1. Detailed CVP Income Statement
Cost-Volume-Profit (CVP) Review
Detailed CVP Income Statement
Internal Use Only

2. C-V-P Review - Breakeven Analysis
Breakeven in Units?
$200,000 / $200 = 1,000
Breakeven in Dollars?
1,000 x $500 = 500,000

3. C-V-P Review - Breakeven Analysis
Breakeven in Units?
$200,000 / $200 = 1,000
Breakeven in Dollars?
1,000 x $500 = 500,000
CM as a ratio ?
$200 ÷ $500 = 40%.
40% of “Sales” is available to cover Fixed Costs and Profit
800,000 x 40% = 320,000
(200, ,000)

4. Ex: Target Net Income: $250,000.
C-V-P Review - Target Net Income
Required Unit Sales ?
450,000 / $200 = 2,250 units
Required Sales Dollars ?
2,250 x $500 = $1,125,000
Required Sales Dollars using CM Ratio?
450, % = $1,125,000
Ex: Target Net Income: $250,000.
($200 / $500)

6. Margin of Safety
Shows how far sales can drop before breakeven point is reached.
Informs management of the risk of loss due to changes in sales.
Useful when a significant proportion of sales are at risk of decline or elimination, as may be the case when a sales contract is coming to an end. (Burger-King and Coke … Amex and Costco)
Small “Margin of Safety” might trigger action to reduce expenses.
The opposite situation may also arise, where the MoS is so large that a business is well-protected from sales variations.
(May lead to a “take-it-or-leave-it” attitude in negotiations).

7. C-V-P Review - Breakeven Analysis
Breakeven in Units?
$200,000 / $200 = 1,000
Breakeven in Dollars?
1,000 x $500 = 500,000
CM as a ratio ?
$200 ÷ $500 = 40%.
40% of “Sales” is available to cover Fixed Costs and Profit
800,000 x 40% = 320,000
(200, ,000)

8. C-V-P Review – *Margin of Safety
Margin of Safety in Dollars ?
(Proj. sales – BE sales)
$800,000 – $500,000 = $300,000
Margin of Safety Ratio ?
300,000 / 800,000 = 37.5%

10. Sales Mix
Sales mix is the relative percentage in which a company sells its products.
If a company’s sells 6,000,000 printers and 2,000,000 computers … its sales mix is 75:25 (or 3 printers to 1 computer)
Sales mix is important because … different products often have very different *CM (*contribution margins).

11. Sales Mix … Break-Even Sales in Units
Compute break-even sales for a mix products by determining the weighted-average unit contribution margin.
Ex: “V” sells Camcorders AND TV sets in these quantities:
1,500 Camcorders and 500 TVs. Total Units Sold = 2,000
Sales mix, as a percentage of total units sold, is:

12. Sales Mix … Break-Even Sales in Units
1st determine the weighted-average contribution margin.
New Info
$200 X = $150
$500 X = $125
$ $125 = $275

13. Sales Mix … Break-Even Sales in Units
2nd use the weighted-average unit contribution margin to compute the break-even point in units
New Info

14. Sales Mix … Break-Even Sales in Units
With a break-even point of 1,000 units, V Video must sell:
750 Camcorders (1,000 units x 75%)
250 TVs (1,000 units x 25%)
At this level, total CM will equal the fixed costs of $275,000.

15. Sales Mix - Break-Even Sales in Dollars
Works well if the company has many products.
Calculates break-even point in terms of sales dollars for
divisions or
product lines,
NOT individual products.

16. Sales Mix - Break-Even Sales in Dollars
Illustration: Kale Garden Supply Company has two divisions.

17. Sales Mix - Break-Even Sales in Dollars
First, determine the weighted-average contribution margin.
Second, calculate break-even point in dollars.

18. Sales Mix - Break-Even Sales in Dollars
With break-even sales of $937,500 and a sales mix of 20% to 80%, Kale must sell:
$187,500 from the Indoor Plant division
$750,000 from the Outdoor Plant division
If the sales mix becomes 50% to 50%, the weighted average contribution margin ratio changes to 35%, resulting in a lower break-even point of $857,143.

20. Resources are finite (limited)
Resources are finite (limited). A business only has so many man hours, so many square feet, and so many machines.
Long-term … a company can expand … or grow.
Short term … limited resources require business to make decisions about which products to make and in what quantities … to maximize profits.
How?  
Look at each products use of the limited resource …
and maximize contribution margin per hour.

21. Sales Mix … Limited Resources
Ex: V Video makes camcorders & TVs.
* Machine capacity is limited to 3,600 hours per month.
Additional New Info

22. Sales Mix … Limited Resources
From previous slide
Management should produce more camcorders if demand exists or else increase machine capacity.

23. Sales Mix … Limited Resources
Assume V Video can increase capacity from 3,600 to 4,200 hrs.
Should the 600 added hours be used to make camcorders or TVs.
To maximize net income, all 600 hours should be used to produce and sell camcorders.

25. Cost Structure & Operating Leverage
Cost Structure: proportion of fixed vs variable costs that a company incurs.
May have a significant effect on profitability.
Company must carefully choose its cost structure.
High Operating Leverage.
Significantly more fixed vs variable cost =
These firms use a lot of fixed costs in their business it is capital intensive.

26. Cost Structure & Operating Leverage
Capital intensive: a lot of fixed costs.
Which companies or industries (types of products) ?
Greater investments, More sensitive to sales decrease.
Economies of scale, More productivity, More profits during up economy.
Opposite of Capital Intensive is:
Labor intensive: a lot of variable costs.
Which companies or industries (types of products) ?
More expensive long-term, inefficient & inconsistent, labor shortage.
Flexibility to meet demands, Personalization, Reduce variable costs.

27. Cost Structure and Operating Leverage
Extent that net income reacts to a given change in sales.
Higher fixed costs vs variable = higher operating leverage.
Increasing sales: means profits will increase rapidly.
Decreasing sales: can have major consequences.

28. Hotel-Casino …. Labor or capital intensive ?
Ex: GM & FORD
Capital intensive (high operating leverage).
High fixed costs … machines, robots, buildings etc.
Economic slowdown hurts a capital intensive firm much more than a company not quite so capital intensive.
Labor intensive (more workers = higher variable costs) has lower operating leverage.
Hotel-Casino …. Labor or capital intensive ?
Labor intensive typically have an easier time surviving (note “surviving”) than capital intensive firms.

29. Cost Structure and Operating Leverage
Ex: “V” Video has a competitor “NW” Inc. Both make camcorders.
“V” uses a labor-intensive (many employees) manufacturing process.
“NW” uses an automated system. (Employees only set-up, adjust, and maintain the machinery.)
CVP income statements

30. Cost Structure and Operating Leverage
Effect on Contribution Margin Ratio
Look at CM ratios.

31. Cost Structure and Operating Leverage
Effect on Contribution Margin Ratio
New Wave contributes 80 cents to net income for each dollar of increased sales while Vargo only contributes 40 cents.
New Wave’s cost structure which relies on fixed costs is more sensitive to changes in sales.

32. Cost Structure and Operating Leverage
Effect on Break-Even Point
Calculate the break-even point.
New Wave needs to generate $150,000 more in sales than Vargo to break-even.
Because of the greater break-even sales required, New Wave is a riskier company than Vargo.

34. APPENDIX … ABSORPTION VS VARIABLE Costing
All we have covered so far are variations of: Absorption Costing
(Job-Order costing, Process costing, Activity-Based-Costing)
All factory costs added to the product during manufacture and are assets until sold … then expense as “Cost of Goods Sold.
Under Absorption Costing, product costs consist of:
Direct Material Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overhead

35. Fixed Manufacturing Overhead
What costs fall under the category of:
Fixed Manufacturing Overhead
Premise: A business cannot continue in existence if it does not “cover” it Fixed Manufacturing Overhead?
The short answer is that the fixed manufacturing overhead is going to be incurred no matter how much is produced. In the long run, a business must recover those costs to survive.
So, how else could you handle Fixed Factory Overhead ?
If we don’t inventory it … we then must EXPENSE it.
Period Cost
Product Cost

36. APPENDIX … ABSORPTION VS VARIABLE Costing FIXED Manufacturing Costs –
not “product” costs … not part of inventory
instead “expensed” as a monthly “period cost”
Under variable costing, product costs consist of:
Direct Materials Direct Labor Variable Manufacturing Overhead NO Fixed Manufacturing Overhead

37. APPENDIX … ABSORPTION VS VARIABLE Costing
The difference between absorption and variable costing:
Under both costing methods, selling and administrative expenses (corporate) are treated as period costs …
BUT, under variable costing “FIXED” Mfg Costs are also considered as period costs and are expensed when incurred (NOT “inventoried” as in absorption costing)

38. APPENDIX … ABSORPTION VS VARIABLE Costing
Comparing Absorption with Variable Costing
Ex: PCorp makes “Fix-It”. Relevant data for Fix-It in JAN 2013, the first month of production, are:

39. APPENDIX … ABSORPTION VS VARIABLE Costing
Comparing Absorption with Variable Costing
Per unit manufacturing cost under each approach.
The mfg cost per unit is $4 ($13 -$9) higher for absorption costing because fixed mfg costs are treated as product costs.

40. APPENDIX … ABSORPTION VS VARIABLE Costing
Absorption Costing Example
P Corp

41. APPENDIX … ABSORPTION VS VARIABLE Costing
Variable Costing Example

42. APPENDIX … ABSORPTION VS VARIABLE Costing
Decision-Making Concerns
GAAP require that absorption costing be used for the costing of inventory for external reporting purposes.
Net income measured under GAAP (absorption costing) is often used internally to
evaluate performance,
justify cost reductions, or
evaluate new projects.

43. APPENDIX … ABSORPTION VS VARIABLE Costing
Decision-Making Concerns
Some companies have recognized that net income calculated using GAAP does not highlight differences between variable and fixed costs and may lead to poor business decisions.
These companies use variable costing for internal reporting purposes.

44. APPENDIX … ABSORPTION VS VARIABLE Costing
Potential Advantages of Variable Costing
The use of variable costing is consistent with cost–volume–profit analysis.
Net income under variable costing is unaffected by changes in production levels. Instead, it is closely tied to changes in sales.
The presentation of fixed costs in the variable costing approach makes it easier to identify fixed costs and to evaluate their impact on the company’s profitability.

46. (a) Unit Cost Direct Materials 7.50 Direct Labor 2.45
Direct Materials
7.50
Direct Labor
2.45
Variable Mfg Overhead
5.80
Mfg Cost Per Unit
15.75

47. Income Statement - Variable Costing
Sales (80,000 lures x $25)
2,000,000
Var Costs (80,000 x $15.75)
1,260,000
Var Selling – Admin Exp (80,000 x $3.90)
312,000
1,572,000
Contribution Margin
428,000
Fixed Mfg Overhead
225,000
Fixed Sell – Admin Exp
240,100
465,100
Net Income (Loss)
(37,100)
Unit Cost
Direct Materials
7.50
Direct Labor
2.45
Variable Mfg Overhead
5.80
Mfg Cost Per Unit
15.75

48. (c) Unit Cost Direct Materials 7.50 Direct Labor 2.45
Direct Materials
7.50
Direct Labor
2.45
Variable Mfg Overhead
5.80
Fixed Mfg Overhead
2.50
Mfg Cost Per Unit
18.25

49. Income Statement - Absorption Costing
Sales (80,000 lures x $25)
2,000,000
Cost of Goods Sold (80,000 x $18.75)
1,460,000
Gross Profit
40,000
Var Sell-Admin Exp (80,000 x $3.90)
312,000
Fixed Sell – Admin Exp
240,100
465,100
Net Income (Loss)
(12,100)
Unit Cost
Direct Materials
7.50
Direct Labor
2.45
Variable Mfg Overhead
5.80
Fixed Mfg Overhead
2.50
Mfg Cost Per Unit
18.25

50. (b)
(b) Absorption Costing
Labor (Crate builders)
38,000
Material (Wood)
54,000
Var Overhead (Utilities)
2,400
Var Overhead (Nails)
350
Fxd Overhead (Utilities)
18,000
Fxd Overhead (Rent)
21,400
Total Mfg Costs
$ 134,150
(a)
(a) Variable Costing
Labor (Crate builders)
38,000
Material (Wood)
54,000
Var Overhead (Utilities)
2,400
Var Overhead (Nails)
350
Total Mfg Costs
$ 94,750
(c)
(c) Difference is due to fixed overhead being included as part of manufacturing costs under absorption costing ONLY. This difference amounts to $39,400 ($18,000 + $21,400).