Agenda:

1
Agenda

• A little more vocabulary
• C-V-P analysis
• Mondays class
• Group problem solving

2
Vocabulary

• Gross Margin Revenue - Cost of goods sold.
• All costs are manufacturing costs.
• It includes some fixed costs.
• Contribution margin Revenue - Variable costs
• Some variable costs are manufacturing costs, but
• some may be nonmanufacturing costs.
• No fixes costs are subtracted.

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Vocabulary

• Gross margin percent Gross margin/Revenue
• Contribution margin percent Contribution
  margin/Revenue

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Gross margin

• Cost of goods sold Direct materials
• Direct labor
• Applied overhead
• Applied overhead Variable overhead
• Fixed overhead

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Contribution margin

• Variable costs manufacturing variable costs
• nonmanufacturing variable costs.
• Gross margin fixed mfg. overhead -
  nonmanufacturing variable costs Contribution
  margin.
• Contribution margin nonmanufacturing variable
  costs - fixed mfg. costs Gross margin.

6
Safety margin

• The dollar amount by which sales exceed what is
  required to break even.
• The number of units by which sales exceed what is
  required to break even.

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Cost-Volume-Profit Analysis A Simple Model for
Evaluating Decision Options

• A model is always an abstraction. It is a
  representation, sometimes mathematical, of what
  are believed to be the relations among the
  relevant decision options.

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Simple model

• The fundamental accounting equation
• Profit (?) Revenues - Costs
• Revenue SPunits sold
• SP selling price
• Costs FC VC(units manufactured)
• FC fixed cost
• VC unit variable costs.

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Within this model

• We are assuming that units manufactured units
  sold.

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What if we want to know how much product we must
sell to break even?

• The breakeven point is the point where profit is
  zero,
• so ?? 0 Revenue - Cost
• SPunits sold - FC - VCunits sold
• (SP - VC)units sold - FC
• units sold FC/(SP - VC)
• We will call units sold at ?? 0 BEunits

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Formula for breakeven point

• Note (SP - VC) unit contribution margin (CM)
• units sold at breakeven point FC/CM
• or
• BEunits FC/CM

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Breakeven revenue

• Breakeven units (BEunits) SP, or
• SP BEunits SP(FC/CM)
• Breakeven revenue FC/(CM/SP)

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Assumptions underlying CVP analysis

• 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.
• The behavior of total revenue is linear (straight
  line). This implies that the price of the
  product or service will not change as sales
  volume varies within the relevant range.

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Assumptions underlying CVP analysis

• The behavior of costs is linear (straight line)
  over the relevant range. This implies the
  following more specific assumptions.
• a. Costs can be categorized as fixed, variable,
  or semi-variable. Total fixed costs remain
  constant as activity changes, and the unit
  variable cost remains unchanged as activity
  varies.
• b. The efficiency and productivity of the
  production process and workers remain constant.

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Assumptions underlying CVP analysis

• In multi-product organizations, the sales mix
  remains constant over the relevant range.
• In multi-product organizations, when we do a
  single CVP analysis, we assume the products all
  are sold in the same market. Substitutes.
• This means that the product mix does not change
  in response to changes in production/sales
  volume.

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Example 1 equation approach

• Movie theater 48,000 monthly fixed costs
• 8 ticket price.
• 2 variable cost per ticket.
• Give breakeven units and revenue
• BEunits 48,000/(8 - 2)
• BEunits 8,000 tickets.
• BErevenue 64,000

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Example 1

• Suppose practical capacity per month is 12,000
  tickets and that the movie theater has operated
  at 60 capacity during December. It is now
  December 30.
• Has the theater made money in December?
• If they could capture 1,000 customers by lowering
  the ticket price to 7 for New Years Eve, should
  they do it?

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Capacity

• What determines the capacity of an operation?
• Theoretical capacity
• Practical capacity
• Normal capacity
• Budgeted capacity

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Example 2

• Data The Doral Company manufactures and sells
  pens. Present sales output is 5,000,000 per year
  at a selling price of .50 per unit. Fixed costs
  are 900,000 per year. Variable costs are .30
  per unit.
• What is the current yearly operating income?
• What is the current breakeven point in sales
  dollars.

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Example 2

• FC 900,000 VC .30 SP .50 previous
  sales 5,000,000 pens.
• Compute the new operating income if . . .
• 1. A .04 per-unit increase in variable costs.

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Example 2

• FC 900,000 VC .30 SP .50 previous
  sales 5,000,000 pens.
• Compute the new operating income if there is

2. A 20 decrease in fixed costs, a 20
decrease in selling price, a 10 decrease in
variable costs, and a 40 increase in units sold.
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Example 2

• FC 900,000 VC .30 SP .50 previous
  sales 5,000,000 pens.

Compute the new breakeven point in units for each
of the following changes.
A 10 increase in fixed costs
A 10 increase in selling price and a
20,000 increase in fixed costs.
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Example 3

• The Rapid Meal has two restaurants that are open
  24 hours per day. Fixed costs for the two
  restaurants together total 450,000 per year.
  Service varies from a cup of coffee to full
  meals. The average sales check for each customer
  is 8.00. The average cost of food and other
  variable costs for each customer is 3.20. The
  income tax rate is 30. Target net income is
  105,000.

Compute the total dollar sales needed to obtain
the target net income.
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Data SP 8.00 VC 3.20 FC
450,000 Target income 105,000 Tax Rate
.30.
Variable cost percentage is 3.20/8.00 40
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Example 3
Data SP 8.00 VC 3.20 FC
450,000 Target income 105,000 Tax Rate
.30.
How many sales checks are needed to earn net
income of 105,000? To break even?
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Example 3
Data SP 8.00 VC 3.20 FC
450,000 Target income 105,000 Tax Rate
.30.
Compute net income if the number of sales
checks is 150,000
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Example 4

• Two products Goldman Co. retails two products,
  a standard and a deluxe version of a luggage
  carrier. The budgeted income statement follows
• Standard Deluxe Total
• Sales in units 150,000 50,000
  200,000
• Sales (20, 30) 3,000,000 1,500,000
  4,500,000
• Variable costs 2,100,000 900,000
  3,000,000
• Contrib margins 900,000 600,000
  1,500,000
• Fixed costs 1,200,000
• Operating income 300,000
• 14 and 18 per unit
• Compute breakeven in units.

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Example 4
Data Standard price 20 and VC 14 Deluxe
price 30 and VC 18 FC 1,200,000
Breakeven units FC/unit CM
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Multiple products
Data Standard price 20 and VC 14 Deluxe
price 30 and VC 18 FC 1,200,000
Compute the breakeven point in units (a) if
only standard carriers are sold and (b) if only
deluxe carriers are sold.
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Multiple products

• Suppose 200,000 units are sold, but only 20,000
  are deluxe.

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Multiple products

• Compute the operating income. Compute the
  breakeven point if these relationships persist in
  the next period. That is, the mix is 20/200
  deluxe . . .

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Example 4 Walk Rite Shoe Company

• 1. What is breakeven in units?

2. If sales commissions were discontinued for
individual salespeople in favor of an
81,000 increase in fixed salaries, what would be
the breakeven in units?
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Example 4 Walk Rite Shoe Company

• Calculate the number of units sold where the
• operating income under (a) a fixed salary plan
• and (b) a lower fixed salary and commission plan
  (original plan) would be equal. Above that number
  of units sold, one plan would be more profitable
  than the other below the reverse would occur.

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Prestige Telephone

• Using CVP analysis to analyze profitability
• You will need to identify variable and fixed
  costs. There may be mixed costs.
• What would you do if you were Mr. Rowe?
• If your job were to advise Ms. Bradley, what
  would you tell her?
• How much better off would the Telephone business
  be without the data processing business?.

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Group work

• Cable Vision