Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 18-1 Chapter 18 Cost volume profit analysis

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 18-2 Cost volume profit (CVP) analysis A technique used to determine the effects of changes in an organisation’s sales volume on its costs, revenue and profit Can be used in profit-seeking organisations and not-for-profit organisations Not confined to profit-seeking enterprises Commonly used in many not-for-profit situations

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 18-3 The break-even point The volume of sales where the total revenues and expenses are equal, and the operation breaks even At this level of sales, there is no profit or loss Can be calculated for an entire organisation or individual projects

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 18-4 Formulas

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 18-5 Terminology Contribution margin (or variable costing) statement –A profit report where costs are reported by cost behaviour and a contribution margin is calculated –Fixed and variable costs are separated Total contribution margin –The difference between the total sales revenue and the total variable costs –The amount available to cover fixed costs and then contribute to profits continued

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 18-6 Terminology Unit contribution margin –The difference between the sales price per unit and the variable cost per unit Contribution margin ratio –The unit contribution margin divided by the unit sales price –The proportion of each sales dollar available to cover fixed costs and earn a profit Contribution margin percentage –The contribution margin ratio multiplied by 100 –The percentage of each sales dollar available to cover fixed costs and earn a profit

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 18-7 Graphing cost volume profit relationships Shows how costs, revenue and profits change as sales volume changes Five steps 1.Draw the axes of the graph 2.Draw the fixed expense line 3.Draw the total expense line 4.Draw the total revenue line 5.Break-even point—where the total revenue and total expense lines intersect

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 18-8

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 18-9 Profit volume (PV) graph Shows the total amount of profit or loss at different sales volumes The graph intercepts the vertical axis at the amount equal to the fixed costs The break-even point is the point at which the line crosses the horizontal axis

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 18-10

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith Target net profit A desired profit level determined by management Can be used within the break-even formula

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith Using CVP analysis for management decision making Common applications include –Safety margin –Changes in fixed expenses –Changes in the unit contribution margin –Multiple changes in key variables

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith Safety margin Difference between the budgeted sales revenue and the break-even sales revenue Gives a feel for how close projected operations are to the break-even point

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith Changes in fixed costs When estimates of fixed costs are revised, the break-even point will change –Percentage change in fixed expenses will lead to a similar increase in the break-even point (in units or dollars) Different fixed costs may apply to different levels of sales/production volume –More than one break-even point

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith Changes in the unit contribution margin Change in unit variable expenses –Changes the unit contribution margin –A new break-even point –An increase in unit variable expenses will increase the break-even point Change in sales price –Changes the unit contribution margin –A new break-even point –An increase in unit price will lower the break-even point continued

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 18-16

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith Multiple changes in key variables May involve –Increasing unit prices –Increasing selling prices –Undertaking a new advertising campaign –Leasing a new office An incremental approach to analysis –Focuses on the differences in the total contribution margin, fixed expenses and profits under the two alternatives

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith CVP analysis with multiple products Sales mix –The relative proportions of each type of product sold by the organisation Weighted average unit contribution margin –The average of the products’ unit contribution margins, weighted by the sales mix

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 18-19

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith Including income taxes in CVP analysis

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith Assumptions underlying CVP analysis The behaviour of total revenue is linear The behaviour of total costs is linear over a relevant range –Costs can be categorised as fixed, variable or semivariable –Labour productivity, production technology and market conditions do not change –There are no capacity changes during the period under consideration continued

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith Assumptions underlying CVP analysis For both variable and fixed costs, sales volume is the only cost driver The sales mix remains constant over the relevant range In manufacturing firms, the levels of inventory at the beginning and end of the period are the same –Thus, the number of units produced and sold during a period are equal

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith CVP analysis and long-term decisions CVP analysis is usually regarded as a short-term or tactical decision tool Classification of costs as variable or fixed is usually based on cost behaviour over the short term The financial impact of long-term decisions is best analysed using capital budgeting techniques –Takes into account the time value of money

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith Treating CVP analysis with caution CVP analysis is merely a simplified model The usefulness of CVP analysis may be greater in less complex smaller firms, or stand-alone projects For larger firms, CVP analysis can be valuable as a decision tool for the planning stages of new projects and ventures

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith An activity-based approach to CVP analysis ABC categorises activities as facility, product, batch or unit costs –Facility, product and batch activities are non-volume activity costs

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith Limiting assumptions of CVP analysis using activity-based costs Total batch level costs are dependent on the batch size and the break-even/target production level Management may change the batch size at certain production volume levels and this will change the break-even volume More complex models are needed where there are multiple products

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith Including customer-related costs in CVP analysis Some ABC systems include customer-related costs –Order level –Customer level –Market level –Facility level

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith Sensitivity analysis and CVP analysis Sensitivity analysis –An approach that examines how an outcome may change due to variations in the predicted data or underlying assumptions Can be run using spreadsheet software, such as Excel Goal seek approaches –The analyst specifies the outcome, and the software specifies the necessary inputs What-if analysis –The analyst specifies changes in assumptions and data to examine the effect of these changes on the outputs continued

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith continued

Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 18-30