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Chapter 6Cost-Volume-Profit Analysis and

Relevant Costing

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1. How is breakeven point computed and what

does it represent?

2. How do costs, revenues, and contribution

margin interact with changes in an activity base

(volume)?

Learning Objectives

C6

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3. How does cost-volume-profit (CVP) analysis in

single-product and multiproduct firms differ?

4. What are the underlying assumptions of CVP

analysis and how do these assumptions create a

short-run managerial perspective?

C6

Continuing . . . Learning

Objectives

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5. How do quality decisions affect the components of CVP

analysis?

6. What constitutes relevance in a decision-making

situation?

C6

Continuing . . . Learning

Objectives

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7. How can management best utilize a scarce

resource?

8. What is the relationship between sales mix and

relevant costing problems?

Continuing . . . Learning

Objectives

C6

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9. How can pricing decisions be used to

maximize profit?

10. How can product margin be used to

determine whether a product line should be

retained or eliminated?

C6

Continuing . . . Learning Objectives

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11. How are breakeven and profit-volume graphs

prepared? (Appendix 1)

12. What are the differences between absorption

and variable costing? ( Appendix 2)

13. Why is linear programming a valuable tool for

managers? (Appendix 3)

C6

Continuing . . . Learning

Objectives

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The Breakeven Point (BEP)

The level of activity, in units or dollars,

at which

REVENUES = COSTS

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Basic Assumption: Relevant RangeCompany is operating within the relevant

range of activity specified in determining the revenue

and cost information used.

Total

$

Act iv i ty L evel

RelevantRange

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Basic Assumption: RevenueTotal revenue fluctuates in direct proportion to levelof activity or volume. On a per unit basis, the selling

price remains constant.

Total

$

Act iv i ty L evel

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Basic Assumption: Variable CostsTotal variable costs fluctuate in direct proportion to

level of activity or volume. On a per unit basis,variable costs remain constant.

Total

$

Act iv i ty L evel

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Basic Assumption: Fixed CostsTotal fixed costs remain constant relative to activity

level changes. Per-unit fixed costs decrease asvolume increases and increase as volume decreases.

Total$

Activity Level

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Basic Assumption: Mixed CostsMixed costs must be separated into variable and fixed

elements.

Total$

Activity Level

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Cost Behavior ExampleSelling price per ice bucket $40

Variable production cost per ice bucket $20

Variable selling cost per ice bucket 4

Total variable cost per ice bucket $24

Fixed production costs $100,000

Fixed selling and administrative costs 20,000

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Contribution Margin Per Unit

Contr ibution margin per uni tequals selling

price per unit less variable cost per unit.

sp -vc = cm

$40 - $24 = $16

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Contribution Margin Ratio

Contr ibution margin ratiois per-unit

contribution margin divided by selling

price, or total contribution margin divided

by total sales dollars.

cm/sp=cm%$16 / $40 = 40%

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Breakeven PointBreakeven pointis the point at which profits are

zero because total revenues equal total costs, or

Total revenues = Total variable costs + Total fixed costs

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Continuing . . . Breakeven PointTotal fixed costs

In units = ---------------------

CM per unit

Total fixed costs

In sales dollars = ---------------------

CM ratio

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Continuing . . . Breakeven Point$120,000

In units = ----------- = 7,500 ice buckets

$16

$120,000

In sales dollars = ----------- = $300,000

.40

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CVP Analysis: Fixed Amount of

Profit Before Taxes (PBT)Total fixed costs + PBT

In units = ------------------------------

CM per unit

Total fixed costs + PBT

In sales dollars = ------------------------------

CM ratio

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CVP Analysis: Fixed Amount of

Profit Before Taxes (PBT)$120,000 + $64,000

In units = ------------------------ = 11,500 buckets

$16

$120,000 + $64,000

In sales dollars = ------------------------ = $460,000

.40

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CVP Analysis: Variable Amount

of Profit Before TaxesAssume PUBT desired is 25% on sales

Therefore, PUBT = .25 ($40) = $10

Total fixed costs

Sales in units = ---------------------------

CM per unit - PUBT

$120,000

Sales in units = ---------------= 20,000 ice buckets

$16 - $6

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CVP Analysis: Variable Amount

of Profit Before TaxesAssume PUBT desired is 25% on sales

Therefore, PUBT = .25 ($40) = $10

Total fixed costs

Sales in $ = ---------------------

CM% - PUBT%

$120,000

Sales in $ = ---------------=$800,000

.40 - .25

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Income StatementDollars Percentages

Sales $800,000 100%Variable costs 480,000 60%

Contribution margin $320,000 40%

Fixed costs 120,000 15%

Income $200,000 25%======= ==

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CVP Analysis - Multiple Products

Ice Serving

Buckets Sets

Selling price $40 $24

Variable cost 24 12

Contribution margin $16 $12

Contribution margin ratio 40.0% 50.0%

Sales mix* 80.6% 19.4%

*5:2 ratio

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Continuing . . .CVP Analysis -

Multiple Products

Ice Serving

Buckets Sets

Contribution margin ratio 40.0% 50.0%

Sales mix* 80.6% 19.4%

Weighted contribution margin 32.2% 9.7%

Contribution margin ratio per bag 41.9%

*5:2 ratio

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Continuing . . . CVP Analysis -

Multiple Products

Total fixed costs

BEP in sales dollars = -----------------------

CM ratio per bag

($120,000 + $30,000*)

BEP in sales dollars = ----------------------------

.419

= $357,995

* $30,000 of additi onal f ixed cost is incur red to

produce both uni ts

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Scarce Resource -- Machine HoursIce Juice

Crushers Extractors

Selling price per unit $15 $12

Variable production cost per unit:

Direct materials $3 $3

Direct labor 4 2

Variable overhead 3 1

Total variable cost 10 6

Unit contribution margin $5 $6

Units of output per machine hour 30 20Contribution margin per machine hour $150 $120

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Sales Mix DecisionsHow many of each product?

R l C i

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Relevant Costs in

Product Line Decisions

Revenues associated with product

Variable costs associated with product

Avoidable fixed costs

Consider product margin

Revenues - Variable costs - Avoidable f ixed costs

E hibi 6 12 P i l P d Li

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Exhibit 6-12: Partial Product Line

Income StatementElectricSkillet

Sales $75,000Total direct variable expenses 43,750Total contribution margin $31,250Total fixed expenses* 39,500Net loss ($8,250)

*Fixed expenses:Avoidable fixed expenses $25,000Unavoidable fixed expenses 4,500Allocated common costs 10,000

Total $39,500

E hibit 6 13 P d t M i f

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Exhibit 6-13: Product Margin for

the Electric Skillet Product LineElectric

Skillet

Sales $75,000

Total direct variable expenses 43,750

Total contribution margin $31,250

Avoidable fixed expenses 25,000

Product margin $6,250

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CVP Graph

Total$

Volume

Total Costs

Total RevenuesBE

P

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Profit-Volume GraphBEP

Fixed Costs

Volume

Profit or Loss

Total$

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Absorption Costing

Also known as full costing

Treats costs of all manufacturing components as

inventoriable, or product, costs

Di rect mater ials

Di rect labor

Variable factory overhead

F ixed factory overhead

Presents expenses on income statement according tofunctional classifications

Cost of goods sold

Selling expenses

Administrative expenses

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Variable Costing

Also known as direct costing

Includes only variable production costs as

inventoriable, or product, costs

Di rect mater ials

Di rect labor

Variable factory overhead

Fixed factory overhead costs treated as period expenses

Income statement separates costs by cost behavior

May also present expenses by functional classif ications within

behavioral categori es

Absorption Costing

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Absorption Costing

Income StatementSales XXX

Cost of Goods Sold:

Beginning inventory XXX

Cost of goods manufactured XXX

Cost of goods available XXXEnding inventory XXX

Cost of goods sold XXX

Gross Margin XXX

Operating Expenses:

Selling XXXAdministrative XXX XXX

Income before Taxes XXX

V i bl C ti

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Variable Costing

Income StatementSales XXX

Cost of Goods Sold:

Beginning inventory XXX

Cost of goods manufactured XXX

Cost of goods available XXX

Ending inventory XXX

Variable cost of goods sold XXX

Product Contribution Margin XXX

Variable Selling Expense XXX

Total Contribution Margin XXX

Fixed Expenses:Factory XXX

Selling XXX

Administrative XXX XXX

Income before Taxes XXX

Absorption Costing vs Variable

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Absorption Costing vs. Variable

Costing Income StatementsAbsorption Costing Variable Costing:

Sales $60,000 Sales $60,000

Cost of sales 30,000 Variable costs:

Gross profit $30,000 Cost of sales 30,000

Operating expenses: Operating expenses 6,000

Variable $6,000 Total variable costs $36,000

Fixed 20,000 Contribution margin: $24,000

Total operating expenses $26,000 Fixed costs 20,000

Income $4,000 Income $4,000