MANAGERIAL ACCOUNTING COST BEHAVIORS, SYSTEMS, AND ANALYSIS

with Gary Hecht

Cost-Volume-Profit Analysis

Foundations and Basic Analyses

LESSON 4-1 OBJECTIVES

You should understand:

The fundamental concepts of CVP analysis

How to apply CVP analysis, recognizing the influence of setting characteristics on method and conclusions

COST-VOLUME-PROFIT ANALYSIS

Analytic tool useful for: “What-if” analysis

Uses relationships among fundamental components of basic “accounting” equation representing income

TWO APPROACHES TO PROFIT

Financial

Revenue - Direct materials - Direct labor - Overhead = Gross margin - Other expenses

= Profit

Managerial Revenue

- Direct materials (V) - Direct labor (V) - Overhead (V) - Other expenses (V)

= Contribution margin - All fixed expenses (F)

= Profit

FUNDAMENTAL EQUATION

Operating Profit = Revenues – Total VC – Total FC

We can use this equation to ask a very basic question: How many units do we have to sell to break even?

Operating Profit = Revenues – Total VC – Total FC

Step 1: Set operating profit to $0

0 = Revenues – Total VC – Total FC

FUNDAMENTAL EQUATION

0 = Revenues – Total VC – Total FC

Step 2: Simplify terms into components (where applicable)

0 = (Selling price x Q) – (VC per unit x Q) – Total FC

FUNDAMENTAL EQUATION

0 = (SP x Q) – (VC x Q) – Total FC

Step 3: Isolate Total FC and factor out Q

Total FC = Q x (SP – VC)

FUNDAMENTAL EQUATION

Total FC = Q x (SP – VC)

Step 4: Isolate Q

Q = Total FC = Total FC

FUNDAMENTAL EQUATION

CM (SP – VC)

EXAMPLE 1

The following information relates to a microchip manufactured by Kane Corporation:

Current selling price, per unit: $7.55 Direct labor, per unit: $1.00 Direct materials, per unit: $2.00 Variable manufacturing overhead, per unit: $1.35 Other variable costs (mostly selling), per unit: $1.20 Fixed manufacturing overhead for microchip: $2.5 M/year Other fixed costs for microchip: $1.5 M/year

EXAMPLE 1

Calculate the break-even point for Kane Company.

ASSUMPTIONS UNDERLYING CVP ANALYSIS

Costs can be categorized as fixed or variable – or broken down appropriately

Everything is linear: Revenue Variable costs Fixed costs

In manufacturing firms, the inventory levels at the beginning and end of the period are the same. This implies that the number of units produced during the period equals the number of units sold.

Efficiency and productivity of production processes remain constant

Sales mix remains constant over the relevant range

Product mix does not change in response to changes in production/sales volume

ASSUMPTIONS UNDERLYING CVP ANALYSIS

EXAMPLE 2 - TAXES Taves Donuts sells donuts, coffee, and other related food items. The following information is available:

Service varies from a single coffee to multiple dozen donuts. The average revenue earned for each customer is $8.00.

The average cost of food and other variable costs for each customer is $3.00.

Total fixed costs for the year is $450,000.

The income tax rate is 30%.

Target (i.e., desired) net income is $105,000.

EXAMPLE 2

Data: SP = $8.00; VC = $3.00; FC = $450,000; Target income = $105,000; Tax Rate = .30 How many customers are needed to break even?

EXAMPLE 2

Data: SP = $8.00; VC = $3.00; FC = $450,000; Target income = $105,000; Tax Rate = .30 How many customers are needed to reach the desired profit?

EXAMPLE 2

EXAMPLE 2

EXAMPLE 2

WHAT WE’VE LEARNED IN LESSON 4-1

How to use the contribution margin approach to facilitate “what-if” decisions

CVP analysis simply fixes four of the five variables in the profit equation and solves for the fifth

Most commonly, we fix target profit, selling price, variable unit costs, and fixed costs, and solve for quantity

Multi-Product Scenarios and Related Concepts

LESSON 4-2 OBJECTIVES

You will understand how to:

Apply CVP analysis in more complex (i.e., multi-product) scenarios

Customize analysis to correspond with assumptions, uncertainty, and managers’ needs

EXAMPLE 3 – MULTIPLE PRODUCTS HOSA Company manufactures two products – Product X and Product Y.

Compute HOSA’s break-even point.

Product X $10 $6

$10,000

Product Y $15 $12

$12,000

Selling price Variable costs Fixed costs

EXAMPLE 3 – MULTIPLE PRODUCTS

EXAMPLE 3 – MULTIPLE PRODUCTS HOSA Company manufactures two products – Product X and Product Y.

Let’s also assume that normally, HOSA’s sales are 60% Product X and 40% Product Y.

Product X $10 $6

$10,000

Product Y $15 $12

$12,000

Selling price Variable costs Fixed costs

EXAMPLE 3 – MULTIPLE PRODUCTS

WHAT WE’VE LEARNED IN LESSON 4-2

Multi-product scenarios Assumptions determine method and conclusions

WHAT WE’VE LEARNED IN MODULE 4

Fundamentals of CVP analysis

Assumptions

Setting-specific