Managerial Accounting by James Jiambalvo Chapter 4: Cost-Volume-Profit-Analysis Slides Prepared by: Scott Peterson Northern State University

Objectives Identify common cost behavior patterns. Estimate the relation between cost and activity using account analysis and the high-low method. Perform cost-volume-profit-analysis for single products. Perform cost-volume-profit-analysis for multiple products.

Objectives (continued) Discuss the effect of operating leverage. Use the contribution margin per unit of the constraint to analyze situations involving a resource constraint.

Common Cost Behavior Patterns Cost-Volume-Profit-Analysis (C-V-P) Variable Costs Fixed Costs Discretionary Fixed Costs Committed Fixed Costs Mixed Costs Step Costs

Variable Costs

Fixed Costs

Mixed Costs

Cost Estimation Methods Cost Estimation Methods are frequently required to separate the fixed and variable components of a total cost pool. Methods include: Account Analysis Scattergraph High-Low Method Regression Relevant Range

Scattergraph

High-Low Method Example: Let total costs at 500 units of output be $150,000 and at 3,000 units of output be $400,000. Calculate variable and fixed costs, respectively.

High-Low Method Solution: High Low Change Costs: $400,000 $150,000 $250,000 Units: 3,000 500 2,500 Calculate Variable Cost Per Unit: $250,000/2,500 = $100 Calculate Total Fixed Costs: $400,000 – (3,000 x 100) = $100,000

High-Low Method

Regression Analysis

Relevant Range

Cost-Volume-Profit Analysis The Profit Equation Breakeven Point Margin of Safety Contribution Margin Contribution Margin Ratio What-if Analysis

The Profit Equation Profit = SP(x) –VC(x) – TFC X = Quantity of units produced and sold SP = Selling price per unit VC = Variable cost per unit TFC = Total fixed cost

Break-Even Point TFC/CM(per unit) = Break-Even (units) X = Quantity of units produced and sold SP = Selling price per unit VC = Variable cost per unit CM = Contribution margin TFC = Total fixed cost

Break-Even Point

Contribution Margin SP(u) – VC(u) = CM (u) SP = Selling price per unit VC = Variable cost per unit CM = Contribution margin u = per unit

Contribution Margin Ratio (SP – VC) / SP = CM% SP = Selling Price per unit VC = Variable Cost per unit CM = Contribution Margin

“What If” Analysis Examples include analyzing changes in: Selling price per unit Variable cost per unit Total fixed cost

Multiproduct Analysis C-V-P applied to multiple products. Contribution Margin Approach (used for similar products). Contribution Margin Ratio Approach (used for substantially different products).

Contribution Margin Approach Example: the contribution margin of product A is $8 and B is $5. Two units of B are sold for each unit of A. The Weighted Average Contribution Margin is $6.00.

Contribution Margin Ratio Approach Example: the contribution margin ratio of product A is 20% and B is 50%. Two units of B are sold for each unit of A. The Weighted Average Contribution Margin Ratio is 40%.

Assumptions in C-V-P Analysis Costs can be accurately separated into variable and fixed components. Fixed costs remain fixed. Variable costs per unit do not change over the relevant range.

Operating Leverage Example of Operating Leverage: Firm 1 Firm 2 Sales $10,000,000 $10,000,000 VC 5,000,000 7,000,000 CM 5,000,000 3,000,000 FC 3,000,000 1,000,000 Profit $2,000,000 $2,000,000 Which firm has more?

Constraints A reference to scarce resources. Examples of constraints include manufacturing space, labor, parts and materials etc.. The focus shifts away from Contribution Margin and to the scarce resource or constraint.

Quick Review Question #1 At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Contribution Margin per unit is? $65 $75 $175 $30

Quick Review Answer #1 At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Contribution margin per unit is? $65 $75 $175 $30

Quick Review Question #2 At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Break-Even Point is? 1,000 units 1,083 units 2,000 units None of these

Quick Review Answer #2 At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Break-Even Point is? 1,000 units 1,083 units 2,000 units None of these

Quick Review Question #3 At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. The Margin of Safety is? $264,000 $384,000 $143,000 $121,000

Quick Review Answer #3 At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. The Margin of Safety is? $264,000 $384,000 $143,000 $121,000

Quick Review Question #4 At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. What is profit expected to be? Answer here: _________________

Quick Review Answer #4 At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. What is profit expected to be? Answer here: $143,000

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