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You will have 2 options with this chapter's online journal

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You will have 2 options with this chapter's online journal. Refer to the back of chapter 21 for these Beyond the Number (BTN) cases.

Option #1: BTN 21-4. Complete the required exercises.

Option #2: BTN 21-6. Complete the required exercise. Each list of questions must contain at least 5 questions.

You ONLY need to complete ONE of the two options to receive full credit.

21 - 1 Cost-Volume-Profit Analysis Chapter 21 PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. 21 - 2 Identifying Cost Behavior Cost-volume-profit analysis is used to answer questions such as: – What sales volume is needed to earn a target income? – What is the change in income if selling prices decline and sales volume increases? – How much does income increase if we install a new machine to reduce labor costs? – What is the income effect if we change the sales mix of our products or services? 21 - 3 Number of Local Calls Total fixed costs remain constant as activity increases. Monthly Basic Telephone Bill per Local Call Fixed Costs Monthly Basic Telephone Bill C1 Number of Local Calls Cost per call declines as activity increases. 21 - 4 C1 Total Costs Cost per Minute Variable Costs Minutes Talked Total variable costs increase as activity increases. Minutes Talked Cost per Minute is constant as activity increases. 21 - 5 C1 Mixed Costs Total Utility Cost Mixed costs contain a fixed portion that is incurred even when the facility is unused, and a variable portion that increases with usage. Utilities typically behave in this manner. st o c d xe i m l a t To Variable Cost per KW Activity (Kilowatt Hours) Fixed Monthly Utility Charge 21 - 6 C1 Step-Wise Costs Total cost increases to a new higher cost for the next higher range of activity, but remains constant within a range of activity. 21 - 7 C1 Curvilinear Costs Costs that increase when activity increases, but in a nonlinear 21 - 8 P1 Measuring Cost Behavior The objective is to classify all costs as either fixed or variable. We will look at three methods: 1.Scatter diagrams. 2.The high-low method. 3.Least–squares regression. A scatter diagram is a plot of cost data points on a graph. It is almost always helpful to plot cost data to be able to observe a visual picture of the relationship between cost and activity. 21 - 9 P1 Scatter Diagrams Draw a line through the plotted data points so that about equal numbers of points fall above and below the line. Total Cost in 1,000’s of Dollars 20 * ** * ** * * * * 10 Estimated fixed cost = 10,000 0 0 1 2 3 4 5 Activity, 1,000’s of Units Produced 6 21 - 10 P1 Scatter Diagrams Δ in cost Δ in units Unit Variable Cost = Slope = Total Cost in 1,000’s of Dollars 20 * ** * ** * * * * 10 Horizontal distance is the change in activity. 0 0 1 2 3 4 Activity, 1,000’s of Units Produced 5 6 Vertical distance is the change in cost. 21 - 11 P1 The High-Low Method The following relationships between units produced and total cost are observed: Using these two levels of activity, compute: ? the variable cost per unit. ? the total fixed cost. 21 - 12 P1 The High-Low Method High activity level - October Low activity level - February Change in activity Units 67,500 17,500 50,000 Cost $ 29,000 20,500 $ 8,500 ? Variable cost per unit is determined as follows: ? Fixed costs are determined as follows: Total cost = $17,525 + $0.17 per unit produced 21 - 13 P1 Least-Squares Regression Least-squares regression is usually covered in advanced cost accounting courses. It is commonly used with spreadsheet programs or calculators. The objective of the cost analysis remains the same: determination of total fixed cost and the variable unit cost. 21 - 14 A1 Using Break-Even Analysis The break-even point (expressed in units of product or dollars of sales) is the unique sales level at which a company earns neither a profit nor incurs a loss. 21 - 15 A1 Contribution Margin and its Measures Sales Revenue (2,000 units) Less: Variable costs Contribution margin Less: Fixed costs Net income Total $ 200,000 140,000 $ 60,000 24,000 $ 36,000 Unit $ 100 70 $ 30 Contribution margin is the amount by which revenue exceeds the variable costs of producing the revenue. Total contribution margin is $60,000 and the contribution margin per unit sold is $30. 21 - 16 A1 Contribution Margin and its Measures Sales Revenue (2,000 units) Less: Variable costs Contribution margin Less: Fixed costs Net income Contribution margin ratio Contribution margin ratio Total $ 200,000 140,000 $ 60,000 24,000 $ 36,000 Unit $ 100 70 $ 30 = Contribution margin per unit Sales price per unit = $30 per unit $100 per unit = 30% 21 - 17 P2 Computing the Break-Even Point Sales Revenue (2,000 units) Less: Va riable costs Contribution margin Less: Fixed costs Net income Total $ 200,000 140,000 $ 60,000 24,000 $ 36,000 Unit $ 100 70 $ 30 How much contribution margin must Rydell Company have to cover its fixed costs (break-even)? Answer: $24,000 How many units must Rydell sell to cover its fixed costs (break-even)? Answer: $24,000 ÷ $30 per unit = 800 units 21 - 18 P2 Computing the Break-Even Point We have just seen one of the basic CVP relationships – the break-even computation. Fixed costs Break-even point in units = Contribution margin per unit Unit sales price less unit variable cost ($30 in previous example) 21 - 19 P2 Computing the Break-Even Point The break-even formula may also be expressed in sales dollars. Fixed costs Break-even point in dollars = Contribution margin ratio Unit contribution margin Unit sales price 21 - 20 P3 Preparing a CVP Chart 21 - 21 P3 Making Assumptions in Cost-Volume-Profit Analysis ? A limited range of activity called the relevant range, where CVP relationships are linear. ? Unit selling price remains constant. ? Unit variable costs remain constant. ? Total fixed costs remain constant. ? Production = sales (no inventory changes). 21 - 22 P3 Working with Changes in Estimates Sales Revenue (2,000 units) Less: Variable costs Contribution margin Less: Fixed costs Net income Total $ 200,000 140,000 $ 60,000 24,000 $ 36,000 Unit $ 100 70 $ 30 What happens to the break-even point if management can increase the sales price to $105, with no changes in fixed or variable costs? Break-even point in units = Break-even point in units = Fixed costs Contribution margin per unit $24,000 = 686 units $105 – $70 21 - 23 C2 Computing Income from Sales and Costs Income (pretax) = Sales – Variable costs – Fixed costs Rydell expects to sell 1,500 units at $100 each next month. Fixed costs are $24,000 per month and the unit variable cost is $70. What amount of income should Rydell expect? Income (pretax) = Sales – Variable costs – Fixed costs = [1,500 units × $100] – [1,500 units × $70] – $24,000 = $21,000 21 - 24 C2 Computing Sales for a Target Income Break-even formulas may be adjusted to show the sales volume needed to earn any amount of income. Fixed costs + Target pretax income Unit sales = Contribution margin per unit Dollar sales = Fixed costs + Target pretax income Contribution margin ratio 21 - 25 C2 Computing Sales (Dollars) for a Target Net Income To convert target net income to before-tax income, use the following formula: Target net income Before-tax income = 1 - tax rate 21 - 26 C2 Computing Sales (Dollars) for a Target Net Income Rydell has a monthly target net income of $9,000. The unit selling price is $100. Monthly fixed costs are $24,000, the unit variable cost is $70, and the tax rate is 25 percent. What is Rydell’s target pretax income? Pretax income = Pretax income = Target net income 1 - tax rate $9,000 1 - 0.25 = $12,000 21 - 27 C2 Computing Sales (Dollars) for a Target Net Income Rydell has a monthly target after-tax income of $9,000. The unit selling price is $100. Monthly fixed costs are $24,000, the unit variable cost is $70, and the tax rate is 25 percent. Let’s compute the sales revenue that Rydell will need to earn $12,000 of pretax income? Dollar sales = Dollar sales = Fixed costs + Target pretax income Contribution margin ratio $24,000 + $12,000 30% = $120,000 21 - 28 C2 Computing Sales (Units) for a Target Net Income The formula for computing dollar sales may be used to compute unit sales by substituting contribution per unit in the denominator. Unit sales = Unit sales = units Fixed costs + Target pretax income Contribution margin per unit $24,000 + $12,000 $30 per unit = 1,200 21 - 29 C2 Computing the Margin of Safety Margin of safety is the amount by which sales can drop before the company incurs a loss. Margin of safety may be expressed as a percentage of expected sales. Margin of safety percentage = Expected sales - Break-even sales Expected sales If Rydell’s sales are $100,000 and break-even sales are $80,000, what is the margin of safety percentage? Margin of safety percentage $100,000 - $80,000 = = 20% $100,000 21 - 30 C2 Using Sensitivity Analysis Rydell Company is considering buying a new machine that would increase monthly fixed costs from $24,000 to $30,000, but decrease unit variable costs from $70 to $60. The $100 per unit selling price would remain unchanged. What is the new break-even point in dollars? Revised Break-even point in dollars Revised Break-even point in dollars = Revised fixed costs Revised contribution margin ratio = $30,000 40% = $75,000 21 - 31 P4 Computing a Multiproduct Break-Even Point The CVP formulas can be modified for use when a company sells more than one product. ? The unit contribution margin is replaced with the contribution margin for a composite unit. ? A composite unit is composed of specific numbers of each product in proportion to the product sales mix. ? Sales mix is the ratio of the volumes of the various products. 21 - 32 P4 Computing a Multiproduct Break-Even Point The resulting break-even formula for composite unit sales is: Break-even point in composite units = Fixed costs Contribution margin per composite unit Consider the following example: Continue 21 - 33 P4 Computing a Multiproduct Break-Even Point Hair-Today offers three cuts as shown below. Annual fixed costs are $192,000. Compute the break-even point in composite units and in number of units for each haircut at the given sales mix. Selling Price Va riable Cost Unit Contribution Sales Mix Ratio Haircuts Basic Ultra Budget $ 20.00 $ 32.00 $ 16.00 13.00 18.00 8.00 $ 7.00 $ 14.00 $ 8.00 4 2 1 A 4:2:1 sales mix means that if there are 500 budget cuts, then there will be 1,000 ultra cuts, and 2,000 basic cuts. 21 - 34 P4 Computing a Multiproduct Break-Even Point Step 1: Compute contribution margin per composite unit. Basic Selling Price $20.00 Variable Cost 13.00 Unit Contribution $7.00 Sales Mix Ratio ×4 Weighted Contribution $ 28.00 Haircuts Ultra Budget $32.00 $16.00 18.00 8.00 $14.00 $8.00 ×2 ×1 + $ 28.00 + $ 8.00 = $ 64.00 Contribution margin per composite unit 21 - 35 P4 Computing a Multiproduct Break-Even Point Step 2: Compute break-even point in composite units. = Fixed costs Contribution margin per composite unit Break-even point in composite units = $192,000 $64.00 per composite unit Break-even point in composite units = 3,000 composite units Break-even point in composite units 21 - 36 P4 Computing a Multiproduct Break-Even Point Step 3: Determine the number of each haircut that must be sold to break-even. Sales Composite Product Mix Cuts Haircuts Basic 4 × 3,000 = 12,000 Ultra 2 × 3,000 = 6,000 Budget 1 × 3,000 = 3,000 Total 21,000 21 - 37 P4 Multiproduct Break-Even Income Statement Step 4: Verify the results. Basic Selling Price $ 20.00 Variable Cost 13.00 Unit Contribution $ 7.00 Sales Volume × 12,000 Total Contribution $ 84,000 Fixed Costs Income Haircuts Ultra $ 32.00 18.00 $ 14.00 × 6,000 $ 84,000 Budget $ 16.00 8.00 $ 8.00 × 3,000 $ 24,000 Combined $192,000 192,000 $ 0 21 - 38 Global View Over 90 percent of German companies surveyed report their cost accounting systems focus on contribution margin. This focus helps German companies like Volkswagen control costs and plan their production levels. 21 - 39 A2 Degree of Operating Leverage AA measure measure of of the the extent extent to to which which fixed fixed costs costs are are being being used used in in an an organization. organization. AA measure measure of of how how aa percentage percentage change change in in sales sales will will affect affect profits. profits. Contribution margin Pretax income = Degree of operating leverage 21 - 40 A2 Operating Leverage Rydell Company Sales (1,200 units) Less: variable expenses Contribution margin Less: fixed expenses Pretax income Contribution margin Net income $120,000 84,000 36,000 24,000 $ 12,000 $36,000 = 3.0 $12,000 = Degree of operating leverage = If Rydell increases sales by 10 percent, what will the percentage increase in income be? Percent increase in sales Degree of operating leverage Percent increase in pretax income 10% × 3 30% 21 - 41 Appendix 21A: Using Excel to Estimate Least-Squares Regression =INTERCEPT(C2:C13, B2:B13) =SLOPE(C2:C13, B2:B13) 21 - 42 End of Chapter 21