Decision Making and CVP EMBA 5412 Fall 2007. Mugan 20072 Decision-Making Process Plan and implement...

Decision Making and CVP

EMBA 5412

Fall 2007

Mugan 2007 2

Decision-Making Process

Plan and implement

Plan and implement

Get feedback and revise

Get feedback and revise

Evaluate alternatives

Evaluate alternatives

Set goals and objectives

Set goals and objectives

Gather information

Gather information

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Strategic Decision Making

Strategic Planning

Answers the following two major questions:

What are the ways of

achieving?

What are the ways of

achieving?

What to we want to accomplish?

What to we want to accomplish?

Company policies and plans to reflect how to reach the company goals.

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Managerial Accounting

• Process of – Identifying– Measuring– Analyzing– Interpreting– Communicating

information in pursuit of a company’s goals– Managerial accountants – business

partners/consultants in companies – Provides information to managers

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Cost Management Perspective

• Provide highest quality service/goods with lowest possible cost

• Objectives:– Determine cost of resources consumed in company’s

activities– Eliminate non-value added activities as much as

possible– Determine efficiency and effectiveness of all major

activities– Identify and evaluate new activities that can improve

the performance of the company

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Strategic Cost Management

• Value chain – Get raw materials and other resources– Research and development – including quality assessment– Product design– Production– Marketing– Distribution– Customer service

• Should understand the value chain • Cost drivers in activities• Managing the cost relationships to a company’s advantage –

strategic cost management

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The Value Chain

Primary processes

R & D Design Supply Production Marketing Distri- bution

Customer service

Value ofproducts

andservices

Value ofproducts

andservices

Exh.1.2

Support services•Accounting

•Human resources•Legal services

•Information systems•Telecommunications

Support services•Accounting

•Human resources•Legal services

•Information systems•Telecommunications

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Strategic Position of a Company and its missions

Low

Low

Medium

Medium

High

High

Risk

Ret

urn

Divest

Harvest

Hold

Build

• Declining market• Exit at lowest cost• Minimize losses• Find a buyer quickly

• Continuing market• Maintain cash flow• Maintain volume• Cut costs

• Continuing market• Maintain growth• Be a major player• Protect market share

• New market potential• Be early entrant• Achieve growth• Capture market share

Exh.1.1

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Types of Costs

• differential costs- (benefits) – costs or benefits that change between/among alternatives

• Irrelevant costs -Costs that don’t change are irrelevant to the decision

• Choose the alternatives where differential benefits exceed differential costs

• Opportunity costs• Sunk costs• Controllable /avoidable costs/discretionary

costs

The opportunity cost is the monetary amount associated with the next best use of the resource.

Costs that have already been incurred and cannot be changed no matter what action is taken in the future.

Costs that have already been incurred and cannot be changed no matter what action is taken in the future.

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Cost Definitions

Fixed Costs: Costs incurred when there is no production.

Marginal cost: cost of producing (and selling) one more unit = variable costs after the initial production stage

Average cost: Total costs divided by number of units produced

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Cost DefinitionsTC = FC + (VC Q) for Q in relevant range

Total costs (TC) are a linear function of quantity (Q) produced over a relevant range.

Variable Cost (VC): Cost to produce one more unit. Variable cost is a linear approximation of marginal opportunity costs.

Fixed Cost (FC): Predicted total costs with no production (Q=0).

Relevant Range: Range of production quantity (Q) where a constant variable cost is a reasonable approximation of opportunity cost.

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Cost CurveT

ota

l Co

st

X

Y Total Cost –Mixed Cost

Average Cost

Fixed Cost

Variable Cost per unit or marginal cost

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Cost Drivers

• Cost driver: units of physical activity most highly associated with total costs in an activity center

Examples of cost drivers:– Quantity produced– Direct labor hours– Number of set-ups– Number of orders processed

• Different activity drivers might be used for different decisions

• Costs could be fixed, variable, or mixed in different situations

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Cost Estimation Example• In each month, Exclusive

Billiards produces between 4 to 10 pool tables. The plant operates on 40-hr shift to produce up to seven tables. Producing more than seven tables requires the craftsmen to work overtime. Overtime work is paid at a higher hourly wage. The plant can add overtime hours and produce up to 10 tables per month. The following table contains the total cost of producing between 4 and 10 pool tables.

• Required: a. compute average cost per pool table for 4 to 10 tables

• Estimate fixed costs per month.

Pool Tables Total Cost4 628005 660006 692007 724008 758009 79200

10 82600

Pool Tables Total Cost Variable Cost Average Cost4 62.800 15.7005 66.000 3.200 13.2006 69.200 3.200 11.5337 72.400 3.200 10.3438 75.800 3.400 9.4759 79.200 3.400 8.800

10 82.600 3.400 8.260

FC= TC - VC66.000 4 x 3200= 12800

FC= 50.000

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Format of Income Statement Financial Accounting (traditional – required for financial

statements and tax ) Sales Revenue

- Cost of goods sold (product costs) = Gross profit - General, selling, administrative, and taxes (period costs) = Net income

Decision Making( useful for managers – internal oriented) Revenue

- Variable costs (product and selling and administration) = Contribution margin - Fixed costs and taxes( product and selling and administration) = Net income

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Income Statement Example

Variable FixedCost of Goods Sold 750.000 540.000Selling Expenses 95.000 60.000Administrative Expenses 80.000 65.000

FM Manufacturing Company has sales of TL 1.800.000 for the first quarter of 2008. In selling 6.000 units of gadgets the company incurred the following costs:

Prepare a traditional and a CVP income statement for the first quarter of 2008.

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Income Statement Example

Sales 1.800.000 TLCost of Goods Sold (1.290.000)Gross Margin 510.000Selling Expenses (155.000)Administrative Expenses (145.000)Net Income Before Tax 210.000 TL

Traditional Income Statement

For the first Quarter 2008FM Manufacturing Income Statement

Sales (5000 units) 1.800.000 TLVariable Costs: Production Costs 750.000 Selling Expenses 95.000 Administrative Expenses 80.000 Total Variable Costs 925.000Contribution Margin 875.000Fixed Costs: Production Costs 540.000 Selling Expenses 60.000 Administrative Expenses 65.000 Total Fixed Costs 665.000Net Income Before Tax 210.000 TL

FM Manufacturing Income StatementFor the first Quarter 2008

CVP Income Statement

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CVP definitions

Cost-Volume-Profit (C-V-P) analysis is very useful for production and marketing decisions.

Contribution margin equals price per unit minus variable cost per unit: CM = (P – VC).

Total contribution margin equals total revenue minus total variable costs: (CM Q) = (P - VC) Q.

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COST VOLUME PROFIT ANALYSIS

• HELPFUL TO UNDERSTAND THE RELATIONSHIP AMONG VARIABLE COSTS, FIXED COSTS AND PROFIT

• BASIC ASSUMPTIONS:– SELLING PRICE IS CONSTANT– COSTS ARE LINEAR AND CAN BE DIVIDED INTO FIXED

AND VARIABLE– FIXED ELEMENT CONSTANT OVER THE RELEVANT

RANGE– UNIT VARIABLE COST CONSTANT OVER THE RELEVANT

RANGE– SALES MIX IS CONSTANT– INVENTORIES STAY AT THE SAME LEVEL

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Basics of Cost-Volume-Profit Analysis

CM is used first to cover fixed

expenses. Any remaining CM

contributes to net operating income.

CM is used first to cover fixed

expenses. Any remaining CM

contributes to net operating income.




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Per Unit

Sales (5000 units) 1.800.000 TL selling price 360 TLVariable Costs: Production Costs 750.000 Unit Cost 150 TL Selling Expenses 95.000 Unit Sell. Exp 19 TL Administrative Expenses 80.000 Unit Adm. Exp 16 TL Total Variable Costs 925.000 variable cost per unit (vcu) 185 TLContribution Margin 875.000 contribution margin per unit (cmu) 175 TLFixed Costs: Production Costs 540.000 Selling Expenses 60.000 Administrative Expenses 65.000 Total Fixed Costs 665.000Net Income Before Tax 210.000 TL


The Contribution Approach Sales, variable expenses, and contribution margin can also be expressed on a

per unit basis. If FM sells an additional gadget, TL 175 additional CM will be generated to cover fixed expenses and profit.

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The Contribution ApproachEach month FM must generate at least TL 665.000

in total CM to break even.

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The Contribution ApproachIf FM sells 3800 units3800 units in a quarter, it will

be operating at the break-even point.

Sales (5000 units) 1.368.000 TLVariable Costs: Production Costs 570.000 Selling Expenses 72.200 Administrative Expenses 60.800 Total Variable Costs 703.000Contribution Margin 665.000Fixed Costs: Production Costs 540.000 Selling Expenses 60.000 Administrative Expenses 65.000 Total Fixed Costs 665.000Net Income Before Tax 0 TL



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The Contribution ApproachIf FM sells one more gadget (3801 gadgets3801 gadgets), net

operating income will increase by TL 175.

Sales (5000 units) 1.368.360 TLVariable Costs: Production Costs 570.150 Selling Expenses 72.219 Administrative Expenses 60.816 Total Variable Costs 703.185Contribution Margin 665.175Fixed Costs: Production Costs 540.000 Selling Expenses 60.000 Administrative Expenses 65.000 Total Fixed Costs 665.000Net Income Before Tax 175 TL



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The Contribution Approach

We do not need to prepare an income statement to estimate profits at a particular sales volume. Simply multiply the number of units sold above break-even by the contribution margin per unit.

If FM sells 4000 gadgets, its net income will be

35.000 TL..

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Break-Even Analysis

Break-even analysis can be approached in two ways:

1. Equation method

2. Contribution margin method

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EQUATION METHOD-1SALES= VARIABLE COSTS+FIXED COSTS + PROFIT

p*q= vcu *q + FC + ¶p= price; q=quantity sold (in terms of units)vcu=variable cost per unit = VC/ q;(includes both manufacturing and selling and

administrative) FC= total fixed costs; ¶= profit

AT BREAKEVEN PROFIT = 0p*q=vcu *q +FCq * (p-vcu) = FC

BREAKEVEN in units sold: (q)

q= FC ÷ (p - vcu) OR q=FC ÷ cmu

Breakeven Sales amount = selling price x breakeven quantity

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EQUATION METHOD-2

Sales = (Variable Cost Ratio x Sales) + Fixed Costs + Profit

VCR = Variable Cost Ratio

FC = total fixed costs (both manufacturing, and selling and administrative)

AT BREAKEVEN PROFIT = 0

Sales = (Sales x VCR) + FC + 0

Therefore

Sales amount (monetary terms) at breakeven point is

Sales (breakeven)= FC ÷ (1-VCR)

BREAKEVEN in units sold= Sales (breakeven) ÷ selling price

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Sensitivity Analysis

EFFECT OF CHANGE IN FIXED COSTS?

EFFECT OF CHANGE IN VARIABLE COSTS?

EFFECT OF CHANGE IN SELLING PRICE?

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Break-Even Analysis

Here is the information from FM Company:

Cost and price information Per UnitTL

Selling Price (p) 360 100,00%

Variable Manufacturing Cost 150Variable Selling Expense 19Variable Administrative Expense 16Variable Cost per Unit (vcu) 185 51,39%Contribution Margin per Unit (cmu) 175 48,61%Total Fixed Costs TL 665.000

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Equation Method-1 We can calculate the break-even point as follows:

Sales = Variable expenses + Fixed expenses + ProfitsSales = Variable expenses + Fixed expenses + Profits

360q = 185q + 665.000 + 0Where:

q = Number of gadgets sold TL 360 = Unit selling price TL 185 = Unit variable expense

TL 665.000 = Total fixed expense

Breakeven units = q= 3800 gadgetsBreakeven units = q= 3800 gadgets

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Equation Method-2 The equation can be modified to calculate

the break-even point in sales dollars.

Sales = Variable expenses + Fixed expenses + ProfitsSales = Variable expenses + Fixed expenses + Profits

X = 0,5139X + 665.000 +X = 0,5139X + 665.000 + 00 Where:

X = Total sales amount0,5139 = Variable expenses as a % of sales TL 665.000 = Total fixed expenses

Breakeven Sales amount = Sales (BE) = TL 1.368.000**rounding error might occurBreakeven Sales amount = Sales (BE) = TL 1.368.000**rounding error might occur

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Reconciliation of the Equation Method 1 and 2

From equation method 1:

Breakeven units:

3800 gadgets x price 360= TL 1.368.000 = sales amount at breakeven

From equation 2:

Breakeven sales amount:

1.368.000 ÷ TL 360 per unit= 3800 gadgets = breakeven units

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CONTRIBUTION MARGIN RATIO

CMR= CONTRIBUTION MARGIN RATIO = CM / SALES OR cmu/p

VCR = VARIABLE COST RATIO = VC/SALES OR vcu/pCM= SALES - TOTAL VC VC= SALES – CM (variable costs include both manufacturing and selling and

administrative variable costs)cmu =CONTRIBUTION MARGIN PER UNIT= p - vcu=CM/q

CM = total contribution margin vcu= variable cost (manufacturing and selling and administrative per unit) p= selling pricecmu = contribution margin per unit CMR +VCR= 1

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Contribution Margin Method

The contribution margin method has two key equations.

Fixed expensesUnit contribution margin

=Break-even point

in units sold

Fixed expenses CM ratio

=Break-even point intotal sales dollars

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Contribution Margin MethodLet’s use the contribution margin method to calculate

the breakeven sales amount at FM Company.

Fixed expenses CM ratio

=Break-even point intotal sales dollars

TL 665.000TL 665.00048,61%48,61% = = TL 1.368.000 break-even salesTL 1.368.000 break-even sales

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PROFIT ANALYSIS

• AT BREAKEVEN PROFIT = 0• BEFORE BREAKEVEN LOSS; AFTER

BREAKEVEN PROFIT• CM COVERS FIXED COST UPTO BREAKEVEN

POINT• AFTER BREAKEVEN POINT INCREASE IN CM

WILL INCREASE NET INCOME

• CM = FC + INCOME BEFORE TAX

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Basic Analysis using CVP

• EFFECT OF CHANGE IN FIXED COSTS?• EFFECT OF CHANGE IN VARIABLE COSTS?• EFFECT OF CHANGE IN SELLING PRICE?

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Target Profit Analysis

The equation and contribution margin methods can be used to determine the sales volume

needed to achieve a target profit.

Suppose FM Company wants to know how many gadgets must be sold to earn a

before tax profit of TL100,000.

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The CVP Equation MethodSales = Variable expenses + Fixed expenses + ProfitsSales = Variable expenses + Fixed expenses + Profits

360q = 185q + 665.000 + 100.000Where:

q = Number of gadgets sold TL 360 = Unit selling price TL 185 = Unit variable expense

TL 665.000 = Total fixed expense TL 100.000 = profit BEFORE tax

Target income units = q= 4372*gadgets*rounded upTarget income units = q= 4372*gadgets*rounded up

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The Contribution Margin Approach

Fixed expenses + Target profit Unit contribution margin

=Unit sales to attain

the target profit

TL 665.000 + TL100,000 TL175 per gadget

= 4372 gadgets

Or

TL 100.000 ÷ TL 175 = 572 more units after the breakeven point need to be sold

3800+572= 4372 gadgets

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Target Income –after tax profitAssume that FM Company’s tax rate is 20%; and the

company wants an after-tax income of TL 100.000. How many units must it sell?

After tax TL 100.000 ÷0.8 (after tax percent of net income) = Before Tax income of TL 125.000

Then the company needs to sell after breakeven

TL 125.000 ÷ TL 175 = 715*(rounded up) more units

3800(breakeven )+715(units after breakeven) =

4515 gadgets

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The Margin of Safety• The margin of safety is the excess of

budgeted (or actual) sales over the break-even amount of sales.

• The margin of safety can also be expressed as– % of sales– Units

Margin of safety = Total sales - Break-even salesMargin of safety = Total sales - Break-even sales

MoS TL = ACTUAL OR BUDGETED SALES - BREAKEVEN SALES $MoS % = MoS TL / ACTUAL OR BUDGETED SALES

MoS units = MoS TL / selling price

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The Margin of Safety FM CompanyFM Manufacturing Income Statement CURRENT BREAKEVEN

For the first Quarter 2008 SALESales units 5.000 3.800Sales 1.800.000 TL 1.368.000Variable Costs: Production Costs 750.000 570.000 Selling Expenses 95.000 72.200 Administrative Expenses 80.000 60.800 Total Variable Costs 925.000 703.000Contribution Margin 875.000 665.000Fixed Costs: Production Costs 540.000 540.000 Selling Expenses 60.000 60.000 Administrative Expenses 65.000 65.000 Total Fixed Costs 665.000 665.000Net Income Before Tax 210.000 TL 0

Margin of safety = 1.800.000 - 1.368.000= TL 432.000Margin of safety = 1.800.000 - 1.368.000= TL 432.000

MoS % =

432.000 ÷ 1.800.000= 24%

MoS units =

432.000 ÷ 360 = 1200 gadgets

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Cost Structure and Profit Stability

Cost structure refers to the relative proportion of fixed and variable costs in an organization.

Managers often have some latitude in determining their organization’s cost structure.

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Operating Leverage• The effect of cost structure on operating

income• Higher operating leverage – very

sensitive to changes in sales volume

Contribution margin Operating income

Degree ofoperating leverage

=

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Operating Leverage

TL 875.000 TL 210.000

=4,17

At FM, the degree of operating leverage is.

FM Manufacturing Income Statement CURRENT For the first Quarter 2008 SALE

Sales units 5.000Sales 1800000Variable Costs: Production Costs 750.000 Selling Expenses 95.000 Administrative Expenses 80.000 Total Variable Costs 925.000Contribution Margin 875.000Fixed Costs: Production Costs 540.000 Selling Expenses 60.000 Administrative Expenses 65.000 Total Fixed Costs 665.000Net Income Before Tax 210.000

If sales increase by 10% income is going increase by 41,67%

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Cost Structure and Profitability

• High variable costs lead to lower CM and less vulnerable in crisis time

• High fixed costs cause higher breakeven point; after the breakeven point profits increase faster than the high variable cost company

• Degree of operating leverage effects: – For a given % change in sales, income will increase by (%

increase in sales *degree of operating leverage)– Degree of operating leverage decreases as the sales move

away from the breakeven point– If variable costs are high degree of operating leverage low; and

vice versa

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Structuring Sales Commissions

Companies generally compensate salespeople by paying them either a

commission based on sales or a salary plus a sales commission. Commissions based on sales dollars can lead to lower profits in a

company.

Let’s look at an example.Let’s look at an example.

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Pipeline Unlimited produces two types of surfboards, the XR7 and the Turbo. The XR7 sells for $100 and generates a contribution margin per unit of $25. The Turbo sells for $150 and earns a contribution margin

per unit of $18.

The sales force at Pipeline Unlimited is compensated based on sales commissions.

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If you were on the sales force at Pipeline, you would push hard to sell the Turbo even though the XR7

earns a higher contribution margin per unit.

To eliminate this type of conflict, commissions can be based on contribution margin rather than on

selling price alone.

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The Concept of Sales Mix

• Sales mix is the relative proportion in which a company’s products are sold.

• Different products have different selling prices, cost structures, and contribution margins.

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• Let’s assume Han sells synthetic fiber filled and dawn feather sleeping bags. Then we’ll calculate a break-even point that encompasses both products and their cost-price parameters.

• Let’s assume Han sells synthetic fiber filled and dawn feather sleeping bags. Then we’ll calculate a break-even point that encompasses both products and their cost-price parameters.

Multiple Products Example

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Cost other related information


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Breakeven Sales Amount =

TL 170.000 ÷ 48.18% = TL 352.880

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Sales mixBreakeven Sale Amount TL

Sale Amount of Each Product TL

Selling Price TL

Number of bags to be sold*

Synthetic 45,50% 352.880 160.560 500 322,00Dawn Feather 54,50% 192.320 1.000 193,00* rounded up to the next whole unit

At Breakeven Han needs to sell of each product

Or we can use the following method

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Weighted-average unit contribution margin

TL 200 × 62.5%TL 200 × 62.5%TL 200 × 62.5%TL 200 × 62.5%


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Break-even point

= Fixed expenses

Weighted-average unit contribution margin

Break-even point

=170,000

331.25

Break-even point

= 514 combined units

Multiple Products ExampleThe break-even point is 514 combined units. We can use the sales

mix to find the number of units of eachproduct that must be sold to break even.

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The break-even point of 514 units is validonly for the sales mix of 62.5% and 37.5%.

Sales amount to break even:

Selling Price TL

Number of bags to be sold

Total Sales

500 321,00 160.5001.000 193,00 193.000

353.500

There is a slight difference between the results of the approaches due to rounding.

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In Class – Multiple CustomersCali sells PROD 1.0 which is a top electronic spreadsheet product.

Now, the company is coming up with the new version –PROD 2.0. The company offers the new version at substantially lower prices to customers who has PROD 1.0 (upgrade customers).

Cali plans to sell 200.000 units of PROD 2.0 and wants to have a net income of TL 7.000.000 after tax. Current tax rate is 20%.

The expected sales mix in units is 60% new customers; and 40% upgrade customers.

Cali management wants to know:• What the expected breakeven in units and TLs for PROD 2.0 at

60/40 sales mix.• Whether they will be able to attain its target income with the

expected sales level and sales mix. • What the optimal sales mix is.

Relevant information appear in the following slide.

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In Class – Multiple Customers

Cali Cost and Revenue New UpgradeInformation Customer Customers

Selling Price 210 120Variable Costs: Production Costs 25 25 Selling Expenses 65 15 Total Variable Costs 90 40Contribution Margin 120 80Fixed Costs: Production Costs 9.000.000 9.000.000 Selling Expenses 3.000.000 3.000.000 Administrative Expenses 2.000.000 2.000.000 Total Fixed Costs 14.000.000 14.000.000

Solution to CALI

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Modeling Multiple Cost Drivers

An insight from activity-based An insight from activity-based costing: costs may be a costing: costs may be a

function of multiple activities, function of multiple activities, not merely sales volume.not merely sales volume.

Total Cost = (Unit variable cost × Sales units)

+ (Batch cost × Batch activity)+ (Product cost × Product activity)+ (Customer cost × Customer activity)+ (Facility cost × Facility activity)

Some costs treated as fixed

(when sales volume is the only activity) may now

be considered variable.

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Multiple Cost Drivers

• Variable costs may arise from multiple cost drivers or activities. A separate variable cost needs to be calculated for each driver. Examples include:– Customer or patient count– Passenger miles– Patient days– Student credit-hours– Set-up Costs – number of setups

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Multiple Cost Drivers

EMBA Company produces a single product with the following costs:

Selling price: TL 200

Variable production costs per product TL 120

Variable gift wrapping costs TL 10 per customer

Fixed costs TL 4500

Determine the breakeven sales.

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Multiple Cost DriversOperating Income = Sales

– (Variable production cost x number of units sold)

- ( Variable gift wrapping cost x number of customers)

- Fixed Costs

Rev/Cost per unit/customer (TL)

Number of products sold

Number of Customers

Total Rev/ Cost (TL)

150 150

Sales 200 30.000 30.000Variable Production costs 120 18.000 18.000Variable Packaging costs 10 1500 1.500Total Variable Costs 19.500Contribution margin 10.500Fixed Costs 4.500Operating Income 6.000

If EMBA sells 150 products to 100 customers?

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Multiple Cost DriversRev/Cost per unit/customer (TL)


Number of Customers


150 100

Sales 200 30.000 30.000Variable Production costs 120 18.000 18.000Variable Packaging costs 10 1000 1.000Total Variable Costs 19.000Contribution margin 11.000Fixed Costs 4.500Operating Income 6.500

Number of units sold is NOT the only determinant of operating income; there are two cost drivers

– the number of units sold; and – the number of customers

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Multiple Cost Drivers• There is no unique breakeven point



Number of Customers


60 30

Sales 200 12.000 12.000Variable Production costs 120 7.200 7.200Variable Packaging costs 10 300 300Total Variable Costs 7.500Contribution margin 4.500Fixed Costs 4.500Operating Income 0



Number of Customers


57 6

Sales 200 11.400 11.400Variable Production costs 120 6.840 6.840Variable Packaging costs 10 60 60Total Variable Costs 6.900Contribution margin 4.500Fixed Costs 4.500Operating Income 0

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In Class – CVP multiple cost driversSade Comp is a distributor of special dolls. For 2008,

Seyda, the manager, plans to purchase the dolls for TL 30 each and sell them for TL 45 each. Sade’s fixed costs are expected to be TL 240.000. Seyda’s only other costs will be variable costs of TL 60 per shipment for each customer regardless of the number of dolls in the order.

Seyda wants to know:How much operating income will be if she sell 40,000 dolls

in 1.000 shipments? 800 shipments?She estimates that she can make 500 shipments in 2008.

She wants to know how many dolls she needs to sell to breakeven.

Is this the only breakeven point? Can she have other breakeven points if she can make more or less shipments?

Solution to Sade Company

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USING CVP with Absorption Costing

Selling price per unit 13variable manufacturing, cost per unit 6Fixed Manufacturing Costs 100.000Variable selling and administrative costs 2Fixed Selling and Administrative costs 0Contribution Margin per unit 5

• Poli Company produces and sells coffee mugs. Cost and revenue related information is provided below.

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Determine the break-even point under contribution approach.

Breakeven for Variable Costing:Fixed Costs: manuf and selling 100.000Contribution Margin per unit 5Breakeven units 20000

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USING CVP with Absorption Costing• If the company uses absorption costing and wants to determine the

breakeven point, three cases arise. Case 1 sales = production

inventory beginning - units 10.000inventory ending - units 10.000production units 25.000sales units 25.000contribution margin per unit 5fixed manufacturing costs 100.000fixed manufacturing costs per unit-current 4fixed manufacturing costs per unit-previous period 4unit sold from inventory 0fixed cost absorbed in units sold 100.000fixed cost absorbed in inventories-beginning 40.000fixed cost absorbed in inventories-ending 40.000total fixed manufacturing costs 100.000breakeven units 20.000

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USING CVP with Absorption Costing• Let’s prove: at 20,000 units – sales=production

Absorption Income Statement Variable Costing Income StatementCase 1 sales = production Case 1 sales = production

Sales 260.000 Sales 260.000Cost of Goods Sold: Variable Costs: Variable Manuf Costs 120.000 Manufacturing 120.000 Fixed Manuf Costs 100.000 Selling, administrative 40.000

220.000 160.000Gross Margin 40.000 Contribution Margin 100.000

Selling and Administrative Costs Fixed Costs: Variable 40.000 Manufacturing 100.000 Fixed 0 Selling, administrative 0

40.000 100.000

Net Income Before Tax 0 Net Income Before Tax 0

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Case 2 sales < production

inventory beginning - units 10.000inventory ending - units 15.000production units 25.000sales units 20.000contribution margin per unit 5fixed manufacturing costs 100.000fixed manufacturing costs per unit-current 4fixed manufacturing costs per unit-previous period 4unit sold from inventory (5.000)fixed cost absorbed in units sold 80.000fixed cost absorbed in inventories-beginning 40.000fixed cost absorbed in inventories-ending 60.000total fixed manufacturing costs 80.000breakeven units 16.000

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Amount of fixed manufacturing costs absorbed in the increase in ending inventory

Amount of fixed manufacturing costs absorbed in the units sold

Absorption Income Statement Variable Costing Income Statementat breakeven per absorption at breakeven per absorption Case 2 sales < production Case 2 sales < production




32.000 100.000

Net Income Before Tax 0 Net Income Before Tax (20.000)

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Case 3 sales > production

inventory beginning - units 10.000inventory ending - units 5.000production units 25.000sales units 30.000contribution margin per unit 5fixed manufacturing costs 100.000fixed manufacturing costs per unit-current 4fixed manufacturing costs per unit-previous period 4unit sold from inventory 5.000fixed cost absorbed in units sold 120.000fixed cost absorbed in inventories-beginning 40.000fixed cost absorbed in inventories-ending 20.000total fixed manufacturing costs 120.000breakeven units 24.000


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USING CVP with Absorption CostingAbsorption Income Statement Variable Costing Income Statementat breakeven per absorption at breakeven per absorption Case 3 sales > production Case 3 sales > production




48.000 100.000

Net Income Before Tax 0 Net Income Before Tax 20.000

Amount of fixed manufacturing costs absorbed in the increase in ending inventory

Amount of fixed manufacturing costs absorbed in the units sold

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With fixed selling and admin costs

Case 1 sales = production Case 1 sales = production Case 1 sales = productionAbsorption Income Statement Variable Income Statement

inventory beginning - units 10.000 Sales 286.000 Sales 286.000inventory ending - units 10.000 Cost of Goods Sold: Variable Costs:production units 25.000 Variable Manuf Costs 132.000 Manufacturing 132.000sales units 25.000 Fixed Manuf Costs 100.000 Selling, administrative 44.000contribution margin per unit 5 232.000 176.000fixed manufacturing costs 100.000 Gross Margin 54.000 Contribution Margin 110.000fixed manufacturing costs per unit-current 4fixed manufacturing costs per unit-previous period 4 Selling and Administrative Costs Fixed Costs:unit sold from inventory 0 Variable 44.000 Manufacturing 100.000fixed cost absorbed in units sold 100.000 Fixed 10.000 Selling, administrative 10.000fixed cost absorbed in inventories-beginning 40.000 54.000 110.000fixed cost absorbed in inventories-ending 40.000total fixed manufacturing costs 100.000 Net Income Before Tax 0 Net Income Before Tax 0fixed selling and administrative 10.000TOTAL FIXED COSTS 110.000breakeven units 22.000

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With fixed selling and admin costsCase 2 sales < production Case 2 sales < production Case 2 sales < production

Absorption Income Statement Variable Income Statementinventory beginning - units 10.000 Sales 234.000 Sales 234.000inventory ending - units 15.000 Cost of Goods Sold: Variable Costs:production units 25.000 Variable Manuf Costs 108.000 Manufacturing 108.000sales units 20.000 Fixed Manuf Costs 80.000 Selling, administrative 36.000contribution margin per unit 5 188.000 144.000fixed manufacturing costs 100.000 Gross Margin 46.000 Contribution Margin 90.000fixed manufacturing costs per unit-current 4fixed manufacturing costs per unit-previous period 4 Selling and Administrative Costs Fixed Costs:unit sold from inventory (5.000) Variable 36.000 Manufacturing 100.000fixed cost absorbed in units sold 80.000 Fixed 10.000 Selling, administrative 10.000fixed cost absorbed in inventories-beginning 40.000 46.000 110.000fixed cost absorbed in inventories-ending 60.000total fixed manufacturing costs 80.000 Net Income Before Tax 0 Net Income Before Tax (20.000)fixed selling and administrative 10.000TOTAL FIXED COSTS 90.000breakeven units 18.000

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With fixed selling and admin costs

Case 3 sales > production Case 3 sales > production Case 3 sales > productionAbsorption Income Statement Variable Income Statement

inventory beginning - units 10.000 Sales 338.000 Sales 338.000inventory ending - units 5.000 Cost of Goods Sold: Variable Costs:production units 25.000 Variable Manuf Costs 156.000 Manufacturing 156.000sales units 30.000 Fixed Manuf Costs 120.000 Selling, administrative 52.000contribution margin per unit 5 276.000 208.000fixed manufacturing costs 100.000 Gross Margin 62.000 Contribution Margin 130.000fixed manufacturing costs per unit-current 4fixed manufacturing costs per unit-previous period 4 Selling and Administrative Costs Fixed Costs:unit sold from inventory 5.000 Variable 52.000 Manufacturing 100.000fixed cost absorbed in units sold 120.000 Fixed 10.000 Selling, administrative 10.000fixed cost absorbed in inventories-beginning 40.000 62.000 110.000fixed cost absorbed in inventories-ending 20.000total fixed manufacturing costs 120.000 Net Income Before Tax 0 Net Income Before Tax 20.000fixed selling and administrative 10.000TOTAL FIXED COSTS 130.000breakeven units 26.000

Decision Making and CVP EMBA 5412 Fall 2007. Mugan 20072 Decision-Making Process Plan and implement...

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