1 Click to edit Master title style Cost Behavior and Cost- Volume-Profit Analysis 4

2 Click to edit Master title style Classify costs by their behavior as variable costs, fixed costs, or mixed costs. Objective 1 4-1

3 Click to edit Master title style Jason Inc. produces stereo sound systems under the brand name of J- Sound. The parts for the J-Sound stereos are purchased from outside suppliers for $10 per unit (a variable cost) and assembled in Jason Inc.’s Waterloo plant. Jason Inc.’s Waterloo Plant 4-1

4 Click to edit Master title style Total Variable Cost Graph Total Direct Materials Cost $300,000 $250,000 $200,000 $150,000 $100,000 $50, Total Units (Model JS-12) Produced (thousands) Variable Cost Graphs (Cont’d) 4-1

5 Click to edit Master title style Unit Variable Cost Graph $20 $15 $10 $5 0 Direct Materials Cost per Unit Total Units (Model JS-12) Produced (thousands) Variable Cost Graphs (Concluded) 4-1

6 Click to edit Master title style Total Costs $300,000 $250,000 $200,000 $150,000 $100,000 $50, $20 $15 $10 $5 0 Cost per Unit Number of Units of Model JS-12 Produced Units Produced (000) Direct Materials Cost per Unit Total Direct Materials Cost 5,000 units$10$ 50,000 10,00010l00,000 15, ,000 20, ,000 25, ,000 30, ,000 Unit Cost Compared to Total Cost 4-1

7 Click to edit Master title style The production supervisor for Minton Inc.’s Los Angeles plant is Jane Sovissi. She is paid $75,000 per year. The plant produces from 50,000 to 300,000 bottles of La Fleur Perfume. Minton Inc.’s Los Angeles Plant 4-1

8 Click to edit Master title style Number of Bottles of Perfume Produced Total Salary for Jane Sovissi 50,000 bottles$75,000$ ,00075, ,00075, ,00075, ,00075, ,00075, Salary per Bottle of Perfume Produced Fixed Versus Variable Cost of Jane Sovissi’s Salary 4-1

9 Click to edit Master title style Total Costs $150,000 $125,000 $100,000 $75,000 $50,000 $25, Bottles Produced (000) Number of Bottles of Perfume Produced Unit Cost $1.50 $1.25 $1.00 $.75 $.50 $ Units Produced (000) Total Salary for Jane Sovissi 50,000 bottles$75,000$ ,00075, ,00075, ,00075, Salary per Bottle of Perfume Produced 4-1

10 Click to edit Master title style 10 Simpson Inc. manufactures sails using rented equipment. The rental charges are $15,000 per year, plus $1 for each machine hour used over 10,000 hours. Simpson Inc. Example 4-1

11 Click to edit Master title style Total Costs 0 Total Machine Hours (000) $45,000 $40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5, Mixed costs are usually separated into their fixed and variable components for management analysis. Mixed Cost Graph for Simpson Inc.’s Equipment Rental Charges 4-1

12 Click to edit Master title style 12 The high-low method is a simple cost estimate technique that may be used for separating mixed costs into their fixed and variable components. High-Low Method 4-1

13 Click to edit Master title style 13 Example Exercise The manufacturing cost of Alex Industries for the first three months of the year are provided below: 27 Total Cost Production January$80,0001,000 units February$125,0002,500 March$100,0001,800 Using the high-low method, determine the (a) variable cost per unit, and (b) the total fixed cost.

14 Click to edit Master title style 14 For Practice: PE4-1A, PE4-1B Follow My Example b.$50,000 = $125,000 – ($30 x 2,500) or $80,000 – ($30 x 1,000) a.$30 per unit = $125,000 – $80,000 (2,500 – 1,000)

15 Click to edit Master title style Total Variable Costs Total Units Produced Unit Variable Costs Total Units Produced Total Costs Per Unit Cost Total costs increase and decrease proportionately with activity level. Summary of Cost Behavior Concepts Unit costs remain the same per unit regardless of activity. 4-1

16 Click to edit Master title style Total Units Produced Total Costs Total Units Produced Per Unit Cost Unit costs remain the same regardless of activity. Total costs increase and decrease with activity level. Summary of Cost Behavior Concepts Total Fixed Costs Unit Fixed Costs 4-1

17 Click to edit Master title style 17 Compute the contribution margin, the contribution margin ratio, and the unit contribution margin, and explain how they may be useful to managers. Objective 2 4-2

18 Click to edit Master title style 18 Cost-Volume-Profit Relationships Cost-volume-profit analysis is the systematic examination of the relationships among selling prices, sales and production volume, costs, expenses, and profits. 4-2

19 Click to edit Master title style 19 The contribution margin is the excess of sales revenues over variable costs. It contributes first toward covering fixed costs, then contributes to profit. 4-2

20 Click to edit Master title style Sales (50,000 units)$1,000,000 Variable costs 600,000 Contribution margin$ 400,000 Fixed costs 300,000 Income from operations$ 100,000 Contribution Margin Income Statement 4-2 4

21 Click to edit Master title style 21 Contribution Margin Ratio % 60% Contribution Margin Ratio = 40% Sales (50,000 units)$1,000,000 Variable costs 600,000 Contribution margin$ 400,000 Fixed costs 300,000 Income from operations$ 100,000 Contribution Margin Ratio = Sales – Variable Costs Sales $1,000,000 – $600,000 $1,000,000 Contribution Margin Ratio = 40% 30% 10%

22 Click to edit Master title style 22 Unit Contribution Margin The unit contribution margin is also useful for analyzing the profit potential of proposed projects. The unit contribution margin is the sales price less the variable cost per unit. 4-2

23 Click to edit Master title style Using Contribution Margin per Unit as a Shortcut Sales ($20)$1,000,000 Variable costs ($12) 600,000 Contribution margin ($8)$ 400,000 Fixed costs 300,000 Income from operations$ 100,000 50,000 units 65,000 units The increase in income from operations of $120,000 could have been determined quickly by multiplying the increase in unit sales (15,000) by the contribution margin per unit ($8). $1,300, ,000 $ 520, ,000 $220,

24 Click to edit Master title style % 60% 40% 30% 10% $20 12 $ 8 Sales (50,000 units)$1,000,000 Variable costs 600,000 Contribution margin$ 400,000 Fixed costs 300,000 Income from operations$ 100,000 Unit contribution margin analyses can provide useful information for managers. 4-2

25 Click to edit Master title style % 60% 40% 30% 10% 1. Total contribution margin in dollars. $20 12 $ 8 Sales (50,000 units)$1,000,000 Variable costs 600,000 Contribution margin$ 400,000 Fixed costs 300,000 Income from operations$ 100, Contribution margin ratio (percentage). The contribution margin can be expressed three ways: 3. Unit contribution margin (dollars per unit). Review 4-2

26 Click to edit Master title style 26 Example Exercise Molly Company sells 20,000 units at $12 per unit. Variable costs are $9 per unit, and fixed costs are $25,000. Determine the (a) contrib- ution margin ratio, (b) unit contribution margin, and (c) income from operations. 40

27 Click to edit Master title style 27 For Practice: PE4-2A, PE4-2B Follow My Example a.25% = ($12 – $9)/$12 or ($240,000 – $180,000)/$240,000 b.$3 per unit = $12 – $9 c.Sales$240,000(20,000 x $12) Variable costs 180,000(20,000 x $9) Contribution margin$ 60,000[20,000 x $12 –$9)] Fixed costs 25,000 Income from operations$ 35,000

28 Click to edit Master title style 28 Using the unit contribution margin, determine the break-even point and the volume necessary to achieve a target profit. Objective 3 4-3

29 Click to edit Master title style 29 Break-Even Point The break-even point is the level of operations at which a business’s revenues and expired costs are exactly equal. 4-3

30 Click to edit Master title style Barker Corporation’s fixed costs are estimated to be $90,000. The unit contribution margin is calculated as follows: Unit selling price$25 Unit variable cost 15 Unit contribution margin$10 4-3

31 Click to edit Master title style The break-even point is calculated using the following equation: Break-Even Sales (units) = Fixed Costs Unit Contribution Margin Break-Even Sales (units) = $90,000 $10 Break-Even Sales (units) = 9,000 units 4-3

32 Click to edit Master title style Proof of the Preceding Computation Sales ($25 x 9,000)$225,000 Variable costs ($15 x 9,000) 135,000 Contribution margin$ 90,000 Fixed costs 90,000 Income from operations$ 0 Income from operations is zero when 9,000 units are sold—hence, break- even is 9,000 units. 4-3

33 Click to edit Master title style Effect of Changes in Fixed Costs Fixed Costs Fixed Costs If Break- Break-Even Even Then FixedCostsFixedCosts If Then Break-EvenBreak-Even 4-3

34 Click to edit Master title style 34 Bishop Co. is evaluating a proposal to budget an additional $100,000 for advertising. Fixed costs before the additional advertising are estimated at $600,000, and the unit contribution margin is $

35 Click to edit Master title style Without additional advertising: 4-3 Break-Even in Sales (units) = Fixed Costs Unit Contribution Margin Break-Even in Sales (units) = $600,000 $20 = 30,000 units With additional advertising: Break-Even in Sales (units) = $700,000 $20 = 35,000 units

36 Click to edit Master title style Effect of Changes in Unit Variable Costs Unit Variable Cost If Break- Break-Even Even Then Unit Variable Costs Costs If Then Break-EvenBreak-Even 4-3

37 Click to edit Master title style Park Co. is evaluating a proposal to pay an additional 2% commission on sales to its salespeople (a variable cost) as an incentive to increase sales. Fixed costs are estimated at $840,000. The unit contribution margin before the additional 2% commission is determined as follows: Unit selling price$250 Unit variable cost 145 Unit contribution margin$

38 Click to edit Master title style Without additional 2% commission: Break-Even in Sales (units) = Fixed Costs Unit Contribution Margin Break-Even in Sales (units) = $840,000 $105 = 8,000 units With additional 2% commission: Break-Even in Sales (units) = $840,000 $100 = 8,400 units $250 – [$145 + ($250 x 2%)] = $

39 Click to edit Master title style Effect of Changes in the Unit Selling Price Unit Selling Price If Break- Break-Even Even Then Unit Selling Price Price If Then Break-EvenBreak-Even 4-3

40 Click to edit Master title style Graham Co. is evaluating a proposal to increase the unit selling price of a product from $50 to $60. The following data have been gathered: Unit selling price$50$60 Unit variable cost Unit contribution margin$20$30 CurrentProposed Total fixed costs$600,000$600,

41 Click to edit Master title style Without price increase: Break-Even in Sales (units) = Fixed Costs Unit Contribution Margin Break-Even in Sales (units) = $600,000 $20 = 30,000 units With price increase: Break-Even in Sales (units) = $600,000 $30 = 20,000 units 4-3

42 Click to edit Master title style Summary of Effects of Changes on Break-Even Point Effect of Change Direction ofon Break-Even ChangeSales (Units) Type of Change Fixed cost Increase Decrease Variable cost per unitIncrease Decrease Unit sales priceIncreaseDecrease Increase Decrease 4-3

43 Click to edit Master title style 43 Example Exercise Nicholas Enterprises sells a product for $60 per unit. The variable cost is $35 per unit, while fixed costs are $80,000. Determine the (a) break-even point in sales units, and (b) break-even point if the selling price were increased to $67 per unit. 57 For Practice: PE4-3A, PE4-3B Follow My Example 4-3 a.3,200 units = $80,000/($60 – $35) b.2,500 units = $80,000/($67 – $35)

44 Click to edit Master title style Target Profit The sales volume required to earn a target profit is determined by modifying the break-even equation. Sales (units) = Fixed Costs + Target Profit Unit Contribution Margin 4-3

45 Click to edit Master title style Fixed costs are estimated at $200,000, and the desired profit is $100,000. Unit contribution margin is $30. Unit selling price$75 Unit variable cost 45 Unit contribution margin$30 Sales (units) = Fixed Costs + Target Profit Unit Contribution Margin $30 Sales (units) = 10,000 units Units Required for Target Profit 4-3 $200,000 $100,000

46 Click to edit Master title style Sales (10,000 units x $75)$750,000 Variable costs (10,000 x $45) 450,000 Contribution margin (10,000 x $30)$300,000 Fixed costs 200,000 Income from operations$100,000 Proof that sales of 10,000 units will provide a profit of $100,

47 Click to edit Master title style 47 Example Exercise The Forest Company sells a product for $140 per unit. The variable cost is $60 per unit, and fixed costs are $240,000. Determine the (a) break-even point in sales units, and (b) break-even point in sales units if the company desires a target profit of $50, For Practice: PE4-4A, PE4-4B Follow My Example 4-4 a.3,000 units = $240,000/($140 – $60) b.3,625 units = ($240,000 + $50,000)/($140 – $60)

48 Click to edit Master title style 48 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. Objective 4 4-4

49 Click to edit Master title style 49 Cost-Volume-Profit (Break- Even) Chart A cost-volume-profit chart, sometimes called a break- even chart, may assist management in understanding relationships among costs, sales, and operating profit or loss. 4-4

50 Click to edit Master title style 50 Unit selling price$ 50 Unit variable cost 30 Unit contribution margin$ 20 Total fixed costs $100,000 The cost-volume-profit chart in Exhibit 5 (Slides 65-73) is based on the following data: 4-4

51 Click to edit Master title style 51 Sales and Costs (in thousands) 0 Units of Sales (in thousands) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Cost-Volume-Profit Chart Volume is shown on the horizontal axis. Dollar amounts are indicated along the vertical axis

52 Click to edit Master title style Cost-Volume-Profit Chart (Continued) Sales and Costs (in thousands) 0 Units of Sales (in thousands) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ A sales line is plotted by determining one value ($500,000 in sales divided by the $50 selling price equals 10,000 units). 4-4

53 Click to edit Master title style Sales and Costs (in thousands) 0 Units of Sales (in thousands) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ Now, beginning at zero on the left corner of the graph, connect a straight line to the dot. Cost-Volume-Profit Chart (Continued) 4-4

54 Click to edit Master title style Sales and Costs (in thousands) 0 Units of Sales (in thousands) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Fixed cost of $100,00 is a horizontal line Cost-Volume-Profit Chart (Continued) 4-4

55 Click to edit Master title style Sales and Costs (in thousands) 0 Units of Sales (in thousands) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Similar to the sales line, a point is determined on the cost line $30 = $300,000 + $100,000 = $400,000) Cost-Volume-Profit Chart (Continued) 4-4

56 Click to edit Master title style Sales and Costs (in thousands) 0 Units of Sales (in thousands) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Beginning with the total fixed cost at the vertical axis ($100,000), draw a line to the red dot. This is the total cost line Cost-Volume-Profit Chart (Continued) 4-4

57 Click to edit Master title style Sales and Costs (in thousands) 0 Units of Sales (in thousands) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Horizontal and vertical lines are drawn at the intersection point of the sales and cost lines, which is the break-even point Cost-Volume-Profit Chart (Continued) 4-4

58 Click to edit Master title style Sales and Costs (in thousands) 0 Units of Sales (in thousands) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ 50 Break-even is sales of 5,000 units or $250, Cost-Volume-Profit Chart (Continued) 4-4

59 Click to edit Master title style Sales and Costs (in thousands) 0 Units of Sales (in thousands) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ Profit area Loss area Cost-Volume-Profit Chart (Concluded) 4-4

60 Click to edit Master title style 60 Revised Cost-Volume-Profit Chart Using the data from Slide 64, assume that a proposal to reduced fixed cost by $20,000 is to be evaluated. A cost- volume-profit chart can be created to assist in this evaluation. 4-4 Click this button to go to Slide 64. Return to this slide by typing “74” and striking “Enter.”

61 Click to edit Master title style Sales and Costs (in thousands) 0 Units of Sales (in thousands) $500 $450 $400 $350 $300 $250 $200 $150 $100 $ $80,000 If fixed costs can be reduced to $80,000, the new break- even point is sales of $200,000 or 4,000 units. Revised Cost-Volume- Profit Chart 4-4

62 Click to edit Master title style Profit-Volume Chart Another graphic approach to cost-volume- profit analysis, the profit-volume chart, plots only the difference between total sales and total costs (or profits). Again, the data from Slide 64 (shown below) will be used. Unit selling price$ 50 Unit variable cost 30 Unit contribution margin$ 20 Total fixed costs $100,

63 Click to edit Master title style 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 The maximum operating loss is equal to the fixed costs of $100,000. Assuming that the maximum unit sales within the relevant range is 10,000 units, the maximum operating profit is $100,000, computed as follows: 4-4 Maximum profit

64 Click to edit Master title style Units of Sales (in thousands) Profit Line Operating loss Operating profit $100,000 $75,000 $50,000 $25,000 $ 0 $(25,000) $(50,000) $(75,000) $(100,000) Operating Profit (Loss) Maximum loss is $100,000, the fixed costs. Profit-Volume Chart Break-Even Point 4-4

65 Click to edit Master title style 65 Assumptions of Cost-Volume-Profit Analysis The primary assumptions are: 1.Total sales and total costs can be represented by a straight line. 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. 4-4

66 Click to edit Master title style 66 Compute the break-even point for a business selling more than one product, the operating leverage, and the margin of safety, and explain how managers use these concepts. Objective 5 4-5

67 Click to edit Master title style 67 Sales Mix Considerations The sales volume necessary to break even or to earn a target profit for a business selling two or more products depends upon the sales mix. The sales mix is the relative distribution of sales among the various products sold by a business. 4-5

68 Click to edit Master title style Cascade Company sold 8,000 units of Product A and 2,000 units of Product B during the past year. Cascade Company’s fixed costs are $200,000. Other relevant data are as follows: UnitUnitUnitSales SellingVariableContributionMix ProductPriceCostMargin% A$ 90$70$2020% B % 4-5

69 Click to edit Master title style For Cascade Company, the overall enterprise product is called E. Unit selling price of E: ($90 x 0.8) + ($140 x 0.2) = $100 Unit variable cost of E: ($70 x 0.8) + ($ 95 x 0.2) = $ 75 Unit contribution margin of E: ($20 x.08) + ($45 x.02) = $ Cascade Company Example

70 Click to edit Master title style Break-Even Point of 8,000 Units of E Break-Even Sales (units) = Fixed Costs Unit Contribution Margin Break-Even Sales (units) = $200,000 $25 Break-Even Sales (units) = 8,000 units

71 Click to edit Master title style Verification of Analysis Break-even point 4-5

72 Click to edit Master title style 72 Example Exercise Megan Company has fixed cost of $180,000. The unit selling price, variable cost per unit, and contribution margin per unit for the company’s two products are provided below : 86 VariableContributionSales SellingCost perMargin perMix ProductPriceUnitUnit% Q$ 160$100$2075% Z % Determine the break-even point in units of Q and Z.

73 Click to edit Master title style 73 For Practice: PE4-5A, PE4-5B Follow My Example Unit selling price of E: ($160 x.75) + ($100 x.25) = $145 Unit variable cost of E: ($100 x.75) + ($80 x.25) = $95 Unit contribution margin of E: ($60 x.75) + ($20 x.25), or $145 – $95 = $50 Break-even sales (units) = 3,600 units = $180,000/$50

74 Click to edit Master title style 74 The relative mix of a business’s variable costs and fixed costs is measured by the operating leverage. It is computed as follows: 4-5 Operating Leverage Operating Leverage = Contribution Margin Income from Operations

75 Click to edit Master title style Both companies have the same contribution margin. Jones Inc. Wilson Inc. Sales$400,000$400,000 Variable costs 300, ,000 Contribution margin$100,000$100,000 Fixed costs 80,000 50,000 Income from operations$ 20,000$ 50,000 Operating leverage? ? 4-5 Operating Leverage Example

76 Click to edit Master title style Contribution Margin Income from Operations $100,000 $20,000 = 5 Jones Inc.: Jones Inc. Wilson Inc. Sales$400,000$400,000 Variable costs 300, ,000 Contribution margin$100,000$100,000 Fixed costs 80,000 50,000 Income from operations$ 20,000$ 50,000 Operating leverage? ? 5 4-5

77 Click to edit Master title style Contribution Margin Income from Operations $100,000 $50,000 = 2 Wilson Inc.: Jones Inc. Wilson Inc. Sales$400,000$400,000 Variable costs 300, ,000 Contribution margin$100,000$100,000 Fixed costs 80,000 50,000 Income from operations$ 20,000$ 50,000 Operating leverage? ?

78 Click to edit Master title style High Versus Low Operating Leverage 4-5

79 Click to edit Master title style 79 Example Exercise The Tucker Company reports the following data. 93 For Practice: PE4-6A, PE4-6B Follow My Example = ($750,000 – $500,000)/($750,000 – $500,000 – $187,500) = $250,000/$62,500 Sales$750,000 Variable costs$500,000 Fixed costs$187,500 Determine Tucker Company’s operating leverage.

80 Click to edit Master title style 80 Margin of Safety The difference between the current sales revenue and the sales revenue at the break- even point is called the margin of safety. 4-5

81 Click to edit Master title style If sales are $250,000, the unit selling price is $25, and the sales at the break-even point are $200,000, the margin of safety is 20%, computed as follows: 4-5 Margin of Safety = Sales – Sales at Break-Even Point Sales Margin of Safety = 20% Margin of Safety = $250,000 – $200,000 $250,000

82 Click to edit Master title style 82 Example Exercise The Rachel Company has sales of $400,000, and the break-even point in sales dollars is $300,000. Determine the company’s margin of safety. 96 For Practice: PE4-7A, PE4-7B Follow My Example % = ($400,000 – $300,000)/$400,000

83 Click to edit Master title style Preparing a Variable Costing Income Statement Number Unit Total Costof UnitsCost Manufacturing costs: Variable$375,00015,000$25 Fixed 150,00015, Total$525,000$35 Selling and administrative expenses: Variable ($5 per unit sold)$ 75,000 Fixed 50,000 Total$125,