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8/10/2019 Ch04 CVP.pdf
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Managerial Accounting
by James JiambalvoChapter 4:
Cost-Volume-Profit Analysis
Slides Prepared by:
Scott Peterson
Northern State University
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Chapter 4: Cost-Volume-
Profit-AnalysisChapter Themes:
Its all about how costs
change in total with
respect to changes inactivity.
C-V-P-A is linear.
You must be able to putall costs into either
variable or fixed costcategories.
Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Common Cost Behavior
PatternsTo perform Cost-Volume-Profit-Analysis (C-V-P-A), youneed to know how costs
behave when businessactivity (production volume,sales volume) changes.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Variable CostsBy definition, Variable Costsare costs that change (intotal) in response to changesin volume or activity. It isassumed, too, that therelationship between variablecosts and activity isproportional. That is, ifproduction volume increasesby 10%, then variable costsin total will rise by 10%.Examples include directlabor, raw materials and salescommissions.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Fixed CostsBy definition, Fixed Costs arecosts that do not change (intotal) in response to changes
in volume or activity.Examples includedepreciation, supervisorysalaries and maintenanceexpenses.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Mixed CostsMixed Costs are costs thatcontain both a variable costelement and a fixed cost
element. These costs aresometimes referred to assemi-variable costs. Anexample would be asalespersons salary where
she receives a base salaryplus commissions.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Cost Estimation MethodsManagers need to be able topredict (plan) costs at variousactivity levels. And becausecost information is often not
broken out in terms of fixedand variable components,managers use costestimation methods to do justthat. Four common methodsare:
1.Account analysis
2.Scattergraph
3.High-Low
4.Regression
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Account AnalysisAccount Analysis is acommon approach toestimating fixed and variablecosts. This method requires
the manager to exerciseprofessional judgment toclassify costs into variableand fixed categories. Oncethis is done, total variablecosts are divided by theactivity level to determinevariable costs per unit ofactivity. Costs classified asfixed costs are used toestimate total fixed cost.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Scattergraph ApproachThe Scattergraph App roachuses cost information from anumber of reporting periods
(monthly for example) todetermine how costs changewith respect to changes inactivity. The periodic costdata are then plotted on agraph to get a visual pictureof the correlation betweencosts and activity levels. Asample Scattergraphappearson the next slide.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Sample ScattergraphRelated Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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High-Low MethodUsing the same periodic dataas the scattergraph method,the High-Low Method may beused to estimate the fixed
and variable components atvarious levels of activity. Thismethod fits a line to thedata, but uses only the highand low data points. Here, theslope of the line (total costcurve) represents the variablecost. The Y-interceptrepresents the estimate of thefixed costs.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Regression AnalysisRegression Analysis is astatistical technique that usesall available data points to
estimate the slope andintercept. That is, unlike theHigh-Low method which usesonly the high and low datapoints, regression uses ALLof the data points to find thebest fit. It should be noted
that Regression Analysis is asuperior method of costestimation.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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The Relevant RangeThe Relevant Range is theactivity level within whichcost behavior holds true.
Most models have limits andthis type of linear analysis isnot different. Above or belowthis range, forecasts of costbehavior may not beaccurate.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Cost-Volume-Profit AnalysisCost-Volume-Profit Analysis(C-V-P) explores therelationship between costs
(fixed and variable), activitylevels and profits. That is,once the variable and fixedelements have beendetermined using the toolsdiscussed in the precedingslides, we use the followingprofit equation: Profit = SP(x)- VC(x)TFC=Net Income.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Break-Even PointOne of the primary purposes ofC-V-P is to calculate the Break-Even Point. It simply representsthe number of units the firm
must sell to generate exactlyzero net incometo earn neitherprofit nor loss. Graphically, asshown in the next slide, Break-Even is the point where the salescurve and cost curve cross. Itshould be noted here that
managers are seldom interestedin merely breaking even. But theBreak-Even is an importantbenchmark!
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Break-Even Point (Graphic)Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Margin of SafetyThe Margin of Safety is thedifference between theexpected level of sales and
break-even sales. It may beexpressed in units or dollarsof sales.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Contribution MarginThe Contribution Margin isthe difference between sellingprice and variable cost per
unit. It measures the amounteach unit sold contributes tocovering fixed cost (first) andincreasing profit (once fixedcosts are covered).
The relationship is as follows:
SP-VC
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Contribution Margin RatioThe Contribution MarginRatio expresses thecontribution of every salesdollar to covering fixed cost
(first) and operating profit(second). It is calculated asfollows: SPVC
SP
In other words, for every
dollar of sales, X% of that willcontribute to covering thefixed costs, and once fixedcosts are covered X% ofevery dollar of sales will becontribute to net income.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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What If AnalysisOnce the cost structure ismodeled (variable and fixedcosts are estimated)managers can do sensitivity
analyses or What IfAnalyses. This analysisexamines what will happen ifa particular action is taken.For example, what willhappen if fixed costs rise byX dollars and variable costsdecrease by Y dollars? Orwhat will happen if sellingprice is decrease by Zdollars?
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Multiproduct AnalysisUp until now we looked at C-
V-P analysis for a singleproduct. The next fewslides examine C-V-P as it
applies to multipleproduct scenarios. Thereare two approaches wewill consider in thissection:
Contribution MarginApproach (for similarproducts)
Contribution Margin RatioApproach (forsubstantially different
products).
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Contribution Margin ApproachAs indicated, if the productsunder analysis are similar(e.g., various flavors of icecream, various models of
boats), the Weighted AverageContribution MarginApproach can be used. Forexample, if the contributionmargin of product A is $8 andthe contribution margin ofproduct B is $5, and if twounits of B are sold for eachunit of A, the WeightedAverage Contribution Marginis $6.00.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Contribution Margin Ratio
ApproachIf the products under analysisare substantial different (e.g.,products in a department
store), the ContributionMargin Ratio Approachshould be used. It makes littlesense in this case to ask howmany units to break even.The question should be how
many dollars of sales tobreak even.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Assumptions in C-V-P AnalysisAs with most models, there
are certain assumptionswhich are made that
affect the validity of theanalysis.
Costs can be accuratelyseparated into variableand fixed components.
Fixed costs remain fixed. Variable costs per unit do
not change over therelevant range.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Operating LeverageOperating Leverage relates tothe level of fixed versusvariable costs in a firms cost
structure. The higher thedegree of fixed costs, themore operating leverage afirm is considered to have.Firms with lower variable andhigher fixed costs havehigher contribution margins.This translates into greaterprofit or loss as salesincrease or decrease.
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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ConstraintsIn the real world there areconstraints on how manyitems can be manufactured or
how much service can bedelivered. So the focus shiftsfrom contribution margin perunit to contribution marginper unit of the constraint.Examples of constraintsinclude manufacturing space,labor, parts and materialsetc
Related Learning Objectives:1. Identify common cost behavior
patterns.
2. Estimate the relation between
cost and activity using accountanalysis, the high-low method,and scattergraphs.
3. Perform cost-volume-profit-analysis for single products.
4. Perform cost-volume-profit-analysis for multiple products.
5. Discuss the effect of operatingleverage.
6. Use the contribution margin perunit of the constraint to analyzesituations involving a resourceconstraint.
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Copyright 2001 John Wiley & Sons, Inc. All rights reserved. Reproduction or
translation of this work beyond that permitted in Section 117 of the 1976
United States Copyright Act without the express written permission of the
copyright owner is unlawful. Request for further information should be
addressed to the Permissions Department, John Wiley & Sons, Inc. Thepurchaser may make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no responsibility for errors,
omissions, or damages, caused by the use of these programs or from the
use of the information contained herein.
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