COST-II: Chapter one-CVP-ANALYSIS & DIRECT COSTING VS. ABSORPTION COSTING.pptx

Cost and Management Accounting-II
CHAPTER-ONE-COST VOLUM PROFIT ANALYSIS

1. JIMMA UNIVERSITY COLLEGE OF BUSINESS AND ECONOMICS DEPARTMENT OF ACCOUNTING AND FINANCE Cost and Management Accounting-II Belay W . 8/30/2024 Belay W. 1

2. Chapter one COST-VOLUME-PROFIT ANALYSIS, ABSORPTION, AND VARIABLE COSTING 8/30/2024 Belay W. 2

3. Cost-Volume-Profit Analysis, Absorption, and Variable Costing Absorption versus Direct Costing The concept of profit contribution Cost-volume-profit (CVP) analysis: understanding the concepts of break-even and margin of safety Cost Volume Profit Analysis under Absorption Costing The use of linear, curvilinear and step functions and how their calculations are used to analyze cost behavior The concepts of cost units, cost centers and profit centers 8/30/2024 Belay W. 3

4. 1. Absorption Costing versus Direct Costing Direct costing Is a method of inventory costing in which All variable manufacturing costs (direct and indirect) are included as inventorable costs . All fixed manufacturing costs are excluded from inventorable costs and instead treated as period costs Another common term used to describe this method is variable costing . 8/30/2024 Belay W. 4

5. Cont. Absorption costing Is a method of inventory in which All variable manufacturing costs and all fixed manufacturing costs are included as inventorable costs , The inventory ‘ absorbs ’ all manufacturing cost . Another common term used to describe this method is full costing . 8/30/2024 Belay W. 5

6. Cont. Similarity Under both direct costing and absorption costing, All variable manufacturing costs are inventorable and All non-manufacturing costs , whether variable or fixed are period costs and are recorded as expenses when incurred. 8/30/2024 Belay W. 6

7. Cont. Difference H ow fixed manufacturing costs are accounted for is the main difference between direct costing and absorption costing. Under direct costing, fixed manufacturing costs are treated as an expense of the period . Under absorption costing, fixed manufacturing costs are inventorable costs . 8/30/2024 Belay W. 7

8. Illustration 1: Stassen Company’s management wants to prepare an income statement for 2012 (the fiscal year just ended) to evaluate the performance of the telescope product line . The operating information for the year are given below: For simplicity and to focus on the main idea, we assume the following about Stassen Company: Stassen incurs manufacturing and marketing cost only . The cost driver for all variable manufacturing costs is units produced . The cost driver for variable marketing costs is units sold . There are no batch level costs and no product sustaining cost. Work in process inventory is assumed to be zero The budgeted level of production for 2012 is 800 units which are used to calculate the budgeted fixed manufacturing cost per unit . 8/30/2024 Belay W. 8

9. Cont. Beginning inventory Production 800 units Sales 600units Ending Inventory 200 units Selling price Br.100 Variable manufacturing cost per unit   Direct material cost per unit 11 Direct manufacturing labor cost per unit 4 Manufacturing overhead cost per unit 5 Total variable manufacturing cost per unit 20 Variable marketing cost per unit ( all indirect) 19 Fixed manufacturing costs (all indirect) 12,000 Fixed marketing costs (all indirect) 10,800 8/30/2024 Belay W. 9

10. Cont. For Stassen, Inventorable costs per unit in 2012 under the two methods is calculated as follows :   Direct costing Absorption costing Variable Manufacturing cost per unit produced     Direct material cost per unit Br.11 Br.11 Direct manufacturing labor cost per unit 4 4 Manufacturing overhead cost per unit 5 5 Fixed manufacturing cost per unit produced - 15 Total invntorable cost per unit Br.20 Br. 35 As you see in the above table, fixed manufacturing cost is added under absorption costing but is not included under direct costing. If inventory levels changes , operating income will differ between the two methods because of the difference in accounting for fixed manufacturing costs . 8/30/2024 Belay W. 10

11. Income statement under the two costing method Both I/st formats include product costs and period costs , although they define these cost classifications differently . The direct costing income statement uses the contribution margin formats whereas the absorption costing income statement uses the gross margin format . In general , the income measurements ( Operating Income ) under the two methods will differ when production and sales amount differs . The f/gs are the formats used to prepare I/St under the two methods : 8/30/2024 Belay W. 11

12. Cont. Format of Absorption Costing Income Statement Sales --------------------------------------- XX Cost of goods sold: Direct material ---------- xx Direct labor ------------ xx Variable MOH ---------- xx Fixed MOH -------------- xx ------ (XX) Gross profit ---------------------------- XX Variable operating expense ---------xx Fixed operating expense ------------ xx Operating income --------------------- XX Format of Direct costing Income Statement Sales revenue -----------------------------XX Variable cost : Direct material -----------xx Direct labor ----------------xx Variable MOH -------------xx Variable expense --------- xx____( XX) Contribution margin ---------------------- XX Fixed MOH cost ----------------------------XX Fixed operating expense ---------------- XX Operating income ------------------------- XX 8/30/2024 Belay W. 12

13. Illustration 2: For Stanssen , income statement under the two approaches can be prepared as follows 8/30/2024 Belay W. 13

14. Cont. Stanssen Company Absorption costing income statement For the year ended December 31, 2012 Sales (600xBr.100)   Br.60,000 Cost of goods sold     Direct material cost (600xBr. 11) Br. 6,600   Direct labor cost (600xBr.4) 2,400   Variable overhead cost ( 600xBr.5) 3,000   Fixed overhead cost ( 600x Br.15) 9,000   Cost of goods sold   21,000 Gross profit   39,000 Variable marketing expense (600xBr.19)   11,400 Fixed marketing expense   10,800 Operating Income   Br.16,800 8/30/2024 Belay W. 14

15. Cont. Stanssen Company Direct costing income statement For the year ended December 31, 2012 Sales (600xBr.100)   Br.60,000 Variable cost and expenses:     Direct material cost (600xBr. 11) Br. 6,600   Direct labor cost (600xBr.4) 2,400   Variable overhead cost ( 600xBr.5) 3,000   Variable marketing expense ( 600xBr.19) 11,400   Total variable costs and expenses   23,400 Contribution margin   Br.36,600 Fixed overhead cost   12,000 Fixed marketing expense   10,800 Operating Income   Br.13,800 8/30/2024 Belay W. 15

16. Cont. In the above two income statement, we can see how the fixed manufacturing cost of br.12, 000 are accounted for under the two methods. The income statement under direct costing Deducts the lump sum br.12, 000 as an expense for the year. In contrast, under absorption costing The br. 12,000 is initially treated as an inventorable cost of the year. Of this br. 9000 (br.15 x 600) subsequently becomes a part of cost of goods sold in the year and Br.3000 (br.15 x 200) remains as an asset part of ending finished goods inventory on December 31, 2012. 8/30/2024 Belay W. 16

17. Cont. Operating income is Br 3, 000 higher under absorption costing compared to direct costing. The variable manufacturing costs are accounted the same way under both methods . The base of the difference between direct costing and absorption costing is how fixed manufacturing costs are accounted for. 8/30/2024 Belay W. 17

18. Inventory Level Changes If inventory level changes , operating income will differ between the two methods because of the difference in accounting for fixed manufacturing cost . To see this , let’s compare telescope sales of 600 , 700 and 800 units by stassen in 2012, when 800 units were produced and the Br.12,000 total fixed manufacturing costs, the amount expressed in the year 2012 income statement would be: 8/30/2024 Belay W. 18

19. Cont.   Direct costing Absorption costing     Fixed Manufacturing cost Fixed Manufacturing cost Units sold End Inventory Included in inventory Amount expensed Included in inventory 15xEnd Inventory Amount expensed 15xunits sold 600 200 12,000 3,000 9,000 700 100 12,000 1,500 10,500 800 12,000 12,000 W here 8,000 units are produced and sold, both variable and absorption costing report the same income because inventory levels are unchanged . 8/30/2024 Belay W. 19

20. Illustration 3: Assume that stassen company above, if the production and sales amount for the year 2013 are 800 and 950 units respectively and all the remaining data are the same as in 2012 . Prepare the income statement under the two inventory costing approaches 8/30/2024 Belay W. 20

21. Cont. Stanssen Company Absorption costing income statement For the year ended December 31, 2013 Sales (950xBr.100)   Br.95,000 Cost of goods sold     Direct material cost (950xBr. 11) Br. 10,450   Direct labor cost (950xBr.4) 3,800   Variable overhead cost ( 950xBr.5) 4,750   Fixed overhead cost ( 950x Br.15) 14,250   Cost of goods sold   33,250 Gross profit   61,750 Variable marketing expense (950xBr.19)   18,050 Fixed marketing expense   10,800 Operating Income   Br.32,900 8/30/2024 Belay W. 21

22. Cont. Stanssen Company Direct costing income statement For the year ended December 31, 2013 Sales (950xBr.100)   Br. 95,000 Variable cost and expenses:     Direct material cost (950xBr. 11) Br. 10,450   Direct labor cost (950xBr.4) 3,800   Variable overhead cost ( 950xBr.5) 4,750   Variable marketing expense ( 950xBr.19) 18,050   Total variable costs and expenses   37,050 Contribution margin   Br.57,950 Fixed overhead cost   12,000 Fixed marketing expense   10,800 Operating Income   Br.35,150 8/30/2024 Belay W. 22

23. cont.. Why do variable costing and absorption costing usually report different income . In general, if the unit level of inventory increase during an accounting period, less operating income will be reported under direct costing than absorption costing. Conversely , if the inventory level decreases, more operating income will be repapered under direct costing than absorption costing. The difference in reported operating income is due solely to; Moving fixed manufacturing costs in to inventories as inventories increase and Moving fixed manufacturing costs out of inventories decrease 8/30/2024 Belay W. 23

24. Cont. The difference between operating income under absorption costing and direct costing can be computed by the following formula which focuses on fixed manufacturing cost in beginning inventory and ending inventory . Absorption costing Operating income - Direct costing Operating income = FMOH cost in end. Inventory - FMOH cost in beg. Inventory For Stassen Company the d/c in operating income for the year2012 and 2013 would be: for the year 2012 16,800 - 13,800 = 200*15 - 0*15 3,000 = 3,000 for the year 2013 32,900 - 35,150 = 50*15 - 200*15 (2,250) = (2,250) 8/30/2024 Belay W. 24

25. Cont. If production is equal to sales, the operating income under absorption costing is the same as operating income under direct costing If production is greater than sales, the operating income under absorption costing is greater than operating income under direct costing If production is less than sales, the operating income under absorption costing is less than operating income under direct costing 8/30/2024 Belay W. 25

26. 2. Cost-Volume-Profit (CVP) Analysis CVP analysis examine... the relationships among cost , volume , and profit by focusing on interactions among the following five elements: Prices of products, Volume or level of activity, Unit variable costs, Total fixed costs, and Mix of products sold.  how operating income changes with changes in output level, selling prices, variable costs, fixed costs, and sales mix . shifts in costs and volume and their resulting effects on profit 8/30/2024 Belay W. 26

27. Cont.. In CVP analysis, volume refers to some measure of profit-generating activity . Volume can be measured by: Sales in units, Sales in Dollar/Birr , Production in units, Hours worked by employees, or Any other activity that might be important. 8/30/2024 Belay W. 27

28. Cont.. Is one of the most powerful tool used by managers : To plan and control operations effectively. To estimate break even point and target profit at different levels of activity. In making decisions about product pricing, product mix, adding or dropping a product line, and accepting special orders. what products and services to offer, what marketing strategy to employ, and what basic cost structure to use . 8/30/2024 Belay W. 28

29. Cont.. In sensitivity analysis to measure the effects of alternative courses of action, such as... changing variable or fixed costs, expanding or contracting sales volume, and increasing or decreasing selling prices. as it answers questions like: what would be the effect of change in Selling price, VC, FC and sales Mix on profits? 8/30/2024 Belay W. 29

30. 2.1. Assumptions of CVP Analysis Changes in volume of activity are the only factors that affect revenues and costs. Changes in the levels of revenues and costs arise only because of changes in the number of product (or service) units sold . Costs can be classified accurately as either variable or fixed. Total costs can be separated into two components: a fixed component that does not vary with units sold and a variable component that changes with respect to units sold . Behavior of both costs and revenues is linear throughout the relevant range of the activity. When represented graphically, the behaviors of total revenues and total costs are linear (meaning they can be represented as a straight line) in relation to units sold within a relevant range and time period . 8/30/2024 Belay W. 30

31. Cont... Selling price , variable cost per unit , and total fixed costs (within a relevant range and time period) are known and constant . Total contribution margin (total revenue – total variable costs) is linear and increase proportionally with output . What is produced is sold ( production & sales are equal ). In manufacturing companies, inventories do not change (i.e., all units produced are sold). In multi-product companies, the sales mix is constant . When more than one type of product is sold, the sales mix will remain constant. 8/30/2024 Belay W. 31

32. Cont... There will be no capacity additions during the period under consideration. If such additions were made, fixed (and, possibly, variable) costs would change. Any changes in fixed or variable costs would violate assumptions 1 through 4. There is either no inflation or, if it can be forecasted, it is incorporated into the CVP model. This eliminates the possibility of cost changes. Labor productivity, production technology, and market conditions will not change . If any of these changes occur, costs would change correspondingly and selling prices might change. Such changes would invalidate assumptions 1 through 4. 8/30/2024 Belay W. 32

33. 2.2. Essentials of CVP Analysis Example: Emma Frost is considering selling GMAT Success , a test prep book and software package for the business school admission test, at a college fair in Chicago. Emma knows she can purchase this package from a wholesaler at $ 120 per package, with the privilege of returning all unsold packages and receiving a full $120 refund per package. She also knows that she must pay $ 2,000 to the organizers for the booth rental at the fair. She will incur no other costs. She must decide whether she should rent a booth . 8/30/2024 Belay W. 33

34. Cont... The booth-rental cost of $2,000 is a fixed cost because it will not change no matter how many packages Emma sells. The cost of the package itself ($120 per package) is a variable cost because it increases in proportion to the number of packages sold. To get an idea of how operating income will change as a result of selling different quantities of packages , Emma calculates operating income if sales are 0, 5, 25 or 40 packages . Having selling price of $200 . 8/30/2024 Belay W. 34

35. Cont... Contribution Margin Format Income Statement for Different Quantities of GMAT Success Packages Sold 8/30/2024 Belay W. 35

36. Revenues and Variable Costs How much revenue will Emma receive if 40 units of GMAT Success Packages are sold? Total Revenues = Selling Price × No. of units sold $200 × 40 = $8,000 How much variable costs will Emma Incur if 40 units of GMAT Success Packages are sold? Total variable costs = VC Per Unit × No. of units sold $120 × 40 = $4,800 8/30/2024 Belay W. 36

37. Total Contribution Margin (CM) / or simply Contribution Margin/ Is total revenue minus total variable costs . All variable costs related to production, selling, and administrations are subtracted from sales to determine total contribution margin ( CM). It is the amount available to cover fixed costs and to contribute to target profit . I ndicates how operating income changes as the number of units sold changes . 8/30/2024 Belay W. 37

38. Cont.. Contribution Margin = Total revenues - Total variable costs Or Contribution Margin = CM per unit × No . of units sold Or Contribution M argin = CMR × Revenues (in dollars) 8/30/2024 Belay W. 38

39. Cont... What will be Emma’s total contribution margin if 40 units of GMAT Success Packages are sold? Contribution Margin = Total Revenue –Total Variable costs $8,000 - $4,800 = $ 3,200 8/30/2024 Belay W. 39

40. Contribution Margin Per Unit (CM Per Unit) Is selling price per unit minus variable cost per unit. CM Per Unit = Selling Price - Variable Cost Per Unit Or CM Per Unit = TCM / No. of Units Sold 8/30/2024 Belay W. 40

41. Cont... What will be Emma’s contribution margin per unit ? CM Per Unit = Selling Price - Variable Cost Per Unit $200 - $120 = $80 8/30/2024 Belay W. 41

42. Contribution Margin Percentage (Ratio) Is the contribution margin per dollar of revenue. Shows the percentage of each dollar of sales available to cover fixed costs and to contribute to target operating income (profit). CMR = CM Per Unit / Selling Price Or CMR = Total C ontribution M argin / Total Revenue 8/30/2024 Belay W. 42

43. Cont... What will be Emma’s contribution margin percentage ? CMR = CM Per Unit / Selling Price $80 / $200 = 0.4 = 40% 8/30/2024 Belay W. 43

44. Cont... Show the r/nship b/n CM and CM Per Unit , and CM and CMR , assuming if 40 units of GMAT Success Packages are sold ? Given that of 40 units of sales , $80 CM Per Unit, and 40% CMR: Contribution Margin = Total Revenue – Total Variable costs $8,000 - $4,800 = $ 3,200 Contribution Margin = CM per unit × No. of units sold $80 × 40 = $3,200 Contribution Margin = CMR × Revenues (in dollars) 40% × $8,000 = 0.4 × $8,000 = $3,200 8/30/2024 Belay W. 44

45. Operating Income (OI) Is total contribution margin minus total fixed costs. Is total revenue from operation minus cost of goods sold and all operating expenses . All fixed costs related to production, selling, and administration are subtracted from total contribution margin to determine operating income . OI = Revenues - Variable Costs - Fixed Costs Or OI = Total Contribution Margin – Fixed Costs 8/30/2024 Belay W. 45

46. Cont... What will be Emma’s Operating Income if 40 units of GMAT Success Packages are sold ? OI = Revenues - Variable Costs - Fixed Costs $8,000 - $4,800 - $2,000 = $1,200 Or OI = Total Contribution Margin – Fixed Costs $3,200 - $2,000 = $1,200 8/30/2024 Belay W. 46

47. Net Income (NI) Is operating income plus non-operating revenues minus non-operating costs minus income tax . Net income= (Operating income) + (non-operating revenue) – (non-operating cost) – (income tax) For the purpose of CVP analysis, we assume non-operating revenue and non-operating cost are zero . Therefore Net income = Operating income – Income taxes 8/30/2024 Belay W. 47

48. Assignment-1: Essentials of CVP Analysis Assume Tecno Phone Manufacturing Plc has the following relevant data for the year 2020: Compute the Following: Unit Contribution Margin(CMU) Total CM, If 1,600 phones are sold CMR 8/30/2024 Belay W. 48 Unit selling price of cell phone $500 Unit variable costs $300 Total annual fixed costs $200,000

49. 2.3. EXPRESSING CVP RELATIONSHIPS The equation method The contribution margin method The graph method 8/30/2024 Belay W. 49

50. Cont... The equation method and the contribution margin method are most useful when managers want to determine operating income at few specific levels of sales. The graph method helps managers visualize the relationship between units sold and operating income over a wide range of quantities of units sold. The different methods are useful for different decisions. 8/30/2024 Belay W. 50

51. Cont... Abbreviations SP or P = Selling price VCU or V = Variable cost per unit Q = Quantity of Output Units Produced and Sold CMU or CMPU = Contribution margin per unit CM% or CMR = Contribution margin percentage (ratio) FC = Fixed Costs (Total Fixed Costs) OI = Operating income TOI = Target operating income TNI = Target net income T = Tax rate 8/30/2024 Belay W. 51

52. Cont... Abbreviations R or TR = Revenues (Total sales revenues) VC or TVC = Variable costs (Total Variable costs) TC = Total Costs Total Costs = Variable costs + Fixed costs 8/30/2024 Belay W. 52

53. Equation Method Operating income = Revenues - Variable costs - Fixed costs Revenues = Selling price (SP) × Quantity of units sold (Q) Variable costs = Variable cost per unit (VCU) × Quantity of units sold (Q ) So, OI = (SP× Q) –(VCU×Q) – FC ............. Eq/n-1. 8/30/2024 Belay W. 53

54. Cont... For example , the calculation of operating income when Emma sells 5 packages is OI = (SP x Q) – (VCU x Q) – FC OI = ($ 200 * 5) - ($120 * 5) - $ 2,000 OI = $1,000 - $600 - $2,000 OI = -$ 1,600 8/30/2024 Belay W. 54

55. Contribution Margin Method Is a short version of the equation technique (eq/n-1) OI = (SP x Q) – (VCU x Q) – FC ……………….. eq/n-1 . Rearranging eq/n-1 by taking Q as a common factor OI = (SP-VCU) × (Q) – FC And since, SP – VCU = CMU So, (SP – VCU) × (Q) = CMU × Q Thus, OI = (CMU× Q) – FC ……………….. Eq/n-2. 8/30/2024 Belay W. 55

56. Cont... In our GMAT Success example, CMU is $80 ($200-$120), so when Emma sells 5 packages , Operating income OI = ( CMU × Q) – FC OI = ($80 * 5) - $ 2,000 OI = $400 - $2,000 OI = -$ 1,600. i.e., Each unit sold helps Emma recover $80 (in contribution margin) of the $2,000 in fixed costs . 8/30/2024 Belay W. 56

57. Graph Method It represent (plot) TC and TR graphically, by plotting TC and TR lines at different activity level. O nly two points are needed to plot the TC and TR lines. B/c of assumption-4, TC and TR have a linear r/nship with volume . In a CVP graph (sometimes called a break-even chart), U nit volume (Q) is represented on the horizontal (X) axis and Dollar amounts on the vertical (Y) axis. 8/30/2024 Belay W. 57

58. Cont... Figure 1 illustrates the graph method for GMAT Success. Preparing a CVP graph involves: Plot FC : as a straight line parallel to the horizontal axis Fixed Cost for Emma is : FC = $2,000 Plot TC & TR lines: choose any two convenient points (volume of sale) and determine the corresponding TC and TR . 8/30/2024 Belay W. 58

59. Cont... If we chose a volume of 0 units and 40 units of GMAT Success, TC & TR of each activity level would be as follows: Total Cost function for Emma is: TC= VC + FC TC = $120 *Q + $2,000 Total Revenues function for Emma is : TR= SP*Q TR = $200 *Q 8/30/2024 Belay W. 59

60. Cont... Volume of o utput level (Q) TC = $120 * Q + $ 2,000 Points $120 * 0 + $ 2,000 = $0 A (0, $2,000) 40 $120 * 40 + $ 2,000 = $6,800 B (40, $6,800) Volume of o utput level (Q) TR = $200 * Q Points $200 * 0 = $0 C (0, $0) 40 $200 * 40 = $8,000 D (40, $8,000) 8/30/2024 Belay W. 60

61. Figure-1: Cost-Volume Graph for GMAT Success 8/30/2024 Belay W. 61

62. 2.4. BREAKEVEN POINT (BEP) Is the quantity of output sold at which total revenues equal total costs . i.e., the quantity of output sold that results in $0 of OI . Is that level of activity (in units or dollars/Birr), at which total revenues equal total costs or operating profit becomes zero . It an be expressed either in units or in sales dollars/birr . 8/30/2024 Belay W. 62

63. Cont... 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 to avoid operating losses Break-even point can be computed in 3-approaches : E quation method Contribution Method Graphic method 8/30/2024 Belay W. 63

64. Equation method Recall eq/n-1: OI = (SP x Q) – (VCU x Q) – FC At BEP, operating income(OI) = 0; and let BEQ = Q That is, = (SP x Q) – (VCU x Q) – FC 0 = Q (SP-VCU) - FC FC = Q (SP-VCU) Q = FC / (SP - VCU ) BEQ = FC / (SP – VCU) And also, the BEP revenues will be: BER = BEQ x SP 8/30/2024 Belay W. 64

65. Cont... BEQ FC SP – VCU = BER BEQ x SP = Equation method 8/30/2024 Belay W. 65

66. Cont... Example: Calculate the breakeven quantity and revenue of Emma Frost using: Equation method Contribution margin method Graphic method 8/30/2024 Belay W. 66

67. Cont... Example: Equation method BEQ = FC / (SP – VCU ) BEQ = $2,000 / ($200 - $120) BEQ = $2,000 / $80 BEQ = 25 Unit BER = BEQ x SP BER = 25 Units x $200 Per Unit BER = $5,000 8/30/2024 Belay W. 67

68. Contribution Margin Method Recall eq/n-2: OI = (CMU × Q) – FC At BEP, operating income(OI) = 0; and let BEQ = Q That is, = (CMU × Q) – FC FC = CMU × Q Q = FC / CMU BEQ = FC / CMU And also, the BEP revenues will be: BER = FC / CMR 8/30/2024 Belay W. 68

69. Cont... BEQ FC CMU = Contribution Margin Method BER FC CMR = 8/30/2024 Belay W. 69

70. Cont... Example: Contribution Margin Method BEQ = FC / CMU BEQ = $2,000 / $80 BEQ = 25 Unit BER = FC / CMR BER = $2,000 / 0.4 BER = $5,000 8/30/2024 Belay W. 70

71. Graphic Method 8/30/2024 Belay W. 71 Revenue Total costs Breakeven Fixed costs

72. Assignment-2: BEP Assume data for Tecno company Compute BEP in units. Compute BER for Tecno Company. Summarize Tecno’s BEP analysis using Graphic Method. 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 . 8/30/2024 Belay W. 72

73. 2.5. Target Operating Income (TOI) I s projected/planned profit before tax . Let.... Q_TOI = Quantity of units required to be sold to attain the TOI R_TOI = Revenues needed to earn TOI 8/30/2024 Belay W. 73

74. Cont... Q_TOI FC + TOI CMU = Contribution Margin Method R _TOI FC + TOI CMR = 8/30/2024 Belay W. 74

75. Cont... Example: How many units must Emma sell to earn an operating income of $1,200 ? Q_TOI = (FC + TOI) / CMU Q_TOI = ($2,000 + $1,200) / $80 Q_TOI = $3,200 / $80 Q_TOI = 40 Unites R_TOI = (FC + TOI) / CMR R_TOI = ($2,000 + $1,200) / 0.4 R_TOI = $3,200 / 0.4 R_TOI = $8,000 8/30/2024 Belay W. 75

76. Profit-Volume Graph for GMAT Success 8/30/2024 Belay W. 76

77. Assignment-3: Target Operating Income (TOI) Assume Tecno Plc data 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. 8/30/2024 Belay W. 77

78. 2.6. Target Net Income (TNI) and Income Taxes The key steps: C onvert TNI into the corresponding TOI . Then use the formula for TOI . Net income = Operating income - Income taxes Income Taxes = OI * Tax rate TNI = (TOI) - (TOI * Tax rate) TNI = (TOI) * (1 - Tax rate) TOI = TNI / (1 – Tax rate) 8/30/2024 Belay W. 78

79. Cont… How many units must be sold(Q)? How much sales should be made(sales)? Fixed costs + Target Net Income (1 – Tax rate)] CMU Fixed costs + Target Net Income ( 1 – Tax rate)] CMR 8/30/2024 Belay W. 79

80. Cont… For example , Emma may be interested in knowing the quantity of units she must sell to earn a net income of $960 , assuming an income tax rate of 40 % . TOI = TNI / (1 – Tax rate ) TOI = $960 / (1 – 0.4) TOI = $960 / 0.6 TOI = $1,600 In other words, to earn a TNI of $960, Emma’s TOI must be$1,600. 8/30/2024 Belay W. 80

81. Cont... How many units must be sold ( Q)? Q_TOI = (FC + TOI) / CMU Q_TOI = ($2,000 + $1,600) / $80 Q_TOI = $3,600 / $80 Q_TOI = 45 Unites How much sales should be made ( R)? R_TOI = (FC + TOI) / CMR R_TOI = ($2,000 + $ 1,600 ) / 0.4 R_TOI = $ 3,600 / 0.4 R_TOI = $9,000 8/30/2024 Belay W. 81

82. Assignment-4: Target Net Income (TNI) and Income Taxes Assume Tecno Pls data 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) 8/30/2024 Belay W. 82

83. 3. CVP Analysis with Multiple Products Assume that Tecno Company also manufactures TV in addition to phone and the following data are summarized for 2020 . 8/30/2024 Belay W. 83 Unit Data Cell Phones TVs Total Annual Sales of 2020 in units 1,500 500 2,000 Selling price $500 $1,000 Variable costs 300 720 Contribution margin $200 $ 280 Sales mix—units 75% 25% Fixed costs $275,000

84. 3.1. BEP with Multiple Products 8/30/2024 Belay W. 84 What is the BEQ and BER ? BEQ = Total fixed Cost Weighted average CM per unit Weighted average CM per unit = $200*.75+ $280*.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

85. Cont... 8/30/2024 Belay W. 85 Break-Even Revenue for the sales mix BER = Total fixed Cost Total CM Ratio or BER = BEQ1*P1+ BEQ2*P2….BEQn*Pn Total CM Ratio = 200*1,500+280*500 500*1,500+1,000*500 = 0.352 Total CM Total Revenue Total CM Ratio =

86. Cont... 8/30/2024 Belay W. 86 Break-Even Revenue for the sales mix BER = $275,000 = $ 781,250 0.352 OR From cell phone = 937.5 units *500 = $468,750 From TV = 312.5 units *1,000 = $312,500 Total $ 781,250