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Cost-Volume-Profit Analyses
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Learning Objectives
After studying this chapter, you should be able to:
[1] Distinguish between variable and fixed costs.
[2] Explain the significance of the relevant range.
[3] Explain the concept of mixed costs.
[4] List the five components of cost-volume-profit analysis.
[5] Indicate what contribution margin is and how it can be expressed.
[6] Identify the three ways to determine the break-even point.
[7] Give the formulas for determining sales required to earn target netincome.
[8] Define margin of safety, and give the formulas for computing it.
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Mixed costs contains both variable and fixed costselements.
What is the behaviour of mixed costs? Changes in totalbut not proportionately with changes in the level ofactivity.
E.g. utility charge: Flat rate plus usage charge or rental
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Can we use mixed costs for CVP? Yes, but we mustseparate the fixed costs from the variable cost.
How do we do that? By an analysis known as High-lowmethod.
Step 1: Variable cost/unit=change in TC/(H-L ActivityLevel)
Step 2: Fixed cost= Total costs Total variable costs ateither high/low activity level answer is the same.
Equation :
Mixed costs = Fixed costs (Step2) + Vc per unit (Step1)
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Componentsof CVP
UnitSellingPrices
Variablecost per
unit
Totalfixedcosts
Salesmix
Level ofActivity
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Behavior of both costs and revenues is linear throughout
the relevant range of the activity index.
All costs can be classified as either variable or fixed with
reasonable accuracy.
Changes in activity are the only factors that affect costs.
All units produced are sold.
When more than one type of product is sold, the sales mix
will remain constant.
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For internal use only
Classifies costs as variable and expenses so as to showCM and then net income. Example below:
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Revenue remainingafter deductingvariable costs
ContributionMargin(CM)
CM per unit= USP-UVC
CM ratio= CM perunit / USP
Method
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BreakEven
Analysis
Net Income = Zero
Total costs=Totalrevenue
CM=FixedCosts
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1. Mathematical Equation:
SP(x)= VC(x) +F C + NI : Net Income=Zero
X= units: $$$= units x selling price(SP)
2. CM technique:
Break even in units= FC + NI/ CM per unit Break even in dollars= FC + NI / CM ratio
3. Graphic Presentation page 217 5th edition
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What is it? Is a tool to help management understand howfar sales could change before company start operating ata net loss.
How do you calculate it:
MOS in dollars= Actual(expected) sales- BE Sales
MOS ratio= MOS in dollars / Actual (exp.) sales
The higher the sales dollars or percentages, the greaterthe MOS
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Learning Objectives
After studying this chapter, you should be able to:
[1] Describe the essential features of a cost-volume-profit income
statement.
[2] Apply basic CVP concepts.
[3] Explain the term sales mix and its effects on break-even sales.
[4] Determine sales mix when a company has limited resources.
[5] Understand how operating leverage affects profitability.
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Sales mix is the relative proportion in which the company sellsits products.
If a companys unit sales are 80% printers and 20%
computers, its sales mix is 80% to 20%. Sales mix is important because different products often
have very different contribution margins.
Breakeven in $$ Breakeven in Units
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Looking at the Formula You are to gather two pieces of information:Step 1: Fixed Costs = Fixed costs of MOH +Fixed Costs Periodexpenses
Step 2: Calculate Weighted Average Unit CM= ((USP-UVC prdA )x
(Sales prdA/Total Sales) ) + ((USP-UVC prdB )x (Sales prdB /TotalSales)
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After you receive TOTAL Break-even point in Units THENyou calculate Break-even point in units per product.
HOW?
1. Total Break-even units x Sales mix % Prd A= BEUnits
Prd A
2. Total Break-even units x Sales mix %Prd B= BEUnitsPrd B
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The calculation of break-even point in units workswell if the company has only a few products Butwhat if there is a large quantity of products?
When there are many products, calculate the break-even point in terms of sales dollars fordivisions or
productlines, NOTindividual products.
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Step one: Fixed costs
Step two: Calculate: Weighted-Average CM Ratio
Illustration 6-16
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Here we consider the Sales Dollars ($$$)
CM Ratio = (Sales Dollars- V. costs Dollars) / SalesDollars
Sales Mix Percentage: Total Sales Revenue Dollars /
Prdx Sales Revenue
Relationship between products and Net Income?
Greater if more higher-contribution margin units are soldthan lower-contribution margin units.
Illustration 6-16
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All companies have limited resourceswhether it be floor
space, raw materials, direct labor hours, etc.
Limited resources force management to decide whichproducts to sell to maximize net income.
To determine the appropriate sales mix, compute thecontribution margin per unit of limited resource:
Product with the higher CM per unit of Limited resource
will be the product managemt should produce more of.
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What is Cost structure? Cost Structure is the relative
proportion of fixed versus variable costs that a companyincurs.
Why is it important?
1. It has an Effect on CM Ratio
It has an Effect on Break-even point in Dollars
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What is Operating leverage? It refers to the extent that
net income reacts to a given change in sales. What is the effect on income levels?
Higher fixed costs relative to variable costs causea company to have higher operating leverage.
When sales revenues are increasing, highoperating leverage means that profits will increaserapidly a good thing.
When sales revenues are declining, too muchoperating leverage can have devastatingconsequences.
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New Waves earnings would go up (or down) by
about two times (5.33 2.67 = 1.99) as much asVargos with an equal increase in sales.
Illustration 6-25
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Announcement:
MST details are on Moodle.
TUESDAY 23/04/2013 at 4pm Fiji time Venue: Contact your respective SAS at the earliest.
Assignment due Tuesday April 9th 2013.