managerial accounting - yola 10... · managerial accounting lecture 10: cost-volume-profit (cvp)...

Managerial AccountingLecture 10: Cost-Volume-Profit (CVP)

Analysis

Chapter

23Chapter

23

Masud JahanDepartment of Science and Humanities

Military Institute of Science and Technology

Cost-volume-profit (CVP) analysis is used toanswer questions such as: How much must I sell to earn my desired income? How will income be affected

if I reduce selling prices toincrease sales volume?

What will happen toprofitability if I expandcapacity?




Cost-Volume-Profit Relationships

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Total fixed costs remain unchangedwhen activity changes.

Monthly factory rent does not changewhen production level is more or less.Monthly factory rent does not changewhen production level is more or less.

Fixed CostsM

onth

ly F

acto

ry R

ent

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Monthly factory rent does not changewhen production level is more or less.Monthly factory rent does not changewhen production level is more or less.

Units produced

Mon

thly

Fac

tory

Ren

t

Fixed costs per unit decline as activity increases.

Fixed Costs

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Factory rent per unitproduced declines as

more units are produced

Factory rent per unitproduced declines as

more units are produced

Units produced

Per

uni

tfa

ctor

y re

nt

Tota

l Ele

ctric

ity B

ill

Total variable costs change when activitychanges.

Variable Costs

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Units used

Tota

l Ele

ctric

ity B

ill

Your total Electricity bill is basedon how many units you used.

Your total Electricity bill is basedon how many units you used.

Per

uni

t Ele

ctric

ity B

ill

Variable costs per unit do not changeas activity increases.

Variable Costs

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Units used

Per

uni

t Ele

ctric

ity B

illThe cost per unit used is constant.

For example, Tk 3 per unit .The cost per unit used is constant.

For example, Tk 3 per unit .

Mixed costs contain a fixed portion that is incurred evenwhen facility is unused, and a variable portion thatincreases with usage.

Mixed costs contain a fixed portion that is incurred evenwhen facility is unused, and a variable portion thatincreases with usage.

Semi variable Costs (Mixed Costs)

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Example: Monthly fixed phone bill Fixed line rent Variable charge per

minute talked

Tota

l Util

ity C

ost

Slope isvariable cost

per unitof activity.

Slope isvariable cost

per unitof activity.

Semi variable Costs (Mixed Costs)

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VariableUtility Charge

Activity (minute talked)

Tota

l Util

ity C

ost

Fixed MonthlyUtility Charge

Summary of Variable and Fixed Cost BehaviorVariable Costs Fixed costs

Per Unit Remains the same evenwhen activity level changes.

Dereases as activity levelincreases.

Total Changes as activity levelchanges.

Remains the same over wideranges of activity.

Cost Behavior Summary

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Summary of Variable and Fixed Cost BehaviorVariable Costs Fixed costs

Per Unit Remains the same evenwhen activity level changes.

Dereases as activity levelincreases.

Total Changes as activity levelchanges.

Remains the same over wideranges of activity.

Learning Objective

To explain how economies ofscale can reduce unit costs.

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To explain how economies ofscale can reduce unit costs.

LO2

Economies of Scale

Mon

thly

mac

hine

ry re

nt p

erun

it m

anuf

actu

red

Consider machinery rent example.Consider machinery rent example.

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Total Units manufactured

Mon

thly

mac

hine

ry re

nt p

erun

it m

anuf

actu

red

Fixed costs per unitdecline as activity

increases.

Fixed costs per unitdecline as activity

increases.

Economies of Scale

Economies of scale are most apparentin business with high fixed costs.


SteelMillsSteelMills

UtilityCompanies

UtilityCompanies

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AirlinesAirlines

OilRefineries

OilRefineries

SteelMillsSteelMills

UtilityCompanies

UtilityCompanies

Economies of Scale



Number Fixed CostFixed Costs of Flights Fixed Cost per Passengerper Month per Month per Flight (250 Passengers/Flight)

100,000,000$ 1,000 100,000$ $400100,000,000$ 2,000 50,000$ $200100,000,000$ 4,000 25,000$ $100100,000,000$ 8,000 12,500$ $50

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Number Fixed CostFixed Costs of Flights Fixed Cost per Passengerper Month per Month per Flight (250 Passengers/Flight)

100,000,000$ 1,000 100,000$ $400100,000,000$ 2,000 50,000$ $200100,000,000$ 4,000 25,000$ $100100,000,000$ 8,000 12,500$ $50

AirlinesAirlines

Total cost remainsconstant within anarrow range of

activity.


activity.

Stair-Step Costs

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Activity

Cos

t


activity.


activity.

Total cost increases to anew higher cost for the

next higher range ofactivity.

Stair-Step Costs

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Activity

Cos

t

Learning Objective

To prepare acost-volume-profit

graph.

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To prepare acost-volume-profit

graph.

LO3

Total Per UnitSales (500 bikes) 250,000$ 500$Less: variable expenses 150,000 300Contribution margin 100,000 200$

SPEEDO BICYCLE CO.Contribution Income Statement

For the Month of June

CM can be expressedin total or per unit.

The Basics of Cost-Volume-Profit(CVP) Analysis

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Total Per UnitSales (500 bikes) 250,000$ 500$Less: variable expenses 150,000 300Contribution margin 100,000 200$



Contribution margin (CM) is the difference betweensales revenue and variable expenses.

The CM ratio is computed by dividing theper unit contribution margin by the per unit selling price.

Tk 200 ÷ Tk 500 = 40%

Total Per UnitSales (500 bikes) 250,000$ 500$Less: variable expenses 150,000 300Contribution margin 100,000 200$Less: fixed expenses 80,000Net income 20,000$



The Basics of Cost-Volume-Profit(CVP) Analysis

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Total Per UnitSales (500 bikes) 250,000$ 500$Less: variable expenses 150,000 300Contribution margin 100,000 200$Less: fixed expenses 80,000Net income 20,000$



After fixed expenses are covered,any additional contribution margin

results in net income.

The Contribution Margin Format

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Used primarily forexternal reporting.

Used primarily bymanagement.

Speedo has $ 80,000 of fixed expenses.If Speedo sells 400 units in a month,

Speedo will generate $ 80,000 in total CM($ 200 CM per unit x 400 units).

Speedo will be operating at its break-even point.

Break-Even Point

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Total Per UnitSales (400 bikes) 200,000$ 500$Less: variable expenses 120,000 300Contribution margin 80,000 200$Less: fixed expenses 80,000Net income $ 0



Total Per UnitSales (401 bikes) 200,500$ 500$Less: variable expenses 120,300 300Contribution margin 80,200 200$Less: fixed expenses 80,000Net income 200$



If Speedo sells one additional unit(that is, 401 bikes), net income will be $ 200.

Additional Unit Sales

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Total Per UnitSales (401 bikes) 200,500$ 500$Less: variable expenses 120,300 300Contribution margin 80,200 200$Less: fixed expenses 80,000Net income 200$



Net income will increase by Tk 200 (the CM per unit)as each additional unit is sold.

The point where total contributionmargin equals total fixed expenses.

The point where total sales revenueequals total expenses (variable andfixed).

The break-even point can be defined as:

The Contribution Approach

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The point where total contributionmargin equals total fixed expenses.

The point where total sales revenueequals total expenses (variable andfixed).

Break-even analysis can be approachedin two ways - contribution margin method

or equation method.Covered here

Viewing CVP relationships in a graph gives managers aperspective that can be obtained in no other way.

Consider the following information for Speedo Company:

Income300 units

Income400 units

Income500 units

Sales 150,000$ 200,000$ 250,000$Less: variable expenses 90,000 120,000 150,000Contribution margin 60,000$ 80,000$ 100,000$Less: fixed expenses 80,000 80,000 80,000Net income (loss) (20,000)$ -$ 20,000$

CVP Relationships in Graphic Form

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Income300 units

Income400 units

Income500 units

Sales 150,000$ 200,000$ 250,000$Less: variable expenses 90,000 120,000 150,000Contribution margin 60,000$ 80,000$ 100,000$Less: fixed expenses 80,000 80,000 80,000Net income (loss) (20,000)$ -$ 20,000$

Cos

ts a

nd R

even

uein

Dol

lars

Revenue Starting at the origin, draw the total revenueline with a slope equal to the unit sales price.

Preparing a CVP Graph

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Volume in Units

Cos

ts a

nd R

even

uein

Dol

lars

Total fixed cost

Total fixed costextends horizontallyfrom the vertical axis.

Cos

ts a

nd R

even

uein

Dol

lars

Break-evenPoint

Profit

Draw the total cost line with a slopeequal to the unit variable cost.

Revenue

Preparing a CVP Graph

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Total cost

Volume in Units

Cos

ts a

nd R

even

uein

Dol

lars

Total fixed cost

Break-evenPoint

Loss

CVP Graph

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

- 100 200 300 400 500 600 700 800

Total Expenses

Total Sales

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-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

- 100 200 300 400 500 600 700 800

Volume in Units

Break-even point

Fixed Expenses

Learning Objective

To compute the contributionmargin and explain

its usefulness.

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To compute the contributionmargin and explain

its usefulness.

LO4

The break-even point (expressed in unitsof product or Tk of sales) is the uniquesales level at which a company neither

earns a profit nor incurs a loss.

Computing Break-Even Point

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The break-even point (expressed in unitsof product or Tk of sales) is the uniquesales level at which a company neither

earns a profit nor incurs a loss.

We have just seen one of the basic CVPrelationships – the break-even computation.

Break-even point in units = Fixed costsContribution margin per unit

Formula for ComputingBreak-Even Sales (in Units)

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Break-even point in units = Contribution margin per unit

Unit sales price less unit variable cost(Tk 20 in previous example)

Unit sales price less unit variable cost(Tk 20 in previous example)

The break-even formula may also beexpressed in sales Tk or $.

Break-even point in Tk = Fixed costs

Formula for ComputingBreak-Even Sales (in Tk)

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Break-even point in Tk = Fixed costsContribution margin ratio

Contribution margin per unitUnit sales price

Computing Break-Even Sales

ABC Co. sells product XYZ at Tk 5.00 per unit. Iffixed costs are Tk 200,000 and variable costs are Tk3.00 per unit, how many units must be sold to breakeven?

a. 100,000 unitsb. 40,000 unitsc. 200,000 unitsd. 66,667 units



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ABC Co. sells product XYZ at Tk 5.00 per unit. Iffixed costs are Tk 200,000 and variable costs areTk 3.00 per unit, how many units must be sold tobreak even?





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Unit contribution = Tk 5.00 - Tk 3.00 =Tk 2.00

Fixed costsUnit contribution

=Tk 200,000

Tk 2.00 perunit= 100,000 units

Use the contribution margin ratio formula todetermine the amount of sales revenue ABC musthave to break even. All information remainsunchanged: fixed costs are Tk 200,000; unit salesprice is Tk 5.00; and unit variable cost is Tk 3.00.

a. Tk 200,000b. Tk 300,000c. Tk 400,000d. Tk 500,000


a. Tk 200,000b. Tk 300,000c. Tk 400,000d. Tk 500,000


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a. Tk 200,000b. Tk 300,000c. Tk 400,000d. Tk 500,000


a. Tk 200,000b. Tk 300,000c. Tk 400,000d. Tk 500,000


a. Tk 200,000b. Tk 300,000c. Tk 400,000d. Tk 500,000


a. Tk 200,000b. Tk 300,000c. Tk 400,000d. Tk 500,000


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a. Tk 200,000b. Tk 300,000c. Tk 400,000d. Tk 500,000


a. Tk 200,000b. Tk 300,000c. Tk 400,000d. Tk 500,000

Unit contribution = Tk 5.00 - Tk 3.00 = Tk 2.00Contribution margin ratio = Tk 2.00 ÷ Tk 5.00 = .40Break-even revenue = Tk 200,000 ÷ .4 = Tk 500,000

Unit contribution = Tk 5.00 - Tk 3.00 = Tk 2.00Contribution margin ratio = Tk 2.00 ÷ Tk 5.00 = .40Break-even revenue = Tk 200,000 ÷ .4 = Tk 500,000

Learning Objective

Determine the sales volumerequired to earn a desiredlevel of operating income.

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Determine the sales volumerequired to earn a desiredlevel of operating income.

LO5

Break-even formulas may be adjusted to showthe sales volume needed to earnany amount of operating income.

Break-even formulas may be adjusted to showthe sales volume needed to earnany amount of operating income.

Computing Sales Needed toAchieve Target Operating Income

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Unit sales = Fixed costs + Target incomeContribution margin per unit

Amount sales = Fixed costs + Target incomeContribution margin ratio

ABC Co. sells product XYZ at Tk 5.00 perunit. If fixed costs are Tk 200,000 andvariable costs are Tk 3.00 per unit, howmany units must be sold to earn operatingincome of Tk 40,000?




Computing Sales Needed toAchieve Target Operating Income

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Computing Sales Needed to AchieveTarget Operating Income

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= 120,000 units

Unit contribution = Tk 5.00 - Tk 3.00 = Tk 2.00

Fixed costs + Target incomeUnit contribution

Tk 200,000 + Tk 40,000Tk 2.00 per unit

What is our Margin of Safety?

Margin of safety is the amount by which sales maydecline before reaching break-even sales:

Margin of safety provides a quick means of estimatingoperating income at any level of sales:

Margin of safety = Actual sales - Break-even sales

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Margin of safety is the amount by which sales maydecline before reaching break-even sales:

Margin of safety provides a quick means of estimatingoperating income at any level of sales:

Operating Margin ContributionIncome of safety margin ratio= ×

What is our Margin of Safety?

ADM contribution margin ratio is 40 percent. Ifsales are Tk 100,000 and break-even sales are

Tk 80,000, what is operating income?

ADM contribution margin ratio is 40 percent. Ifsales are Tk 100,000 and break-even sales are

Tk 80,000, what is operating income?

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Operating Margin ContributionIncome of safety margin ratio

Operating Margin ContributionIncome of safety margin ratio== ××

OperatingIncome

OperatingIncome = Tk 20,000 × .40 = Tk 8,000= Tk 20,000 × .40 = Tk 8,000

Learning Objective

To use the contributionmargin to estimate thechange in operatingincome caused by a

change in sales volume.

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LO6

To use the contributionmargin to estimate thechange in operatingincome caused by a

change in sales volume.

What Change In OperatingIncome Do We Anticipate?Once break-even is reached, every additional Tk of

contribution margin becomes operating income:

ADM expects sales to increase by Tk 15,000 and has acontribution margin ratio of 40%. How much will

operating income increase?

Change in Change in Contributionoperating income sales volume margin ratio= ×

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Once break-even is reached, every additional Tk ofcontribution margin becomes operating income:

ADM expects sales to increase by Tk 15,000 and has acontribution margin ratio of 40%. How much will

operating income increase?

Change inoperating income = Tk 15,000 × .40 = Tk 6,000

Change in Change in Contributionoperating income sales volume margin ratio= ×

Learning Objective

To use CVP relationshipsto evaluate a new

marketing strategy.

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LO7

To use CVP relationshipsto evaluate a new

marketing strategy.

Total Per Unit PercentSales (500 bikes) ৳ 250,000.00 ৳ 500.00 ৳ 1.00Less: variable expenses ৳ 150,000.00 ৳ 300.00 ৳ 0.60Contribution margin ৳ 100,000.00 ৳ 200.00 ৳ 0.40Less: fixed expenses ৳ 80,000.00Operating income ৳ 20,000.00

Consider the following information developed bythe accountant at Speedo, a bicycle retailer:

Business Applications of CVP

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Should Speedo spend Tk 12,000 on advertisingto increase sales by 10 percent?



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500 550Bikes Bikes

Sales ৳ 250,000.00 ৳ 275,000.00Less: variable expenses ৳ 150,000.00 ৳ 165,000.00Contribution margin ৳ 100,000.00 ৳ 110,000.00Less: fixed expenses ৳ 80,000.00 ৳ 92,000.00Operating income ৳ 20,000.00 ৳ 18,000.00

550 × Tk 500


Should Speedo spend Tk 12,000 onadvertising to increase sales by 10 percent?

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500 550Bikes Bikes


550 × Tk 300

Tk 80K + Tk 12K

No, income is decreased.

500Bikes

Sales ৳ 250,000.00Less: variable expenses ৳ 150,000.00Contribution margin ৳ 100,000.00Less: fixed expenses ৳ 80,000.00Operating income ৳ 20,000.00

Now, in combination with the advertising,Speedo is considering a 10 percent price reduction that willincrease sales by 25 percent. What is the income effect?


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500Bikes


500 625Bikes Bikes


625 × Tk 450

Now, in combination with the advertising,Speedo is considering a 10 percent price reduction that willincrease sales by 25 percent. What is the income effect?

1.25 × 500


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500 625Bikes Bikes


625 × Tk 300

Tk 80K + Tk 12K

Income is decreased even more.

625 × Tk 450

500Bikes


Business Applications of CVPNow, in combination with advertising and a price cut, Speedowill replace Tk 50,000 in sales salaries with a Tk 25 per bike

commission, increasing sales by 50 percent above theoriginal 500 bikes. What is the effect on income?

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500Bikes


500 750Bikes Bikes


750 × Tk 450

Business Applications of CVPNow, in combination with advertising and a price cut, Speedowill replace Tk 50,000 in sales salaries with a Tk 25 per bike

commission, increasing sales by 50 percent above theoriginal 500 bikes. What is the effect on income?

1.5 × 500

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500 750Bikes Bikes


The combination of advertising, a price cut,and change in compensation increases income.

750 × Tk 325

Tk 92K - Tk 50K

750 × Tk 450

500Bikes


Should Speedo use higher quality parts would increase variable costsby Tk 10. However, the sales manager believes that the higher quality parts

will increase bike sales from 500 units to 540 units.

Should the increase be approved?


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500Bikes


500 540Bikes Bikes


500+40

Business Applications of CVPShould Speedo use higher quality parts would increase variable costs

by Tk 10. However, the sales manager believes that the higher quality partswill increase bike sales from 500 units to 540 units.

Should the increase be approved?

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500 540Bikes Bikes


540 × Tk 310

Net income increases by Tk 2,600.So, it’s acceptable

540 × Tk 500

Learning Objective

To determine semi variablecost elements.

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LO8

To determine semi variablecost elements.

Matrix, Inc. recorded the following production activityand maintenance costs for two months:

Using these two levels of activity, compute: the variable cost per unit. the total fixed cost. total cost formula.

Units CostHigh activity level 9,000 9,700$Low activity level 5,000 6,100Change 4,000 3,600$

The High-Low Method

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Matrix, Inc. recorded the following production activityand maintenance costs for two months:

Using these two levels of activity, compute: the variable cost per unit. the total fixed cost. total cost formula.



The High-Low Method

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Unit variable cost = = = Tk 0.90 per

unit

Tk 3,6004,000

∆in cost∆ in units


The High-Low Method

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unit Fixed cost = Total cost – Total variable cost

Tk 3,6004,000



The High-Low Method

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Fixed cost = Tk 9,700 – (Tk 0.90 per unit × 9,000 units)Fixed cost = Tk 9,700 – Tk 8,100 = Tk 1,600


Tk 3,6004,000


The High-Low Method

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Fixed cost = Tk 9,700 – (Tk 0.90 per unit × 9,000 units)Fixed cost = Tk 9,700 – Tk 8,100 = Tk 1,600

Total cost = Tk 1,600 + Tk .90 per unit

Tk 3,6004,000


The High-Low Method

If sales commissions are Tk 10,000 when 80,000units are sold and Tk 14,000 when 120,000 unitsare sold, what is the variable portion of salescommission per unit sold?

a. Tk .08 per unitb. Tk .10 per unitc. Tk .12 per unitd. Tk .125 per unit



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If sales commissions are Tk 10,000 when80,000 units are sold and Tk 14,000 when120,000 units are sold, what is the variableportion of sales commission per unit sold?




The High-Low Method

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Tk 4,000 ÷ 40,000units

= Tk .10 per unit

Units CostHigh leve l 120,000 14,000$Low leve l 80,000 10,000Change 40,000 4,000$

The High-Low Method

If sales commissions are Tk 10,000 when 80,000units are sold and Tk 14,000 when 120,000 unitsare sold, what is the fixed portion of the salescommission?

a. Tk 2,000b. Tk 4,000c. Tk 10,000d. Tk 12,000


a. Tk 2,000b. Tk 4,000c. Tk 10,000d. Tk 12,000

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a. Tk 2,000b. Tk 4,000c. Tk 10,000d. Tk 12,000


a. Tk 2,000b. Tk 4,000c. Tk 10,000d. Tk 12,000

If sales commissions are Tk 10,000 when80,000 units are sold and Tk 14,000 when120,000 units are sold, what is the fixedportion of the sales commission?

a. Tk 2,000b. Tk 4,000c. Tk 10,000d. Tk 12,000


a. Tk 2,000b. Tk 4,000c. Tk 10,000d. Tk 12,000

Total cost = Total fixed cost +Total variable cost

$14,000 = Total fixed cost +($.10 × 120,000 units)

Total fixed cost = $14,000 - $12,000

Total fixed cost = $2,000

The High-Low Method

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a. Tk 2,000b. Tk 4,000c. Tk 10,000d. Tk 12,000


a. Tk 2,000b. Tk 4,000c. Tk 10,000d. Tk 12,000

Total cost = Total fixed cost +Total variable cost

$14,000 = Total fixed cost +($.10 × 120,000 units)

Total fixed cost = $14,000 - $12,000

Total fixed cost = $2,000

A limited range of activity, called the relevantrange, where CVP relationships are linear.Unit selling price remains constant.Unit variable costs remain constant.Total fixed costs remain constant.

Sales mix remains constant. Production = sales (no inventory changes).

Assumptions Underlying CVPAnalysis

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A limited range of activity, called the relevantrange, where CVP relationships are linear.Unit selling price remains constant.Unit variable costs remain constant.Total fixed costs remain constant.

Sales mix remains constant. Production = sales (no inventory changes).

End of Lecture 10THANK YOU ALL…

End of Lecture 10THANK YOU ALL…

managerial accounting - yola 10... · managerial accounting lecture 10: cost-volume-profit (cvp)...

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