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Cost Behaviour and Cost-Volume Relationships

Cost Behaviour and Cost-Volume Relationships. 2. Cost Behaviour. Cost Driver an activity which influences how a cost is incurred kilometers traveled is a cost driver for gasoline costs. Variable Cost a cost which changes in direct proportion to changes in the cost driver

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Cost Behaviour and Cost-Volume Relationships

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  1. Cost Behaviourand Cost-Volume Relationships 2

  2. Cost Behaviour Cost Driver • an activity which influences how a cost is incurred • kilometers traveled is a cost driver for gasoline costs • Variable Cost • a cost which changes in direct proportion to changes in the cost driver • is constant per unit as volume changes • Fixed Cost • a cost which is not influenced by changes in the cost driver over the relevant range • per unit fixed costs change as volume changes $ Volume $ Volume

  3. Cost-Volume-Profit Analysis • the study of the relationships between revenues, costs, volume and profits Contribution Margin per unit Contribution Margin % (or CM per unit) (or CM%) = Revenue per unit = CM per unit / revenue per unit - variable cost per unit = $0.10 / $0.50 = $0.50 - $0.40 = 20% = $0.10 per unit Break-Even Point in Units Break-Even Point in Dollars = Fixed costs / CM per unit = Fixed costs / CM% = $6,000 / $0.10 = $6,000 / 20% = 60,000 units = $30,000

  4. Cost-Volume-Profit Graph $ Break-even Point Sales Total Expenses Net income area Net loss area Relevant Range of volume Volume

  5. Decrease Variable Costs Sales Expenses $ Volume Increase Fixed Costs Decrease Fixed Costs Sales Expenses Sales Expenses $ $ Volume Volume Changes in Model Factors Basic Model $ Sales Expenses Volume

  6. Target Net Income and Income Taxes Target Sales in Units Target Sales in Dollars = (Fixed costs + Target income) = (Fixed costs + Target income) / CM per unit / CM% = ($6,000 + $480) / $0.10 = ($6,000 + $480) / 20% = 64,800 units = $32,400 Income Taxes • note that income taxes are neither a variable nor a fixed cost • convert desired after-tax net income to its before-tax equivalent before adding into the target sales formula Target income before income taxes = Target after-tax net income / (1 - tax rate) = $288 / (1 - .40) = $288 / .6 = $480

  7. Sales Mix Analysis • Sales mix is defined as the relative proportions or combinations of quantities of different products that comprise total sales • If the proportions of the mix change, the cost-volume-profit relationships also change • A breakeven point is unique to a given sales mix

  8. Cost-Volume-Profit AnalysisMultiple Product Situations SalesMix in units • relative mix based on the # of units sold • A = 40%; B = 60% Sales Mix in dollars • relative mix based on the $ value of sales • A = 25%; B = 75% A $5 A $5 B $10 B $10 B $10 Average contribution margin per unit = ($CM A x SM% units A ) + ($CM B x SM% units B ) Average contribution margin percentage = (CM% A x SM% $ A ) + (CM% B x SM% $ B ) Break-even point in units Break-even point in dollars = Fixed costs / Average CM per Unit = Fixed Costs / Average CM %

  9. Operating Leverage Sales Sales $ $ Total Expenses Total Expenses Volume Volume High Operating Leverage High Fixed / Low Variable Costs Higher Break-even Point Greater Risk Greater Potential Returns Low Operating Leverage Low Fixed / High Variable Costs Lower Break-even Point Reduced Risk Lower Potential Returns

  10. Contribution Margin vs. Gross Margin • Contribution margin is the difference between sales and variable costs • Gross margin is the difference between sales and cost of goods sold • Cost of goods sold is the cost of the merchandise that is acquired or manufactured and then resold

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