Prepared by Debby Bloom-Hill CMA, CFM CHAPTER CHAPTER 44 Cost-Volume-Profit Analysis Slide 4-2 Management Management Questions Questions  Planning   What level of profit should be in the budget for the coming year? Control  Did the manager responsible for production costs a good job of controlling costs?  Decision making  Should the price be increased? Slide 4-3 Learning objective 1: Identify common cost behavior patterns Common CommonCost CostBehavior BehaviorPatterns Patterns  Variable Costs  Costs which change directly in proportion to changes in quantity or activity  Fixed Costs  Costs which not change when quantity or activity volume changes Slide 4-4 Learning objective 1: Identify common cost behavior patterns Common CommonCost CostBehavior BehaviorPatterns Patterns  Mixed Costs   Costs that have both variable and fixed elements Step Costs  Fixed for a range of output, but increase when upper bound of range is exceeded Slide 4-5 Learning objective 1: Identify common cost behavior patterns Variable Variable Costs Costs  Costs that change in proportion to changes in volume or activity  An automobile manufacturer will need 400 tires to make 100 cars, but 4,000 tires to make 1,000 cars  A bakery will need eggs to make cake and 20 eggs to make 10 cakes  If activity increases by a certain percentage, cost increases by that same percentage Slide 4-6 Learning objective 1: Identify common cost behavior patterns Test Your Knowledge A company has decided that direct labor costs are 100% variable Last month total direct labor costs were $125,000 and total direct labor hours worked were 10,000 What is the direct labor cost per hour? $125,000 / 10,000 hours = $12.50 per hour Predict labor costs in a month when 12,000 labor hours are worked $12.50 per hour × 12,000 hours = $150,000 Slide 4-7 Learning objective 1: Identify common cost behavior patterns Variable Variable Costs Costs Total Variable Cost = $91 × Units produced Slide 4-8 Learning objective 1: Identify common cost behavior patterns Fixed Fixed Costs Costs   Do not change in response to changes in activity level Typical fixed costs are depreciation, supervisory salaries, and building maintenance • Rent for a bakery will not double if output increases from 100 to 200 cakes  If activity increases by a certain percentage, costs remain unchanged Slide 4-9 Learning objective 1: Identify common cost behavior patterns Fixed Fixed Costs Costs Total fixed cost = $94,000 Slide 4-10 Learning objective 1: Identify common cost behavior patterns Multiproduct Multiproduct Analysis Analysis  Contribution margin approach    Used if the items sold are similar Calculate a weighted average contribution margin per unit Use the weighted average contribution margin in the profit formula to calculate breakeven point and target sales  The relative product mix is then used to calculate the required sales of individual items Slide 4-50 Learning objective 3: Perform cost-volume profit analysis for single products Multiproduct Multiproduct Analysis Analysis  The company has fixed costs of $3,500,000 Slide 4-51 Learning objective 4: Perform cost-volume profit analysis for multiple products Multiproduct Multiproduct Analysis Analysis  Break-even sales in units = = 2,500 units  The 2,500 units is made up of the 2:1 mix, so Rohr must sell 1,667 Model A (2/3 of 2,500) and 833 Model B units (1/3 0f 2,500) Slide 4-52 Learning objective 4: Perform cost-volume profit analysis for multiple products Multiproduct Multiproduct Analysis Analysis  Contribution Margin Ratio Approach    Products are substantially different Calculate total company contribution margin ratio Use total company contribution margin ratio to compute required sales in dollars  Total company fixed costs (common costs) are not included for contribution margin approach but used for contribution margin ratio approach Slide 4-53 Learning objective 4: Perform cost-volume profit analysis for multiple products Multiproduct Multiproduct Analysis Analysis A company with divisions has the following information available: Total sales $6,450,000 Total variable costs $4,706,000 Total direct fixed costs $484,000 Total common fixed costs $1,120,000 Calculate total contribution margin ratio ($6,450,000 – $4,706,000) / $6,450,000 = 2704 Calculate total company break-even sales in dollars ($484,000 + $1,120,000) / 2704 = $5,931,953 Slide 4-54 Learning objective 4: Perform cost-volume profit analysis for multiple products Assumptions Assumptions in in CVP CVP Analysis Analysis  Assumptions can affect the validity of the analysis Costs can be separated into fixed and variable components Total fixed cost and unit variable cost not change over the levels of interest  Multiproduct analysis assumes the product mix does not change Despite assumptions, CVP is useful Slide 4-55 Learning objective 4: Perform cost-volume profit analysis for multiple products Operating Operating Leverage Leverage   Level of fixed versus variable costs in a company A company with a high level of fixed costs has a high operating leverage  Companies with high operating leverage have large fluctuations in profit when sales increase or decrease  These companies are seen as more risky  High operating leverage is better when sales are expected to increase Slide 4-56 Learning objective 5: Discuss the effect of operating leverage Constraints Constraints    Due to shortages of space, equipment or labor there can be constraints on how many items can be produced Utilize contribution margin per unit to analyze situations   Calculate contribution margin per unit of constraint Produce product with highest contribution margin per unit of constraint Linear programming can solve multiple constraints Slide 4-57 Learning objective 6: Use the cost per unit of the constraint to analyze situations involving a resource constraint Constraints Constraints A company can produce Product A or Product B using the same machinery Only 1,000 machine hours are available Slide 4-58 Learning objective 6: Use the cost per unit of the constraint to analyze situations involving a resource constraint Constraints Constraints  With the 1,000 available machine hours,    Product A generates $20,000 of contribution margin Product B generates $50,000 of contribution margin Although Product A has the higher contribution margin per unit, Product B has the higher contribution margin per unit of constraint Slide 4-59 Learning objective 6: Use the cost per unit of the constraint to analyze situations involving a resource constraint CHAPTER CHAPTER 44 Cost-Volume-Profit Analysis Appendix Slide 4-60 Regression Regression Analysis Analysis Slide 4-61 Learning objective 2: Estimate the relation between cost and activity using account analysis and the high-low method Regression Regression Analysis Analysis Slide 4-62 Learning objective 2: Estimate the relation between cost and activity using account analysis and the high-low method Regression Regression Analysis Analysis Slide 4-63 Learning objective 2: Estimate the relation between cost and activity using account analysis and the high-low method 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 Slide 4-64