chapter 3: analysis of cost volume and...
TRANSCRIPT
©2014 Pearson Education. All rights reserved.
CHAPTER 3:
ANALYSIS OF COST–VOLUME AND
PRICING TO INCREASE
PROFITABILITY - CVP ANALYSIS
©2014 Pearson Education. All rights reserved.
Learning Objectives
1. Explain the features of cost-volume-profit (CVP)
analysis
2. Determine the breakeven point and output level
needed to achieve a target operating income
3. Explain how managers use CVP analysis in
decision making
4. Explain how sensitivity analysis helps managers
cope with uncertainty
©2014 Pearson Education. All rights reserved.
Learning Objectives
6. Use CVP analysis to plan variable and fixed costs
7. Apply CVP analysis in service and not-for-profit
organizations
8. Distinguish contribution margin from gross margin
©2014 Pearson Education. All rights reserved.
Learning Objective 1
Explain the Features of Cost-
Volume-Profit (CVP) Analysis
©2014 Pearson Education. All rights reserved.
Cost-Volume-Profit Analysis
Analysis of the behavior and relationship among
total revenues, total costs, and income as the units
sold, selling price, variable cost per unit, or fixed
costs change
©2014 Pearson Education. All rights reserved.
Steps in Decision Making
Identify the problem and uncertainties
Obtain information
Make predictions about the future
Make decisions by choosing among alternatives
Implement the decision, evaluate performance, and learn
©2014 Pearson Education. All rights reserved.
Contribution Margin
Difference between total revenues and total variable
costs
©2014 Pearson Education. All rights reserved.
Exhibit 3.1 - Contribution Income
Statement
©2014 Pearson Education. All rights reserved.
Contribution Margin Percentage
Calculating contribution margin per unit is
cumbersome when companies have multiple
products
It is contribution margin as a percentage, instead of
dollars
It is the contribution margin per dollar of revenue
©2014 Pearson Education. All rights reserved.
Expressing CVP Relationships
Three related ways in which cost-volume-profit
relationships can be analyzed:
Equation method
Contribution method
Graph method
©2014 Pearson Education. All rights reserved.
Equation Method
Based on the operating income equation:
This equation can be further expanded as:
Operating income = [(Selling price × Quantity of units sold) −
(Variable per unit × Quantity of units sold)] − Fixed costs
Operating income = Revenues − Variable costs − Fixed costs
©2014 Pearson Education. All rights reserved.
Contribution Margin Method
Uses the contribution margin per unit to calculate
the operating income
Operating income = [(Contribution margin per unit) × (Quantity
of units sold)] − Fixed costs
©2014 Pearson Education. All rights reserved.
Exhibit 3.2 - Graph Method
©2014 Pearson Education. All rights reserved.
Cost-Volume-Profit Assumptions
The number of units sold is the only revenue driver
and the only cost driver
Total costs can be separated into two components: a
fixed component and a variable component
When represented graphically, the behaviors of
total revenues and total costs are linear
Selling price, variable cost per unit, and total fixed
costs are known
©2014 Pearson Education. All rights reserved.
Learning Objective 2
Determine the Breakeven Point and
Output Level Needed to Achieve a
Target Operating Income
©2014 Pearson Education. All rights reserved.
Breakeven Point
Quantity of output sold at which total revenues
equal total costs
When there are multiple products, it is convenient to
calculate breakeven point directly in terms of
revenue
©2014 Pearson Education. All rights reserved.
Target Operating Income
Helps in determining the number of units that should
be sold to achieve a target operating income
©2014 Pearson Education. All rights reserved.
Exhibit 3.3 - Profit-Volume Graph
Shows how changes in the quantity of units sold
affect operating income
©2014 Pearson Education. All rights reserved.
Target Net Income and Income
Taxes
Helps managers asses the effects of their decisions
on operating income after taxes
©2014 Pearson Education. All rights reserved.
Learning Objective 4
Explain How Managers Use CVP
Analysis in Decision Making
©2014 Pearson Education. All rights reserved.
Using CVP Analysis for Decision
Making
Managers use CVP analysis to guide other decisions
Decision to advertise
Decision to reduce selling price
Determining target prices
It helps managers make product decisions by
estimating the expected profitability of these
decisions
©2014 Pearson Education. All rights reserved.
Learning Objective 5
Explain How Sensitivity Analysis
Helps Managers Cope with
Uncertainty
©2014 Pearson Education. All rights reserved.
Sensitivity Analysis
“What-if ” technique used to recognize uncertainty
by examining how an outcome will change if the
original predicted data or assumption change
Broadens managers’ perspectives to possible
outcomes that might occur before the company
commits to funding the project
Electronic spreadsheets enable managers to
systematically and efficiently conduct analyses
©2014 Pearson Education. All rights reserved.
Margin of Safety
©2014 Pearson Education. All rights reserved.
Learning Objective 6
Use CVP Analysis to Plan
Variable and Fixed Costs
©2014 Pearson Education. All rights reserved.
Alternative Fixed-Cost/Variable-Cost
Structures
Managers have the ability to choose the levels of
fixed and variable costs in their cost structures
Sensitivity analysis helps examine the risks and
returns in a company cost structure
As fixed costs are substituted for variable costs
©2014 Pearson Education. All rights reserved.
Operating Leverage
Describes the effects that fixed costs have on
changes in operating income as changes occur in
units sold and contribution margin.
Organizations with high proportion of fixed costs
will have higher operating leverage
©2014 Pearson Education. All rights reserved.
Learning Objective 7
Apply CVP Analysis to a
Company Producing Multiple
Products
©2014 Pearson Education. All rights reserved.
Effects of Sales Mix on CVP
Formulae presented to this point have assumed a
single product is produced and sold
Most companies sell a large variety of products
Sales mix is the quantities or proportions of various
products or services that constitute total unit sales of
a company
©2014 Pearson Education. All rights reserved.
Effects of Sales Mix on CVP
Total number of units that must be sold to break
even in a multiproduct company depends on the
sales mix
CVP analysis with multiple products is performed by
calculating a weighted average contribution margin
based upon a constant sales mix percentage
©2014 Pearson Education. All rights reserved.
Calculation of Break-even-point With
Multiple Products
Assume that the budgeted sales mix will not change
at different levels of total unit sales
©2014 Pearson Education. All rights reserved.
Effects of Sales Mix on Income
Many different sales mixes can result a given
contribution margin
Choice of sales mix affects the operating income of
a company
Companies adjust their sales mix to respond to
demand changes
©2014 Pearson Education. All rights reserved.
Learning Objective 8
Apply CVP Analysis in Service
and Not-for-Profit Organizations
©2014 Pearson Education. All rights reserved.
CVP Analysis in Service and Not-for-
Profit Organizations
To apply CVP analysis, the focus must be on
measuring organizational output
Measuring output is different from the tangible units
sold by manufacturing and merchandising
companies
©2014 Pearson Education. All rights reserved.
Learning Objective 9
Distinguish Contribution Margin
from Gross Margin
©2014 Pearson Education. All rights reserved.
Contribution Margin v/s Gross
Margin
Contribution margin
indicates how much of
a company’s revenues
are available to cover
fixed costs
Gross margin
measures how much a
company can charge
for its products over
and above the cost of
acquiring or producing
them
Contribution Margin Gross Margin