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PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 6 Cost-Volume-Profit Analysis

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6- 3 Assumptions of CVP

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6- 4 Cost-Volume-Profit in Graph Total Revenue Line Total Cost Line Number of Coffee Drinks Served Loss $18,000 Target Profit Break-Even Point

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6- 5 Basic CVP Analysis Break-even analysis is a special case of the simplest form of cost-volume-profit analysis. The goal of break-even analysis is to determine the level of sales (in either units or total sales dollars) needed to break even, or earn zero profit. Methods 1.Profit equation method 2.Unit contribution margin method 3.Contribution margin ratio method

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6- 6 Profit Equation Approach (Unit price × Q) – (Unit variable costs × Q) – Total fixed costs = Profit Q = Quantity of unit sold Total sales revenue – Total variable costs – Total fixed costs = Profit

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6- 7 To find the break-even point, we simply set the profit equation equal to zero, and solve for the quantity of units (Q). Break-Even Analysis (Unit Price × Q) – (Unit Variable Costs × Q) – Total Fixed Costs = Profit ($2.50 ×Q) – ($1.00 × Q) – $12,000 = 0 $1.50Q = $12,000 Q = $12,000 ÷ $1.50 Q = 8,000 Profit Equation Approach

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6- 8 Assume that the target profit was $18,000. Target Profit Analysis (Unit Price × Q) – (Unit Variable Costs × Q) – Total Fixed Costs = Profit ($2.50 × Q) – ($1.00 × Q) – $12,000 = $18,000 1.5Q = $30,000 Q = 20,000 units Profit Equation Approach

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6- 9 Unit Contribution Margin Approach Compute the breakeven point in units for Starbucks. Recall that Starbucks’s total fixed costs are $12,000 and the unit contribution margin is $1.50 per cup. Break-Even Units Total Fixed Costs Unit Contribution Margin = Break-Even Units = $12,000 ÷ $1.50 per cup Break-Even Units = 8,000 cups

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6- 10 Contribution Margin Ratio Approach

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6- 11 Contribution Margin Ratio Approach At break-even, the total contribution margin must equal total fixed costs, with nothing left over as profit. $12,000 ÷ 60% = Break-Even Sales ($) $20,000 = Break-Even Sales ($) $12,000 ÷ 60% = Break-Even Sales ($) $20,000 = Break-Even Sales ($)

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6- 12 Changes in Cost Structure Cost structure refers to how a company uses variable costs versus fixed costs to perform its operations. Starbucks Example: Investing in touch screens to allow customers to place their own order. Increase fixed costs by $14,000 per month. Decrease variable costs per unit by $0.70. Unit sales price will be unchanged at $2.50. What level of volume would be needed to justify this expenditure?

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6- 13 Changes in Cost Structure Automation increases the break- even point because fixed costs are higher. But each unit adds more profit because of the lower variable cost per unit. Before Automation After Automation

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6- 14 Degree of Operating Leverage Degree of operating leverage measures the extent to fixed costs are used to operate the business. In general, high fixed costs indicate that a company is highly leveraged.

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6- 15 Multi-Product Cost-Volume-Profit Analysis Product mix is the relative mix of products or services stated in terms of the number of units sold. The product mix is used to compute the weighted- average contribution margin per unit. Sales mix is the relative mix of products or services as a percentage of total sales revenue. The sales mix is used to compute the weighted- average contribution margin ratio, or contribution margin as a percentage of sales. Product mix is the relative mix of products or services stated in terms of the number of units sold. The product mix is used to compute the weighted- average contribution margin per unit. Sales mix is the relative mix of products or services as a percentage of total sales revenue. The sales mix is used to compute the weighted- average contribution margin ratio, or contribution margin as a percentage of sales.

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6- 16 End of Chapter 6

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