IDENTIFYING COST BEHAVIOR PATTERNS For each of the following situations, identify the graph that illustrates the cost behavior pattern involved: 1. Co Cosst of of ra raw ma materia erials ls used used 2. Electricity Bill – – a a flat fixed charge, plus a variable cost after a certain number of kilowatt hours hours are used. 3. Cit Cityy wat water er bill bill,, whic which h is co comp mput uted ed as fol follo lows ws:: First 1,000,000 gallons or less
$1,000 flat fee
Next 10,000 gallons
$0.003 per gallon used
Next 10,000 gallons
$0.006 per gallon used
Next 10,000 gallons
$0.009 per gallon used
Etc
Etc
City Water Bill $1,200
$1,150
$1,100
$1,050
City Water Bill
$1,000
$950
$900
0
1,000,000
1,010,000
1,020,000
1,030,000
IDENTIFYING COST BEHAVIOR PATTERNS •
•
Rent on a factory building donated by the city, where the agreement calls for a fixed fee payment unless 200,000 labor-hours or more are worked, in which case no rent need be paid. Salaries of maintenance workers, where one maintenance worker is needed for every 1,000 hours of machine-hours or less (that is, 0 to 1,000 hours require one maintenance worker, 1,001 to 2,000 requires two maintenance workers, etc.)
CONTRIBUTION FORMAT VS. TRADITIONAL FORMAT OF INCOME STATEMENT TRADITIONAL FORMAT
CONTRIBUTION FORMAT
Sales
Sales
- COGS
- Variable expenses
= Gross Profit
= Contribution Margin
- Selling & Administrative Expenses
- Fixed Expenses
= Net Income
= Net Income
Marwick’s Pianos, Inc., purchases pianos from a large manufacturer and sells them at the retail level. The pianos cost, on the average, $2,450 each from the manufacturer. Marwick’s Pianos, Inc., sells the pianos to its customers at an average price of $3,125 each. The selling and administrative costs that the company incurs in a typical month are presented below: SELLING COSTS
ADMINISTRATIVE COSTS
Advertising…..$700 per month
Executive salaries…..$2,500 per month
Sales salaries and commissions…..$950 per month, plus 8% of sales
Insurance…..$400 per month
Delivery of pianos to customers…$30/piano sold
Clerical…..$1,000/month, plus $20/piano sold
Utilities…..$350 per month
Depreciation of office equipment....$300/month
Depreciation of sales facilities…..$800/month
During August, Marwick’s Pianos, sold and delivered 40 pianos.
TRADITIONAL FORMAT Sales
$125,000
Less: Cost of Goods Sold
$98,000
Gross Margin
$27,000
Less: Operating Expenses Selling
$14,000
Administrative $5,000 Net Income
$19,000 $8,000
CONTRIBUTION FORMAT INCOME STATEMENT Sales Variable Expenses: Variable production Variable selling Variable admin Contribution margin Fixed Expenses: Fixed selling Fixed admin Net Operating Income
$125,000 $98,000 $11,200 $800
$2,800 $4,200
$110,000 $15,000
$7,000 $8,000
COST VOLUME PROFIT ANALYSIS
Cost-volume-profit analysis is based upon determining the breakeven point of cost and volume of goods. CVP Analysis can help answer questions like: what products and services to offer and what prices to charge, etc. It can be useful for managers making short-term economic decisions. Running this analysis involves using several equations using price, cost and other variables and plotting them out on an economic graph.
COST VOLUME PROFIT ANALYSIS •
CVP analysis has following assumptions: –
–
–
All cost can be categorized as variable or fixed. Sales price per unit, variable cost per unit and total fixed cost are constant. All units produced are sold.
CONTRIBUTION INCOME STATEMENT FOR ABC COMBANY Total
Per Unit
Sales*
$100,000
$250
Variable Expenses
$60,000
150
Contribution margin
$40,000
$100
Fixed Expenses:
$35,000
Net Operating Income
$5,000
*400 SPEAKERS SOLD
CONTRIBUTION INCOME STATEMENT If 1 speakers is sold!!
Total
Per Unit
Sales
$250
$250
Variable Expenses:
$150
150
Contribution margin
$100
$100
Fixed Expenses:
$35,000
Net Operating Income
$(34,900)
CONTRIBUTION INCOME STATEMENT If 2 speakers are sold!
Total
Per Unit
Sales
$500
$250
Variable Expenses:
$300
150
Contribution margin
$200
$100
Fixed Expenses:
$35,000
Net Operating Income
$(34,800)
CONTRIBUTION INCOME STATEMENT Sales of 350 Speakers
Total
Per Unit
Sales
$87,500
$250
Variable Expenses
$52,500
150
Contribution margin
$35,000
$100
Fixed Expenses:
$35,000
Net Operating Income
$
0
CONTRIBUTION INCOME STATEMENT Sales of 351 Speakers
Sales Variable Expenses Contribution margin Fixed Expenses: Net Operating Income
Total $87,750 $52,650 $35,100 $35,000 $ 100
Per Unit $250 150 $100
“Once the break even point has been reached, net
operating income will increase by the amount of the unit contribution margin for each additional unit sold.”
Volume (400 speakers)
Sales Volume (425 speakers)
Difference (25 speakers)
Per Unit
$100,000
$106,250
$6,250
$250
Variable expenses**
60,000
63,750
3,750
150
Contribution Margin
40,000
42,500
2,500
$100
Fixed Expense
35,000
35,000
0
Net operating income
$5,000
$7,500
$2,500
Sales*
*Sales= Price × Volume: $250 × 400 = $100,000 **Variable expense = Variable expense per speaker × Volume: $150 × 400 = $60,000
SUMMARY •
•
•
If sales are zero, loss would equal fixed expenses. Each unit sold reduces the loss by the amount of unit contribution margin. After reaching break-even point, each additional unit sold increases the company's profit by the amount of the unit contribution margin.
CVP RELATIONSHIPS IN GRAPHIC FORM $160,000 $140,000 $120,000 $100,000
Fixed Expense
Total Sales Revenue
$80,000
Total Expense
$60,000 $40,000 $20,000 $0 0
100 200 300 400 500 600 700 800
CONTRIBUTION MARGIN RATIO CM Ratio = Total Contribution Margin Total Sales OR CM Ratio = Unit Contribution Margin Unit selling price
CONTRIBUTION MARGIN RATIO Total
Per Unit
% of sales
Sales*
$100,000
$250
100%
Variable Expenses
$60,000
150
60%
Contribution margin
$40,000
$100
40%
Fixed Expenses:
$35,000
Net Operating Income
$5,000
*400 SPEAKERS SOLD
$30,000 increase in sales? Present
Expected
Increase
% of sales
Sales
$100,000*
$130,000
$30,000
100%
Variable expenses
60,000**
78,000
18,000
60%
Contribution Margin
40,000
52,000
12,000
40%
Fixed Expense
35,000
35,000
0
Net operating income
$5,000
$17,000
$12,000
*Sales= Price × Volume: $250 × 400 = $100,000 **Variable expense = Variable expense per speaker × Volume: $150 × 400 = $60,000 OR 60% of sales
APPLICATIONS OF CVP CONCEPTS
Changes in Fixed Cost & Sales Volume
Change in Variable Costs & Sales Volume
Changes in Fixed Cost, Sales Price, & Sales Volume
Changes in Variable Cost, Fixed Cost, and Sales Volume
Change in Selling Price
CHANGES IN FIXED COST & SALES VOLUME Current Sales
Sales with Difference % of Sales Additional Advertising Budget
Sales
$100,000
$130,000
$30,000
100%
Variable Expenses
(60,000)
78,000*
18,000
60%
40,000
52,000
12,000
40%
(35,000)
45,000**
10,000
$5,000
7,000
2,000
Contribution Margin Fixed Expenses Net Operating Income
*520 units × $150 per unit = $78,000 **35,000 + additional $10,000 monthly advertising budget = $45,000.
ALTERNATIVE SOLUTION 1 Expected total contribution margin: $130,000 × 40% CM ratio
$52,000
Present total contribution margin $100,000 × 40% CM ratio
40,000
Incremental contribution margin
12,000
Change in fixed expenses Less incremental advertising expense
10,000
Increased net operating income
$2,000
ALTERNATIVE SOLUTION 2 Incremental contribution margin: $30,000 × 40% CM ratio…………………. $12,000 Less Incremental advertising expense………. 10,000 Increased net operating margin……………….. $ 2,000
