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Dr. Mohamed A. Hamada Lecturer of Accounting Information Systems 1-1 Chapter 5 COST-VOLUME-PROFIT ANALYSIS

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2 1. Determine the number of units sold to break even or earn a targeted profit. 2. Calculate the amount of revenue required to break even or earn a targeted profit. 4. Prepare a profit-volume graph & a cost-volume-profit graph, and explain the meaning of each. 5. Explain the impact of risk, uncertainty, & changing variables on cost-volume-profit analysis. LEARNING OBJECTIVES

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7-3 The Break-Even Point The break-even point is the point in the volume of activity where the organization’s revenues and expenses are equal.

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7-4 Equation Approach Sales revenue – Variable expenses – Fixed expenses = Profit UnitsalespriceSalesvolume in units × UnitvariableexpenseSalesvolume × × X) ($500 × X) × X) ($300 × X)– –$80,000 = $0 X) ($200X)–$80,000 = $0 X = 400 unit

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7-5 Contribution-Margin Approach Consider the following information developed by the accountant at Curl, Inc.: Contribution margin= Sales –Variable Expenses Net income = Contribution margin – Fixed Expenses

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7-6 Contribution-Margin Approach Fixed expenses Fixed expenses Unit contribution margin Unit contribution margin = Break-even point (in units) $80,000 $80,000 $200 = 400 surf boards

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7-7 Contribution-Margin Approach 400 × $500 = $200,000 400 × $300 = $120,000

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7-8 Contribution Margin Ratio Calculate the break-even point in sales dollars rather than units by using the contribution margin ratio. Contribution margin Sales = CM Ratio Fixed expense Fixed expense CM Ratio Break-even point (in sales dollars) =

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7-9 Contribution Margin Ratio $80,000 $80,00040% $200,000 sales =

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7-10 Graphing Cost-Volume-Profit Relationships Viewing CVP relationships in a graph gives managers a perspective that can be obtained in no other way. Consider the following information for Curl, Inc.:

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7-11 Cost-Volume-Profit Graph Fixed expenses

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7-12 Cost-Volume-Profit Graph Fixed expenses Total expenses

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7-13 Cost-Volume-Profit Graph Fixed expenses Total expenses

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7-14 Cost-Volume-Profit Graph Fixed expenses Total expenses Total sales

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7-15 Cost-Volume-Profit Graph Fixed expenses Total expenses Total sales Break-even point Break-even point Profit area Loss area

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7-16 Target Net Profit We can determine the number of units that the company must sell to earn a profit of $100,000 using the contribution margin approach. Fixed expenses + Target profit Unit contribution margin = Units sold to earn the target profit $80,000 + $100,000 $80,000 + $100,000 $200 $200 $80,000 + $100,000 $80,000 + $100,000 $200 $200 = 900 surf boards

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7-17 Equation Approach Sales revenue – Variable expenses – Fixed expenses = Profit × X) ($500 × X) × X) ($300 × X)–– $100,000 $80,000 = $100,000 X) ($200X) = $180,000 X = 900 Unit

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7-18 Applying CVP Analysis Safety Margin The difference between budgeted sales revenue and break-even sales revenue. The amount by which sales can drop before losses begin to be incurred. Safety Margin The difference between budgeted sales revenue and break-even sales revenue. The amount by which sales can drop before losses begin to be incurred.

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7-19 Safety Margin Curl, Inc. has a break-even point of $200,000. If actual sales are $250,000, the safety margin is $50,000 or 100 surf boards.

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7-20 Changes in Fixed Costs- Decision approach Curl is currently selling 500 surfboards per year. The owner believes that an increase of $10,000 in the annual advertising budget, would increase sales to 540 units. Should the company increase the advertising budget? Curl is currently selling 500 surfboards per year. The owner believes that an increase of $10,000 in the annual advertising budget, would increase sales to 540 units. Should the company increase the advertising budget?

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7-21 Changes in Fixed Costs $80,000 + $10,000 advertising = $90,000 540 units × $500 per unit = $270,000

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7-22 Changes in Fixed Costs Sales will increase by $20,000, but net income decreased. decreased by $2,000. Sales will increase by $20,000, but net income decreased. decreased by $2,000.

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7-23 Predicting Profit Given Expected Volume Fixed expenses Unit contribution margin Target net profit Find: {req’d sales volume}Given: Fixed expenses Unit contribution margin Expected sales volume Find: {expected profit}Given:

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7-24 Predicting Profit Given Expected Volume In the coming year, Curl’s owner expects to sell 525 surfboards. The unit contribution margin is expected to be $190, and fixed costs are expected to increase to $90,000. × 525) ($190 × 525) – $90,000 = X X = $9,750 profit X = $99,750 – $90,000 Total contribution - Fixed cost = Profit

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7-25 CVP Relationships and the Income Statement

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7-26 Measuring Operating Leverage Measuring Operating Leverage Contribution margin Net income Operating leverage factor = $100,000 $100,000 $20,000 $20,000 = 5

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27 VARIABLE COST RATIO: Definition Is the proportion of each sales dollar used to cover variable costs.

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