Electronic Presentation by Douglas Cloud Pepperdine University Survey of Accounting Electronic Presentation by Douglas Cloud Pepperdine University Carl S.Warren

Task Force Clip Art included in this electronic presentation is used with the permission of New Vision Technology of Nepean Ontario, Canada.

Chapter 11 Cost Behavior and Cost-Volume-Profit Analysis

After studying this chapter, you should be able to: Learning Objectives 1. Classify costs according to their behavior as variable costs, fixed costs, or mixed costs. 2. Compute the contribution margin, the contribution margin ratio, and the unit contribution margin, and explain how they can be useful to managers. After studying this chapter, you should be able to: Continued

Learning Objectives 3. Using the unit contribution margin, determine the break-even point and the volume necessary to achieve a target profit. 4. Using a cost-volume-profit chart and a profit-volume chart, determine the break-even point and the volume necessary to achieve a target profit. Continued

Learning Objectives 5. Calculate the break-even point for a business selling more than one product. 6. Compute the margin of safety and the operating leverage, and explain how managers use these concepts. 7. List the assumptions underlying cost-volume-profit analysis.

Learning Objective 1 Classify costs according to their behavior as variable costs, fixed costs, or mixed costs.

Total Variable Cost Graph Unit Variable Cost Graph Variable Costs Total Variable Cost Graph Unit Variable Cost Graph $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $20 $15 $10 $5 Total Costs Cost per Unit 10 20 30 Units Produced (000) 10 20 30 Units Produced (000) Units Total Cost Produced Cost per Unit 5,000 $ 50,000 $10 10,000 100,000 10 15,000 150,000 10 20,000 200,000 10 25,000 250,000 10 30,000 300,000 10

Total Variable Cost Graph Unit Variable Cost Graph Variable Costs Total Variable Cost Graph Unit Variable Cost Graph $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $20 $15 $10 $5 Total Costs Cost per Unit 10 20 30 Units Produced (000) 10 20 30 Units Produced (000) Units Total Cost Produced Cost per Unit 5,000 $ 50,000 $10 10,000 100,000 10 15,000 150,000 10 20,000 200,000 10 25,000 250,000 10 30,000 300,000 10

Total Variable Cost Graph Unit Variable Cost Graph Variable Costs Total Variable Cost Graph Unit Variable Cost Graph $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $20 $15 $10 $5 Total Costs Cost per Unit 10 20 30 Units Produced (000) 10 20 30 Units Produced (000) Units Total Cost Produced Cost per Unit 5,000 $ 50,000 $10 10,000 100,000 10 15,000 150,000 10 20,000 200,000 10 25,000 250,000 10 30,000 300,000 10

Fixed Costs Total Fixed Cost Graph Unit Fixed Cost Graph $150,000 $125,000 $100,000 $75,000 $50,000 $25,000 $1.50 $1.25 $1.00 $.75 $.50 $.25 Total Costs Cost per Unit 100 200 300 100 200 300 Units Produced (000) Units Produced (000) Units Total Cost Produced Cost per Unit 50,000 $75,000 $1.500 100,000 75,000 .750 150,000 75,000 .500 200,000 75,000 .375 250,000 75,000 .300 300,000 75,000 .250

Fixed Costs Total Fixed Cost Graph Unit Fixed Cost Graph $150,000 $125,000 $100,000 $75,000 $50,000 $25,000 $1.50 $1.25 $1.00 $.75 $.50 $.25 Total Costs Cost per Unit 100 200 300 100 200 300 Units Produced (000) Units Produced (000) Units Total Cost Produced Cost per Unit 50,000 $75,000 $1.500 100,000 75,000 .750 150,000 75,000 .500 200,000 75,000 .375 250,000 75,000 .300 300,000 75,000 .250

Fixed Costs Total Fixed Cost Graph Unit Fixed Cost Graph $150,000 $125,000 $100,000 $75,000 $50,000 $25,000 $1.50 $1.25 $1.00 $.75 $.50 $.25 Total Costs Cost per Unit 100 200 300 100 200 300 Units Produced (000) Units Produced (000) Units Total Cost Produced Cost per Unit 50,000 $75,000 $1.500 100,000 75,000 .750 150,000 75,000 .500 200,000 75,000 .375 250,000 75,000 .300 300,000 75,000 .250

Mixed Costs Total Mixed Cost Graph $40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 Mixed costs are sometimes called semivariable or semifixed costs. Total Costs Mixed costs are usually separated into their fixed and variable components for management analysis. 10 20 30 40 Total Machine Hours (000)

Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total Units Cost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level Lowest level Difference

Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total Units Cost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level Difference

Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total Units Cost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level 750 41,250 Difference

Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total Units Cost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level 750 41,250 Difference 1,350 $20,250 1 Variable cost per unit Difference in total cost Difference in production =

Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total Units Cost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level 750 41,250 Difference 1,350 $20,250 1 Variable cost per unit Difference in total cost Difference in production $20,250 1,350 units = = = $15

Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total Units Cost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level 750 41,250 Difference 1,350 $20,250 1 Variable cost per unit Difference in total cost Difference in production $20,250 1,350 units = = = $15 Fixed cost 2 Total cost Variable cost per unit Units of production = – x

Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total Units Cost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level 750 41,250 Difference 1,350 $20,250 1 Variable cost per unit Difference in total cost Difference in production $20,250 1,350 units = = = $15 Fixed cost 2 Total cost Variable cost per unit Units of production = – x Highest level: = $61,500 – ( $15 x 2,100 ) = $30,000

Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total Units Cost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level 750 41,250 Difference 1,350 $20,250 1 Variable cost per unit Difference in total cost Difference in production $20,250 1,350 units = = = $15 Fixed cost 2 Total cost Variable cost per unit Units of production = – x Highest level: = $61,500 – ( $15 x 2,100 ) = $30,000 Lowest level: = $41,250 – ( $15 x 750 ) = $30,000

Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total Units Cost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level 750 41,250 Difference 1,350 $20,250 1 Variable cost per unit Difference in total cost Difference in production $20,250 1,350 units = = = $15 Fixed cost 2 Total cost Variable cost per unit Units of production = – x Highest level: = $61,500 – ( $15 x 2,100 ) = $30,000 Lowest level: = $41,250 – ( $15 x 750 ) = $30,000

Variable Costs Fixed Costs Total Variable Costs Total Fixed Costs Total Costs Total Costs Total Units Produced Total Units Produced Unit Fixed Costs Unit Variable Costs Per Unit Cost Per Unit Cost Total Units Produced Total Units Produced

regardless of activity level. Variable Costs Fixed Costs Total Variable Costs Total Fixed Costs Used for planning. Remains the same regardless of activity level. Total Costs Total Costs $75,000 total Total Units Produced Total Units Produced Unit Fixed Costs Unit Variable Costs Per Unit Cost Per Unit Cost $10 per unit Total Units Produced Total Units Produced

Learning Objective 2 Compute the contribution margin, the contribution margin ratio, and the unit contribution margin, and explain how they can be useful to managers.

Contribution Margin Income Statement The contribution margin is available to cover the fixed costs and income from operations. Total Sales (50,000 units) $1,000,000 Variable costs 600,000 Contribution margin $400,000 Fixed costs 300,000 Income from operations $100,000 Variable costs Sales Fixed costs Income from operations

Contribution Margin Income Statement Total Per Unit Percent Sales (50,000 units) $1,000,000 $20 100% Variable costs 600,000 12 60% Contribution margin $400,000 $ 8 40% Fixed costs 300,000 Income from operations $100,000 The statement can be extended to include per unit dollars and percentage numbers.

Contribution Margin Income Statement Total Per Unit Percent Sales (50,000 units) $1,000,000 $20 100% Variable costs 600,000 12 60% Contribution margin $400,000 $ 8 40% Fixed costs 300,000 Income from operations $100,000 Income from operations Variable costs Fixed costs Sales = + + Variable costs Contribution margin Sales – =

Contribution Margin Income Statement Total Per Unit Percent Sales (50,000 units) $1,000,000 $20 100% Variable costs 600,000 12 60% Contribution margin $400,000 $ 8 40% Fixed costs 300,000 Income from operations $100,000 Unit Contribution Margin Contribution Margin Ratio The contribution margin can be expressed three ways: 1. Total contribution margin in dollars. 2. Unit contribution margin (dollars per unit). 3. Contribution margin ratio (percentage).

Learning Objective 3 Using the unit contribution margin, determine the break-even point and the volume necessary to achieve a target profit.

Calculating the Break-Even Point Total Per Unit Percent Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $300,000 $ 8 40% Fixed costs 300,000 Income from operations $ 0 At the break-even point, fixed costs and the contribution margin are equal.

Calculating the Break-Even Point Divide by either: $8 per unit or 40% Total Per Unit Percent Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 300,000 $ 8 40% Fixed costs 300,000 Income from operations $ 0 / or Divide by either: $8 per unit or 40% Break-even sales Fixed costs Contribution margin = /

Calculating the Break-Even Point Total Per Unit Percent Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 300,000 $ 8 40% Fixed costs 300,000 Income from operations $ 0  or Break-even sales Fixed costs Contribution margin = / What is the break-even sales in units?

Calculating the Break-Even Point Total Per Unit Percent Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 300,000 $ 8 40% Fixed costs 300,000 Income from operations $ 0 / or Break-even sales Fixed costs Contribution margin = / Break-even sales = $300,000 / $8 = 37,500 units What is the break-even sales in dollars?

Calculating the Break-Even Point Total Per Unit Percent Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 300,000 $ 8 40% Fixed costs 300,000 Income from operations $ 0 / or Break-even sales Fixed costs Contribution margin = / Break-even sales = $300,000 / $8 = 37,500 units Break-even sales = $300,000 / 40% = $750,000

Calculating a Planned Sales Level Total Per Unit Percent Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 400,000 $ 8 40% Fixed costs 300,000 Income from operations $ 100,000 / or Fixed Target costs profit Planned sales Contribution margin + = / Fixed costs plus the target profit equals the required total contribution margin.

Calculating a Planned Sales Level Total Per Unit Percent Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 400,000 $ 8 40% Fixed costs 300,000 Income from operations $ 100,000 / or Planned sales Fixed Target costs profit Contribution margin + = / $8 per unit or 40%

Calculating a Planned Sales Level Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 400,000 $ 8 40% Fixed costs 300,000 Income from operations $ 100,000 Total Per Unit Percent / or Planned sales Fixed Target costs profit Contribution margin + = / What is the planned sales level in units?

Calculating a Planned Sales Level Sales (50,000 units) ? $20 100% Variable costs ? 12 60% Contribution margin $ 400,000 $ 8 40% Fixed costs 300,000 Income from operations $ 100,000 Total Per Unit Percent / or Planned sales Fixed Target costs profit Contribution margin + = / Planned sales = ($300,000 + $100,000) / $8 = 50,000 units What is the planned sales level in dollars?

Calculating a Planned Sales Level Total Per Unit Percent Sales (50,000 units) $1,000,000 $20 100% Variable costs 600,000 12 60% Contribution margin $ 400,000 $ 8 40% Fixed costs 300,000 Income from operations $ 100,000 / or Planned sales Fixed Target costs profit Contribution margin = + / Planned sales = ($300,000 + $100,000) / $8 = 50,000 units Planned sales = ($300,000 + $100,000) / 40% = $1,000,000 $1,000,000

Learning Objective 4 Using a cost-volume-profit chart and a profit-volume chart, determine the break-even point and the volume necessary to achieve a target profit.

Cost-Volume-Profit Chart $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Total Sales Sales and Costs ($000) 1 2 3 4 5 6 7 8 9 10 Units of Sales (000) Unit selling price $ 50 Unit variable cost 30 Unit contribution margin $ 20 Total fixed costs $100,000

Cost-Volume-Profit Chart $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Total Sales Sales and Costs ($000) 60% Variable Costs 1 2 3 4 5 6 7 8 9 10 Units of Sales (000) Unit selling price $ 50 Unit variable cost 30 Unit contribution margin $ 20 Total fixed costs $100,000

Cost-Volume-Profit Chart $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Total Sales Contribution Margin 40% Sales and Costs ($000) 60% Variable Costs 1 2 3 4 5 6 7 8 9 10 Units of Sales (000) 100% 60% 40% Unit selling price $ 50 Unit variable cost 30 Unit contribution margin $ 20 Total fixed costs $100,000

Cost-Volume-Profit Chart $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Total Sales Total Costs Sales and Costs ($000) Fixed Costs Variable Costs 1 2 3 4 5 6 7 8 9 10 Units of Sales (000) Unit selling price $ 50 Unit variable cost 30 Unit contribution margin $ 20 Total fixed costs $100,000

Cost-Volume-Profit Chart $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Total Sales Total Costs Sales and Costs ($000) 1 2 3 4 5 6 7 8 9 10 Units of Sales (000) Unit selling price $ 50 Unit variable cost 30 Unit contribution margin $ 20 Total fixed costs $100,000

Cost-Volume-Profit Chart $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Total Sales Operating Profit Area Total Costs Sales and Costs ($000) Operating Loss Area 1 2 3 4 5 6 7 8 9 10 Units of Sales (000) Unit selling price $ 50 Unit variable cost 30 Unit contribution margin $ 20 Total fixed costs $100,000

Cost-Volume-Profit Chart $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Total Sales Total Costs Sales and Costs ($000) Break-Even Point 1 2 3 4 5 6 7 8 9 10 Units of Sales (000) Unit selling price $ 50 Unit variable cost 30 Unit contribution margin $ 20 Total fixed costs $100,000

Cost-Volume-Profit Chart $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Total Sales Total Costs Sales and Costs ($000) Break-Even Point 1 2 3 4 5 6 7 8 9 10 Units of Sales (000) Unit selling price $ 50 Unit variable cost 30 Unit contribution margin $20 Total fixed costs $100,000 $100,000 $20 = 5,000 units

Cost-Volume-Profit Chart (Break-Even) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Total Sales Operating Profit Area Total Costs Sales and Costs ($000) Break-Even Point Operating Loss Area 1 2 3 4 5 6 7 8 9 10 Units of Sales (000) Unit selling price $ 50 Unit variable cost 30 Unit contribution margin $ 20 Total fixed costs $100,000 $100,000 $20 = 5,000 units

Revised Cost-Volume-Profit Chart $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Total Sales Operating Profit Area Total Costs Sales and Costs ($000) Revised Break-Even Point Operating Loss Area 1 2 3 4 5 6 7 8 9 10 Units of Sales (000) Unit selling price $ 50 Unit variable cost 30 Unit contribution margin $ 20 Total fixed costs $80,000 $80,000 $20 = 4,000 units

Profit-Volume Chart Relevant range is 10,000 units. $100 $75 $50 $25 $ 0 $(25) $(50) $(75) $(100) Operating Profit (Loss) $000’s Relevant range is 10,000 units. 1 2 3 4 5 6 7 8 9 10 Units of Sales (000’s) Sales (10,000 units x $50) $500,000 Variable costs (10,000 units x $30) 300,000 Contribution margin (10,000 units x $20) $200,000 Fixed costs 100,000 Operating profit $100,000

Profit-Volume Chart Maximum profit within the relevant range. $100 $75 $50 $25 $ 0 $(25) $(50) $(75) $(100) Operating Profit (Loss) $000’s Maximum profit within the relevant range. 1 2 3 4 5 6 7 8 9 10 Units of Sales (000’s) Maximum loss is equal to the total fixed costs. Sales (10,000 units x $50) $500,000 Variable costs (10,000 units x $30) 300,000 Contribution margin (10,000 units x $20) $200,000 Fixed costs 100,000 Operating profit $100,000

Profit-Volume Chart Sales (10,000 units x $50) $500,000 $100 $75 $50 $25 $ 0 $(25) $(50) $(75) $(100) Profit Line Operating Profit Operating Profit (Loss) $000’s Operating Loss 1 2 3 4 5 6 7 8 9 10 Units of Sales (000’s) Sales (10,000 units x $50) $500,000 Variable costs (10,000 units x $30) 300,000 Contribution margin (10,000 units x $20) $200,000 Fixed costs 100,000 Operating profit $100,000

Profit-Volume Chart Sales (10,000 units x $50) $500,000 $100 $75 $50 $25 $ 0 $(25) $(50) $(75) $(100) Profit Line Operating Profit Operating Profit (Loss) $000’s Operating Loss Break-Even Point 1 2 3 4 5 6 7 8 9 10 Units of Sales (000’s) Sales (10,000 units x $50) $500,000 Variable costs (10,000 units x $30) 300,000 Contribution margin (10,000 units x $20) $200,000 Fixed costs 100,000 Operating profit $100,000

Learning Objective 5 Calculate the break-even point for a business selling more than one product.

Sales Mix Considerations Contribution margin Products A B Sales $ 90 $140 Variable costs 70 95 Contribution margin $ 20 $ 45 Sales mix 80% 20% What is the average contribution for each product?

Sales Mix Considerations Contribution margin Products A B Sales $ 90 $140 Variable costs 70 95 Contribution margin $ 20 $ 45 Sales mix x 80% x 20% Product contribution $ 16 $ 9 What is the total product contribution?

Sales Mix Considerations Contribution margin Products A B Sales $ 90 $140 Variable costs 70 95 Contribution margin $ 20 $ 45 Sales mix x 80% x 20% Product contribution $ 16 $ 9 Total product contribution $ 25 Break-even sales units Total fixed costs $200,000 Product contribution $25 What is the break-even sales units?

Sales Mix Considerations Contribution margin Products A B Sales $ 90 $140 Variable costs 70 95 Contribution margin $ 20 $ 45 Sales mix x 80% x 20% Product contribution $ 16 $ 9 Total product contribution $ 25 Break-even sales units Total fixed costs $200,000 Product contribution $25 Break-even sales units 8,000 Product A units (80%) 6,400 Product B units (20%) 1,600 = 8,000 units

Sales Mix Considerations Contribution margin Products A B Sales $ 90 $ 140 Variable costs 70 95 Contribution margin $ 20 $ 45 Sales mix 60% 40% If the sales mix is 60% for product A and 40% for product B, what is the break-even sales units?

Sales Mix Considerations Contribution margin Products A B Sales $ 90 $140 Variable costs 70 95 Contribution margin $ 20 $ 45 Sales mix x 60% x 40% Product contribution $ 12 $ 18 Total product contribution $ 30 Break-even sales units Total fixed costs $200,000 Product contribution $30 Break-even sales units 6,667 Product A units (60%) 4,000 Product B units (40%) 2,667 = 6,667 units

Learning Objective 6 Compute the margin of safety and the operating leverage, and explain how managers use these concepts.

Sales – Sales at break-even point Margin of Safety Sales – Sales at break-even point Sales Dollars Units Sales $250,000 10,000 Break-even sales 200,000 8,000 Excess $ 50,000 2,000

Sales – Sales at break-even point Margin of Safety Sales – Sales at break-even point Sales Dollars Units A Sales $250,000 10,000 Break-even sales 200,000 8,000 Excess $ 50,000 2,000 Actual sales level.

Sales – Sales at break-even point Margin of Safety Sales – Sales at break-even point Sales Dollars Units A Sales $250,000 10,000 Break-even sales 200,000 8,000 Excess $ 50,000 2,000 Margin of safety (B/A) B Excess of actual sales over the break-even sales. What is the margin of safety as a percentage?

Sales – Sales at break-even point Margin of Safety Sales – Sales at break-even point Sales Dollars Units A Sales $250,000 10,000 Break-even sales 200,000 8,000 Excess $ 50,000 2,000 Margin of safety (B/A) 20% B Margin of safety expressed in units. Margin of safety indicates the decrease in sales that may occur before an operating loss results.

Operating Leverage Contribution margin Operating income Operating leverage is a measure of the relative mix of variable costs and fixed costs. Jones Inc. Wilson Inc. Sales $400,000 $400,000 Variable costs 300,000 300,000 Contribution margin $100,000 $100,000 Fixed costs 80,000 50,000 Income from operations $20,000 $ 50,000

Both companies have the same contribution margin. Operating Leverage Contribution margin Operating income Operating leverage is a measure of the relative mix of variable costs and fixed costs. Jones Inc. Wilson Inc. Sales $400,000 $400,000 Variable costs 300,000 300,000 Contribution margin $100,000 $100,000 Fixed costs 80,000 50,000 Income from operations $20,000 $ 50,000 A Both companies have the same contribution margin.

What is the operating leverage? Contribution margin Operating income Operating leverage is a measure of the relative mix of variable costs and fixed costs. Jones Inc. Wilson Inc. Sales $400,000 $400,000 Variable costs 300,000 300,000 Contribution margin $100,000 $100,000 Fixed costs 80,000 50,000 Income from operations $20,000 $ 50,000 Operating leverage (A/B) A B What is the operating leverage?

What do these numbers mean? Operating Leverage Contribution margin Operating income Operating leverage is a measure of the relative mix of variable costs and fixed costs. Jones Inc. Wilson Inc. Sales $400,000 $400,000 Variable costs 300,000 300,000 Contribution margin $100,000 $100,000 Fixed costs 80,000 50,000 Income from operations $20,000 $ 50,000 Operating leverage (A/B) A B 5 2 What do these numbers mean?

Operating Leverage Contribution margin Operating income Operating leverage is a measure of the relative mix of variable costs and fixed costs. Jones Inc. Wilson Inc. Sales $400,000 $400,000 Variable costs 300,000 300,000 Contribution margin $100,000 $100,000 Fixed costs 80,000 50,000 Income from operations $20,000 $ 50,000 Operating leverage (A/B) A B 5 2 Capital intensive? Labor intensive?

Learning Objective 7 List the assumptions underlying cost-volume-profit analysis.

Assumptions of Cost-Volume-Profit Analysis The reliability of cost-volume-profit analysis depends upon several assumptions. 1. Total sales and total costs can be represented by straight lines. 2. Within the relevant range of operating activity, the efficiency of operations does not change. 3. Costs can be accurately divided into fixed and variable components. 4. The sales mix is constant. 5. There is no change in the inventory quantities during the period.

Chapter 11 The End