Financial & Managerial Accounting rd Edition Weygandt Kimmel Kieso Chapter 19 Cost-Volume-Profit Analysis: Additional Issues Chapter Outline Learning Objectives LO Apply basic CVP concepts LO Explain the term sales mix and its effects on break-even sales LO Determine sales mix when a company has limited resources LO Indicate how operating leverage affects profitability Copyright ©2018 John Wiley & Son, Inc Basic CVP Concepts CVP analysis: Study of the effects of changes in costs and volume on a company’s profit Important to profit planning Critical in management decisions such as: LO  determining product mix,  maximizing use of production facilities,  setting selling prices Copyright ©2018 John Wiley & Son, Inc Basic CVP Concepts Basic Concepts Management often wants the information reported in a special format income statement CVP income statement is for internal use only: LO  Costs and expenses classified as fixed or variable  Reports contribution margin as a total amount and on a per unit basis Copyright ©2018 John Wiley & Son, Inc Basic CVP Concepts ILLUSTRATION 19.1 Basic CVP income statement Basic Concepts LO Copyright ©2018 John Wiley & Son, Inc ILLUSTRATION 19.2 Detailed CVP income statement LO Copyright ©2018 John Wiley & Son, Inc Break-Even Analysis Vargo Electronic’s CVP income statement (Ill 6.2) shows that total contribution margin is $320,000, and the company’s contribution margin per unit is $200 Contribution margin can also be expressed as the contribution margin ratio which is 40% ($200 ÷ $500) Unit Contribution Margin Fixed Costs ÷ $200,000 ÷ $200 Break-Even Point in = Units = 1,000 units ILLUSTRATION 19.3 Break-even point in units LO Copyright ©2018 John Wiley & Son, Inc Break-Even Analysis Vargo Electronic’s CVP income statement (Ill 6.2) shows that total contribution margin is $320,000, and the company’s contribution margin per unit is $200 Contribution margin can also be expressed as the contribution margin ratio which is 40% ($200 ÷ $500) Unit Contribution Ratio Fixed Costs ÷ $200,000 ÷ 40 Break-Even Point in = Dollars = $500,000 ILLUSTRATION 19.4 Break-even point in dollars LO Copyright ©2018 John Wiley & Son, Inc Target Net Income Once a company achieves break-even sales, a sales goal can be set that will result in a target net income Illustration: Assuming Vargo’s target net income is $250,000, compute required sales in units to achieve target net income : Unit Contribution (Fixed Costs + Target Net Income) ($200,000 + $250,000) ÷ ÷ Margin $200 Sales in Units = = 2,250 units ILLUSTRATION 19.5 Target net income in units LO Copyright ©2018 John Wiley & Son, Inc Target Net Income Once a company achieves break-even sales, a sales goal can be set that will result in a target net income Illustration: The contribution margin ratio is used to compute required sales in dollars (Fixed Costs + Target Net Income) ($200,000 + $250,000) ÷ ÷ Contribution Margin Ratio 40 Sales in Dollars = = $1,125,000 ILLUSTRATION 19.6 Target net income in dollars LO Copyright ©2018 John Wiley & Son, Inc 10 DO IT! Operating Leverage (2 of 2) Old Sales New $2,000,000 $2,000,000 1,400,000 600,000 Contribution margin 600,000 1,400,000 Fixed costs 400,000 1,200,000 Net income $200,000 $200,000 Variable costs Compute the degree of operating leverage Contribution Margin Old New LO Net Income ÷ = Degree of Operating Leverage $600,000 ÷ $200,000 = 3.00 $1,400,000 ữ $200,000 = 7.00 Copyright â2018 John Wiley & Son, Inc 55 Absorption Costing vs Variable Costing Under variable costing, product costs consist of: Direct Materials Direct Labor Variable Manufacturing Overhead Difference between absorption and variable costing is: Absorption Costing Variable Costing Fixed Product Cost Manufacturing Period Cost Overhead ILLUSTRATION 19A.1 LO Copyright ©2018 John Wiley & Son, Inc 56 Absorption Costing vs Variable Costing The difference between absorption and variable 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 LO Copyright ©2018 John Wiley & Son, Inc 57 Absorption vs Variable Costing (1 of 2) Illustration: Premium Products Corporation manufactures a sealant, called Fix-It, for car windshields Relevant data for Fix-It in January 2020, the first month of production is shown Selling price $20 per unit Units Produced 30,000; sold 20,000; beginning Variable unit costs inventory zero Manufacturing $9 (direct materials $5, direct labor $3, and variable overhead $1) Selling and administrative expenses $2 Fixed costs Manufacturing overhead $120,000 Selling and administrative expenses $15,000 ILLUSTRATION 19.A2 LO Copyright ©2018 John Wiley & Son, Inc 58 Absorption vs Variable Costing (2 of 2) Per unit manufacturing cost under each approach Type of Cost Absorption Variable Direct materials $5 Direct labor 3 ILLUSTRATION 19A.3 $5 Variable manufacturing overhead 1 Fixed manufacturing overhead ($120,000 ÷ 30,000 units produced) Manufacturing cost per unit $13 $9 Manufacturing cost per unit is $4 ($13 -$9) higher for absorption costing because fixed manufacturing costs are treated as product costs LO Copyright ©2018 John Wiley & Son, Inc 59 Absorption Costing Example ILLUSTRATION 19A.4 LO Copyright ©2018 John Wiley & Son, Inc 60 Variable Costing Example LO ILLUSTRATION 19A.5 Copyright ©2018 John Wiley & Son, Inc 61 Absorption Costing vs Variable Costing Question Fixed manufacturing overhead costs are recognized as: LO a Period costs under absorption 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 Copyright ©2018 John Wiley & Son, Inc 62 Decision-Making Concerns Generally accepted accounting principles require that absorption costing be used for the costing of inventory for external reporting purposes Net income measured under GAAP (absorption costing) is often used internally to LO  evaluate performance,  justify cost reductions, or  evaluate new projects Copyright ©2018 John Wiley & Son, Inc 63 Decision-Making Concerns Net income calculated using GAAP does not highlight differences between variable and fixed costs and may lead to poor business decisions Some companies use variable costing for internal reporting purposes LO Copyright ©2018 John Wiley & Son, Inc 64 Advantages of Variable Costing Net income computed under variable costing is unaffected by changes in production levels Variable costing readily supports cost-volume-profit analysis Net income computed under variable costing is closely tied to changes in sales levels and therefore provides a more realistic assessment of a company’s success or failure The presentation of fixed and variable cost components on the variable costing income statement makes it easier to identify these costs LO Copyright ©2018 John Wiley & Son, Inc 65 DO IT! Variable Costing (1 of 3) Franklin Company produces and sells tennis balls The following costs are available for the year ended December 31, 2020 The company has no beginning inventory In 2020, 8,000,000 units were produced, but only 7,500,000 units were sold The unit selling price was $0.50 per ball Costs and expenses were as follows Variable costs per unit Direct materials $0.10 Direct labor 0.05 Variable manufacturing overhead 0.08 Variable selling and administrative expenses 0.02 Annual fixed costs and expenses Manufacturing overhead $500,000 Selling and administrative expenses LO 100,000 Copyright ©2018 John Wiley & Son, Inc 66 DO IT! Variable Costing (2 of 3) Variable costs per unit Direct materials $0.10 Direct labor 0.05 Variable manufacturing overhead 0.08 Variable selling and administrative expenses 0.02 Annual fixed costs and expenses Manufacturing overhead $500,000 Selling and administrative expenses a 100,000 Compute the cost of one unit using variable costing Direct materials $0.10 $0.23 Direct labor 0.05 Variable manufacturing overhead LO 0.08 Copyright ©2018 John Wiley & Son, Inc 67 DO IT! Variable Costing (3 of 3) b Prepare a 2020 income statement using variable costing LO Copyright ©2018 John Wiley & Son, Inc 68 Copyright Copyright © 2018 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States 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 Copyright ©2018 John Wiley & Son, Inc 69 ... leverage affects profitability Copyright ©2018 John Wiley & Son, Inc Basic CVP Concepts CVP analysis: Study of the effects of changes in costs and volume on a company’s profit Important to profit planning... Its profits are greater than its total costs c The company should sell more units d Its selling price is less than its variable costs Copyright ©2018 John Wiley & Son, Inc 18 DO IT! CVP Analysis. .. IT! CVP Analysis (3 of 3) Using the contribution margin technique, compute the break-even point in units and dollars and margin of safety in dollars assuming changes to sales price and volume