxx

Sourdough Alaska, Inc.Sourdough Alaska, Inc.

SalesSales $900,000$900,000Cost of SalesCost of Sales Direct Materials Direct Materials $100,000$100,000 Direct Labor Direct Labor 160,000160,000 Mfg. Overhead Mfg. Overhead 100,000100,000 361,000361,000 VC=$55,000 VC=$55,000 FC=$45,000 FC=$45,000Marketing CostsMarketing Costs Variable Variable 18,00018,000 Fixed Fixed 82,00082,000 100,000100,000Admin. Costs (Fixed)Admin. Costs (Fixed) $150,000$150,000

Sourdough Alaska, Inc.Traditional Income Statement

For Year Ended December 31, 2002

Sourdough Alaska, Inc.Traditional Income Statement


SalesSales $900,000$900,000 100%100%Cost of SalesCost of Sales Direct Materials Direct Materials $100,000$100,000 Direct Labor Direct Labor 160,000160,000 Mfg. Overhead Mfg. Overhead 100,000100,000 360,000360,000 40%40%Gross MarginGross Margin $540,000$540,000 60%60%Marketing/Admin CostsMarketing/Admin Costs Marketing Costs Marketing Costs $100,000$100,000 Administrative Costs Administrative Costs 150,000150,000 250,000250,000Net IncomeNet Income $290,000$290,000


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?

Sourdough Alaska, Inc.Contribution Format Income Statement


Sourdough Alaska, Inc.Contribution Format Income Statement


SalesSales $900,000$900,000 100%100%Cost of SalesCost of Sales Direct Materials Direct Materials $100,000$100,000 Direct Labor Direct Labor 160,000160,000 Mfg. Overhead Mfg. Overhead 55,00055,000 Variable Mkt. Exp Variable Mkt. Exp 18,00018,000 $333,000$333,000 37%37%Contribution MartinContribution Martin $567,000$567,000 63%63%Fixed CostsFixed Costs Manufacturing Manufacturing 45,00045,000 Marketing Marketing 82,00082,000 Administrative Administrative 150,000150,000 277,000277,000Net IncomeNet Income $290,000$290,000


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?

Sourdough Alaska, Inc.Projected Increase in Net Income


Sourdough Alaska, Inc.Projected Increase in Net Income


Sales ($900,000 x 120%)Sales ($900,000 x 120%) $1,080,000$1,080,000

Contribution MarginContribution Margin 688,400688,400

Projected Net IncomeProjected Net Income 403,400403,400

Less: VC: ($333,000 x 120%)Less: VC: ($333,000 x 120%) 399,600399,600

Less: Fixed CostsLess: Fixed Costs 277,000277,000

Less Original NI ProjectionLess Original NI Projection 290,000290,000

Projected Increase in Net IncomeProjected Increase in Net Income $113,400$113,400


2• Can be computed two ways:

– The equation method

– The contribution margin method

Breakeven Analysis


2• Can be computed in two

forms:

Breakeven Analysis

– Number of units required to break even; or

– Sales dollars required to break even.

The Equation Method

Exhaustion Unlimited – An Illustration


Exhaustion Unlimited

• Exhaustion Unlimited makes and distributes high end exercise equipment.

• One of their best selling products is an exercise bike –Model IMATRD-1

Per Bike Percent SP $500 100%VC 300 60%CM $200 40%Fixed Costs = $80,000

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

Sales $xxx

Variable Costs (xx)

Contribution Margin $xxx

Fixed Costs (xx)

Net Operating Income $xxx

• At breakeven profit = 0

The equation becomes:The equation becomes:

•Use our BE Equation; and•Let X = BE Point in Bikes

Sales = VC + FC

$500X = $300X + $80,000$200X = $80,000

X = 400 Bikes

Sales FCVC

•Use our BE Equation; and•Let X = BE Point in Sales $

Sales = VC + FC

1X = .6X + $80,000

.4X = $80,000

X = $200,000

Sales FCVC

Exhaustion UnlimitedIncome Statement

For Year Ended 12/31/01

Sales (400 x $500) $200,000

VC (400 x $300) 120,000

CM $80,000

FC 80,000

Net Income $-0-

The Unit Contribution

Method

Exhaustion Unlimited – An Illustration


Unit-Contribution Method

•Is a variation of the equation method.

•The method may be just a bit more intuitive than the equation method.


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



•The Formula . . .


Fixed Expenses= BEPUnit Contribution

Margin

Bikes400200$

000,80$

Fixed Costs

Unit CMBEP in Units

000,200$%40

000,80$

Fixed Costs

CM %BEP in $


Unit Contribution Method

•Let’s look at a series of income statements that graphically point out the concept of a contribution margin.


1 Bike 2 Bikes400

Bikes401

Bikes

Sales $500 $1,000$200,00

0$200,50

0

VC 300 600 120,000$120,30

0

CM $200 $400 $80,000 $80,200

FC 80,000 80,000 80,000 80,000

NI($79,800

)($79,600

)$-0- $200

Break-Even Analysis

Target Net Profit Analysis



•A firm’s targeted NI is the amount of income the firm wishes to make . . .

–Pre-Tax OI; or

–After-Tax NI



•Recall the BE formula:



•Using data from Exhaustion Unlimited.

•Assume the firm wants to make a before-tax profit of $40,000.

Per Bike Percent SP $500 100%VC 300 60%CM $200 40%Fixed Costs = $80,000

•Use our BE Equation; and•Let X = BE Point in Bikes

Sales = VC + FC + Profits

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

$200X = $120,000

X = 600 Bikes

Sales FCVC

Desired Profit

•Use our BE Equation; and•Let X = BE Point in Sales $

Sales = VC + FC + Profits1X = .6X + $80,000 +

$40,000

.4X = $12,000X = $300,000

Sales FCVC

Desired Profit


For Year Ended 12/31/01

Sales (600 x $500) $300,000

VC (600 x $300) 180,000

CM $120,000

FC 80,000

Net Income $40,000

Target Before-Tax Profit Analysis

The Unit Contribution Method


•The Formula . . .


Fixed Expenses= BEPUnit Contribution

Margin

Add Targeted Before-Tax OI (TI) to the Fixed

Expenses

Fixed Expenses +TI= BEPUnit Contribution

Margin

Add Targeted Before-Tax OI (TI) to the Fixed

Expenses

Bikes600200$

000,40$000,80$

Fixed Costs

Unit CM BEP in Units

Desired BT OI (TI)

000,300$%40

000,40$000,80$

Fixed Costs

CM % BEP in $

Desired BT OI


What About Taxes?

The equation becomes:The equation becomes:

Remember this?

Profit = Taxes

• At breakeven profit = 0


Tax Effects . . .


Net Income OI = ------------------

(1 – TR)

This, then, is our handy-dandy formula to calculate an after-

tax net income (ATNI).



•Back to Exhaustion Unlimited

•Assume management wants $40,000 after taxes

•Tax Rate = 30%

)30.1(

000,40$000,80$300$500$

XX

Sales = VC + FC + ATNI

Sales FC

VCTargeted ATNI

)30.1(

000,40$000,80$300$500$

XX

)30.1(

000,40$000,80$300$500$

XX

Sales = VC + FC + ATNI

686

143,137$200$

143,57$000,80$300$500$

X

X

XX

686

143,137$200$

143,57$000,80$300$500$

X

X

XX

Bikes

686200$

)30.1(000,40$

000,80$

Bikes


Limiting Assumptions

• CVP assumes a linear revenue and cost function.

• CVP analysis assumes a relevant range.

• CVP assumes that production equals sales.


Limiting Assumptions

• Sales mix remains constant.

• Sales prices and costs are known with certainty.

Download - Cost-Volume-Profit Relationships UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee

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