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CHAPTER 6 MORE CVP ANALYSIS. SALES MIX Understanding and managing sales mix is critical to company...
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Transcript of CHAPTER 6 MORE CVP ANALYSIS. SALES MIX Understanding and managing sales mix is critical to company...
CHAPTER 6
MORE CVP ANALYSIS
SALES MIX
Understanding and managing
sales mix is
critical to company success
SALES MIX
Companies often sell more than one product
Critical decision:what mix of products to sell
Relative percentage in which each product is sold when more than one product is sold
Important because different products have substantially different contribution margins
SALES MIXBreak-Even Sales In Units
Steps for a mix of two or more products:
Compute the weighted-average unit contribution margin of all the products:
Product 1 Unit Contribution Margin X Percentage of Sales
+ Product 2 Unit Contribution Margin X Percentage of Sales
= Weighted Average Unit Contribution Margin
Compute the break-even point in units:
Fixed Costs ) Weighted Average = Break-even Unit Contribution Point
Margin in Units
SALES MIXBreak-Even Sales In Units
Example – Vargo Video Basic Data
Sells both DVD players and TVs
Fixed costs of $200,000
SALES MIX - Break-Even Sales In Units Example – Vargo Video Continued
Determine weighted-average unit contribution margin for the sales mix of 75 percent DVDs and 25 percent TVs:
Determine the break-even point in units:
SALES MIX - Break-Even Sales In Units Example – Vargo Video (Continued)
Verify the number of DVDs and TVs to be sold to break even with a sales mix of 75 % DVDs and 25 % TVs and with fixed costs of $200,000:
SALES MIXBreak-Even Sales In Units
At any level of units sold,
net income will be greater
if more high contribution margin units
are sold
than low contribution margin units.
SALES MIXBreak-Even Sales In Dollars
Steps for a mix of many products in two or more product lines or divisions:
Compute the weighted-average unit contribution margin ratio of all product lines or divisions:
Division 1 Contribution Margin Ratio X Percentage of Sales
+ Division 2 Contribution Margin Ratio X Percentage of Sales
= Weighted Average Contribution Margin Ratio
Compute the break-even point in dollars:Weighted Average Break-
evenFixed Costs ÷ Contribution = Point
Margin Ratio in Dollars
SALES MIXBreak-Even Sales In Dollars
Example – Kale Garden Supply Co. Basic Data
Total fixed costs $300,000
Two Product Divisions:
Indoor Plants: Sales Mix Ratio 20% Contribution Margin Ratio 40%
Outdoor Plants: Sales Mix Ratio 80% Contribution Margin Ratio 30%
SALES MIX - Break-Even Sales In Dollars Example – Kale Garden Supply (Continued)
Determine weighted-average contribution margin ratio for all divisions:
Determine the break-even point in dollars:
SALES MIX - Break-Even Sales In Dollars Example – Kale Garden Supply (Continued)
Using Kale’s sales mix of 20 percent and 80 percent, break-even sales from each division:
Indoor Plant Division:$187,500 (.20 X $937,500)
Outdoor Plant Division:$750,000(.80 X $937,500)
SALES MIX - Break-Even Sales In Dollars Example – Kale Garden Supply (Continued)
Break-even point affected by a shift in sales from one division to another
Shift sales to the Indoor Plant Division: Division’s higher contribution margin ratio increases
weighted average contribution margin ratio
Results in a lower break-even point in sales dollars
Shift sales to the Outdoor Plant Division: Opposite effect occurs due to Division’s lower
contribution margin ratio
COST STRUCTURE AND OPERATING LEVERAGE
Cost Structure
Relative proportion of fixed versus variable costs for a company
Can have a significant impact on profits
COST STRUCTURE AND OPERATING LEVERAGE
Operating LeverageExtent to which a company’s net income
reacts to a given change in sales
Higher fixed cost structure increases sensitivity to changes in sales; thus, higher operating leverage
Profits increase rapidly when sales increase and plunge drastically when sales decrease
When used carefully, can add to company profitability
COST STRUCTURE AND OPERATING LEVERAGE
Example – Makers of Croquet Mallets
Old English Mallet Company - Labor-intensive manufacturing approach
New Wave Mallet Company - Completely automated system
Same sales and same net income Managed differently due to different cost structures
COST STRUCTURE AND OPERATING LEVERAGE
Operating Leverage
0
100000
200000
300000
400000
500000
SalesOld Total CostsOld Var Costs
Old Fixed CostsNew Total CostsNew Var CostsNew Fixed Costs
COST STRUCTURE AND OPERATING LEVERAGE
Effect on Contribution Margin Ratio
Example – Makers of Croquet Mallets (Continued)
Higher cost structure for New Wave More sensitive to changes in sales Higher operating leverage Net income increases 60¢ for each additional sales dollar Net income decreases 60¢ for each lost sales dollar
COST STRUCTURE AND OPERATING LEVERAGE Degree of Operating Leverage
Measures earnings volatility
Example – Makers of Croquet Mallets (Continued)
Higher operating leverage for New Wave Net income changes 4 times (6 ÷ 1.5) as much as Old
English with an equal change in sales Exposed to greater earnings volatility risk
COST STRUCTURE AND OPERATING LEVERAGE
Effect on Break-Even Point
Example – Makers of Croquet Mallets (Continued)
Higher break-even point for New Wave Needs $150,000 more in sales than Old English to break
even Riskier than Old English Cannot survive for very long unless it breaks even
COST STRUCTURE AND OPERATING LEVERAGE Effect on Margin of Safety Ratio
Example – Makers of Croquet Mallets (Continued)
Old English could sustain a 67 percent decline in sales before operating at a loss
New Wave could only have a 17 percent decline in sales prior to being in “the red”
Thus, New Wave is riskier than Old English
APPENDIX: ABSORPTION COSTING VERSUS VARIABLE COSTING
Full or Absorption Costing Assigns all variable and fixed manufacturing costs to the
product
Required for external reporting
Variable Costing Assigns only variable manufacturing costs to the product Direct material, direct labor, variable manufacturing
overhead
ABSORPTION COSTING VERSUS VARIABLE COSTING
COMPARISON
Primary Difference
Under variable costing, fixed manufacturing overhead is an expense in the current period.
You will remember:
Under absorption costing, fixed manufacturing overhead is part of the O/H pool allocated to inventory under Standard or ABC costing.
ABSORPTION COSTING VERSUS VARIABLE COSTINGCOMPARISON - Continued
Variable costing does not defer fixed manufacturing overhead to the future - i.e., they are not inventoried
Net income under absorption costing compared to net income under variable costing: Higher when units produced exceed units sold
Lower when units produced are less than units sold
Equal when units produced and sold are the same:
• There is no added ending inventory so fixed costs are not deferred into the future
ABSORPTION COSTING VERSUS VARIABLE COSTING
Example – Premium Products
Manufactures Fix-it, a sealant for car windows
Relevant data for the first month of production:
ABSORPTION COSTING VERSUS VARIABLE COSTING
Example - Continued
Per unit manufacturing cost under each approach:
Manufacturing costs are $4 ($13 - $9) higher for absorption costing because fixed manufacturing costs are product costs.
ABSORPTION COSTING VERSUS VARIABLE COSTING
Absorption Costing Income Statement
ABSORPTION COSTING VERSUS VARIABLE COSTING
Variable Costing Income Statement
ABSORPTION vs VARIABLE COSTING
1. Last year, fixed manufacturing overhead was $30,000, variable production costs were $48,000, fixed selling and administration costs were $20,000, and variable selling administrative expenses were $9,600. There was no beginning inventory. During the year, 3,000 units were produced and 2,400 units were sold at a price of $40 per unit. Under variable costing, net income would be:
a) a profit of $6,000.
b) a profit of $4,000.
c) a loss of $2,000.
d) a loss of $4,400.
ABSORPTION vs VARIABLE COSTING
Given: Absorption VariableInc Stmt End Inv Inc Stmt End Inv
Sales $Sales Units 2,400
Mfg: Var. 48,000 Fixed 30,000SG&A: Var. 9,600 Fixed 20,000
Total Cost: 107,600Net Inc:
ABSORPTION vs VARIABLE COSTING
Given: Absorption VariableInc Stmt End Inv Inc Stmt End Inv
Sales $Sales Units 2,400 600 600
Mfg: Var. 48,000 Fixed 30,000SG&A: Var. 9,600 Fixed 20,000
Total Cost: 107,600Net Inc:
ABSORPTION vs VARIABLE COSTING
Given: Absorption VariableInc Stmt End Inv Inc Stmt End Inv
Sales $ 96,000 96,000 96,000Sales Units 2,400 600 600
Mfg: Var. 48,000 Fixed 30,000SG&A: Var. 9,600 Fixed 20,000
Total Cost: 107,600Net Inc:
2,400 units x $40
ABSORPTION vs VARIABLE COSTING
Given: Absorption VariableInc Stmt End Inv Inc Stmt End Inv
Sales $ 96,000 96,000 96,000Sales Units 2,400 2,400 600 2,400 600
Mfg: Var. 48,000 Fixed 30,000SG&A: Var. 9,600 9,600 9,600 Fixed 20,000 20,000 20,000
Total Cost: 107,600Net Inc:
ABSORPTION vs VARIABLE COSTING
Given: Absorption VariableInc Stmt End Inv Inc Stmt End Inv
Sales $ 96,000 96,000 96,000Sales Units 2,400 2,400 600 2,400 600
Mfg: Var. 48,000 Fixed 30,000SG&A: Var. 9,600 9,600 9,600 Fixed 20,000 20,000 20,000
Total Cost: 107,600Net Inc:
Product Cost Product Cost
Product Cost Period Cost
ABSORPTION vs VARIABLE COSTING
Given: Absorption VariableInc Stmt End Inv Inc Stmt End Inv
Sales $ 96,000 96,000 96,000Sales Units 2,400 2,400 600 2,400 600
Mfg: Var. 48,000 38,400 9,600 Fixed 30,000SG&A: Var. 9,600 9,600 9,600 Fixed 20,000 20,000 20,000
Total Cost: 107,600Net Inc:
ABSORPTION vs VARIABLE COSTING
Given: Absorption VariableInc Stmt End Inv Inc Stmt End Inv
Sales $ 96,000 96,000 96,000Sales Units 2,400 2,400 600 2,400 600
Mfg: Var. 48,000 38,400 9,600 38,400 9,600 Fixed 30,000SG&A: Var. 9,600 9,600 9,600 Fixed 20,000 20,000 20,000
Total Cost: 107,600Net Inc:
ABSORPTION vs VARIABLE COSTING
Given: Absorption VariableInc Stmt End Inv Inc Stmt End Inv
Sales $ 96,000 96,000 96,000Sales Units 2,400 2,400 600 2,400 600
Mfg: Var. 48,000 38,400 9,600 38,400 9,600 Fixed 30,000 24,000 6,000SG&A: Var. 9,600 9,600 9,600 Fixed 20,000 20,000 20,000
Total Cost: 107,600Net Inc:
ABSORPTION vs VARIABLE COSTING
Given: Absorption VariableInc Stmt End Inv Inc Stmt End Inv
Sales $ 96,000 96,000 96,000Sales Units 2,400 2,400 600 2,400 600
Mfg: Var. 48,000 38,400 9,600 38,400 9,600 Fixed 30,000 24,000 6,000 30,000SG&A: Var. 9,600 9,600 9,600 Fixed 20,000 20,000 20,000
Total Cost: 107,600Net Inc:
ABSORPTION vs VARIABLE COSTING
Given: Absorption VariableInc Stmt End Inv Inc Stmt End Inv
Sales $ 96,000 96,000 96,000Sales Units 2,400 2,400 600 2,400 600
Mfg: Var. 48,000 38,400 9,600 38,400 9,600 Fixed 30,000 24,000 6,000 30,000SG&A: Var. 9,600 9,600 9,600 Fixed 20,000 20,000 20,000
Total Cost: 107,600 92,000 15,600 98,000 9,600Net Inc: 4,000 <2,000>
ABSORPTION vs VARIABLE COSTING
1. Last year, fixed manufacturing overhead was $30,000, variable production costs were $48,000, fixed selling and administration costs were $20,000, and variable selling administrative expenses were $9,600. There was no beginning inventory. During the year, 3,000 units were produced and 2,400 units were sold at a price of $40 per unit. Under variable costing, net income would be:
a) a profit of $6,000.
b) a profit of $4,000.
c) a loss of $2,000.
d) a loss of $4,400.
ABSORPTION vs VARIABLE COSTING Summary of Income Effects
DECISION-MAKING CONCERNS
Generally Accepted Accounting Principles (GAAP) Must be followed for external reporting
Requires absorption costing for inventory
Does not differentiate between fixed and variable costs
Poor business decisions may result
Thus, variable costing used for internal decision making
DECISION-MAKING CONCERNS
Example - Basic Data for Lighting Division
Decision: Produce 20,000 or 30,000 units?
DECISION-MAKING CONCERNS
Example – Continued
At 20,000 units, net income is $85,000.
At 30,000 units, net income is $105,000 with 10,000 unit ending inventory.
Difference in income due to $20,000 fixed costs assigned to ending inventory.
Comparative Absorption Costing Income Statements
Based on these statements, should production be increased?
DECISION-MAKING CONCERNS
Example – Continued
At both levels, net income is $85,000.
Fixed costs treated as a period expense.
10,000 units of ending inventory include only variable costs.
Comparative Variable Costing Income Statements
Based on these statements, should production be increased?
ADVANTAGES OF VARIABLE
COSTING
Consistent with CVP and incremental analysis
Net income unaffected by changes in production levels
Net income closely tied to changes in sales levels – not production levels
Easier to identify fixed and variable costs and their effect on company
SERVICE COMPANY PERSPECTIVE
Distinction between fixed and variable costs very relevant Shipping companies rely heavily
on variable costing for pricing decisions
When operating below full capacity, absorption costing results in a high charge per shipment
Resulting in price too high compared to competitors
Creates further decline in operations
Quiz Question 1Quiz Question 1
Fixed manufacturing overhead costs are recognized as:
a. Period costs under absorption costing
b. Product costs under absorption costs
c. Product costs under variable costing
d. Part of ending inventory costs under both absorption and variable costing
Let’s ReviewLet’s Review
Fixed manufacturing overhead costs are recognized as:
a. Period costs under absorption costing
b. Product costs under absorption costs
c. Product costs under variable costing
d. Part of ending inventory costs under both absorption and variable costing
