Chapter 7 Notes - MGMT 201
Chapter 7 Notes - MGMT 201 MGMT 201
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This 3 page Class Notes was uploaded by boilermaker2016 on Thursday March 3, 2016. The Class Notes belongs to MGMT 201 at Purdue University taught by David Scott in Spring 2016. Since its upload, it has received 38 views. For similar materials see Managerial accounting in Business, management at Purdue University.
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Date Created: 03/03/16
Chapter 7 Cost-Volume-Profit Analysis • What effect on profit can United Airlines expect if it adds an additional flight on the Chicago to New York route? • How will NBC’s profit change if the ratings increase for its evening news program? • How many patient days of care does Massachusetts General Hospital provide in order to break even for the year? • These type of questions relate directly to the effects on costs and revenues when an organization’s activity changes • The analytical technique used by managerial accountants to address these types of questions is called o Cost-Volume-Profit analysis o CVP summarizes the effects of changes in an organization’s volume of activity on its costs, revenues, and profit § Total Variable Cost • CVP can be extended to cover the effects on profits of changes in selling prices, service fees, costs, income tax rates, and product mix • What happens to overall profits if the New York Yankees raise ticket prices? o CVP analysis provides management with a comprehensive overview of the effects on costs and revenue of all kinds of short run financial changes. Key Assumptions of CVP Analysis • For any CVP analysis to be valid, the following important assumptions must be reasonably satisfied within the relevant range o The behavior of total revenue is linear (straight-line). This implies that the price of the product or service will not change as sales volume varies within the relevant range o The behavior of total expenses is linear (straight-line) over the relevant range. This implies the following more specific assumptions: § Expenses can be categorized as fixed, variable, or semi-variable. Total fixed expenses remain constant as activity changes, and the unit variable expense remains unchanged as activity varies. § The efficiency and productivity of the production process and workers remain constant. § In multiproduct organizations, the sales mix remains constant over the relevant range. § In manufacturing firms, the inventory levels at the beginning and end of the period are the same. This implies that the number of units produced during the period equals the number of units sold. Break-Even Point • The level of activity where total revenues = total expenses (Variable + Fixed) • Notice that the projected expenses are separated into o Fixed Expenses o Variable Expenses Total Contribution Margin • Total Sales Revenue - Total Variable Expenses = Total Contribution Margin • Is the amount of revenue available to cover fixed costs • Revenue first goes to covering the variable costs • Then goes towards covering the fixed costs Contribution Margin Per Unit Approach To Calculate Breakeven • Sales price - variable cost per unit • $16 - $10 • Contribution Margin Ratio = Contribution Margin per unit / Sales price per unit Graphing CVP Relationships • Draw the fixed-expense line • Compute total expense at any volume at plot the point (A) • Draw the total-expense line from the intercept of the fixed-expense line on the vertical axis and the plotted point A • Compute total sales revenue at any volume and plot the point (B) • Draw the total revenue line from the origin through the plotted point B Target Profit • Just use the break-even formulas + the target profit Safety Margin • The amount by which sales can drop before a loss occurs • If the Theater's business manager expects every performance of each play to be sold out, then budgeted monthly sales revenue is $144,000 (450 seats × 20 performances of each play × $16 per ticket) • Since break-even sales revenue is $128,000, the Theater’s safety margin is $16,000 ($144,000 − $128,000) Time Out on the Field • Overlook Inn is a small bed-and-breakfast inn located in the Great Smoky Mountains of Tennessee. The charge is $50 per person for one night's lodging and a full breakfast in the morning. The retired couple who own and manage the inn estimate that the variable expense per person is $20. This includes such expenses as food, maid service, and utilities. The inn's fixed expenses total $42,000 per year. The inn can accommodate 10 guests each night. o Contribution margin per unit of service (one night's lodging for one guest) o Contribution-margin ratio o Annual break-even point in units of service and in dollars of service revenue o Number of units of service required to earn a target net profit of $60,000 for the year (ignore income taxes) • Contribution Margin per Unit of Service o Night change - variable per person = contribution margin per unit of service $50 - $20 = $30 • Contribution-Margin Ratio o = Contribution margin per unit / nightly room change .60 = $30/$50 • Break-Even Point in Units of Service o = Fixed expenses / Contribution margin per unit 1,400 = $42,000/$30 • Break-Even Point in Dollars of Service Revenue o = Fixed expenses / Contribution margin ration $70,000 = $42,000 / .60 • Number of units of service required to earn a target net profit of $60,000 for the year (ignore income taxes) o Sigma = (fixed expenses + target net profit) / (Contribution margin per unit of service) 3,400 = ($42,000 + $60,000) / $30 CVP Analysis with Multiple Products • For a company with more than one product o Sales mix is the relative combination (proportion) that a company’s product are sold • Different products have different selling prices, cost structures, and contribution margins Weighted-Average Unit Contribution Margin • The sales mix is used to compute a weighted-average unit contribution margin o = Average of the several products unit contribution margins, weighted by the relative sales proportion of each product • Seattle Contemporary Theater's weighted-average unit contribution margin would be: Contribution Margin Income Statement • The contribution format highlights the distinction between variable and fixed expenses
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