Financial managerial accounting 3rd kieso ch19(cost volume profit analysis additional issues)

Financial & Managerial Accounting
rd
3 Edition
Weygandt Kimmel Kieso

Chapter 19

Cost-Volume-Profit
Analysis: Additional Issues


Chapter Outline
Learning Objectives
LO 1

Apply basic CVP concepts.

LO 2

Explain the term sales mix and its effects on break-even sales.

LO 3

Determine sales mix when a company has limited resources.

LO 4

Indicate how operating leverage affects profitability.

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Basic CVP Concepts
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 such as:

LO 1

.

determining product mix,

.

maximizing use of production facilities,

.

setting selling prices.

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Basic CVP Concepts
Basic Concepts

Management often wants the information reported in a special format income statement.
CVP income statement is for internal use only:

LO 1

.

Costs and expenses classified as fixed or variable.

.

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

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Basic CVP Concepts

ILLUSTRATION 19.1
Basic CVP income statement

Basic Concepts

LO 1

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5

ILLUSTRATION 19.2
Detailed CVP income statement

LO 1

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6


Break-Even Analysis
Vargo Electronic’s CVP income statement (Ill. 6.2) 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).

Unit Contribution
Margin
Fixed Costs

ữ

$200,000

ữ

$200

Break-Even Point in

=

Units

=

1,000 units

ILLUSTRATION 19.3
Break-even point in units

LO 1

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Break-Even Analysis
Vargo Electronic’s CVP income statement (Ill. 6.2) 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).

Unit Contribution
Ratio
Fixed Costs

ữ

$200,000

ữ

.40

Break-Even Point in
=

Dollars

=

$500,000

ILLUSTRATION 19.4
Break-even point in dollars

LO 1

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Target Net Income
Once a company achieves break-even sales, a sales goal can be set that will result in a target
net income
Illustration: Assuming Vargo’s target net income is $250,000, compute required sales in units
to achieve target net income :
Unit Contribution

(Fixed Costs + Target Net
Income)

($200,000 + $250,000)

÷

÷

Margin

$200

Sales in Units
=

=

2,250 units

ILLUSTRATION 19.5
Target net income in units

LO 1

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Target Net Income
Once a company achieves break-even sales, a sales goal can be set that will result in a target
net income
Illustration: The contribution margin ratio is used to compute required sales in dollars.

(Fixed Costs + Target Net
Income)

($200,000 + $250,000)

÷

÷

Contribution
Margin Ratio

.40

Sales in Dollars
=

=

$1,125,000

ILLUSTRATION 19.6
Target net income in dollars

LO 1

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10


Margin of Safety

a.

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

b.

can be expressed in dollars or as a ratio.

Illustration: Assume Vargo’s sales are $800,000:

Margin of

Actual (Expected) Sales
$800,000

-

-

Break-Even Sales
$500,000

=

=

Safety in
Dollars
$300,000

ILLUSTRATION 19.7
Margin of safety in dollars

LO 1

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Margin of Safety

a.

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

b.

can be expressed in dollars or as a ratio.

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

Margin of Safety in
Dollars
$300,000

ữ

ữ

Actual (Expected)
Sales
$800,000

=

=

Margin of
Safety Ratio
37.5%

ILLUSTRATION 19.8
LO 1

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Margin of safety ratio

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CVP and Changes in the Business Environment (1 of 5)

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

LO 1

Unit selling price

$500

Unit variable cost

$300

Total fixed costs

$200,000

Break-even sales

$500,000 or 1,000 units

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CVP and Changes in the Business Environment (2 of 5)

Case I: A competitor is offering a 10% discount on the selling price of its camcorders. What
effect will a 10% discount on selling price ($500 x 10% = $50) have on the breakeven point?

Break-Even
Fixed Costs
$200,000

÷

÷

Unit Contribution Margin
$150
($450 - $300)

=

=

Sales
1,333 units
(rounded)

ILLUSTRATION 19.10
Computation of break-even sales in units

LO 1

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CVP and Changes in the Business Environment (3 of 5)

Case II: 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 30% and
variable cost per unit will decrease 30%. What effect will the new equipment have on the
sales volume required to break even?

ILLUSTRATION 19.11

Break-Even
Fixed Costs
$260,000

÷

÷

Unit Contribution Margin
($500 - $210)

=

=

Sales
897 units
(rounded)

LO 1

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CVP and Changes in the Business Environment (4 of 5)

Case III: Vargo’s principal supplier of raw materials has just announced a price increase. The
higher cost is expected to increase the variable cost of cell phones by $25 per unit.
Management 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?

LO 1

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CVP and Changes in the Business Environment (5 of 5)

Variable cost per unit increases to $325 ($300 + $25).
Fixed costs are reduced to $182,500 ($200,000 - $17,500).
Contribution margin per unit becomes $175 ($500 - $325).

Unit Contribution

(Fixed Cost + Target Net Income)
($182,500 + $80,000)

÷

÷

Margin
$175

=

=

Sales in Units
1,500

ILLUSTRATION 19.12
Computation of required sales
LO 1

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

LO 1

a.

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

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.

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DO IT! 1 CVP Analysis (1 of 3)
Krisanne Company reports the following for June.
Total Per Unit
Sales (5,000 units) $300,000

$60

Variable costs

36

180,000

Contribution margin
Fixed expenses

120,000

$24

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%.

LO 1

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DO IT! 1 CVP Analysis (2 of 3)
Using the contribution margin technique, compute the break-even point in units and dollars and margin of safety in
dollars assuming no changes to sales price or costs.

Solution
a.

Assuming no changes to sales price or costs:
Break-even point in units = 4,167 units (rounded) ($100,000 ÷ $24)
a
Break-even point in sales dollars = $250,000 ($100,000 ÷ .40 )
Margin of safety in dollars = $50,000 ($300,000 − $250,000)

a

LO 1

$24 ÷ $60

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DO IT! 1 CVP Analysis (3 of 3)
Using the contribution margin technique, compute the break-even point in units and dollars and margin of safety in
dollars assuming changes to sales price and volume as described.
b
Break-even point in units = 5,556 units (round) ($100,000 ÷ $18 )
c
Break-even point in sales dollars = $300,000 ($100,000 ÷ ($18 ÷ $54 ))
d
Margin of safety in dollars = $37,500 ($337,500 − $300,000)
b

c

($60 − (.10 × $60) − 36 = $18)

($60 − (.10 × $60)

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

LO 1

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Sales Mix and Break-Even Sales

a.

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

b.

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

c.

Sales mix is important because different products often have very different contribution
margins.

LO 2

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Break-Even Sales in Units (1of 5)
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. Vargo sells
its products in the following amounts: 1,500 cell phones and 500 TVs.

Cell Phones

TVs

1,500 units ÷ 2,000 units = 75%

500 units ÷ 2,000 units =
25%

LO 2

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Break-Even Sales in Units (2of 5)
Additional information related to Vargo Electronics.
Cell Phones

TVs

1,500 units ÷ 2,000 units =

500 units ÷ 2,000 units =

75%

25%

Unit Data Cell Phones

TVs

Selling price

$500

$1,000

300

500

Contribution margin

$200

$500

Sales mix—units

75%

25%

Variable costs

Fixed costs = $275,000

LO 2

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Break-Even Sales in Units (3 of 5)
First, determine weighted-average contribution margin.
Unit Data Cell Phones

TVs

Selling price

$500

$1,000

300

500

Contribution margin

$200

$500

Sales mix—units

75%

25%

Variable costs

Fixed costs = $275,000
ILLUSTRATION 6.15

LO 2

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