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MANAGERIAL ACCOUNTING

COST BEHAVIORS, SYSTEMS, AND ANALYSIS


with Gary Hecht

Cost-Volume-Profit Analysis

Foundations and Basic Analyses

LESSON 4-1 OBJECTIVES

You should understand:


The fundamental concepts of CVP analysis
How to apply CVP analysis, recognizing
the influence of setting characteristics on
method and conclusions

COST-VOLUME-PROFIT
ANALYSIS
Analytic tool useful for:
What-if analysis

Uses relationships among


fundamental components of
basic accounting equation
representing income

TWO APPROACHES TO PROFIT

Financial

Managerial

Revenue
- Direct materials
- Direct labor
- Overhead

Revenue
- Direct materials (V)
- Direct labor (V)
- Overhead (V)
- Other expenses (V)

= Gross margin
- Other expenses
= Profit

= Contribution margin
- All fixed expenses (F)
= Profit

FUNDAMENTAL EQUATION

Operating Profit = Revenues Total VC Total FC


We can use this equation to ask a very basic question:
How many units do we have to sell to break even?

FUNDAMENTAL EQUATION

Operating Profit = Revenues Total VC Total FC


Step 1: Set operating profit to $0
0 = Revenues Total VC Total FC

FUNDAMENTAL EQUATION

0 = Revenues Total VC Total FC


Step 2: Simplify terms into components (where applicable)
0 = (Selling price x Q) (VC per unit x Q) Total FC

FUNDAMENTAL EQUATION

0 = (SP x Q) (VC x Q) Total FC


Step 3: Isolate Total FC and factor out Q
Total FC = Q x (SP VC)

FUNDAMENTAL EQUATION

Total FC = Q x (SP VC)


Step 4: Isolate Q
Q = Total FC = Total FC
(SP VC)

CM

EXAMPLE 1
The following information relates to a microchip manufactured by
Kane Corporation:
Current selling price, per unit: $7.55
Direct labor, per unit: $1.00
Direct materials, per unit: $2.00
Variable manufacturing overhead, per unit: $1.35
Other variable costs (mostly selling), per unit: $1.20
Fixed manufacturing overhead for microchip: $2.5 M/year
Other fixed costs for microchip: $1.5 M/year

EXAMPLE 1

Calculate the break-even


point for Kane Company.

ASSUMPTIONS UNDERLYING CVP ANALYSIS


Costs can be categorized as fixed or variable
or broken down appropriately
Everything is linear:
Revenue
Variable costs
Fixed costs

In manufacturing firms, the inventory levels at the beginning and


end of the period are the same. This implies that the number of
units produced during the period equals the number of units sold.

ASSUMPTIONS UNDERLYING CVP ANALYSIS


Efficiency and productivity of
production processes remain
constant
Sales mix remains constant over
the relevant range
Product mix does not change
in response to changes in
production/sales volume

EXAMPLE 2 - TAXES
Taves Donuts sells donuts, coffee, and other related food items.
The following information is available:
Service varies from a single coffee to multiple dozen donuts. The average
revenue earned for each customer is $8.00.
The average cost of food and other variable costs for each customer is $3.00.
Total fixed costs for the year is $450,000.
The income tax rate is 30%.
Target (i.e., desired) net income is $105,000.

EXAMPLE 2

Data: SP = $8.00; VC = $3.00; FC = $450,000;


Target income = $105,000; Tax Rate = .30
How many customers are needed to break even?

EXAMPLE 2

Data: SP = $8.00; VC = $3.00; FC = $450,000;


Target income = $105,000; Tax Rate = .30
How many customers are needed to reach the desired profit?

EXAMPLE 2

EXAMPLE 2

EXAMPLE 2

WHAT WEVE LEARNED


IN LESSON 4-1
How to use the contribution margin
approach to facilitate
what-if decisions
CVP analysis simply fixes four of the
five variables in the profit equation
and solves for the fifth
Most commonly, we fix target profit,
selling price, variable unit costs,
and fixed costs, and solve for quantity

Multi-Product Scenarios
and Related Concepts

LESSON 4-2 OBJECTIVES

You will understand how to:


Apply CVP analysis in more complex
(i.e., multi-product) scenarios
Customize analysis to correspond with
assumptions, uncertainty, and managers
needs

EXAMPLE 3 MULTIPLE PRODUCTS


HOSA Company manufactures two products Product
X and Product Y.
Selling price
Variable costs
Fixed costs

Product X

Product Y

$10
$6
$10,000

$15
$12
$12,000

Compute HOSAs break-even point.

EXAMPLE 3
MULTIPLE PRODUCTS

EXAMPLE 3 MULTIPLE PRODUCTS


HOSA Company manufactures two products Product
X and Product Y.

Selling price
Variable costs
Fixed costs

Product X

Product Y

$10
$6
$10,000

$15
$12
$12,000

Lets also assume that normally, HOSAs sales are 60%


Product X and 40% Product Y.

EXAMPLE 3
MULTIPLE PRODUCTS

WHAT WEVE LEARNED


IN LESSON 4-2

Multi-product scenarios
Assumptions determine method and
conclusions

WHAT WEVE LEARNED


IN MODULE 4

Fundamentals of CVP analysis


Assumptions
Setting-specific