Garrison Lecture Chapter - Managerial Accounting and The Business Environment

Chapter
1
Managerial Accounting
and the Business
Environment
1-2
Learning Objectives
After studying this chapter, you should be able to:
1. Identify the major differences and

similarities between financial and
managerial accounting.
2. Understand the role of management
accountants in an organization.
3. Understand the basic concepts underlying
just-in-time (JIT), total quality management
(TQM), process reengineering, and the
theory of constraints (TOC).
© McGraw-Hill Ryerson Limited., 2004
1-3
Learning Objectives
After studying this chapter, you should be able to:
4. Discuss the impact of international
competition on businesses and on
managerial accounting.
5. Explain the importance of upholding ethical
standards.

1-4
Managerial Accounting and

Financial Accounting
Managerial accounting Financial accounting

provides information provides information
to managers of an to stockholders,
organization who creditors, and others
direct and control who are outside
its operations. the organization.

1-5
Work of Management
Planning
Directing and
Motivating
Controlling

1-6
Planning and Control Cycle

Formulating long- and Begin
short-term plans
(Planning)
Comparing actual to Implementing

planned performance Decision plans (Directing and
(Controlling) Making Motivating)
Measuring
performance
(Controlling)
1-7
Comparison of Financial and

Financial Managerial
Accounting Accounting
1. Users External persons who Managers who plan for
make financial decisions and control an organization
2. Time focus Historical perspective Future emphasis
3. Emphasis Objectivity and Relevance

Verifiability for planning and control
4. Importance Precision of information Timeliness of information

5. Subject focus Summarized data for Detailed segment reports
the whole organization of an organization
6. Requirements Must follow GAAP Need not follow GAAP
and required for and no mandatory use
external reports

1-8
Expanding Role of Managerial

Accounting
Increasing complexity and
size of organizations
Regulatory
environment
Factors that
Increased
increase the need for
emphasis
managerial accounting
on quality
information
World-wide
competition
Rapid development and
implementation of technology
1-9
Organizational Structure
An organization is a group of people
united for a common purpose.
Corporate Organization Chart

Board of Directors
President
Purchasing Personnel Vice President Chief Financial

Operations Officer
Treasurer Controller
1-10
Decentralization
Decentralization is the delegation of decision-
making authority throughout an organization.
Corporate Organization Chart

Board of Directors
President
Purchasing Personnel Vice President Chief Financial

Operations Officer
Treasurer Controller
1-11
Line and Staff Relationships
Line positions are Staff positions support

directly involved in and assist line
achievement of the positions.
basic objectives of an ❖ Example: Cost
organization. accountants in the
❖ Example: Production manufacturing plant.
supervisors in a
manufacturing plant.

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The Controller
The chief accountant in an organization

with responsibility for:
❖Financial planning and analysis.
❖Cost control.
❖Financial reporting.
❖Accounting information systems.

1-13
The Professional Management

Accountant
⚫ Three types of professional accountants
work as management accountants in
Canada:
❖CGA.
❖CA.
❖CMA.

1-14
The Changing Business

Environment
A more competitive
environment emphasizing:
 Higher quality products
 Lower prices and costs
 Global competition Business environment
changes in the past
 Meeting and anticipating
customer needs twenty years

1-15
The Changing Business

Environment
New tools for

managers!
Just-In-Time
Total Quality
Management
Process Reengineering
Theory of Constraints

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Just-in-Time (JIT) Systems

Receive
customer Complete products
orders. just in time to
ship to customers.
Schedule
production.
Receive materials Complete parts

just in time for just in time for
production. assembly into products.

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Key Elements for a Successful

JIT System
Zero production
Improved defects
plant layout
Reduced Flexible
setup time workforce
JIT purchasing
Fewer, but more ultra-reliable suppliers.
Frequent JIT deliveries in small lots.
Defect-free supplier deliveries.
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Benefits of a JIT System
Reduced Greater
inventory customer
costs satisfaction
Higher quality
products
More rapid
response to
Less warehouse customer orders
space needed

1-19
Total Quality Management

Where are we?
Benchmarking
Where do we want to go?
Plan
Do we need How do
to change Act Do we start?
the plan? is
Check Continuous
Improvement
How are we doing?
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A business process
is diagrammed
in detail.
Every step in The process is

the business redesigned to include
process must only those steps that add
be justified. value to the product.

1-21
A business process Anticipated results:
is diagrammed  Process is simplified.
in detail.  Process is completed
in less time.
 Costs are reduced.
 Opportunities for
errors are reduced.
Every step in The process is

the business redesigned to include
process must only those steps that make
be justified. the product more valuable.

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Theory of Constraints
A sequential process of identifying and

removing constraints in a system.
Restrictions or barriers that impede

progress toward an objective

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International Competition
Meeting world-class competition demands a

world-class management accounting system.
Managers must make decisions to plan, direct,
and control a world-class organization.

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Professional Ethics in Accounting
⚫ Ethical accounting practices build trust and

promote loyal, productive relationships with
users of accounting information.
⚫ Many companies and professional
organizations, such as the International
Federation of Accountants (IFAC),
have written codes of ethics that
serve as guides.

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IFAC Code of Ethics for

Professional Accountants
Competence
Confidentiality
Integrity
Objectivity

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End of Chapter 1

1-27

and Cost Concepts
1-29
Learning Objective 1
Understand cost
classifications used for
assigning costs to cost
objects: direct costs and
indirect costs..

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Assigning Costs to Cost Objects

Direct costs Indirect costs
• Costs that can be easily and • Costs that cannot be easily and
conveniently traced to a unit of conveniently traced to a unit of
product product
or other cost object. or other cost object.
• Examples: direct material and • Example: manufacturing Overhead
direct labor
Common costs
Indirect costs incurred to support a
number
of cost objects. These costs cannot be
traced to any individual cost object.

1-31
Identify and give examples

of each of the three basic
manufacturing cost
categories.

1-32
Manufacturing Costs
Direct Direct Manufacturing

Materials Labor Overhead
The Product

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Direct Materials
Raw materials that become an integral

part of the product and that can be
conveniently traced directly to it.
Example: A radio installed in an automobile

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Direct Labor
Those labor costs that can be easily

traced to individual units of product.
Example: Wages paid to automobile assembly workers

1-35
Manufacturing Overhead
Manufacturing costs that cannot be traced
directly to specific units produced.
Examples: Indirect materials and indirect labor
Materials used to support Wages paid to employees

the production process. who are not directly
involved in production
Examples: lubricants and work.
cleaning supplies used in the Examples: maintenance
automobile assembly plant. workers, janitors and
security guards.

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Nonmanufacturing Costs
Selling Administrative
Costs Costs
Costs necessary to All executive,

secure the order and organizational, and
deliver the product. clerical costs.

1-37
Distinguish between
product costs and period
costs and give examples
of each.

1-38
Product Costs Versus Period Costs
Product costs include Period costs include all

direct materials, direct selling costs and
labor, and administrative costs.
manufacturing
overhead.
Inventory Cost of Good Sold Expense
Sale
Balance Income Income

Sheet Statement Statement
1-39
Quick Check ✓
Which of the following costs would be

considered a period rather than a product
cost in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
1-40
Quick Check ✓
Which of the following costs would be

considered a period rather than a product
cost in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production
facility.
E. Sales commissions.
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Classifications of Costs
Manufacturing costs are often

classified as follows:
Direct Direct Manufacturing
Material Labor Overhead
Prime Conversion
Cost Cost

1-42
Comparing Merchandising and

Manufacturing Companies
Merchandisers . . . Manufacturers . . .
➢ Buy finished ➢ Buy raw
goods. materials.
➢ Sell finished ➢ Produce and sell
goods. finished goods.
MegaLoMart
McGraw-Hill/Irwin © McGraw-Hill Ryerson Limited., 2004

1-43
Balance Sheet
Merchandiser Manufacturer
Current assets Current Assets
◆Cash Cash
Receivables
◆Receivables
Inventories
◆Merchandise • Raw Materials
Inventory • Work in Process
• Finished Goods

1-44
Balance Sheet
Merchandiser Manufacturer
Current assets Current Assets
◆ Cash Cash waiting to
Materials
◆ Receivables Receivables
be processed.
◆ Merchandise Inventory Inventories
Partially complete
products – some • Raw Materials
material, labor, or • Work in Process
overhead has been • Finished Goods
added.
Completed products
awaiting sale.

1-45
Prepare an income
statement including
calculation of the cost of
goods sold.

1-46
The Income Statement

Cost of goods sold for manufacturers differs
only slightly from cost of goods sold for
merchandisers.
Merchandising Company Manufacturing Company
Cost of goods sold: Cost of goods sold:
Beg. merchandise Beg. finished
inventory $ 14,200 goods inv. $ 14,200
+ Purchases 234,150 + Cost of goods
Goods available manufactured 234,150
for sale $ 248,350 Goods available
- Ending for sale $ 248,350
merchandise - Ending
inventory (12,100) finished goods
= Cost of goods inventory (12,100)
sold $ 236,250 = Cost of goods
sold $ 236,250

1-47
Basic Equation for Inventory

Accounts
Withdrawals
Beginning Additions Ending
balance + to inventory = balance + from
inventory

1-48
Quick Check ✓
If your inventory balance at the beginning

of the month was $1,000, you bought
$100 during the month, and sold $300
during the month, what would be the
balance at the end of the month?
A. $1,000.
B. $ 800.
C. $1,200.
D. $ 200.
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Quick Check ✓
If your inventory balance at the beginning

of the month was $1,000, you bought
$100 during the month, and sold $300
during the month, what would be the
balance at the$1,000 + $100
end of = $1,100
the month?
$1,100 - $300 = $800
A. $1,000.
B. $ 800.
C. $1,200.
D. $ 200.
1-50
Prepare a schedule of cost

of goods manufactured.

1-51
Schedule of Cost of Goods

Manufactured
Calculates the cost of raw
material, direct labor, and
manufacturing overhead
used in production.
Calculates the manufacturing

costs associated with goods
that were finished during the
period.
1-52
Product Cost Flows

Manufacturing Work
Raw Materials Costs In Process
Beginning raw Direct materials

materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production
– Ending raw materials
inventory
= Raw materials used
As items are removed from raw
in production materials inventory and placed into
the production process, they are
called direct materials.
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Product Cost Flows

Manufacturing Work
Conversion
Beginning raw Direct materials
materials inventory + Direct labor
costs are costs
+ Raw materials + Mfg. overhead incurred to
purchased = Total manufacturing convert the
= Raw materials costs
direct material
available for use
in production into a finished
– Ending raw materials product.
inventory
= Raw materials used
in production

1-54
Product Cost Flows

Manufacturing Work
Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials
inventory All manufacturing costs incurred
= Raw materials used during the period are added to the
in production
beginning balance of work in
process.

1-55
Product Cost Flows

Manufacturing Work
Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
inventory
Costs associated with the goods that process inventory
= Raw materials used = Cost of goods
areincompleted
production
during the period are manufactured
transferred to finished goods
inventory.

1-56
Product Cost Flows

Work
In Process Finished Goods
Beginning work in Beginning finished

process inventory goods inventory
+ Manufacturing costs + Cost of goods
for the period manufactured
= Total work in process = Cost of goods
for the period available for sale
– Ending work in - Ending finished
process inventory goods inventory
= Cost of goods Cost of goods
manufactured sold

1-57
Manufacturing Cost Flows

Balance Sheet Income
Costs Inventories Statement
Expenses
Material Purchases Raw Materials
Direct Labor Work in

Process
Manufacturing
Overhead Cost of
Finished
Goods
Goods
Sold
Selling and Period Costs Selling and

Administrative Administrative
1-58
Quick Check ✓
Beginning raw materials inventory was $32,000.

During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. What is the cost of direct material
used?
A. $276,000
B. $272,000
C. $280,000
D. $ 2,000
1-59
Quick Check ✓
Beginning raw materials inventory was $32,000.

During the month, $276,000 of raw material was
purchased. A count at the end of the month
revealed that $28,000 of raw material was still
present. What is the cost
Beg.of direct
raw material$ 32,000
materials
+ Raw materials
used? purchased 276,000
A. $276,000 = Raw materials available
for use in production $ 308,000
B. $272,000 – Ending raw materials
C. $280,000 = Rawinventory
materials used
28,000
D. $ 2,000 in production $ 280,000

1-60
Quick Check ✓
Direct materials used in production totaled

$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?
A. $555,000
B. $835,000
C. $655,000
D. Cannot be determined.

1-61
Quick Check ✓
Direct materials used in production totaled

$280,000. Direct labor was $375,000 and
factory overhead was $180,000. What were
total manufacturing costs incurred for the
month?
A. $555,000
B. $835,000 Direct Materials $ 280,000
C. $655,000 + Direct Labor 375,000
+ Mfg. Overhead 180,000
D. Cannot be=determined.
Mfg. Costs Incurred
for the Month $ 835,000

1-62
Quick Check ✓
Beginning work in process was $125,000.

Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month?
A. $1,160,000
B. $ 910,000
C. $ 760,000

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Quick Check ✓
Beginning work in process was $125,000.

Manufacturing costs incurred for the month
were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the
Beginning work month.
in
process inventory $ 125,000
What was the cost of goods manufactured
+ Mfg. costs incurred
during the month? for the period 835,000
A. $1,160,000 = Total work in process

during the period $ 960,000
B. $ 910,000 – Ending work in
C. $ 760,000 = Costprocess inventory
of goods
200,000
manufactured $ 760,000

1-64
Quick Check ✓
Beginning finished goods inventory was

$130,000. The cost of goods manufactured for
the month was $760,000. And the ending
finished goods inventory was $150,000. What
was the cost of goods sold for the month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000.

1-65
Quick Check ✓
Beginning finished goods inventory was

$130,000. The cost of goods manufactured for
the month was $760,000. And the ending
finished goods inventory was $150,000. What
was the cost of goods sold for the month?
A. $ 20,000.
B. $740,000. $130,000 + $760,000 = $890,000
C. $780,000. $890,000 - $150,000 = $740,000
D. $760,000.

1-66
Understand the
differences between
variable costs and fixed
costs.

1-67
Cost Classifications for Predicting

Cost Behavior
How a cost will react to
changes in the level of
activity within the
relevant range.
❖ Total variable costs
change when activity
changes.
❖ Total fixed costs
remain unchanged
when activity changes.

1-68
Variable Cost
Your total texting bill is based on how

many texts you send.
Total Texting Bill
Number of Texts Sent

1-69
Variable Cost Per Unit
The cost per text sent is constant at

5 cents per text.
Cost Per Text Sent

Number of Texts Sent
1-70
Fixed Cost
Your monthly contract fee for your cell
phone is fixed for the number of monthly
minutes in your contract. The monthly
contract fee does not change based on the
Monthly Cell Phone
number of calls you make.

Contract Fee
Number of Minutes Used

Within Monthly Plan
1-71
Fixed Cost Per Unit

Within the monthly contract allotment, the average
fixed cost per cell phone call made decreases as
more calls are made.
Monthly Cell Phone

Contract Fee
Number of Minutes Used
Within Monthly Plan
1-72
Cost Classifications for Predicting

Cost Behavior
Behavior of Cost (within the relevant range)

Cost In Total Per Unit
Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.

1-73
Quick Check ✓
Which of the following costs would be variable

with respect to the number of cones sold at a
Baskins & Robbins shop? (There may be more
than one correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.

1-74
Quick Check ✓
Which of the following costs would be variable

with respect to the number of cones sold at a
Baskins & Robbins shop? (There may be more
than one correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.

1-75
Understand the
differences between direct
and indirect costs.

1-76
Assigning Costs to Cost

Objects
Direct costs Indirect costs
⚫ Costs that can be ⚫ Costs that cannot
easily and be easily and
conveniently traced conveniently traced
to a unit of product to a unit of product
or other cost object. or other cost object.
⚫ Examples: direct ⚫ Example:
material and direct manufacturing
labor overhead
McGraw-Hill/Irwin © McGraw-Hill Ryerson Limited., 2004

1-77
Define and give examples
of cost classifications used
in making decisions:
differential costs,
opportunity costs, and
sunk costs.

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Cost Classifications for Decision

Making
⚫ Every decision involves a
choice between at least two
alternatives.
⚫ Only those costs and benefits

that differ between alternatives
are relevant in a decision. All
other costs and benefits can
and should be ignored.

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Differential Cost and Revenue
Costs and revenues that differ

among alternatives.
Example: You have a job paying $1,500 per month in
your hometown. You have a job offer in a neighboring
city that pays $2,000 per month. The commuting cost
to the city is $300 per month.
Differential revenue is: Differential cost is:

$2,000 – $1,500 = $500 $300

1-80
Opportunity Cost
The potential benefit that is given
up when one alternative is selected
over another.
Example: If you were

not attending college,
you could be earning
$15,000 per year.
Your opportunity cost
of attending college for
one year is $15,000.

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Sunk Costs
Sunk costs have already been incurred

and cannot be changed now or in the
future. These costs should be ignored
when
Example: You making
bought decisions.
an automobile that cost
$10,000 two years ago. The $10,000 cost is sunk
because whether you drive it, park it, trade it, or sell
it, you cannot change the $10,000 cost.

1-82
Quick Check ✓
Suppose you are trying to decide whether to

drive or take the train to Portland to attend a
concert. You have ample cash to do either, but
you don’t want to waste money needlessly. Is
the cost of the train ticket relevant in this
decision? In other words, should the cost of the
train ticket affect the decision of whether you
drive or take the train to Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.

1-83
Quick Check ✓

the cost of the train ticket relevant in this
decision? In other words, should the cost of the
train ticket affect the decision of whether you
drive or take the train to Portland?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.

1-84
Quick Check ✓

the annual cost of licensing your car relevant in
this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.

1-85
Quick Check ✓

the annual cost of licensing your car relevant in
this decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.

1-86
Quick Check ✓
Suppose that your car could be sold now for

$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.

1-87
Quick Check ✓
Suppose that your car could be sold now for

$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.

1-88
Summary of the Types of Cost

Classifications
Financial Predicting Cost

Reporting Behavior
Assigning Costs Making Business

to Cost Objects Decisions

Further Classification of Labor
Costs
Appendix 2A
1-90
(Appendix 2A)
Properly account for labor
costs associated with idle
time, overtime, and fringe
benefits.

1-91
Idle Time
Machine Material
Breakdowns Shortages
Power
Failures
The labor costs incurred

during idle time are ordinarily
treated as manufacturing
overhead.
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Overtime
The overtime premiums for all factory

workers are usually considered to be part
of manufacturing overhead.

1-93
Labor Fringe Benefits
Fringe benefits include employer paid costs for

insurance programs, retirement plans,
supplemental unemployment programs, Social
Security, Medicare, workers’ compensation,
and unemployment taxes.
Some companies Other companies treat

include all of these fringe benefit
costs in expenses of direct
manufacturing laborers as additional
overhead. direct labor costs.
Cost of Quality
Appendix 2B
1-95
(Appendix 2B)
Identify the four types of
quality costs and explain
how they interact.

1-96
Quality of Conformance
When the overwhelming majority of products

produced conform to design specifications
and are free from defects.

1-97
Prevention and Appraisal Costs

Support activities
Prevention whose purpose is to
Costs reduce the number of
defects
Incurred to identify
defective products
Appraisal Costs before the products are
shipped to customers

1-98
Internal and External Failure Costs

Incurred as a result of
Internal Failure
identifying defects
Costs before they are shipped
Incurred as a result of
External Failure defective products
Costs being delivered to
customers

1-99
Examples of Quality Costs

Appraisal Costs
Prevention Costs
• Testing and inspecting
• Quality training
incoming materials
• Quality circles
• Final product testing
• Statistical process
• Depreciation of testing
control activities
equipment
External Failure Costs

Internal Failure Costs
• Cost of field servicing and
• Scrap
handling complaints
• Spoilage
• Warranty repairs
• Rework
• Lost sales

1-
100
Distribution of Quality Costs

1-
101
(Appendix 2B)
Prepare and interpret a
quality cost report.

Quality Cost Report 1-
For Years 1 and 2 102
Year 2 Year 1
Amount Percent* Amount Percent*
Prevention costs:
Systems development $ 400,000 0.80% $ 270,000 0.54%
Quality training 210,000 0.42% 130,000 0.26%
Supervision of prevention activities 70,000 0.14% 40,000 0.08%
Quality improvement 320,000 0.64% 210,000 0.42%
Total prevention cost 1,000,000 2.00% 650,000 1.30%
Appraisal costs:
Inspection 600,000 1.20% 560,000 1.12%
Quality cost
Reliability testing
Supervision of testing and inspection
580,000
120,000
1.16%
0.24%
420,000
80,000
0.84%
0.16%
reports provide
Depreciation of test equipment 200,000 0.40% 140,000 0.28% an estimate of
Total appraisal cost 1,500,000 3.00% 1,200,000 2.40%
the financial
Internal failure costs:
Net cost of scrap 900,000 1.80% 750,000 1.50% consequences
Rework labor and overhead 1,430,000 2.86% 810,000 1.62%
Downtime due to defects in quality 170,000 0.34% 100,000 0.20% of the
Disposal of defective products
Total internal failure cost
500,000
3,000,000
1.00%
6.00%
340,000
2,000,000
0.68%
4.00% company’s
External failure costs:
current defect
Warranty repairs
Warranty replacements
400,000
870,000
0.80%
1.74%
900,000
2,300,000
1.80%
4.60%
rate.
Allowances 130,000 0.26% 630,000 1.26%
Cost of field servicing 600,000 1.20% 1,320,000 2.64%
Total external failure cost 2,000,000 4.00% 5,150,000 10.30%
Total quality cost $ 7,500,000 15.00% $ 9,000,000 18.00%
* As a percentage of total sales. In each year sales totaled $50,000,000.

1-
103
Quality Cost Reports in Graphic

Form
$10 20
9
Quality 18
Quality Cost as a Percentage of Sales

8
reports 16
Quality Cost (in millions)
7
External External
can also 14
External External
6 Failure Failure be 12 Failure Failure
5 prepared 10
4 Internal
Failure
in 8 Internal
Failure
3 Internal
Failure
graphic 6 Internal
Failure
2
Appraisal form. 4
Appraisal
Appraisal Appraisal
1 2
Prevention Prevention Prevention Prevention
0 0
1 2 1 2
Year Year
1-
104
Uses of Quality Cost Information

Help managers see the
financial significance of
defects.
Help managers identify

the relative importance
of the quality problems.
Help managers see
whether their quality
costs are poorly
distributed.
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105
Limitations of Quality Cost

Information
Simply measuring and
reporting quality cost
problems does not solve
quality problems.
Results usually lag

behind quality
improvement programs.
The most important

quality cost, lost sales, is
often omitted from
quality cost reports.
1-
106
ISO 9000 Standards

ISO 9000 standards have become
international measures of quality.
To become ISO 9000 certified, a
company must demonstrate:
1. A quality control system is in use, and the
system clearly defines an expected level of
quality.
2. The system is fully operational and is
backed up with detailed documentation of
quality control procedures.
3. The intended level of quality is being
achieved on a sustained basis.

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107
End of Chapter 2

1-
108

Cost-Volume-Profit Relationships
Chapter 5
1-
110
Key Assumptions of CVP Analysis
1. Selling price is constant.

2. Costs are linear and can be accurately
divided into variable (constant per unit)
and fixed (constant in total) elements.
3. In multiproduct companies, the sales mix is
constant.
4. In manufacturing companies, inventories
do not change (units produced = units
sold).

1-
111
Explain how changes in

activity affect contribution
margin and net operating
income.

1-
112
Basics of Cost-Volume-Profit Analysis

The contribution income statement is helpful to managers
in judging the impact on profits of changes in selling price,
cost, or volume. The emphasis is on cost behavior.
Racing Bicycle Company
Contribution Income Statement
For the Month of June
Sales (500 bicycles) $ 250,000
Less: Variable expenses 150,000
Contribution margin 100,000
Less: Fixed expenses 80,000
Net operating income $ 20,000
Contribution Margin (CM) is the amount remaining from

sales revenue after variable expenses have been deducted.
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113
Basics of Cost-Volume-Profit Analysis
CM is used first to cover fixed expenses.

Any remaining CM contributes to net operating income.
Sales (500 bicycles) $ 250,000
Less: Variable expenses 150,000

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114
The Contribution Approach
Sales, variable expenses, and contribution

margin can also be expressed on a per unit
basis. If Racing sells an additional bicycle,
$200 additional CM will be generated to cover
fixed expenses and profit.
Total Per Unit
Sales (500 bicycles) $ 250,000 $ 500
Less: Variable expenses 150,000 300
Contribution margin 100,000 $ 200

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115
Each month, RBC must generate at least

$80,000 in total contribution margin to
break-even (which is the level of sales at
which profit is zero).
Total Per Unit
Sales (500 bicycles) $ 250,000 $ 500

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116
If RBC sells 400 units in a month, it will be

operating at the break-even point.
Total Per Unit
Sales (400 bicycles) $ 200,000 $ 500
Net operating income $ -

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117
If RBC sells one more bike (401 bikes), net

operating income will increase by $200.
Total Per Unit
Sales (401 bicycles) $ 200,500 $ 500
Net operating income $ 200

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118

We do not need to prepare an income statement to
estimate profits at a particular sales volume. Simply
multiply the number of units sold above break-even
by the contribution margin per unit.
If Racing sells
430 bikes, its net
operating income
will be $6,000.

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119
CVP Relationships in Equation Form
The contribution format income statement can be

expressed in the following equation:
Profit = (Sales – Variable expenses) – Fixed expenses

Total Per Unit
Sales (401 bicycles) $ 200,500 $ 500
Net operating income $ 200

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120
This equation can be used to show the profit RBC

earns if it sells 401. Notice, the answer of $200 mirrors
our earlier solution.
401 units × $500 $80,000

401 units × $300
$200 = ($200,500 – $120,300)

Profit – $80,000
Variable expenses) – Fixed
Fixed expenses
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121
When a company has only one product we can further

refine this equation as shown on this slide.
Quantity sold (Q) Quantity sold (Q)

× Selling price per unit (P) × Variable expenses per unit (V)
= Sales (Q × P) = Variable expenses (Q × V)
Profit = (P × Q – V × Q) – Fixed expenses

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122
This equation can also be used to show the $200

profit RBC earns if it sells 401 bikes.
$200 = ($500 × 401 – $300 × 401) – $80,000

Profit

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123
It is often useful to express the simple profit equation in

terms of the unit contribution margin (Unit CM) as follows:
Unit CM = Selling price per unit – Variable expenses per unit
Unit CM = P – V
Profit = (P – V) × Q – Fixed expenses
Profit = Unit CM × Q – Fixed expenses

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124

Profit = (P – V) × Q – Fixed expenses
Profit = ($500 – $300) × 401 – $80,000

Profit = $200 × 401 – $80,000
This equation
Profit = $80,200 – $80,000 can also be
Profit = $200 used to compute
RBC’s $200 profit
if it sells 401
bikes.

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125
Prepare and interpret a

cost-volume-profit (CVP)
graph and a profit graph.

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126
CVP Relationships in Graphic Form
The relationships among revenue, cost, profit, and

volume can be expressed graphically by preparing a
CVP graph. Racing Bicycle developed contribution
margin income statements at 0, 200, 400, and 600
units sold. We will use this information to prepare the
CVP graph.
Units Sold
0 200 400 600
Sales $ - $ 100,000 $ 200,000 $ 300,000
Total variable expenses - 60,000 120,000 180,000
Contribution margin - 40,000 80,000 120,000
Fixed expenses 80,000 80,000 80,000 80,000
Net operating income (loss) $ (80,000) $ (40,000) $ - $ 40,000

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127
Preparing the CVP Graph

$350,000
$300,000
$250,000
$200,000
$150,000
$100,000
In a CVP graph, unit volume is usually
$50,000
represented on the horizontal (X) axis
and dollars on the vertical (Y) axis.
$0
0 100 200 300 400 500 600
Units © McGraw-Hill Ryerson Limited., 2004

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128

$350,000

Draw a line parallel to the volume axis to
$300,000
represent total fixed expenses.
$250,000
$200,000
Fixed expenses
$150,000
$100,000
$50,000
$0
0 100 200 300 400 500 600

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129

$350,000 
Choose some sales volume, say 400 units, and plot the point representing
total expenses
$300,000
(fixed and variable). Draw a line through the data point
back to where the fixed expenses line intersects the dollar axis.
$250,000
$200,000
Total expenses
Fixed expenses
$150,000
$100,000
$50,000
$0
0 100 200 300 400 500 600

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130

$350,000 
Choose some sales volume, say 400 units, and plot the point representing
total sales.
$300,000
Draw a line through the data point back to the point of origin.
$250,000
$200,000
Sales
Total expenses
$150,000 Fixed expenses
$100,000
$50,000
$0
0 100 200 300 400 500 600

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131

$350,000 Break-even point
(400 units or $200,000 in sales) Profit Area
$300,000
$250,000
$200,000
Sales
Total expenses
$150,000 Fixed expenses
$100,000
$50,000
$0
0 100 200 300 400 500 600
Loss Area
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132
Profit = Unit CM × Q – Fixed Cost

$ 60,000
$ 40,000
$ 20,000
Profit
$0
-$20,000 An even simpler form of

the CVP graph is called
-$40,000
the profit graph.
-$60,000
0 100 200 300 400 500 600

Number of bicycles sold

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133
$ 60,000
Break-even point, where
$ 40,000
profit is zero, is 400
$ 20,000
units sold.
Profit
$0
-$20,000
-$40,000
-$60,000
0 100 200 300 400 500 600

Number of bicycles sold

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134
Use the contribution

margin ration (CM ratio)
to compute changes in
contribution margin and
net operating income
resulting from changes in
sales volume.

1-
135
Contribution Margin Ratio (CM Ratio)
The CM ratio is calculated by dividing the total contribution

margin by total sales.
Total Per Unit CM Ratio
Sales (500 bicycles) $ 250,000 $ 500 100%
Less: Variable expenses 150,000 300 60%
Contribution margin 100,000 $ 200 40%
$100,000 ÷ $250,000 = 40%
Each $1 increase in sales results in a total contribution
margin increase of 40¢. © McGraw-Hill Ryerson Limited., 2004
1-
136
The contribution margin ratio at Racing

Bicycle is:
CM per unit $200
CM Ratio = = = 40%
SP per unit $500
The CM ratio can also be calculated by

dividing the contribution margin per unit by
the selling price per unit.

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137

If Racing Bicycle increases sales from 400 to 500 bikes ($50,000),
contribution margin will increase by $20,000 ($50,000 × 40%).
Here is the proof:
400 Units 500 Units
Sales $ 200,000 $ 250,000
Less: variable expenses 120,000 150,000
Contribution margin 80,000 100,000
Less: fixed expenses 80,000 80,000
Net operating income $ - $ 20,000
A $50,000 increase in sales revenue results in a $20,000

increase in CM ($50,000 × 40% = $20,000).
1-
138
Quick Check ✓
Coffee Klatch is an espresso stand in a downtown

office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense per
cup is $0.36. The average fixed expense per month is
$1,300. An average of 2,100 cups are sold each
month. What is the CM Ratio for Coffee Klatch?
a. 1.319
b. 0.758
c. 0.242
d. 4.139

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139
Quick Check ✓

month. What is the CM Ratio for Coffee Klatch?
a. 1.319 Unit contribution margin
CM Ratio =
b. 0.758 Unit selling price
c. 0.242 ($1.49 - $0.36)
=
d. 4.139 $1.49
$1.13
= = 0.758
$1.49
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140
The relationship between profit and the CM ratio

can be expressed using the following equation:
Profit = (CM ratio × Sales) – Fixed expenses

If Racing Bicycle increased its sales volume to 500
bikes, what would management expect profit or net
operating income to be?
Profit = (40% × $250,000) – $80,000
Profit = $100,000 – $80,000
Profit = $20,000
1-
141
Show the effects on net

operating income of
changes in variable costs,
fixed costs, selling price,
and volume.

1-
142
The Variable Expense Ratio
The variable expense ratio is the ratio of variable

expenses to sales. It can be computed by dividing the
total variable expenses by the total sales, or in a single
product analysis, it can be computed by dividing the
variable expenses per unit by the unit selling price.
Sales (500 bicycles) $ 250,000 $ 500 100%

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143
Changes in Fixed Costs and Sales

Volume
What is the profit impact if Racing Bicycle

can increase unit sales from 500 to 540 by
increasing the monthly advertising budget
by $10,000?

1-
144

Volume
$80,000 + $10,000 advertising = $90,000
500 units 540 units

Sales $ 250,000 $ 270,000
Less: Variable expenses 150,000 162,000
Less: Fixed expenses 80,000 90,000
Net operating income $ 20,000 $ 18,000
Sales increased by $20,000, but net operating

income decreased by $2,000.
1-
145

Volume
A shortcut solution using incremental

analysis
Increase in CM (40 units X $200) $ 8,000
Increase in advertising expenses 10,000
Decrease in net operating income $ (2,000)

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146
Change in Variable Costs and Sales

Volume
What is the profit impact if Racing

Bicycle can use higher quality raw
materials, thus increasing variable costs
per unit by $10, to generate an increase
in unit sales from 500 to 580?

1-
147
Change in Variable Costs and Sales

Volume
580 units × $310 variable cost/unit = $179,800
500 units 580 units

Sales $ 250,000 $ 290,000
Sales increase by $40,000 and net operating income

increases by $10,200.
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148
Change in Fixed Cost, Sales Price,

and Volume
What is the profit impact if RBC: (1) cuts its

selling price $20 per unit, (2) increases its
advertising budget by $15,000 per month,
and (3) increases sales from 500 to 650
units per month?

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149
Change in Fixed Cost, Sales Price,

and Volume
650 units × $480 = $312,000
500 units 650 units

Sales $ 250,000 $ 312,000
Sales increase by $62,000, fixed costs increase by

$15,000, and net operating income increases by $2,000.
1-
150
Change in Variable Cost, Fixed Cost,

and Sales Volume
What is the profit impact if RBC: (1) pays a

$15 sales commission per bike sold instead
of paying salespersons flat salaries that
currently total $6,000 per month, and (2)
increases unit sales from 500 to 575 bikes?

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151
Change in Variable Cost, Fixed Cost,

and Sales Volume
575 units × $315 = $181,125

500 units 575 units
Sales $ 250,000 $ 287,500
Sales increase by $37,500, fixed expenses decrease by

$6,000, and net operating income increases by $12,375.
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152
Change in Regular Sales Price
If RBC has an opportunity to sell 150

bikes to a wholesaler without disturbing
sales to other customers or fixed
expenses, what price would it quote to
the wholesaler if it wants to increase
monthly profits by $3,000?

1-
153
Change in Regular Sales Price
$ 3,000 ÷ 150 bikes = $ 20 per bike

Variable cost per bike = 300 per bike
Selling price required = $ 320 per bike
150 bikes × $320 per bike = $ 48,000

Total variable costs = 45,000
Increase in net operating income = $ 3,000

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154
Determine the break-even

point.

1-
155
Break-even Analysis
The equation and formula methods can be used to

determine the unit sales and dollar sales needed to
achieve a target profit of zero. Let’s use the RBC
information to complete the break-even analysis.
Sales (500 bicycles) $ 250,000 $ 500 100%

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156
Break-even in Unit Sales:

Equation Method
Profits = Unit CM × Q – Fixed expenses

Suppose RBC wants to know how many
bikes must be sold to break-even
(earn a target profit of $0).
$0 = $200 × Q + $80,000
Profits are zero at the break-even point.

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157

Equation Method
Profits = Unit CM × Q – Fixed expenses

$0 = $200 × Q + $80,000
$200 × Q = $80,000
Q = 400 bikes

1-
158

Formula Method
Let’s apply the formula method to solve
for the break-even point.
Unit sales to Fixed expenses

=
break even CM per unit
$80,000
Unit sales =
$200
Unit sales = 400

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159
Break-even in Dollar Sales:

Equation Method
Suppose Racing Bicycle wants to compute

the sales dollars required to break-even (earn
a target profit of $0). Let’s use the equation
method to solve this problem.
Profit = CM ratio × Sales – Fixed expenses
Solve for the unknown “Sales.”

1-
160

Equation Method

$ 0 = 40% × Sales – $80,000
40% × Sales = $80,000
Sales = $80,000 ÷ 40%
Sales = $200,000

1-
161

Formula Method
Now, let’s use the formula method to calculate the

dollar sales at the break-even point.
Dollar sales to Fixed expenses

=
break even CM ratio
$80,000
Dollar sales =
40%
Dollar sales = $200,000

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162
Quick Check ✓

month. What is the break-even sales dollars?
a. $1,300
b. $1,715
c. $1,788
d. $3,129

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163
Quick Check ✓

coffee is $1.49 and the average variable expense
per cup is $0.36. The average fixed expense per
month is $1,300. An average of 2,100 cups are sold
each month. What is the break-even sales dollars?
a. $1,300 Break-even Fixed expenses
b. $1,715 =
sales CM Ratio
c. $1,788 $1,300
=
0.758
d. $3,129
= $1,715

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164
Quick Check ✓

month. What is the break-even sales in units?
a. 872 cups
b. 3,611 cups
c. 1,200 cups
d. 1,150 cups

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165
Quick Check ✓

$1,300. An average Break-even
of 2,100 cups Fixed
are soldexpenses
each
= CM per Unit
month. What is the break-even sales in units?
a. 872 cups $1,300
=
$1.49/cup - $0.36/cup
b. 3,611 cups
c. 1,200 cups $1,300
=
$1.13/cup
d. 1,150 cups
= 1,150 cups
1-
166
Determine the level of sales

needed to achieve a desired
target profit.

1-
167
Target Profit Analysis
We can compute the number of

units that must be sold to attain a
target profit using either:
(1) Equation method, or
(2) Formula method.

1-
168
Equation Method
Our goal is to solve for the unknown “Q” which

represents the quantity of units that must be sold to
attain the target profit.

1-
169
Suppose RBC’s management wants to

know how many bikes must be sold to
earn a target profit of $100,000.
$100,000 = $200 × Q – $80,000
$200 × Q = $100,000 – $80,000
Q = ($100,000 + $80,000) ÷ $200
Q = 900
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170
The Formula Method
The formula uses the following equation.
Unit sales to attain Target profit + Fixed expenses

=
the target profit CM per unit

1-
171
Target Profit Analysis in Terms of

Unit Sales
Suppose Racing Bicycle Company wants
to know how many bikes must be sold to
earn a profit of $100,000.
Unit sales to attain Target profit + Fixed expenses

=
the target profit CM per unit
$100,000 + $80,000
Unit sales =
$200
Unit sales = 900
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172
We can also compute the target profit in terms of

sales dollars using either the equation method or
the formula method.
Equation OR Formula
Method Method

1-
173
Equation Method

Our goal is to solve for the unknown “Sales,”
which represents the dollar amount of sales
that must be sold to attain the target profit.
Suppose RBC management wants to know the
sales volume that must be generated to earn a
target profit of $100,000.
$100,000 = 40% × Sales – $80,000
40% × Sales = $100,000 + $80,000
Sales = ($100,000 + $80,000) ÷ 40%
Sales = $450,000
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174
Formula Method
We can calculate the dollar sales needed to

attain a target profit (net operating profit) of
$100,000 at Racing Bicycle.
Dollar sales to attain Target profit + Fixed expenses

=
the target profit CM ratio
$100,000 + $80,000
Dollar sales =
40%
Dollar sales = $450,000
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175
Quick Check ✓
Coffee Klatch is an espresso stand in a
downtown office building. The average
selling price of a cup of coffee is $1.49 and
the average variable expense per cup is
$0.36. The average fixed expense per month
is $1,300. Use the formula method to
determine how many cups of coffee would
have to be sold to attain target profits of
$2,500 per month.
a. 3,363 cups
b. 2,212 cups © McGraw-Hill Ryerson Limited., 2004
1-
176
Quick Check ✓
Coffee Klatch is an espresso stand in a downtown office
building. The average selling price of a cup of coffee is $1.49
and the average variable expense per cup is $0.36. The
average fixedUnit salesper month is $1,300. Use the formula
expense Target profit + Fixed expenses
to attainhow=many cups of coffee would have to
method to determine Unit CM
targettarget
be sold to attain profit
profits of $2,500 per month.
a. 3,363 cups $2,500 + $1,300
= $1.49 - $0.36
b. 2,212 cups
c. 1,150 cups $3,800
=
d. 4,200 cups $1.13
= 3,363 cups

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177
Quick Check ✓
$0.36. The average fixed expense per month
is $1,300. Use the formula method to
determine the sales dollars that must be
generated to attain target profits of $2,500
per month.
a. $2,550
b. $5,013 © McGraw-Hill Ryerson Limited., 2004
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178
Quick Check ✓
building. The average selling price of a cup of coffee is
$1.49 and the average variable expense per cup is
$0.36. The average fixed expense per month is $1,300.
Use the formula method to determine the sales dollars
Sales $
that must be generated to Targettarget
attain profitprofits
+ Fixed ofexpenses
$2,500
to attain = CM ratio
per month. target profit
a. $2,550 $2,500 + $1,300
= ($1.49 – 0.36) ÷ $1.49
b. $5,013
c. $8,458 $3,800
=
d. $10,555 0.758
= $5,013
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179
Compute the margin of

safety and explain its
significance.

1-
180
The Margin of Safety in Dollars
The margin of safety in dollars is the

excess of budgeted (or actual) sales over
the break-even volume of sales.
Margin of safety in dollars = Total sales - Break-even sales
Let’s look at Racing Bicycle Company and

determine the margin of safety.

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181
The Margin of Safety in Dollars
If we assume that RBC 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 Break-even
shown.
sales Actual sales
400 units 500 units
Sales $ 200,000 $ 250,000
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182
The Margin of Safety Percentage
RBC’s margin of safety can be expressed

as 20% of sales.
($50,000 ÷ $250,000)
Break-even
sales Actual sales
400 units 500 units
Sales $ 200,000 $ 250,000

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183
The Margin of Safety
The margin of safety can be expressed in

terms of the number of units sold. The
margin of safety at RBC is $50,000, and
each bike sells for $500; hence, RBC’s
margin of safety is 100 bikes.
Margin of $50,000
= = 100 bikes
Safety in units $500

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184
Quick Check ✓

$0.36. The average fixed expense per
month is $1,300. An average of 2,100
cups are sold each month. What is the
margin of safety expressed in cups?
a. 3,250 cups
b. 950 cups
1-
185
Quick Check ✓

building. The average selling price of a cup of coffee is
$1.49 and the average variable expense per cup is $0.36.
The Margin
average of safety
fixed = Total
expense month–isBreak-even
persales $1,300. An sales
average
of 2,100 cups are sold =each
2,100
month. – 1,150
cupsWhat cups
is the margin of
= 950 cups
safety expressed in cups?
a. 3,250 cups
b. 950 cups
c. 1,150 cups
d. 2,100 cups

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186
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.

1-
187
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 A disadvantage of a high fixed
will be higher in good years cost structure is that income
compared to companies will be lower in bad years
with lower proportion of compared to companies
fixed costs. with lower proportion of
fixed costs.
Companies with low fixed cost structures enjoy greater
stability in income across good and bad years.
1-
188
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.

1-
189
Operating Leverage
Operating leverage is a measure of how

sensitive net operating income is to
percentage changes in sales. It is a
measure, at any given level of sales, of
how a percentage change in sales
volume will affect
Degree of profits.margin
Contribution
operating leverage = Net operating income

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190
Operating Leverage
To illustrate, let’s revisit the contribution income statement

for RBC.
Actual sales
500 Bikes
Sales $ 250,000
Less: variable expenses 150,000
Less: fixed expenses 80,000
Net income $ 20,000
Degree of
Operating $100,000
= $20,000 = 5
Leverage
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191
Operating Leverage
With an operating leverage of 5, if RBC

increases its sales by 10%, net operating
income would increase by 50%.
Percent increase in sales 10%
Degree of operating leverage × 5
Percent increase in profits 50%
Here’s the verification!

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192
Operating Leverage
Actual sales Increased
(500) sales (550)
Sales $ 250,000 $ 275,000
Less variable expenses 150,000 165,000
Less fixed expenses 80,000 80,000
10% increase in sales from

$250,000 to $275,000 . . .
. . . results in a 50% increase in

income from $20,000 to $30,000.
1-
193
Quick Check ✓

$0.36. The average fixed expense per
month is $1,300. An average of 2,100
cups are sold each month. What is the
operating leverage?
a. 2.21
b. 0.45
c. 0.34
1-
194
Quick Check ✓
Coffee Klatch is an espresso stand in a downtown Actual sales

2,100 cups
Sales $ 3,129
coffee is $1.49 and the average variable expense per 756
Less: Variable expenses
cup is $0.36. The averageContribution
fixed expense
marginper month is2,373
$1,300. An average of 2,100
Less:cups
Fixedare sold each
expenses 1,300
month. What is the operating leverage?
a. 2.21
b. 0.45
c. 0.34 Operating Contribution margin
leverage = Net operating income
d. 2.92
$2,373
= $1,073 = 2.21
1-
195
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, the average fixed expense per month is
$1,300, and an average of 2,100 cups are sold each
month.
If sales increase by 20%, by how much should net
operating income increase?
a. 30.0%
b. 20.0%
c. 22.1%
d. 44.2%

1-
196
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, the average fixed expense per month is
$1,300, and an average of 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%
b. 20.0%
× Degree of operating leverage 2.21
c. 22.1% Percent increase in profit 44.20%
d. 44.2%

1-
197
Verify Increase in Profit
Actual Increased
sales sales
2,100 cups 2,520 cups
Sales $ 3,129 $ 3,755
Less: Variable expenses 756 907
% change in sales 20.0%
% change in net operating income 44.2%
1-
198
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.

1-
199

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.
1-
200

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.

1-
201
Compute the break-even

point for a multiproduct
company and explain the
effects of shifts in the sales
mix on contribution margin
and the break-even point.

1-
202
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.
⚫When a company sells more than one
product, break-even analysis becomes
more complex as the following example
illustrates.
Let’s assume Racing Bicycle Company

1-
203
Multi-Product Break-Even Analysis

Bikes comprise 45% of RBC’s total sales revenue and the
carts comprise the remaining 55%. RBC provides the
following information:
Bicycle Carts Total
Sales $ 250,000 100% $ 300,000 100% $ 550,000 100.0%
Variable expenses 150,000 60% 135,000 45% 285,000 51.8%
Contribution margin 100,000 40.0% 165,000 55% 265,000 48.2%
Fixed expenses 170,000
Sales mix $ 250,000 45% $ 300,000 55% $ 550,000 100%
$265,000 = 48.2% (rounded)

$550,000

1-
204
Multi-Product Break-Even Analysis
Dollar sales to Fixed expenses

=
break even CM ratio
Dollar sales to $170,000

= = $352,697
break even 48.2%
Bicycle Carts Total

Sales $ 158,714 100% $ 193,983 100% $ 352,697 100.0%
Variable expenses 95,228 60% 87,293 45% 182,521 51.8%
Contribution margin 63,485 40% 106,691 55% 170,176 48.2%
Fixed expenses 170,000
Net operating income Rounding error $ 176
Sales mix $ 158,714 45% $ 193,983 55% $ 352,697 100.0%

1-
205
End of Chapter 5

Garrison Lecture Chapter - Managerial Accounting and The Business Environment

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Chapter

1. Identify the major differences and

© McGraw-Hill Ryerson Limited., 2004

Managerial Accounting and

Managerial accounting Financial accounting

© McGraw-Hill Ryerson Limited., 2004

© McGraw-Hill Ryerson Limited., 2004

Planning and Control Cycle

Comparing actual to Implementing

Comparison of Financial and

2. Time focus Historical perspective Future emphasis

3. Emphasis Objectivity and Relevance

4. Importance Precision of information Timeliness of information

© McGraw-Hill Ryerson Limited., 2004

Expanding Role of Managerial

Corporate Organization Chart

Purchasing Personnel Vice President Chief Financial

Corporate Organization Chart

Purchasing Personnel Vice President Chief Financial

Line and Staff Relationships

Line positions are Staff positions support

© McGraw-Hill Ryerson Limited., 2004

The chief accountant in an organization

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The Professional Management

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The Changing Business

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The Changing Business

New tools for

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Just-in-Time (JIT) Systems

Receive materials Complete parts

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Key Elements for a Successful

Benefits of a JIT System

© McGraw-Hill Ryerson Limited., 2004

Total Quality Management

Every step in The process is

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Every step in The process is

© McGraw-Hill Ryerson Limited., 2004

A sequential process of identifying and

Restrictions or barriers that impede

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Meeting world-class competition demands a

© McGraw-Hill Ryerson Limited., 2004

Professional Ethics in Accounting

⚫ Ethical accounting practices build trust and

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IFAC Code of Ethics for

© McGraw-Hill Ryerson Limited., 2004

© McGraw-Hill Ryerson Limited., 2004

© McGraw-Hill Ryerson Limited., 2004

© McGraw-Hill Ryerson Limited., 2004

Assigning Costs to Cost Objects

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Identify and give examples

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Direct Direct Manufacturing

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Raw materials that become an integral

Example: A radio installed in an automobile