Ch04 PPT Hongren CostAccounting 2e-2

Chapter 4
Costvolumeprofit
analysis
PowerPoint to accompany:
LEARNING OBJECTIVES
Describe the features of costvolumeprofit (CVP) analysis
Determine the break-even point and output level needed to

achieve a target profit
Describe how income taxes affect CVP analysis
Describe how managers use CVP analysis in decision making
Copyright 2014 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442563377/Horngren/Cost accounting/2e
LEARNING OBJECTIVES
Explain how sensitivity analysis helps managers cope with

uncertainty
Use CVP analysis to plan variable and fixed costs
Apply CVP analysis to a company producing multiple products
Adapt CVP analysis to situations in which a product has more than

one cost driver.
Essentials of CVP analysis
Identify the problem and uncertainties
Collect relevant information
Determine possible courses of action and consider

the consequences of each
Evaluate each possible course of action and select

the best one
Implement the decision, evaluate performance,

and learn.

Contribution margins:
manipulation of the basic equations yields an extremely

important and powerful tool extensively used in cost
accounting: the contribution margin
contribution margin = total revenues total variable costs
contribution margin per unit equals selling price less variable

cost per unit
CM = TR VC
CMpu = SP VCpu
contribution margin also equals contribution margin per

unit multiplied by the number of units sold (Q)
CM = CMpu x Q
contribution margin ratio (percentage) equals contribution

margin per unit divided by selling price
CMR = CMpu SP
interpretation: how many cents out of every sales dollar
are represented by contribution margin?

Expressing CVP relationships
there are three methods that show CVP relationships:

1.
the equation method
2.
the contribution margin method
3.
the graph method.

Basic formulae:
Total revenue (TR ) Variable costs (VC ) Fixed costs (FC ) = Operating
profit (P )
Total revenue (TR ) = Selling price (SP ) Quantity of units
sold (Q )
and
Variable costs (VC ) = Variable cost per unit (VCPU ) Quantity of units
sold (Q )

Equation method:
or

Contribution margin method:
rearranging equation 1
or
10

Graph method:
1.total
costs line the total

costs (TC) line is the sum of
fixed costs and variable
costs; fixed costs are
constant within the relevant
range
2.total
11
revenues line
Costvolumeprofit assumptions
12
Changes in production/sales volume are the sole cause for

cost and revenue changes.
Total costs consist of fixed costs and variable costs.
Revenue and costs behave, and can be graphed, as a linear
function (a straight line).
Selling price, variable cost per unit, and fixed costs are all
known and constant.
In many cases only a single product will be analysed. If
multiple products are studied, their relative sales proportions
are known and constant.
The time value of money (interest) is ignored.
Break-even point and target profit

Recall the last equation in an earlier slide (CMpu x Q) FC = P:
a
simple manipulation of this formula, and setting P to zero will

result in the break-even point (quantity)
BEP = FC CMpu
at
this point, a firm has no profit or loss at the given sales level
if
per-unit values are not available, the break-even point may be

restated in its alternative format
13
BEP = FC CMR

Target operating profit:
with a simple adjustment, the break-even point formula can be

modified to become a profit planning tool
profit is now reinstated to the BE formula, changing it to a simple

sales volume equation
Q = (FC + P)
CMpu
14

Target net profit and income taxes
From time to time it is necessary to move back and forth
between target profit before tax (PBT) and target profit
after tax (PAT), depending on the facts presented:
target profit after tax can be calculated by
PBT x (1-Tax Rate) = PAT
PAT can substitute into the profit planning equation

through this form
PBT =
PAT
(1-Tax Rate)
15
Break-even point and target profit web link
16
A three-part explanation of break-even analysis with questions and

quizzes can be found at:
http://www.accountingcoach.com/online-accounting-course/01Xpg0
1.html
Using CVP analysis for decision making
17
CVP analysis is useful for calculating the units that need to be sold:
to break even
to achieve a target profit or target net profit after tax.
CVP can also be used to guide other decisions, many of them

strategic, such as:
the decision to advertise
the decision to reduce selling price.
Using CVP analysis for decision making web link
18
A worked case study How Is Cost-Volume-Profit Analysis Used for

Decision Making? can be found at:
http://2012books.lardbucket.org/books/managerial-accounting-v1.
0/section_10.html
Sensitivity analysis and margin of safety

Sensitivity analysis:
19
is a what-if technique that managers use to examine

how an outcome will change if the original predicted data
are not achieved, or if an underlying assumption changes
CVP provides structure to answer a variety of what-if

scenarios: what happens to profit if
selling price changes
volume changes
cost structure changes
variable cost per unit changes
fixed costs change.
The margin of safety (MOS) measures the distance

between budgeted sales and break-even sales:
The MOS ratio removes the firms size from the output,
and expresses itself in the form of a percentage:
MOS ratio = MOS budgeted sales
20
21
Sensitivity analysis and margin of safety web links
A YouTube lecture on Sensitivity Analysis, Margin of Safety,

Breakeven, Contribution Margin can be found at:
http://www.youtube.com/watch?v=kQszXQWOBfk
And a YouTube lecture on Margin of Safety can be found at:

http://www.youtube.com/watch?v=cDsISa1swms
22
Cost planning and CVP

Alternative fixed
cost/variable cost
structures:
CVP-based
sensitivity
analysis highlights the
risks and returns as fixed
costs are substituted for
variable costs in a
companys cost structure.
23
Cost planning and CVP

Operating leverage:
operating leverage (OL) is the effect that fixed costs have

on changes in operating profit as changes occur in units
sold and contribution margin
OL = contribution margin
operating profit
24
remember that, in the presence of fixed costs, the

degree of operating leverage is different at different
levels of sales.
Effects of sales mix on income

Sales mix:
25
the quantities (or proportion) of various products (or services)

that constitute total unit sales of a company
the formulae presented to this point have assumed a single

product is produced and sold
a more realistic scenario involves multiple products sold in

different volumes with different costs
the same formulae are used, but use a weighted average

contribution margin for bundles of products.
Multiple cost drivers
26
Variable costs may arise from multiple cost drivers or activities.
A separate variable cost needs to be calculated for each driver.
CVP analysis in service and not-for-profit

organisations
To apply CVP analysis in service and not-for-profit organisations,

we focus on measuring their output, which is different from the
tangible units sold by manufacturing and retail companies.
Examples of output measures in service and not-for-profit

industries include:
27
passenger kilometres
room nights occupied
patient days
PhD completions.
APPENDIX 4-1
Break-even points in variable costing and absorption costing
Variable costing:
28
There is only one break-even point in this case, and it depends on:
fixed (manufacturing and operating) costs and
contribution margin per unit.
APPENDIX 4-1
Break-even points in variable costing and absorption costing
Absorption costing:
29
the required number of units to be sold to earn a specific target

operating profit is not unique because of the number of variables
involved.
APPENDIX 4-2
Decision models and uncertainty:
30
coping with uncertainty
role of a decision model
expected value
sound decisions versus satisfactory outcomes.
APPENDIX 4-2
Decision models and uncertainty:
31

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Chapter 4

Describe the features of costvolumeprofit (CVP) analysis

Determine the break-even point and output level needed to

Describe how income taxes affect CVP analysis

Describe how managers use CVP analysis in decision making

Explain how sensitivity analysis helps managers cope with

Use CVP analysis to plan variable and fixed costs

Apply CVP analysis to a company producing multiple products

Adapt CVP analysis to situations in which a product has more than

Essentials of CVP analysis

Identify the problem and uncertainties

Collect relevant information

Determine possible courses of action and consider

Evaluate each possible course of action and select

Implement the decision, evaluate performance,

Essentials of CVP analysis

manipulation of the basic equations yields an extremely

contribution margin = total revenues total variable costs

contribution margin per unit equals selling price less variable

Essentials of CVP analysis

contribution margin also equals contribution margin per

contribution margin ratio (percentage) equals contribution

Essentials of CVP analysis

there are three methods that show CVP relationships:

the equation method

the contribution margin method

the graph method.

Essentials of CVP analysis

Essentials of CVP analysis

Essentials of CVP analysis

Essentials of CVP analysis

costs line the total

Changes in production/sales volume are the sole cause for

Break-even point and target profit

simple manipulation of this formula, and setting P to zero will

per-unit values are not available, the break-even point may be

Break-even point and target profit

with a simple adjustment, the break-even point formula can be

profit is now reinstated to the BE formula, changing it to a simple

Break-even point and target profit

target profit after tax can be calculated by

PBT x (1-Tax Rate) = PAT

PAT can substitute into the profit planning equation

Break-even point and target profit web link

A three-part explanation of break-even analysis with questions and

Using CVP analysis for decision making

to achieve a target profit or target net profit after tax.

CVP can also be used to guide other decisions, many of them

the decision to advertise

the decision to reduce selling price.

Using CVP analysis for decision making web link

A worked case study How Is Cost-Volume-Profit Analysis Used for

Sensitivity analysis and margin of safety

is a what-if technique that managers use to examine

CVP provides structure to answer a variety of what-if

Sensitivity analysis and margin of safety

The margin of safety (MOS) measures the distance

Sensitivity analysis and margin of safety

Sensitivity analysis and margin of safety web links

A YouTube lecture on Sensitivity Analysis, Margin of Safety,

And a YouTube lecture on Margin of Safety can be found at:

Cost planning and CVP

Cost planning and CVP

operating leverage (OL) is the effect that fixed costs have