The contribution margin per unit is the selling price per unit less the variable cost per unit. Contribution margin per unit (N) 2 Fixed cost 5 0 Contribution margin per unit (N) 5 Fixed cost N 5 Fixed cost 4 Contribution margin per unit. Both the comparison method and the contribution margin per unit method yield the amount of break-even sales measured in units.
The equation method and the method with coverage contribution per unit gives a break-even point measured in units. The break-even point expressed in dollars can be determined using the contribution margin method. After reviewing the accountant's calculations, the president asked the marketing manager, "What are our chances of achieving a sales volume of 8,334 units?" The manager replied, "Slim to none." She noted that no Bright Day product has ever sold more than 4,000 bottles when originally offered.
Lowering unit contributions will dramatically increase the sales volume needed to achieve the desired profit.
ASSESSING THE EFFECTS OF CHANGES IN FIXED COSTS
The Effect of Cost Structure on the Break-Even Point
It follows that companies with high fixed cost structures will have higher break-even points than companies with low fixed cost structures. A high break-even point indicates that a company must achieve a high sales volume or face an operating loss.
USING THE COST-VOLUME-PROFIT GRAPH
Procedures for Drawing the CVP Graph
After analyzing the graph, the president concludes that the sales volume of 4,375 units is well above the break-even point of 1,875 units. At one time, GM's breakeven point was estimated at about 16 million vehicles per year. GM's CEO until 2000, Rick Wagoner, introduced changes that lowered the company's breakeven point to 12 million units.
The Treasury Department would ask the new leadership at GM to take steps to reduce the company's breakeven point to 10 million units. It would be a major achievement if GM can reduce its break-even level from 16 million to 10 million units in the space of a few years.
REALITY BYTES
Pick some arbitrary level of activity and multiply that quantity by the selling price per unit. Plot the result on a graph and draw a line from the origin (zero units, zero revenue) through this point. First, the auto industry is characterized by high fixed production costs for things like buildings, equipment, research and development, as well as financing costs associated with borrowed funds, such as bonds for interest costs.
Second, the sector is globally competitive and companies in the United States often have a cost disadvantage. Some of this cost disadvantage comes from obvious sources, such as having to pay higher wages than companies in countries like South Korea.
CALCULATING THE MARGIN OF SAFETY
CHECK YOURSELF 3.3
PERFORMING SENSITIVITY ANALYSIS USING SPREADSHEET SOFTWARE
ASSESSING THE EFFECT OF SIMULTANEOUS CHANGES IN CVP VARIABLES
A Decrease in Sales Price Accompanied by an Increase in Sales Volume
An Increase in Fixed Cost Accompanied by an Increase in Sales Volume
A Simultaneous Reduction in Sales Price, Fixed Costs, Variable Costs, and Sales Volume
MULTIPRODUCT COST-VOLUME-PROFIT ANALYSIS
Determining the Break-Even Point
The contribution approach can be used to analyze independent or simultaneous changes in the CVP variables. Using the contribution margin per unit approach, the breakeven point in total units can be determined by dividing the fixed costs by the weighted average contribution margin as follows. To determine the number of bottles of each product, multiply the total number of bottles by the proportional share of the sales mix as follows.
The following income statement confirms that these sales volume figures constitute the break-even point.
Determining the Sales Volume Necessary to Reach a Desired Profit
Managing the Sales Mix
It is important to note that the sales mix affects all aspects of the CVP analysis. For example, the new break-even point for a sales mix of 60y40 is calculated as discussed here. The first step is to calculate the weighted average contribution margin per unit as follows.
This proves that changing the sales mix not only increases the net profit, but also reduces the break-even point. 880 units represents the total number of bottles of both products combined that must be sold in a 60x40 sales mix for the company to break even. The unit contribution formula can be used to determine the number of units needed to achieve a target profit.
Simply add the desired profit to the fixed costs and then divide it by the weighted average contribution margin per unit.
COST-VOLUME-PROFIT LIMITATIONS
A Look Back <<
Sales 2 Variable costs 2 Fixed costs 5 Profit
The margin of safety is the number of units or amount of sales dollars that actual sales can fall below expected sales before incurring a loss. The margin of safety can also be expressed as a percentage so that companies of different sizes can be compared. The margin of safety can be calculated as a percentage by dividing the difference between budgeted sales and break-even sales by the amount of budgeted sales.
Spreadsheet software and the contribution margin approach can be used to perform sensitivity analyzes of cost-volume-profit relationships. For example, a manager may need to determine the costs of making a product, providing a service, or running a department. Determine the sales volume in units and dollars needed to make a profit of $12,000.
Selling price per unit (N) 2 Variable cost per unit (N) 2 Fixed cost 5 Profit contribution margin per unit (N) 2 Fixed cost 5 Profit. The formula for the sales of computer units needed to achieve the desired profit is Sales 2 Variable costs 2 Fixed costs 5 profits. In what three ways can contribution margin be useful in cost-volume-profit analysis?
Explain how the results of this method differ from those of the contribution margin approach. Use the unit contribution margin approach to determine the breakeven point in units and dollars. Use the contribution margin approach to determine the sales volume in dollars and units needed to achieve the desired profit.
MULTIPLE-CHOICE QUESTIONS
Naylor Company currently produces and sells 6,400 units annually of a product that has a variable cost of $18 per unit. unit and annual fixed costs of $161,400. Assume that Naylor has the opportunity to invest in new labor-saving production equipment that will allow the company to reduce variable costs to $16 per unit. Use the equation method to determine the selling price per unit under existing conditions (current equipment is used).
The company pays $16 per unit for variable product costs and has annual fixed costs of $176,000. Variable manufacturing costs are $22 per engine and annual fixed manufacturing costs are $196,000. PBI), produces oak barrels for the wine industry at its facility in the USA.
What effect, if any, would the change in the exchange rate have on PBI's variable unit costs for September versus January 2009? What effect, if any, would the change in the exchange rate have on PBI's contribution margin. What effect, if any, would the change in the exchange rate have on PBI's fixed unit costs?
The marketing manager of Ross Corporation has determined that there is a market for a telephone with a selling price of $19 per unit. How much can Ross afford to spend on variable costs per unit if production and sales equal 46,000 phones. Determine the total number of products (units of Super and Supreme combined) that Eaton must sell to break even.
The relative product sales mix is 80 percent for Super and 20 percent for Supreme. Use the unit contribution margin approach to determine the unit break-even point. Use the unit contribution margin approach to determine the unit sales level and.
Analyzing change in sales price using the contribution margin ratio Hugh Company reported the following data regarding the product it sells
The manager has decided that any new product must at least break even in the first year. If the selling price is set at $65, how many units must Tainan sell to break even? Tainan has decided to heavily advertise the product and set the selling price at $66.
Margin of safety and operating leverage
Comprehensive CVP analysis
If the sales price falls to $55 per unit, what level of sales is necessary to achieve the desired profit? If fixed costs decrease to $16,800, what level of sales is needed to achieve the desired profit? If variable costs drop to $39 per unit, what level of sales is needed to achieve the desired result?
Assessing simultaneous changes in CVP relationships
Determining the break-even point and margin of safety for a company with multiple products
CHECK FIGURES
Verify the break-even point by preparing an income statement for each product as well as one.
Equation method
Per-unit contribution margin approach
Contribution margin ratio
Cost structure, risk, and the break-even point
Prestige pricing
Determining variable cost from incomplete data
Contribution margin per unit approach for break-even and desired profit
Changing sales price
Simultaneous change in sales price and desired profit
Components of break-even graph
Evaluating simultaneous changes in fixed and variable costs
Margin of safety
Cost-volume-profit relationship
Complexities of CVP analysis in multinational companies
The contract requires CWP to pay the supplier in dollars, although all other costs incurred by CWP are to be paid in Chinese renminbi. The following is a summary of production costs for a box of 1,000 sets of chopsticks based on the expected production rate: Based on the exchange rate at the time of the U.S. contract Exchange rates are rounded to the nearest cent.).
Explain which of these assumptions would be violated if CWP had to pay for one of its raw materials in dollars while the other costs and revenues were priced in yen. What effect, if any, would the change in the exchange rate have on CWP's unit variable costs for September 2007 compared to September 2009? What effect, if any, would the change in the exchange rate have on CWP's contribution margin per unit for September 2007 versus September 2009.
What effect, if any, would the change in the exchange rate have on CWP's fixed unit costs for September 2007 compared to September 2009?
Target costing
Multiple product break-even analysis
Determining the break-even point and preparing a contribution margin income statement
Determining the break-even point and preparing a break-even graph Executive officers of Vaclar Company are assessing the profitability of a potential new
Effect of converting variable to fixed costs
Analyzing change in sales price using the contribution margin ratio Kaito Company reported the following data regarding the one product it sells
Margin of safety and operating leverage
Analyzing sales price and fixed cost using the equation method Salazar Company is analyzing whether its new product will be profitable. The following data are
Prepare revised income statements for each product, assuming a 20 percent increase in budgeted sales volume. For each product, determine the percentage change in net income that results from the 20 percent increase in sales.
Comprehensive CVP analysis
Assessing simultaneous changes in CVP relationships
Determining the break-even point and margin of safety for a company with multiple products
Business Applications Cost-volume-profit behavior at Apple Inc
Group Assignment Effect of changes in fixed and variable cost on profitability
Decreased commissions paid to the sales staff by $8 per unit, thereby decreasing sales by 10 units. The teacher will divide the class into groups and then organize the groups into two sections. Having more groups in one section than in another is acceptable because there are compensating advantages and disadvantages.
Having more groups is advantageous because more people will work on the task, but it is disadvantageous because having more people complicates communication. The sections must compete with each other to see which section can identify the most profitable alternative in the shortest time. In other words, each section must organize itself in terms of how to solve the task of choosing the best alternative.
If any section submits an incorrect answer, the instructor or a spokesperson for the winning group must explain how the correct answer was determined.
Research Assignment Using real world data from Southwest Airlines Use the 2008 Form 10-K for Southwest Airlines to complete the requirements below. To obtain
Writing Assignment Operating leverage, margin of safety, and cost behavior
Ethical Dilemma Opportunity to manipulate earnings
Spreadsheet Assignment Using Excel
Spreadsheet Assignment Mastering Excel Required
