1. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Cost Behavior and Cost-Volume- Profit Analysis Chapter 11

2. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Learning Objectives After studying this chapter, you should be able to: Classify costs as variable costs, fixed costs, or mixed costs Compute the contribution margin, the contribution margin ratio, and the unit contribution margin Determine the break-even point and sales necessary to achieve a target profit Using a cost-volume-profit chart and a profit- volume chart, determine the break-even point and sales necessary to achieve a target profit Compute the break-even point for a company selling more than one product, the operating leverage, and the margin of safety

3. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Classify costs as variable costs, fixed costs, or mixed costs Learning Objective 1

4. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Cost Behavior Refers to the manner in which a cost changes as a ________ changes Can be variable, fixed, or _____ Two factors to consider: ____________ – activities that causes a cost to change (e.g., food service costs change with the number of hospital patients) ____________ – changes in cost are of interest

5. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Variable Costs Costs that vary in proportion to changes in the _________ Normally activity base is units produced, direct materials and direct labor costs

6. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Variable Costs

7. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Fixed Costs Costs that _____ in total over the relevant range of activity, but ________ per unit with the level of activity

8. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Fixed Costs

9. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Mixed Costs Mixed costs share characteristics of both a variable and a fixed cost: fixed over a _____, then increasing based on ______ Sometimes called ________ or _______ costs

10. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. High-Low Method Total maintenance costs during the last five months Total maintenance cost at highest and lowest levels of production

11. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. High-Low Method

12. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Compute the contribution margin, the contribution margin ratio, and the unit contribution margin Learning Objective 2

13. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Cost-Volume-Profit Analysis The systematic examination of the relationships among selling prices, sales and production volume, costs, expenses, and profits Provides management with useful information for decision making _________________ Sales Total Costs $ units

14. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Contribution Margin Identifies revenues available to cover fixed costs and to provide income from operations Contribution Margin = _______ – ________ ______ ____

15. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Contribution Margin Income Statement

16. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Contribution Margin Ratio Percentage of each sales dollar available to cover fixed costs and to provide income from operations Sometimes referred to as the ________ ratio Measures the effect of an increase/decrease in sales volume on income from operations ________ – _________ _______ Contribution Margin Ratio =

17. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Contribution Margin Ratio Sales $ 1,000,000 An $80,000 increase in sales volume would increase income from operations by $32,000 ($80,000 × 40%) CM Ratio = = __% $1,000,000 – $______ $1,000,000 Variable Costs 600,000 Contribution Margin 400,000 Sales = $1 Variable costs = ¢60 Contribution margin = ¢__ or __% of every dollar in sales

18. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Contribution Margin Ratio 60% of $80,000 increase in sales will go to variable costs and the remaining 40% will go to contribution margin The increase in contribution margin will flow to income from operations as ________ do not change with increase in sales

19. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Unit Contribution Margin Useful when an increase/decrease in sales volume is measured in _______ (not dollars) The change in sales volume (units) multiplied by the _________________ equals the change in income from operations Unit Contribution Margin =_____________ – _____________

20. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Unit Contribution Margin Sales Price/Unit $20 Unit Variable Cost 12 Unit Contribution Margin $ 8 If sales increases by 15,000 units, from 50,000 units to 65,000 units:

21. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Determine the break-even point and sales necessary to achieve a target profit Learning Objective 3

22. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Break-Even Point Level of operations where _______ and ______ are the same Useful in business planning, especially when increasing or decreasing operations _____________________

23. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Break-Even Point Fixed Costs UCM $90,000 $10 = 9,000 units Fixed Costs = $90,000 Fixed Costs = $90,000 Selling price per unit Selling price per unit Variable cost per unit Variable cost per unit __________ _________ __________ _________ $10 $25$15 _________________ (Units) = =

24. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Break-Even Point $______/$10 = _____ units needed to break even

25. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Effect of Changes in Fixed Costs There is a _____ relationship between total fixed costs and break-even units

26. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Effect of Changes in Fixed Costs How would a $100,000 increase in fixed costs affect the break-even sales units? ITEMNOWPROPOSEDCHANGE Selling Price$90 Same Variable Cost per Unit$70 Same Unit Contribution Margin$20 Same Fixed Costs$600,000$700,000$100,000 Break-Even Sales (units)30,00035,0005,000 unit Now: $600,000/$20 UCM = 30,000 break-even Proposed: $700,000/$20 UCM = 35,000 break-even

27. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Effect of Changes in Unit Variable Costs There is a _____ relationship between unit variable costs and break-even units

28. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Effect of Changes in Unit Variable Costs How would an extra 2% commission (increase in variable cost per unit) affect the break-even sales units? ITEMNOWPROPOSEDCHANGE Selling Price$250 Same Variable Cost per Unit$145$1502% of sales Unit Contribution Margin$105$100$5 per unit Fixed Costs$840,000 Same Break-Even Sales (units)8,0008,400400 units Now: $840,000/$105 UCM = 8,000 break-even Proposed: $840,000/$100 UCM = 8,400 break-even

29. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Effect of Changes in Unit Selling Price There is an _____ relationship between unit selling price and break-even units

30. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Effect of Changes in Unit Selling Price How would a $10 price increase affect the break- even sales units? ITEMNOWPROPOSEDCHANGE Selling Price$50$60$10 Variable Cost per Unit$30 Same Unit Contribution Margin$20$30$10 Fixed Costs$600,000 Same Break-Even Sales (units)30,00020,00010,000 units Now: $600,000/$20 UCM = 30,000 break-even Proposed: $600,000/$30 UCM = 20,000 break-even

31. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Target Profit To find units needed to attain a certain target profit, add the target profit to the fixed costs in the break-even formula ________ + ________ ______ Break-Even Sales (Units) =

32. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Calculating Sales (units) Fixed Costs + Target Profit UCM $______ + $______ $__ = _____ units Target Profit = $100,000 Fixed Costs = $200,000 Selling price Per unit Selling price Per unit Contribution Margin per unit Contribution Margin per unit Variable Cost Per unit Variable Cost Per unit $75 $30 $45 =

33. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Verification of Units Required to Achieve Target Profit Target Profit

34. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Using a cost-volume-profit chart and a profit-volume chart, determine the break- even point and sales necessary to achieve a target profit Learning Objective 4

35. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Cost-Volume-Profit (CVP) Chart Cost-volume-profit charts assist management in understanding relationships among costs, sales, and operating profit or loss We’ll construct a CVP chart assuming: $50 selling price $30 unit variable cost $20 unit contribution margin $100,000 in fixed costs

36. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Cost-Volume-Profit (CVP) Chart

37. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Cost-Volume-Profit (CVP) Chart When fixed costs decrease by $20,000, break-even decreases to 4,000 units ($200,000)

38. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Profit-Volume Chart Focuses on profits Plots the difference between total _____ and total _____ We’ll construct a profit-volume chart assuming: $50 selling price $30 unit variable cost $20 unit contribution margin $100,000 in fixed costs Maximum loss is $100,000 in fixed costs (if no sales). Assume maximum profit is $100,000 (based on 10,000 maximum sales)

39. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Profit-Volume Chart

40. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Calculate the break-even point for a business selling more than one product, the operating leverage, and margin of safety Learning Objective 5

41. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Sales Mix Considerations Most businesses sell more than one product, and each product contributes _______ to overall profit Sales mix: The relative distribution of _____ among the various products sold The sales volume necessary to break even when more than one product is sold depends on the ______

42. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Sales Mix Assume Burr Company sold 8,000 units of Product A and 2,000 units of Product B last year

43. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Sales Mix Combining individual unit information to represent one single product – Product E Assuming fixed costs are $200,000, 8,000 units of Product E are needed to break even ($200,000/$25). But how many of Products A and B does that mean?

44. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Sales Mix Product A: 8,000 × 80% = 6,400 units Product B: 8,000 × 20% = 1,600 units _________ _____

45. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Operating Leverage Companies with ____ fixed costs (capital intensive) have high operating leverage Companies with ____ fixed costs (labor intensive) have low operating leverage Managers use operating leverage to measure how ____________ affect changes in income from operations The relative mix of _____ and _____ costs is measured by operating leverage Operating Levearge =

46. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Operating Leverage 10% 50% 10% __% Operating Leverage = __Operating Leverage = 2 Increase in sales Increase in operating income High Operating LeverageLow Operating Leverage

47. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. Margin of Safety Margin of safety measures how much sales revenue can drop before _________ occurs Assume current sales are $250,000 and break- even sales are $200,000. Margin of safety = (250,000−200,000)/250,000 = 20% Sales would have to drop by more than __% before an operating loss would result Margin of Safety = _____ – __________ ________

48. ©2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publically accessible website, in whole or in part. End of Chapter 11