Contribution Income Statement and CVP Relationships for Racing Bicycle Company, Study notes of Management Accounting

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Cost-Volume-Profit Relationships

Chapter 6

Learning Objective 1

Explain how changes in Explain how changes in

activity affect contribution activity affect contribution

margin and net operating margin and net operating

income. income.

Basics of Cost-Volume-Profit Analysis

CM is used first to cover fixed expenses. Any remaining CM contributes to net operating income. CM is used first to cover fixed expenses. Any remaining CM contributes to net operating income.

Sales (500 bicycles) $ 250,

Less: Variable expenses 150,

Contribution margin 100,

Less: Fixed expenses 80,

Net operating income $ 20,

Racing Bicycle Company

Contribution Income Statement

For the Month of June

Total Per Unit Sales (500 bicycles) $ 250,000 $ 500 Less: Variable expenses 150,000 300 Contribution margin 100,000 $ 200 Less: Fixed expenses 80, Net operating income $ 20, Racing Bicycle Company Contribution Income Statement For the Month of June

The Contribution Approach

Sales, variable expenses, and contribution margin can also be expressed on a per unit basis. If Racing sells an additional bicycle, $200 additional CM will be generated to cover fixed expenses and profit.

Total Per Unit Sales ( 400 bicycles) $ 200,000 $ 500 Less: Variable expenses 120,000 300 Contribution margin 80,000 $ 200 Less: Fixed expenses 80, Net operating income $ - Racing Bicycle Company Contribution Income Statement For the Month of June

The Contribution Approach

If RBC sells 400 units in a month, it will be

operating at the break-even point.

Total Per Unit Sales ( 401 bicycles) $ 200,500 $ 500 Less: Variable expenses 120,300 300 Contribution margin 80,200 $ 200 Less: Fixed expenses 80, Net operating income $ 200 Racing Bicycle Company Contribution Income Statement For the Month of June

The Contribution Approach

If RBC sells one more bike (401 bikes), net operating income will increase by $.

CVP Relationships in Equation Form

The contribution format income statement can be

expressed in the following equation:

Profit = (Sales – Variable expenses) – Fixed expenses^ Profit = (Sales – Variable expenses) – Fixed expenses Total Per Unit Sales ( 401 bicycles) $ 200,500 $ 500 Less: Variable expenses 120,300 300 Contribution margin 80,200 $ 200 Less: Fixed expenses 80, Net operating income $ 200 Racing Bicycle Company Contribution Income Statement For the Month of June

CVP Relationships in Equation Form

This equation can be used to show the profit RBC

earns if it sells 401. Notice, the answer of $200 mirrors

our earlier solution.

Profit = (Sales – Variable expenses) – Fixed expenses^ Profit = (Sales – Variable expenses) – Fixed expenses

401 units × $500401 units × $

401 units × $300401 units × $

Profit =Profit = ($200,500 – $120,300)Profit = ($200,500 – $120,300) – $80,000$200 = ($200,500 – $120,300) – $80,000 ($200,500 – Variable expenses) – Fixed – Fixed expenses

CVP Relationships in Equation Form

This equation can also be used to show the $

profit RBC earns if it sells 401 bikes.

Profit = (Sales – Variable expenses) – Fixed expenses^ Profit = (Sales – Variable expenses) – Fixed expenses

Profit = (P × Q – V × Q) – Fixed expenses

Profit = ($500 × 401 – $300 × 401) – $80,000Profit = ($500 × 401 – $300 × 401) – $80,000$200$200$200$200^ = ($500 × 401 – $300 × 401) – $80,000= ($500 × 401 – $300 × 401) – $80,

CVP Relationships in Equation Form

Unit CM = Selling price per unit – Variable expenses per unit

It is often useful to express the simple profit equation in

terms of the unit contribution margin (Unit CM) as follows:

Profit = (P × Q – V × Q) – Fixed expenses Profit = (P – V) × Q – Fixed expenses Profit = Unit CM × Q – Fixed expenses Profit = (P × Q – V × Q) – Fixed expenses Profit = (P – V) × Q – Fixed expenses Profit = Unit CM × Q – Fixed expenses

Unit CM = P – V

Learning Objective 2

Prepare and interpret a Prepare and interpret a

cost-volume-profit (CVP) cost-volume-profit (CVP)

graph and a profit graph. graph and a profit graph.

CVP Relationships in Graphic Form

The relationships among revenue, cost, profit and volume

can be expressed graphically by preparing a CVP graph.

Racing Bicycle developed contribution margin income

statements at 0, 200, 400, and 600 units sold. We will

use this information to prepare the CVP graph.

(^0 200) 400 600 Sales $ - $ 100,000 $ 200,000 $ 300, Total variable expenses - 60,000 120,000 180, Contribution margin - 40,000 80,000 120, Fixed expenses 80,000 80,000 80,000 80, Net operating income (loss) $ (80,000) $ (40,000) $ - $ 40, Units Sold

Preparing the CVP Graph

Break-even point Break-even point

(400 units or $200,000 in sales) (400 units or $200,000 in sales)

Break-even point Break-even point

(400 units or $200,000 in sales) (400 units or $200,000 in sales)

Units Dollars

Loss AreaLoss Area

Profit AreaProfit Area

Learning Objective 3

Use the contribution margin Use the contribution margin ratio (CM ratio) to compute ratio (CM ratio) to compute changes in contribution changes in contribution margin and net operating margin and net operating income resulting from income resulting from changes in sales volume. changes in sales volume.