4 CVP Analysis

Managerial Accounting by James Jiambalvo
Chapter 4: Cost-Volume-ProfitAnalysis Slides Prepared by: Scott Peterson Northern State University
Objectives
1. Identify common cost behavior patterns. 2. Estimate the relation between cost and activity using account analysis and the high-low method. 3. Perform cost-volume-profit-analysis for single products. 4. Perform cost-volume-profit-analysis for multiple products.
Objectives
(continued)
5. Discuss the effect of operating leverage. 6. Use the contribution margin per unit of the constraint to analyze situations involving a resource constraint.
Common Cost Behavior Patterns

1. Cost-Volume-Profit-Analysis (C-V-P) 2. Variable Costs 3. Fixed Costs a. Discretionary Fixed Costs b. Committed Fixed Costs 4. Mixed Costs 5. Step Costs
Variable Costs
Fixed Costs
Mixed Costs
Cost Estimation Methods

Cost Estimation Methods are frequently required to separate the fixed and variable components of a total cost pool. Methods include: 1. 2. 3. 4. 5. Account Analysis Scattergraph High-Low Method Regression Relevant Range
Scattergraph
High-Low Method
Example: Let total costs at 500 units of output be $150,000 and at 3,000 units of output be $400,000. Calculate variable and fixed costs, respectively.
High-Low Method
Solution: High Low Change Costs: $400,000 $150,000 $250,000 Units: 3,000 500 2,500 Calculate Variable Cost Per Unit: $250,000/2,500 = $100 Calculate Total Fixed Costs: $400,000 (3,000 x 100) = $100,000
High-Low Method
Regression Analysis
Relevant Range
Cost-Volume-Profit Analysis
1. 2. 3. 4. 5. 6. The Profit Equation Breakeven Point Margin of Safety Contribution Margin Contribution Margin Ratio What-if Analysis
The Profit Equation

Profit = SP(x) VC(x) TFC
X = Quantity of units produced and sold SP = Selling price per unit VC = Variable cost per unit TFC = Total fixed cost
Break-Even Point
TFC/CM(per unit) = Break-Even (units)
X = Quantity of units produced and sold SP = Selling price per unit VC = Variable cost per unit CM = Contribution margin TFC = Total fixed cost
Break-Even Point
Contribution Margin
SP(u) VC(u) = CM (u)
SP = Selling price per unit VC = Variable cost per unit CM = Contribution margin u = per unit
Contribution Margin Ratio

(SP VC) / SP = CM%
SP = Selling Price per unit VC = Variable Cost per unit CM = Contribution Margin
What If Analysis
Examples include analyzing changes in: 1. Selling price per unit 2. Variable cost per unit 3. Total fixed cost
Multiproduct Analysis
C-V-P applied to multiple products.
1. Contribution Margin Approach (used for similar products). 2. Contribution Margin Ratio Approach (used for substantially different products).
Contribution Margin Approach

Example: the contribution margin of product A is $8 and B is $5. Two units of B are sold for each unit of A. The Weighted Average Contribution Margin is $6.00.
Contribution Margin Ratio Approach

Example: the contribution margin ratio of product A is 20% and B is 50%. Two units of B are sold for each unit of A. The Weighted Average Contribution Margin Ratio is 40%.
Assumptions in C-V-P Analysis

1. Costs can be accurately separated into variable and fixed components. 2. Fixed costs remain fixed. 3. Variable costs per unit do not change over the relevant range.
Operating Leverage
Example of Operating Leverage: Firm 1 Firm 2 Sales $10,000,000 $10,000,000 VC 5,000,000 7,000,000 CM 5,000,000 3,000,000 FC 3,000,000 1,000,000 Profit $2,000,000 $2,000,000 Which firm has more?
Constraints
1. A reference to scarce resources. 2. Examples of constraints include manufacturing space, labor, parts and materials etc.. 3. The focus shifts away from Contribution Margin and to the scarce resource or constraint.
Quick Review Question #1

1. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Contribution Margin per unit is? a. $65 b. $75 c. $175 d. $30
Quick Review Answer #1

1. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Contribution margin per unit is? a. $65 b. $75 c. $175 d. $30

2. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Break-Even Point is? a. 1,000 units b. 1,083 units c. 2,000 units d. None of these

2. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Break-Even Point is? a. 1,000 units b. 1,083 units c. 2,000 units d. None of these

3. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. The Margin of Safety is? a. $264,000 b. $384,000 c. $143,000 d. $121,000

3. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. The Margin of Safety is? a. $264,000 b. $384,000 c. $143,000 d. $121,000

4. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. What is profit expected to be? Answer here: _________________

4. At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. What is profit expected to be? Answer here: $143,000
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2004 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

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Managerial Accounting by James Jiambalvo

Common Cost Behavior Patterns

Cost Estimation Methods

The Profit Equation

Contribution Margin Ratio

Contribution Margin Approach

Contribution Margin Ratio Approach

Assumptions in C-V-P Analysis

Quick Review Question #1

Quick Review Answer #1

Quick Review Question #2

Quick Review Answer #2

Quick Review Question #3

Quick Review Answer #3

Quick Review Question #4

Quick Review Answer #4

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