105136
DESCRIPTION
TRANSCRIPT
Cost Classifications for Predicting Cost Behavior
How a cost will react to changes in the level of
business activity.
– Total variable costs change when activity changes.
– Total fixed costs remain unchanged when activity changes.
How a cost will react to changes in the level of
business activity.
– Total variable costs change when activity changes.
– Total fixed costs remain unchanged when activity changes.
Total Variable Cost
Your total long distance telephone bill is based on how many minutes you talk.
Minutes Talked
Tot
al L
ong
Dis
tanc
eT
elep
hone
Bill
Variable Cost Per Unit
Minutes Talked
Per
Min
ute
Tel
epho
ne C
harg
e
The cost per long distance minute talked is constant. For example, 10 cents per minute.
Total Fixed Cost
Your monthly basic telephone bill probably does not change when you make more local
calls.
Number of Local Calls
Mon
thly
Bas
ic
Tel
epho
ne B
ill
Fixed Cost Per Unit
Number of Local Calls
Mon
thly
Bas
ic T
elep
hone
B
ill p
er L
ocal
Cal
l
The average cost per local call decreases as more local calls are made.
Cost Classifications for Predicting Cost Behavior
Behavior of Cost (within the relevant range)
Cost In Total Per Unit
Variable Total variable cost changes Variable cost per unit remainsas activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Fixed cost per unit goesthe same even when the down as activity level goes up. activity level changes.
The Activity Base
A measure of the event that causes the incurrence of a
variable cost – a cost driver
A measure of the event that causes the incurrence of a
variable cost – a cost driver
Unitsproduced
Unitsproduced
Miles driven
Miles driven
Labor hours
Labor hours
Machine hours
Machine hours
Step-Variable Costs
Activity
Co
st
Total cost remainsconstant within anarrow range of
activity.
Total cost remainsconstant within anarrow range of
activity.
Step-Variable Costs
Activity
Co
st
Total cost increases to a new higher cost for the
next higher range of activity.
Total cost increases to a new higher cost for the
next higher range of activity.
RelevantRange
A straight line closely
approximates a curvilinear
variable cost line within the
relevant range.
A straight line closely
approximates a curvilinear
variable cost line within the
relevant range.
Activity
To
tal
Co
st
Economist’sCurvilinear Cost
Function
The Linearity Assumption and the Relevant Range
Accountant’s Straight-Line Approximation (constant
unit variable cost)
Exh.5-4
Cost Behavior
MerchandisersCost of Goods Sold
MerchandisersCost of Goods Sold
ManufacturersDirect Material, Direct Labor, and Variable
Manufacturing Overhead
ManufacturersDirect Material, Direct Labor, and Variable
Manufacturing Overhead
Merchandisers and Manufacturers
Sales commissions and shipping costs
Merchandisers and Manufacturers
Sales commissions and shipping costs
Service Organizations Supplies and travel
Service Organizations Supplies and travel
Examples of normally variable costsExamples of normally variable costs
Examples of normally fixed costsExamples of normally fixed costs
Merchandisers, manufacturers, and service organizations
Real estate taxes, Insurance, Sales salariesDepreciation, Advertising
Merchandisers, manufacturers, and service organizations
Real estate taxes, Insurance, Sales salariesDepreciation, Advertising
ExamplesAdvertising and Research and Development
ExamplesAdvertising and Research and Development
ExamplesDepreciation on Buildings and
Equipment
ExamplesDepreciation on Buildings and
Equipment
Types of Fixed Costs
DiscretionaryMay be altered in the short-term by current managerial decisions
DiscretionaryMay be altered in the short-term by current managerial decisions
CommittedLong-term, cannot be reduced in the short
term.
CommittedLong-term, cannot be reduced in the short
term.
Ren
t C
ost
in
T
ho
usa
nd
s o
f D
oll
ars
0 1,000 2,000 3,000 Rented Area (Square Feet)
0
30
60
Fixed Costs and Relevant Range
90
Relevant
Range
Total cost doesn’t change for a wide range of activity,
and then jumps to a new higher cost for
the next higher range of activity.
Total cost doesn’t change for a wide range of activity,
and then jumps to a new higher cost for
the next higher range of activity.
Exh.5-6
Fixed Monthly
Utility Charge
Variable
Cost per KW
Activity (Kilowatt Hours)
To
tal
Uti
lity
Co
st
X
Y
A mixed cost has both fixed and variablecomponents. Consider the example of utility cost.
A mixed cost has both fixed and variablecomponents. Consider the example of utility cost.
Mixed Costs
Total mixed cost
Total Per UnitSales (500 bikes) 250,000$ 500$ Less: variable expenses 150,000 300 Contribution margin 100,000 200$
Less: fixed expenses 80,000 Net operating income 20,000$
WIND BICYCLE CO.Contribution Income Statement
For the Month of June
The Basics of Cost-Volume-Profit (CVP) Analysis
Contribution Margin (CM) is the amount remaining from sales revenue after variable expenses have been
deducted.
Total Per UnitSales (500 bikes) 250,000$ 500$ Less: variable expenses 150,000 300 Contribution margin 100,000 200$
Less: fixed expenses 80,000 Net operating income 20,000$
WIND BICYCLE CO.Contribution Income Statement
For the Month of June
The Basics of Cost-Volume-Profit (CVP) Analysis
CM goes to cover fixed expenses.CM goes to cover fixed expenses.
Total Per UnitSales (500 bikes) 250,000$ 500$ Less: variable expenses 150,000 300 Contribution margin 100,000 200$
Less: fixed expenses 80,000 Net operating income 20,000$
WIND BICYCLE CO.Contribution Income Statement
For the Month of June
The Basics of Cost-Volume-Profit (CVP) Analysis
After covering fixed costs, any remaining CM contributes to income.
The Contribution Approach
For each additional unit Wind sells, $200 more in contribution margin will help to
cover fixed expenses and profit.
The Contribution Approach
Each month Wind must generate at least $80,000 in total CM to break even.
The Contribution Approach
If Wind sells 400 units in a month, it will be operating at the break-even point.
Total Per UnitSales (401 bikes) 200,500$ 500$ Less: variable expenses 120,300 300 Contribution margin 80,200 200$
Less: fixed expenses 80,000 Net operating income 200$
WIND BICYCLE CO.Contribution Income Statement
For the Month of June
The Contribution Approach
If Wind sells one more bike (401 bikes), net
operating income will increase by $200.
CVP Relationships in Graphic Form
Viewing CVP relationships in a graph is often helpful. Consider the following information for Wind Co.:
Income 300 units
Income 400 units
Income 500 units
Sales 150,000$ 200,000$ 250,000$ Less: variable expenses 90,000 120,000 150,000 Contribution margin 60,000$ 80,000$ 100,000$ Less: fixed expenses 80,000 80,000 80,000 Net operating income (20,000)$ -$ 20,000$
Income 300 units
Income 400 units
Income 500 units
Sales 150,000$ 200,000$ 250,000$ Less: variable expenses 90,000 120,000 150,000 Contribution margin 60,000$ 80,000$ 100,000$ Less: fixed expenses 80,000 80,000 80,000 Net operating income (20,000)$ -$ 20,000$
-
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
- 100 200 300 400 500 600 700 800
CVP Graph
Fixed expenses
Units
Dol
lars Total Expenses
Total Sales
-
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
- 100 200 300 400 500 600 700 800
Units
Dol
lars
CVP Graph
Break-even point
Profit Area
Loss Area
Contribution Margin Ratio
The contribution margin ratio is:
For Wind Bicycle Co. the ratio is:
$ 80,000$200,000
= 40%
Total CMTotal sales
CM Ratio =
Contribution Margin Ratio
Or, in terms of units, the contribution margin ratio is:
For Wind Bicycle Co. the ratio is:
$200$500
= 40%
Unit CMUnit selling price
CM Ratio =
Contribution Margin Ratio
At Wind, each $1.00 increase in sales revenue results in a total contribution margin
increase of 40¢.
If sales increase by $50,000, what will be the If sales increase by $50,000, what will be the increase in total contribution margin? increase in total contribution margin?
Contribution Margin Ratio
400 Bikes 500 BikesSales 200,000$ 250,000$ Less: variable expenses 120,000 150,000 Contribution margin 80,000 100,000 Less: fixed expenses 80,000 80,000 Net operating income -$ 20,000$
400 Bikes 500 BikesSales 200,000$ 250,000$ Less: variable expenses 120,000 150,000 Contribution margin 80,000 100,000 Less: fixed expenses 80,000 80,000 Net operating income -$ 20,000$
A $50,000 increase in sales revenue
Changes in Fixed Costs and Sales Volume
Wind is currently selling 500 bikes per month. The company’s sales manager believes that an
increase of $10,000 in the monthly advertising budget would increase bike sales to 540 units.
Should we authorize the requested increase in the advertising budget?
Current Sales (500 bikes)
Projected Sales (540
bikes)
Sales 250,000$ 270,000$ Less: variable expenses 150,000 162,000 Contribution margin 100,000 108,000 Less: fixed expenses 80,000 90,000 Net operating income 20,000$ 18,000$
Current Sales (500 bikes)
Projected Sales (540
bikes)
Sales 250,000$ 270,000$ Less: variable expenses 150,000 162,000 Contribution margin 100,000 108,000 Less: fixed expenses 80,000 90,000 Net operating income 20,000$ 18,000$
Changes in Fixed Costs and Sales Volume
Sales increased by $20,000, but net operating income decreased by $2,000..
Sales increased by $20,000, but net operating income decreased by $2,000..
$80,000 + $10,000 advertising = $90,000$80,000 + $10,000 advertising = $90,000
Changes in Fixed Costs and Sales Volume
The Shortcut SolutionThe Shortcut Solution
Increase in CM (40 units X $200) 8,000$ Increase in advertising expenses 10,000 Decrease in net operating income (2,000)$
Increase in CM (40 units X $200) 8,000$ Increase in advertising expenses 10,000 Decrease in net operating income (2,000)$
Break-Even Analysis
Break-even analysis can be approached in three ways:
1. Graphical analysis.
2. Equation method.
3. Contribution margin method.
Equation Method
Profits = Sales – (Variable expenses + Fixed expenses)
Sales = Variable expenses + Fixed expenses + Profits
OR
At the break-even point profits equal zero.
Break-Even Analysis
Here is the information from Wind Bicycle Co.:
Total Per Unit PercentSales (500 bikes) 250,000$ 500$ 100%Less: variable expenses 150,000 300 60%Contribution margin 100,000$ 200$ 40%
Less: fixed expenses 80,000 Net operating income 20,000$
Total Per Unit PercentSales (500 bikes) 250,000$ 500$ 100%Less: variable expenses 150,000 300 60%Contribution margin 100,000$ 200$ 40%
Less: fixed expenses 80,000 Net operating income 20,000$
Equation Method
We calculate the break-even point as follows:
Sales = Variable expenses + Fixed expenses + Profits
$500Q = $300Q + $80,000 + $0
Where: Q = Number of bikes sold $500 = Unit selling price $300 = Unit variable expense $80,000 = Total fixed expense
Equation Method
We calculate the break-even point as follows:
Sales = Variable expenses + Fixed expenses + Profits
$500Q = $300Q + $80,000 + $0$200Q = $80,000 Q = $80,000 ÷ $200 per bike Q = 400 bikes
Equation Method
We can also use the following equation to compute the break-even point in sales dollars.
Sales = Variable expenses + Fixed expenses + Profits
X = 0.60X + $80,000 + $0 Where:
X = Total sales dollars 0.60 = Variable expenses as a % of sales $80,000 = Total fixed expenses
Equation Method
X = 0.60X + $80,000 + $0 0.40X = $80,000 X = $80,000 ÷ 0.40 X = $200,000
We can also use the following equation to compute the break-even point in sales dollars.
Sales = Variable expenses + Fixed expenses + Profits
Contribution Margin Method
The contribution margin method is a variation of the equation method.
Fixed expensesUnit contribution margin
=Break-even point
in units sold
Fixed expenses CM ratio
=Break-even point intotal sales dollars
Target Profit Analysis
Suppose Wind Co. wants to know how many bikes must be sold to earn a profit of
$100,000.
We can use our CVP formula to determine the sales volume needed to achieve a target net
profit figure.
The CVP Equation
Sales = Variable expenses + Fixed expenses + Profits
$500Q = $300Q + $80,000 + $100,000
$200Q = $180,000
Q = 900 bikes
The CVP Equation
Sales = Variable expenses + Fixed expenses + Profits
$500Q = $300Q + $80,000 + $100,000
$200Q = $180,000
Q = 900 bikes