University:
California State University, Northridge
Course:
ACCT 230 | Introduction to Managerial Accounting
Academic year:

2024
Views:

150

Pages:

28
Author:

Amani Galvan

Chapter 6 Cost-Volume-Profit Relationships, Part 3 Target Profit Analysis The equation and contribution margin methods can be used to determine the sales volume needed to achieve a target profit. Suppose Racing Bicycle Company wants to know how many bikes must be sold to earn a profit of $100,000. 6-50 The CVP Equation Method Sales = Variable expenses + Fixed expenses + Profits $500Q = $300Q + $80,000 + $100,000 $200Q = $180,000 Q = 900 bikes 6-51 The Contribution Margin Approach The contribution margin method can be used to determine that 900 bikes must be sold to earn the target profit of $100,000. Unit sales to attain = the target profit Fixed expenses + Target profit Unit contribution margin $80,000 + $100,000 = 900 bikes $200/bike 6-52  UnitQuick sales Check Fixed expenses + Target profit to attain = Unit CM Coffee Klatch is an espresso stand in a downtown target profit office building. The average price of a cup $1,300selling + $2,500 = the average variable of coffee is $1.49 and $1.49 - $0.36 expense per cup is $0.36. The average fixed $3,800 How many cups of expense per month =is $1,300. $1.13 coffee would have to be sold to attain target profits = 3,363 cups of $2,500 per month? a. 3,363 cups b. 2,212 cups c. 1,150 cups d. 4,200 cups 6-54 Learning Objective LO7 To compute the margin of safety and explain its significance. 6-55 The Margin of Safety The margin of safety is the excess of budgeted (or actual) sales over the break-even volume of sales. Margin of safety = Total sales - Break-even sales Let’s look at Racing Bicycle Company and determine the margin of safety. 6-56 The Margin of Safety If we assume that Racing Bicycle Company has actual sales of $250,000, given that we have already determined the break-even sales to be $200,000, the margin of safety is $50,000 as shown Break-even sales 400 units Sales $ 200,000 Less: variable expenses 120,000 Contribution margin 80,000 Less: fixed expenses 80,000 Net operating income $ - Actual sales 500 units $ 250,000 150,000 100,000 80,000 $ 20,000 6-57 The Margin of Safety The margin of safety can be expressed as 20% of sales. ($50,000 ÷ $250,000) Break-even sales 400 units Sales $ 200,000 Less: variable expenses 120,000 Contribution margin 80,000 Less: fixed expenses 80,000 Net operating income $ - Actual sales 500 units $ 250,000 150,000 100,000 80,000 $ 20,000 6-58 The Margin of Safety The margin of safety can be expressed in terms of the number of units sold. The margin of safety at Racing is $50,000, and each bike sells for $500. Margin of $50,000 = = 100 bikes Safety in units $500 6-59 Quick Check  Coffee Klatch is an espresso stand in a downtown building. selling Margin office of safety = Total The salesaverage – Break-even sales = 2,100 cups –and 1,150 cups price of a cup of coffee is $1.49 the = 950 cups average variable expense per cup is $0.36. or The average fixed expense per month is cups Margin of safety2,100950 $1,300. On average cups are sold each = 2,100 cups = 45% percentage month. What is the margin of safety? a. 3,250 cups b. 950 cups c. 1,150 cups d. 2,100 cups 6-61 Cost Structure and Profit Stability Cost structure refers to the relative proportion of fixed and variable costs in an organization. Managers often have some latitude in determining their organization’s cost structure. 6-62 Cost Structure and Profit Stability There are advantages and disadvantages to high fixed cost (or low variable cost) and low fixed cost (or high variable cost) structures. An advantage of a high fixed cost structure is that income will be higher in good years compared to companies A disadvantage of a high fixed with lower proportion of cost structure is that income fixed costs. will be lower in bad years compared to companies with lower proportion of fixed costs. 6-63 Learning Objective LO8 To compute the degree of operating leverage at a particular level of sales and explain how it can be used to predict changes in net operating income. 6-64 Operating Leverage A measure of how sensitive net operating income is to percentage changes in sales. Degree of Contribution margin = operating leverage Net operating income 6-65 Operating Leverage At Racing, the degree of operating leverage is 5. Actual sales 500 Bikes Sales $ 250,000 Less: variable expenses 150,000 Contribution margin 100,000 Less: fixed expenses 80,000 Net income $ 20,000 $100,000 = 5 $20,000 6-66 Operating Leverage With an operating leverage of 5, if Racing increases its sales by 10%, net operating income would increase by 50%. Percent increase in sales Degree of operating leverage Percent increase in profits × 10% 5 50% Here’s the verification! 6-67 Operating Leverage Actual sales (500) Sales $ 250,000 Less variable expenses 150,000 Contribution margin 100,000 Less fixed expenses 80,000 Net operating income $ 20,000 Increased sales (550) $ 275,000 165,000 110,000 80,000 $ 30,000 10% increase in sales from $250,000 to $275,000 . . . . . . results in a 50% increase in income from $20,000 to $30,000. 6-68 Quick Check  Actual sales Coffee Klatch is an espresso stand in a 2,100 cups downtown office building. $ Sales The average selling 3,129 price of a cup of coffee is $1.49 and the Less: Variable expenses 756 Contribution margin average variable expense per cup is $0.36. 2,373 Less: Fixed 1,300 The average fixed expense perexpenses month is Net operating income $ 1,073 $1,300. On average2,100 cups are sold each month. What is the operating leverage? a. 2.21 Operating Contribution margin b. 0.45 leverage = Net operating income c. 0.34 $2,373 = $1,073 = 2.21 d. 2.92 6-70 Quick Check  At Coffee Klatch the average selling price of a cup of coffee is $1.49, the average variable expense per cup is $0.36, and the average fixed expense per month is $1,300. On average 2,100 cups are sold each month. If sales increase by 20%, by how much should net operating income increase? a. 30.0% Percent increase in sales 20.0% 2.21 b. 20.0% × Degree of operating leverage Percent increase in profit 44.20% c. 22.1% d. 44.2% 6-72 Verify Increase in Profit Actual sales 2,100 cups Sales $ 3,129 Less: Variable expenses 756 Contribution margin 2,373 Less: Fixed expenses 1,300 Net operating income $ 1,073 % change in sales % change in net operating income Increased sales 2,520 cups $ 3,755 907 2,848 1,300 $ 1,548 20.0% 44.2% 6-73 Structuring Sales Commissions Companies generally compensate salespeople by paying them either a commission based on sales or a salary plus a sales commission. Commissions based on sales dollars can lead to lower profits in a company. Let’s look at an example. 6-74 Structuring Sales Commissions Pipeline Unlimited produces two types of surfboards, the XR7 and the Turbo. The XR7 sells for $100 and generates a contribution margin per unit of $25. The Turbo sells for $150 and earns a contribution margin per unit of $18. The sales force at Pipeline Unlimited is compensated based on sales commissions. 6-75 Structuring Sales Commissions If you were on the sales force at Pipeline, you would push hard to sell the Turbo even though the XR7 earns a higher contribution margin per unit. To eliminate this type of conflict, commissions can be based on contribution margin rather than on selling price alone. 6-76 The Concept of Sales Mix  Sales mix is the relative proportion in which a company’s products are sold.  Different products have different selling prices, cost structures, and contribution margins. Let’s assume Racing Bicycle Company sells bikes and carts and that the sales mix between the two products remains the same. 6-78 Multi-product break-even analysis Racing Bicycle Co. provides the following information: $265,000 = 48.2% (rounded) $550,000 6-79 Multi-product break-even analysis Break-even sales Fixed expenses = CM Ratio $170,000 = 48.2% = $352,697 6-80 Key Assumptions of CVP Analysis  Selling price is constant.  Costs are linear.  In multi-product companies, the sales mix is constant.  In manufacturing companies, inventories do not change (units produced = units sold). 6-81