Chapter 3 Cost, Revenue, and Income Behavior

1
Chapter 3Cost, Revenue, and Income Behavior
2
The Contribution Format
3
Contribution Margin Practice

(a)

(b)

(c)

(d)

(e)

(f)


Per Unit

Var. Cost

Total

Total

Total


Operating

Selling

Per

Units


Fixed

Income

CM

Price

Unit

Sold


Costs










30


120,000

720,000

640,000











10

6

100,000


320,000










9

80,000


160,000

120,000



4
Contribution Margin Method to Determine Break-even

Break-even point in total sales dollars
Fixed expenses CM ratio


5
CVP Graph
Dollars
Units
6
CVP Graph
Profit Area
Dollars
Loss Area
Units
7
Profit-Volume Graph
Profit area
Loss area
Break-even point
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Target Operating Profit - CM Approach
Original contribution margin formula
Break Even Point in Units Fixed Expenses
Contribution Margin per Unit
Target operating profit modification
Units Sold to Earn Target Profit Fixed Expenses
Target Op. Profit Unit Contribution
Margin
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After-Tax Profit Targets
Net income Operating profit Income taxes
Operating profit (Tax rate x Operating profit)
Operating profit (1 Tax rate)
10
After-Tax Profit Targets
Fisher Company has a selling price of 40 for its
only product. Variable cost per unit is 24, and
fixed costs are 800,000 for the year. The
Company wants to achieve an annual net income
(after taxes) of 487,500. How many units must it
sell if its income tax rate is 35 percent.
11
The Margin of Safety

• Excess of budgeted (or actual) sales over the
  break-even volume of sales. The amount by which
  sales can drop before losses begin to be incurred.

Margin of safety Total sales - Break-even
sales
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Cost Structure and Profitability
Alpha Alpha Beta Beta Gamma Gamma
Amount Amount Amount
Sales 800,000 100 800,000 100 800,000 100
Variable Expenses 400,000 50 300,000 37.5 200,000 25
Contribution Margin 400,000 50 500,000 62.5 600,000 75
Fixed Expenses 300,000 400,000 500,000
Op. Income 100,000 100,000 100,000
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Effect on Profit of 10 Increase in Sales Revenue
Increase in Sales Revenue Contribution Margin Ratio Increase in Op.Income
Alpha 80,000 X 50 40,000 40
Beta 80,000 X 62.5 50,000 50
Gamma 80,000 X 75 60,000 60
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Break-Even Points
Fixed Expenses 300,000 / 400,000 / 500,000 / Contribution Margin Ratio 50 62.5 75 Break-Even Sales Revenue 600,000 640,000 666,667
Alpha Beta Gamma Fixed Expenses 300,000 / 400,000 / 500,000 / Contribution Margin Ratio 50 62.5 75 Break-Even Sales Revenue 600,000 640,000 666,667
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Margin of Safety
Actual Sales Revenue Break-Even Sales Revenue Margin of Safety
Alpha Beta Gamma 800,000 - 800,000 - 800,000 - 600,000 640,000 666,667 200,000 160,000 133,333
16
Definition of Operating Leverage

• The relative mix of a firms fixed and variable
  costs determines its operating leverage.
• At a given level of sales
• Degree of operating
  Contribution Margin
• leverage
  Operating Income
• The higher a firms fixed cost as compared to its
  variable cost, the greater its operating
  leverage.
• Operating leverage acts like a multiplier. The
  greater the operating leverage, the greater the
  change in operating income for a given change in
  sales.
• Lets calculate the operating leverage for each
  firm.

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Application of Operating Leverage

• At a given level of sales, the operating leverage
  is a measure of how a given percentage change in
  sales will affect operating profits.
• In fact, the operating profit will increase by
  the operating leverage times the percentage
  change in sales.
• For a 10 increase in sales , Firm Alphas
  operating income increased 40 (4 times 10).
• For a 10 increase in sales , Firm Betas
  operating income increased 50 (5 times 10).
• For a 10 increase in sales , Firm Gammas
  operating income increased 60 (6 times 10).

18
Break-even Analysis (in Units) with Multiple
Products

• Curl Company provides us with the following
  information

Fixed cost is 120,000. What is the break-even
point in units? What are the sales of Surfboards
and Sailboards at the break-even point?
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Break-even Analysis (in Sales Dollars) with
Multiple Products

• Curls Contribution Margin income statement is
  shown below

150,000 450,000
33.3
What is the break-even point in Sales? What are
the sales of Surfboards and Sailboards at the
break-even point?