Module 2: Cost Concepts, Classification, and Cost Behavior

X Cost Concepts and Classification (FS Preparation, Behavior, Decision Making, Cost Assignment)
X Traditional Format Income Statement versus Contribution Format Income Statement
X Splitting of Mixed Cost (Scattergraph, High-Low Method, Least Squares Method)
X Learning Curve Analysis

Module 3: CVP Analysis

X CVP Ratios and Relationships
X Sensitivity (What-If) Analysis: Breakeven Analysis, Target Profit Analysis, Changes in Assumptions
X Margin of Safety and Degree of Operating Leverage
X Multi-Product CVP
(1) Analyzing Contribution Format Income Statement
Total Per Unit % of Sales
Sales $ 1,200,000 $ 60 100%
Variable Costs 900,000 45 75%
Contribution Margin 300,000 15 25%
Fixed Costs 240,000 12 20%
Net Operating Income $ 60,000 3 5%

Sales Volume 20,000 units

CM Ratio = Unit Contribution Margin / Unit Selling Price

= $15 / $60
= 25%

Variable expense ratio = Unit Variable Expense / Unit Selling Price

= $45 / $60
= 75%

(2) Breakeven Analysis

Current Breakeven
Total Per Unit % of Sales Total Per Unit % of Sales
Sales $ 1,200,000 $ 60 100% $ 960,000 60 100%
Variable Costs 900,000 45 75% 720,000 45 75%
Contribution Margin 300,000 15 25% 240,000 15 25%
Fixed Costs 240,000 12 20% 240,000
Net Operating Income $ 60,000 3 5% $ -

Sales Volume 20,000 units 16,000 units

Using Equation Method:

NOI = Contribution Margin - Fixed Cost
NOI = (Unit Sales Volume x Unit CM) - FC
$0 = (Q x $15) - $240,000
$15Q = $ 240,000
Q = 16,000 units

Sales = Unit Sales Volume x Selling Price

= 16000 units x $60
Sales = $ 960,000

Using Formula Method:

Breakeven Sales = Fixed Cost / Contribution Margin per Unit
= $240000 / $15
= 16,000 units
 Breakeven Sales = Fixed Cost / Contribution Margin Ratio
= $240000 / 25%
= $ 960,000

(3) Sensitivity (What if) Analysis

Current Simulated
Total Per Unit % of Sales Total Per Unit % of Sales
Sales $ 1,200,000 $ 60 100% $ 1,600,000 60 100%
Variable Costs 900,000 45 75% 1,200,000 45 75%
Contribution Margin 300,000 15 25% 400,000 15 25%
Fixed Costs 240,000 12 20% 240,000
Net Operating Income $ 60,000 3 5% $ 160,000

Increase in NOI ($160000 - $60000) $ 100,000

Using Incremental Analysis:

Increase in Contribution Margin ($400000 x 25%) $ 100,000
Increase in Fixed Cost -
Increase in NOI $ 100,000

(4) Target Profit Analysis

Current Simulated
Total Per Unit % of Sales Total Per Unit % of Sales
Sales $ 1,200,000 $ 60 100% $ 1,320,000 $ 60 100%
Variable Costs 900,000 45 75% 990,000 45 75%
Contribution Margin 300,000 15 25% 330,000 15 25%
Fixed Costs 240,000 12 20% 240,000
Net Operating Income $ 60,000 3 5% $ 90,000

Sales Volume 20,000 units 22,000 units

Using Equation Method:

NOI = Contribution Margin - Fixed Cost
NOI = (Unit Sales Volume x Unit CM) - FC
$90,000 = (Q x $15) - $240,000
$15Q = $ 330,000
Q = 22,000 units

Using Formula Method:

Target Sales = (Target Profit + Fixed Cost) / Contribution Margin per Unit
= ($90000 + $240000) / $15
= 22,000 units
(5) Margin of Safety (MS)
MS in dollars = Total Sales - Breakeven Sales
= $1200000 - $960000
= $ 240,000

MS % = MS in dollars / Total Sales

= $240000 / $1200000
= 20%

(6) (a) Degree of Operating Leverage (DOL)

DOL = Contribution Margin / NOI
= $300000 / $60000
= 5 times

= CM Ratio / Profit Ratio

= 25% / 5%
= 5 times

(b) Sensitivity (What-if) Analysis

%Increase in NOI = %Increase in Sales x DOL
= 8% x 5
= 40%

(c) Contribution Format Income Statement

Current Simulated
Total Per Unit % of Sales Total Per Unit % of Sales
Sales $ 1,200,000 $ 60 100% 1,296,000 $ 60 100%
Variable Costs 900,000 45 75% 972,000 45 75%
Contribution Margin 300,000 15 25% 324,000 15 25%
Fixed Costs 240,000 12 20% 240,000
Net Operating Income $ 60,000 3 5% $ 84,000

%Increase in NOI [($84000 - $60000) / $60000] 40%

(7) (a) Sensitivity (What-If Analysis)

Current Simulated
Total Per Unit % of Sales Total Per Unit % of Sales
Sales $ 1,200,000 $ 60 100% 1,440,000 $ 60 100%
Variable Costs 900,000 45 75% 1,152,000 48 80%
Contribution Margin 300,000 15 25% 288,000 12 20%
Fixed Costs 240,000 12 20% 210,000
Net Operating Income $ 60,000 3 5% $ 78,000

(b) Breakeven Analysis

 Breakeven Sales = Fixed Cost / Contribution Margin per Unit
= $210000 / $12
= 17,500 units

Breakeven Sales = Fixed Cost / Contribution Margin Ratio

= $210000 / 20%
= $ 1,050,000

(c) Yes, because it will increase NOI by $18,000 ($78,000 - $60,000)

MS in dollars = Total Sales - Breakeven Sales

= $1440000 - $1050000
= $ 390,000

Additionally, it will increase margin of safety by $150,000 ($390,000 - $240,000), which provides
more cushion for adverse situations e.g. decline in industry sales.
% of Sales
% of Sales

% of Sales
% of Sales

% of Sales
(1) Contribution Format Income Statement
Flight Dynamic Sure Shot
Total % of Sales Total % of Sales
Sales $ 150,000 100.0% $ 250,000 100.0%
Variable Costs 30,000 20.0% 160,000 64.0%
Contribution Margin 120,000 80.0% 90,000 36.0%
Fixed Costs
Net Operating Income

(2) Breakeven Analysis

Sales Mix 37.5% 62.5%

Flight Dynamic Sure Shot

Total % of Sales Total % of Sales
Sales $ 131,250 100.0% $ 218,750 100.0%
Variable Costs 26,250 20.0% 140,000 64.0%
Contribution Margin 105,000 80.0% 78,750 36.0%
Fixed Costs
Net Operating Income

Using Formula Method:

Breakeven Sales = Fixed Cost / Contribution Margin Ratio
= $183750 / 52.5%
= $ 350,000

BE Sales (Flight) = $350000 x 37.5%

= $ 131,250

BE Sales (Flight) = $350000 x 62.5%

= $ 218,750

(2) Sensitivity (What-if) Analysis

Using Incremental Analysis Total
Increase in Contribution Margin ($100000 x 52.5%) $ 52,000
Flight Dynamic ($100000 x 37.5% x 80%)
Sure Shot ($100000 x 62.5% x 64%)
Increase in Fixed Cost -
Increase in NOI $ 52,000

Flight Dynamic Sure Shot

Total % of Sales Total % of Sales
Sales 187,500 100.0% 312,500 100.0%
Variable Costs 37,500 20.0% 200,000 64.0%
Contribution Margin 150,000 80.0% 112,500 36.0%
Fixed Costs
Net Operating Income

Increase in NOI $ 30,000 $ 22,500

 Total
Total % of Sales
$ 400,000 100.0%
190,000 47.5%
210,000 52.5%
183,750
$ 26,250

100.0%

Total
Total % of Sales
$ 350,000 100.0%
166,250 47.5%
183,750 52.5%
183,750
$ -

Flight Dynamic Sure Shot

30,000
22,500
- -
$ 30,000 $ 22,500

Total
Total % of Sales
500,000 100.0%
237,500 47.5%
262,500 52.5%
 183,750
$ 78,750

$ 52,500