Chapter 18

Identify how changes in volume affect costs

Variable Fixed

Mixed
Copyright (c) 2009 Prentice Hall. All rights reserved 3
 Total variable costs change in direct proportion to
changes in the volume of activity
If activity increases, so does the cost
Unit variable cost remains constant
Units Direct Total direct
produced materials materials
cost per unit cost
100 $25 $2,500
200 $25 5,000
300 $25 7,500
400 $25 10,000
500 $25 12,500
Copyright (c) 2009 Prentice Hall. All rights reserved 4
Copyright (c) 2009 Prentice Hall. All rights reserved 5
 Do not change over wide ranges in volume
Examples:
Straight-line depreciation
Salaries
Fixed cost per unit is inversely proportional to
activity
The more activity, the less the fixed cost per unit

Copyright (c) 2009 Prentice Hall. All rights reserved 6

Copyright (c) 2009 Prentice Hall. All rights reserved 7
 Have both a fixed and variable component
Example:
Utilities that charge a set fee per month, plus a charge for
usage

Copyright (c) 2009 Prentice Hall. All rights reserved 8

 $4,500
$4,000
Sales Compensation

$3,500
$3,000 Variable
$2,500
$2,000
$1,500
$1,000 Fixed
$500
$0
$0 $10,000 $20,000 $30,000 $40,000

Total Sales
Copyright (c) 2009 Prentice Hall. All rights reserved
9
 Band of volume:
Where total fixed costs remain constant and variable cost
per unit remains constant
Outside the relevant range, costs can differ

Copyright (c) 2009 Prentice Hall. All rights reserved 10

Use CVP analysis to compute breakeven points
Costs can be classified as fixed
or variable.

Volume is only factor that affects

costs. Fixed costs dont change.

Copyright (c) 2009 Prentice Hall. All rights reserved 12

 Sales level at which operating income is zero
Sales above breakeven result in a profit
Sales below breakeven result in a loss
Two methods:
Income statement approach
Contribution margin approach

Copyright (c) 2009 Prentice Hall. All rights reserved 13

 Sales Variable costs Fixed costs = Operating income

Selling price Variable

Fixed Operating
per unit x cost per unit
costs income
units sold x units sold

Solve for
units sold Set to
zero
14
Copyright (c) 2009 Prentice Hall. All rights reserved
 Sales Variable Contribution
revenue costs per margin per
per unit unit unit

Fixed costs
Breakeven
point in units
Contribution margin per unit

Copyright (c) 2009 Prentice Hall. All rights reserved 15

Contribution Sales Contribution
margin revenue margin ratio

Fixed costs Breakeven

point in
sales dollars
Contribution margin ratio

Copyright (c) 2009 Prentice Hall. All rights reserved 16

Copyright (c) 2009 Prentice Hall. All rights reserved 17
Copyright (c) 2009 Prentice Hall. All rights reserved 18
Copyright (c) 2009 Prentice Hall. All rights reserved 19
Use CVP analysis for profit planning, and graph
the CVP relations
Fixed costs + Desired operating income

Contribution margin ratio

Target sales in dollars

Copyright (c) 2009 Prentice Hall. All rights reserved 21

 $20,000

$15,000
Dollars

$10,000 Revenues

$5,000

$0
0 500 1,000 1,500
Volume of Units

Copyright (c) 2009 Prentice Hall. All rights reserved

22
 $20,000

$15,000
Dollars

Revenues
$10,000
Fixed costs

$5,000

$0
0 500 1,000 1,500
Volume of Units

Copyright (c) 2009 Prentice Hall. All rights reserved

23
 $20,000

$15,000
Dollars

Revenues
$10,000 Fixed costs
Total cost
$5,000

$0
0 500 1,000 1,500
Volume of Units

Copyright (c) 2009 Prentice Hall. All rights reserved

24
 $20,000
Breakeven point
$15,000
Dollars

Profit
$10,000

$5,000
Loss
$0
0 500 1,000 1,500
Volume of Units

Copyright (c) 2009 Prentice Hall. All rights reserved

25
Use CVP methods to perform sensitivity analysis
 Management tool to predict how changes in sale
prices, cost or volume affects profits
What-if? analysis

Copyright (c) 2009 Prentice Hall. All rights reserved 27

 Change in
Change
variable
selling All
price
costs
would impact
breakeven point

Change in
fixed costs

Copyright (c) 2009 Prentice Hall. All rights reserved 28

 Cause Effect Result

Change Contribution Breakeven

margin point
Selling price increases Increase Decrease

Selling price decreases Decrease Increase

Variable cost per unit increases Decrease Increase

Variable cost per unit decreases Increase Decrease

Fixed costs increase No effect Increase

Fixed costs decrease No effect Decrease

Copyright (c) 2009 Prentice Hall. All rights reserved 29

 Excess of expected sales over breakeven sales
Cushion company can absorb without incurring a
loss
Expected sales Breakeven Margin of
in units sales in units safety in units

Margin of
Expected sales Breakeven
safety in
in dollars sales in dollars
dollars

Copyright (c) 2009 Prentice Hall. All rights reserved 30

Calculate the breakeven point for multiple product
lines or services
 Selling prices and variable costs differ for each
product
Different contribution to profits
Weighted-average contribution margin computed
Sales mix provides weights
Combination of products that make up total sales

Copyright (c) 2009 Prentice Hall. All rights reserved 32

 Calculate weighted average contribution margin
per unit A company has two products with the sales prices
and variable costs per unit indicated in the table

Product A Product B Total

Sales price per unit $100 The$150
sales mix weights are
added as well as the
Variable cost per unit 58 60
products contribution
Last year,
Contribution the company
margin per unit 42 90 margins
sold 5,000 units of A and
Sales mix per unit
3,000 units of B. This
5 3 8
Contribution
results in margin
a sale mix of 5:3 210 270 480
Weighted average contribution margin $60
The $480
sales divided
mix weightby 8isresults in
multipliedaby the products
weighted average
contribution
contribution
margin
margin of $60
Copyright (c) 2009 Prentice Hall. All rights reserved 33
 Calculate breakeven point for the package of
products
Fixed costs

Weighted average contribution

margin per unit

assumed $600,000
10,000
units
$60

Copyright (c) 2009 Prentice Hall. All rights reserved 34

 Calculate the breakeven point for each product
line
Multiply the package breakeven point by each product
lines proportion of the sales mix

Breakeven point 10,000 x 5/8 6,250 units

Product A
Breakeven point 10,000 x 3/8 3,750 units
Product B

Copyright (c) 2009 Prentice Hall. All rights reserved 35

Copyright (c) 2009 Prentice Hall. All rights reserved 36