1. PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 22 C OST -V OLUME -P ROFIT A NALYSIS

2. 22 - 2 F IXED C OSTS Total fixed costs remain constant as activity increases. remain constant as activity increases. Number of Local Calls Monthly Basic Telephone Bill Cost per call declines as activity increases. Number of Local Calls Monthly Basic Telephone Bill per Local Call C 1

3. 22 - 3 V ARIABLE C OSTS Total variable costs increase as activity increases. Total variable costs increase as activity increases. Minutes Talked Total Costs Cost per Minute Minutes Talked Cost per Minute is constant as increases. Cost per Minute is constant as activity increases. C 1

4. 22 - 4 M IXED C OSTS Mixed costs contain a fixed portion that is incurred even when the facility is unused, and a variable portion that increases with usage. Utilities typically behave in this manner. Fixed Monthly Utility Charge Variable Cost per KW Activity (Kilowatt Hours) Total Utility Cost Total mixed cost C 1

5. 22 - 5 0 1 2 3 4 5 6 * Total Cost in 1,000’s of Dollars 10 20 0 * * * * * * * * * Activity, 1,000’s of Units Produced Estimated fixed cost = 10,000 Draw a line through the plotted data points so that about equal numbers of points fall above and below the line. S CATTER D IAGRAMS P 1

6. 22 - 6 Vertical distance is the change in cost. Horizontal distance is the change in activity. Unit Variable Cost = Slope = Δ in cost Δ in units 0 1 2 3 4 5 6 * Total Cost in 1,000’s of Dollars 10 20 0 * * * * * * * * * Activity, 1,000’s of Units Produced S CATTER D IAGRAMS P 1

7. 22 - 7 The following relationships between units produced and total cost are observed: Using these two levels of activity, compute:  the variable cost per unit.  the total fixed cost. T HE H IGH -L OW M ETHOD P 1

8. 22 - 8  Variable cost per unit is determined as follows:  Fixed costs are determined as follows: T HE H IGH -L OW M ETHOD Total cost = $17,525 + $0.17 per unit produced P 1

9. 22 - 9 Contribution margin is the amount by which revenue exceeds the variable costs of producing the revenue. C ONTRIBUTION M ARGIN AND ITS M EASURES Total contribution margin is $60,000 and the contribution margin per unit sold is $30. A 1

10. 22 - 10 C ONTRIBUTION M ARGIN AND ITS M EASURES Contribution margin ratio Contribution margin per unit Sales price per unit = Contribution margin ratio = $30 per unit $100 per unit = 30% A 1

11. 22 - 11 How much contribution margin must Rydell Company have to cover its fixed costs (break-even)? Answer: $24,000 C OMPUTING THE B REAK -E VEN P OINT How many units must Rydell sell to cover its fixed costs (break-even)? Answer: $24,000 ÷ $30 per unit = 800 units P 2

12. 22 - 12 Unit sales price less unit variable cost ($30 in previous example) We have just seen one of the basic CVP relationships – the break-even computation. C OMPUTING THE B REAK -E VEN P OINT Break-even point in units = Fixed costs Contribution margin per unit P 2

13. 22 - 13 The break-even formula may also be expressed in sales dollars. C OMPUTING THE B REAK -E VEN P OINT Unit contribution margin Unit sales price Break-even point in dollars = Fixed costs Contribution margin ratio P 2

14. 22 - 14 C OMPUTING S ALES FOR A T ARGET I NCOME Break-even formulas may be adjusted to show the sales volume needed to earn any amount of income. Unit sales = Fixed costs + Target pretax income Contribution margin per unit Dollar sales = Fixed costs + Target pretax income Contribution margin ratio C 2

15. 22 - 15 Before-tax income = Target net income 1 - tax rate C OMPUTING S ALES (D OLLARS ) FOR A T ARGET N ET I NCOME To convert target net income to before-tax income, use the following formula: C 2

16. 22 - 16 The CVP formulas can be modified for use when a company sells more than one product.  The unit contribution margin is replaced with the contribution margin for a composite unit.  A composite unit is composed of specific numbers of each product in proportion to the product sales mix.  Sales mix is the ratio of the volumes of the various products. C OMPUTING A M ULTIPRODUCT B REAK -E VEN P OINT P 4

17. 22 - 17 A measure of the extent to which fixed costs are being used in an organization. A measure of how a percentage change in sales will affect profits. Contribution margin Pretax income = Degree of operating leverage D EGREE OF O PERATING L EVERAGE A 2

18. 22 - 18 E ND OF C HAPTER 22