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Chapter 4- accounting.docx

4 Pages

Course Code
ACC 406
Vincent Cappelli

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Chapter 4- cost volume profit analysis; a managerial planning tool  Cost volume-profit (CVP) analysis estimates how changes in costs (both variable and fixed), sales volume, and price affect a company’s profit. CVP is a powerful tool for planning and decision making.  CVP is one of the most versatile and widely applicable tools used by managerial accountants to help managers make better decisions.  The Break-even point is the point where total revenue equals total cost. (id. The point of zero profit)  CVP analysis can address many other issues as well, such as the number of units that must be sold to break even, the impact of a given reduction in a fixed cost on the break-even point and the impact of an increase in price of profit.  In a CVP analysis, cost refer to all costs of the company-production, selling, and administration. So variable costs are all costs that increase as more unit sold, including direct materials, direct labour, variable overhead and variable selling and administrative costs.  Similarly, fixed costs include fixed overhead and fixed selling and administrative expenses.  The income statement format that is based on the separation of costs into fixed and variable components is called the contribution margin income statement.  Contribution margin is defined as the excess of sales over variable costs:  Contribution margin= sales – variable costs  Contribution margin refers to the amount left after the variable costs are covered to contribute toward fixed costs.  Contribution margin ratio indicates the percentage the percentage of each sales dollar available to cover fixed costs and to provide income from operations.  Contribution margin ratio= contribution margin/ sales  The contribution margin ratio is most useful when the increase or decrease in sales volume in sales dollars  CMR is also useful in developing business strategies  Unit contribution margin is also useful for analyzing the profit potential of proposed decisions  Unit contribution margin = sales price per unit- variable cost per unit  The unit contribution margin is most useful when the increase or decrease in sales volume is measured in sales.  Change in income from operation = change in sales units x unit contribution margin  Operating income = Sales – total variable expenses – Total fixed expenses. o Expanded .. =( price x number of units sold ) – ( variable cost per unit x number of units sold) – total fixed cost.  The operating income equation can be rearranged as the following as well :  Break even units = total fixed cost/ price- variable cost per unit  If a company sells enough units for the contribution margin to just cover fixed costs, it will earn zero operating income .. in other words, it will break even.  units sold measure can be converted to a sales revenue measure by multiplying the unit selling price by the units sold.  The contribution margin ratio is the proportion of each sales dollar available to cover fixed costs and provide for profit.  Total contribution margin is the revenue remaining after total variable costs are covered, it must be the revenue available to cover fixed costs and contribute to profit.  There are three possibilities that fixed costs to contribution margin effect operating income .. 1. Fixed costs can equal contribution margin – break even 2. Fixed costs can be less than contribution margin – company earns positive income 3. Fixed costs can be larger than contribution margin – company earns an operating loss  Break even sales = total fixed expenses/ contribution margin ratio  Equation formula approach to break even analysis :  Sales = VC = FC = PROFIT  BE = (P x Q) = Q x VCU + FC + O P x Q – Q x VCU = FC Q( P – VCU) = FC QCM = FC Q = FC/CM *P = selling price per unit *Q= quantity (volume or number of units) * P(Q)= total revenue *VCU= variable cost per unit *VC(Q)= total variable cost *FC= total fixed cost  Number of units to earn target income = fixed cost = target income / price – variable cost per unit  Assuming that fixed costs remain the same, the impact on a firms income resulting from a change in the number of units sold can be assessed by multiplying the unit contribution margin by the change in the units sold.  Sales dollars to earn target income = fixed cost = target income/ contribution margin ratio
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