Cost-Volume-Profit Analysis (CVP)

Operating Leverage

Operating leverage describes the effects that fixed costs have on changes in operating income as changes occur in units sold and , hence, in contribution margin. The degree of operating leverage (DOL) is defined as:DOL= % change in operating income % change in sales

Operating Leverage The DOL at a particular level of sales is calculated as:Sales - variable costs DOL= Sales - variable costs = fixed costs Contribution margin Contribution margin fixed costs Contribution margin Operating income

Notice these two items are identical, except for fixed costs

Operating LeverageEXERCISE Carlisle Company currently sells 400,000 bottles of perfume each year. Each bottle costs $0.84 to produce and sells for $1.00. Fixed costs are $28,000 per year. What is DOL for Carlisle Company? The degree of operating leverage for Carlisle Company DOL= [400,000 (1- 0.84)][(400,000 (1- 0.84)) - 28,000] = 1.78

Operating LeverageDOL Margin of safety ratio 1

Margin of safety ratio

Sales Breakeven sales Sales

(Sales Breakeven sales) contribution margin ratio Sales contribution margin ratio

Operating income Contribution margin Contribution margin DOL Operating income DOL Margin of safety ratio

Effects of Sales Mix on IncomeDo-All Units sold Revenues, $200 and $100 per unit Variable costs, $120 and $70 per unit Contribution margin, $80 and $30 per unit Fixed costs Operating income Budgeted sales mix: 3 units of Do-All: 2 units of Superword 60 $12,000 7,200 $4,800 Superword 40 $4,000 2,800 $1,200 Total 100 $16,000 10,000 6,000 4,500 $1,500

Effects of Sales Mix on IncomeDo-Alls units contribution sold margin per unit Superwords units contribution sold margin per unit

Weighted-average contribution margin per unit

Total units sold($80 per unit60 units) ($30 per unit40 units)

$60 per unitBreakeven point

100 units

Fixed costsWeighted-average contribution margin per unit

$4,500 $60

75 units

Effects of Sales Mix on IncomeExercise 3-42Weighted-average ($6 per unit150,000 units) ($12 per unit50,000 units) contribution 200,000 units margin per unit

$7.5 per unitBreakeven point

Fixed costsWeighted-average contribution margin per unit

$1,200,000 $7.5

160,000 units

Effects of Sales Mix on IncomeExercise 3-42Let Q = Number of units of Deluxe carrier to breakeven 3Q = Number of units of Standard carrier to breakeven Revenues Variable costs Fixed costs = Zero operating income $20(3Q) + $30Q $14(3Q) $18Q $1,200,000 = 0 $60Q + $30Q $42Q $18Q = $1,200,000 $30Q = $1,200,000 Q = 40,000 units of Deluxe 3Q = 120,000 units of Standard The breakeven point is 120,000 Standard units plus 40,000 Deluxe units, a total of 160,000 units.

Contribution Margin vs. Gross MarginContribution Income Statement Emphasizing Contribution Margin Revenues Variable COGS Variable operating costs Contribution margin Fixed operating costs Operating income $120 43 163 37 19 $18 Gross margin Operating costs ($43+$19) Operating income 80 62 $18 $200 Financial Accounting Income Statement Emphasizing Gross Margin Revenues COGS $200 120

Contribution Margin vs. Gross MarginContribution Income Statement Emphasizing Contribution Margin Revenues Variable manufacturing costs Variable nonmanufacturing costs Contribution margin Fixed manufacturing costs Fixed nonmanufacturing costs Operating income 160 138 298 $182 $250 270 520 480 Gross margin Operating costs ($270+$138) Operating income 590 408 $182 $1,000 Financial Accounting Income Statement Emphasizing Gross Margin Revenues COGS ($250+$160) $1,000 410

Contribution Margin vs. Gross MarginExercise 3-431a.

Cost of goods sold Fixed manufacturing costs Variable manufacturing costs

$1,600,000 (500,000) $1,100,000

Variable manufacturing costs per unit = $1,100,000 200,000 = $5.50 per unit1b.

Total marketing and distribution costs Variable marketing and distribution (200,000 $4) Fixed marketing and distribution costs

$1,150,000 (800,000) $350,000

Contribution Margin vs. Gross MarginExercise 3-432.

Selling price = $2,600,000 200,000 units = $13 per unit Variable Variable Contribution Selling marketing and manufacturing margin per unit price distribution cost per unit costs per unit = $13 $5.50 $4.00 = $3.50 Fixed Contribution Fixed Sales marketing and Operating income = manufacturing margin per quantity distribution unit costs costs = ($3.50 230,000) $500,000 $350,000 $45,000

Contribution Margin vs. Gross MarginExercise 3-432.

Fixed manufacturing, marketing and distribution costs Breakeven point in units Contribution margin per unit 850,000 / $3.5 = 242,858 units Breakeven point in revenue = 242,858 $13 = $3,157,154

Job Costing

Cost AssignmentCost Tracing

Direct Costs

Cost AssignmentIndirect CostsCost Allocation

Cost Object

Cost-allocation basea cost driver is used as a basis upon which to build a systematic method of distributing indirect costs (number of machine-hours, direct labor) The cause-and-effect link between changes in the level of the cost driver and changes in indirect costs

Costing Systems

Job-Costing (Job order): system accounting for distinct cost objects called Jobs. Each job may be different from the next, and consumes different resources Costs are assigned to each job (or to each batch).Each job (or batch) has its own distinguishing characteristics.

Costing Systems

Process-Costing: system accounting for mass production of identical or similar products. Process-Costing accumulates product-related costs for a period of time. The costs are assigned to departments or processes for a set period of time.

Costing SystemsExercise 4-16a. b. c. d. e. f. g. h. i. j. k. Job costing Process costing Job costing Process costing Job costing Process costing Job costing Process costing Process costing Job costing l. n. o. p. q. r. t. u. Job costing Job costing Job costing Job costing Job costing Process costing Job costing Process costing Job costing m. Process costing

Job costing (but some process costing) s.

Actual Costing Indirect costs based on the actual indirect-cost rates times the actual activity consumption.Actual direct-cost rates Actual quantities of the direct-cost inputs

Direct Costs

Actual Costing() Indirect Costs Actual indirect-cost rates Actual quantities of the cost-allocation bases

Cost Object

Normal Costing Indirect costs based on the budgeted indirect-cost rates times the actual activity consumption.Actual direct-cost rates Actual quantities of the direct-cost inputs

Direct Costs

Normal Costing() Indirect Costs

Cost ObjectBudgeted indirect-cost rates Actual quantities of the costallocation bases

Seven-step Job Costing1. Identify the Job to be costed. 2. Identify the Direct Costs of the Job. 3. Select the Cost-Allocation base(s) to use for allocating Indirect Costs to the Job. 4. Match Indirect Costs to their respective Cost-Allocation base(s). 5. Calculate an Overhead Allocation Rate. 6. Allocate Overhead Costs to the Job. 7. Compute Total Job Costs by adding all direct and indirect costs together

Seven-step Job CostingExercise 4-171. Budgeted Budgeted manufacturing overhead costs manufacturing Budgeted direct manufacturing labor costs overhead rate 1,750,000 / 1,000,000 = 1.75

Actual manufacturing overhead rate

Actual manufacturing overhead costs Actual direct manufacturing labor costs

1,862,000 / 980,000 = 1.9

Seven-step Job CostingExercise 4-172. Costs of Job 626 under actual and normal costing follow: Actual Costing Direct materials Direct manufacturing labor costs Manufacturing overhead costs $30,000 1.90; $30,000 1.75 Total manufacturing costs of Job 626 $ 40,000 30,000 57,000 $ 127,000 Normal Costing $ 40,000 30,000 52,500 $ 122,500

Seven-step Job CostingExercise 4-173. Total manufacturing Actual overhead allocated manufacturing under normal costing labor costs Budgeted overhead rate

= $980,000 1.75 $1,715,000 Underallocated manufacturing overhead

Manufacturing Actual manufacturing overhead allocated overhead costs

= $1,862,000 $1,715,000 = $147,000