Ac202 Chapter 18 Notes

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Chapter 18 Cost Volume Profit Analysis
Prof. Baick 1. Cost-Volume Profit Analysis A technique that examines changes in profits in response to changes in sales volumes, costs, and prices 2. Components of Graphing CVP Analysis Relationships

$

D C B A

units
where: F = Total fixed costs P = Price per unit of product (goods or services) Profit = Targeted profit level Q = Quantity of product sold (goods or services) TR = Total revenue TVC = Total variable costs V = Variable cost per unit

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3.

Assumptions Made in CVP Analysis Number of output units only revenue driver and only cost driver Total costs can be separated into the primary categories of variable costs and fixed costs Total revenues and total costs are linear within the relevant range (and time period) Unit selling price, unit variable costs, and fixed costs known and constant Single product or constant sales mix Time value of money effects ignored

4.

Basic Formula and Terminology Assume that: U = Number of Units Produced and SOLD SP = Selling Price per Unit VC = Variable Cost per Unit FC = Total Fixed Costs

Sales

-

Variable Costs

-

Fixed Costs =

Profit

Breakeven The level of sales whereby total profits are equal to zero. Contribution margin Sales Revenue – Variable Costs Contribution margin per unit Selling price per unit – Variable cost per unit Contribution margin ratio = Total Sales Revenue – Total Variable Costs Total Sales Revenue OR: Selling price per Unit – Variable costs per Unit Selling price per Unit

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5.

Breakeven Analysis Breakeven sales Breakeven units

6.

Target Profit Target sales Target units

7.

Margin of Safety

8.

Margin of Safety Ratio

9.

Product Mix Decisions

10.

Leverage and Cost Structure Definition Increasing sales by a given percent and increasing profits by an increasingly larger proportion.

Operating leverage

Financial leverage

11.

Primacy of Contribution Margin

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CVP Graphical Analysis

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IMPORTANT FORMULAS: SP VC FC U = = = = Selling price per unit Variable cost per unit Total Fixed costs Units sold

Revenue

-

Expenses Variable Fixed FC

=

Net Income

SP(U)

- VC(U) -

=

NI

BREAK EVEN MEANS REVENUES = EXPENSES OR NET INCOME IS 0 Contribution Margin Ratio =

Break-even (Units) =

FC __ SP - VC FC____________ Contribution Margin Ratio

Break-even (Sales) =

Target Profit (Units) =FC + TP SP - VC Target Profit (Sales) = FC + TP Contribution Margin Ratio = Actual (Expected) Sales – Break-even Sales

Margin of Safety

Margin of Safety Ratio =

Margin of Safety Actual (Expected) Sales

Higher is better!

Three Ways of Computing Break-Even 1. Mathematical equation SP(U) – VC(U) – FC = NI 2. Contribution Margin Technique (Formulas) 3. Graphs

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In-Class Problems
Example 1. If sales are $80,000, variable costs are $50,000, and fixed costs are $20,000, the contribution margin ratio is: Sales – Variable Costs Sales 80,000 – 50,000 80,000 = .375 or 37.5%

Example 2. A firm with fixed costs of $61,500 per month sells three products with the following characteristics: Sales Mix Contribution Product Percentage Margin P 25% $48 Q 50% 50 R 25% 52 How many total units must be sold to breakeven? First Compute the Weighted-Average Contribution Margin per Unit = ($48 x .25) + ($50 x .50) + ($52 x .25) = $12 + $25 + $13 = $50 This figure will be used to compute the break-even in total units.

Breakeven in Total Units = Total Fixed Costs Weighted-Avg Contribution Margin per Unit $61,500 50

=

= 1,230 units in total

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Example 3. The Pierson Co. has the following unit and mix data: Do Dah Unit sales price $5.00 $4.00 Unit contribution margin 0.75 1.20 Sales mix ($) 80% 20% Fixed costs Target profit How many units of Dah must be sold at the breakeven point? = $ 99,000 ($0.75 x .80) + ($1.20 x .20) = $99,000 $0.84 = 117,857.143 -> 117, 858 Total units at breakeven (round up).

Total

$99,000...
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