Ch04 PPT Hongren CostAccounting 2e-2

Chapter 4

Cost–volume–profitanalysis

PowerPoint to accompany:

2 Copyright ©2014 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442563377/Horngren/Cost accounting/2e

LEARNING OBJECTIVES

• Describe the features of cost–volume–profit (CVP) analysis

• Determine the break-even point and output level needed to achieve a target profit

• Describe how income taxes affect CVP analysis

• Describe how managers use CVP analysis in decision making


LEARNING OBJECTIVES

• Explain how sensitivity analysis helps managers cope with uncertainty

• Use CVP analysis to plan variable and fixed costs

• Apply CVP analysis to a company producing multiple products

• Adapt CVP analysis to situations in which a product has more than one cost driver.


Essentials of CVP analysis

• Identify the problem and uncertainties

• Collect relevant information

• Determine possible courses of action and consider the consequences of each

• Evaluate each possible course of action and select the best one

• Implement the decision, evaluate performance, and learn.



Contribution margins:

• manipulation of the basic equations yields an extremely important and powerful tool extensively used in cost accounting: the contribution margin

• contribution margin = total revenues – total variable costs

• CM = TR – VC

• contribution margin per unit equals selling price less variable cost per unit

• CMpu = SP – VCpu



• contribution margin also equals contribution margin per unit multiplied by the number of units sold (Q)• CM = CMpu x Q

• contribution margin ratio (percentage) equals contribution margin per unit divided by selling price• CMR = CMpu ÷ SP

• interpretation: how many cents out of every sales dollar are represented by contribution margin?



Expressing CVP relationships

• there are three methods that show CVP relationships:

1. the equation method

2. the contribution margin method

3. the graph method.



and

Basic formulae:

Total revenue (TR ) – Variable costs (VC ) – Fixed costs (FC ) = Operating profit (P )

Total revenue (TR ) = Selling price (SP ) × Quantity of units sold (Q )

Variable costs (VC ) = Variable cost per unit (VCPU ) × Quantity of units sold (Q )



Equation method:

or



Contribution margin method:

rearranging equation 1

or



Graph method:

1.total costs line – the total costs (TC) line is the sum of fixed costs and variable costs; fixed costs are constant within the relevant range

2.total revenues line


Cost–volume–profit assumptions

• Changes in production/sales volume are the sole cause for cost and revenue changes.

• Total costs consist of fixed costs and variable costs.• Revenue and costs behave, and can be graphed, as a linear

function (a straight line).• Selling price, variable cost per unit, and fixed costs are all

known and constant.• In many cases only a single product will be analysed. If

multiple products are studied, their relative sales proportions are known and constant.

• The time value of money (interest) is ignored.


Break-even point and target profit

Recall the last equation in an earlier slide (CMpu x Q) – FC = P:

•a simple manipulation of this formula, and setting P to zero will result in the break-even point (quantity)

• BEP = FC ÷ CMpu

•at this point, a firm has no profit or loss at the given sales level

•if per-unit values are not available, the break-even point may be restated in its alternative format

• BEP = FC ÷ CMR



Target operating profit:

• with a simple adjustment, the break-even point formula can be modified to become a profit planning tool

• profit is now reinstated to the BE formula, changing it to a simple sales volume equation

• Q = (FC + P)

CMpu



Target net profit and income taxes

From time to time it is necessary to move back and forth between target profit before tax (PBT) and target profit after tax (PAT), depending on the facts presented:

• target profit after tax can be calculated by

‒ PBT x (1-Tax Rate) = PAT

• PAT can substitute into the profit planning equation through this form

‒ PBT = PAT

(1-Tax Rate)


Break-even point and target profit – web link

• A three-part explanation of break-even analysis with questions and quizzes can be found at: http://www.accountingcoach.com/online-accounting-course/01Xpg01.html

http://www.accountingcoach.com/online-accounting-course/01Xpg01.html

http://www.accountingcoach.com/online-accounting-course/01Xpg01.html


Using CVP analysis for decision making

• CVP analysis is useful for calculating the units that need to be sold:

• to break even

• to achieve a target profit or target net profit after tax.

• CVP can also be used to guide other decisions, many of them strategic, such as:

• the decision to advertise

• the decision to reduce selling price.


Using CVP analysis for decision making – web link

• A worked case study ‘How Is Cost-Volume-Profit Analysis Used for Decision Making?’ can be found at: http://2012books.lardbucket.org/books/managerial-accounting-v1.0/section_10.html

http://2012books.lardbucket.org/books/managerial-accounting-v1.0/section_10.html

http://2012books.lardbucket.org/books/managerial-accounting-v1.0/section_10.html


Sensitivity analysis and margin of safety

Sensitivity analysis:

• is a ‘what-if’ technique that managers use to examine how an outcome will change if the original predicted data are not achieved, or if an underlying assumption changes

• CVP provides structure to answer a variety of ‘what-if’ scenarios: ‘what’ happens to profit ‘if’

– selling price changes– volume changes– cost structure changes– variable cost per unit changes– fixed costs change.



• The margin of safety (MOS) measures the distance between budgeted sales and break-even sales:

• The MOS ratio removes the firm’s size from the output, and expresses itself in the form of a percentage:

MOS ratio = MOS ÷ budgeted sales




Sensitivity analysis and margin of safety – web links

• A YouTube lecture on ‘Sensitivity Analysis, Margin of Safety, Breakeven, Contribution Margin’ can be found at: http://www.youtube.com/watch?v=kQszXQWOBfk

• And a YouTube lecture on ‘Margin of Safety’ can be found at: http://www.youtube.com/watch?v=cDsISa1swms

http://www.youtube.com/watch?v=kQszXQWOBfk

http://www.youtube.com/watch?v=cDsISa1swms


Cost planning and CVP

Alternative fixed cost/variable cost structures:

•CVP-based sensitivity analysis highlights the risks and returns as fixed costs are substituted for variable costs in a company’s cost structure.


Cost planning and CVP

Operating leverage:

• operating leverage (OL) is the effect that fixed costs have on changes in operating profit as changes occur in units sold and contribution margin

OL = contribution margin

operating profit

• remember that, in the presence of fixed costs, the degree of operating leverage is different at different levels of sales.


Effects of sales mix on income

Sales mix:

• the quantities (or proportion) of various products (or services) that constitute total unit sales of a company

• the formulae presented to this point have assumed a single product is produced and sold

• a more realistic scenario involves multiple products sold in different volumes with different costs

• the same formulae are used, but use a weighted average contribution margin for bundles of products.


Multiple cost drivers

• Variable costs may arise from multiple cost drivers or activities.

• A separate variable cost needs to be calculated for each driver.


CVP analysis in service and not-for-profitorganisations

• To apply CVP analysis in service and not-for-profit organisations, we focus on measuring their output, which is different from the tangible units sold by manufacturing and retail companies.

• Examples of output measures in service and not-for-profit industries include:

‒ passenger kilometres

‒ room nights occupied

‒ patient days

‒ PhD completions.


APPENDIX 4-1

Break-even points in variable costing and absorption costing

Variable costing:

• There is only one break-even point in this case, and it depends on:

‒ fixed (manufacturing and operating) costs and

‒ contribution margin per unit.


APPENDIX 4-1

Break-even points in variable costing and absorption costing

Absorption costing:

• the required number of units to be sold to earn a specific target operating profit is not unique because of the number of variables involved.


APPENDIX 4-2

Decision models and uncertainty:

• coping with uncertainty

‒ role of a decision model

‒ expected value

‒ sound decisions versus satisfactory outcomes.


APPENDIX 4-2

Decision models and uncertainty:

Date post:	27-Jan-2016
Category:	Documents
Upload:	nexus-real
View:	235 times
Download:	1 times

Ch04 PPT Hongren CostAccounting 2e-2

Documents