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Social Science
Economics
Finance
Chapter 11 Cost-Volume-Profit
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Terms in this set (42)
objective 1
Explain variable, fixed, and mixed costs and the relevant range.
cost behavior analysis
is the study of how specific costs respond to changes in the level of business activity
- some costs change, others remain the same
- helps management plan operations and decide between alternative courses of action
- applies to all types of businesses and entities
- starting point is measuring key business activities
activity levels may be expressed in terms of:
-sales dollars (in retail company)
-miles driven (in a trucking company)
-room occupancy (in a hotel)
-dance classes taught (by a dance studio)
- many companies use more than one measurement base
- changes in the level or volume of activity should be correlated with changes in costs
- activity level selected is called activity or volume index
activity index
- identifies the activity that causes in the behavior of costs
- allows costs to be classified as variable, fixed, or mixed
variable costs
- costs that cary in total directly and proportionately with changes in the activity level
- example: if the activity level increases 10 percent, total variable costs increase 10 percent
- example: if the activity level decreases by 25 percent, total variable costs decrease by 25 percent
- variable costs remain the same per unit at every level of activity
illustration:Damon Company manufactures tablet computers that contain a $10 camera. The activity index is the number of tablets produced. As Damon manufactures each tablet, the total cost of the cameras used increases by $10.
The total variable cost of the cameras will be $20,000 if Damon produces 2,000 tablets, and $100,000 when it produces 10,000 tablets.
Total Variable cost increases or decreases proportionately in total with changes in activity.
illustration:Damon Company manufactures tablet computers that contain a $10 camera. The activity index is the number of tablets produced. As Damon manufactures each tablet, the total cost of the cameras used increases by $10.
- the unit costs of $10 for the camera is the same whether Damon produces 2,000 or 10,000 tablets
- per unit variable costs stay the same regardless of changes in activity
fixed costs
costs that remain the same in total regardless of changes in the activity level within a relevant range.
- fixed cost per unit cost varies inversely with activity: as volume increases, unit cost declines, and vise versa
- examples: property taxes, insurance, rent , depreciation on buildings and equipment
Illustration: Damon Company leases its productive facilities at a cost of $10,000 per month.
- total fixed costs of the facilities will stay the same at every level of activity
Illustration: Damon Company leases its productive facilities at a cost of $10,000 per month.
If 2,000 units are produced, the unit cost per tablet computer is $5 ($10,000 ÷ 2,000). If10,000 units are produced, the unit cost of the rent is only $1 per tablet ($10,000 ÷ 10,000).
- per unit fixed costs will decrease as activity increases
- per unit fixed costs will increase as activity decreases
relevant range
- throughout the range of possible levels of activity, a straight-line relationship usually does not exist for either variable costs or fixed costs
- relationship between variable costs and changes in activity level is often curvilinear
- for fixed costs, the relationship is also nonlinear- some fixed costs will not change over the entire range of activities, while other fixed costs may change
- range of activity over which company expects to operate during a year
mixed costs
- costs have both a variable element and a fixed element
- change in the total but not proportionately with changes in activity level
objective 2
Apply the high-low method to determine the components of mixed costs.
high-low method
- uses the total costs incurred at the high and low levels of activity to classify mixed costs into fixed and variable components
- the difference in costs between the high and low levels represents variable costs, since only variable-cost element can change as activity levels change
step 1: DETERMINE VARIABLE COST PER UNIT using the following formula
- change in total costs / (high-low activity level) = variable cost per unit
Illustration: Metro Transit Company has the following maintenance costs and mileage data for its fleet of buses over a 6-month period.
Change in Costs
(63,000 - 30,000) $33,000
High minus Low
50,000 - 20,000) 30,000 = 1.10
STEP 2: Determine the fixed cost by subtracting the total variable cost at either the high or the low activity level from the total cost at that activity level.
slide 20
example
maintenance costs are therefore $8,000 per month of fixed costs plus $1.10 per mile of variable costs. This is presented by the following formula
maintenance costs= $8,000 + ($1.10 x miles driven)
do it! 2 high low method
byrnes company accumulates the following data concerning a mixed cost, using units produced as the activity level.
a) Compute the variable- and fixed-cost elements using the high-low method.
variable costs: 14,740-11,100/ (9,800-7,000)= $1,30 per unit
Fixed cost: $14,740 - $12,740 ($1.30 x 9,800 units) = $2,000
or $11,100 - $9,100 ($1.30 x 7,000) = $2,000
b) Estimate the total cost if the company produces 8,000 units.
-Total cost (8,000 units):
$2,000 + $10,400 ($1.30 x 8,000) = $12,400
practice on slide 26
...
objective 3
Prepare a CVP income statement to determine contribution margin.
cost volume profit ( CVP) analysis
- is the study of the effects of changes in costs and volume on a company's profits
- important in profit planning
- critical factor in management decisions as selling prices, determining product mix, and maximizing use of production facilities
basic components
assumptions
1. behavior of both cost and revenues is linear throughout the relevant range of the activity index
2. costs can be classified accurately as either variable or fixed
3. changes in activity are the only factors that affect costs
4. all units produced are sold
5.
CVP income statement
- statement of internal use
- classifies costs and expenses as fixed or variable
- reports contribution margin in the body of the statement
- contribution margin is the amount of revenue remaining after deducting variable costs
- reports the same net income as a traditional income statement
formula: CM = sales - variable costs
Illustration: Vargo Video Company produces a high-definition digital camcorder. Relevant data for the camcorders sold by this company in June 2017 are as follows.
- (500 x 1600) - (300x1600)= the contribution margin
- 800,000 x 480,000= 320,000 CM
320,000- Fixed costs (200,000)= 120,000 net income
Unit contribution Margin
- contribution margin is available to cover costs and to contribute to income
- formula for contribution margin per unit and the computation for Varo Video are
-Unit selling price - unit variable costs = Unit contribution Margin
- Vargo's CVP income statement assuming a zero net income
- sales 1,000 camcorders (500 per unit) - variable costs (300 per unit) = CM
- 500,000 -300,000 = 200,000 - 200,000 (fixed costs)= 0
Contribution Margin Ratio
- shows the percentage of each sales dollar available to apply toward fixed costs and profits
- formula for CMR and computation for Vargo Video are: UCM/ Unit Selling Price
Using Contribution margin Ration to determine increase in Net income
-Assume Vargo Video's current sales are $500,000 and it wants to know the effect of a $100,000 (200-unit) increase in sales.
- total 600,000-360,000= 240,000 - 200,000 = 40,000 net income
Do IT! 3 CVP income Statement
Ampco Industries produces and sells a cell phone-operated thermostat. Information regarding the costs and sales of thermostats during September 2017 are provided below.
Unit selling price of thermostat $85
Unit variable costs $32
Total monthly fixed costs $190,000
Units sold 4,000
Prepare a CVP income statement for Ampco Industries for the month of September. Provide per unit values and total values.
- selling price - variable costs= CM
(340,000 - 128,000= 212,000 - 190,000 = 22,000 net income)
Objective 4 Compute the break-even point using contribution margin
...
Break Even Analysis
- process of finding the break even point level of activity at which total revenues equal total cots (both fixed and Variable)
- at the break even point, net income equal zero
- revenues = costs
- expressed either in sales units or in sales dollars
contribution margin technique
- at the break even point, contribution margin must equal total fixed costs ( CM = total revenue - variable costs)
- break even point can be computed using either contribution margin per unit or contribution margin ratio
- use the contribution margin per unit to determine break even units
- use the contribution margin ration to determine break even in sales dollars
contribution margin in units
- when the break even point in units is desired, contribution margin per unit is used in the following formula ( fixed costs/ UCM = Break-even point in units
contribution margin ratio
when the break even point in dollars is desired, contributiom margin ratio is used in the following formula ( FIxed costs / CMR0
Do it! 4 Break even analysis
Lombardi Company has a unit selling price of $400, variable costs per unit of $240, and fixed costs of $180,000. Compute the break-even point in units using the contribution margin per unit.
- CM= selling price - variable costs
( 400-240= 160)
- Answer: 180,000 (fixed costs)/ 160 (CMU) = 1125 units to break even
Objective 5
Determine the sales required to earn target net income and determine margin of safety.
Target Net Income
- level of sales necessary to achieve a specified income
- modify the break-even formula to solve for sales necessary to earn a target income
- expressed either in sales units or in sales dollars
- for sales units, use contribution margin per unit
- for sales dollars, use contribution ratio
Contribution margin technique
to determine the requires sales in units for Vargo Video:
- Formula: (fixed costs + target Net Income) / UCM = Required sales in unit
to determine he required sales in dollars For Vargo Video
- use the formula: (fixed costs + target net income) / CMR = Required sales in dollars
margin of safety
- difference between actual or expected sales and sales at the break even point
- measures the cushion that a particular level of sales provided
- may be expressed in dollars or as a ratio
- assuming actual/expected sales are $750,000
formula: actual (expected) sales - break-even sales = margin of safety in dollars
Margin of safety Ratio
- margin of safety ratio expresses the margin of safety as a percentage of actual or expected sales
- computed by dividing the margin of safety in dollars by the actual or expected sales
-formula: margin of safety in dollars / actual or expected sales = margin of safety ratio
- the higher the dollars or percentage, the greater the margin of safety
do it! 5
Zootsuit Inc. makes travel bags that sell for $56 each. For the coming year, management expects fixed costs to total $320,000 and variable costs to be $42 per unit. Compute the following:
a) break-even point in dollars using the contribution margin (CM) ratio;
b) the margin of safety and margin of safety ratio assuming actual sales are $1,382,400; and
c) the sales dollars required to earn net income of $410,000.
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