CHAPTER 18

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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

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

10 20 30

Units Produced (000)

0

10 20 30

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

100 200 300

100 200 300

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

10 20 30 40

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

Production Total

Units Cost

Production Total

Units Cost

June 1,000 \$45,550

July 1,500 52,000

August 2,100 61,500

September 1,800 57,500

October 750 41,250

Highest level

Lowest level

Difference

Mixed Costs: High-Low Method

Actual costs incurred

Highest and lowest levels

Production Total

UnitsCost

Production Total

Units Cost

June 1,000 \$45,550

July 1,500 52,000

August 2,100 61,500

September 1,800 57,500

October 750 41,250

Highest level 2,100 \$61,500

Lowest level

Difference

Mixed Costs: High-Low Method

Actual costs incurred

Highest and lowest levels

Production Total

UnitsCost

Production Total

Units Cost

June 1,000 \$45,550

July 1,500 52,000

August 2,100 61,500

September 1,800 57,500

October 750 41,250

Highest level 2,100 \$61,500

Lowest level 750 41,250

Difference

Mixed Costs: High-Low Method

Actual costs incurred

Highest and lowest levels

Production Total

UnitsCost

Production Total

Units Cost

June 1,000 \$45,550

July 1,500 52,000

August 2,100 61,500

September 1,800 57,500

October 750 41,250

Highest level 2,100 \$61,500

Lowest level 750 41,250

Difference 1,350 \$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

Production Total

UnitsCost

Production Total

Units Cost

June 1,000 \$45,550

July 1,500 52,000

August 2,100 61,500

September 1,800 57,500

October 750 41,250

Highest level 2,100 \$61,500

Lowest level 750 41,250

Difference 1,350 \$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

Production Total

UnitsCost

Production Total

Units Cost

June 1,000 \$45,550

July 1,500 52,000

August 2,100 61,500

September 1,800 57,500

October 750 41,250

Highest level 2,100 \$61,500

Lowest level 750 41,250

Difference 1,350 \$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

Production Total

UnitsCost

Production Total

Units Cost

June 1,000 \$45,550

July 1,500 52,000

August 2,100 61,500

September 1,800 57,500

October 750 41,250

Highest level 2,100 \$61,500

Lowest level 750 41,250

Difference 1,350 \$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

Production Total

UnitsCost

Production Total

Units Cost

June 1,000 \$45,550

July 1,500 52,000

August 2,100 61,500

September 1,800 57,500

October 750 41,250

Highest level 2,100 \$61,500

Lowest level 750 41,250

Difference 1,350 \$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

Production Total

UnitsCost

Production Total

Units Cost

June 1,000 \$45,550

July 1,500 52,000

August 2,100 61,500

September 1,800 57,500

October 750 41,250

Highest level 2,100 \$61,500

Lowest level 750 41,250

Difference 1,350 \$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!