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# Chapter

14

Cost-VolumeProfit Analysis
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CVP Analysis???
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Learning
Learning Objectives
Objectives
Describe different types of cost

## Identify assumptions in cost

behavior in relation to

## Determine cost estimates using Describe several applications

three different methods.
Compute the break-even point
for a single product company.
Graphs costs and sales for a
single product company.

of cost-volumeprofit analysis.
Compute break-even point
for a multiproduct company.
Analyze changes in sales
using the degree of operating
leverage.

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Questions
by
Cost-Volume-Profit
Cost-Volume-Profit Analysis
Analysis
CVP
CVP analysis
analysis is
is used
used to
questions
such
such as:
as:
How
How much
much must
must II sell
sell to
to earn
earn my
my desired
desired
income?
income?
How
How will
will income
income be
be affected
affected ifif II reduce
reduce
selling
selling prices
prices to
to increase
increase sales
sales volume?
volume?
How
How will
will income
income be
be affected
affected ifif II change
change the
the
sales
sales mix
mix of
of my
my products?
products?

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Identifying
Identifying Cost
Cost Behavior
Behavior
Refers to the manner in which a cost changes as
a related activity changes.
3 common classifications:
Fixed Cost
Variable Cost
Mixed Cost

Total
Total Fixed
Fixed Cost
Cost

Cost (\$)

## Total fixed costs remain unchanged when activity

changes.
Eg: Factory Insurance, Factory Rent

## Your monthly rent for a

factory buildings does not
change at any level of
production.
Volume (units produced)

Fixed
Fixed Cost
Cost Per
Per Unit
Unit

Cost (\$)

## Fixed costs per unit decline as activity increases.

unit decreases as
production increases.
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## Volume (units produced)

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Total
Total Variable
Variable Cost
Cost
Total variable costs change when activity changes.

Cost (\$)

## Eg: Direct materials, Direct labor

changes with the level of
productions
Volume (units produced)
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Variable
Variable Cost
Cost Per
Per Unit
Unit
Variable costs per unit do not change as activity
increases.

Cost (\$)

unit doest not change at
any level of production.
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## Volume (units produced)

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Mixed
Mixed Cost
Cost
Mixed cost includes both fixed and variable cost
components. It is greater than zero when volume is
zero, but increases when production is increased.
Eg: Utility charge

## Facility costs is incurred even

when facility is unused, and
increases with usage.

Cost (\$)

Total
Total Mixed
Mixed Costs
Costs

l
a
t
To

os
c
d
e
x
i

Variable
Utility Charge
Fixed Monthly
Utility Charge

## Volume (units produced)

Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

Step-Wise
Step-Wise Costs
Costs

Cost

## Total cost remains

constant within a
narrow range of
activity.

## Volume (unit produced)

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Step-Wise
Step-Wise Costs
Costs

Cost

## Total cost increases to a

new higher cost for the next
higher range of activity.

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Curvilinear
Curvilinear Costs
Costs

Cost (\$)

## Costs that increase when production increases,

but in a nonlinear manner.

## Volume (units produced)

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Measuring
Measuring Cost
Cost Behavior
Behavior

## The objective is to classify all costs as either

fixed or variable.
Analysis of past cost behavior is required in
order to identify costs.
3 different methods can be used to determine
cost estimates:
1. Scatter Diagram
2. High-Low Method
3. Least-Squares Regression
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Scatter
Scatter Diagram
Diagram

Total Cost in
1,000s of Dollars

## The Scatter Diagram Method estimates costs on

a visual fit on the cost line.
20

10

* *
* *

* ** *
**
Plot the data points on a graph
(total cost vs. activity).

0
1
2
3
4
Volume, 1,000s of Units Produced

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Scatter
Scatter Diagram
Diagram

Total Cost in
1,000s of Dollars

## Draw a line through the plotted data points so that about

equal numbers of points fall above and below the line.
20

10

* *
* *

* ** *
**

## Estimated fixed cost = 10,000

0

0
1
2
3
4
Volume, 1,000s of Units Produced

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Scatter
Scatter Diagram
Diagram

Total Cost in
1,000s of Dollars

## Unit Variable Cost = Slope =

20

10

* *
* *

in cost
in units

* ** *
**

Horizontal distance is
the change in activity.

Vertical
distance
is the
change
in cost.

0
1
2
3
4
Volume, 1,000s of Units Produced

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High-Low
High-Low Method
Method

Total Cost in
1,000s of Dollars

## The High-Low Method cost estimates from the high-low

method are based only on costs corresponding to the
lowest and highest sales.
20

10

* *
*
* *
*
*
*
High-Low
line of cost behavior
*
*
Estimated fixed cost

0
1
2
3
4
Volume, 1,000s of Units Produced

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High-Low
High-Low Method
Method
The following relationships between sales
and costs are observed:

## High activity level

Low activity level
Change

Sales
\$ 67,500
17,500
\$ 50,000

Cost
\$ 29,000
20,500
\$ 8,500

## Using these two levels of activity, compute:

the variable cost per unit.
the total fixed cost.

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The
The High-Low
High-Low Method
Method
High activity level
Low activity level
Change

in units

Sales
\$ 67,500
17,500
\$ 50,000

Cost
\$ 29,000
20,500
\$ 8,500

\$50,000

## The McGraw-Hill Companies, Inc., 2007

The
The High-Low
High-Low Method
Method
High activity level
Low activity level
Change

Sales
\$ 67,500
17,500
\$ 50,000

Cost
\$ 29,000
20,500
\$ 8,500

## = \$8,500 =\$0.17 per unit

\$50,000
in units
Fixed cost = Total cost Total variable

## The McGraw-Hill Companies, Inc., 2007

The
The High-Low
High-Low Method
Method
High activity level
Low activity level
Change

Sales
\$ 67,500
17,500
\$ 50,000

Cost
\$ 29,000
20,500
\$ 8,500

## \$8,500 = \$0.17 per unit

\$50,000
in units
Fixed cost = Total cost Total variable cost

## Fixed cost = \$29,000 (\$0.17 per sales \$ \$67,500)

Fixed cost = \$29,000 \$11,475 = \$17,525
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Least-Squares
Least-Squares Regression
Regression

Total Cost in
1,000s of Dollars

The least-squares regression method is a statistical technique and uses all data
points.
It is commonly used with computer software because of the large number of
calculations required.

20

10

* *
*
* *
*
*
*
Regression
Line of Cost Behavior
*
*
Estimated fixed cost

0
1
2
3
4
Larson, Wild, Chiapetta,
Ropidah, Haslinda,
Aryati, Lianaof Units Produced The McGraw-Hill Companies, Inc., 2007
Volume,
1,000s

Break
Break Even
Even Analysis
Analysis
The break-even point (expressed in units of
product or dollars of sales) is the unique sales
level at which a company earns neither a profit
nor incurs a loss which total revenues equal to
total costs.
To compute a break even point in terms of sales
unit, we divide total fixed costs by the contribution
margin per unit.
To compute a break even point in terms of sales
dollars, we divide total fixed costs by the
contribution margin ratio.
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Contribution
Contribution Margin
Margin
Contribution
Contribution margin
margin is
is amount
amount by
by which
which revenue
revenue
exceeds
exceeds the
the variable
variable costs
costs of
of producing
producing the
the
revenue.
revenue.
Contribution
Contribution margin
margin can
can be
be expressed
expressed in
in 33 ways:
ways:
1.
1.Total
Total contribution
contribution margin
margin in
in dollars.
dollars.
2.
2.Unit
Unit contribution
contribution margin
margin (dollars
(dollars per
per unit)
unit)
3.
3.Contribution
Contribution margin
margin ratio
ratio (%)
(%)
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Contribution
Contribution Margin
Margin Per
Per Unit
Unit
Selling price per unit less unit variable cost.
Dollar from each unit of sales available to cover
fixed cost and income from operation.
Useful when increase / decrease in sales volume
is measured in sales unit (quantity)
Contribution
Contribution Margin
Margin per
per Unit
Unit == Selling
Selling price
price per
per unit
unit
Variable
Variable cost
cost per
per unit.
unit.
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Contribution
Contribution Margin
Margin Ratio
Ratio
Contribution margin per unit divide by selling price
per unit.
It measures the effect on income from operations
of an increase or a decrease in sales volume.
Useful when sales volume is measured in sales
dollars.
Contribution
Contribution Margin
Margin == Unit
Unit Selling
Selling price
price Variable
Variable cost
cost per
per unit.
unit.
Ratio
Ratio

Selling
Selling price
price per
per unit
unit

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Computing
Computing Break-Even
Break-Even Point
Point
We have just seen one of the basic CVP
relationships the break-even computation.

Fixed costs
Break-even point in units =
Contribution margin per unit
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Computing
Computing Break-Even
Break-Even Point
Point
The break-even formula may also be expressed
sales dollars.

Fixed costs
Break-even point in dollars =
Contribution margin ratio
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Computing
Computing Break-Even
Break-Even Point
Point
Sales Revenue (2,000 units)
Variable costs
Contribution margin
Fixed costs
Profit for the period

Total
\$ 100,000
(60,000)
\$ 40,000
(30,000)
\$ 10,000

Unit
\$ 50
(30)
\$ 20

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Break-Even
Break-Even Point
Point
Sales Revenue (2,000 units)
Variable costs
Contribution margin
Fixed costs
Profit for the period

Total
\$ 100,000
(60,000)
\$ 40,000
(30,000)
\$ 10,000

Unit
\$ 50
(30)
\$ 20

## How much contribution margin must this company

have to cover its fixed costs (break even)?
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Break-Even
Break-Even Point
Point
Sales Revenue (2,000 units)
Variable costs
Contribution margin
Fixed costs
Profit for the period

Total
\$ 100,000
(60,000)
\$ 40,000
(30,000)
\$ 10,000

Unit
\$ 50
(30)
\$ 20

## How many units must this company sell to cover its

fixed costs (break even)?
Answer: \$30,000 \$20 per unit = 1,500
units
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## Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

Computing
Computing Break-Even
Break-Even Point
Point
Illustration
Illustration 11
ABC
ABC Co.
Co. sells
sells product
product XYZ
XYZ at
at \$5.00
\$5.00 per
per unit.
unit. IfIf
fixed
fixed costs
costs are
are \$200,000
\$200,000 and
and variable
variable costs
costs are
are
\$3.00
\$3.00 per
per unit,
unit, how
how many
many units
units must
must be
be sold
sold to
to
break
break even?
even?
a.
a.
b.
b.
c.
c.
d.
d.

100,000
100,000 units
units
40,000
40,000 units
units
200,000
200,000 units
units
66,667
66,667 units
units

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Break-Even
Break-Even Point
Point
ABC
ABC Co.
Co. sells
sells product
product XYZ
XYZ at
at \$5.00
\$5.00 per
per unit.
unit. IfIf
fixed
fixed costs
costs are
are \$200,000
\$200,000 and
and variable
variable costs
costs are
are
\$3.00
\$3.00 per
per unit,
unit, how
how many
many units
units must
must be
be sold
sold to
to
break
break even?
even?
a.
a.
b.
b.
c.
c.
d.
d.

100,000
100,000 units
units
40,000
40,000 units
units
Unit contribution = \$5.00 - \$3.00 = \$2.00
200,000
200,000 units
units Fixed costs
\$200,000
= \$2.00 per unit
66,667
66,667 units
units
Unit contribution
= 100,000 units

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Break-Even
Break-Even Point
Point
Illustration
Illustration 22
Use
Use the
the contribution
contribution margin
margin ratio
ratio formula
formula to
to determine
determine
the
the amount
amount of
of sales
sales revenue
revenueABC
ABC must
must have
have to
to break
break
even.
even. All
All information
information remains
remains unchanged:
unchanged: fixed
fixed costs
costs
are
are \$200,000;
\$200,000; Selling
Selling price
price per
per unit
unit isis \$5.00;
\$5.00; and
and unit
unit
variable
variable cost
cost isis \$3.00.
\$3.00.
a.
a.
b.
b.
c.
c.
d.
d.

\$200,000
\$200,000
\$300,000
\$300,000
\$400,000
\$400,000
\$500,000
\$500,000

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Break-Even
Break-Even Point
Point
Use
Use the
the contribution
contribution margin
margin ratio
ratio formula
formula to
to determine
determine
the
the amount
amount of
of sales
sales revenue
revenueABC
ABC must
must have
have to
to break
break
even.
even. All
All information
information remains
remains unchanged:
unchanged: fixed
fixed costs
costs
are
are \$200,000;
\$200,000; Selling
Selling price
price per
per unit
unit isis \$5.00;
\$5.00; and
and unit
unit
variable
variable cost
cost isis \$3.00.
\$3.00.
a.
a.
b.
b.
c.
c.

\$200,000
\$200,000
\$300,000
\$300,000
\$400,000
\$400,000

d.
d. \$500,000
\$500,000
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

Unit contribution
= \$5.00 - \$3.00 =
\$2.00
Contribution margin ratio
= \$2.00 \$5.00 = .
40
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Companies, Inc., 2007
Break-even revenue
=

Preparing
Preparing aa CVP
CVP Chart
Chart

in Dollars

Total costs

## Draw the total cost line with a slope

equal to the unit variable cost.

Volume in Units
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Preparing
Preparing aa CVP
CVP Chart
Chart
Starting at the origin, draw the sales line

Sales

Total costs
Break-even
Point
Volume in Units

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Assumptions
Assumptions of
of CVP
CVP Analysis
Analysis
A limited range of activity called the relevant
range, where CVP relationships are linear.
Selling price per unit remains constant.
Variable costs per unit remain constant.
Total fixed costs remain constant.
Production = sales (no inventory changes).

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Sensitivity
Sensitivity Analysis
Analysis
Cost-Volume-Profit Analysis can be used to predict
what can happen under alternatives strategies
concerning sales volume, selling prices, variable
costs or fixed costs.

Profit
Profit(pretax)
(pretax)== Sales
SalesVariable
Variablecosts
costsFixed
Fixedcosts
costs
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## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Profit
Profit
from
from Expected
Expected Sales
Sales Illustration
Illustration 11
Rydell expects to sell 1,500 units at \$100 each
next month. Fixed costs are \$24,000 per month
and the unit variable cost is \$70. What amount
of income should Rydell expect?
Profit
Profit (pretax)
(pretax) ==Sales
SalesVariable
Variablecosts
costsFixed
Fixedcosts
costs
==[[1,500
1,500units
units \$100
\$100]] [[1,500
1,500units
units\$70
\$70]]\$24,000
\$24,000
==\$21,000
\$21,000

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Sales
Sales for
for aa Target
Target Profit
Profit
Break-even formulas may be adjusted to show
the sales volume needed to earn
any amount of income.

Unit sales =

## Fixed costs + Target profit

Contribution margin per unit

## Fixed costs + Target profit

Dollar sales =
Contribution margin ratio

Computing
Computing Sales
Sales for
for aa Target
Target Profit
Profit
Illustration2
Illustration2
ABC
ABC Co.
Co. sells
sells product
product XYZ
XYZ at
at \$5.00
\$5.00 per
per unit.
unit. IfIf
fixed
fixed costs
costs are
are \$200,000
\$200,000 and
and variable
variable costs
costs are
are
\$3.00
\$3.00 per
per unit,
unit, how
how many
many units
units must
must be
be sold
sold to
to
earn
earn income
income of
of \$40,000?
\$40,000?
a.
a.
b.
b.
c.
c.
d.
d.

100,000
100,000 units
units
120,000
120,000 units
units
80,000
80,000 units
units
200,000
200,000 units
units

Computing
Computing Sales
Sales for
for aa Target
Target Profit
Profit
ABC
ABC Co.
Co. sells
sells product
product XYZ
XYZ at
at \$5.00
\$5.00 per
per unit.
unit. IfIf
fixed
fixed costs
costs are
are \$200,000
\$200,000 and
and variable
variable costs
costs are
are
\$3.00
\$3.00 per
per unit,
unit, how
how many
many units
units must
must be
be sold
sold to
to
earn
earn income
income of
of \$40,000?
\$40,000?
a.
a.
b.
b.
c.
c.
d.
d.

100,000
100,000 units
units
120,000
120,000 units
units
80,000
80,000 units
units
200,000
200,000 units
units

## Unit contribution = \$5.00 - \$3.00

= \$2.00
Fixed costs + Target profit
Unit contribution
\$200,000 + \$40,000 = 120,000 units
\$2.00 per unit
The McGraw-Hill Companies, Inc., 2007

Computing
Computing Sales
Sales (Dollars)
(Dollars) for
for aa
Target
Target Profit
Profit
Target profit is income after income tax.

Dollar sales =

Fixed + Target
+ Income
costs
profit
taxes
Contribution margin ratio

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Sales
Sales (Dollars)
(Dollars) for
for aa
Target
Target Profit
Profit
To convert target profit to before-tax profit, use the
following formula:

Before-tax profit

Target profit
1 - tax rate

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Sales
Sales (Dollars)
(Dollars) for
for aa
Target
Target Profit
Profit Illustration
Illustration 11
Rydell has a monthly target profit of \$18,000. The unit
selling price is \$100. Monthly fixed costs are \$24,000, the
unit variable cost is \$70, and the tax rate is 25 percent.
What is Rydells before-tax profit and
income tax expense?

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Sales
Sales (Dollars)
(Dollars) for
for aa
Target
Target Profit
Profit
Rydell has a monthly target profit of \$18,000. The unit
selling price is \$100. Monthly fixed costs are \$24,000,
the unit variable cost is \$70, and the tax rate is 25
percent.
What is Rydells before-tax profit and
income tax expense?
Before-tax profit =
Before-tax profit =

Target profit
1 - tax rate
\$18,000
=
1 - .25

\$24,000

## Income tax = .25 \$24,000 =

\$6,000
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## Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

Computing
Computing Sales
Sales (Dollars)
(Dollars) for
for aa
Target
Target Profit
Profit Illustration
Illustration 22
Rydell has a monthly target profit of \$18,000. The unit
selling price is \$100. Monthly fixed costs are \$24,000, the
unit variable cost is \$70, and the tax rate is 25 percent.
What monthly sales revenue will Rydell
need to earn the target profit?

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Sales
Sales (Dollars)
(Dollars) for
for aa
Target
Target Profit
Profit
Rydell has a monthly target profit of \$18,000. The unit
selling price is \$100. Monthly fixed costs are \$24,000,
the unit variable cost is \$70, and the tax rate is 25
percent.
What monthly sales revenue will Rydell
need to earn the target profit?

Dollar sales =

Dollar sales =

Fixed + Target
+ Income
costs
profit
taxes
Contribution margin ratio

= \$160,000
30%

## The McGraw-Hill Companies, Inc., 2007

Formula
Formula for
for Computing
Computing Sales
Sales (Units)
(Units)
for
for aa Target
Target Profit
Profit
The
The formula
formula for
for computing
computing dollar
dollar sales
sales may
may be
be used
used
to
to compute
compute unit
unit sales
sales by
by substituting
substituting contribution
contribution per
per
unit
unit in
in the
the denominator.
denominator.

Unit sales =

Fixed + Target
+ Income
costs
profit
taxes
Contribution margin per unit

## \$24,000 + \$18,000 + \$6,000

Unit sales =
\$30 per unit
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

= 1,600 units

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing the
the Margin
Margin of
of Safety
Safety
Margin of safety is the amount by which sales
may decline before reaching break-even sales.
Margin of safety may be expressed as a
percentage of expected sales.

Margin of safety
percentage

=
Expected sales

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing the
the Margin
Margin of
of Safety
Safety
Illustration
Illustration
If Rydells sales are \$100,000 and break-even
sales are \$80,000, what is the margin of safety
in dollars and as a percentage?

Margin of safety
percentage

Expected sales

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing the
the Margin
Margin of
of Safety
Safety
If Rydells sales are \$100,000 and break-even
sales are \$80,000, what is the margin of safety
in dollars and as a percentage?
Margin of safety = \$100,000 - \$80,000 = \$20,000
Margin of safety
percentage

## Expected sales - Break-even sales

Expected sales

Margin of safety
percentage

\$100,000 - \$80,000
\$100,000

= 20%

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Multiproduct
Multiproduct
Break-Even
Break-Even Point
Point
The CVP formulas may be modified for use when
a company sells more than one product.
The unit contribution margin is replaced with the
contribution margin for a composite unit.
A composite unit is composed of specific numbers of
each product in proportion to the product sales mix.
Sales mix is the ratio of the volumes of the various
products.

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Multiproduct
Multiproduct
Break-Even
Break-Even Point
Point
The resulting break-even formula for composite
unit sales is:
Break-even point
in composite units

Fixed costs
Contribution margin
per composite unit

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Multiproduct
Multiproduct
Break-Even
Break-Even Point
Point -- Illustration
Illustration
Hair-Today offers three cuts as shown below. Annual
fixed costs are \$96,000. Compute the break-even
point in composite units and in number of units for
each haircut at the given sales mix.

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Multiproduct
Multiproduct
Break-Even
Break-Even Point
Point
Hair-Today offers three cuts as shown below. Annual
fixed costs are \$96,000. Compute the break-even
point in composite units and in number of units for
haircut
the given
salesare
mix.
A each
4:2:1 sales
mix at
means
that if there
500
budget cuts, then there will be 1,000 ultra cuts,
and 2,000 basic cuts.

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Multiproduct
Multiproduct
Break-Even
Break-Even Point
Point
Step 1: Compute contribution margin per composite
unit.

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Multiproduct
Multiproduct
Break-Even
Break-Even Point
Point
Step 1: Compute contribution margin per composite
unit.

## Contribution margin per composite unit

Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Multiproduct
Multiproduct
Break-Even
Break-Even Point
Point
Step 2: Compute break-even point in composite units.

Break-even point
in composite units

## Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

Fixed costs
Contribution margin
per composite unit

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Multiproduct
Multiproduct
Break-Even
Break-Even Point
Point
Step 2: Compute break-even point in composite
units.
=

Fixed costs
Contribution margin
per composite unit

Break-even point
in composite units

\$96,000
\$32.00 per
composite unit

Break-even point
in composite units

## 3,000 composite units

Break-even point
in composite units

## The McGraw-Hill Companies, Inc., 2007

Computing
Computing Multiproduct
Multiproduct
Break-Even
Break-Even Point
Point
Step 3: Determine the number of each haircut
that must be sold to break even.
Sales Composite
Product Mix
Cuts
Haircuts
Basic
4

3,000
= 12,000
Ultra
2

3,000
= 6,000
Budget
1

3,000
= 3,000

## The McGraw-Hill Companies, Inc., 2007

Multiproduct
Multiproduct Break-Even
Break-Even
Income
Income Statement
Statement
Step 4: Verify the results.

Selling Price
Variable Cost
Unit Contribution
Sales Volume
Total Contribution
Fixed Costs
Profit

Basic
\$ 10.00
(6.50)
\$
3.50

12,000
\$ 42,000

Haircuts
Ultra
\$ 16.00
(9.00)
\$
7.00

6,000
\$ 42,000

Budget
\$
8.00
(4.00)
\$
4.00

3,000
\$ 12,000

Combined

\$ 96,000
96,000
\$
0

## The McGraw-Hill Companies, Inc., 2007

Degree
Degree of
of Operating
Operating Leverage
Leverage
A measure of the extent to which fixed costs
are being used in an organization.
Also used to measure the impact of changes in
sales on income from operation.
A high operating leverage indicates that a small
increase in sales will yield a large percentage
increase in income
Contribution margin (\$)
= Degree of operating leverage
Pretax profit
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

## The McGraw-Hill Companies, Inc., 2007

Operating
Operating Leverage
Leverage -- Illustration
Illustration
Rydell Company
Sales (1,600 units)
Variable expenses
Contribution margin
Fixed expenses
Profit for the period

Contribution margin
Profit

## If Rydell increases sales by 10

percent, what will the percentage
increase in income be?
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

\$ 160,000
(112,000)
48,000
(24,000)
\$ 24,000

\$48,000
\$24,000

= 2.0

## The McGraw-Hill Companies, Inc., 2007

Operating
Operating Leverage
Leverage
Rydell Company
Sales (1,600 units)
Variable expenses
Contribution margin
Fixed expenses
Profit for the period

\$ 160,000
(112,000)
48,000
(24,000)
\$ 24,000

## Percent increase in sales

Degree of operating leverage
Percent increase in income
Larson, Wild, Chiapetta, Ropidah, Haslinda, Aryati, Liana

10%

2
20%

## The McGraw-Hill Companies, Inc., 2007

End of Chapter 14