Cost II - Chapter 1; Cost-Volum_Profit.pptx

Cost and management accounting II
Chapter one

1. Cost and Management Accounting This slide deck contains animations. Please disable animations if they cause issues with your device. Chapter - One Cost-Volume-Profit Analysis

2. Cost-Volume-Profit Analysis- Introduction 2 CVP analysis is a study of the relationships between the sale volume , expenses , revenue and profit in an organization . It focuses on interactions between the five CVP Components. the five CVP analysis Components are: Price, Volume, Variable cost, Fixed cost and Mix of products sold. is one of the most powerful tool used by managers: In estimation of break even and Profit at different levels of activity. as it answers questions like: what would be the effect change in Selling price, VC, FC and sales Mix on profits?

3. CVP- Analysis Contribution margin – amount of revenue remaining after deducting variable costs. It is the amount available to cover fixed costs and to contribute to target profit Formula for unit contribution margin is: 3 1.3 Contribution Margin

4. Example: Contribution Margin Assume Tecno Phone Manufacturing Plc has the following relevant data for the year 2020 4 Unit selling price of cell phone $500 Unit variable costs $300 Total annual fixed costs $200,000

5. Unit Contribution Margin(UCM) ? 5 T otal Contribution Margin? = Total Revenue – Total Variable Cost or = Unit contribution margin * total units sold For example if 1,600 phones are sold total CM will be: = ( 500- 300)*1,600 = $320,000

6. CVP Analysis 1.4 Contribution Margin Ratio The percentage of the contribution margin to sales Shows the percentage of each sales available to cover fixed costs and profits. 6 Contribution margin ratio is computed by: The contribution margin ratio for Tecno Plc will be : Means:60% of sales is VC and 40% is there to cover FC and target profit

7. Computing the break-even point The break-even point is always a point of interest in CVP analysis Finding break-even point is often the first step in planning decision t o avoid operating losses The break-even point is the level of activity at which total revenues equal total costs or operating profit becomes zero. Break-even point can be computed in two approaches : Equation method Contribution Method Graphic method Break even point can be expressed either in units or in sales dollars/birr 7 1.5 Break-Even Analysis

8. Equation Method – Break even quantity(BEQ) Break-even occurs where total sales equal variable costs plus fixed costs and operating income is zero…. i.e Profit (Operating Income) =(P XQ)-( VxQ )-F where P =sales price per unit Q = quantity sold V = variable cost per unit F =total fixed cost per period OI = Operating income At break-even point, operating income(OI) = 0 That is, OI=PQ-VQ-F 0= PQ-VQ-F 0= Q(P-V)- F Cont ….. 8

9. Equation Method – Break even quantity(BEQ ) 0= Q(P-V)- F F= Q(P-V) Q = F/(P-V) 9 Break-even quantity (in units) Fixed costs Unit selling Price – Unit variable cost =

10. Contribution Margin Method – Break even quantity(BEQ ) When we rewirite the équation method , Break even quantity(Q) Q = F/(P-V) P-V= Unit contribution margin There fore, BEQ using Contribution Margin Method is: 10 Break-even quantity (in units) Fixed costs Unit contribution margin =

11. Example 11 Assume data for Tecno company and Compute break even point in units using equation and Contribution margin Method.

12. Break Even Revenue(BER) Is break even point in sales or a total sales that would be equal to total cost Equation Method BER= BEQ * Unit selling Price Contribution Margin Method 12 Example : Compute BER for Tecno Company

13. BEP – Graphic Meth In the graphical method we plot the total costs and revenue lines to obtain their point of intersection, which is the breakeven point. Total costs line . is the sum of the fixed costs and the variable costs. To plot the total cost line, choose some volume of sale and plot the point representing total expenses (fixed and variable) at the activity level you have selected. TC= TVC + TFC Total Cost function for Tecno is: TC = $300Q+$200,000 13

14. BEP – Graphic Meth Total Revenue Line: The break-even point is where the total revenues line and the total costs line intersect. This is where total revenues just equal total costs. TR = Q *SP Total Revenue Function of Tecno is : TR= $500Q Tecno’s BEP analysis is summarized in next slide. 14

15. C V P- Analysis – Graphic Method 15 Copyright ©2018 John Wiley & Sons, Inc. L O 4

16. Exercise Question A Company is planning to sell 200,000 units for $4 per unit. The contribution margin ratio is 25%. If the company will break even at this level of sales, what are the fixed costs? A Company manufactures and sales a single product. During the year just ended, the company produced and sold 60,000 units at a price of Br.20 per unit. Variable manufacturing costs were Br 8 per unit, and variable marketing costs were Br 4 per unit . Fixed costs amounted to Br. 180,000 for manufacturing and Br.72, 000 for marketing. What is breakeven point in units and birr for the year. 16

17. 1.6 Target Operating income and Net Income Determine the sales required to earn target operating/ net income Target Operating Income Target Operating income is projected/planned profit before tax. CVP analysis is applied to compute the level of sales in units/ birr necessary to achieve this target profit . Sales required to achieve target profit can be expressed either in sales units or in sales dollars/birr. 17

18. Target Operating Income Quantity for target Income = Fixed costs + Target profit Unit contribution margin Sales for target Income = Fixed costs + Target profit Contribution margin ratio LO 3-1

19. Example Assume Tecno Pls data and Compute the number of cell phones to be sold to earn an operating income of $120,000 during the year Compute the required sales in dollar to earn an operating income of $150,000 during the year If Tecno’s variable manufacturing costs are expected to increase 10 % in the coming year. Compute the firm’s new breakeven point in sales and in units If Tecno’s variable manufacturing costs do increase 10 %, compute the selling price that would yield the same CM-ratio in the coming year. 19

20. Target Net Income ( profit after tax) So far we have ignored income taxes. However, profit-seeking enterprises must pay income taxes on their profits. A firm’s profit after tax is operating income less profit tax This fact is expressed in the following formula: Target net income = Operating Income (1 – tax rate) 20

21. Target Income After Taxes How many units must be sold(Q)? Fixed costs + Target Profit after tax (1 – Tax rate)] Unit contribution margin LO 3-4 Fixed costs + Target profit after tax ( 1 – Tax rate)] contribution margin ratio How many sales should be made(sales)?

22. Example Assume Tecno Pls data and Compute the number of cell phones to be sold to earn a Net income of $120,000 during the year(assume 30% tax) Compute the required sales in dollar to earn a net income of $150,000 during the year(assume 30% tax) 22

23. Sales mix is the relative percentage in which a company sells its products. Based on the premise that different products have different selling prices, cost structures, and contribution margins If a company’s unit sales are 80% printers and 20% computers, its sales mix is 80% to 20%. If the proportions of the mix change, the CVP relationships also change. Thus, managers try to achieve the combination, or mix, that will yield the greatest amount of profit. . 1.7 CVP Analysis with Multiple Products (Sales Mix and CVP Analysis)

24. CVP Analysis with Multiple Products A shift in sales-mix from high-margin items to low-margin items can cause total profits to decrease even though total sales may increase and vise versa. The computation of the break-even point (BEP) in multi product firm follows: BEQ = Total fixed Cost Weighted average CM per unit Weighted average CM per unit = CMUp1*W1+CMUp2*W2+…..+ CMUpn * Wn 24

25. CVP Analysis with Multiple Products the computation of the break-even point in birr for multi product is : BER = Total fixed Cost Total CM Ratio or = BEQp1*USPp1 + BEQp2*USPp2+….+ BEQpn * USPpn 25

26. Assume that Tecno Company also manufactures TV in addition to phone and the following data are summarized for 2020. Unit Data Cell Phones TVs Selling price $500 $1,000 Variable costs 300 720 Contribution margin $200 $ 280 Sales mix—units 75% 25% Fixed costs = $275,000 Cell Phones TVs Total Annual Sales of 2020 in units 1,500 500 2,000 Sales mix 75% 25 % Example:

27. Example Cont… What is the BEQ and BER ? 27 BEQ = Total fixed Cost Weighted average CM per unit Weighted average CM per unit = $200*.75+ $ 28 *.25 = $ 220 BEQ= $275,000/ $ 220 = 1,250 units of which Cell phone = 1,250 *.75= 937.5 units TV = 1,250 *.25 = 312.5 units

28. Break-Even Revenue for the sales mix BER = Total fixed Cost Total CM Ratio or = BEQ1*P1+ BEQ2*P2…. BEQn * Pn 28 Total CM Ratio CM Ratio = 200*1,500+280*500 500*1,500+1,000*500 = 0.352 Total CM Total Revenue

29. Break-Even Revenue for the sales mix BER = $275,000 = $ 781,250 0.352 OR 29 From cell phone = 937.5 units *500 = $468,750 From TV = 312.5 units * 1,000 = $312,500 Total $ 781,250

30. Target Profit for Multiple Product Quantity for target Profit = Fixed costs + Target profit W.A. Unit contribution margin Sales for target Profit = Fixed costs + Target profit Total Contribution margin ratio LO 3-1

31. Example Assume the previous data for Tecno and a Target Profit of $33,000 31 What total units need to be sold to achieve the target profit How many units of TV and cell phone need to be sold to achieve the target profit What should be the sales to achieve the target profit

32. Example Cont… Quantity for target Profit = Fixed costs + Target profit W.A. Unit contribution margin LO 3-1 = 275,000+ 33,000 220 = 1,400 units Phone = 1,400*.75 = 1,050 units TV = 1,400*.25 = 350 units

33. Example Cont… Sales for target Profit = Fixed costs + Target profit Total Contribution margin ratio LO 3-1 = 275,000+33,000 0.352 = $875,000 Or From Phone = 1050*500= $525,000 From TV = 350*1000= 350,000 Total $875,000

34. Exercise: Manzeck Bicycles International produces and sells three different types of mountain bikes. Information regarding the three models is shown below. Pro Intermediate Standard Total Units sold 5,000 10,000 25,000 40,000 Selling price $800 $500 $350 Variable costs $500 $300 $250 The company’s total fixed costs are $7,500,000. Determine the sales mix as a function of units sold for the three products . Determine the weighted-average unit contribution margin Determine the total number of units that the company must sell to break even Determine the number of units of each model that the company must sell to break even

35. 1.8 Sensitivity Analysis L O 1 35 Sensitivity analysis is a “what if” technique that examine how a result will change if the original predicted data are not achieved or if an underlying assumption changes In the context of CVP, sensitivity analysis answers questions like: what will operating income be if the out put , variable cost, selling price , fixed cost and sales mix changes by a given percentage from the original prediction ?

36. Example Original/Current sales and cost data for Tecno is as shown. Unit selling price $500 Unit variable cost $300 Total fixed costs $200,000 Break-even sales/ units Annual sales Current profit …………… $500,000 or 1,000 units 1,400 units $80,000 36

37. Case . What will be the impact of a 10% decrease in selling price on Break even point and annual profit ? Management invests in new equipment that will lower the amount of direct labor required to make cell phones. They estimate that total fixed costs will increase by 30% and variable cost per unit will decrease by 30%. What effect will the new equipment have on the sales volume required to be break even and to maintain current annual profit ? Tecno’s principal supplier of raw materials has just announced a price increase. This higher cost is expected to increase the variable cost of cell phones by $25 per unit. 37

38. Case cont… Management plans a cost-cutting program that will save $17,500 in fixed costs . What increase in units sold will be needed to maintain the same level of annual Profit ? The management of Tecno thinks that a $ 10 , 000 increase in annual advertising budget(FC) would increase annual sales by 100 cell phones beyond current sales . Should the advertising budget be increased? Why ? The sales manager would like to cut selling price by $ 20 per unit and increase the advertising cost(FC) $ 15, 000 . The sales manager argues that if these two steps are taken, unit sales will increase by 50%. Should the change be made? The sales manager would like to replace the sales staff on a commission basis of $ 15 per Phone sold, rather than on flat salaries(FC) that now total $ 10, 000 per year. The sales manager is confident that the change will increase annual sales by 15%. Should the change be made? 38

39. 1.2 CVP Analysis -Assumptions Behavior of both costs and revenues is linear throughout the relevant range of the activity Costs can be classified accurately as either variable or fixed. Changes in activity are the only factors that affect costs. All units produced are sold. When more than one type of product is sold, the sales mix will remain constant . 39

40. Margin of Safety Measures how close expected sales are to the break-even point. Is the excess of projected sales over the break-even point. Difference between actual or expected sales and sales at the break-even point. 40 Measures the “cushion” that a particular level of sales provides. May be expressed in dollars or as a ratio. Assuming actual/expected sales of Tecno is $750,000:

41. Margin of Safety Formula for margin of safety ratio Computed by dividing the margin of safety in dollars by the actual (or expected) sales. 41 Assuming actual/expected sales are $750,000: The higher the dollars or percentage, the greater the margin of safety.

42. Margin of Safety Question 42 Marshall Company had actual sales of $600,000 when break-even sales were $420,000. What is the margin of safety ratio? a. 25%. b. 30%. c. 33⅓%. d. 45%. L O 5

43. Margin of Safety Answer 43 Marshall Company had actual sales of $600,000 when break-even sales were $420,000. What is the margin of safety ratio? a. 25%. b. Answer: 30%. c. 33 1/3%. d. 45%. L O 5

44. Exercise 1.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 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. 44

45. Exercise Kris Company reports the following for June. Total Per Unit Sales (5,000 units) $300,000 $60 Variable costs 180,000 36 Contribution margin 120,000 $24 Fixed expenses 100,000 Net income $ 20,000 To increase net income, management is considering reducing the selling price by 10%, with no changes to unit variable costs or fixed costs. Management is confident that this change will increase unit sales by 25%. L O 1 45

46. Required: Compute a) break-even point in dollars b) the margin of safety and margin of safety c) Expected operating profit L O 1 46