Chapter 7.

7-30A,
Cost-Volume-Profit (CVP) Analysis
5 components

Sales price per unit

Volume Sold
Variable costs per unit
Fixed cost
Operating income

CVP assumptions
1)
2)
3)
4)

Change in volume only factor that affects costs

Costs and revenues are linear throughout relevant range
Inventory levels will not change
Sales mix of products will not change

Contribution margin income statement

Sales revenue (550 posters)..................................... $ 19,250

Less: Variable expenses ............................................ (11,550)
Contribution margin .................................................
7,700
Less: Fixed expenses.................................................. (7,000)
Operating income...................................................... $
700

Unit contribution margin

Sales price per unit

- Variable costs per unit
Contribution margin per unit

$ 35
(21)
$ 14

Contribution margin ratio

Unit contribution margin / Sales price per unit = 14/35

Total contribution margin / sales revenue

Calculating break even

1) Income statement approach
2) Shortcut approach using unit contribution margin
3) Shortcut approach using contribution margin ratio
(Fixed expenses + Operating income) / Contribution margin ratio
(Fixed expenses + Operating income) / Contribution margin per unit *
Sales price per unit
Sensitivity Analysis (What if cost changes?)

What if fixed cost change? Only happen when you are outside of relevant
range

Changes infixed costs do not affect the contribution margin

Sales mix calculation

Sales Mix Calculation

Regular
Large
o Product
Product
Sales price per unit ........................
$ 35
$ 70
Less: Variable cost per unit ...........
(21)
(40)
Contribution margin per unit ........
$ 14
$ 30
Sales mix .......................................
x5
x 3
Contribution margin .....................
$ 70
$ 90
Weighted-average contribution
margin per unit ($160/8) ...........

Total

8
$160
$ 20

Total units sold = 350 then Regular : 350 x 5/8 = 218.75

(Operating income + Fixed expenses) / Target sales in units = Weighted average
CM per unit
Margin of safety : The excess of expected sales over break-even sales
Operating leverage : The relative amount of fixed and variable costs that make up a
companys total costs
Operating leverage factor
Lowest possible value for this factor is 1, if the company has no fixed costs
Contribution margin / Operating income = operating leverage factor
High operating leverage companies

Higher levels of fixed costs and lower levels of variable costs

High contribution margin ratio
Changes in volume significantly affect operating income (high risk, higher
potential for reward)
e.g golf courses, hotels, rental car agencies, theme parks, airlines, cruse lines

Low operating leverage companies

Higher levels of variable costs and lower levels of fixed costs

lower contribution margin ratio
Changes in volume do not havesignificantly affect operating income (low risk,
low reward)
e.g merchandising companies, fast-food restaurants

Chapter 8
S8-015,
Minimum transfer price = Variable cost + (contribution margin lost)
With sufficient capacity, the lost contribution margin is no longer a concern

How managers make decisions

Relevant
o Expected future (cost and revenue) data
o Differs among alternative courses of action
o Is both quantitative and qualitative
Irrelevant
o Costs that do not differ between alternatives (fixed cost)
o Sunk costs (incurred in past and cannot be changed)

Pricing consideration
Price takers
Product lacs uniqueness
Heavy competition
Pricing approach emphasizes target
costing

Price setters
Product is unique
Less competition
Pricing emphasizes cost-plus pricing

Cost plus : Adding desired profit to total cost

Fixed cost
+Variable cost
+Desired profit
Target revenue

Target costing : Revenue at market price desired profit

Other strategies

Increase in sales
Change or add to its product mix
Differentiate its products (make it unique)

Special order consideration

1)
2)
3)
4)

Do we have excess capacity available to fill this order?

If revenues are greater than expected cost increase?
Will the special order affect regular sales in the long run?
The special sales price high enough to cover the variable manufacturing
costs?

Product mix
Emphasize the product with the highest contribution margin per unit of constraint
For product mix, fixed manufacturing overhead cost doesnt included for calculating
contribution margin

Sales per unit

Less: Variable cost per unit
Contribution margin per unit

Units per machine hour

Contribution margin per machine hour

If fixed cost remains the same, even department losses money but if they it has
positive contribution margin it helps to pay the fixed cost. So keep it.
Chapter 9.
E9-34A S9-11, E9-20A,
Budgeting

A plan for a specific period of time

Helps management determine how to use resources
Used to estimate future costs & revenue
Develop strategy -> Plan > Act -> Control ->

Participative budgeting

Involves many levels of management

Benefits
o Lower level managers have more detailed knowledge for creating
realistic budgets
o Managers are more likely to accept/be motivated by budgets they help
create
Disadvantages
o Process can be complex
o Managers may intentionally build slack into budgets

Operating budget
Sales budget -> Production budget -> (direct materials, direct labour,
manufacturing overhead budget) -> Operating expense budget -> budgeted income
statement
Capital Expenditures and Financial Budgets
Budgeted income statement (Captial expenditure budget, cash budget, budgeted
balance sheet) = Financial budgets
Production budget

+ Units needed for sales

+ Desired ending inventory
= Total units needed
- Units in beginning inventory
= Units to produce

Direct materials budget

+ Quantity of direct materials needed for production

+ Desired direct materials ending inventory

= Total quantity of direct materials needed

- Direct materials beginning inventory
= Quantity of direct materials to purchase

Direct labour budget

Direct labour hour per unit

= Total direct labour hours needed
Cost per direct labour hour
= Total direct labour cost

Terms

Rolling budget is a budget that is continuously updated by adding months

to the end of the budgeting period
Master budget is the comprehensive planning document for the entire
organization
These budgets, Financial budgets, project both the collection and payment
of cash and forecast the companys budgeted balance sheet
The production budget is used to forecast how many units should be made
to meet the sales projections
Ground up, it is using zero-based budgeting
Strategic planning is the process of setting long-term goals that may
extend several years into the future
Managers sometimes build slack into their budget to protect themselves
The variance is the difference between actual and budgeted figures and is
used to evaluate how well the manager controlled operations during the
period
Budget committee are often used by companies to review submitted
budgets, make revision as needed
Safety stock is extra inventory of finished goods that is kept
The sales budget and production budget are examples of operating
budgets
Participative budgeting is a budgeting process that begins with
departmental managers and flows up through middle management to top
management

Terms

Maintenance department is a cost centre

The concession stand at the zoo is a profit centre
The menswear Department at The Bay, is responsible for buying and selling
merchandise, is a profit centre
A production line at a BlackBerry plant is a cost centre
A responsibility centre is any segment of the business whose manager is
accountable for specific activities
Quaker, a division of PepsiCo, is an investment centre

The sales manager in charge of Nikes northwest sales territory oversees a

revenue centre
Managers of cost and revenue centres are at lower levels of the org than are
managers of profit and investment centres

Chapter 10.
E10-34A, S10-14

Static budget : Prepared for one level of sales volume

Flexible budgets prepared for different levels of volume
Variance difference between actual results and the budget
Flexible budget variance
Sales volume variance
Static budget variance

Use flexible budgets at the end of the period to evaluate the companys financial
performance and help control costs
Compare the actual results against the flexible budget for the actual volume of
output that occurred during the period

Quantity standards components

Direct materials
Direct labour
Manufacturing overhead

Price standards components

Direct materials Purchase price (after early-pay discount) + freight-in +

receiving costs
Direct labour basic pay rates + payroll taxes + fringe benefits
Manufacturing overhead determine resources needed for support activities
and determine appropriate allocation base

Standard manufacturing overhead rate = Estimated total overhead cost /

Estimated total allocation base
Standard cost of inputs

Direct Materials Standard Cost

+ Direct labour Standard Cost
+ Variable Overhead Standard Cost

=
+
=

Standard Variable Manufacturing Cost per Unit

Fixed Overhead Standard Cost
Standard Manufacturing Cost per Product

Price variance : (Actual Price x Actual Quantity) (Standard Price x Actual Quantity)
Efficiency Variance : (Standard Price x Actual Quantity) (Standard Price x Standard
Quanity)

Actual variable overhead Flexible budget variable over head = variable overhead
spending variance
Tells managers that incurred more or less than what they have expected for volume
to produce

Price Variance : ($8.5 - $8) x 10600 kg = $5300 U

Efficiency variance : (10600 kg 9600 kg ) x $8 = $8000 U
Flexible budget variance = $5300 + $8000 = 13300

Variance entry is on debit Unfavourable, on Credit Favourable

Chapter. 11

Responsibility centers

Cost center : controlling costs, Production line at Dell computer

Revenue center : Generating sales revenue, Midwest sales region at pace
foods
Profit center : Producing profit thorugh generating sales and controlling costs,
Product line at bush
Ivenstment center : Producing profit and managing the divisions invested
capital, company divisions Walt Disney World resorts

Linking goals to key performance indicators

Critical factors : Customer satisfaction, operational efficiency, employee

excellence, financial profitability
Key performance indicators (KPI) : market share, yield rate, employee training
hours, revenue growth

Report financial performance of responsibility centers

Cost center: focus on flexible budget variance

Revenue center: focus on flexible budget variance and sales volume variance
Profit center: focus on flexible budget variance
Includes allocated charges from service departments

Investment centers

Financial evaluation must measure

o Income generated
o Effective use of centers assets
Performance measures
o Return on investment (ROI)
o Residual income (RI)
o Economic value added (EVA)

ROI = Operating income / Total assets ,

(Operating income/Sales) Profit margin X (sales/total assets) Asset turnover
RI = Operating income (Target rate of return X total assets) Minimum
acceptable income
EVA (economic value added)
After-tax operating income [(total assets current liabilits) WACC%]
Other terms
Asset turnover : Sales / Total assets
Profit margin : OI / Sales
Lag indicators
Are performance mearsures that tend to reveal the results of past action. Come
after decision and actions taken in the past. Typically financial measures
Lead indicators
Performance measures that tend to indicate future performance. Typically
operational measures
Residual Income looks at income through the eyes of management
EVA looks at it through the eyes of the sharleholders and long-term creditors