Chapter 7 Cost Volume Profit Analysis A Benefits of Cost Volume Profit for Managers a Cost Volume Profit Analysis volume and profit or loss i Data Required expresses the relationships among cost 1 Sale Price 2 Volume 3 Variable Costs 4 Fixed Costs 5 Profit or Loss ii CVP Assumptions 1 Change in volume is only factor that affects cost 2 managers can classify each cost as either variable or fixed and they are linear throughout the model revenue are linear throughout the relevant range of volume 3 inventory levels will not change 4 5 Sales Mix sales is the combination to products that make up total a Remains unchanged iii Unit Contribution Margin 1 Contribution Margin income Statement costs by behavior rather than by function which separates a Can divide variable and fixed costs is the excess of sales revenue over 2 Contribution Marin variable expenses a How much revenue is left after variable to contribute towards fixed costs and profit 3 Contribution Margin per Unit or unit contribution margin is the excess of the selling price per unit over the variable cost of obtaining and selling each unit a How much profit each unit provides before fixed costs Contribution Margin Ratio Unit Contribution Marin Sales Price per Unit Contribution Margin Ratio Contribution Margin Sales Revenue 4 both formulas are equal 5 can not be used if number of units changes the sales level at which the operating income is 0 sales below B Break Even Point equals a loss and sales above equals a profit Income Statement Approach a Operating Income Sales Revenue Variable Expenses Fixed Expenses Operating Income Sales price unit units sold variable cost unit units sold fixed costs Operating Income Sales revenue Variable Expenses Fixed Expenses Sales in units fixed Expenses Operating Income Contribution Margin per Unit b Contribution Method c contribution Method Operating Income Sales revenue Variable Expenses Fixed Expenses Sales In Fixed Expenses Operating Income Contribution Margin Ratio C Using CVP for changing Business Conditions a Sensitivity Analysis a what if technique that asks what results will be if actual prices or costs change or if an underlying assumption such as sales mixes changes b Change in sales price i Sales price Decreases Unit Contribution Margin Decreases Volume needed for break even increases ii Sales Price Increases Unit Contribution Margin Increases Volume needed for break even decreases c Changing Variable Cost i Variable Cost Increases Unit Contribution Margin Decreases Volume needed for break even increases ii Variable Cost Decreases Unit Contribution Increases Volume needed for break even decreases d Changing Fixed Costs i Fixed Costs Increase Volume needed for break even increaeases ii Fixed costs Decrease Volume needed for break even decreases is the excess of actual or expected sales over break even i Cushion or drop in sales that the company can absorb before incurring losses ii Margin of safety Expected sales in units break even in sales refers to the relative amount of fixed and variable costs b Operating Leverage that make up its total cost i high operating leverage means relatively more fixed costs than variable costs ii higher contribution margin ratios iii higher potential for risk reward iv Operating Leverage factor operating income is to change in volume tells us how responsive a company s 1 operating level factor Contribution Margin operating income 2 D Indicators of Risk a Margin of Safety
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