2-1

End of Part 1 Agenda for the Evening

(Week 10 of 13)
Review of CVP Part 1
u Exercises/Problems/Questions u

u Coming Up: Chapter 8 Test (Blackboard)

u Problem 8.1
u Other Questions/Concerns/Comments

u Completing CVP Analysis (Part 2 of 2)

© 2017 McGraw-Hill Education 39 © 2017 McGraw-Hill Education 40

Target Profit Analysis Review of the CVP Formula

Suppose Wind Co. wants to know how many u Sales = Variable expenses + Fixed expenses + Profits
bikes must be sold to earn a profit of
$100,000.
u Sales Price x Q = (Variable Cost x Q) + Fixed + Profits
We can use our CVP formula to determine
the sales volume needed to achieve a
target net profit figure.

© 2017 McGraw-Hill Education 41 © 2017 McGraw-Hill Education 42

The CVP Equation Contribution Margin Approach

Sales = Variable expenses + Fixed expenses + Profits

$500Q = $300Q + $80,000 + $100,000 Units to attain = Fixed Cost + Profit /

target profit Contribution Margin
$200Q = $180,000

Q = 900 bikes

© 2017 McGraw-Hill Education 43 © 2017 McGraw-Hill Education 44

 2-2

The Contribution Margin Approach Quick Check ü

We can determine the number of bikes that must be Coffee Klatch is an espresso stand in a
sold to earn a profit of $100,000 using the downtown office building. The average
contribution margin approach. selling price of a cup of coffee is $1.49
and the average variable expense per cup
Units sold to attain Fixed expenses + Target profit is $0.36. The average fixed expense per
= month is $1,300. How many cups of
the target profit Unit contribution margin
coffee would have to be sold to attain
target profits of $2,500 per month?
$80,000 + $100,000 a. 3,363 cups
= 900 bikes
$200 b. 2,212 cups
c. 1,150 cups
d. 4,200 cups

© 2017 McGraw-Hill Education 45 © 2017 McGraw-Hill Education 46

Quick Check Solutionü The Effect of Income Tax

To this point, taxes have been ignored;
Coffee Klatch is an espresso stand in a however tax is a real expense for
downtown office building. The average organizations that they must consider
selling price of a cup of coffee is $1.49 and in their decision making.
the average q variable F + Target profit
to attainexpense
target =per cup is To convert after-tax income into its
$0.36. The average fixed expense percm month before-tax equivalent we would use
is $1,300. How many cups$1,300 + $2,500
of coffee would the following formula:
=
have to be sold to attain target profits
$1.49 of
- $0.36
$2,500 per month? $3,800 Before-tax income = After-tax income / (1 – t)
a. 3,363 cups
=
$1.13
= 3,363
© 2017 McGraw-Hill Education 47 © 2017 McGraw-Hill Education 48

Calculating BTI and ATI Quick Check ü

Coffee Klatch is an espresso stand in a
downtown office building with an average
u If Jane earns $50,000 per year BTI, tax rate of 20%. The average selling price
and her average tax rate is 25%, ATI of a cup of coffee is $1.49 and the average
variable expense per cup is $0.36. The
is $50,000 x (1-TAX%) or $37,500 average fixed expense per month is
$1,300. How many cups of coffee would
have to be sold to attain target profits of
u If Jane desires to earn $50,000 ATI, $2,500 per month ATI?
a. 3,363 cups
and her average tax rate is 25%, BTI b. 2,212 cups

needs to be $50,000/(1-TAX%) or c. 3,916 cups

d. 4,200 cups
$66,667
© 2017 McGraw-Hill Education 49 © 2017 McGraw-Hill Education 50
 2-3

Including Taxes The Margin of Safety

Excess of budgeted (or actual) sales over the break-even
volume of sales.
1300+((2500/(1-TAX%)) The amount by which sales can drop before losses begin to
= ____________________ be incurred.

1.49-0.36 Margin of safety = Total sales - Break-even sales

*3916 cups
1300+(2500/0.80) Margin of safety percentage = Margin of safety in dollars
Total budgeted (or actual) sales
= ________________
1.13 Let’s calculate the margin of
safety for Wind.

© 2017 McGraw-Hill Education 51 © 2017 McGraw-Hill Education 52

The Margin of Safety The Margin of Safety

Example Part 1 Example Part 2
Wind has a break-even point of $200,000. If The margin of safety can be expressed
actual sales are $250,000, the margin of safety
as 20 percent of sales.
is $50,000 or 100 bikes.
($50,000 ÷ $250,000)
Break-even
sales Actual sales
Break-even
400 units 500 units sales Actual sales
Sales $ 200,000 $ 250,000 400 units 500 units
Less: variable expenses 120,000 150,000 Sales $ 200,000 $ 250,000
Contribution margin 80,000 100,000 Less: variable expenses 120,000 150,000
Less: fixed expenses 80,000 80,000 Contribution margin 80,000 100,000
Net income $ - $ 20,000 Less: fixed expenses 80,000 80,000
Net income $ - $ 20,000

© 2017 McGraw-Hill Education 53 © 2017 McGraw-Hill Education 54

Quick Check ü Quick Check Solution ü

Coffee Klatch is an espresso stand in a Coffee Klatch is an espresso stand in a
downtown office building. The average downtown office building.
Margin The
of safety = Total sales average
- Breakeven sales
selling price of a cup of coffee is $1.49 and
the average variable expense per cup is
selling price of a cup =of coffee
2,100 cups - 1,150is $1.49
cups

$0.36. The average fixed expense per and the average variable expense per
= 950 cups
month is $1,300. 2,100 cups are sold each cup is $0.36. The average fixed expense
or
month on average. What is the margin of per month is $1,300. 2,100 cups are sold
safety? each month on Margin
average. = What =is45% the
of safety 950 cups
percentage 2,100 cups
a. 3,250 cups margin of safety?
b. 950 cups
b. 950 cups
c. 1,150 cups
d. 2,100 cups

© 2017 McGraw-Hill Education 55 © 2017 McGraw-Hill Education 56

 2-4

Operating Leverage Operating Leverage Example

q A measure of how sensitive net income is Actual sales

500 Bikes
to percentage changes in sales.
Sales $ 250,000
q With high leverage, a small percentage Less: variable expenses 150,000
increase in sales can produce a much Contribution margin 100,000
larger percentage increase in net income. Less: fixed expenses 80,000
Net income $ 20,000
Degree of Contribution margin
operating leverage = Net income
$100,000 = 5
$20,000
© 2017 McGraw-Hill Education 57 © 2017 McGraw-Hill Education 58

Operating Leverage Operating Leverage

With a measure of operating leverage of 5, if Wind increases

Actual sales Increased
its sales by 10%, net income would increase by 50%.
(500) sales (550)
Sales $ 250,000 $ 275,000
Less variable expenses 150,000 165,000
Percent increase in sales 10% Contribution margin 100,000 110,000
Degree of operating leverage × 5 Less fixed expenses 80,000 80,000
Net income $ 20,000 $ 30,000
Percent increase in profits 50%
10% increase in sales from
$250,000 to $275,000 . . .
Here’s the proof… . . . results in a 50% increase in
income from $20,000 to $30,000.
© 2017 McGraw-Hill Education 59 © 2017 McGraw-Hill Education 60

Quick Check Solution ü

Quick Check ü Actual sales
2,100 cups
Coffee Klatch is an espresso stand in a Coffee Klatch is an espresso
Sales stand in a$ 3,129
downtown office building. The average Less: Variable expenses 756
downtown office building. The average selling
selling price of a cup of coffee is $1.49 Contribution margin 2,373
and the average variable expense per cup price of a cup of coffee
Less:isFixed
$1.49 and the 1,300
expenses
is $0.36. The average fixed expense per average variable expense per cup is $0.36.
Net income $ The
1,073
month is $1,300. 2,100 cups are sold average fixed expense per month is $1,300.
each month on average. What is the
operating leverage?
2,100 cups are sold each month on average.
Operating Contribution margin
What is the operating leverage?
=
a. 2.21 leverage Net income
b. 0.45 a. 2.21
c. 0.34 $2,373
= = 2.21
d. 2.92 $1,073

© 2017 McGraw-Hill Education 61 © 2017 McGraw-Hill Education 62

 2-5

Quick Check ü Quick Check Solution ü

At Coffee Klatch the average selling price of a At Coffee Klatch the average
cup of coffee is $1.49, the average variable selling price of a cup of coffee is
expense per cup is $0.36, and the average $1.49, the average variable expense
fixed expense per month is $1,300. 2,100 cups per cup is $0.36, and the average
are sold each month on average.
fixed expense per month is $1,300.
If sales increase by 20%, by how much should 2,100 cups are sold each month on
net income increase?
a. 30.0%
average.
Percent increase in sales 20.00%
b. 20.0% If sales increase byoperating
x Degree of 20%, by leverage
how 2.21
c. 22.1% much should net income
Percent increaseincrease?
in profit 44.20%
d. 44.2% d. 44.2%

© 2017 McGraw-Hill Education 63 © 2017 McGraw-Hill Education 64

Multi-Product Break-Even
Analysis Multi-Product BEP
q Many companies have multiple products, often
these products are not equally profitable; thus
overall profit depends on the sales mix.
q Sales Mix: the relative proportions in which
a company’s products/services are sold
q Break-even analysis is more complex for multi-
product companies as each product will have a
different selling price, costs, and contribution
margins

© 2017 McGraw-Hill Education 65 © 2017 McGraw-Hill Education 66

u Example:
u The BBA company manufactures three products –
product X, product Y and product Z. The variable
Weighted Average expenses and sales prices of all the products are
given below:

u The weighted average selling price is worked out

as follows:
u (Sale price of product A × Sales percentage of u The total fixed expenses of the company are
product A) + (Sale price of product B × Sale $50,000 per month. For the coming moth. Monster
percentage of product B)... expects the sale of three products in the following
ratio:
u The weighted average variable expenses are Product X: 20%;
worked out as follows: Product Y: 30%;
Product Z: 50%
u (Variable expenses of product A × Sales percentage
of product A) + (Variable expenses of product B × u Required: Compute the break-even point of
Sales percentage of product B)... BBA company in units and dollars for the coming
month.

© 2017 McGraw-Hill Education 67 © 2017 McGraw-Hill Education 68

 2-6

BBA Company Solution Absorption Costing and

u *Weighted average selling price: Variable Costing
= ($200 × 20%) + ($100 × 30%) + ($50 × 50%)
= $40 + $30 + $25 Absorption Costing: Variable Costing:
= $95
• all product costs (both • Only manufacturing costs
u *Weighted average variable expenses: fixed and variable) are that vary with output are
= ($100 × 20%) + ($75 × 30%) + ($25 × 50%) assigned to products. treated as product costs
(DM, DL & variable MOH)
= $20 + 22.50 + 12.50 • Both the COGM and COGS
= $55 will consist of both fixed • Both the COGM and COGS
and variable costs of will consist of only
manufacturing variable costs of
manufacturing.
u FC / CM per unit
• Fixed manufacturing costs
u $50,000 / (95-55) are treated as period
u The company will have to sell 1,250 units to break- costs and expensed during
the accounting period.
even

© 2017 McGraw-Hill Education 69 © 2017 McGraw-Hill Education 70

Computation of Product Costs

under Absorption and Variable
Costing To illustrate
the
difference
between
variable and
absorption
costing we
will look at
an example:

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An Example: Unit Product

Cost
The first step is to calculate the unit product cost. We
will calculate the unit product cost under both variable
and absorption costing:
Variable Costing includes
only variable costs in the
unit product cost. Fixed
costs are all expensed.
Absorption
Costing
includes the
FMOH in the
product cost.
An Example: Unit Product Cost
q Recap from previous slide: absorption costing:
q Fixed MOH is included in product cost
q Fixed MOH cost per unit = total FMOH/# of units
produced
q For simplicity, we will use the actual production
quantity as the denominator activity level (therefore
assuming the company is using an actual costing
system).
q Under a normal costing system a predetermined
fixed overhead rate will be used (denominator uses
budgeted quantity) and will typically result in
over- or underapplied overhead.

© 2017 McGraw-Hill Education 73 © 2017 McGraw-Hill Education 74

 2-7

Variable Costing Contribution

Format Income Statement

We now need to reconcile the variable costing income with the

absorption costing income…

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Reconciliation Comparative Income Effects –

Absorption and Variable Costing
The variable and the absorption costing net operating incomes can be
reconciled by determining how much fixed manufacturing overhead
was deferred in, or released from, inventories during the period:

© 2017 McGraw-Hill Education 77 © 2017 McGraw-Hill Education 78

Advantages of Variable Costing Chapter Summary

and the Contribution Approach
u The contribution margin income statement is the basis
Variable costing combined with the contribution for cost-volume-profit analysis. This statement
approach, creates many advantages for internal separates costs according to their behavior.

reports: u CVP analysis provides information on sales, margins and

profitability. Managers can use this analysis to
q Enabling CVP analysis determine the breakeven point, revenues required to
q Explaining changes in net operating income make target profit, margin of safety, and degree of
q Supporting decision making operating leverage.
u Multi-product companies can also complete this analysis
but must take sales mix into account.
u Under absorption costing, fixed and variable product
costs are assigned to products whereas variable costing
only includes variable cost of goods sold to determine
the cost of a product.

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 2-8

End of Part 2

u Let's complete Problem 8.2

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