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# CHAPTER 18 - PowerPoint PPT Presentation

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?

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CHAPTER 18

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## 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 Graph

Unit Variable Cost Graph

\$300,000

\$250,000

\$200,000

\$150,000

\$100,000

\$50,000

\$20

\$15

\$10

\$5

Cost per Unit

Total Costs

0

102030

Units Produced (000)

0

102030

Units Produced (000)

Units Total Cost

Produced Cost per Unit

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

Fixed Costs

Total Fixed Cost Graph

Unit Fixed Cost Graph

\$150,000

\$125,000

\$100,000

\$75,000

\$50,000

\$25,000

\$1.50

\$1.25

\$1.00

\$.75

\$.50

\$.25

Total Costs

Cost per Unit

0

0

100200300

100200300

Units Produced (000)

Units Produced (000)

Units Total Cost

Produced Cost per Unit

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

### 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 ________________.

\$

Total costs

Equation of line : y = a + bx

Slope = VC/unit

FC

activity

Mixed Costs

Total Mixed Cost Graph

\$40,000

\$35,000

\$30,000

\$25,000

\$20,000

\$15,000

\$10,000

\$5,000

Mixed costs are sometimes called semivariable or semifixed costs.

Total Costs

Mixed costs are usually separated into their fixed and variable components for management analysis.

0

10203040

Total Machine Hours (000)

### Identifying and MeasuringCost Behavior

The objective is to classifyall costs as either fixed or variable.

### Measuring Cost Behavior: Scatter Diagram …

20

*

*

*

*

*

*

*

*

Total Cost in1,000’s of Dollars

*

*

10

0

0 1 2 3 4

Activity, 1,000s of Units Produced

• 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

### Measuring Cost Behavior: Scatter Diagram …

Δin costΔin units

20

*

*

*

*

*

*

*

*

Total Cost in1,000’s of Dollars

*

*

10

0

0 1 2 3 4

Activity, 1,000s of Units Produced

Variable Cost unit= Slope =

Vertical distance is the change in cost.

Horizontal distance is the change in activity.

### 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

Highest and lowest levels

ProductionTotal

UnitsCost

ProductionTotal

UnitsCost

June1,000\$45,550

July1,50052,000

August2,10061,500

September1,80057,500

October75041,250

Highest level

Lowest level

Difference

Mixed Costs: High-Low Method

Actual costs incurred

Highest and lowest levels

ProductionTotal

UnitsCost

ProductionTotal

UnitsCost

June1,000\$45,550

July1,50052,000

August2,10061,500

September1,80057,500

October75041,250

Highest level2,100\$61,500

Lowest level

Difference

Mixed Costs: High-Low Method

Actual costs incurred

Highest and lowest levels

ProductionTotal

UnitsCost

ProductionTotal

UnitsCost

June1,000\$45,550

July1,50052,000

August2,10061,500

September1,80057,500

October75041,250

Highest level2,100\$61,500

Lowest level75041,250

Difference

Mixed Costs: High-Low Method

Actual costs incurred

Highest and lowest levels

ProductionTotal

UnitsCost

ProductionTotal

UnitsCost

June1,000\$45,550

July1,50052,000

August2,10061,500

September1,80057,500

October75041,250

Highest level2,100\$61,500

Lowest level75041,250

Difference1,350\$20,250

Difference in total cost

Difference in production

Variable cost

per unit

1

=

Mixed Costs: High-Low Method

Actual costs incurred

Highest and lowest levels

ProductionTotal

UnitsCost

ProductionTotal

UnitsCost

June1,000\$45,550

July1,50052,000

August2,10061,500

September1,80057,500

October75041,250

Highest level2,100\$61,500

Lowest level75041,250

Difference1,350\$20,250

Difference in total cost

Difference in production

\$20,250

1,350 units

Variable cost

per unit

1

=

=

=

\$15

Mixed Costs: High-Low Method

Actual costs incurred

Highest and lowest levels

ProductionTotal

UnitsCost

ProductionTotal

UnitsCost

June1,000\$45,550

July1,50052,000

August2,10061,500

September1,80057,500

October75041,250

Highest level2,100\$61,500

Lowest level75041,250

Difference1,350\$20,250

Difference in total cost

Difference in production

\$20,250

1,350 units

Variable cost

per unit

1

=

=

=

\$15

Total

cost

Fixed

cost

Variable cost

per unit

Units of

production

2

=

x

Mixed Costs: High-Low Method

Actual costs incurred

Highest and lowest levels

ProductionTotal

UnitsCost

ProductionTotal

UnitsCost

June1,000\$45,550

July1,50052,000

August2,10061,500

September1,80057,500

October75041,250

Highest level2,100\$61,500

Lowest level75041,250

Difference1,350\$20,250

Difference in total cost

Difference in production

\$20,250

1,350 units

Variable cost

per unit

1

=

=

=

\$15

Total

cost

Fixed

cost

Variable cost

per unit

Units of

production

2

=

x

=

=

Highest level:

\$61,500

( \$15 x 2,100 )

\$30,000

Mixed Costs: High-Low Method

Actual costs incurred

Highest and lowest levels

ProductionTotal

UnitsCost

ProductionTotal

UnitsCost

June1,000\$45,550

July1,50052,000

August2,10061,500

September1,80057,500

October75041,250

Highest level2,100\$61,500

Lowest level75041,250

Difference1,350\$20,250

Difference in total cost

Difference in production

\$20,250

1,350 units

Variable cost

per unit

1

=

=

=

\$15

Total

cost

Fixed

cost

Variable cost

per unit

Units of

production

2

=

x

=

=

Highest level:

\$61,500

( \$15 x 2,100 )

\$30,000

=

=

Lowest level:

\$41,250

( \$15 x 750 )

\$30,000

Mixed Costs: High-Low Method

Actual costs incurred

Highest and lowest levels

ProductionTotal

UnitsCost

ProductionTotal

UnitsCost

June1,000\$45,550

July1,50052,000

August2,10061,500

September1,80057,500

October75041,250

Highest level2,100\$61,500

Lowest level75041,250

Difference1,350\$20,250

Difference in total cost

Difference in production

\$20,250

1,350 units

Variable cost

per unit

1

=

=

=

\$15

Total

cost

Fixed

cost

Variable cost

per unit

Units of

production

2

=

x

=

=

Highest level:

\$61,500

( \$15 x 2,100 )

\$30,000

=

=

Lowest level:

\$41,250

( \$15 x 750 )

\$30,000

### 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?

### Computing Break-Even Point

Contribution margin is amount by which revenue exceeds the variable costsof producing the revenue.

Computing Break-Even Point

P2

How much contribution margin must this company have to cover its fixed costs (break even)?

Computing Break-Even Point

P2

How many units must this company sell to cover its fixed costs (i.e. to break even)?

Answer: \$24,000 ÷ \$30 per unit = 800 units

### 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 Safety

Margin of safety Expected sales - Break-even salespercentage Expected sales

=

C3

Exh.

22-17

### 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

### Operating Leverage

Contribution margin

Net income

Degree of ____________________=

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.

### 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!