ACTG 3000 Managerial Accounting and Cost- Volume-Profit Analysis

Nature of Managerial Accounting ManagerialFinancial InternalExternal Future-orientedHistorical SegmentedWhole company Any formatFollows GAAP

Users and Uses Users – Internal Main Responsibilities of Management Accountants – Planning – Directing – Controlling – Improving – Decision Making Head Accountant – Controller Top Positions – Chief Financial Officer (CFO)

Cost Behavior Variable costs - costs that change in total with changes in activity Activity bases – what causes variable costs to change Fixed costs - costs that stay the same in total with changes in activity Mixed - costs that have some fixed and some variable behavior; you must split these costs into variable and fixed costs Relevant range – point where cost behavior assumptions hold true

Cost Behavior In Total Variable - changes directly Fixed - stays same These relationships hold over the relevant range. Per unit Variable - stays same Fixed - changes inversely

Variable Costs Assume $30 unit VolumePer unitTotal cost 100 units$30? 200 units$30? 300 units$30?

Fixed Costs Assume $3,000 in total VolumePer unitTotal cost 100 units ?$3, units?$3, units?$3,000

High-low Method Method used to separate the variable and fixed costs in a mixed cost Procedure – Find the highest activity and the lowest activity – Subtract the lowest from the highest activity – The difference represents the variable part of the activity – Determine the variable cost per unit – Apply the variable cost per unit to either the low or the high amount and subtract this amount from the total cost – The difference is the fixed cost. – You now have a cost formula: Total cost = fixed cost in total + variable cost per unit

Cost-Volume-Profit Analysis Procedure that examines changes in costs -- variable and fixed-- and volume levels and the resulting effects on net income. Used for planning -- to determine effects of anticipated changes in revenues, variable costs, fixed costs and volume Used for controlling -- what happens to net income when changes occur

Contribution Margin Contribution margin = Sales – variable costs Example: Billy Bob’s Bicycles (Sales of 200 bikes) Sales Revenues $100,000 Var. Costs 40,000 Contr. Margin 60,000 Less Fixed costs 30,000 Net Income $30,000

Contribution Margin Per unit – Sales Price per unit - var. costs per unit – Tells us how much in $ is contributed to firm Ratio – CM per unit/Sales price per unit – Tells us what % of each dollar is contributed to the firm

Contribution Margin CM in total = $60,000 CM per unit = – $100,000/200 bikes = $500 sales price per bike – $ 40,000/200 bikes = $200 var.costs per bike – $ 60,000/200 bikes = $300 CM per bike CM Ratio = – $300/$500 = 60% OR – $60,000/$100,000 = 60%

Cost-Volume-Profit Relationships Break-even point = point where total costs = total revenues; no profit Costs = Fixed + variable Revenues Revenue per unit = fixed costs in total + variable cost per unit Rev(x) = Fixed + Var(x) Solve for x

Break-even Analysis Mathematical Method Sales = Var. Costs + Fixed Costs $500x = $200x + $30,000 $300x = $30,000 x = 100 bikes Check Sales $50,000 (100 x $500) Var. Costs 20,000 (100 x $200) CM $30,000 - Fixed 30,000 Net Income -0-

Break-even Analysis Contribution Margin Method 1) Determine the CM per unit $500 - $200 = $300 2) Calculate how many units must be sold to break even by the following formula: Fixed costs $30,000 = 100 bikes CM per unit $300

Break-even Analysis In Sales Dollars B.E. in units x Sales price per unit OR Fixed Costs CM ratio = $30,000/.60 = $50,000

Sensitivity Analysis A change in any of the variables will yield a new break-even point. – Sales prices Increase (decrease) – increased (decreased) break-even point – Fixed costs Increase (decrease) – increased (decreased) break-even point – Variable costs Increase (decrease) – increased (decreased) break-even point

Target Profit Analysis Add desired profit to fixed costs Mathematical Method $500x = $200x + $30,000 fixed + $60,000 Desired profit $300x = $90,000 x = 300 bikes CM Approach $30,000 + $60,000 $300 = $90,000/300 = 300 bikes

Margin of safety Tells us the amount sales dollars can drop before we have a net loss Therefore, it is the difference between current sales and break-even sales dollars

Cost Structure- Operating Leverage Company 1 - Pizza Pizza Sales$200,000 -Var. costs 150,000 CM 50,000 -Fixed costs 20,000 Net income 30,000 Company 2 - Pizza oven manufacturers Sales$200,000 -Var. costs 50,000 CM 150,000 -Fix. costs 120,000 Net income 30,000

Cost Structure What is CM ratio for each company? Company 1 = 50,000/200,000 Company 2 = 150,000/200,000 Which company is riskier? Operating Leverage = Contribution Margin Net Income Higher operating leverage, more risky company

C-V-P in a Multiproduct Environment Sales Mix - more than one product sold – Ratio of each product sold to total – Example: Pizza Hut sells pizza, breadsticks, etc. – How many pizzas sold per breadsticks? – Assume four pizzas to one breadstick – Sales mix = 4P + 1B – This equation is called a “basket” of goods

C-V-P in a Multiproduct Environment Breakeven/Target Profit analysis for multiproducts - use the CM per basket of goods Example: Assume the CM for pizzas is $4 and the CM for breadsticks is $2, equation would be: 4P ($4) + 1B ($2) = $18 CM per basket of goods Proceed as usual with break-even analysis

C-V-P for Multiproducts Basket of Goods Approach Example: Fixed costs = $90,000 Break-even point = $90,000/18 CM = 5,000 baskets of goods 1 bag = 4 P + 1B, therefore Break-even is 4 x 5000 = 20,000 pizzas and 1 x 5000 = 5,000 breadsticks All analysis is based on baskets of goods!!!