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Chapter Six

Cost-Volume-ProfitRelationships

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Learning Objective 1

Explain how changes inExplain how changes inactivity affect contributionactivity affect contributionmargin and net operatingmargin and net operating

income.income.

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asics of Cost-Volume-Profit !nal"sis

Contribution #argin $C#% is the amountremaining from sales revenue after variable

e&penses have been 'e'ucte'(

Contribution #argin $C#% is the amountremaining from sales revenue after variable

e&penses have been 'e'ucte'(

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asics of Cost-Volume-Profit !nal"sis

C# is use' first to cover fi&e'e&penses( !n" remaining C#

contributes to net operating income(

C# is use' first to cover fi&e'e&penses( !n" remaining C#

contributes to net operating income(

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+he Contribution !pproach

Sales, variable expenses, and contribution margin canalso be expressed on a per unit basis. If Racing sellsan additional bicycle, $!! additional C" will be

generated to cover fixed expenses and profit.

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+he Contribution !pproach

Each month, Racing must generate at least$#!,!!! in total C" to brea even.

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+he Contribution !pproach

If Racing sells %!! units%!! unitsin a month, it will beoperating at the break-even point.

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+he Contribution !pproach

If Racing sells one more bie &%!' bies%!' bies(, netoperating income will increase by $200.

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+he Contribution !pproach

)e do not need to prepare an income statementto estimate profits at a particular sales volume.Simply multiply the number of units sold above

brea*even by the contribution margin per unit.

If Racing sellsIf Racing sells

%+! bies, its%+! bies, its

net income willnet income willbe $,!!!.be $,!!!.

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Learning Objective 2

-repare and interpret a-repare and interpret acost*volume*profit &C-(cost*volume*profit &C-(

graph.graph.

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CVP Relationships in 0raphic orm

/he relationship among revenue, cost, profit and volumecan be expressed graphically by preparing a C-graph. Racing developed contribution margin incomestatements at +!!, %!!, and 0!! units sold. )e will

use this information to prepare the C- graph.

ncome

3// units

ncome

)// units

ncome

*// units

ales 1*/4///5 2//4///5 2*/4///5

Less variable e&penses ./4/// 12/4/// 1*/4///Contribution margin 6/4///5 /4///5 1//4///5

Less fi&e' e&penses /4/// /4/// /4///

7et operating income $2/4///%5 -5 2/4///5

ncome

3// units

ncome

)// units

ncome

*// units

ales 1*/4///5 2//4///5 2*/4///5

Less variable e&penses ./4/// 12/4/// 1*/4///

Contribution margin 6/4///5 /4///5 1//4///5

Less fi&e' e&penses /4/// /4/// /4///

7et operating income $2/4///%5 -5 2/4///5

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CVP 0raph

1nits

2o

llars

In a C- graph,In a C- graph, unit volumeunit volumeisisusually represented on theusually represented on the

hori8ontal $9% a&ishori8ontal $9% a&isandand 'ollars'ollarsonon

thethe vertical $:% a&isvertical $:% a&is..

In a C- graph,In a C- graph, unit volumeunit volumeisis

usually represented on theusually represented on thehori8ontal $9% a&ishori8ontal $9% a&isandand 'ollars'ollarsonon

thethe vertical $:% a&isvertical $:% a&is..

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CVP 0raph

1nits

2o

llars

i&e' ;&penses

6 1)

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CVP 0raph

2o

llars

1nits

i&e' ;&penses

+otal ;&penses

6 1*

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CVP 0raph

i&e' ;&penses2

oll

ars +otal ;&penses

+otal ales

1nits

6 16

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CVP 0raph

2o

llars

1nits

rea

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Learning Objective 3

1se the contribution1se the contributionmargin ratio &C" ratio( tomargin ratio &C" ratio( to

compute changes incompute changes incontribution margin andcontribution margin and

net operating incomenet operating income

resulting from changes inresulting from changes insales volume.sales volume.

6 1

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Contribution #argin Ratio

/he contribution margin ratio is5

6or Racing 7icycle Company the ratio is5

+otal C#+otal sales

C# Ratio =

Each $'.!! increase in sales results in atotal contribution margin increase of %!8.

= )/>5/4///

52//4///

6 1.

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Contribution #argin Ratio

9r, in terms of units, the contribution margin ratiois5

6or Racing 7icycle Company the ratio is5

52//

5*//

= )/>

?nit C#?nit selling price

C# Ratio =

6 2/

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)// i

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@uic< Chec

6-22

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Coffee =latch is an espresso stand in a downtownoffice building. /he average selling price of a cup ofcoffee is $'.%> and the average variable expenseper cup is $!.+. /he average fixed expense per

month is $',+!!. ,'!! cups are sold each monthon average. )hat is the C" Ratio for Coffee=latch?

a. '.+'>

b. !.@0#

c. !.%

d. %.'+>

@uic< Checof sales.

&$0!,!!! B $0!,!!!(

rea

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+he #argin of afet"

/he margin of safety can be expressed interms of the number of units sold. /he

margin of safety at Racing is $0!,!!!, and

each bie sells for $0!!.

"argin ofSafety in units

< < '!! bies$0!,!!!

$0!!

6-6/

@uic< Chec andthe average variable expense per cup is

$!.+. /he average fixed expense per monthis $',+!!. ,'!! cups are sold each monthon average. )hat is the operating leverage?

a. .'

b. !.%0

c. !.+%

d. .>

Coffee =latch is an espresso stand in adowntown office building. /he averageselling price of a cup of coffee is $'.%> andthe average variable expense per cup is

$!.+. /he average fixed expense per monthis $',+!!. ,'!! cups are sold each monthon average. )hat is the operating leverage?

a. .'

b. !.%0

c. !.+%

d. .>

6-,/

@uic< Chec

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Coffee =latch is an espresso stand in adowntown office building. /he averageselling price of a cup of coffee is $'.%> andthe average variable expense per cup is

$!.+. /he average fixed expense per monthis $',+!!. ,'!! cups are sold each monthon average. )hat is the operating leverage?

a. .'

b. !.%0

c. !.+%

d. .>

Coffee =latch is an espresso stand in adowntown office building. /he averageselling price of a cup of coffee is $'.%> andthe average variable expense per cup is

$!.+. /he average fixed expense per monthis $',+!!. ,'!! cups are sold each monthon average. )hat is the operating leverage?

a. .'

b. !.%0

c. !.+%

d. .>

@uic< Chec