Chapter 6-1 CHAPTER COST–VOLUME–PROFIT ANALYSIS: ADDITIONAL ISSUES Managerial Accounting, Fifth Edition Chapter 6-2 Study Study Objectives Objectives Describe the essential features of a cost-volumeprofit income statement Apply basic CVP concepts Explain the term sales mix and its effects on break-even sales Determine sales mix when a company has limited resources Understand how operating leverage affects profitability Chapter 6-3 Preview Preview of of Chapter Chapter The relationship between a company’s fixed and variable costs can have a huge impact on its profitability The current trend is toward companies with cost structures dominated by fixed costs This has significantly increased the volatility of many companies’ net income Thus, the use of CVP analysis has additional uses in making sound business decisions Chapter 6-4 Cost-Volume-Profit Cost-Volume-Profit Analysis: Analysis: Additional Additional Issues Issues Cost-VolumeCost-VolumeProfit Profit (CVP) (CVP) Review Review Basic concepts Basic computations CVP and changes in the business environment Chapter 6-5 Sales Sales Mix Mix Break-even sales in units Break-even in dollars Sales mix with limited resources Cost Cost Structure Structure and and Operating Operating Leverage Leverage Effect on contribution margin ration Effect on break-even point Effect on margin of safety ratio Operating leverage Cost-Volume-Profit Cost-Volume-Profit (CVP) (CVP) Review Review As noted in Chapter 5, CVP analysis is: the study of the effects of changes in costs and volume on a company’s profit CVP analysis is important to profit planning CVP analysis is critical in management decisions such as: determining product mix, maximizing use of production facilities, setting selling prices Chapter 6-6 Basic Basic Concepts Concepts CVP is so important, management often wants the information reported in a special format income statement The CVP income statement is for internal use only, classifies costs and expenses as fixed or variable, reports a contribution margin in the body of the statement Contribution margin – amount of revenue remaining after deducting all variable costs The contribution margin is often reported as a total amount and on a per unit basis Chapter 6-7 SO 1: Describe the essential features of a cost-volume-profit income statement CVP CVP Income Income Statement Statement Example Example The CVP income statement for Vargo Video Company is illustrated below: (This illustration was also presented as Illustration 5-11 in Chapter 5.) Illustration 6-1 Chapter 6-8 SO 1: Describe the essential features of a cost-volume-profit income statement CVP CVP Income Income Statement Statement –– Example Example Cont’d Cont’d A detailed CVP income statement for Vargo Video Company is illustrated below: (This uses the same base information as the previous statement.) Chapter 6-9 Illustration 6-2 SO 1: Describe the essential features of a cost-volume-profit income statement Basic Basic Computations Computations –– A A Review Review Break-Even Analysis As noted in Chapter 5, Vargo Video’s contribution margin per unit is $200 (sales price $500 - $300 variable costs) It was also shown that Vargo Video’s contribution margin ratio was: Chapter 6-10 SO 2: Apply basic CVP concepts Operating Operating Leverage Leverage The degree of operating leverage provides a measure of a company’s earnings volatility The degree of operating leverage is computed by dividing total contribution margin by net income The computations for Vargo and New Wave are: Illustration 6-25 New Wave’s earnings would go up (or down) by about two times (5.33 ÷ 2.67 = 1.99) as much as Vargo’s with an equal increase in sales Chapter 6-45 SO 5: Understand how operating leverage affects profitability Let’s Let’s Review Review The degree of operating leverage: a Can be computed by dividing total contribution margin by net income b Provides a measure of the company’s earnings volatility c Affects a company’s break-even point d All of the above Chapter 6-46 SO 5: Understand how operating leverage affects profitability All All About About You You Big Decisions for Your Energy Future The cost of wind powered electricity can be as low as or cents per kilowatt hour (about the same as coal) It costs about $77,500 to install a residential solarpowered system It would take 50 years without subsidies to recover your cost or ten years with subsidies Industrial plants using solar power have a cost of 30 cents per kilowatt hour A new approach could lower this to – 12 cents EPA Energy Star designated products could save 30% in energy use as well as about $12 billion on utility bills Chapter 6-47 All All About About You You What Do You Think? Do you think that it is possible to compare coal with alternative energy sources without considering environmental costs? Should environmental costs be incorporated into decision formulas when evaluating new power plants? Chapter 6-48 Chapter Chapter Review Review Brief Brief Exercise Exercise 6-9 6-9 Presto Candle Supply makes candles The sales mix (as a percent of total dollar sales) of its three product lines is as follows: birthday candles, 30%; standard tapered candles, 50%; and large scented candles, 20% The contribution margin ratio of each candle type is shown below Candle Type Contribution Margin Ratio Birthday 10% Standard tapered 20% Large scented 45% What is the weighted-average contribution margin ratio? Chapter 6-49 Chapter Chapter Review Review Brief Brief Exercise Exercise 6-9 6-9 Type of Candles CMR Sales Mix Birthday 10% × 30% = 3% Standard tapered 20% × 50% = Large scented 45% × 20% = 9% Weighted Average Contribution Margin Ratio 10% 22% If the company’s fixed costs are $440,000 per year, what is the dollar amount of each type of candle that must be sold to break even? Step 1: Fixed Costs: $440,000 ÷ WACMR 22% = $ BEP = $2,000,000 Step 2: Birthday candles $2,000,000 × 30% = $ 600,000 Standard tapered $2,000,000 × 50% = 1,000,000 Large scented $2,000,000 × 20% = 400,000 Chapter 6-50 Appendix Appendix Absorption Absorption Costing Costing vs vs Variable Variable Costing Costing Under variable costing, product costs consist of: Direct Materials  Direct Labor Variable Mfg Overhead The difference between absorption and variable costing is: Illustration 6A-1 Chapter 6-51 SO 6: Explain the difference between absorption costing and variable costing Appendix Appendix Absorption Absorption Costing Costing vs vs Variable Variable Costing Costing Under both costing methods, selling and administrative expenses are treated as period costs Companies may not use variable costing for external financial reports because GAAP requires that fixed manufacturing overhead be treated as a product cost Chapter 6-52 Fixed Mfg Overhead SO 6: Explain the difference between absorption costing and variable costing Appendix Appendix Absorption Absorption Costing Costing vs vs Variable Variable Costing Costing Example – Premium Products Manufactures Fix-it, a sealant for car windows Relevant data for January 2011, the first month of production are: Illustration 6A-2 Chapter 6-53 SO 6: Explain the difference between absorption costing and variable costing Appendix Appendix Absorption Absorption Costing Costing vs vs Variable Variable Costing Costing Example – Continued Per unit manufacturing cost under each approach Illustration 6A-3 The manufacturing cost per unit is $4 ($13 - $9) higher for absorption costing because fixed manufacturing costs are treated as product costs Chapter 6-54 SO 6: Explain the difference between absorption costing and variable costing Appendix Appendix Absorption Absorption Costing Costing Income Income Statement Statement Illustration 6A-4 Chapter 6-55 SO 6: Explain the difference between absorption costing and variable costing Appendix Appendix Variable Variable Costing Costing Income Income Statement Statement Illustration 6A-5 Chapter 6-56 SO 6: Explain the difference between absorption costing and variable costing Appendix Appendix Summary Summary of of Income Income Effects Effects Illustration 6A-14 Chapter 6-57 SO 7: Discuss net income effects under absorption costing versus variable costing Let’s Let’s Review Review Fixed manufacturing overhead costs are recognized as: a Period costs under absorption costing costing b Product costs under absorption costing c Product costs under variable costing d Part of ending inventory costs under both absorption and variable costing Chapter 6-58 SO 6: Explain the difference between absorption costing and variable costing Copyright Copyright Copyright © 2010 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Chapter 6-59 .. .CHAPTER COST–VOLUME–PROFIT ANALYSIS: ADDITIONAL ISSUES Managerial Accounting, Fifth Edition Chapter 6-2 Study Study Objectives Objectives Describe... many companies’ net income Thus, the use of CVP analysis has additional uses in making sound business decisions Chapter 6-4 Cost-Volume-Profit Cost-Volume-Profit Analysis: Analysis: Additional... prices Chapter 6-6 Basic Basic Concepts Concepts CVP is so important, management often wants the information reported in a special format income statement The CVP income statement is for internal