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Classify costs by their behavior as variable costs, fixed costs, or mixed costs. Use a cost-volume-profit chart and a profit-volume chart to determine the break-even point. Use the contribution margin, the contribution margin ratio, and the unit contribution margin. Calculate the margin of safety and the operating leverage, and explain how managers use these concepts.
Classify costs by their behavior as variable costs, fixed costs, or mixed costs. Use a cost-volume-profit chart and a profit-volume chart to determine the break-even point. Use the contribution margin, the contribution margin ratio, and the unit contribution margin. Calculate the margin of safety and the operating leverage, and explain how managers use these concepts.
Classify costs by their behavior as variable costs, fixed costs, or mixed costs. Use a cost-volume-profit chart and a profit-volume chart to determine the break-even point. Use the contribution margin, the contribution margin ratio, and the unit contribution margin. Calculate the margin of safety and the operating leverage, and explain how managers use these concepts.
1 1 Accounting: A Malaysian Perspective, 4 th ed (Adapted from Accounting 22 nd ed) Warren, Reeve and Duchac Cost Behaviour and Cost- Volume-Profit Analysis 8 2 Click to edit Master title style 2 2 2 1. Classify costs by their behavior as variable costs, fixed costs, or mixed costs. 2. Compute the contribution margin, the contribution margin ratio, and the unit contribution margin, and explain how they may be useful to managers. After studying this chapter, you should be able to: 3 Click to edit Master title style 3 3 3 3. Use the unit contribution margin, determine the break-even point and the volume necessary to achieve a target profit. 4. Use a cost-volume-profit chart and a profit- volume chart, determine the break-even point and the volume necessary to achieve a target profit. After studying this chapter, you should be able to: 4 Click to edit Master title style 4 4 4 5. Compute the margin of safety and the operating leverage, and explain how managers use these concepts 6. List the assumptions underlying cost-volume- profit analysis. After studying this chapter, you should be able to: 5 Click to edit Master title style 5 5 5 Classify costs by their behavior as variable costs, fixed costs, or mixed costs. Objective 1 8-1 6 Click to edit Master title style 6 6 6 Cost Behavior 8-1 Cost behavior refers to the manner in which a cost changes as a related activity changes. Such activities are called activity base (or activity drivers). The range of activity over which the changes in the cost are of interest is called the relevant range. 7 Click to edit Master title style 7 7 7 Variable Costs 8-1 Variable costs are costs that vary in proportion to changes in the level of activity. 8 Click to edit Master title style 8 8 8 Syarikat Tah produces stereo sound systems under the brand name of T-Sound. The parts for the T-Sound stereos are purchased from outside suppliers for RM10 per unit (a variable cost) and assembled in Syarikat Tahs Sintok plant. 8-1 Syarikat Tah 9 Click to edit Master title style 9 9 9 9 Total Variable Cost Graph T o t a l
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RM300,000 RM250,000 RM200,000 RM150,000 RM100,000 RM50,000 10 20 30 0 Total Units (Model TS-12) Produced (thousands) Variable Cost Graphs 8-1 (Continued) 10 Click to edit Master title style 10 10 10 10 Unit Variable Cost Graph RM20 RM15 RM10 RM5 0 D i r e c t
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10 20 30 Total Units (Model TS- 12) Produced (thousands) 8-1 (Concluded) 11 Click to edit Master title style 11 11 11 11 T o t a l
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RM300,000 RM250,000 RM200,000 RM150,000 RM100,000 RM50,000 10 20 30 0 RM20 RM15 RM10 RM5 0 C o s t
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10 20 30 Number of Units of Model JS-12 Produced Units Produced (000) Units Produced (000) Direct Materials Cost per Unit Total Direct Materials Cost 5,000 units RM10 RM 50,000 10,000 10 l00,000 15,000 10 150,000 20,000 10 200,000 25,000 10 250,000 30,000 10 300,000 8-1 Unit Cost Compared to Total Cost 12 Click to edit Master title style 12 12 12 Fixed Costs 8-1 Fixed costs are costs that remain the same in total dollar amount as the level of activity changes. 13 Click to edit Master title style 13 13 13 The production supervisor for Syarikat Mons Jitra plant is Siti Maimon. She is paid RM75,000 per year. The plant produces from 50,000 to 300,000 bottles of La Fleur Perfume. Syarikat Mons Jitra Plant 8-1 14 Click to edit Master title style 14 14 14 14 Number of Bottles of Perfume Produced Total Salary for Siti Maimon 50,000 bottles RM75,000 RM1.500 100,000 75,000 0.750 150,000 75,000 0.500 200,000 75,000 0.375 250,000 75,000 0.300 300,000 75,000 0.250 Salary per Bottle of Perfume Produced Fixed Versus Variable Cost of Siti Maimons Salary 8-1 15 Click to edit Master title style 15 15 15 15 T o t a l
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RM150,000 RM125,000 RM100,000 RM75,000 RM50,000 RM25,000 100 200 300 0 Bottles Produced (000) Number of Bottles of Perfume Produced U n i t
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RM1.50 RM1.25 RM1.00 RM.75 RM.50 RM.25 100 200 300 0 Units Produced (000) Total Salary for Siti Maimon 50,000 bottles RM75,000 RM1.500 100,000 75,000 0.750 150,000 75,000 0.500 200,000 75,000 0.375 Salary per Bottle of Perfume Produced 8-1 16 Click to edit Master title style 16 16 16 Mixed Costs 8-1 A mixed cost (sometimes called semivariable or semifixed costs) has characteristics of both a variable and a fixed cost. Over one range of activity, the total mixed cost may remain the same. Over another range of activity, the mixed cost may change in proportion to changes in level of activity. 17 Click to edit Master title style 17 17 17 Syarikat Syed manufactures sails using rented equipment. The rental charges are RM15,000 per year, plus RM1 for each machine hour used over 10,000 hours. Syarikat Syed Example 8-1 18 Click to edit Master title style 18 18 18 18 T o t a l
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0 Total Machine Hours (000) RM45,000 RM40,000 RM35,000 RM30,000 RM25,000 RM20,000 RM15,000 RM10,000 RM5,000 10 20 30 40 Mixed costs are usually separated into their fixed and variable components for management analysis. Mixed Cost Graph for Syarikat Syed Equipment Rental Charges 8-1 19 Click to edit Master title style 19 19 19 The high-low method is a simple cost estimate technique that may be used for separating mixed costs into their fixed and variable components. High-Low Method 8-1 20 Click to edit Master title style 20 20 20 20 First, select the highest and lowest levels of activity. 8-1 Variable Cost per Unit = Difference in Total cost Difference in Production Estimating Variable Cost Using High-Low Production Total (Units) Cost June 1,000 RM45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Actual costs incurred 21 Click to edit Master title style 21 21 21 Production Total (Units) Cost June 1,000 RM45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 8 Then, fill in the formula. 8-1 Variable Cost per Unit = Difference in Total Cost Difference in Production RM61,500 41,250 RM20,250 Estimating Variable Cost Using High-Low RM20,250 22 Click to edit Master title style 22 22 22 22 8-1 Variable Cost per Unit = Difference in total cost Difference in Production 2,100 750 1,350 RM20,250 1,350 Estimating Variable Cost Using High-Low Then, fill in the formula. Production Total (Units) Cost June 1,000 RM45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 23 Click to edit Master title style 23 23 23 23 Variable cost per unit is RM15 8-1 Estimating Variable Cost Using High-Low = RM15 RM20,250 1,350 Variable Cost per Unit = Production Total (Units) Cost June 1,000 RM45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 24 Click to edit Master title style 24 24 24 24 Next, insert the variable cost of RM15 into the formula. Total cost = (RM15 x Units of Production) + Fixed cost 8-1 Estimating Fixed Cost Using High-Low Total Cost = (Variable Cost per Unit x Units of Production) + Fixed cost Production Total (Units) Cost June 1,000 RM45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 25 Click to edit Master title style 25 25 25 25 Using the highest level of production, we insert the total cost and units produced in the formula. Total cost = (RM15 x Units of Production) + Fixed Cost 8-1 Estimating Fixed Cost Using High-Low RM61,500 2,100 units) Production Total (Units) Cost June 1,000 RM45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Total Cost = (Variable Cost per Unit x Units of Production) + Fixed cost 26 Click to edit Master title style 26 26 26 26 8-1 Estimating Fixed Cost Using High-Low RM61,500 = (RM15 x 2,100 units) + Fixed cost RM61,500 = RM31,500 + Fixed cost RM61,500 RM31,500 = Fixed cost RM30,000 = Fixed cost If the lowest level had been chosen, the results of the formula would provide the same fixed cost of RM30,000. 27 Click to edit Master title style 27 27 27 Example Exercise 8-1 8-1 The manufacturing cost of Perusahaan Alisa for the first three months of the year are provided below: 27 Using the high-low method, determine the (a) variable cost per unit, and (b) the total fixed cost. Total Cost Production January RM80,000 1,000 units February RM125,000 2,500 March RM100,000 1,800 28 Click to edit Master title style 28 28 28 For Practice: PE8-1 Follow My Example 8-1 28 8-1 b. RM50,000 = RM125,000 (RM30 x 2,500) or RM80,000 (RM30 x 1,000) a. RM30 per unit = RM125,000 RM80,000 (2,500 1,000) 29 Click to edit Master title style 29 29 29 29 Total Variable Costs Total Units Produced Unit Variable Costs Total Units Produced T o t a l
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Total costs increase and decrease proportionately with activity level. 8-1 Summary of Cost Behavior Concepts Unit costs remain the same per unit regardless of activity. 30 Click to edit Master title style 30 30 30 30 Total Units Produced T o t a l
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Unit costs remain the same regardless of activity. Total costs increase and decrease with activity level. 8-1 Summary of Cost Behavior Concepts Total Fixed Costs Unit Fixed Costs 31 Click to edit Master title style 31 31 31 Compute the contribution margin, the contribution margin ratio, and the unit contribution margin, and explain how they may be useful to managers. Objective 2 8-2 32 Click to edit Master title style 32 32 32 8-2 Cost-Volume-Profit Relationships Cost-volume-profit analysis is the systematic examination of the relationships among selling prices, sales and production volume, costs, expenses, and profits. 33 Click to edit Master title style 33 33 33 8-2 The contribution margin is the excess of sales revenues over variable costs. It contributes first toward covering fixed costs, then contributes to profit. 34 Click to edit Master title style 34 34 34 34 Sales (50,000 units) RM1,000,000 Variable costs 600,000 Contribution margin RM 400,000 Fixed costs 300,000 Income from operations RM 100,000 8-2 Contribution Margin Income Statement 4 35 Click to edit Master title style 35 35 35 8-2 Contribution Margin Ratio 35 100% 60% Contribution Margin Ratio = 40% Sales (50,000 units) RM1,000,000 Variable costs 600,000 Contribution margin RM 400,000 Fixed costs 300,000 Income from operations RM 100,000 Contribution Margin Ratio = Sales Variable Costs Sales RM1,000,000 RM600,000 RM1,000,000 Contribution Margin Ratio = 40% 30% 10% 36 Click to edit Master title style 36 36 36 8-2 Unit Contribution Margin The unit contribution margin is also useful for analyzing the profit potential of proposed projects. The unit contribution margin is the sales price less the variable cost per unit. 37 Click to edit Master title style 37 37 37 37 8-2 Using Contribution Margin per Unit as a Shortcut The increase in income from operations of RM120,000 could have been determined quickly by multiplying the increase in unit sales (15,000) by the contribution margin per unit (RM8). Sales (RM20) RM1,000,000 Variable costs (RM12) 600,000 Contribution margin (RM8)RM400,000 Fixed costs 300,000 Income from operations RM 100,000 50,000 units 65,000 units RM1,300,000 780,000 RM 520,000 300,000 RM220,000 38 Click to edit Master title style 38 38 38 38 100% 60% 40% 30% 10% RM20 12 RM 8 Sales (50,000 units) RM1,000,000 Variable costs 600,000 Contribution margin RM 400,000 Fixed costs 300,000 Income from operations RM 100,000 8-2 Unit contribution margin analyses can provide useful information for managers. 39 Click to edit Master title style 39 39 39 39 100% 60% 40% 30% 10% 1. Total contribution margin in dollars. RM20 12 RM 8 Sales (50,000 units) RM1,000,000 Variable costs 600,000 Contribution margin RM 400,000 Fixed costs 300,000 Income from operations RM 100,000 2. Contribution margin ratio (percentage).
The contribution margin can be expressed three ways: 3. Unit contribution margin (dollars per unit).
Review 8-2 40 Click to edit Master title style 40 40 40 Example Exercise 8-2 8-2 Syarikat Molly sells 20,000 units at RM12 per unit. Variable costs are RM9 per unit, and fixed costs are RM25,000. Determine the (a) contribution margin ratio, (b) unit contribution margin, and (c) income from operations. 40 41 Click to edit Master title style 41 41 41 For Practice: PE 8-2 Follow My Example 8-2 41 8- 2 a. 25% = (RM12 RM9)/RM12 or (RM240,000 RM180,000)/RM240,000 b. RM3 per unit = RM12 RM9 c. Sales RM240,000 (20,000 x RM12) Variable costs 180,000 (20,000 x RM9) Contribution margin RM 60,000 [20,000 x (RM12 RM9)] Fixed costs 25,000 Income from operationsRM 35,000 42 Click to edit Master title style 42 42 42 Using the unit contribution margin, determine the break-even point and the volume necessary to achieve a target profit. Objective 3 8-3 43 Click to edit Master title style 43 43 43 8-3 Break-Even Point The break-even point is the level of operations at which a businesss revenues and expired costs are exactly equal. 44 Click to edit Master title style 44 44 44 44 8-3 Syarikat Bakar fixed costs are estimated to be RM90,000. The unit contribution margin is calculated as follows: Unit selling price RM25 Unit variable cost 15 Unit contribution margin RM10 45 Click to edit Master title style 45 45 45 45 8-3 The break-even point is calculated using the following equation: Break-Even Sales (units) = Fixed Costs Unit Contribution Margin Break-Even Sales (units) = RM90,000 RM10 Break-Even Sales (units) = 9,000 units 46 Click to edit Master title style 46 46 46 46 8-3 Proof of the Preceding Computation Sales (RM25 x 9,000) RM225,000 Variable costs (RM15 x 9,000) 135,000 Contribution margin RM 90,000 Fixed costs 90,000 Income from operations RM 0 Income from operations is zero when 9,000 units are soldhence, break- even is 9,000 units. 47 Click to edit Master title style 47 47 47 47 8-3 Effect of Changes in Fixed Costs Fixed Costs If Break- Even Then Fixed Costs If Then Break- Even 48 Click to edit Master title style 48 48 48 8-3 Syarikat Lazer is evaluating a proposal to budget an additional RM100,000 for advertising. Fixed costs before the additional advertising are estimated at RM600,000, and the unit contribution margin is RM20. Increasing Fixed Costs 49 Click to edit Master title style 49 49 49 49 8-3 Without additional advertising: Break-Even in Sales (units) = Fixed Costs Unit Contribution Margin Break-Even in Sales (units) = RM600,000 RM20 = 30,000 units With additional advertising: Break-Even in Sales (units) = RM700,000 RM20 = 35,000 units 50 Click to edit Master title style 50 50 50 50 8-3 Effect of Changes in Unit Variable Costs Unit Variable Cost If Break- Even Then Unit Variable Costs If Then Break- Even 51 Click to edit Master title style 51 51 51 51 8-3 Syarikat Antah. is evaluating a proposal to pay an additional 2% commission on sales to its salespeople (a variable cost) as an incentive to increase sales. Fixed costs are estimated at RM840,000. The unit contribution margin before the additional 2% commission is determined as follows: Unit selling price RM250 Unit variable cost 145 Unit contribution marginRM105 52 Click to edit Master title style 52 52 52 52 8-3 Without additional 2% commission: RM250 [RM145 + (RM250 x 2%)] = RM100 Break-Even in Sales (units) = RM840,000 RM105 = 8,000 units With additional 2% commission: Break-Even in Sales (units) = RM840,000 RM100 = 8,400 units Break-Even in Sales (units) = Fixed Costs Unit Contribution Margin 53 Click to edit Master title style 53 53 53 53 8-3 Effect of Changes in the Unit Selling Price Unit Selling Price If Break- Even Then Unit Selling Price If Then Break- Even 54 Click to edit Master title style 54 54 54 54 8-3 Syarikat Jendi is evaluating a proposal to increase the unit selling price of a product from RM50 to RM60. The following data have been gathered: Unit selling price RM50 RM60 Unit variable cost 30 30 Unit contribution margin RM20 RM30 Current Proposed Total fixed costs RM600,000RM600,000 55 Click to edit Master title style 55 55 55 55 8-3 Without price increase: Break-Even in Sales (units) = Fixed Costs Unit Contribution Margin Break-Even in Sales (units) = RM600,000 RM20 = 30,000 units With price increase: Break-Even in Sales (units) = RM600,000 RM30 = 20,000 units 56 Click to edit Master title style 56 56 56 56 8-3 Summary of Effects of Changes on Break-Even Point Effect of Change Direction of on Break-Even Change Sales (Units) Type of Change Fixed cost Increase Increase Decrease Decrease Variable cost per unit Increase Increase Decrease Decrease Unit sales price Increase Decrease Increase Decrease 57 Click to edit Master title style 57 57 57 Example Exercise 8-3 8-3 Nik Enterprise sells a product for RM60 per unit. The variable cost is RM35 per unit, while fixed costs are RM80,000. Determine the (a) break-even point in sales units, and (b) break-even point if the selling price were increased to RM67 per unit. 57 For Practice: PE 8-3 Follow My Example 8-3 a. 3,200 units = RM80,000/(RM60 RM35) b. 2,500 units = RM80,000/(RM67 RM35) 58 Click to edit Master title style 58 58 58 58 8-3 Target Profit The sales volume required to earn a target profit is determined by modifying the break-even equation. Sales (units) = Fixed Costs + Target Profit Unit Contribution Margin 59 Click to edit Master title style 59 59 59 8-3 Units Required for Target Profit 59 Fixed costs are estimated at RM200,000, and the desired profit is RM100,000. Unit contribution margin is RM30. Unit selling price RM75 Unit variable cost 45 Unit contribution margin RM30 Sales (units) = Fixed Costs + Target Profit Unit Contribution Margin RM30 Sales (units) = 10,000 units RM200,000 RM100,000 60 Click to edit Master title style 60 60 60 60 Sales (10,000 units x RM75) RM750,000 Variable costs (10,000 x RM45) 450,000 Contribution margin (10,000 x RM30) RM300,000 Fixed costs 200,000 Income from operations RM100,000 Proof that sales of 10,000 units will provide a profit of RM100,000. 8-3 61 Click to edit Master title style 61 61 61 Example Exercise 8-4 8-3 Syarikat Fika sells a product for RM140 per unit. The variable cost is RM60 per unit, and fixed costs are RM240,000. Determine the (a) break-even point in sales units, and (b) break-even point in sales units if the company desires a target profit of RM50,000. 61 For Practice: PE 8-4 Follow My Example 8-4 a. 3,000 units = RM240,000/(RM140 RM60) b. 3,625 units = (RM240,000 + RM50,000)/(RM140 RM60) 62 Click to edit Master title style 62 62 62 Using a cost-volume-profit chart and a profit-volume chart, determine the break-even point and the volume necessary to achieve a target profit. Objective 4 8-4 63 Click to edit Master title style 63 63 63 8-4 Cost-Volume-Profit (Break- Even) Chart A cost-volume-profit chart, sometimes called a break-even chart, may assist management in understanding relationships among costs, sales, and operating profit or loss. 64 Click to edit Master title style 64 64 64 Unit selling price RM 50 Unit variable cost 30 Unit contribution margin RM 20
Total fixed costs RM100,000 The cost-volume-profit chart in Exhibit 5 (Slide 65) is based on the following data: 8-4 65 Click to edit Master title style 65 65 65 S a l e s
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0 Units of Sales (in thousands) RM500 RM450 RM400 RM350 RM300 RM250 RM200 RM150 RM100 RM 50 8-4 Cost-Volume-Profit Chart Dollar amounts are indicated along the vertical axis. 65 1 2 3 4 5 6 7 8 9 10 (Continued) Volume is shown on the horizontal axis. 66 Click to edit Master title style 66 66 66 66 8-4 Cost-Volume-Profit Chart (Continued) S a l e s
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0 Units of Sales (in thousands) RM500 RM450 RM400 RM350 RM300 RM250 RM200 RM150 RM100 RM 50 1 2 3 4 5 6 7 8 9 10 At sales of RM500,000 and knowing that each unit sells for RM50, we can find the values of the two axis. Where the horizontal sales and costs line intersects the vertical 10,000 unit of sales line is Point A. Point A 67 Click to edit Master title style 67 67 67 67 8-4 S a l e s
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0 Units of Sales (in thousands) RM500 RM450 RM400 RM350 RM300 RM250 RM200 RM150 RM100 RM 50 1 2 3 4 5 6 7 8 9 10 Now, beginning at zero on the left corner of the graph, connect a straight line to the dot (Point A). Note: Point A could have been plotted at any sales level because linearity is assumed. Cost-Volume-Profit Chart (Continued) Point A 68 Click to edit Master title style 68 68 68 68 8-4 S a l e s
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0 Units of Sales (in thousands) RM500 RM450 RM400 RM350 RM300 RM250 RM200 RM150 RM100 RM 50 Fixed cost of RM100,000 is a horizontal line. 1 2 3 4 5 6 7 8 9 10 Cost-Volume-Profit Chart (Continued) 69 Click to edit Master title style 69 69 69 69 8-4 S a l e s
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0 Units of Sales (in thousands) RM500 RM450 RM400 RM350 RM300 RM250 RM200 RM150 RM100 RM 50 Similar to the sales line, a point is determined on the cost line (10,000 x RM30) + RM100,000 = RM400,000 1 2 3 4 5 6 7 8 9 10 Cost-Volume-Profit Chart (Continued) 70 Click to edit Master title style 70 70 70 70 8-4 S a l e s
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0 Units of Sales (in thousands) RM500 RM450 RM400 RM350 RM300 RM250 RM200 RM150 RM100 RM 50 Beginning with the total fixed cost at the vertical axis (RM100,000), draw a line to the red dot. This is the total cost line. 1 2 3 4 5 6 7 8 9 10 Cost-Volume-Profit Chart (Continued) 71 Click to edit Master title style 71 71 71 71 8-4 S a l e s
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0 Units of Sales (in thousands) RM500 RM450 RM400 RM350 RM300 RM250 RM200 RM150 RM100 RM 50 1 2 3 4 5 6 7 8 9 10 Cost-Volume-Profit Chart (Continued) Horizontal and vertical lines are drawn at the intersection point of the sales line and the costs line, which is the break-even point. 72 Click to edit Master title style 72 72 72 72 8-4 S a l e s
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0 Units of Sales (in thousands) RM500 RM450 RM400 RM350 RM300 RM250 RM200 RM150 RM100 RM 50 Break-even is sales of 5,000 units or RM250,000. 1 2 3 4 5 6 7 8 9 10 Cost-Volume-Profit Chart (Continued) 73 Click to edit Master title style 73 73 73 73 8-4 S a l e s
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0 Units of Sales (in thousands) RM500 RM450 RM400 RM350 RM300 RM250 RM200 RM150 RM100 RM 50 1 2 3 4 5 6 7 8 9 10 Profit area Cost-Volume-Profit Chart (Concluded) 74 Click to edit Master title style 74 74 74 8-4 Revised Cost-Volume-Profit Chart Using the data in Slide 73, assume that a proposal to reduce fixed cost by RM20,000 is to be evaluated. A cost- volume-profit chart can be created to assist in this evaluation. 75 Click to edit Master title style 75 75 75 75 8-4 S a l e s
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0 Units of Sales (in thousands) RM500 RM450 RM400 RM350 RM300 RM250 RM200 RM150 RM100 RM 50 1 2 3 4 5 6 7 8 9 10 RM80,000 If fixed costs can be reduced to RM80,000, the new break- even point is sales of RM200,000, or 4,000 units. Revised Cost-Volume- Profit Chart 76 Click to edit Master title style 76 76 76 76 8-4 Profit-Volume Chart Another graphic approach to cost-volume- profit analysis, the profit-volume chart, plots only the difference between total sales and total costs (or profits). Again, the data from Exhibit 5 will be used. Unit selling price RM 50 Unit variable cost 30 Unit contribution margin RM 20 Total fixed costs RM100,000
77 Click to edit Master title style 77 77 77 77 Sales (10,000 units x RM50) RM500,000 Variable costs (10,000 units x RM30) 300,000 Contribution margin (10,000 units x RM20) 200,000 Fixed costs 100,000 Operating profit RM100,000 8-4 The maximum operating loss is equal to the fixed costs of RM100,000. Assuming that the maximum unit sales within the relevant range is 10,000 units, the maximum operating profit is RM100,000, computed as follows: Maximum profit 78 Click to edit Master title style 78 78 78 78 Units of Sales (in thousands) 1 2 3 4 5 6 7 8 9 10 Profit Line Operating loss Operating profit RM100,000 RM75,000 RM50,000 RM25,000 RM 0 RM(25,000) RM(50,000) RM(75,000) RM(100,000) O p e r a t i n g
P r o f i t
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Maximum loss is RM100,000, the fixed costs. 8-4 Profit-Volume Chart Break-Even Point 79 Click to edit Master title style 79 79 79 Compute the margin of safety and the operating leverage, and explain how managers use these concepts. Objective 5 8-2 80 Click to edit Master title style 80 80 80 8-5 The relative mix of a businesss variable costs and fixed costs is measured by the operating leverage. It is computed as follows: Operating Leverage = Contribution Margin Income from Operations Operating Leverage 81 Click to edit Master title style 81 81 81 89 Both companies have the same contribution margin. Syarikat Salam Syarikat Sinar Sales RM400,000 RM400,000 Variable costs 300,000 300,000 Contribution margin RM100,000 RM100,000 Fixed costs 80,000 50,000 Income from operations RM 20,000 RM 50,000 Operating leverage ? ? 8-5 Operating Leverage Example 82 Click to edit Master title style 82 82 82 90 Contribution Margin Income from Operations RM100,000 RM20,000 = 5 Syarikat Salam Syarikat Salam Syarikat Sinar Sales RM400,000 RM400,000 Variable costs 300,000 300,000 Contribution margin RM100,000 RM100,000 Fixed costs 80,000 50,000 Income from operations RM 20,000 RM 50,000 Operating leverage ? ? 8-5 5 83 Click to edit Master title style 83 83 83 91 Contribution Margin Income from Operations RM100,000 RM50,000 = 2 Syarikat Sinar: Syarikat Salam Syarikat Sinar Sales RM400,000 RM400,000 Variable costs 300,000 300,000 Contribution margin RM100,000 RM100,000 Fixed costs 80,000 50,000 Income from operations RM 20,000 RM 50,000 Operating leverage ? ? 8-5 2 5 84 Click to edit Master title style 84 84 84 92 High Versus Low Operating Leverage 8-5 85 Click to edit Master title style 85 85 85 Example Exercise 8-5 8-5 Syarikat Tariq reports the following data: 93 For Practice: PE8-5 Follow My Example 8-5 4.0 = (RM750,000 RM500,000)/(RM750,000 RM500,000 RM187,500) = RM250,000/RM62,500 Sales RM750,000 Variable costs RM500,000 Fixed costs RM187,500 Determine Syarikat Tariqs operating leverage. 86 Click to edit Master title style 86 86 86 Margin of Safety 8-5 The difference between the current sales revenue and the sales revenue at the break-even point is called the margin of safety. 87 Click to edit Master title style 87 87 87 95 Margin of Safety = Sales Sales at Break-Even Point Sales Margin of Safety = 20% 8-5 If sales are RM250,000, the unit selling price is RM25, and the sales at the break-even point are RM200,000, the margin of safety is 20%, computed as follows: Margin of Safety = RM250,000 RM200,000 RM250,000 88 Click to edit Master title style 88 88 88 The margin of safety may also be stated in terms of units. In this illustration, for example, the margin of safety of 20% is equivalent to RM50,000 in sales (RM250,000 x 20%). In units, the margin of safety is 2,000 units (RM50,000/RM25). 8-5 89 Click to edit Master title style 89 89 89 Example Exercise 8-6 8-5 Syarikat Rafiq has sales of RM400,000, and the break- even point in sales dollars is RM300,000. Determine the companys margin of safety. 97 For Practice: PE8-6 Follow My Example 8-6 25% = (RM400,000 RM300,000)/RM400,000 90 Click to edit Master title style 90 90 90 List the assumptions underlying cost-volume-profit analysis. Objective 6 8-2 91 Click to edit Master title style 91 91 91 8-6 Assumptions of Cost-Volume-Profit Analysis The primary assumptions are: 1. Total sales and total costs can be represented by a straight line. 2. Within the relevant range of operating activity, the efficiency of operations does not change. 3. Costs can be accurately divided into fixed and variable components. 4. The sales mix is constant. 5. There is no change in the inventory quantities during the period.