managerial accounting chapter 6

CVP analysis

Study of the effects of changes in costs and volume on a company’s profit.

Important to profit planning.

Critical in management decisions

o determining product mix,

o maximizing use of production facilities

o setting selling prices.

CVP income statement is for internal use only:

o Costs and expenses classified as fixed or variable.

o Reports contribution margin as a total amount and on a per unit basis.

Vargo Electronic’s CVP income statement shows that total contribution margin is $320,000, and the company’s contribution margin per unit is $200. Contribution margin can also be expressed as the contribution margin ratio which is 40% ($200 ÷ $500).

Vargo Electronic’s CVP income statement shows that total contribution margin is $320,000, and the company’s contribution margin per unit is $200. Break-even point in sales dollars is $500,000 ($200,000 ÷ .40)

Assume Vargo’s management has a target net income of $250,000. Compute the required sales in units to achieve its target net income:

Whats break-even point in sales and break-even point in sales dollars ?

Compute the required sales in units and compute required sales in dollars.

Assume Vargo’s sales are $800,000:what is margin of safety in dollars?

tells us how far sales can drop before the company will operate at a loss

fixed costs / Unit contribution margin = break-even point in sales?

200,000 / 200 = 1,000 units

fixed costs//contribution ratio = break-even point in sales dollars

200,000 / 0.40 = 500,000

(fixed costs + target net income) / unit contribution margin = sales in units

(200.000 + 250,000) / 200 = 2250

(fixed costs + target net income) / contribution margin ration = sales in dollars

(200,000 + 250,000) / 0.40 = 1,125,000

actual (expected) sales - break even sales = margin of safety in dollars

800,000 - 500,000 = 300,000

margin of safety in dollars / actual (expected) sales = margin of safety as a ratio

300,000 / 800,000 = 37.5%

Vargo’s sales could drop by $300,000, or 37.5%, before the company would operate at a loss

Original cell phone sales and cost data for Vargo Electronics is as shown.

Unit selling price $500

Unit variable costs $300

Total fixed costs $200,000

Break-even sales $500,000 or 1,000 units

A competitor is offering a 10% discount on the selling price of its cell phones. What effect will a 10% discount on selling price ($500 × 10% = $50) have on the breakeven point?

fixed costs / unit contribution margin = break-even sales

200,000 / 1.50 = 1,333 units (rounded)

Unit selling price $500

Unit variable costs $300

Total fixed costs $200,000

Break-even sales $500,000 or 1,000 units

Management invests in new robotic equipment that will lower the amount of direct labor required to make cell phones. The company estimates that total fixed costs will increase 30% and that unit variable cost will decrease 30%. What effect will the new equipment have on the sales volume required to break even?

fixed costs / unit contribution margin = break-even sales

260,000 / (500-210) = 897 units (rounded)

Vargo’s principal supplier of raw materials has just announced a price increase. The higher cost is expected to increase the unit variable cost of cell phones by $25. Management decides that it does not want to increase the selling price of the cell phones. It plans a cost-cutting program that will save $17,500 in fixed costs per month. Vargo is currently realizing monthly net income of $80,000 on sales of 1,400 cell phones. What increase in units sold will be needed to maintain the same level of net income?

Unit variable costs increase to $325 ($300 + $25).

Fixed costs are reduced to $182,500 ($200,000 − $17,500).

Unit contribution margin becomes $175 ($500 − $325)

(fixed costs + target net income) / unit contribution margin = sales in units

(182,500 +80,000) / 175 = 1500

Croc Catchers calculates its contribution margin to be less than zero. Which statement is true?

a. Its fixed costs are less than the unit variable cost.

b. Its profits are greater than its total costs.

c. The company should sell more units.

d. Its selling price is less than its variable costs.

d. Answer: Its selling price is less than its variable costs

DO IT! 1: CVP Analysis

Krisanne Company reports the following operating results for the month of June. 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%. Using the contribution margin technique, compute the break- even point in sales units and sales dollars and margin of safety in dollars assuming no changes to sales price or costs.

Break-even point in units = 4,167 units (rounded) ($100,000 ÷ $24) Break-even point in sales dollars = $250,000 ($100,000 ÷ 40a) Margin of safety in dollars = $50,000 ($300,000 − $250,000) a$24 ÷ $60

Break-even point in units = 5,556 units (round) ($100,000 ÷ $18b)

Break-even point in sales dollars = $300,000 ($100,000 ÷ ($18 ÷ $54c))

Margin of safety in dollars = $37,500 ($337,500d − $300,000)

b($60 − (.10 × $60) − 36 = $18)

c($60 − (.10 × $60)

d(5,000 + (.25 × 5,000) = 6,250 units, 6,250 units × $54 = $337,500)

Sales mix

is the relative percentage in which a company sells its products.

If a company’s unit sales are 80% printers and 20% PCs, its sales mix is 80% to 20%.

Sales mix as a percentage of units sold

Companies can compute break-even sales for a mix of two or more products by determining the weighted- average unit contribution margin of all the products. Illustration: Vargo Electronics sells not only cell phones but high-definition TVs as well. Vargo sells its two products in the following amounts: 1,500 cell phones and 500 TVs.

Cell Phones Tv’s

1,500 units ÷ 2,000 units = 75% 500 units ÷ 2,000 units = 25%

Unit Data Cell Phones TVs

Selling price $500 $1,000

Variable costs 300 500

Contribution margin $200 $500

Sales mix ─ units 75% 25%

Fixed costs = $275,000

determine weighted-average unit contribution margin

ompute the break-even point in sales units

Cell Phones TVs

(unit contribution margin x sales mix %) + (unit contribution margin x sales mix %) = weighten-average unit contribution margin

(200 x .75) + (500 × 0.25) = 275

fixed costs / weighted-average unit contribution margin = break-even point in sales units

275,000 / 275 = 1,000 units

With break-even point of 1,000 units, Vargo must sell:

o 750 cell phones (1,000 units × 75%)

o 250 TVs (1,000 units × 25%)

• At this level, the total contribution margin will equal to -

the fixed costs of $275,000.

product unit sales x unit contribution margin = total contribution margin

cell phones 750 x 200 = 150,000

tv’s 250 x 500 = 125,000

1,000 =275,000

Calculates break-even point in terms of sales dollars for

divisions or product lines,

not individual products.

Company total formula

Contribution margin ratio
(contribution margin/sales)

page 29 company total, Weighted average contribution margin, break-even point in sales dollars

Contribution margin ratio     80,000   =0.40         240,000=0.30   320,000=0.32 (total)

(contribution margin/sales) 200,000     800,000 1,000,000

(0.40 x 0.20) + (0.30 x 0.80) = 0.32 weighted-average contribution margin ratio

300,000 / 0.32 = 937.500

weighted-average contribution margin formula

(contribution margin ratio x sales mix percentage)+(Contribution margin ratio x sales mix percentage) 

break-even point in sales dollars formula

Fixed costs/weighted-average contribution margin ratio

Net income will be:

-Greater if more higher-contribution margin units are sold than lower-contribution margin units.

-Greater if more lower-contribution margin units are sold than higher-contribution margin units.

-Equal as long as total sales remain equal, regardless of which products are sold.

- Unaffected by changes in the mix of products sold.

Greater if more higher-contribution margin units are sold than lower-contribution margin units

page 35 Manzeck Bicycles International produces and sells three different types of mountain bikes. Information regarding the three models is shown below.

The company’s total fixed costs to produce the bicycles 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

- Pro = 5,000/40,000 = 12.5% intermediate=10,000/40,000=25% standard=25,000/40,000=62.5%

- (0.125 x (800 - 500)) + (0.25 x (500-300)) +(0.625 x (350-250))=150

- 7,500,000 / 150 = 50,000 units

- Pro: 50,000 units × 12.5% = 6,250 units

Intermediate: 50,000 units × 25% = 12,500 units

Standard: 50,000 units × 62.5% = 31,250 units

50,000 units

page 40, Vargo manufactures cell phones and TVs. Machine capacity is limited to 3,600 hours per month.

Calculate the contribution margin per unit of limited resource

page 41 Question on test slide 41 on chapter 6

Approach used to identify and manage constraints so as to maximize the contribution margin given the constraint. Company must continually

identify its constraints and o find ways to reduce or eliminate them, where appropriate.

If the unit contribution margin is $15 and it takes 3.0 machine hours to produce the unit, the contribution margin per unit of limited resource is:

$25.

$5.

$4.

No correct answer is given.

$5

page 46What is the contribution margin per unit of limited resource for each type of bearing

unit contribution margin / limited resource consumed per unit

Fine= $2/0.02 = 100

Extra-fine= $3.5/0.04=87.50

Super-fine= $5/0.08=62.50

Cost Structure is

the relative proportion of fixed versus variable costs that a company incurs.

May have effect on profitability

Company must carefully consider its cost structure

page 50

Contribution margin ratio for two companies

Break-Even Point in sales dollars

Margin of Safety ratio

degree of operating leverage

want higher contribution margin so new wave is better.

contribution margin/ sales= contribution margin ratio

vargo - 320,000/800,000 = 40%

new wave- 640,000/800,000=80%

fixed costs / contributiion margin ratio= break even point in sales dollars

vargo - 200,000 / 0.40 = 500,000

new wave- 520,000 / 0.80 = 650,000

(actual sales - break-even sales) / Actual sales =Margin of Safety ratio

vargo- (800,000 - 500,000) / 800,000 = 38%

new wave- (800,000 - 650,000) / 800,000 = 19%

contribution margin / net income= degree of operating leverage

vargo - 320,000 / 120,000 = 2.67

new wave- 640,000/120,000=5.33

degree of operating leverage

contribution margin / net income= degree of operating leverage

The degree of operating leverage:

Can be computed by dividing contribution margin by

net income.

Provides a measure of the company’s earnings

volatility.

Affects a company’s break-even point.

All of the above

All of the above

page 59
Compute the degree of operating leverage.

Contribution Margin ÷ Net Income = Degree of Operating Leverage

Old $600,000 ÷ $200,000 = 3.00

New $1,400,000 ÷ $200,000 = 7.00

we classified both variable and fixed manufacturing costs as product costs. This costing approach is referred to as

an alternative approach, __ ___, which is consistent with the cost-volume-

profit material (Variable costs ans absorption costs are going to be calculated for the test)

full or absorption costing.

variable costing

Under variable costing, product costs consist of
Difference between absorption and variable costing is:

Direct Materials

• Direct Labor

• Variable Manufacturing Overhead

Absorption costing variable costing

product cost ←- fixed manufacturing overhead -→ period cost

The difference between absorption and variable costing:

Under both costing methods, selling and administrative expenses are treated as period costs.

Companies may not use variable costing for external financial reports because GAAP requires that fixed manufacturing overhead be treated as a product cost

Selling Price $20 per unit.

Units Produced 30,000; sold 20,000; beginning inventory zero.

Unit variable costs Manufacturing $9 (direct materials $5, direct labor $3, and variable

overhead $1). Selling and administrative expenses $2.

Fixed costs Manufacturing overhead $120,000. Selling and administrative expenses $15,000.

page 64

Manufacturing cost per unit is

4 ($13 − $9) higher for absorption costing because fixed manufacturing costs are treated as product costs

Fixed manufacturing overhead costs are recognized as:

Period costs under absorption costing.

Product costs under absorption costing.

Product costs under variable costing.

Part of ending inventory costs under both absorption and variable costing

Product costs under absorption costing

Generally accepted accounting principles require that

absorption costing be used for the costing of inventory for external reporting purposes.

Net income measured under GAAP

page 72,73 Franklin Company produces and sells tennis balls. The following costs are available for the year ended December 31, 2022. The company has no beginning inventory. In 2022, 8,000,000 units were produced, but only 7,500,000 units were sold. The unit selling price was $0.50 per ball. Costs and expenses were as follows.

Compute the manufacturing cost of one unit of product using variable costing.

Prepare a 2022 income statement for Franklin Company using variable costing

page 73,74

a. direct materials 0.10

direct labor 0.05

variable manufacturing overhead 0.08

manufacturing cost of one unit of product using variable costing = 0.23

(not on test)

Making business decisions considers financial and non-financial information

Financial information and nonfinancial information

FI - Revenues and costs

NFI -Overall company image

(not on test but is important) Important concepts used in incremental analysis

Incremental analysis is the process of identifying the financial data that

• Relevant costs and revenues

• Opportunity cost

• Sunk cost

• Sometimes involves changes that seem contrary to intuition

• Variable costs sometimes do not change under alternatives

• Fixed costs sometimes change between alternatives

change under alternative courses of action

(not on test) page 6

Incremental revenue is $15,000 less under Alternative B

Incremental cost savings of $20,000 is realized

Alternative B produces $5,000 more net income

Common types of decisions involving incremental analysis

Accept an order at a special price

Make or buy component parts or finished products

Sell products or process them further

Repair, retain, or replace equipment

Eliminate an unprofitable business segment or product

Learning objective 2,3,4,5,6 chapter 7 will be questions on test. (this question onward)

Sunbelt Company produces 100,000 Smoothie blenders per month, which is 80% of factory capacity. Variable manufacturing costs are $8 per unit. Fixed manufacturing costs are $400,000, or $4 per unit. The Smoothie blenders are normally sold directly to retailers at $20 each. Kensington Co. (a foreign wholesaler) has offered to purchase an additional 2,000 blenders from Sunbelt at $11 per unit. Management has determined that acceptance of the offer would not affect normal sales of the product, and the additional units can be manufactured without increasing factory capacity. What should management do? (THIS WILL BE ON TEST) PIC ON CANVAS EXCELL

page 16 Fixed costs do not change since within existing capacity – thus fixed costs are not relevant

Variable manufacturing costs and expected revenues change – thus both are relevant to the decision

selling price 20 11

variable cost 8 8

contribution margin 12 3

fixed costs 8 4 4/na (cross out 4, there’s no answer )

100,000

Cobb Company incurs costs of $28 per unit ($18 variable and $10 fixed) to make a product that normally sells for $42. A foreign wholesaler offers to buy 5,000 units at $25 each. The special order results in additional shipping costs of $1 per unit. Compute the increase or decrease in net income Cobb realizes by accepting the special order, assuming Cobb has

excess operating capacity. Should Cobb Company accept the special?

page 17The analysis indicates net income increases by $30,000; therefore, Cobb Company should accept the special order

absorbtion variable

85,000 45,000

40,000

4/fixed costs = 10,000 slide 66

Baron Company incurs the following annual costs in producing 25,000 ignition switches for motorcycles.

Direct materials $50,000

Direct labor 75,000

Variable manufacturing overhead 40,000

Fixed manufacturing overhead 60,000

Total manufacturing costs $225,000

Total cost per unit ($225,000 ÷ 25,000) $9.00

Instead of making switches, Baron might purchase ignition switches at a price of $8 per unit. If they do this, all variable costs and $10,000 of fixed costs will be eliminated. What should Baron do?

page 19) Manufacturing cost is $1 higher per unit than purchase price

Must absorb at least $50,000 of fixed costs under either option

In a make-or-buy decision, relevant costs are

Manufacturing costs that will be saved, The purchase price of the units, Opportunity costs

The lost potential benefit that could have been obtained from

following an alternative course of action. If there is an opportunity to use this productive capacity

in some other manner, then this opportunity cost must be considered

Juanita Company must decide whether to make or buy some of its components for the appliances it produces. The costs of producing 166,000 electrical cords for its appliances are as follows.

Direct materials $90,000 Variable overhead $32,000

Direct labor 20,000 Fixed overhead 24,000

Instead of making the electrical cords at an average cost per unit of $1.00 ($166,000 ÷ 166,000), the company has an opportunity to buy the cords at $0.90 per unit. If the company purchases the cords, all variable costs and one-fourth of the fixed costs are eliminated. Make or Buy?

Prepare an incremental analysis showing whether the company should make or buy the electrical cords

Will your answer be different if the released productive capacity of the production facility will generate additional income of $5,000?

page 25,26) a) Juanita Company should make the components.

b) Yes, the answer is different. The analysis shows that net income increases by $3,600 if Juanita Company purchases the electrical cords rather than making them. Juanita Company should buy the components.

May have option to sell product at a given point in production or continuing to process and sell later at a higher price.

Decision Rule:

Process further as long as the incremental revenue from such processing exceeds the incremental processing costs

Woodmasters Inc. makes tables. The cost to manufacture an unfinished table is $35. The selling price per unfinished unit is $50. Woodmasters has unused capacity that can be used to finish the tables and sell them at $60 per unit. For a finished table, direct materials will increase $2 and direct labor costs will increase $4. Variable manufacturing overhead costs will increase by $2.40 (60% of direct labor). No increase is anticipated in fixed manufacturing overhead.

Direct materials $15

Direct labor 10

Variable manufacturing overhead 6

Fixed manufacturing overhead 4

Manufacturing cost per unit $35 (page 29)

Should Woodmasters sell or process further?

Woodmasters should process further.

Joint product costs are ___ ____ and thus ___ ____ to the sell-or-process-further decision

sunk costs

not relevant

(page 32) Determine whether the company should simply sell the cream or process it further into cottage cheese

page 33) Marais should or begin underline should not page 35) end underline process the cream further?

Marais should not process the cream further.

page 35) Determine whether the company should sell the skim milk or process further into condensed milk.

Sell skim milk or process into condensed milk?

(page 36) Marais should or should not process the skim milk further

Marais should process the skim milk further.

Process further as long as the incremental revenue from processing exceeds

Incremental processing costs

Easy Does It manufactures unpainted furniture for the do- it-yourself (DIY) market. It currently sells a child’s rocking chair for $25. Production costs per unit are $12 variable and $8 fixed. Easy Does It is considering painting the rocking chair and selling it for $35. Variable costs to paint each chair are expected to be $9, and fixed costs are expected to be $2. Prepare an analysis showing whether Easy Does It should sell unpainted or painted chairs

Sell Process Further Net Income Increase (Decrease)

Revenues $25 $35 $10

Variable costs 12 21^a (9)

Fixed costs 8 10^b (2)

Net income $5 $4 $(1)

^a$12 + $9; ^b$8 + $2

Jeffcoat Company has a factory machine that originally cost $110,000. It has a balance in Accumulated Depreciation of $70,000, so the machine’s book value is $40,000. It has a remaining useful life of four years. The company is considering replacing this machine with a new machine.

A new machine is available that costs $120,000. It is expected to have zero salvage value at the end of its four-year useful life. If the new machine is acquired, variable manufacturing costs are expected to decrease from $160,000 to $125,000 annually, and the old unit could be sold for $5,000.

Prepare the incremental analysis for the four-year period. Retain or Replace? (page 43)

Jeffcoat Company should replace the machine.