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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?

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chapter 18

CHAPTER 18

Cost Behavior & Cost-Volume-Profit Analysis

cost behavior
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.
slide3
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

slide4
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
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 behavior1
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
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

slide8
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 measuring cost behavior
Identifying and MeasuringCost Behavior

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

measuring cost behavior scatter diagram
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 diagram1
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 behavior high low method
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.
slide13
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

slide14
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

slide15
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

slide16
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

=

slide17
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

slide18
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

slide19
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

slide20
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

slide21
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
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
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
Computing Break-Even Point

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

slide25
Computing Break-Even Point

P2

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

Answer: $24,000

slide26
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
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
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
margin of safety
__________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
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
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
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
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
The End!!

Now, let’s look at the quick studies!

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