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Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Chapter 19 1.

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Presentation on theme: "Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Chapter 19 1."— Presentation transcript:

1 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Chapter 19 1

2 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 2

3 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 3

4 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 4

5 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 5

6 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 6

7 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 7

8 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 8

9 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 9 Variable cost per unit = Change in total cost ÷ Change in activity volume Total fixed cost = Total mixed cost – Total variable cost Total mixed cost = (Variable cost per unit X number of units) + Total fixed costs

10 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Data Step 1 Step 2 10

11 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 11 ($2 x 400 event-playing hours) + $1,000 = $1,800 Now check your formula against the original data ($2 x $1000 = $1960) or ($2 x $1,000 = $1480)

12 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Range of volume: Where total fixed costs remain constant and variable cost per unit remains constant Outside the relevant range, costs can differ 12

13 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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) 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 M V

14 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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) 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 inspectors salary F V M V F

15 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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. 1.Calculate (a) the variable rate per machine hour and (b) Martins total fixed utility cost. Variable cost per unit = Change in total cost ÷ Change in activity volume 15 a. Variable cost per unit = ($2,800 - $2,600) ÷ (1,400 – 900) Variable cost per unit = $200 ÷ 500 = 0.40 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 = $2,800 - $560 Total fixed cost = $2,240

16 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 Martins. $ 0.40 per machine hour + $2, If Martins anticipates using 1,200 machine hours in January, predict his total utility bill using the equation from Requirement 2. ($ 0.40 per machine hour x 1,200 machine hours) + $2,240 $480 +$2,240 = $2,720 16

17 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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? 17

18 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 18

19 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 19

20 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 20

21 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Unit sale price Unit variable cost Fixed costs Unit contribution margin $200 $80 $12,000 $120 ($200 - $80) 21

22 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Express income in equation form and then break it down into its components: 22

23 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 23

24 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Rearrange the income statementuse the contribution margin to develop a shortcut method Shortcut equation: 24

25 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Given fixed costs total $12,000. The contribution margin per event is $120 ($200 sale price – $80 variable cost) Check your answer 25

26 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 26

27 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Formula: Example: Yields the same breakeven as the contribution margin approach earlier 27 Unit CM $120 Unit Sale Price$200

28 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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. 28 Units sold = ($240, ) ÷ ($50 - $10) Units sold = $240,000 ÷ $40 = 6,000 units to breakeven

29 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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. 29 Total sales revenue $300,000 (6,000 x 50) -Variable cost 60,000 (6,000 x 10) Contribution margin $240,000 - Fixed cost 240,000 Operating income $ 0

30 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 Parks contribution margin ratio. Carry your computation to two decimal places. 30 $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. $240,000 ÷ 0.80 = $300,000

31 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Use CVP analysis for profit planning, and graph the CVP relations

32 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 32

33 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 33

34 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Graph provides a picture that shows how changes in the levels of sales will affect profits Four steps: 1.Choose a sales volume and plot the point for total sales revenue at that volume 2.Draw the fixed cost line 3.Draw the total cost line (total costs are the sum of variable costs plus fixed costs) 4.Identify the breakeven point and the areas of operating income and loss 34

35 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 35

36 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Consider the following facts: 36 ABC Number of units1,3003, Sale price per unit$100$40$125 Variable costs per unit Total fixed costs72,00060,00040,000 Target operating income180,00075,000100,000 Calculate: Contribution margin per unit Contribution margin ratio Breakeven points in units Breakeven point in sales dollars Units to achieve target operating income

37 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Consider the following facts: 37 ABC Number of units1,3003,6007.,00 Sale price per unit$100$40$125 Variable costs per unit Total fixed costs72,00060,00040,000 Target operating income180,00075,000100,000 Calculate: Contribution margin per unit$60$30$25 Contribution margin ratio60%75%20% Breakeven points in units1,2002,0001,600 Breakeven point in sales dollars$120,000$80,000$200,000 Units to achieve target operating income4,2004,5005,600 $72,000/$60 ($72,000 + $180,000)/$60

38 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 38

39 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 39

40 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. How will increased costs affect the breakeven point? Higher cost yields higher unit sales to breakeven Lower cost yields lower unit sales to breakeven 40

41 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 41

42 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Exhibit

43 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 43

44 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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. 44 Units sold = ($240, ) ÷ ($40 - $10) Units sold = $240,000 ÷ $30 = 8,000 units to breakeven $320,000 sales dollars to breakeven Old Breakeven 6,000 units, $300,000

45 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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. 45 Units sold = ($240, ) ÷ ($50 - $20) Units sold = $240,000 ÷ $30 = 8,000 units to breakeven = $400,000 in sales dollars

46 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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. 46 Expected sales - Breakeven sales = Margin of safety in units 6,200 – 6,000 = 200 in units Margin of safety in units x Sales price = Margin of safety in dollars 200 units x $50 = $10,000

47 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 47

48 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 products proportion of the sales mix 48

49 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Calculate the weighted-average contribution margin per unit: 49

50 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Calculate the breakeven point in units for the package of products: 50

51 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Calculate the breakeven point in units for each product. Multiply the package breakeven point in units by each products proportion of the sales mix: 51

52 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Prove this breakeven point by preparing a contribution margin income statement: 52

53 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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 Weekends 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. 53 IndividualFamily Sale price per ticket3090 Variable cost per ticket1560

54 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Wet Weekend expects to sell two individual tickets for every four family tickets. Wet Weekends total fixed costs are $75, Compute the weighted-average contribution margin per ticket. 54 IndividualFamilyTotal Sale price per ticket$ 30$ 90 Variable cost per ticket Contribution margin per unit Sales mix in units 2 46 Contribution margin$30$ Weighted-average contribution margin per unit $25

55 Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 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. 55 IndividualFamilyTotal Sale price per ticket$ 30$ 90 Variable cost per ticket Contribution margin per unit Sales mix in units 2 46 Contribution margin$30$ Weighted-average contribution margin per unit $25 $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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