Chapter 11
Cost-volume-profit analysis
for decision making
PowerPoint presentation by Anne Abraham
University of Wollongong
©2009 John Wiley & Sons Australia, Ltd
DiBella Coffee is a relatively new entrant
to the coffee industry. Why coffee?
2
COST BEHAVIOUR
• Explains how costs respond to changes in
the level of business activity
• Three important CVP costs:
– variable
– fixed
– mixed
• Must evaluate each cost incurred to
determine the cost function that best
describes the item’s cost behaviour
3
1
Could you talk briefly about the nature
of DiBella’s fixed and variable costs
4
COST BEHAVIOUR
continued
• A cost function is a relationship between
cost and activity
• All cost functions are assumed to be linear
y = a + bx
where
y = total cost (dependent variable)
a = fixed portion of total cost (y-intercept)
b = variable cost rate (slope of function)
x = measure of activity or volume
(independent variable)
5
COST BEHAVIOUR
continued
y=a
a
Activity level
y
Cost
y
Cost
Cost
y
a
x
Fixed cost
y = a + bx
since b = 0
y=a
Activity level
x
Variable cost
y = a + bx
since a = 0
y = bx
Activity level
x
Mixed cost
y = a + bx
6
2
Variable cost behaviour
• Few variable costs behave exactly in linear
functions
• Two notable exceptions:
– A curvilinear function
– A step function
• However, they are assumed to be linear
within the relevant range
• The relevant range is the range of activity
in which the entity normally operates
7
Fixed cost behaviour
• Total fixed costs will remain constant over a
range of activity within the relevant range
• Discretionary costs can be changed or
discontinued by management if enough
time is available
e.g., advertising, R&D, employee training
programs
• Committed costs are required even if the
operation is closed down temporarily
e.g., depreciation, rates, insurance, senior
management salaries
8
Mixed cost behaviour
• Divide into fixed and variable components
• Techniques for separation:
– Visual fit of a scatter diagram
– High-low method
– Linear regression analysis
• Based on collection of historical data
9
3
Assumptions of CVP analysis
•
•
•
•
Unit sales price remains constant
Costs can be identified as variable or fixed
Variable costs change with volume
Total fixed costs remain constant over
relevant range
• Efficiency remains relatively unchanged
• When more than one product is sold, total
sales are in some predictable sales mix
10
COST BEHAVIOUR AND INCOME
STATEMENT
• Management must be able to evaluate how
costs and profits fluctuate with changes in
sales volume
• Conventional income statement of limited
value because it has no predictive value re
sales volume
11
COST BEHAVIOUR AND INCOME
STATEMENT continued
BUTLER ENTERPRISES
Income Statement
for the year ended 30 June 2010
INCOME
Sales revenue
Less: Cost of sales
GROSS PROFIT
EXPENSES
Selling and distribution expenses
Administrative expenses
Finance and other expenses
PROFIT
Amount
%
$ 1 000 000
520 000
480 000
100
52
48
200 000
140 000
20 000
360 000
$120 000
20
14
2
36
12
12
4
Contribution margin
• Equals sales revenue less all variable
costs
• Gives the amount of sales revenue
available to:
– absorb fixed costs, then
– contribute to profit
• Varies directly as a fixed % with sales
volume
• Emphasising CM makes income statement
more useful for decision making
• CM ratio equals CM divided by sales
13
Contribution margin
continued
BUTLER ENTERPRISES
Income Statement
for the year ended 30 June 2010
INCOME
Sales revenue
Variable cost of sales
Variable operating expenses
CONTRIBUTION MARGIN
Fixed expenses
Selling and distribution expenses
Administrative expenses
Finance and other expenses
PROFIT
Amount
%
$ 1 000 000
400 000
200 000
400 000
100
40
20
40
120 000
140 000
20 000
280 000
$120 000
12
14
2
28
12
14
PROFIT PLANNING WITH CVP
ANALYSIS
• CVP can answer questions about
– Entity’s breakeven point
– Impact on sales volume and profit of
increased advertising costs
– Sales level needed to make a profit
– Impact of changes in selling price
– Most profitable sales mix
15
5
What tools/techniques do you use in the
estimation/planning of your costs?
16
PROFIT PLANNING WITH CVP
ANALYSIS continued
SUNSHINE STABILISERS LTD
Condensed Income Statement
for the year ended 30 June 2009
Sales revenue (8 000 units @ $50)
Less: Variable cost of sales
Manufacturing margin
Other variable expenses
Contribution margin
Fixed costs
Factory overhead
Other fixed expenses
PROFIT (LOSS)
Amount
$400 000
240 000
160 000
40 000
120 000
110 000
40 000
$(30 000)
%
100
60
40
10
30
27.5
10
(7.5)
.
17
BREAK-EVEN ANALYSIS
• Break-even equation
– Determined mathematically or graphically
– Net profit zero
Sales revenue = Variable expenses + Fixed expenses + Profit
18
6
Break-even equation
Example: Sunshine Stabilisers
Fixed expenses
= $150 000
Variable expenses
= $280 000 8000
= $35 per unit
Determine breakeven sales
$50S
$15S
S
= $35S + $150 000
= $150 000
= 10 000 units
19
Contribution margin approach
• Break-even sales in dollars
Break-even
sales in dollars
=
Fixed costs
Contribution margin ratio
• Break-even sales in units
Break-even
sales in units
=
Fixed costs
Unit contribution margin
20
Contribution margin approach
21
7
MARGIN OF SAFETY AND
TARGET SALES
• Determining a margin of safety
– The amount by which sales can decrease
before a loss occurs
• Determining target sales and profit
– Profit goal expressed as either:
• fixed amount of profit
• percentage of sales
Sales target = VC + FC + target profit before tax
22
MARGIN OF SAFETY AND
TARGET SALES continued
Example: Sunshine Stabilisers
• Find target sales, given that desired profit
before tax is $60 000
S
$50S
$15S
S
= VC + FC + target profit before tax
= $35S + $150 000 + $60 000
= $210 000
= 140 000 units
23
ANALYSING CVP RELATIONSHIPS FOR
PROFIT PLANNING
• Effective profit and marketing planning
must be concerned with the impact on
profits of
– Change in selling price
– Change in variable costs
– Change in fixed and variable costs
– Change in fixed costs and sales volume
24
8
What role does cost and management
accounting information play in the
management of DiBella?
25
Change in selling price
Example: Sunshine Stabilisers
• A price reduction of 10% (to $45) is
expected to increase the budgeted number
of units sold by 20%, from 10 000 units to
12 000 units
• What is the impact on break-even sales?
$50S = $30S + $150 000
$20S = $150 000
S = 7500 units or $375 000
26
Change in variable cost
Example: Sunshine Stabilisers
• Changes in the manufacturing process are
expected to make labour use more efficient
and reduce variable costs by $5 per unit
• What is the impact on break-even sales?
$50S = $30S + $150 000
$20S = $150 000
S = 7500 units or $375 000
27
9
Change in fixed and variable costs
Example: Sunshine Stabilisers
• Mgt is considering paying sales
representatives a fixed sum of $40 000 per
year, instead of salaries on commission of
10% of sales
• What is the impact on break-even sales?
This will make VC be 70% – 10% = 60%
$50S = $30S + $190 000
$20S = $190 000
S = 9500 units or $475 000
28
Change in fixed costs and
sales volume
Example: Sunshine Stabilisers
• Mgt is considering an advertising campaign
that will cost $30 000 per year and estimated
to increase by 30% from 10 000 to 13 000
units
• What is the impact on break-even sales?
$50S = $35S + $180 000
$15S = $180 000
S = 12 000 units or $600 000
29
USING CVP ANALYSIS WITH MULTIPLE
PRODUCTS
• Weighted average contribution margin used
– Determine break-even sales
– Plan profits
Example: Sunshine Stabilisers
Std model
$50
35
Deluxe model
$80
48
Contribution margin
$15
$32
Contribution margin ratio
30%
40%
Selling price
Variable expenses
30
10
USING CVP ANALYSIS WITH MULTIPLE
PRODUCTS continued
• Fixed costs are $184 000
• Expected product mix is 4 standard models
for each deluxe
• What is the weighted average CM margin?
Total CM for 5 units of product
($15 x 4) + ($32 x 1)
= $92.00
Divided by no. of units
5
Average CM per unit
= $18.40
31
USING CVP ANALYSIS WITH MULTIPLE
PRODUCTS continued
• What is the break-even sales for the two
products?
S
=
Fixed costs
Weighted avg CM per unit
S
=
$184 000
$18.40
S
=
10 000 units
i.e., 8000 standard models and 2000
deluxe models
32
CONTRIBUTION MARGIN VARIANCE
ANALYSIS
• Compare actual profit results with planned
results to calculate:
– Sales price variance
– Sales volume variance
– Variable cost variance
33
11
34
12