Survey Of Accounting - Chapter 18 Notes

Chapter 18 Notes Acct 203 Cost-volume-profit analysis (CVP) CVP is a great tool used to ballpark the break even point for a particular product or group of products. FIRST, management must classify all costs are either FIXED or VARIABLE. Remember that FIXED means the costs do not change when volume of activity changes from period to period over a specified relevant range. The relevant range is important because while the fixed costs of owning building DO NOT depend on the volume of activity, once the building is operating at capacity, any additional volume will require that you obtain another building. The relevant range we speak of is for the building at hand and not for the expansion of the business to include new buildings. Remember that VARIABLE means the costs change in proportion to changes in volume of the activity. The PER UNIT cost may not change, BUT the total DOLLAR amounts change. If an item being manufactured needs a product costing $20, it stands to reason that every unit produced will need one of the product costing $20. Common variable costs are DIRECT LABOR and RAW MATERIALS. A MIXED COST includes both FIXED AND VARIABLE components. We will not deal with these costs. A STEP WISE COST simply means that another lump sum cost has to be incurred within the relevant range. Usually this is the addition of another supervisor when another shift is added due to increased volume. We will not deal with these costs. Curvilinear Costs increase in a nonlinear manner (i.e. not directly proportional to volume). We will not deal with these costs. No Scatter Diagrams, high-low method, or least squares regression or comparison of cost estimation methods either!!!! You will get that in plenty of other courses. USING BREAKEVEN ANALYSIS We must know breakeven analysis. We use what is called the contribution margin to solve for the break even point. The definition of contribution margin is: the amount a product’s unit selling price exceeds it total unit variable cost. This excess contributes to covering the fixed costs and then generating profits on a per unit basis. Let’s use an example to get to the bottom of this. If the product selling price (i.e. what the company is selling its finished good for) is $100 and the total variable costs per unit are $70, then the contribution margin per unit is $30. Think of it as the profit made using JUST the variable costs and ignoring the fixed costs. Contribution margin per unit = Sales price less total variable costs We often express this in percent as well and it is called the contribution margin ratio: Contribution Margin Ratio = Using numbers: Contribution margin per unit _______________________________ Sales price per unit. $30 contribution per unit __________________________ = 30% $100 sales price per unit Now, we still have fixed costs to cover since we know that every product has BOTH variable and fixed costs to manufacturer. We now have to figure out how many units of the product we need to sell to COVER THE FIXED COSTS. That will determine the BREAKEVEN point. We can express breakeven in either UNITS SOLD or total dollars of sales. First, breakeven in units: Breakeven = Fixed Costs _________________________ Contribution margin per unit Clearly, we just calculated the contribution margin per unit above as $30 for that product. Let’s assume that management is estimating $24,000 in fixed costs. Then $24,000 fixed costs divided by the contribution margin per unit of $30 gives you 800 Units sold per month to arrive at breakeven. For breakeven in dollars: Breakeven = Fixed costs ______________________ Contribution margin ratio $24,000 fixed costs _________________________ = $80,000 sales 30% contribution margin ratio Expressed either way, you need to sell 800 units at $100 per unit or $80,000 in total sales in order to break even given $24,000 of fixed costs and a contribution margin per unit of $30 ( remember the $30 is simply the sales price of $100 less the variable costs of $70). If you want to determine how many units to sell to make a profit of some amount (i.e. assume $10,000 profit), then you simply add the amount of the expected profit to the fixed costs to determine breakeven. Example, using the information above, if you want to make a profit of $10,000, you would add the $10,000 to the $24,000 of fixed costs (i.e. total of $34,000) and then divide by the $30 contribution per unit. The result is $34,000/30 which is 1,133 units. To prove it out: Units Sold 1,133 Sale price per unit $100 = Var cost is 1,133x $70 = Contribution margin = Less fixed costs Equals profit = total revenue of total var costs of $ 113,300 79,310 33,990 24,000 9,990 rounds to $10,000