decision making and cvp emba 5412 fall 2007. mugan 20072 decision-making process plan and implement...
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Decision Making and CVP
EMBA 5412
Fall 2007
Mugan 2007 2
Decision-Making Process
Plan and implement
Plan and implement
Get feedback and revise
Get feedback and revise
Evaluate alternatives
Evaluate alternatives
Set goals and objectives
Set goals and objectives
Gather information
Gather information
Mugan 2007 3
Strategic Decision Making
Strategic Planning
Answers the following two major questions:
What are the ways of
achieving?
What are the ways of
achieving?
What to we want to accomplish?
What to we want to accomplish?
Company policies and plans to reflect how to reach the company goals.
Mugan 2007 4
Managerial Accounting
• Process of – Identifying– Measuring– Analyzing– Interpreting– Communicating
information in pursuit of a company’s goals– Managerial accountants – business
partners/consultants in companies – Provides information to managers
Mugan 2007 5
Cost Management Perspective
• Provide highest quality service/goods with lowest possible cost
• Objectives:– Determine cost of resources consumed in company’s
activities– Eliminate non-value added activities as much as
possible– Determine efficiency and effectiveness of all major
activities– Identify and evaluate new activities that can improve
the performance of the company
Mugan 2007 6
Strategic Cost Management
• Value chain – Get raw materials and other resources– Research and development – including quality assessment– Product design– Production– Marketing– Distribution– Customer service
• Should understand the value chain • Cost drivers in activities• Managing the cost relationships to a company’s advantage –
strategic cost management
Mugan 2007 7
The Value Chain
Primary processes
R & D Design Supply Production Marketing Distri- bution
Customer service
Value ofproducts
andservices
Value ofproducts
andservices
Exh.1.2
Support services•Accounting
•Human resources•Legal services
•Information systems•Telecommunications
Support services•Accounting
•Human resources•Legal services
•Information systems•Telecommunications
Mugan 2007 8
Strategic Position of a Company and its missions
Low
Low
Medium
Medium
High
High
Risk
Ret
urn
Divest
Harvest
Hold
Build
• Declining market• Exit at lowest cost• Minimize losses• Find a buyer quickly
• Continuing market• Maintain cash flow• Maintain volume• Cut costs
• Continuing market• Maintain growth• Be a major player• Protect market share
• New market potential• Be early entrant• Achieve growth• Capture market share
Exh.1.1
Mugan 2007 9
Types of Costs
• differential costs- (benefits) – costs or benefits that change between/among alternatives
• Irrelevant costs -Costs that don’t change are irrelevant to the decision
• Choose the alternatives where differential benefits exceed differential costs
• Opportunity costs• Sunk costs• Controllable /avoidable costs/discretionary
costs
The opportunity cost is the monetary amount associated with the next best use of the resource.
Costs that have already been incurred and cannot be changed no matter what action is taken in the future.
Costs that have already been incurred and cannot be changed no matter what action is taken in the future.
Mugan 2007 10
Cost Definitions
Fixed Costs: Costs incurred when there is no production.
Marginal cost: cost of producing (and selling) one more unit = variable costs after the initial production stage
Average cost: Total costs divided by number of units produced
Mugan 2007 11
Cost DefinitionsTC = FC + (VC Q) for Q in relevant range
Total costs (TC) are a linear function of quantity (Q) produced over a relevant range.
Variable Cost (VC): Cost to produce one more unit. Variable cost is a linear approximation of marginal opportunity costs.
Fixed Cost (FC): Predicted total costs with no production (Q=0).
Relevant Range: Range of production quantity (Q) where a constant variable cost is a reasonable approximation of opportunity cost.
Mugan 2007 12
Cost CurveT
ota
l Co
st
X
Y Total Cost –Mixed Cost
Average Cost
Fixed Cost
Variable Cost per unit or marginal cost
Mugan 2007 13
Cost Drivers
• Cost driver: units of physical activity most highly associated with total costs in an activity center
Examples of cost drivers:– Quantity produced– Direct labor hours– Number of set-ups– Number of orders processed
• Different activity drivers might be used for different decisions
• Costs could be fixed, variable, or mixed in different situations
Mugan 2007 14
Cost Estimation Example• In each month, Exclusive
Billiards produces between 4 to 10 pool tables. The plant operates on 40-hr shift to produce up to seven tables. Producing more than seven tables requires the craftsmen to work overtime. Overtime work is paid at a higher hourly wage. The plant can add overtime hours and produce up to 10 tables per month. The following table contains the total cost of producing between 4 and 10 pool tables.
• Required: a. compute average cost per pool table for 4 to 10 tables
• Estimate fixed costs per month.
Pool Tables Total Cost4 628005 660006 692007 724008 758009 79200
10 82600
Pool Tables Total Cost Variable Cost Average Cost4 62.800 15.7005 66.000 3.200 13.2006 69.200 3.200 11.5337 72.400 3.200 10.3438 75.800 3.400 9.4759 79.200 3.400 8.800
10 82.600 3.400 8.260
FC= TC - VC66.000 4 x 3200= 12800
FC= 50.000
Mugan 2007 15
Format of Income Statement Financial Accounting (traditional – required for financial
statements and tax ) Sales Revenue
- Cost of goods sold (product costs) = Gross profit - General, selling, administrative, and taxes (period costs) = Net income
Decision Making( useful for managers – internal oriented) Revenue
- Variable costs (product and selling and administration) = Contribution margin - Fixed costs and taxes( product and selling and administration) = Net income
Mugan 2007 16
Income Statement Example
Variable FixedCost of Goods Sold 750.000 540.000Selling Expenses 95.000 60.000Administrative Expenses 80.000 65.000
FM Manufacturing Company has sales of TL 1.800.000 for the first quarter of 2008. In selling 6.000 units of gadgets the company incurred the following costs:
Prepare a traditional and a CVP income statement for the first quarter of 2008.
Mugan 2007 17
Income Statement Example
Sales 1.800.000 TLCost of Goods Sold (1.290.000)Gross Margin 510.000Selling Expenses (155.000)Administrative Expenses (145.000)Net Income Before Tax 210.000 TL
Traditional Income Statement
For the first Quarter 2008FM Manufacturing Income Statement
Sales (5000 units) 1.800.000 TLVariable Costs: Production Costs 750.000 Selling Expenses 95.000 Administrative Expenses 80.000 Total Variable Costs 925.000Contribution Margin 875.000Fixed Costs: Production Costs 540.000 Selling Expenses 60.000 Administrative Expenses 65.000 Total Fixed Costs 665.000Net Income Before Tax 210.000 TL
FM Manufacturing Income StatementFor the first Quarter 2008
CVP Income Statement
Mugan 2007 18
CVP definitions
Cost-Volume-Profit (C-V-P) analysis is very useful for production and marketing decisions.
Contribution margin equals price per unit minus variable cost per unit: CM = (P – VC).
Total contribution margin equals total revenue minus total variable costs: (CM Q) = (P - VC) Q.
Mugan 2007 19
COST VOLUME PROFIT ANALYSIS
• HELPFUL TO UNDERSTAND THE RELATIONSHIP AMONG VARIABLE COSTS, FIXED COSTS AND PROFIT
• BASIC ASSUMPTIONS:– SELLING PRICE IS CONSTANT– COSTS ARE LINEAR AND CAN BE DIVIDED INTO FIXED
AND VARIABLE– FIXED ELEMENT CONSTANT OVER THE RELEVANT
RANGE– UNIT VARIABLE COST CONSTANT OVER THE RELEVANT
RANGE– SALES MIX IS CONSTANT– INVENTORIES STAY AT THE SAME LEVEL
Mugan 2007 20
Basics of Cost-Volume-Profit Analysis
CM is used first to cover fixed
expenses. Any remaining CM
contributes to net operating income.
CM is used first to cover fixed
expenses. Any remaining CM
contributes to net operating income.
Sales (5000 units) 1.800.000 TLVariable Costs: Production Costs 750.000 Selling Expenses 95.000 Administrative Expenses 80.000 Total Variable Costs 925.000Contribution Margin 875.000Fixed Costs: Production Costs 540.000 Selling Expenses 60.000 Administrative Expenses 65.000 Total Fixed Costs 665.000Net Income Before Tax 210.000 TL
FM Manufacturing Income StatementFor the first Quarter 2008
CVP Income Statement
Mugan 2007 21
Per Unit
Sales (5000 units) 1.800.000 TL selling price 360 TLVariable Costs: Production Costs 750.000 Unit Cost 150 TL Selling Expenses 95.000 Unit Sell. Exp 19 TL Administrative Expenses 80.000 Unit Adm. Exp 16 TL Total Variable Costs 925.000 variable cost per unit (vcu) 185 TLContribution Margin 875.000 contribution margin per unit (cmu) 175 TLFixed Costs: Production Costs 540.000 Selling Expenses 60.000 Administrative Expenses 65.000 Total Fixed Costs 665.000Net Income Before Tax 210.000 TL
FM Manufacturing Income StatementFor the first Quarter 2008
The Contribution Approach Sales, variable expenses, and contribution margin can also be expressed on a
per unit basis. If FM sells an additional gadget, TL 175 additional CM will be generated to cover fixed expenses and profit.
Mugan 2007 22
Sales (5000 units) 1.800.000 TLVariable Costs: Production Costs 750.000 Selling Expenses 95.000 Administrative Expenses 80.000 Total Variable Costs 925.000Contribution Margin 875.000Fixed Costs: Production Costs 540.000 Selling Expenses 60.000 Administrative Expenses 65.000 Total Fixed Costs 665.000Net Income Before Tax 210.000 TL
FM Manufacturing Income StatementFor the first Quarter 2008
CVP Income Statement
The Contribution ApproachEach month FM must generate at least TL 665.000
in total CM to break even.
Mugan 2007 23
The Contribution ApproachIf FM sells 3800 units3800 units in a quarter, it will
be operating at the break-even point.
Sales (5000 units) 1.368.000 TLVariable Costs: Production Costs 570.000 Selling Expenses 72.200 Administrative Expenses 60.800 Total Variable Costs 703.000Contribution Margin 665.000Fixed Costs: Production Costs 540.000 Selling Expenses 60.000 Administrative Expenses 65.000 Total Fixed Costs 665.000Net Income Before Tax 0 TL
FM Manufacturing Income StatementFor the first Quarter 2008
CVP Income Statement
Mugan 2007 24
The Contribution ApproachIf FM sells one more gadget (3801 gadgets3801 gadgets), net
operating income will increase by TL 175.
Sales (5000 units) 1.368.360 TLVariable Costs: Production Costs 570.150 Selling Expenses 72.219 Administrative Expenses 60.816 Total Variable Costs 703.185Contribution Margin 665.175Fixed Costs: Production Costs 540.000 Selling Expenses 60.000 Administrative Expenses 65.000 Total Fixed Costs 665.000Net Income Before Tax 175 TL
FM Manufacturing Income StatementFor the first Quarter 2008
CVP Income Statement
Mugan 2007 25
The Contribution Approach
We do not need to prepare an income statement to estimate profits at a particular sales volume. Simply multiply the number of units sold above break-even by the contribution margin per unit.
If FM sells 4000 gadgets, its net income will be
35.000 TL..
Mugan 2007 26
Break-Even Analysis
Break-even analysis can be approached in two ways:
1. Equation method
2. Contribution margin method
Mugan 2007 27
EQUATION METHOD-1SALES= VARIABLE COSTS+FIXED COSTS + PROFIT
p*q= vcu *q + FC + ¶p= price; q=quantity sold (in terms of units)vcu=variable cost per unit = VC/ q;(includes both manufacturing and selling and
administrative) FC= total fixed costs; ¶= profit
AT BREAKEVEN PROFIT = 0p*q=vcu *q +FCq * (p-vcu) = FC
BREAKEVEN in units sold: (q)
q= FC ÷ (p - vcu) OR q=FC ÷ cmu
Breakeven Sales amount = selling price x breakeven quantity
Mugan 2007 28
EQUATION METHOD-2
Sales = (Variable Cost Ratio x Sales) + Fixed Costs + Profit
VCR = Variable Cost Ratio
FC = total fixed costs (both manufacturing, and selling and administrative)
AT BREAKEVEN PROFIT = 0
Sales = (Sales x VCR) + FC + 0
Therefore
Sales amount (monetary terms) at breakeven point is
Sales (breakeven)= FC ÷ (1-VCR)
BREAKEVEN in units sold= Sales (breakeven) ÷ selling price
Mugan 2007 29
Sensitivity Analysis
EFFECT OF CHANGE IN FIXED COSTS?
EFFECT OF CHANGE IN VARIABLE COSTS?
EFFECT OF CHANGE IN SELLING PRICE?
Mugan 2007 30
Break-Even Analysis
Here is the information from FM Company:
Cost and price information Per UnitTL
Selling Price (p) 360 100,00%
Variable Manufacturing Cost 150Variable Selling Expense 19Variable Administrative Expense 16Variable Cost per Unit (vcu) 185 51,39%Contribution Margin per Unit (cmu) 175 48,61%Total Fixed Costs TL 665.000
Mugan 2007 31
Equation Method-1 We can calculate the break-even point as follows:
Sales = Variable expenses + Fixed expenses + ProfitsSales = Variable expenses + Fixed expenses + Profits
360q = 185q + 665.000 + 0Where:
q = Number of gadgets sold TL 360 = Unit selling price TL 185 = Unit variable expense
TL 665.000 = Total fixed expense
Breakeven units = q= 3800 gadgetsBreakeven units = q= 3800 gadgets
Mugan 2007 32
Equation Method-2 The equation can be modified to calculate
the break-even point in sales dollars.
Sales = Variable expenses + Fixed expenses + ProfitsSales = Variable expenses + Fixed expenses + Profits
X = 0,5139X + 665.000 +X = 0,5139X + 665.000 + 00 Where:
X = Total sales amount0,5139 = Variable expenses as a % of sales TL 665.000 = Total fixed expenses
Breakeven Sales amount = Sales (BE) = TL 1.368.000**rounding error might occurBreakeven Sales amount = Sales (BE) = TL 1.368.000**rounding error might occur
Mugan 2007 33
Reconciliation of the Equation Method 1 and 2
From equation method 1:
Breakeven units:
3800 gadgets x price 360= TL 1.368.000 = sales amount at breakeven
From equation 2:
Breakeven sales amount:
1.368.000 ÷ TL 360 per unit= 3800 gadgets = breakeven units
Mugan 2007 34
CONTRIBUTION MARGIN RATIO
CMR= CONTRIBUTION MARGIN RATIO = CM / SALES OR cmu/p
VCR = VARIABLE COST RATIO = VC/SALES OR vcu/pCM= SALES - TOTAL VC VC= SALES – CM (variable costs include both manufacturing and selling and
administrative variable costs)cmu =CONTRIBUTION MARGIN PER UNIT= p - vcu=CM/q
CM = total contribution margin vcu= variable cost (manufacturing and selling and administrative per unit) p= selling pricecmu = contribution margin per unit CMR +VCR= 1
Mugan 2007 35
Contribution Margin Method
The contribution margin method has two key equations.
Fixed expensesUnit contribution margin
=Break-even point
in units sold
Fixed expenses CM ratio
=Break-even point intotal sales dollars
Mugan 2007 36
Contribution Margin MethodLet’s use the contribution margin method to calculate
the breakeven sales amount at FM Company.
Fixed expenses CM ratio
=Break-even point intotal sales dollars
TL 665.000TL 665.00048,61%48,61% = = TL 1.368.000 break-even salesTL 1.368.000 break-even sales
Mugan 2007 37
PROFIT ANALYSIS
• AT BREAKEVEN PROFIT = 0• BEFORE BREAKEVEN LOSS; AFTER
BREAKEVEN PROFIT• CM COVERS FIXED COST UPTO BREAKEVEN
POINT• AFTER BREAKEVEN POINT INCREASE IN CM
WILL INCREASE NET INCOME
• CM = FC + INCOME BEFORE TAX
Mugan 2007 38
Basic Analysis using CVP
• EFFECT OF CHANGE IN FIXED COSTS?• EFFECT OF CHANGE IN VARIABLE COSTS?• EFFECT OF CHANGE IN SELLING PRICE?
Mugan 2007 39
Target Profit Analysis
The equation and contribution margin methods can be used to determine the sales volume
needed to achieve a target profit.
Suppose FM Company wants to know how many gadgets must be sold to earn a
before tax profit of TL100,000.
Mugan 2007 40
The CVP Equation MethodSales = Variable expenses + Fixed expenses + ProfitsSales = Variable expenses + Fixed expenses + Profits
360q = 185q + 665.000 + 100.000Where:
q = Number of gadgets sold TL 360 = Unit selling price TL 185 = Unit variable expense
TL 665.000 = Total fixed expense TL 100.000 = profit BEFORE tax
Target income units = q= 4372*gadgets*rounded upTarget income units = q= 4372*gadgets*rounded up
Mugan 2007 41
The Contribution Margin Approach
Fixed expenses + Target profit Unit contribution margin
=Unit sales to attain
the target profit
TL 665.000 + TL100,000 TL175 per gadget
= 4372 gadgets
Or
TL 100.000 ÷ TL 175 = 572 more units after the breakeven point need to be sold
3800+572= 4372 gadgets
Mugan 2007 42
Target Income –after tax profitAssume that FM Company’s tax rate is 20%; and the
company wants an after-tax income of TL 100.000. How many units must it sell?
After tax TL 100.000 ÷0.8 (after tax percent of net income) = Before Tax income of TL 125.000
Then the company needs to sell after breakeven
TL 125.000 ÷ TL 175 = 715*(rounded up) more units
3800(breakeven )+715(units after breakeven) =
4515 gadgets
Mugan 2007 43
The Margin of Safety• The margin of safety is the excess of
budgeted (or actual) sales over the break-even amount of sales.
• The margin of safety can also be expressed as– % of sales– Units
Margin of safety = Total sales - Break-even salesMargin of safety = Total sales - Break-even sales
MoS TL = ACTUAL OR BUDGETED SALES - BREAKEVEN SALES $MoS % = MoS TL / ACTUAL OR BUDGETED SALES
MoS units = MoS TL / selling price
Mugan 2007 44
The Margin of Safety FM CompanyFM Manufacturing Income Statement CURRENT BREAKEVEN
For the first Quarter 2008 SALESales units 5.000 3.800Sales 1.800.000 TL 1.368.000Variable Costs: Production Costs 750.000 570.000 Selling Expenses 95.000 72.200 Administrative Expenses 80.000 60.800 Total Variable Costs 925.000 703.000Contribution Margin 875.000 665.000Fixed Costs: Production Costs 540.000 540.000 Selling Expenses 60.000 60.000 Administrative Expenses 65.000 65.000 Total Fixed Costs 665.000 665.000Net Income Before Tax 210.000 TL 0
Margin of safety = 1.800.000 - 1.368.000= TL 432.000Margin of safety = 1.800.000 - 1.368.000= TL 432.000
MoS % =
432.000 ÷ 1.800.000= 24%
MoS units =
432.000 ÷ 360 = 1200 gadgets
Mugan 2007 45
Cost Structure and Profit Stability
Cost structure refers to the relative proportion of fixed and variable costs in an organization.
Managers often have some latitude in determining their organization’s cost structure.
Mugan 2007 46
Operating Leverage• The effect of cost structure on operating
income• Higher operating leverage – very
sensitive to changes in sales volume
Contribution margin Operating income
Degree ofoperating leverage
=
Mugan 2007 47
Operating Leverage
TL 875.000 TL 210.000
=4,17
At FM, the degree of operating leverage is.
FM Manufacturing Income Statement CURRENT For the first Quarter 2008 SALE
Sales units 5.000Sales 1800000Variable Costs: Production Costs 750.000 Selling Expenses 95.000 Administrative Expenses 80.000 Total Variable Costs 925.000Contribution Margin 875.000Fixed Costs: Production Costs 540.000 Selling Expenses 60.000 Administrative Expenses 65.000 Total Fixed Costs 665.000Net Income Before Tax 210.000
If sales increase by 10% income is going increase by 41,67%
Mugan 2007 48
Cost Structure and Profitability
• High variable costs lead to lower CM and less vulnerable in crisis time
• High fixed costs cause higher breakeven point; after the breakeven point profits increase faster than the high variable cost company
• Degree of operating leverage effects: – For a given % change in sales, income will increase by (%
increase in sales *degree of operating leverage)– Degree of operating leverage decreases as the sales move
away from the breakeven point– If variable costs are high degree of operating leverage low; and
vice versa
Mugan 2007 49
Structuring Sales Commissions
Companies generally compensate salespeople by paying them either a
commission based on sales or a salary plus a sales commission. Commissions based on sales dollars can lead to lower profits in a
company.
Let’s look at an example.Let’s look at an example.
Mugan 2007 50
Structuring Sales Commissions
Pipeline Unlimited produces two types of surfboards, the XR7 and the Turbo. The XR7 sells for $100 and generates a contribution margin per unit of $25. The Turbo sells for $150 and earns a contribution margin
per unit of $18.
The sales force at Pipeline Unlimited is compensated based on sales commissions.
Mugan 2007 51
Structuring Sales Commissions
If you were on the sales force at Pipeline, you would push hard to sell the Turbo even though the XR7
earns a higher contribution margin per unit.
To eliminate this type of conflict, commissions can be based on contribution margin rather than on
selling price alone.
Mugan 2007 52
The Concept of Sales Mix
• Sales mix is the relative proportion in which a company’s products are sold.
• Different products have different selling prices, cost structures, and contribution margins.
Mugan 2007 53
• Let’s assume Han sells synthetic fiber filled and dawn feather sleeping bags. Then we’ll calculate a break-even point that encompasses both products and their cost-price parameters.
• Let’s assume Han sells synthetic fiber filled and dawn feather sleeping bags. Then we’ll calculate a break-even point that encompasses both products and their cost-price parameters.
Multiple Products Example
Mugan 2007 54
Cost other related information
Multiple Products Example
Mugan 2007 55
Multiple Products Example
Breakeven Sales Amount =
TL 170.000 ÷ 48.18% = TL 352.880
Mugan 2007 56
Multiple Products Example
Sales mixBreakeven Sale Amount TL
Sale Amount of Each Product TL
Selling Price TL
Number of bags to be sold*
Synthetic 45,50% 352.880 160.560 500 322,00Dawn Feather 54,50% 192.320 1.000 193,00* rounded up to the next whole unit
At Breakeven Han needs to sell of each product
Or we can use the following method
Mugan 2007 57
Weighted-average unit contribution margin
TL 200 × 62.5%TL 200 × 62.5%TL 200 × 62.5%TL 200 × 62.5%
Multiple Products Example
Mugan 2007 58
Break-even point
= Fixed expenses
Weighted-average unit contribution margin
Break-even point
=170,000
331.25
Break-even point
= 514 combined units
Multiple Products ExampleThe break-even point is 514 combined units. We can use the sales
mix to find the number of units of eachproduct that must be sold to break even.
Mugan 2007 59
Multiple Products Example
The break-even point of 514 units is validonly for the sales mix of 62.5% and 37.5%.
Sales amount to break even:
Selling Price TL
Number of bags to be sold
Total Sales
500 321,00 160.5001.000 193,00 193.000
353.500
There is a slight difference between the results of the approaches due to rounding.
Mugan 2007 60
In Class – Multiple CustomersCali sells PROD 1.0 which is a top electronic spreadsheet product.
Now, the company is coming up with the new version –PROD 2.0. The company offers the new version at substantially lower prices to customers who has PROD 1.0 (upgrade customers).
Cali plans to sell 200.000 units of PROD 2.0 and wants to have a net income of TL 7.000.000 after tax. Current tax rate is 20%.
The expected sales mix in units is 60% new customers; and 40% upgrade customers.
Cali management wants to know:• What the expected breakeven in units and TLs for PROD 2.0 at
60/40 sales mix.• Whether they will be able to attain its target income with the
expected sales level and sales mix. • What the optimal sales mix is.
Relevant information appear in the following slide.
Mugan 2007 61
In Class – Multiple Customers
Cali Cost and Revenue New UpgradeInformation Customer Customers
Selling Price 210 120Variable Costs: Production Costs 25 25 Selling Expenses 65 15 Total Variable Costs 90 40Contribution Margin 120 80Fixed Costs: Production Costs 9.000.000 9.000.000 Selling Expenses 3.000.000 3.000.000 Administrative Expenses 2.000.000 2.000.000 Total Fixed Costs 14.000.000 14.000.000
Solution to CALI
Mugan 2007 63
Modeling Multiple Cost Drivers
An insight from activity-based An insight from activity-based costing: costs may be a costing: costs may be a
function of multiple activities, function of multiple activities, not merely sales volume.not merely sales volume.
Total Cost = (Unit variable cost × Sales units)
+ (Batch cost × Batch activity)+ (Product cost × Product activity)+ (Customer cost × Customer activity)+ (Facility cost × Facility activity)
Some costs treated as fixed
(when sales volume is the only activity) may now
be considered variable.
Mugan 2007 64
Multiple Cost Drivers
• Variable costs may arise from multiple cost drivers or activities. A separate variable cost needs to be calculated for each driver. Examples include:– Customer or patient count– Passenger miles– Patient days– Student credit-hours– Set-up Costs – number of setups
Mugan 2007 65
Multiple Cost Drivers
EMBA Company produces a single product with the following costs:
Selling price: TL 200
Variable production costs per product TL 120
Variable gift wrapping costs TL 10 per customer
Fixed costs TL 4500
Determine the breakeven sales.
Mugan 2007 66
Multiple Cost DriversOperating Income = Sales
– (Variable production cost x number of units sold)
- ( Variable gift wrapping cost x number of customers)
- Fixed Costs
Rev/Cost per unit/customer (TL)
Number of products sold
Number of Customers
Total Rev/ Cost (TL)
150 150
Sales 200 30.000 30.000Variable Production costs 120 18.000 18.000Variable Packaging costs 10 1500 1.500Total Variable Costs 19.500Contribution margin 10.500Fixed Costs 4.500Operating Income 6.000
If EMBA sells 150 products to 100 customers?
Mugan 2007 67
Multiple Cost DriversRev/Cost per unit/customer (TL)
Number of products sold
Number of Customers
Total Rev/ Cost (TL)
150 100
Sales 200 30.000 30.000Variable Production costs 120 18.000 18.000Variable Packaging costs 10 1000 1.000Total Variable Costs 19.000Contribution margin 11.000Fixed Costs 4.500Operating Income 6.500
Number of units sold is NOT the only determinant of operating income; there are two cost drivers
– the number of units sold; and – the number of customers
Mugan 2007 68
Multiple Cost Drivers• There is no unique breakeven point
Rev/Cost per unit/customer (TL)
Number of products sold
Number of Customers
Total Rev/ Cost (TL)
60 30
Sales 200 12.000 12.000Variable Production costs 120 7.200 7.200Variable Packaging costs 10 300 300Total Variable Costs 7.500Contribution margin 4.500Fixed Costs 4.500Operating Income 0
Rev/Cost per unit/customer (TL)
Number of products sold
Number of Customers
Total Rev/ Cost (TL)
57 6
Sales 200 11.400 11.400Variable Production costs 120 6.840 6.840Variable Packaging costs 10 60 60Total Variable Costs 6.900Contribution margin 4.500Fixed Costs 4.500Operating Income 0
Mugan 2007 69
In Class – CVP multiple cost driversSade Comp is a distributor of special dolls. For 2008,
Seyda, the manager, plans to purchase the dolls for TL 30 each and sell them for TL 45 each. Sade’s fixed costs are expected to be TL 240.000. Seyda’s only other costs will be variable costs of TL 60 per shipment for each customer regardless of the number of dolls in the order.
Seyda wants to know:How much operating income will be if she sell 40,000 dolls
in 1.000 shipments? 800 shipments?She estimates that she can make 500 shipments in 2008.
She wants to know how many dolls she needs to sell to breakeven.
Is this the only breakeven point? Can she have other breakeven points if she can make more or less shipments?
Solution to Sade Company
Mugan 2007 71
USING CVP with Absorption Costing
Selling price per unit 13variable manufacturing, cost per unit 6Fixed Manufacturing Costs 100.000Variable selling and administrative costs 2Fixed Selling and Administrative costs 0Contribution Margin per unit 5
• Poli Company produces and sells coffee mugs. Cost and revenue related information is provided below.
Mugan 2007 72
USING CVP with Absorption Costing
Determine the break-even point under contribution approach.
Breakeven for Variable Costing:Fixed Costs: manuf and selling 100.000Contribution Margin per unit 5Breakeven units 20000
Mugan 2007 73
USING CVP with Absorption Costing• If the company uses absorption costing and wants to determine the
breakeven point, three cases arise. Case 1 sales = production
inventory beginning - units 10.000inventory ending - units 10.000production units 25.000sales units 25.000contribution margin per unit 5fixed manufacturing costs 100.000fixed manufacturing costs per unit-current 4fixed manufacturing costs per unit-previous period 4unit sold from inventory 0fixed cost absorbed in units sold 100.000fixed cost absorbed in inventories-beginning 40.000fixed cost absorbed in inventories-ending 40.000total fixed manufacturing costs 100.000breakeven units 20.000
Mugan 2007 74
USING CVP with Absorption Costing• Let’s prove: at 20,000 units – sales=production
Absorption Income Statement Variable Costing Income StatementCase 1 sales = production Case 1 sales = production
Sales 260.000 Sales 260.000Cost of Goods Sold: Variable Costs: Variable Manuf Costs 120.000 Manufacturing 120.000 Fixed Manuf Costs 100.000 Selling, administrative 40.000
220.000 160.000Gross Margin 40.000 Contribution Margin 100.000
Selling and Administrative Costs Fixed Costs: Variable 40.000 Manufacturing 100.000 Fixed 0 Selling, administrative 0
40.000 100.000
Net Income Before Tax 0 Net Income Before Tax 0
Mugan 2007 75
USING CVP with Absorption Costing
Case 2 sales < production
inventory beginning - units 10.000inventory ending - units 15.000production units 25.000sales units 20.000contribution margin per unit 5fixed manufacturing costs 100.000fixed manufacturing costs per unit-current 4fixed manufacturing costs per unit-previous period 4unit sold from inventory (5.000)fixed cost absorbed in units sold 80.000fixed cost absorbed in inventories-beginning 40.000fixed cost absorbed in inventories-ending 60.000total fixed manufacturing costs 80.000breakeven units 16.000
Mugan 2007 76
USING CVP with Absorption Costing
Amount of fixed manufacturing costs absorbed in the increase in ending inventory
Amount of fixed manufacturing costs absorbed in the units sold
Absorption Income Statement Variable Costing Income Statementat breakeven per absorption at breakeven per absorption Case 2 sales < production Case 2 sales < production
Sales 208.000 Sales 208.000Cost of Goods Sold: Variable Costs: Variable Manuf Costs 96.000 Manufacturing 96.000 Fixed Manuf Costs 80.000 Selling, administrative 32.000
176.000 128.000Gross Margin 32.000 Contribution Margin 80.000
Selling and Administrative Costs Fixed Costs: Variable 32.000 Manufacturing 100.000 Fixed 0 Selling, administrative 0
32.000 100.000
Net Income Before Tax 0 Net Income Before Tax (20.000)
Mugan 2007 77
Case 3 sales > production
inventory beginning - units 10.000inventory ending - units 5.000production units 25.000sales units 30.000contribution margin per unit 5fixed manufacturing costs 100.000fixed manufacturing costs per unit-current 4fixed manufacturing costs per unit-previous period 4unit sold from inventory 5.000fixed cost absorbed in units sold 120.000fixed cost absorbed in inventories-beginning 40.000fixed cost absorbed in inventories-ending 20.000total fixed manufacturing costs 120.000breakeven units 24.000
USING CVP with Absorption Costing
Mugan 2007 78
USING CVP with Absorption CostingAbsorption Income Statement Variable Costing Income Statementat breakeven per absorption at breakeven per absorption Case 3 sales > production Case 3 sales > production
Sales 312.000 Sales 312.000Cost of Goods Sold: Variable Costs: Variable Manuf Costs 144.000 Manufacturing 144.000 Fixed Manuf Costs 120.000 Selling, administrative 48.000
264.000 192.000Gross Margin 48.000 Contribution Margin 120.000
Selling and Administrative Costs Fixed Costs: Variable 48.000 Manufacturing 100.000 Fixed 0 Selling, administrative 0
48.000 100.000
Net Income Before Tax 0 Net Income Before Tax 20.000
Amount of fixed manufacturing costs absorbed in the increase in ending inventory
Amount of fixed manufacturing costs absorbed in the units sold
Mugan 2007 79
With fixed selling and admin costs
Case 1 sales = production Case 1 sales = production Case 1 sales = productionAbsorption Income Statement Variable Income Statement
inventory beginning - units 10.000 Sales 286.000 Sales 286.000inventory ending - units 10.000 Cost of Goods Sold: Variable Costs:production units 25.000 Variable Manuf Costs 132.000 Manufacturing 132.000sales units 25.000 Fixed Manuf Costs 100.000 Selling, administrative 44.000contribution margin per unit 5 232.000 176.000fixed manufacturing costs 100.000 Gross Margin 54.000 Contribution Margin 110.000fixed manufacturing costs per unit-current 4fixed manufacturing costs per unit-previous period 4 Selling and Administrative Costs Fixed Costs:unit sold from inventory 0 Variable 44.000 Manufacturing 100.000fixed cost absorbed in units sold 100.000 Fixed 10.000 Selling, administrative 10.000fixed cost absorbed in inventories-beginning 40.000 54.000 110.000fixed cost absorbed in inventories-ending 40.000total fixed manufacturing costs 100.000 Net Income Before Tax 0 Net Income Before Tax 0fixed selling and administrative 10.000TOTAL FIXED COSTS 110.000breakeven units 22.000
Mugan 2007 80
With fixed selling and admin costsCase 2 sales < production Case 2 sales < production Case 2 sales < production
Absorption Income Statement Variable Income Statementinventory beginning - units 10.000 Sales 234.000 Sales 234.000inventory ending - units 15.000 Cost of Goods Sold: Variable Costs:production units 25.000 Variable Manuf Costs 108.000 Manufacturing 108.000sales units 20.000 Fixed Manuf Costs 80.000 Selling, administrative 36.000contribution margin per unit 5 188.000 144.000fixed manufacturing costs 100.000 Gross Margin 46.000 Contribution Margin 90.000fixed manufacturing costs per unit-current 4fixed manufacturing costs per unit-previous period 4 Selling and Administrative Costs Fixed Costs:unit sold from inventory (5.000) Variable 36.000 Manufacturing 100.000fixed cost absorbed in units sold 80.000 Fixed 10.000 Selling, administrative 10.000fixed cost absorbed in inventories-beginning 40.000 46.000 110.000fixed cost absorbed in inventories-ending 60.000total fixed manufacturing costs 80.000 Net Income Before Tax 0 Net Income Before Tax (20.000)fixed selling and administrative 10.000TOTAL FIXED COSTS 90.000breakeven units 18.000
Mugan 2007 81
With fixed selling and admin costs
Case 3 sales > production Case 3 sales > production Case 3 sales > productionAbsorption Income Statement Variable Income Statement
inventory beginning - units 10.000 Sales 338.000 Sales 338.000inventory ending - units 5.000 Cost of Goods Sold: Variable Costs:production units 25.000 Variable Manuf Costs 156.000 Manufacturing 156.000sales units 30.000 Fixed Manuf Costs 120.000 Selling, administrative 52.000contribution margin per unit 5 276.000 208.000fixed manufacturing costs 100.000 Gross Margin 62.000 Contribution Margin 130.000fixed manufacturing costs per unit-current 4fixed manufacturing costs per unit-previous period 4 Selling and Administrative Costs Fixed Costs:unit sold from inventory 5.000 Variable 52.000 Manufacturing 100.000fixed cost absorbed in units sold 120.000 Fixed 10.000 Selling, administrative 10.000fixed cost absorbed in inventories-beginning 40.000 62.000 110.000fixed cost absorbed in inventories-ending 20.000total fixed manufacturing costs 120.000 Net Income Before Tax 0 Net Income Before Tax 20.000fixed selling and administrative 10.000TOTAL FIXED COSTS 130.000breakeven units 26.000
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