Module 7 Cost Behavior

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Module 7: Cost Behavior & Cost-Volume-Profit Analysis

ACG 2071

Created by: M. Mari

Fall 2007-1



Cost-Volume-Profit Analysis (CVP)

Which helps them predict how changes incosts and sales levels affect income

CVP analysis involves computing the saleslevel at which a company neither earns anincome nor incurs a loss – break evenpoint



Cost Behavior

refers to the manner in which a costchanges as a related activity changes.

Activity bases – activities that are thoughtto cause the cost to be incurred.

Relevant range – range of activity overwhich the changes in the cost that are ofinterest.



Cost Classifications

Three types Variable Cost

Fied Cost

!ied Cost



Variable costs

costs that vary inproportion to changesin the level of activity. Direct materials

Direct labor

Units Produced Direct Materials

per unit

Total Direct

Material Costs

5,000 units $10 $ 50,000

10,000 units $10 100,000

15,000 units $10 150,000



i!ed Costs

costs that remain thesame in total dollaramounts as the level

of activity changes.Number of Bottles Total Salary for

Supervisor

Salary per bottle

produced

50,000 $75,000 $1.50

100,000 $75,000 $0.75

150,000 75,000 $0.50



Mi!ed Costs

has characteristics of both a variable and afied cost. Could behave as a fied costs for part of the

relevant range and then variable cost



Contribution Margin Concept

Contribution mar"in " #ales – Variable costs

Contribution mar"in ratio "

#ales – Variable costs #ales

Is most useful when the increase or decrease in sales

volume is measured in sales dollars #nit contribution mar"in

" #ales price per unit – Variable cost per unit



$!am%le

The Company has sales of $%&'''&'''& variable costs of $(''&'''.The company sold )'&''' units. Compute the contribution margin andthe contribution margin ratio.

Contribution margin " #ales – Variable cost

" $%&'''&''' * $(''&''' " $+''&'''

Contribution margin ratio " ,#ales – VC-#ales " ,%&'''&''' – (''&'''-%&'''&''' " +'/

0nit Contribution margin " Contribution margin 0nits sold " $+''&''' )'&''' " $1



Brea-even Analysis

to determine the units of sales necessary toachieve the break even pint in operations

to determine the units of sales necessary toachieve a target or desired profit



Brea-$ven Point

2s the level of operations at which abusiness3s revenues and epired costs areeactly e4ual5

6 business will have neither an income nora loss from operations.



Brea $ven Point

Revenues Expenses



Brea even formula

B$P ' i!ed Costs

#nit contribution mar"in



$!am%le

#uppose that selling price is $+)& variable cost $%) and fied costsare $7'&'''. What is break even point5

89P " Fied costs 0nit Contribution !argin " $7'&''' ,+) – %)- " $7'&'''$%' " 7&''' units

6t sales level of 7&''' units will result in no gain or loss to thecompany.

Proof:

#ales: ,$+) ; 7&'''- $++)&''' Variable cost: ,$%) 7&'''- %<).''' Contribution margin 7'&''' Fied costs 7'&''' =perating income *'*



Changes in fied costs

$!am%le: #uppose that selling price is$+)& variable cost $%) and fied costs are$7'&'''. What is break even point if fied

costs increase to $%''&'''5

BEP = Fixed costs/ Unit Contribution margin

= $100,000/ !"#1" = 10,000 units

%ue to an increase in &ixed costs &rom $'0,000 to $100,000,

brea( even point increased



Changes in !ariable costs

$!am%le: #uppose that selling price is $+)& variablecost $%) and fied costs are $7'&'''. What is breakeven point if variable costs decrease to $%'5

89P " Fied costs 0nit Contribution margin

" $7'&''' ,+)*%'- " >&''' units

?ue to a decrease in variable costs from $%) to$%'& break even point decreased to >&''' unitsfrom 7&''' units or a decrease of <&''' units



Changes in selling price

$!am%le: #uppose that selling price is $+)& variablecost $%) and fied costs are $7'&'''. What is breakeven point if selling price increase to $<'5

89P " Fied costs 0nit Contribution margin

" $7'&''' ,<'*%)- " >&''' units

?ue to an increase in sales price from $+) to$<'& break even point decreased to >&''' unitsfrom 7&''' units or a decrease of <&''' units.



esired or *ar"et Profit

89P " Fied costs @ ?esired Profit 0nit contribution margin

$!am%le: #uppose that selling price is $1)& variable cost $<'& andfied costs are $>'&'''. The company wants a desired profit of

$1)&'''. What is break even point5

89P " Fied costs @ ?esired profit 0nit Contribution margin " ,$>'&'''- ,1)*<'- " 1&''' units

89P " Fied costs @ ?esired profit 0nit Contribution margin " ,$>'&''' @ $1)&'''- ,1)*<'- " A&''' units

To create $45,000 of rofit, must sell !,000 units or ",000 more thanbrea# even oint



Charts

Costs

Units

Fixed costs

)ariab*e

+ota* cost



+ra%hical , Brea even %oint

$

Units0

+ota* costs

a*es

Brea( even point

a*es = +C

Pro&it

-oss



ales Mi! Consideration

!ore than one product issold at varying sellingprices

Products often have

different unit variablecosts

Products have differentcontribution margin

#ales volume necessarymust a mi of bothproducts



$!am%le .:

Cascade Co produces two products Bukand unk. Buk has a selling price of $7'per unit and variable cost of $A'. unk

has a selling price of $%1' and variablecost of $7). Fied costs are $+''&'''.unk3s sales are approimately ('/ of

total sales for the company. What is thebreak even point for the sales mi5



$!am%le .:

Product ellin"Price

VariableCost

ContributionMar"in

ales

/

ales mi!Contribution

Mar"in

Buk $7' $A' $+' ('/ $%>

unk $%1' $7) $1) +'/ $7

#alesmi

012012



$!am%le .:

BEP = Fixed Costs

a*es mix C.

= $!00,000

$!"

BEP = ,000 units

Of what products:

U2 ,000 units 3 04 = 5,600 units

7U2 ,000 units 3 !04 = 1,500 units



$!am%le 7:

68C Company has two products B and ;.B has a selling price of $%'' and variablecosts of $>'. 2t is A'/ of total sales. ;

has a selling price of $)' and variablecost of $+). Fied costs are $+1(&)''.What is 89P5



Mar"in of afety

2ndicates possibledecrease in sales thatmay occur before an

operating loss occurs.

!argin of #afety "

#ales – #ales at 89P #ales



Mar"in of afety

2f sales are $1''&''' and sales at breakeven are $<''&''' what is margin ofsafety5

!s " #ales – #ales 89P " $1'' * $<''

#ales $1''

" +)/



$!am%le 6

!onth Production Total Cost

Dune %&''' $1)&))'Duly %&)'' $)+&'''

6ug +&%'' $>%&)''

#ept %&('' $)A&)''=ct A)' $1%&+)'



$!am%le

te %& 'ind highest and lowest level of roduction(

Month #nits *otal Cost

Eigh 6ugust +&%'' $>%&)''

ow =ctober A)' $1%&+)'

Step 2: Get the difference

?ifference %&<)' $+'&+)'



$!am%le continued

te "& )omute *ariable cost er unit Variable cost " ?ifference in Total Cost

?ifference in 0nits

"$+'&+)'

%&<)'

" $%) per unit Total cost " FC @ VC $>%&)'' " FC @ ,$%) G+&%'' units- $>%&)'' " FC @ <%&)'' FC " $<'&'''



$!am%le Contd

te 4& )omute 'i+ed costs

Total cost " Fied Costs @ Variable Cost

using the data at +&%'' units ofproduction& we solve for fied costs

$>%&)'' " FC @ ,$%) G+&%'' units-

$>%&)'' " FC @ <%&)'' FC " $<'&'''



$!am%le Continued

iven the information in the prior slide&what is the total cost at +&''' units ofoutput5

Total cost " Fied costs @ Variable costs

Total cost " $<'&''' @ ,$%) ; +&'''-

Total cost " $>'&'''



$!am%le 1

!onth Production Total Cost

Dune +&)'' $1)&'''Duly +&''' $1'&'''

6ug %&)'' $<).'''

#ept <&''' $)'&'''=ct %&('' $<(&'''89at is t9e variab*e cost per unit and &ixed cost:



8%eratin" 4evera"e

o The relative mi of a business3s variable costsand fied costs is measured by the operatingleverage

#ince the difference between contribution marginand income from operations is fied costs&companies with large amounts of fied costs willgenerally have a high operating leverage. 2ndicates that a small increase in sales will yield a

large percentage increase in income from operations. ow operating leverage

2ndicates that a large increase in sales is necessary tosignificantly increase income from operations



8%eratin" 4evera"e

=perating everage

" Contribution !argin

2ncome from operations

Module 7 Cost Behavior

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