IDENTIFYING COST BEHAVIOR PATTERNS

IDENTIFYING COST BEHAVIOR PATTERNSFor each of the following situations, identify the graph that illustrates the cost behavior pattern involved:Cost of raw materials usedElectricity Bill a flat fixed charge, plus a variable cost after a certain number of kilowatt hours are used.City water bill, which is computed as follows:

First 1,000,000 gallons or less$1,000 flat feeNext 10,000 gallons$0.003 per gallon usedNext 10,000 gallons$0.006 per gallon usedNext 10,000 gallons$0.009 per gallon usedEtcEtcIDENTIFYING COST BEHAVIOR PATTERNSRent on a factory building donated by the city, where the agreement calls for a fixed fee payment unless 200,000 labor-hours or more are worked, in which case no rent need be paid.

Salaries of maintenance workers, where one maintenance worker is needed for every 1,000 hours of machine-hours or less (that is, 0 to 1,000 hours require one maintenance worker, 1,001 to 2,000 requires two maintenance workers, etc.)CONTRIBUTION FORMAT VS. TRADITIONAL FORMAT OF INCOME STATEMENTTRADITIONAL FORMATCONTRIBUTION FORMATSalesSales- COGS- Variable expenses= Gross Profit= Contribution Margin- Selling & Administrative Expenses- Fixed Expenses= Net Income= Net IncomeMarwicks Pianos, Inc., purchases pianos from a large manufacturer and sells them at the retail level. The pianos cost, on the average, $2,450 each from the manufacturer. Marwicks Pianos, Inc., sells the pianos to its customers at an average price of $3,125 each. The selling and administrative costs that the company incurs in a typical month are presented below:

During August, Marwicks Pianos, sold and delivered 40 pianos.SELLING COSTSADMINISTRATIVE COSTSAdvertising..$700 per monthExecutive salaries..$2,500 per monthSales salaries and commissions..$950 per month, plus 8% of salesInsurance..$400 per monthDelivery of pianos to customers$30/piano soldClerical..$1,000/month, plus $20/piano soldUtilities..$350 per monthDepreciation of office equipment....$300/monthDepreciation of sales facilities..$800/monthTRADITIONAL FORMATSales$125,000Less: Cost of Goods Sold$98,000Gross Margin$27,000Less: Operating ExpensesSelling$14,000Administrative $5,000$19,000Net Income$8,000CONTRIBUTION FORMAT INCOME STATEMENTSales$125,000Variable Expenses:Variable production$98,000Variable selling$11,200Variable admin$800 $110,000Contribution margin$15,000Fixed Expenses:Fixed selling$2,800Fixed admin$4,200 $7,000Net Operating Income$8,000COST VOLUME PROFIT ANALYSISCost-volume-profit analysis is based upon determining the breakeven point of cost and volume of goods.CVP Analysis can help answer questions like: what products and services to offer and what prices to charge, etc. It can be useful for managers making short-term economic decisions.Running this analysis involves using several equations using price, cost and other variables and plotting them out on an economic graph.

COST VOLUME PROFIT ANALYSISCVP analysis has following assumptions:All cost can be categorized as variable or fixed.Sales price per unit, variable cost per unit and total fixed cost are constant.All units produced are sold.

CONTRIBUTION INCOME STATEMENT FOR ABC COMBANYTotalPer UnitSales*$100,000$250Variable Expenses$60,000 150Contribution margin$40,000$100Fixed Expenses:$35,000Net Operating Income$5,000

*400 SPEAKERS SOLDCONTRIBUTION INCOME STATEMENTIf 1 speakers is sold!!Total Per UnitSales$250$250Variable Expenses:$150 150Contribution margin$100$100Fixed Expenses:$35,000Net Operating Income$(34,900)CONTRIBUTION INCOME STATEMENTIf 2 speakers are sold!Total Per UnitSales$500$250Variable Expenses:$300 150Contribution margin$200$100Fixed Expenses:$35,000Net Operating Income$(34,800)

CONTRIBUTION INCOME STATEMENTSales of 350 SpeakersTotal Per UnitSales$87,500$250Variable Expenses$52,500 150Contribution margin$35,000$100Fixed Expenses:$35,000Net Operating Income$0

CONTRIBUTION INCOME STATEMENTSales of 351 SpeakersTotal Per UnitSales$87,750$250Variable Expenses$52,650 150Contribution margin$35,100$100Fixed Expenses:$35,000Net Operating Income$ 100

Once the break even point has been reached, net operating income will increase by the amount of the unit contribution margin for each additional unit sold.Volume (400 speakers)Sales Volume(425 speakers)Difference(25 speakers)Per UnitSales* $100,000$106,250$6,250$250Variable expenses**60,00063,7503,750150Contribution Margin40,00042,5002,500$100Fixed Expense35,00035,0000Net operating income$5,000$7,500$2,500*Sales= Price Volume: $250 400 = $100,000**Variable expense = Variable expense per speaker Volume: $150 400 = $60,000SUMMARYIf sales are zero, loss would equal fixed expenses.Each unit sold reduces the loss by the amount of unit contribution margin.After reaching break-even point, each additional unit sold increases the company's profit by the amount of the unit contribution margin.CVP RELATIONSHIPS IN GRAPHIC FORMCONTRIBUTION MARGIN RATIOCM Ratio = Total Contribution MarginTotal SalesOR

CM Ratio = Unit Contribution MarginUnit selling price

CONTRIBUTION MARGIN RATIOTotalPer Unit% of salesSales*$100,000 $250 100%Variable Expenses$60,000 150 60%Contribution margin$40,000 $100 40%Fixed Expenses:$35,000Net Operating Income$5,000

*400 SPEAKERS SOLD

$30,000 increase in sales?PresentExpectedIncrease% of salesSales $100,000*$130,000$30,000100%Variable expenses60,000**78,00018,00060%Contribution Margin40,00052,00012,00040%Fixed Expense35,00035,0000Net operating income$5,000$17,000$12,000*Sales= Price Volume: $250 400 = $100,000**Variable expense = Variable expense per speaker Volume: $150 400 = $60,000 OR 60% of sales

APPLICATIONS OF CVP CONCEPTSChanges in Fixed Cost & Sales VolumeChange in Variable Costs & Sales VolumeChanges in Fixed Cost, Sales Price, & Sales VolumeChanges in Variable Cost, Fixed Cost, and Sales VolumeChange in Selling PriceCHANGES IN FIXED COST & SALES VOLUMECurrent SalesSales with Additional Advertising BudgetDifference% of SalesSales$100,000$130,000$30,000100%Variable Expenses(60,000)78,000*18,00060%Contribution Margin40,00052,00012,00040%Fixed Expenses(35,000)45,000**10,000Net Operating Income$5,0007,0002,000*520 units $150 per unit = $78,000**35,000 + additional $10,000 monthly advertising budget = $45,000.ALTERNATIVE SOLUTION 1Expected total contribution margin: $130,000 40% CM ratio$52,000Present total contribution margin $100,000 40% CM ratio 40,000Incremental contribution margin 12,000Change in fixed expenses Less incremental advertising expense 10,000Increased net operating income$2,000ALTERNATIVE SOLUTION 2Incremental contribution margin:$30,000 40% CM ratio. $12,000

Less Incremental advertising expense. 10,000Increased net operating margin.. $ 2,000