Transcript + Total fixed costs

Chapter 19
1
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Identify how changes in volume affect
costs
Use CVP analysis to compute breakeven
points
Use CVP analysis for profit planning, and
graph the CVP relations
Use CVP methods to perform sensitivity
analyses
2
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Calculate the breakeven point for multiple
products or services
Distinguish between variable costing and
absorption costing (see Appendix 19A,
located at myaccountinglab.com)
3
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1
Identify how changes in volume affect costs
4
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The effect of volume of activity on costs
Variable costs
Increase or decrease in total in direct proportion
to changes in the volume of activity
Fixed costs
Do not change over wide ranges of volume
Mixed costs
Have both variable and fixed components
5
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Total variable costs change in direct proportion
to changes in the volume of activity
If activity increases, so does the cost
Unit variable cost remains constant
Volume can be measured in many different
ways:
Number of units sold
Number of units produced
Number of miles driven by a delivery vehicle
Number of phone calls placed
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Tend to remain the same in amount, regardless
of variations in level of activity
Examples:
Straight-line depreciation
Salaries
Part-time manager’s salary
Total fixed costs do not change, but the fixed
cost per event depends on the number of events
The more activity, the less the fixed cost per unit
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Have both a fixed and variable component
Example:
Utilities that charge a set fee per month, plus a
charge for usage
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11
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Method to separate mixed costs into variable
and fixed components
Identify the highest and lowest levels of activity
over a period of time
STEP 1: Calculate variable cost per unit
Variable cost per unit = Change in total cost ÷ Change in activity volume
STEP 2: Calculate total fixed cost
Total fixed cost = Total mixed cost – Total variable cost
STEP 3: Create and use equation to show the
behavior of a mixed cost
Total mixed cost = (Variable cost per unit X number of units) + Total fixed costs
12
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Data
Step 1
Step 2
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($2 x 400 event-playing hours) + $1,000 = $1,800
Now check your formula against the original data
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Range of volume:
Where total fixed costs remain constant and variable
cost per unit remains constant
Outside the relevant range, costs can differ
15
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Philadelphia Acoustics builds innovative speakers for
music and home theater systems. Consider the
following costs. Identify the costs as variable (V), fixed
(F), or mixed (M).
1. Units of production depreciation on routers used
V
to cut wood enclosures
V
2. Wood for speaker enclosures
F
3. Patents on crossover relays
M
4. Total compensation to salesperson, who receives
a salary plus a commission based on meeting sales
goals
V
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5. Crossover relays
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Philadelphia Acoustics builds innovative speakers for
music and home theater systems. Consider the
following costs. Identify the costs as variable (V), fixed
(F), or mixed (M).
F
6. Straight-line depreciation on manufacturing plant
V
7. Grill cloth
M
8. Cell phone costs of salesperson (plan includes
1,200 minutes; overseas calls are charged at an
average of $0.15 per minute)
V
9. Glue
F
10. Quality inspector’s salary
17
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Martin owns a machine shop. In reviewing his utility bill for the last
12 months, he found that his highest bill of $2,800 occurred in
August when his machines worked 1,400 machine hours. His lowest
utility bill of $2,600 occurred in December when his machines
worked 900 machine hours.
1. Calculate (a) the variable rate per machine hour and (b)
Martin’s total fixed utility cost.
Variable cost per unit = Change in total cost ÷ Change in activity
volume
a. Variable cost per unit = ($2,800 - $2,600) ÷ (1,400 – 900)
Variable cost per unit = $200 ÷ 500 + 0.40 per machine hour
b. Total fixed cost = Total mixed cost – Total variable cost
Total fixed cost = $2,800 – (0.40 X 1,400)
Total fixed cost = $2,800 - $560
Total fixed cost = $2,240
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Martin owns a machine shop. In reviewing his utility bill for the
last 12 months, he found that his highest bill of $2,800 occurred in
August when his machines worked 1,400 machine hours. His
lowest utility bill of $2,600 occurred in December when his
machines worked 900 machine hours.
2. Show the equation for determining the total utility cost for
Martin’s.
$ 0.40 per machine hour + $2,240
19
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Martin owns a machine shop. In reviewing his utility bill for the
last 12 months, he found that his highest bill of $2,800 occurred in
August when his machines worked 1,400 machine hours. His
lowest utility bill of $2,600 occurred in December when his
machines worked 900 machine hours.
3. If Martin’s anticipates using 1,200 machine hours in January,
predict his total utility bill using the equation from Requirement 2.
($ 0.40 per machine hour x 1.200 machine hours) + $2,240
$480 +$2,240 = $2,720
20
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Martin owns a machine shop. In reviewing his utility bill for the last
12 months, he found that his highest bill of $2,800 occurred in
August when his machines worked 1,400 machine hours. His lowest
utility bill of $2,600 occurred in December when his machines
worked 900 machine hours.
4. Draw a graph illustrating your total cost under this plan. Label the
axes, and show your costs at 900, 1,200, and 1,400 machine hours.
21
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2
Use CVP analysis to compute breakeven points
22
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Expresses the relationships among costs, volume, and
profit or loss
Answers:
How many products or services must the company sell to
break even?
What will profits be if sales double?
How will changes in selling price, variable costs, or fixed
costs affect profits?
Assumptions:
Managers can classify each cost as either variable or fixed
Only factor that affects total costs is change in volume,
which increases variable and mixed costs
Fixed costs do not change
23
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Sales level at which
operating income is zero:
Total revenues equal total costs (expenses)
Sales above breakeven result in a profit
Sales below breakeven result in a loss
Two methods to compute breakeven point:
Income statement approach
Sales revenue − Total costs = Operating income
Contribution margin approach
Sales revenue – Variable costs = Contribution margin –
Fixed costs = Operating income
24
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Express income in equation form and then break
it down into its components:
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Shortcut method
The contribution margin is sales revenue minus
variable costs (expenses)
Called contribution margin because the excess
of sales revenue over variable costs contributes
to covering fixed costs
26
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Rearrange the income statement—use the
contribution margin to develop a shortcut
method
Shortcut equation:
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Given fixed costs total $12,000. The
contribution margin per event is $120 ($200 sale
price – $80 variable cost)
Check your answer
28
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Ratio of contribution margin to sales revenue
Used to compute the breakeven point in terms of
sales dollars
Contribution margin is equal to:
Sales price – variable cost
Contribution margin divided by sales revenue
yields a percentage
Percentage of each dollar of sales revenue that
contributes toward fixed costs and profit
29
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Formula:
Example:
Yields the same breakeven as the contribution
margin approach earlier
30
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Story Park competes with Splash World by providing a
variety of rides. Story sells tickets at $50 per person as a
one-day entrance fee. Variable costs are $10 per person,
and fixed costs are $240,000 per month.
1. Compute the number of tickets Story must sell to break
even. Perform a numerical proof to show that your
answer is correct.
Units sold = ($240,000 + 0) ÷ ($50 - $10)
Units sold = $240,000 ÷ $40
= 6,000 units to breakeven
31
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Story Park competes with Splash World by providing a
variety of rides. Story sells tickets at $50 per person as a
one-day entrance fee. Variable costs are $10 per person,
and fixed costs are $240,000 per month.
1. Compute the number of tickets Story must sell to break
even. Perform a numerical proof to show that your
answer is correct.
Total sales revenue
$300,000
-Variable cost
60,000
Contribution margin
$240,000
- Fixed cost
240,000
Operating income
$
0
32
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Story Park competes with Splash World by providing a
variety of rides. Story sells tickets at $50 per person as a
one-day entrance fee. Variable costs are $10 per person,
and fixed costs are $240,000 per month.
1. Compute Story Park’s contribution margin ratio. Carry
your computation to two decimal places.
$50 - $10 = $40
$40 ÷ $50 = 0.80 or 80%
33
Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.
Story Park competes with Splash World by providing a
variety of rides. Story sells tickets at $50 per person as a
one-day entrance fee. Variable costs are $10 per person,
and fixed costs are $240,000 per month.
2. Use the contribution margin ratio CVP formula to
determine the sales revenue Story Park needs to break
even.
$240,000 ÷ 0.80 = $300,000
34
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3
Use CVP analysis for profit planning, and
graph the CVP relations
35
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Managers more interested in:
Sales level needed to earn a target profit
Profits they can expect to earn
How many products or service events must be sold
to earn a specific operating profit
Use either method
Set operating profit equal to desired profit
36
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Graph provides a picture that shows how changes in the
levels of sales will affect profits
Four steps:
1. Choose a sales volume and plot the point for total
sales revenue at that volume
2. Draw the fixed cost line
3. Draw the total cost line (total costs are the sum of
variable costs plus fixed costs)
4. Identify the breakeven point and the areas of
operating income and loss
37
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38
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Consider the following facts:
A
B
C
Number of units
1,300
3,600
7.500
Sale price per unit
$100
$40
$125
40
10
100
72,000
60,000
40,000
180,000
75,000
100,000
Variable costs per unit
Total fixed costs
Target operating income
Calculate:
Contribution margin per unit
Contribution margin ratio
Breakeven points in units
Breakeven point in sales dollars
Units to achieve target operating income
39
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Consider the following facts:
A
B
C
Number of units
1,300
3,600
7.,00
Sale price per unit
$100
$40
$125
40
10
100
72,000
60,000
40,000
180,000
75,000
100,000
$60
$30
$25
Contribution margin ratio
60%
75%
20%
Breakeven points in units
1,200
2,000
1,600
$120,000
$80,000
$200,000
4,200
4,500
5,600
Variable costs per unit
Total fixed costs
Target operating income
Calculate:
Contribution margin per unit
Breakeven point in sales dollars
Units to achieve target operating income
40
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John Kyler is considering starting a Web-based educational
business, e-Prep MBA. He plans to offer a short-course review of
accounting for students entering MBA programs. The materials
would be available on a password-protected Web site; students
would complete the course through self-study. Kyler would have to
grade the course assignments, but most of the work is in developing
the course materials, setting up the site, and marketing.
Unfortunately, Kyler’s hard drive crashed before he finished his
financial analysis.
However, he did recover the following partial CVP chart:
1. Label each axis, the sales revenue line, the total costs line, the
fixed costs, the operating income area, and the breakeven point.
2. If Kyler attracts 300 students to take the course, will the venture
be profitable?
3. What are the breakeven sales in students and dollars?
41
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1. Label each axis, the sales revenue line, the total costs line, the
fixed costs, the operating income area, and the breakeven point.
Breakeven
Fixed Cost
2. If Kyler attracts 300 students to take the course, will the venture
be profitable? Will not be profitable. Possible loss of $8,000
3. What are the breakeven sales in students and dollars?
Breakeven at 400 students, $40,000 in sales
42
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4
Use CVP methods to perform sensitivity analysis
43
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Predict how changes in sale prices, cost, or
volume affect profits
“What-if?” analysis
Allows managers to see how various business
strategies affect profits
Changing selling price
Changing variable Costs
Changing fixed Costs
44
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How will the lower sale price affect the
breakeven point?
Lower price yields higher unit sales to breakeven
Higher prices yields lower unit sales to breakeven
45
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How will increased costs affect the breakeven
point?
Higher cost yields higher unit sales to breakeven
Lower cost yields lower unit sales to breakeven
46
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How will the increased fixed costs affect the
breakeven point?
Higher fixed costs yields higher unit sales to
breakeven
Lower fixed costs yields lower unit sales to
breakeven
47
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Exhibit 19-6
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Excess of expected sales over breakeven sales
Cushion, drop in sales, a company can absorb
without incurring a loss
Margin of safety in units
Margin of safety in dollars
49
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Story Park competes with Splash World by providing a
variety of rides. Story sells tickets at $50 per person as a
one-day entrance fee. Variable costs are $10 per person,
and fixed costs are $240,000 per month.
1. Suppose Story Park cuts its ticket price from $50 to $40
to increase the number of tickets sold. Compute the new
breakeven point in tickets and in sales dollars.
Units sold = ($240,000 + 0) ÷ ($40 - $10)
Units sold = $240,000 ÷ $30
= 8,000 units to breakeven
$320,000 sales dollars to breakeven
50
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Story Park competes with Splash World by providing a
variety of rides. Story sells tickets at $50 per person as a
one-day entrance fee. Variable costs are $10 per person,
and fixed costs are $240,000 per month.
2. Ignore the information in Requirement 1. Instead,
assume that Story Park increases the variable cost from
$10 to $20 per ticket. Compute the new breakeven point in
tickets and in sales dollars.
Units sold = ($240,000 + 0) ÷ ($50 - $20)
Units sold = $240,000 ÷ $30
= 8,000 units to breakeven
= $400,000 in sales dollars
51
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Story Park competes with Splash World by providing a
variety of rides. Story sells tickets at $50 per person as a
one-day entrance fee. Variable costs are $10 per person,
and fixed costs are $240,000 per month.
1. If Story Park expects to sell 6,200 tickets, compute the
margin of safety in tickets and in sales dollars.
Expected sales - Breakeven sales = Margin of safety in units
6,200 –
6,000
= 200 in units
Margin of safety in units x Sales price = Margin of safety in dollars
200 units
x
$50
= $10,000
52
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5
Calculate the breakeven point for multiple
product lines or services
53
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Selling prices and variable costs differ for each
product
Different contribution to profits
Weighted-average contribution margin
computed
Sales mix provides weights to make up total
product sales
Weights equal 100% of total product sales
54
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To compute breakeven sales in units for multiple
products, complete the following three steps:
STEP 1: Calculate the weighted-average
contribution margin per unit
STEP 2: Calculate the breakeven point in units for
the “package” of products
STEP 3: Calculate the breakeven point in units for
each product and then multiply the “package”
breakeven point in units by each product’s
proportion of the sales mix
55
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Calculate the weighted-average contribution
margin per unit:
56
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Calculate the breakeven point in units for the
“package” of products:
57
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Calculate the breakeven point in units for each
product. Multiply the “package” breakeven
point in units by each product’s proportion of
the sales mix:
58
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Prove this breakeven point by preparing a
contribution margin income statement:
59
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Wet Weekend Swim Park sells individual and family tickets, which
include a meal, three beverages, and unlimited use of the swimming
pools. Wet Weekend has the following ticket prices and variable
costs for 2012:
Sale price per ticket
Variable cost per ticket
Individual
30
15
Family
90
60
Wet Weekend expects to sell two individual tickets for every four
family tickets. Wet Weekend’s total fixed costs are $75,000.
1. Compute the weighted-average contribution margin per ticket.
2. Calculate the total number of tickets Wet Weekend must sell to
break even.
3. Calculate the number of individual tickets and the number of
family tickets the company must sell to break even.
60
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Wet Weekend expects to sell two individual tickets for every four
family tickets. Wet Weekend’s total fixed costs are $75,000.
1. Compute the weighted-average contribution margin per ticket.
Sale price per ticket
Variable cost per ticket
Contribution margin per unit
Sales mix in units
Contribution margin
Weighted-average
contribution margin per unit
61
Individual
$ 30
Family
$ 90
15
60
15
2
30
4
$30
$120
Total
6
150
$25
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Sale price per ticket
Variable cost per ticket
Contribution margin per unit
Sales mix in units
Contribution margin
Weighted-average
contribution margin per unit
Individual
$ 30
Family
$ 90
15
60
15
30
2
$30
4
$120
Total
6
150
$25
2. Calculate the total number of tickets Wet Weekend must sell to
break even.
$75,000 ÷ $25 = 3,000 total tickets
3. Calculate the number of individual tickets and the number of
family tickets the company must sell to break even.
3,000 total tickets x 2/6 = 1,000 individual tickets
3,000 total tickets x 4/6 = 2,000 family tickets
62
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6
Distinguish between variable costing and
absorption costing
(Appendix 19A—online at myaccountinglab.com
63
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Absorption costing:
Considers fixed manufacturing costs as
inventoriable product costs
Variable costing:
Considers fixed manufacturing costs as period costs
(expenses)
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Type of Cost
Absorption Costing
Product Costs
(capitalized as Inventory
until expensed as Cost of
goods sold)
Direct materials
Direct labor
Variable manufacturing
overhead
Fixed manufacturing overhead
Direct materials
Direct labor
Variable manufacturing
overhead
Period Costs (expensed
in period incurred)
Variable nonmanufacturing
costs
Fixed nonmanufacturing costs
Fixed manufacturing
overhead
Variable nonmanufacturing
costs
Fixed nonmanufacturing
costs
Income Statement
Format
Conventional income
statement
Contribution margin
income statement
65
Variable Costing
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Variable costs are those costs that increase or
decrease in total as the volume of activity
increases or decreases. Fixed costs are costs that
do not change over wide ranges of volume. Costs
that have both variable and fixed components are
called mixed costs.
The high-low method is an easy way to separate
mixed costs into variable and fixed components
by requiring you to identify the highest and
lowest levels of activity over a period of time.
The relevant range is the range of activity where
total fixed cost stays the same and variable cost
per unit stays the same.
66
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The breakeven point is the sales level at which
operating income is zero—total revenues equal
total costs. The breakeven point can be found by
using the income statement approach, using zero
for operating income. The breakeven point can
also be found by dividing total fixed cost by the
contribution margin per unit (sales price per unit –
variable cost per unit).
Breakeven analysis can be used to calculate the
sales volume needed to earn a certain amount of
profit, called target profit. Target profit is the
operating income that results when sales revenue
minus variable costs and minus fixed costs equals
management’s
profit goal.
67
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Graphing various activity levels and costs gives a
visual representation of operating levels that
generate net income and operating levels that
result in net loss.
Sensitivity analysis is a “what if” technique that
asks what results are likely if selling price or
costs change or if an underlying assumption
changes. The income statement approach to
breakeven is just adjusted for the new proposed
values.
The margin of safety is the “cushion” or drop in
sales that the company can absorb before
incurring a loss.
68
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Most companies sell more than one product.
Selling price and variable costs differ for each
product, so each product makes a different
contribution to profits. To calculate break even for
each product, we compute the weighted-average
contribution margin of all the company’s products.
The combination of products that make up total
sales, called the sales mix (or product mix),
provides the weights that make up total product
sales.
69
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Variable costing assigns only variable
manufacturing costs to products. Fixed
manufacturing costs are considered period costs
and are expensed immediately because the
company incurs these fixed costs whether or not it
produces any products or services.
In variable costing, fixed manufacturing costs are
not treated as product costs. Management
accountants often prefer variable costing because
contribution margin is readily apparent on the
variable costing income statement.
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