Chapter 18-1. Chapter 18-2 CHAPTER 18 COST - VOLUME - PROFIT Accounting, Fourth Edition.

Chapter 18-1

Chapter 18-2

CHAPTER CHAPTER 1818

COST - VOLUME - COST - VOLUME - PROFITPROFIT

Accounting, Fourth Edition

Chapter 18-3

Chapter PreviewChapter PreviewChapter PreviewChapter Preview

Chapter 18-4

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

1. Distinguish between variable and fixed costs.

2. Explain the significance of the relevant range.

3.3. Explain the concept of Explain the concept of mixed costs.mixed costs.

4.4. List the five components of List the five components of cost-volume-profit cost-volume-profit analysis.analysis.

5.5. Indicate what contribution Indicate what contribution margin is and how it can margin is and how it can be expressed.be expressed.

Chapter 18-5

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

6.6. Identify the three ways Identify the three ways to determine the break-to determine the break-even point.even point.

7.7. Give the formulas for Give the formulas for determining sales determining sales required to earn target required to earn target net income.net income.

8.8. Define margin of safety, Define margin of safety, and give the formulas and give the formulas for computing it.for computing it.

Chapter 18-6

Preview of ChapterPreview of ChapterPreview of ChapterPreview of Chapter

To manage any business, you must understand:To manage any business, you must understand:

How costs respond to changes in sales volume,and

The effect of costs and revenues on profit.

To understand cost-volume-profit (CVP), you To understand cost-volume-profit (CVP), you must know how costs behave.must know how costs behave.

Chapter 18-7

Cost-Volume-ProfitCost-Volume-ProfitCost-Volume-ProfitCost-Volume-Profit

Cost Behavior Cost Behavior

AnalysisAnalysis

Cost Behavior Cost Behavior

AnalysisAnalysisCost-Volume-Cost-Volume-

Profit AnalysisProfit Analysis

Cost-Volume-Cost-Volume-

Profit AnalysisProfit Analysis

Variable costsVariable costs

Fixed costsFixed costs

Relevant rangeRelevant range

Mixed costsMixed costs

Identifying Identifying variable and fixed variable and fixed costscosts

Basic componentsBasic components

CVP income statementCVP income statement

Break-even analysisBreak-even analysis

Target net incomeTarget net income

Margin of safetyMargin of safety

Chapter 18-8

Cost Behavior AnalysisCost Behavior AnalysisCost Behavior AnalysisCost Behavior Analysis

Cost Behavior Analysis is:Cost Behavior Analysis is:the study of how specific costs respond the study of how specific costs respond

to to changes in the level of business changes in the level of business activity.activity.

Some costs change; others remain the same.Some costs change; others remain the same.

A knowledge of cost behavior helps management A knowledge of cost behavior helps management plan operations and decide between alternative plan operations and decide between alternative courses of action.courses of action.

Cost behavior analysis applies to all types of Cost behavior analysis applies to all types of entities.entities.

Chapter 18-9

Cost Behavior Analysis - ContinuedCost Behavior Analysis - ContinuedCost Behavior Analysis - ContinuedCost Behavior Analysis - Continued

Starting point in cost behavior analysis is Starting point in cost behavior analysis is measuring key business activities.measuring key business activities.

Activity levels may be expressed in terms of:Activity levels may be expressed in terms of:

Sales dollarsSales dollars (in a retail company). (in a retail company).Miles drivenMiles driven (in a trucking company). (in a trucking company).Room occupancyRoom occupancy (in a hotel). (in a hotel).Dance classes taughtDance classes taught (by a dance studio). (by a dance studio).

Many companies use more than one Many companies use more than one measurement base.measurement base.

Chapter 18-10

Cost Behavior Analysis - ContinuedCost Behavior Analysis - ContinuedCost Behavior Analysis - ContinuedCost Behavior Analysis - Continued

For an activity level to be useful: For an activity level to be useful:

Changes in the level or volume of activity Changes in the level or volume of activity should be correlated with changes in costs.should be correlated with changes in costs.

The activity level selected is called theThe activity level selected is called theactivity or volume index.activity or volume index.

The activity index:The activity index:Identifies the activity that causes changes in Identifies the activity that causes changes in

the behavior of costs.the behavior of costs.Allows costs to be classified according to their Allows costs to be classified according to their

response to changes in activity as response to changes in activity as either:either:

Variable Costs Fixed Costs Mixed CostsVariable Costs Fixed Costs Mixed Costs

Chapter 18-11

Variable CostsVariable CostsVariable CostsVariable Costs

Variable costs are costs that Variable costs are costs that vary vary in totalin total directly and proportionately with changes in the directly and proportionately with changes in the activity level.activity level.

Example:Example: If the activity level If the activity level increasesincreases 10 percent, 10 percent, total variable costs total variable costs will increasewill increase 10 percent . 10 percent .Example:Example: If the activity level If the activity level decreasesdecreases by 25 percent, by 25 percent, total variable costs total variable costs will decreasewill decrease by 25 percent. by 25 percent.

Variable costs Variable costs remain the same remain the same per unitper unit at at every level of activity.every level of activity.

SO 1: Distinguish between variable and fixed costs.SO 1: Distinguish between variable and fixed costs.

Chapter 18-12

Variable CostsVariable CostsVariable CostsVariable Costs

Examples of Variable Costs:Examples of Variable Costs:Direct Materials.Direct Materials.Direct Labor.Direct Labor.Cost of Goods Sold.Cost of Goods Sold.Sales Commissions.Sales Commissions.Freight-Out for a Merchandiser.Freight-Out for a Merchandiser.Gasoline at a Taxi Company.Gasoline at a Taxi Company.


Chapter 18-13

Variable Costs – ExampleVariable Costs – ExampleVariable Costs – ExampleVariable Costs – Example

Damon Company manufactures radios that Damon Company manufactures radios that contain a $10 digital clock.contain a $10 digital clock.

The The activity indexactivity index is the number of radios is the number of radios produced.produced.

For each radio produced, the total cost of the For each radio produced, the total cost of the clocks increases by $10:clocks increases by $10:

If 2,000 radios are produced, the total cost of the If 2,000 radios are produced, the total cost of the clocks is $20,000 (2,000 × $10).clocks is $20,000 (2,000 × $10).

If 10,000 radios are produced, the total cost of the If 10,000 radios are produced, the total cost of the clocks is $100,000 (10,000 × $10).clocks is $100,000 (10,000 × $10).


Chapter 18-14

Variable Costs – GraphsVariable Costs – GraphsVariable Costs – GraphsVariable Costs – Graphs


Illustration 18-1

Chapter 18-15

Fixed CostsFixed CostsFixed CostsFixed Costs

Fixed costs are costs that Fixed costs are costs that remain the same in total regardless of changes in the activity regardless of changes in the activity level.level.

Fixed costs Fixed costs per unit costper unit cost varyvary inversely with activity:with activity:As volume increases, unit cost declines, and vice versa.

Examples include:Examples include:Depreciation on buildings and equipment,Depreciation on buildings and equipment,

Property taxesProperty taxesInsurance, andInsurance, and

Rent.


Chapter 18-16

Fixed Costs - ExampleFixed Costs - ExampleFixed Costs - ExampleFixed Costs - Example

Damon Company leases its productive facilities at Damon Company leases its productive facilities at a cost of $10,000 per month.a cost of $10,000 per month.

Total fixed costs of the facilities remain constant Total fixed costs of the facilities remain constant at every level of activity - $10,000 per month.at every level of activity - $10,000 per month.

Fixed costs on a Fixed costs on a per unitper unit basis vary inversely basis vary inversely with activity - as activity increases, unit cost with activity - as activity increases, unit cost declines and vice versa.declines and vice versa.At 2,000 radios, the unit cost is At 2,000 radios, the unit cost is $5 $5 ($10,000 ($10,000 ÷ 2,000 units).÷ 2,000 units).

At 10,000 radios, the unit cost is At 10,000 radios, the unit cost is $1$1 ($10,000 ($10,000 ÷ 10,000 ÷ 10,000 units).units).


Chapter 18-17

Fixed Costs - GraphsFixed Costs - GraphsFixed Costs - GraphsFixed Costs - Graphs


Illustration 18-2

Chapter 18-18

Variable costs are costs that:Variable costs are costs that:

a.a. Vary in total directly and proportionately with Vary in total directly and proportionately with changes in the activity levelchanges in the activity level.

b. Remain the same in total at every activity level.

c. Decrease per unit as volume increases.

d. Increase per unit as volume increases.

Let’s ReviewLet’s ReviewLet’s ReviewLet’s Review

SO 1: SO 1: Distinguish between variable and fixed costsDistinguish between variable and fixed costs..

Chapter 18-19

Relevant RangeRelevant RangeRelevant RangeRelevant Range

Throughout the range of possible levels of Throughout the range of possible levels of activity, a activity, a straight-line relationship usually does not exist for either variable costs or fixed for either variable costs or fixed costs.costs.

The relationship between variable costs and The relationship between variable costs and changes in activity level is often changes in activity level is often curvilinear.

For fixed costs, the relationship is also For fixed costs, the relationship is also nonlinear – some fixed costs will not change over the entire – some fixed costs will not change over the entire range of activities while other fixed costs may range of activities while other fixed costs may change.change.

SO 2: Explain the significance of the relevant range.SO 2: Explain the significance of the relevant range.

Chapter 18-20

Relevant Range - GraphsRelevant Range - GraphsRelevant Range - GraphsRelevant Range - Graphs


Illustration 18-3

Chapter 18-21

Relevant Range Relevant Range Relevant Range Relevant Range

Defined as the range of activity over which a Defined as the range of activity over which a companycompany expects to operate during a year.

Within this range, a straight-line relationshipWithin this range, a straight-line relationship usually exists for both variable and fixed costs.usually exists for both variable and fixed costs.

SO 2: Explain the significance of the relevant range.SO 2: Explain the significance of the relevant range.Illustration 18-4

Chapter 18-22

The relevant range is:The relevant range is:

a.a. The range of activity in which variable costs The range of activity in which variable costs will be curvilinearwill be curvilinear.

b. The range of activity in which fixed costs will be curvilinear.

c. The range over which the company expects to operate during a year.

d. Usually from zero to 100% of operating capacity.



Chapter 18-23

Mixed CostsMixed CostsMixed CostsMixed Costs

Costs that have Costs that have both a variable a variable cost element cost element and a fixed a fixedcost element.cost element.

Sometimes calledSometimes calledsemivariable cost..

Change Change in total but not proportionately with changes inwith changes inactivity level.activity level.

SO 3: Explain the concept of mixed costs.SO 3: Explain the concept of mixed costs.

Illustration 18-5

Chapter 18-24

Mixed Costs: High–Low MethodMixed Costs: High–Low MethodMixed Costs: High–Low MethodMixed Costs: High–Low Method

For purposes of Cost-Volume-Profit (CVP) For purposes of Cost-Volume-Profit (CVP) analysis, mixed costs must be classified into analysis, mixed costs must be classified into their their fixed and and variable elements. elements.

One approach to separate the costs is called the One approach to separate the costs is called the high-low method.

Uses the total costs incurred at the high and low Uses the total costs incurred at the high and low levels of activity to classify mixed costs into levels of activity to classify mixed costs into fixed and variable components.fixed and variable components.

The difference in costs between the high and The difference in costs between the high and low levels low levels represents variable costs, since only variable costs change as activity levels change. change.


Chapter 18-25

Mixed Costs: Mixed Costs: Steps in High–Low-Method Steps in High–Low-Method

Mixed Costs: Mixed Costs: Steps in High–Low-Method Steps in High–Low-Method

STEP 1: Determine variable cost per unit using the following formula:

STEP 2: Determine the fixed cost by subtracting the total variable cost at either the high or the low activity level from the total cost at that level.


Illustration 18-6

Chapter 18-26

Mixed Costs: Mixed Costs: High–Low Method ExampleHigh–Low Method Example

Mixed Costs: Mixed Costs: High–Low Method ExampleHigh–Low Method Example

High Level of Activity:High Level of Activity: AAprilpril $63,000$63,000 50,000 miles50,000 milesLow Level of Activity: Low Level of Activity: JanuaryJanuary 30,000 30,000 20,000 miles20,000 miles DifferenceDifference $33,000 $33,000 30,000 miles30,000 miles

Step 1:Step 1: Using the formula, variable costs per unit are: Using the formula, variable costs per unit are:

$33,000 $33,000 30,000 miles = 30,000 miles = $1.10 variable cost per $1.10 variable cost per mile.mile.

Data for Metro Transit Company for 4 month period:


Illustration 18-7

Chapter 18-27

Mixed Costs: Mixed Costs: High–Low-Method ExampleHigh–Low-Method Example

Mixed Costs: Mixed Costs: High–Low-Method ExampleHigh–Low-Method Example

Step 2:Step 2: Determine the fixed costs by subtracting total Determine the fixed costs by subtracting total variable costs at variable costs at either the high or low activity the high or low activity level from the total cost at that same level. level from the total cost at that same level.

SO 3: Explain the concept of mixed costs.SO 3: Explain the concept of mixed costs.Illustration 18-8

Chapter 18-28

Mixed Costs:Mixed Costs:High–Low-Method ExampleHigh–Low-Method Example

Mixed Costs:Mixed Costs:High–Low-Method ExampleHigh–Low-Method Example

Maintenance costs:Maintenance costs: $8,000 per month plus $1.10 per mile.$8,000 per month plus $1.10 per mile.

To determine maintenance costs at a particular To determine maintenance costs at a particular activity level:activity level:

1. Multiply the activity level times the variable cost per unit,

2. Then add that total to the fixed cost.

EXAMPLE: If the activity level is 45,000 miles, the If the activity level is 45,000 miles, the estimated maintenance costs would be $8,000 estimated maintenance costs would be $8,000 fixed costs and $49,500 variable ($1.10 × fixed costs and $49,500 variable ($1.10 × 45,000 miles) for a total of $57,500.45,000 miles) for a total of $57,500.


Chapter 18-29

Mixed costs consist of a:Mixed costs consist of a:

a.a. Variable cost element and a fixed cost Variable cost element and a fixed cost element.element.

b. b. Fixed cost element and a semi-variable Fixed cost element and a semi-variable cost element. cost element.

c. c. Relevant cost element and a fixed cost Relevant cost element and a fixed cost element.element.

d. d. Variable cost element and a relevant cost Variable cost element and a relevant cost elementelement.



Chapter 18-30

Cost-Volume-Profit AnalysisCost-Volume-Profit AnalysisCost-Volume-Profit AnalysisCost-Volume-Profit Analysis

CVP Analysis - the study of the CVP Analysis - the study of the effects of changes in costs and volume on on a company’s profits.a company’s profits.

Important in profit planning.Important in profit planning.

A critical factor in setting:A critical factor in setting: selling prices,selling prices,

determining product mix, and determining product mix, and

maximizing use of production facilities.maximizing use of production facilities.

SO 4: List the five components of cost-volume-profit analysis.SO 4: List the five components of cost-volume-profit analysis.

Chapter 18-31

Cost-Volume-Profit AnalysisCost-Volume-Profit AnalysisCost-Volume-Profit AnalysisCost-Volume-Profit Analysis

CVP analysis considers the interrelationships CVP analysis considers the interrelationships among five basic components:among five basic components:


Illustration 18-9

Chapter 18-32

Assumptions Underlying CVP AnalysisAssumptions Underlying CVP AnalysisAssumptions Underlying CVP AnalysisAssumptions Underlying CVP Analysis

Behavior of both costs and revenues is Behavior of both costs and revenues is linear throughout the throughout the relevant range of the activity of the activity index.index.

Costs can be classified accurately as either Costs can be classified accurately as either variable or fixed.

Changes in Changes in activity are the only factors that are the only factors that affect costsaffect costs..

All units All units produced are sold.

When more than one type of product is sold, the When more than one type of product is sold, the sales mix will remain constant.


Chapter 18-33

One of the following is One of the following is NOTNOT involved in CVP involved in CVP analysis. That factor is:analysis. That factor is:

a.a. Sales mixSales mix.

b. Unit selling prices.

c. Fixed costs per unit.

d. Volume or level of activity.


SO 4: List the five components of cost-volume-profit SO 4: List the five components of cost-volume-profit analysis.analysis.

Chapter 18-34

CVP Income StatementCVP Income StatementCVP Income StatementCVP Income Statement

Classifies costs and expenses as fixed or variable.Reports contribution margin in the body of the statement.

Contribution margin –Amount of revenue remaining

after deducting all variable costs.

Reports the same netincome as a traditional income statement.income statement.

A statement for internal use only.

SO 5: Indicate what contribution margin is and how it can be expressed.SO 5: Indicate what contribution margin is and how it can be expressed.

Chapter 18-35

CVP Income Statement - ExampleCVP Income Statement - ExampleCVP Income Statement - ExampleCVP Income Statement - Example

Vargo Video Company produces a DVD Vargo Video Company produces a DVD player/recorder. player/recorder.

Relevant data for June 2010: Relevant data for June 2010:


Illustration 18-11

Illustration 18-10

Chapter 18-36

Contribution Margin Per UnitContribution Margin Per UnitContribution Margin Per UnitContribution Margin Per Unit

Contribution margin is the amount availableContribution margin is the amount available to cover fixed costs and to contribute to income.

The formula for The formula for contribution margin per unit and the and the computation of the contribution margin per unit for computation of the contribution margin per unit for Vargo Video are:Vargo Video are:

Thus, for every DVD player sold, Vargo Video has $200 Thus, for every DVD player sold, Vargo Video has $200 to cover fixed costs and contribute to net income.to cover fixed costs and contribute to net income.


Illustration 18-12

Chapter 18-37

CVP Income Statement – Contribution Margin CVP Income Statement – Contribution Margin EffectEffect


Since Vargo Video has fixed costs of $200,000, it must Since Vargo Video has fixed costs of $200,000, it must sell 1,000 DVD players ($200,000 ÷ $200) before it can sell 1,000 DVD players ($200,000 ÷ $200) before it can earn any net income.earn any net income.

Vargo’s CVP income statement, assuming a zero net Vargo’s CVP income statement, assuming a zero net income is:income is:


Illustration 18-13

Chapter 18-38



For every DVD player that Vargo sells above 1,000 units, For every DVD player that Vargo sells above 1,000 units, net income increases by the amount of the contribution net income increases by the amount of the contribution margin, $200.margin, $200.

Vargo’s CVP income statement, assuming 1,001 units Vargo’s CVP income statement, assuming 1,001 units sold is:sold is:


Illustration 18-14

Chapter 18-39

Contribution Margin RatioContribution Margin RatioContribution Margin RatioContribution Margin Ratio

Shows the percentage of each sales dollar available to Shows the percentage of each sales dollar available to apply toward fixed costs and profitsapply toward fixed costs and profits.

The contribution margin ratio is the contribution margin per unit divided by the unit selling price. For Vargo Company, the computation is:he computation is:

In this case, the contribution margin ratio of 40% means In this case, the contribution margin ratio of 40% means that $ 0.40 of each sales dollar is available to apply to that $ 0.40 of each sales dollar is available to apply to fixed costs and contribute to net income.fixed costs and contribute to net income.


Illustration 18-15

Chapter 18-40

Contribution Margin RatioContribution Margin RatioContribution Margin RatioContribution Margin Ratio

As shown below, the contribution margin ratio helps to determine the effect of changes in sales on net income.


Illustration 18-16

Chapter 18-41

Contribution margin:Contribution margin:

a.a. Is revenue remaining after deducting all Is revenue remaining after deducting all variable costs.variable costs.

b. b. Is revenue remaining after deducting all Is revenue remaining after deducting all variable and fixed costs.variable and fixed costs.

c. c. Is selling price less cost of goods sold.Is selling price less cost of goods sold.

d. d. Is totally about fixed costs.Is totally about fixed costs.


SO 5: Indicate what contribution margin is and how it can be SO 5: Indicate what contribution margin is and how it can be expressed.expressed.

Chapter 18-42

Break-Even AnalysisBreak-Even AnalysisBreak-Even AnalysisBreak-Even Analysis

A key relationship in CVP analysis is the level of activity at A key relationship in CVP analysis is the level of activity at which which total revenue equals total costs (both fixed and (both fixed and variable).variable).

This level of activity is called the break-even point.

At this volume of sales, the company will realize no At this volume of sales, the company will realize no income, but will also suffer no loss.income, but will also suffer no loss.

Can be computed or derived:Can be computed or derived:from a mathematical equation,by using contribution margin, orfrom a cost-volume profit (CVP) graph..

The break-even point can be expressed either in sales units or in sales dollars.

SO 6: Identify the three ways to determine the break-even point.SO 6: Identify the three ways to determine the break-even point.

Chapter 18-43

Break-Even Analysis: Mathematical Break-Even Analysis: Mathematical EquationEquation

Break-Even Analysis: Mathematical Break-Even Analysis: Mathematical EquationEquation

Break-even occurs where total sales equal variable costs plus fixed costs; i.e., net income is zero.

The formula for the The formula for the break-even point in unitsin units and and the computation for Vargo Video are:the computation for Vargo Video are:

To find To find sales dollarssales dollars required to break-even: required to break-even:1,000 units × $500 = $500,000 (break-even sales dollars).1,000 units × $500 = $500,000 (break-even sales dollars).


Illustration 18-18

Chapter 18-44

Break-Even Analysis:Break-Even Analysis:Contribution Margin TechniqueContribution Margin Technique

Break-Even Analysis:Break-Even Analysis:Contribution Margin TechniqueContribution Margin Technique

At the break-even point, contribution margin must equal total fixed costs.

(Contribution Margin = Total revenues – Variable costs)

The break-even point (BEP) can be computed using either contribution margin per unit or contribution margin ratio.


Chapter 18-45

Contribution Margin TechniqueContribution Margin TechniqueContribution Margin TechniqueContribution Margin Technique

When the contribution margin per unit is used, the formula to compute the BEP in units for Vargo Video is:

When the BEP in dollars is desired, contribution margin ratio is used in the following formula for Vargo Video:


Illustration 18-19

Illustration 18-20

Chapter 18-46

Break-Even Analysis: Graphic Break-Even Analysis: Graphic PresentationPresentation


A cost-volume profit (CVP) graph shows the relationships between costs, volume and profits.

To construct a CVP graph:To construct a CVP graph:

Plot the total-sales line starting at the zero activity level,

Plot the total fixed cost using a horizontal line,

Plot the total-cost line (starts at the fixed-cost line at zero activity),

Determine the break-even point from the intersection of the total-cost line and the total-sales line..


Chapter 18-47




Illustration 18-21

Chapter 18-48

Gossen Company is planning to sell 200,000 pliers Gossen Company is planning to sell 200,000 pliers for $4 per unit. The contribution margin ratio is 25 for $4 per unit. The contribution margin ratio is 25 percent. If Gossen will break even at this level of percent. If Gossen will break even at this level of sales, what are the fixed costs?sales, what are the fixed costs?

a.a. $100,000$100,000.

b. $160,000.

c. $200,000.

d. $300,000.



Sales 200,000 x $4= $800,000

$800,000 x 25% = $200,000

Chapter 18-49

Break-Even Analysis: Target Net Break-Even Analysis: Target Net IncomeIncome

Break-Even Analysis: Target Net Break-Even Analysis: Target Net IncomeIncome

Rather than just breaking even, management usually sets an income objective called “target net income.”

Indicates sales or units necessary to achieve this specified level of income.

Can be determined from each of the approaches used Can be determined from each of the approaches used to determine break-even sales/units:to determine break-even sales/units:

From a mathematical equation,

By using contribution margin, or

From a cost-volume profit (CVP) graph..

Expressed either in sales units or in sales dollars.

SO 7: Give the formulas for determining sales SO 7: Give the formulas for determining sales required to earn target net income.required to earn target net income.

Chapter 18-50

Break-Even Analysis: Target Net IncomeBreak-Even Analysis: Target Net IncomeBreak-Even Analysis: Target Net IncomeBreak-Even Analysis: Target Net Income

Mathematical Equation

Using the basic formula for the Using the basic formula for the break-even point, simply include the desired net income as a factor. The computation for Vargo Video is as The computation for Vargo Video is as follows:follows:


Illustration 18-23

Chapter 18-51

Break-Even Analysis: Target Net IncomeBreak-Even Analysis: Target Net IncomeBreak-Even Analysis: Target Net IncomeBreak-Even Analysis: Target Net Income

Contribution Margin TechniqueContribution Margin Technique

To determine the required sales in units for Vargo Video:

To determine the required sales in dollars for Vargo Video:


Chapter 18-52

The mathematical equation for computing The mathematical equation for computing required sales to obtain target net income is:required sales to obtain target net income is:

Required sales = ?Required sales = ?

a.a. Variable costs + Target net incomeVariable costs + Target net income.

b. Variable costs + Fixed costs + Target net income.

c. Fixed costs + Target net income.

d. No correct answer is given.


SO 7: Give the formulas for determining sales required SO 7: Give the formulas for determining sales required to earn target net income.to earn target net income.

Chapter 18-53

Break-Even Analysis: Margin of SafetyBreak-Even Analysis: Margin of SafetyBreak-Even Analysis: Margin of SafetyBreak-Even Analysis: Margin of Safety

Difference between actual or expected sales and sales at the break-even point.

Measures the “cushion” that management has, allowing it to break-even even if expected sales fail to materialize.

May be expressed in dollars or as a ratio.

To determine the margin of safety in dollars for Vargo Video assuming that actual/expected sales are $750,000:

SO 8: Define margin of safety, and give the formulas for SO 8: Define margin of safety, and give the formulas for computing it.computing it.

Illustration 18-26

Chapter 18-54

Break-Even Analysis: Margin of SafetyBreak-Even Analysis: Margin of SafetyBreak-Even Analysis: Margin of SafetyBreak-Even Analysis: Margin of Safety

Margin of Safety RatioMargin of Safety Ratio

Computed by dividing the margin of safety in dollars by the actual or expected sales.

To determine the margin of safety ratio for Vargo Video assuming that actual/expected sales are $750,000:

The higher the dollars or the percentage, the greater the margin of safety.

SO 8: Define margin of safety, and give the formulas for SO 8: Define margin of safety, and give the formulas for computing it.computing it.

Illustration 18-27

Chapter 18-55

Marshall Company had actual sales of $600,000 Marshall Company had actual sales of $600,000 when break-even sales were $420,000. What is when break-even sales were $420,000. What is the margin of safety ratio?the margin of safety ratio?

a.a. 25%25%.

b. 30%.

c. 33 1/3%.

d. 45%.


SO 8: Define margin of safety, and give the formulas SO 8: Define margin of safety, and give the formulas for computing it.for computing it.

$600 - $420 = $180$180 ÷ $600 = 30%

Chapter 18-56

Chapter Review - Brief ExerciseChapter Review - Brief ExerciseChapter Review - Brief ExerciseChapter Review - Brief Exercise

Monthly production costs in the Loder Company for two Monthly production costs in the Loder Company for two levels of production are as follows levels of production are as follows COSTCOST 3,000 Units3,000 Units 6,000 Units6,000 UnitsIndirect Labor Indirect Labor $ 10,000$ 10,000 $ 20,000$ 20,000Supervisory salariesSupervisory salaries $ 5,000$ 5,000 $ 5,000$ 5,000MaintenanceMaintenance $ 4,000$ 4,000 $ 7,000$ 7,000

Indicate which costs are variable, fixed, and mixed and give the reason why.

Indirect labor is variable cost because it increases in total directly and proportionately with the changes in the activity level.Supervisory salaries is a fixed cost because it remains the same in total regardless of the changes in the activity level.Maintenance is a mixed cost because it increases in total but not proportionately with changes in activity level.

Chapter 18-57


Pasaveno Company accumulates the following data Pasaveno Company accumulates the following data concerning a mixed cost, using miles as the activity level.concerning a mixed cost, using miles as the activity level.

MilesMiles Total Total Miles Miles TotalTotal DrivenDriven CostCost Driven Driven CostCost

January 8,000 $14,150 March 8,500 $15,000$14,150 March 8,500 $15,000

FebruaryFebruary 7,5007,500 $13,600 April 8,200 $14,490$13,600 April 8,200 $14,490

Compute the variable and fixed cost elements using the high-low method.

High Level of Activity: March $15,0008,500 milesLow Level of Activity: February 13,6007,500 miles

Difference $ 1,4001,000 miles

Step 1: Variable Cost per Unit = $1,400 ÷ 1,000 miles

= $1.40 variable cost per mile

Chapter 18-58


High Level of Activity:High Level of Activity: MarchMarch $15,000$15,0008,500 miles8,500 milesLow Level of Activity: Low Level of Activity: FebruaryFebruary 13,600 13,600 7,500 miles 7,500 miles

DifferenceDifference $ 1,400$ 1,400 1,000 miles 1,000 miles

Step 1Step 1: : Variable Cost per Unit = $1,400 ÷ 1,000 milesVariable Cost per Unit = $1,400 ÷ 1,000 miles

= = $1.40 variable cost per mile$1.40 variable cost per mileStep 2:Step 2: High High LowLowTotal Cost:Total Cost: $15,000 $13,600 $15,000 $13,600

Variable Cost:Variable Cost:

8,500 × $1.408,500 × $1.40 11,900 11,900 7,500 × $1.40 7,500 × $1.40 10,500 10,500

Total Fixed Costs 3,100Total Fixed Costs 3,100 3,100 3,100

Chapter 18-59

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Chapter 18-1. Chapter 18-2 CHAPTER 18 COST - VOLUME - PROFIT Accounting, Fourth Edition.

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