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**Cost-Volume-Profit Analysis**

Chapter 19 Chapter 19 explains cost-volume-profit analysis (CVP Analysis).

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**Types of Costs The effect of volume of activity on costs**

Variable costs Increase or decrease in total in direct proportion to changes in the volume of activity Fixed costs Do not change over wide ranges of volume Mixed costs Have both variable and fixed components Some costs, like COGS, increase as the volume of activity increases. Other costs, like straight-line depreciation expense, are not affected by volume changes. Managers need to know how a business’s costs are affected by changes in the volume of activity. Let’s look at the three different types of costs: ● Variable costs that increase or decrease in total in direct proportion to increases or decreases in the volume of activity. ● Fixed costs tend to remain the same in amount, regardless of variations in level of activity. ● Mixed costs have both variable and fixed components are called mixed costs.

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Variable Costs Total variable costs change in direct proportion to changes in the volume of activity If activity increases, so does the cost Unit variable cost remains constant Volume can be measured in many different ways: Number of units sold Number of units produced Number of miles driven by a delivery vehicle Number of phone calls placed Total variable costs change in direct proportion to changes in the volume of activity. An activity is a business action that affects costs. Those activities include selling, producing, driving, and calling. These activities can be measured by units sold, units produced, miles driven, and the number of phone calls placed. So variable costs are those costs that increase or decrease in total as the volume of activity increases or decreases. Total variable costs increase as activity increases, but the variable cost per unit does not change. For example, direct materials is a variable cost. The more production that occurs, the more direct materials that are needed. The direct materials cost per unit stays constant at—say—$25, but the total direct materials cost increases proportionately with production.

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Total Variable Costs This graph emphasizes the direct relationship between production and direct materials costs. As you can see, the total variable cost of equipment rental increases proportionately as the number of events increases. But the equipment rental cost per event does not change. Exhibit 19-1 graphs total variable cost for equipment rental as the number of events increases from 0 to 30, but the cost for each equipment rental stays at $15 per event. If there are no events, the company incurs no equipment rental cost, so the total variable cost line begins at the bottom left corner. This point is called the origin, and it represents zero volume and zero cost. The slope of the variable cost line is the change in equipment rental cost (on the vertical axis) divided by the change in the number of events (on the horizontal axis). The slope of the graph equals the variable cost per unit. In Exhibit 19-1, the slope of the variable cost line is 15 because Greg’s spends $15 on equipment rental for each event. Total variable costs fluctuate with changes in volume, but the variable cost per unit remains constant.

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Fixed Costs Tend to remain the same in amount, regardless of variations in level of activity Examples: Straight-line depreciation Salaries Total fixed costs do not change, but the fixed cost per event depends on the number of events The more activity, the less the fixed cost per unit In contrast, total fixed costs are costs that do not change over wide ranges of volume. Fixed costs tend to remain the same in amount, regardless of variations in level of activity. A company’s fixed costs may include depreciation on the cars, as well as the part-time manager’s salary.

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**Total Fixed Costs and Fixed Costs per Unit**

This graph represents fixed costs. The straight blue line shows that fixed costs remain constant regardless of activity. Total fixed cost does not change, as shown in Exhibit But the fixed cost per event depends on the number of events. For example, if Greg’s Tunes performs at 15 events, the fixed cost per event is $800 ($12,000 ÷ 15 events). If the number of events doubles to 30, the fixed cost per event is cut in half to $400 ($12,000 ÷ 30 events). Therefore, the fixed cost per event is inversely proportional to the number of events.

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**Mixed Costs Have both a fixed and variable component Example:**

Utilities that charge a set fee per month, plus a charge for usage Your cell phone provider Costs that have both variable and fixed components are called mixed costs. For example, a cell phone company charges $10 a month to provide the service and $0.15 for each minute of use. If the cell phone is used for 100 minutes, the company will bill $25 [$10 + (100 minutes $0.15)]. The $10 monthly charge is a fixed cost because it is the same no matter how many minutes the company uses the cell phone. The $0.15-perminute charge is a variable cost that increases in direct proportion to the number of minutes of use.

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Mixed Costs This graph represents a mixed cost–cell phone. In this situation, the cell phone plan has a base cost of $10 per month, which is the fixed portion. In addition, each call cost is $0.15 per call; that is the variable portion.

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High-Low Method Method to separate mixed costs into variable and fixed components Identify the highest and lowest levels of activity over a period of time STEP 1: Calculate variable cost per unit STEP 2: Calculate total fixed cost STEP 3: Create and use equation to show the behavior of a mixed cost Variable cost per unit = Change in total cost ÷ Change in activity volume Total fixed cost = Total mixed cost – Total variable cost An easy method to separate mixed costs into variable and fixed components is the high-low method. This method requires you to identify the highest and lowest levels of activity over a period of time. This method provides a rough estimate of fixed and variable costs for cost-volume- profit analysis. The high and low volumes become the relevant range, which we discuss in the next section. Managers find the high-low method to be quick and easy, but regression analysis provides the most accurate estimates and is discussed in cost accounting textbooks. There are three steps to complete the high-low method. First, variable cost per unit is computed. That amount is used to determine the total fixed costs. Then, an equation is created to show the cost behavior. Total mixed cost = (Variable cost per unit X number of units) + Total fixed costs

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**High-Low Method: Steps 1 and 2**

Data Step 1 Step 2 The highest and lowest levels of activity (and the related costs) for a period of time are determined. To determine the variable cost per unit, the change in cost is divided by the change in activity. The next step is to pick one level of activity―either the high point or low point―and “plug” the variable cost per unit in the formula. Then, subtract that amount from the total cost for that point.

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**Step 3 ($2 x 400 event-playing hours) + $1,000 = $1,800**

Create and use an equation to show the behavior of the mixed costs. This equation is expressed as variable cost per unit multiplied by the number of units. This amount is added to the total fixed costs. This example uses the highest cost and volume to calculate the total fixed cost, but you can use any volume and calculate the same $1,000 total fixed cost. Using this equation, the estimated music equipment maintenance cost for 400 event-playing hours would be $1,800. Now check your formula against the original data ($2 x $1000 = $1960) or ($2 x $1,000 = $1480)

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**Relevant Range Range of volume:**

Where total fixed costs remain constant and variable cost per unit remains constant Outside the relevant range, costs can differ The relevant range is the range of volume where total fixed costs remain constant and the variable cost per unit remains constant. In other words, the relevant range is the range of events (or other activity) where total fixed costs and variable cost per unit stays the same. To estimate costs, managers need to know the relevant range. Why? Because: ● total fixed costs can differ from one relevant range to another. ● the variable cost per unit can differ in various relevant ranges. Variable cost per unit can also change outside the relevant range.

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**S19-1: Variable, fixed, and mixed costs**

Philadelphia Acoustics builds innovative speakers for music and home theater systems. Consider the following costs. Identify the costs as variable (V), fixed (F), or mixed (M). 1. Units of production depreciation on routers used to cut wood enclosures 2. Wood for speaker enclosures 3. Patents on crossover relays 4. Total compensation to salesperson, who receives a salary plus a commission based on meeting sales goals 5. Crossover relays V V F Short exercise 19-1 focuses on variable, fixed and mixed costs. M V

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**S19-1: Variable, fixed, and mixed costs**

Philadelphia Acoustics builds innovative speakers for music and home theater systems. Consider the following costs. Identify the costs as variable (V), fixed (F), or mixed (M). 6. Straight-line depreciation on manufacturing plant 7. Grill cloth 8. Cell phone costs of salesperson (plan includes 1,200 minutes; overseas calls are charged at an average of $0.15 per minute) 9. Glue 10. Quality inspector’s salary F V M The exercise continues on this slide. V F

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**S19-3: Mixed costs—high-low method**

Martin owns a machine shop. In reviewing his utility bill for the last 12 months, he found that his highest bill of $2,800 occurred in August when his machines worked 1,400 machine hours. His lowest utility bill of $2,600 occurred in December when his machines worked 900 machine hours. Calculate (a) the variable rate per machine hour and (b) Martin’s total fixed utility cost. Variable cost per unit = Change in total cost ÷ Change in activity volume a. Variable cost per unit = ($2,800 - $2,600) ÷ (1,400 – 900) Variable cost per unit = $200 ÷ 500 = per machine hour b. Total fixed cost = Total mixed cost – Total variable cost Total fixed cost = $2,800 – (0.40 X 1,400) Total fixed cost = $2, $560 Total fixed cost = $2,240 Short exercise 19-3 addresses mixed costs and using the high-low method.

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**S19-3: Mixed costs—high-low method**

Martin owns a machine shop. In reviewing his utility bill for the last 12 months, he found that his highest bill of $2,800 occurred in August when his machines worked 1,400 machine hours. His lowest utility bill of $2,600 occurred in December when his machines worked 900 machine hours. 2. Show the equation for determining the total utility cost for Martin’s. $ 0.40 per machine hour + $2, If Martin’s anticipates using 1,200 machine hours in January, predict his total utility bill using the equation from Requirement 2. ($ 0.40 per machine hour x 1,200 machine hours) + $2,240 $480 +$2,240 = $2,720 The exercise continues on this slide.

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Basic CVP Analysis Expresses the relationships among costs, volume, and profit or loss Answers: How many products or services must the company sell to break even? What will profits be if sales double? How will changes in selling price, variable costs, or fixed costs affect profits? Cost-volume-profit analysis expresses the relationships among costs, volume, and profit or loss. This analysis can answer questions such as: How many products or services must the company sell to break even? What will profits be if sales double? How will changes in selling price, variable costs, or fixed costs affect profits? Assumptions made in using CVP include that: managers can classify each cost as either variable or fixed. the only factor that affects total costs is change in volume, which increases variable and mixed costs. Fixed costs do not change. Most business conditions do not perfectly meet these assumptions (consider that most businesses have some mixed costs), so managers regard CVP analysis as approximate, not exact.

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**Basic CVP Analysis Assumptions:**

Managers can classify each cost as either variable or fixed Only factor that affects total costs is change in volume, which increases variable and mixed costs Fixed costs do not change

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**Breakeven Point Sales level at which operating income is zero:**

Total revenues equal total costs (expenses) Sales above breakeven result in a profit Sales below breakeven result in a loss Virtually all businesses want to know their breakeven point. The breakeven point is the sales level at which operating income is zero―total revenues equal total costs. Sales below the breakeven point result in a loss. Sales above breakeven provide a profit. There are several ways to figure the breakeven point, including the: • income statement approach. • contribution margin approach.

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**Breakeven Point Two methods to compute breakeven point:**

Income statement approach Sales revenue − Total costs = Operating income Contribution margin approach Sales revenue – Variable costs = Contribution margin – Fixed costs = Operating income

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**Break Even Example Data**

Unit sale price Unit variable cost Fixed costs Unit contribution margin $200 $80 $12,000 $120 ($200 - $80)

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**Income Statement Approach**

Express income in equation form and then break it down into its components: In the income statement approach, we start by expressing income in equation form and then break it down into its components: Sales revenue − Total costs = Operating income Sales revenue − Variable costs – Fixed costs = Operating income Sale price per unit times units sold minus variable cost per unit times units sold minus fixed cost is equal to operating income. Sales revenue equals the unit sale price ($200 per event in this case) multiplied by the number of units (events) sold. Variable costs equal variable cost per unit ($80 in this case) times the number of units (events) sold. Greg’s fixed costs total $12,000. At the breakeven point, operating income is zero. We use this information to solve the income statement equation for the number of DJ events Greg’s must sell to break even. Greg’s Tunes must sell 100 events to break even. The breakeven sales level in dollars is $20,000 (100 events $200).

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**Contribution Margin Approach**

Shortcut method The contribution margin is sales revenue minus variable costs (expenses) Called contribution margin because the excess of sales revenue over variable costs contributes to covering fixed costs Contribution margin is a shortcut method of computing the breakeven point. The contribution margin is sales revenue minus variable costs (expenses). It is called the contribution margin because the excess of sales revenue over variable costs contributes to covering fixed costs and then to providing operating income. The contribution margin income statement shows costs by cost behavior—variable costs or fixed costs—and highlights the contribution margin. So: Sales revenue – Variable costs = Contribution margin – Fixed costs = Operating income

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**Contribution Margin Approach**

Rearrange the income statement—use the contribution margin to develop a shortcut method Shortcut equation: Now let’s rearrange the income statement formula and use the contribution margin to develop a shortcut method for finding the number of products or services one must provide to break even. Dividing both sides of the equation by the contribution margin per unit yields the alternate equation.

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**Contribution Margin Approach**

Given fixed costs total $12,000. The contribution margin per event is $120 ($200 sale price – $80 variable cost) Check your answer Fixed costs total $12,000. Operating income is zero at break even. The contribution margin per event is $120 ($200 sale price – $80 variable cost). Why does this shortcut method work? Each event Greg’s Tunes sells provides $120 of contribution margin. To break even in one month, Greg’s must generate enough contribution margin to cover $12,000 of monthly fixed costs. At the rate of $120 per event, Greg’s must sell 100 events ($12,000/$120) to cover monthly fixed costs. You can see that the contribution margin approach just rearranges the income statement equation, so the breakeven point is the same under both methods.

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**Contribution Margin Ratio**

Ratio of contribution margin to sales revenue Used to compute the breakeven point in terms of sales dollars Contribution margin is equal to: Sales price – variable cost Contribution margin divided by sales revenue yields a percentage Percentage of each dollar of sales revenue that contributes toward fixed costs and profit Companies can use the contribution margin ratio to compute their breakeven point in terms of sales dollars. The contribution margin ratio is the ratio of contribution margin to sales revenue. The contribution margin ratio approach differs from the shortcut contribution margin approach in only one way—here we use the contribution margin ratio rather than the dollar amount of the contribution margin.

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**Contribution Margin Ratio**

Formula: Example: Yields the same breakeven as the contribution margin approach earlier Unit CM $120 Unit Sale Price $200 Why does the contribution margin ratio formula work? Each dollar of Greg’s sales contributes $0.60 to fixed costs and profit. To break even, Greg’s must generate enough contribution margin at the rate of 60% of sales to cover the $12,000 fixed costs ($12,000 ÷ 0.60 = $20,000). We have seen how companies use contribution margin to estimate breakeven points in CVP analysis. But managers use the contribution margin for other purposes too, such as motivating the sales force. Salespeople who know the contribution margin of each product can generate more profit by emphasizing high-margin products over low-margin products. This is why many companies base sales commissions on the contribution margins produced by sales rather than on sales revenue alone.

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**S19-4: Computing breakeven point in sales units**

Story Park competes with Splash World by providing a variety of rides. Story sells tickets at $50 per person as a one-day entrance fee. Variable costs are $10 per person, and fixed costs are $240,000 per month. 1. Compute the number of tickets Story must sell to break even. Perform a numerical proof to show that your answer is correct. Short exercise 19-4 reviews how to compute the breakeven point in sales units. Units sold = ($240, ) ÷ ($50 - $10) Units sold = $240,000 ÷ $40 = 6,000 units to breakeven

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**S19-4: Computing breakeven point in sales units**

Story Park competes with Splash World by providing a variety of rides. Story sells tickets at $50 per person as a one-day entrance fee. Variable costs are $10 per person, and fixed costs are $240,000 per month. 1. Compute the number of tickets Story must sell to break even. Perform a numerical proof to show that your answer is correct. Total sales revenue $300,000 (6,000 x 50) Variable cost ,000 (6,000 x 10) Contribution margin $240,000 - Fixed cost ,000 Operating income $ The exercise continues on this slide.

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**S19-5: Computing breakeven point in sales dollars**

Story Park competes with Splash World by providing a variety of rides. Story sells tickets at $50 per person as a one-day entrance fee. Variable costs are $10 per person, and fixed costs are $240,000 per month. 1. Compute Story Park’s contribution margin ratio. Carry your computation to two decimal places. $50 - $10 = $40 $40 ÷ $50 = 0.80 or 80% 2. Use the contribution margin ratio CVP formula to determine the sales revenue Story Park needs to break even. Short exercise 19-5 focuses on computing the breakeven point in sales dollars. $240,000 ÷ = $300,000

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**Use CVP analysis for profit planning, and graph the CVP relations**

3 Use CVP analysis for profit planning, and graph the CVP relations The third learning objective is to use CVP analysis for profit planning, and graph the CVP relations.

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**Using CVP to Plan Profits**

Managers more interested in: Sales level needed to earn a target profit Profits they can expect to earn How many products or service events must be sold to earn a specific operating profit Use either method (equation or CM) Set operating profit equal to desired profit For established products and services, managers are more interested in the sales level needed to earn a target profit than in the breakeven point. Target profit is the operating income that results when sales revenue minus variable costs and minus fixed cost equals management’s profit goal. Managers of new business ventures are also interested in the profits they can expect to earn. We can use the income statement approach or the shortcut contribution margin approach to find the answer.

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**Using CVP to Plan Profits**

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**Graphing Cost-Volume-Profit Relations**

Graph provides a picture that shows how changes in the levels of sales will affect profits Four steps: Choose a sales volume and plot the point for total sales revenue at that volume Draw the fixed cost line Draw the total cost line (total costs are the sum of variable costs plus fixed costs) Identify the breakeven point and the areas of operating income and loss A graph provides a picture that shows how changes in the levels of sales will affect profits. As in the variable-, fixed-, and mixed-cost graphs of Exhibits 19-1, 19-2, and 19-3, Blanding shows the volume of units (events) on the horizontal axis and dollars on the vertical axis. Then she follows four steps to graph the CVP relations for Greg’s Tunes, as illustrated in Exhibit 19-5. STEP 1: Choose a sales volume, such as 200 events. Plot the point for total sales revenue at that volume—200 events at $200 per event = sales of $40,000. Draw the sales revenue line from the origin (0) through the $40,000 point. Why start at the origin? If Greg’s sells no events, there is no revenue. STEP 2: Draw the fixed cost line, a horizontal line that intersects the dollars axis at $12,000. The fixed cost line is flat because fixed costs are the same, $12,000, no matter how many events are sold. STEP 3: Draw the total cost line. Total costs are the sum of variable costs plus fixed costs. Thus, total costs are mixed. So the total cost line follows the form of the mixed cost line in Exhibit Begin by computing variable costs at the chosen sales volume—200 events at $80 per event = variable costs of $16,000. Add variable costs to fixed costs: $16,000 + $12,000 = $28,000. Plot the total cost point of $28,000 for 200 events. Then draw a line through this point from the $12,000 fixed cost intercept on the dollars vertical axis. This is the total cost line. The total cost line starts at the fixed cost line because even if Greg’s Tunes sells no events, the company still incurs the $12,000 of fixed costs. STEP 4: Identify the breakeven point and the areas of operating income and loss. The breakeven point is where the sales revenue line intersects the total cost line. This is where revenue exactly equals total costs—at 100 events, or $20,000 in sales.

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Preparing a CVP Chart Why bother with a graph? Why not just use the income statement approach or the shortcut contribution margin approach? Graphs like Exhibit 19-5 help managers quickly estimate the profit or loss earned at different levels of sales. The income statement and contribution margin approaches indicate income or loss for only a single sales amount. 35

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**Consider the following facts:**

S19-6: Computing contribution margin, breakeven point, and units to achieve operating income Consider the following facts: A B C Number of units 1,300 3,600 7.500 Sale price per unit $100 $40 $125 Variable costs per unit 40 10 100 Total fixed costs 72,000 60,000 40,000 Target operating income 180,000 75,000 100,000 Calculate: Contribution margin per unit Contribution margin ratio Breakeven points in units Breakeven point in sales dollars Units to achieve target operating income Short exercise 19-6 addresses computing contribution margin, breakeven point and units to achieve operating income.

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**Consider the following facts:**

S19-6: Computing contribution margin, breakeven point, and units to achieve operating income Consider the following facts: A B C Number of units 1,300 3,600 7.,00 Sale price per unit $100 $40 $125 Variable costs per unit 40 10 100 Total fixed costs 72,000 60,000 40,000 Target operating income 180,000 75,000 100,000 Calculate: Contribution margin per unit $60 $30 $25 Contribution margin ratio 60% 75% 20% Breakeven points in units 1,200 2,000 1,600 Breakeven point in sales dollars $120,000 $80,000 $200,000 Units to achieve target operating income 4,200 4,500 5,600 The exercise continues on this slide. $72,000/$60 ($72,000 + $180,000)/$60

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Sensitivity Analysis Predict how changes in sale prices, cost, or volume affect profits “What-if?” analysis Allows managers to see how various business strategies affect profits Changing selling price Changing variable Costs Changing fixed Costs Managers often want to predict how changes in sale price, costs, or volume affect their profits. Managers can use CVP relationships to conduct sensitivity analysis. Sensitivity analysis is a “what if” technique that asks what results are likely if selling price or costs change, or if an underlying assumption changes. So sensitivity analysis allows managers to see how various business strategies will affect how much profit the company will make and thus empowers managers with better information for decision making.

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**Sensitivity Analysis: Example**

How will the lower sale price affect the breakeven point? Lower price yields higher unit sales to breakeven Higher prices yields lower unit sales to breakeven Using the components of the breakeven formula, managers can perform “what if” scenarios by changing selling price, variable costs, and fixed costs to determine the impact on the breakeven point. The lower the breakeven point, the sooner the company begins earning a profit. With the original $200 sale price, Greg’s Tunes’ breakeven point was 100 events. With the new lower sale price of $180 per event, the breakeven point increases to 120 events. The lower sale price means that each event contributes less toward fixed costs, so Greg’s Tunes must sell 20 more events to break even.

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**Sensitivity Analysis: Example**

How will increased costs affect the breakeven point? Higher cost yields higher unit sales to breakeven Lower cost yields lower unit sales to breakeven Higher variable costs per event reduce Greg’s Tunes’ per-unit contribution margin from $120 per event to $80 per event. As a result, Greg’s must sell more events to break even—150, rather than the original 100. This analysis shows why managers are particularly concerned with controlling costs during an economic downturn. Increases in cost raise the breakeven point, and a higher breakeven point can lead to problems if demand falls due to a recession. Of course, a decrease in variable costs would have the opposite effect. Lower variable costs increase the contribution margin on each event and, therefore, lower the breakeven point.

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**Sensitivity Analysis: Example**

How will the increased fixed costs affect the breakeven point? Higher fixed costs yields higher unit sales to breakeven Lower fixed costs yields lower unit sales to breakeven Higher fixed costs increase the total contribution margin required to break even. In this case, increasing the fixed costs from $12,000 to $15,000 increases the breakeven point to 125 events (from the original 100 events). Managers usually prefer a lower breakeven point to a higher one. But do not overemphasize this one aspect of CVP analysis. Even though investing in the Web banner ads increases Greg’s Tunes’ breakeven point, the company should pay the extra $3,000 if that would increase both sales and profits.

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**Sensitivity Analysis Summary**

Exhibit 19-6 This table summarizes the effect of changes in selling price, variable costs per unit, and fixed costs on both the contribution margin and breakeven point. Notice the inverse relationship between contribution margin and breakeven point on the first four lines of the table.

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**Margin of Safety Excess of expected sales over breakeven sales**

Cushion, drop in sales, a company can absorb without incurring a loss Margin of safety in units Margin of safety in dollars The margin of safety is the excess of expected sales over breakeven sales. The margin of safety is therefore the “cushion” or drop in sales that the company can absorb without incurring an operating loss. Managers use the margin of safety to evaluate the risk of both their current operations and their plans for the future. Margin of safety focuses on the sales part of the equation—that is, how many sales dollars the company is generating above breakeven sales dollars. Conversely, target profit focuses on how much operating income is left over from sales revenue after covering all variable and fixed costs.

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**Units sold = ($240,000 + 0) ÷ ($40 - $10) Units sold = $240,000 ÷ $30 **

S19-7: Sensitivity analysis of changing sale price and variable costs on breakeven point Story Park competes with Splash World by providing a variety of rides. Story sells tickets at $50 per person as a one-day entrance fee. Variable costs are $10 per person, and fixed costs are $240,000 per month. 1. Suppose Story Park cuts its ticket price from $50 to $40 to increase the number of tickets sold. Compute the new breakeven point in tickets and in sales dollars. Units sold = ($240, ) ÷ ($40 - $10) Units sold = $240,000 ÷ $30 = 8,000 units to breakeven $320,000 sales dollars to breakeven Short exercise 19-7 addresses a sensitivity analysis of changing sale price and variable costs on the breakeven point. Old Breakeven 6,000 units, $300,000

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**Units sold = ($240,000 + 0) ÷ ($50 - $20) Units sold = $240,000 ÷ $30 **

S19-7: Sensitivity analysis of changing sale price and variable costs on breakeven point Story Park competes with Splash World by providing a variety of rides. Story sells tickets at $50 per person as a one-day entrance fee. Variable costs are $10 per person, and fixed costs are $240,000 per month. 2. Ignore the information in Requirement 1. Instead, assume that Story Park increases the variable cost from $10 to $20 per ticket. Compute the new breakeven point in tickets and in sales dollars. The exercise continues on this slide. Units sold = ($240, ) ÷ ($50 - $20) Units sold = $240,000 ÷ $30 = 8,000 units to breakeven = $400,000 in sales dollars

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**S19-9: Computing margin of safety**

Story Park competes with Splash World by providing a variety of rides. Story sells tickets at $50 per person as a one-day entrance fee. Variable costs are $10 per person, and fixed costs are $240,000 per month. 1. If Story Park expects to sell 6,200 tickets, compute the margin of safety in tickets and in sales dollars. Expected sales - Breakeven sales = Margin of safety in units 6,200 – 6, = 200 in units Margin of safety in units x Sales price = Margin of safety in dollars 200 units x $50 = $10,000 Short exercise 19-9 computes the margin of safety.

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**Breakeven Point Multiple Product Lines**

Selling prices and variable costs differ for each product Different contribution to profits Weighted-average contribution margin computed Sales mix provides weights to make up total product sales Weights equal 100% of total product sales Most companies sell more than one product. Selling price and variable costs differ for each product, so each product makes a different contribution to profits. The same CVP formulas we used earlier apply to a company with multiple products. To calculate break even for each product, we must compute the weighted-average contribution margin of all the company’s products. The sales mix provides the weights that make up total product sales. The weights equal 100% of total product sales. Sales mix (or product mix) is the combination of products that make up total sales.

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**Steps for Computing Breakeven Point with Multiple Product Lines**

To compute breakeven sales in units for multiple products, complete the following three steps: STEP 1: Calculate the weighted-average contribution margin per unit STEP 2: Calculate the breakeven point in units for the “package” of products STEP 3: Calculate the breakeven point in units for each product and then multiply the “package” breakeven point in units by each product’s proportion of the sales mix To compute breakeven sales in units for multiple products, you just complete the following three steps STEP 1: Calculate the weighted-average contribution margin per unit. STEP 2: Calculate the breakeven point in units for the “package” of products. STEP 3: Calculate the breakeven point in units for each product. Multiply the “package” breakeven point in units by each product’s proportion of the sales mix.

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**Step 1 Calculate the weighted-average contribution margin per unit:**

Cool Cat’s total fixed costs are $40,000. The cat bed’s unit selling price is $44 and variable cost per bed is $24. The scratching post’s unit selling price is $100 and variable cost per post is $30. Calculate the weighted-average contribution margin per unit.

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Step 2 Calculate the breakeven point in units for the “package” of products: The second step is to calculate the breakeven point for the package of products.

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Step 3 Calculate the breakeven point in units for each product. Multiply the “package” breakeven point in units by each product’s proportion of the sales mix: Calculate the breakeven point in units for each product. Multiply the “package” breakeven point in units by each product’s proportion of the sales mix. In this example, the calculations yield round numbers. When the calculations do not yield round numbers, round your answer up to the next whole number. The overall breakeven point in sales dollars is $66,400.

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Proof Prove this breakeven point by preparing a contribution margin income statement: If the sales mix changes, then Cool Cat can repeat this analysis using new sales mix information to find the breakeven points for each product. In addition to finding the breakeven point, Cool Cat can also estimate the sales needed to generate a certain level of operating profit. Suppose Cool Cat would like to earn operating income of $20,000. How many units of each product must Cool Cat now sell?

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**S19-10: Calculating weighted-average contribution margin**

Wet Weekend Swim Park sells individual and family tickets, which include a meal, three beverages, and unlimited use of the swimming pools. Wet Weekend has the following ticket prices and variable costs for 2012: Wet Weekend expects to sell two individual tickets for every four family tickets. Wet Weekend’s total fixed costs are $75, Compute the weighted-average contribution margin per ticket. 2. Calculate the total number of tickets Wet Weekend must sell to break even. 3. Calculate the number of individual tickets and the number of family tickets the company must sell to break even. Individual Family Sale price per ticket 30 90 Variable cost per ticket 15 60 Short exercise calculates the weighted-average contribution margin.

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**S19-10: Calculating weighted-average contribution margin**

Wet Weekend expects to sell two individual tickets for every four family tickets. Wet Weekend’s total fixed costs are $75, Compute the weighted-average contribution margin per ticket. Individual Family Total Sale price per ticket $ 30 $ 90 Variable cost per ticket 15 60 Contribution margin per unit 30 Sales mix in units 2 4 6 Contribution margin $30 $120 150 Weighted-average contribution margin per unit $25 The exercise continues on this slide.

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**S19-10: Calculating weighted-average contribution margin**

Individual Family Total Sale price per ticket $ 30 $ 90 Variable cost per ticket 15 60 Contribution margin per unit 30 Sales mix in units 2 4 6 Contribution margin $30 $120 150 Weighted-average contribution margin per unit $25 The exercise concludes on this slide. 2. Calculate the total number of tickets Wet Weekend must sell to break even. 3. Calculate the number of individual tickets and the number of family tickets the company must sell to break even. $75,000 ÷ $25 = 3,000 total tickets 3,000 total tickets x 2/6 = 1,000 individual tickets 3,000 total tickets x 4/6 = 2,000 family tickets

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