CHAPTER 18
Cost Behavior & Cost-Volume-Profit Analysis
Cost Behavior
• In planning, we must understand how costs behave.
• For example, do costs change as production activity changes or do they stay the same?
__________– costs that increase as production activity increases (direct materials, direct labor)
__________– costs that stay the same over a range of activity levels (depreciation, rent) within a given time period.
Variable Costs
Total Variable Cost GraphTo
tal C
osts
$300,000
$250,000
$200,000
$150,000
$100,000
$50,00010 20 300
Unit Variable Cost Graph
$20
$15
$10
$50C
ost
per
Uni
t
10 20 30
5,000 $ 50,000 $10 10,000 100,000 10 15,000 150,000 10 20,000 200,000 10 25,000 250,000 10 30,000 300,000 10
Units Total CostProduced Cost per Unit
Units Produced (000)
Units Produced (000)
Fixed Costs
Total Fixed Cost GraphTo
tal C
osts
0
Unit Fixed Cost Graph
Cos
t pe
r U
nit
50,000 $75,000 $1.500 100,000 75,000 .750 150,000 75,000 .500 200,000 75,000 .375 250,000 75,000 .300 300,000 75,000 .250
Units Total CostProduced Cost per Unit
$150,000
$125,000
$100,000
$75,000
$50,000
$25,000100 200 300
$1.50
$1.25
$1.00
$.75
$.50
$.25100 200 3000
Units Produced (000) Units Produced (000)
Relevant Range
• Cost relationships remain stable only over some range of production activity.
• Outside that range the relationships may change.
• __________is the expected range of activity we are interested in. We estimate the cost relationships within
that range. We cannot extrapolate outside the range.
Cost Behavior
• __________Costs include both fixed and variable costs; we
separate fixed from variable costs when perform cost-volume profit analysis.
• __________ Costs fixed within a relevant range, but if total
production increases significantly, total costs increase by a lump sum amount
• __________ Costs increase at a non-constant rate as volume
increases.
Mixed Costs• Some costs have a _______ component
and a __________ component.• We can separate mixed costs into the
two components using the ________________.
FC
$
activity
Total costs
Slope = VC/unitEquation of line : y = a + bx
Mixed Costs
Total Mixed Cost Graph
Tota
l Cos
ts
0
Total Machine Hours (000)
$40,000
$35,000
$30,000
$25,000
$20,000
$15,000
$10,000
$5,00010 20 30 40
Mixed costs are usually separated into their fixed and variable components for management analysis.
Mixed costs are usually separated into their fixed and variable components for management analysis.
Mixed costs are sometimes called semivariable or semifixed costs.
Mixed costs are sometimes called semivariable or semifixed costs.
The objective is to classifyall costs as either fixed or variable.
Identifying and MeasuringCost Behavior
Measuring Cost Behavior: Scatter Diagram …
• A __________of past cost behavior may be helpful in analyzing mixed costs.Draw a line through the plotted data points so that about
equal numbers of points fall above and below the line.
Estimated fixed cost = 10,000
0 1 2 3 4
*
Tota
l C
ost
in
1,00
0’s
of
Do
llar
s
10
20
0
***
**
**
*
*
Activity, 1,000s of Units Produced
Measuring Cost Behavior: Scatter Diagram …
Variable Cost unit = Slope =
Δin costΔin units
0 1 2 3 4
*
Tota
l C
ost
in
1,00
0’s
of
Do
llar
s
10
20
0
***
**
**
*
*
Activity, 1,000s of Units Produced
Horizontal distance is the change in activity.
Vertical distance
is the change in cost.
Measuring Cost BehaviorHigh/Low Method
• Determine the __________ by finding the slope change in ____ ÷ change in _____ (see prev. slide)
• Determine the __________ component Using the high (or the low) point, plug in
the cost (y), the activity (x), and the slope (VC/unit).
Solve for the y- intercept.• Given the equation of the cost line, we
can now use it to predict cost over some range of activity.
Mixed Costs: High-Low Method
Actual costs incurred
June 1,000 $45,550July 1,500 52,000August 2,100 61,500September 1,800 57,500October 750 41,250
Production TotalUnits Cost
Highest level Lowest level Difference
Production TotalUnits Cost
Highest and lowest levels
Mixed Costs: High-Low Method
Actual costs incurred Production Total
Units Cost
Highest level 2,100 $61,500Lowest level Difference
Production TotalUnits Cost
Highest and lowest levels
June 1,000 $45,550July 1,500 52,000August 2,100 61,500September 1,800 57,500October 750 41,250
Mixed Costs: High-Low Method
Actual costs incurred Production Total
Units Cost
Highest level 2,100 $61,500Lowest level 750 41,250Difference
Production TotalUnits Cost
Highest and lowest levels
June 1,000 $45,550July 1,500 52,000August 2,100 61,500September 1,800 57,500October 750 41,250
Mixed Costs: High-Low Method
Actual costs incurred Production Total
Units Cost
Variable costper unit
Difference in total cost
Difference in production=
Highest level 2,100 $61,500Lowest level 750 41,250Difference 1,350 $20,250
Production TotalUnits Cost
Highest and lowest levels
1
June 1,000 $45,550July 1,500 52,000August 2,100 61,500September 1,800 57,500October 750 41,250
Mixed Costs: High-Low Method
Actual costs incurred
June 1,000 $45,550July 1,500 52,000August 2,100 61,500September 1,800 57,500October 750 41,250
Production Total Units Cost
Variable costper unit
Difference in total cost
Difference in production
$20,250
1,350 units= = =
Production TotalUnits Cost
Highest and lowest levels
1 $15
Highest level 2,100 $61,500Lowest level 750 41,250Difference 1,350 $20,250
Mixed Costs: High-Low Method
Actual costs incurred
June 1,000 $45,550July 1,500 52,000August 2,100 61,500September 1,800 57,500October 750 41,250
Production Total Units Cost
Variable costper unit
Difference in total cost
Difference in production
$20,250
1,350 units$15= = =
Totalcost
= –Fixedcost
Highest level 2,100 $61,500Lowest level 750 41,250Difference 1,350 $20,250
Production TotalUnits Cost
Highest and lowest levels
Variable costper unit
x Units ofproduction
1
2
Mixed Costs: High-Low Method
Actual costs incurred
June 1,000 $45,550July 1,500 52,000August 2,100 61,500September 1,800 57,500October 750 41,250
Production Total Units Cost
Variable costper unit
Difference in total cost
Difference in production
$20,250
1,350 units$15= = =
Totalcost
= –Fixedcost
Highest level 2,100 $61,500Lowest level 750 41,250Difference 1,350 $20,250
Production TotalUnits Cost
Highest and lowest levels
Variable costper unit
x Units ofproduction
Highest level: $61,500= – ( $15 x 2,100 ) = $30,000
1
2
Mixed Costs: High-Low Method
Actual costs incurred
June 1,000 $45,550July 1,500 52,000August 2,100 61,500September 1,800 57,500October 750 41,250
Production Total Units Cost
Variable costper unit
Difference in total cost
Difference in production
$20,250
1,350 units$15= = =
Totalcost
= –Fixedcost
Highest level 2,100 $61,500Lowest level 750 41,250Difference 1,350 $20,250
Production TotalUnits Cost
Highest and lowest levels
Variable costper unit
x Units ofproduction
Highest level: $61,500= – ( $15 x 2,100 ) = $30,000
Lowest level: $41,250= – ( $15 x 750 ) = $30,000
1
2
Mixed Costs: High-Low Method
Actual costs incurred
June 1,000 $45,550July 1,500 52,000August 2,100 61,500September 1,800 57,500October 750 41,250
Production Total Units Cost
Variable costper unit
Difference in total cost
Difference in production
$20,250
1,350 units$15= = =
Totalcost
= –Fixedcost
Highest level 2,100 $61,500Lowest level 750 41,250Difference 1,350 $20,250
Production TotalUnits Cost
Highest and lowest levels
Variable costper unit
x Units ofproduction
Highest level: $61,500= – ( $15 x 2,100 ) = $30,000
Lowest level: $41,250= – ( $15 x 750 ) = $30,000
1
2
Cost-Volume-Profit & Breakeven Analysis
• Given our fixed and variable costs, we can use CVP techniques to help predict our profit at various activity levels.
• We define __________= Sales – VC __________= SP/unit – VC/unit __________= CM/SP
Related Questions
• We can use this set of techniques to answer the following types of questions. How many units do we need to sell to
break even? How much profit will we generate at a
given level of sales? If we want to earn a target profit, how
many units do we need to sell? If we change our sales price, what
happens to our profitability?
Contribution margin is amount by which revenue exceeds the variable costs of producing the revenue.
Contribution margin is amount by which revenue exceeds the variable costs of producing the revenue.
Total Unit
Sales Revenue (2,000 units) 200,000$ 100$
Less: Variable costs 140,000 70
Contribution margin 60,000$ 30$
Less: Fixed costs 24,000
Net income 36,000$
Computing Break-Even Point
Total Unit
Sales Revenue (2,000 units) 200,000$ 100$
Less: Variable costs 140,000 70
Contribution margin 60,000$ 30$
Less: Fixed costs 24,000
Net income 36,000$
How much contribution margin must this company have to cover its fixed costs (break even)?
Answer: $24,000
P2 Computing Break-Even Point
How many units must this company sell to cover its fixed costs (i.e. to break even)?
Total Unit
Sales Revenue (2,000 units) 200,000$ 100$
Less: Variable costs 140,000 70
Contribution margin 60,000$ 30$
Less: Fixed costs 24,000
Net income 36,000$
Answer: $24,000 ÷ $30 per unit = 800 units
P2 Computing Break-Even Point
Breakeven Sales• Sales = VC + FC + profit or• Profit = Sales – VC – FC• At breakeven, profit = 0
0 = (Sales – VC) – FC 0 = CM - FC CM = FC or (CM/unit)(units) = FC And Breakeven Units = FC/(CM/unit) Or Breakeven in $ = FC/(CM ratio)
Target Net Income
• You can use the CVP idea to determine how much we can sell to earn a desired profit. Profit = Sales – VC – FC Profit + FC = Sales – VC = CM =
CM/unit(units) Target Salesunits = (FC + Profit) /
CM/unit Target Sales$ = (FC + Profit) / CM
ratio
• __________is the amount by which sales can drop before the company incurs a loss.
• Margin of safety may be expressed as a percentage of expected sales.
Margin of SafetyExh. 22-17
Margin of safety Expected sales - Break-even sales percentage Expected sales
=
C3
Breakeven for Multiple Products
• BEunits = FC/(CMcomposite), where
• CMcomposite = [(%A)CMA + (%B) CMB]
The number of units that we get will be a combined unit of A and B together.
You then have to determine the number of A and B each that are actually sold.
Breakeven for Multiple Products - Example
• If FC = $100,000 and CM(a) = $40 and CM(b) = $20, and we sell 3 times as many units of B as A, what is the BE point?
• BEunits = 100,000/[(0.25)($40) + (0.75)($20)]
= 4,000 units
• A = (0.25)(4,000) or 1,000 units of A • B = (0.75)(4,000) or 3,000 units of B
A measure of the extent to which fixed costs are being used in an organization.
A measure of the extent to which fixed costs are being used in an organization.
A measure of how a percentage change in sales will affect profits.
A measure of how a percentage change in sales will affect profits.
Contribution margin Net income
Degree of ____________________=
Operating Leverage
Contribution Margin Reporting
• We can recast the income statement to highlight the contribution margin.
• Sales• - VC• = CM• - FC• = operating income
For Internal Reporting purposes only
The End!!Now, let’s look at the quick studies!