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CVP analysis

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CVP Analysis

Understand how cost behavior and cost-volume-profit analysis are used by managers.

Cost-Profit-Volume Analysis

What is cost-volume-profit analysis?

It is the study of the effects of output volume on revenue (sales), expenses (costs), and net income (net profit).

How much must I sell to earn my desired income? How will income be affected if I reduce selling prices to increase sales volume? What will happen to profitability if I expand capacity?

Variable Costs

Fixed Costs

Mixed Costs

Cost Estimation Methods are frequently required to separate the fixed and variable components of a total cost pool. Methods include:

1. 2. 3. 4. 5. Account Analysis Scattergraph High-Low Method Regression Relevant Range

Scattergraph

High-Low Method

Example: Let total costs at 500 units of output be $150,000 and at 3,000 units of output be $400,000. Calculate variable and fixed costs, respectively.

High-Low Method

Solution: High Low Change Costs: $400,000 $150,000 $250,000 Units: 3,000 500 2,500 Calculate Variable Cost Per Unit: $250,000/2,500 = $100 Calculate Total Fixed Costs: $400,000 (3,000 x 100) = $100,000

High-Low Method

Regression Analysis

Relevant Range

Understanding cost behavior is vital to the managers decision-making role, because one of the main goals of management accounting is controlling costs.

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Cost-Volume-Profit Analysis

1. 2. 3. 4. 5. 6. The Profit Equation Breakeven Point Margin of Safety Contribution Margin Contribution Margin Ratio What-if Analysis

Profit = SP(x) VC(x) TFC

X = Quantity of units produced and sold SP = Selling price per unit VC = Variable cost per unit TFC = Total fixed cost

Break-Even Point

The break-even point is the level of sales at which revenue equals expenses and net income is zero.

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Break-Even Point

Break-Even Point

TFC/CM(per unit) = Break-Even (units)

X = Quantity of units produced and sold SP = Selling price per unit VC = Variable cost per unit CM = Contribution margin TFC = Total fixed cost

Gross margin (which is also called gross profit) is the excess of sales over the cost of goods sold.

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Contribution Margin

SP(u) VC(u) = CM (u)

SP = Selling price per unit VC = Variable cost per unit CM = Contribution margin u = per unit

(SP VC) / SP = CM%

SP = Selling Price per unit VC = Variable Cost per unit CM = Contribution Margin

CVP Scenario

Selling price Variable cost Difference Per Unit $5 4 $1 Percentage 100 80 20

Total monthly fixed expenses = $8,000 Rent $2,000 Labor $5,500 Other $ 500

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Equation Technique

Let N = number of units to be sold to break even $5N $4N $8,000 = 0 $1N = $8,000 N = $8,000 $1 N = 8,000 Units

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Equation Technique

Let S = sales in dollars needed to break even S 0.80S $8,000 = 0 .20S = $8,000 S = $8,000 .20 S = $40,000

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Margin of Safety

The margin of safety shows how far sales can fall below the planned level before losses occur.

Margin of safety

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Managers can also use CVP analysis to determine the total sales, in units and dollars, needed to reach a target net profit.

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Revenues (2,535 $90) Variable costs (2,535 $32) Contribution margin: Fixed costs: Operating income: Income taxes: ($51,030 .30) Net income $228,150 81,120 $147,030 96,000 $ 51,030 15,309 $ 35,721

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Contribution Margin Technique Target sales volume in units = Fixed expenses + Target net income Contribution margin per unit

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