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Chapter 20 Cost-Volume-Profit Analysis McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Introduction • Cost-volume-profit analysis – Analysis of how profits change as costs change in response to changes in production or sales volumes • Absorption costing • Direct Costing 20-2 Direct Costing • Determining cost of goods manufactured – Product costs – manufacturing costs that vary proportionately with volume of production • Also called variable costing – Period costs – costs that are identified with time intervals • All period costs are charged directly to expense in the period in which they are incurred 20-3 Direct Costing (cont’d) – Not accepted under Generally Accepted Accounting Principles (GAAP) – Often used by management in making operating decisions – Prime benefit is the use of data in profitability, break-even and decision cost analysis 20-4 Comparison of Absorption and Direct Costing – Direct costing more clearly reflects the impact of sales volume on costs and profits – If production is greater than sales, the net income under absorption costing will be greater • Increase in inventory results in a lower net income under direct costing – When production equals sales, both methods report the same net income 20-5 Cost-Volume-Profit Analysis • Analysis data helps in determining – Sales volume required in order for business to break even – Sales volume required to produce a given amount of profit – Impact of a specific change in gross profit per unit or gross profit percentage – Profit at a specified sales volume 20-6 Computing Break-Even Point • Break-even point – sales volume at which there is neither loss nor profit Fixed cost per period Break-even sales in units = Contribution margin per unit Contribution margin ratio = Contribution margin per unit Sales price per unit Break-even sales in dollars = Fixed costs per period Contribution margin ratio 20-7 Estimating Profits and Sales Volumes • Estimating profits at different sales volume Profits = (unit sales x contribution margin per unit) – fixed costs per period • Estimating the sales volume necessary to earn a desired profit Sales in dollars for specific profit = (fixed cost per period + profit per period) / contribution margin ratio Sales in units for specific profit = (fixed cost per period + profit per period) / contribution margin per unit 20-8 Break-Even Chart • A graph that shows the total sales and total costs at any sales volume – Provides a means of estimating profit or loss at any sales volume 20-9 Break-Even Chart (cont’d) Dollars 4000 3000 2000 1000 100 200 300 400 500 600 700 Unit sales in month 20-10 Analyzing the Effects of Changes in C-V-P Factors • Often used by management in estimating the effects on profit that would result from changes in – Economic conditions – Operating conditions – Marketing strategies • Use of C-V-P greatly simplifies the task of arriving at a decision 20-11