Survey of accounting 6e chapter 11

Learning ObjectivesAfter studying this chapter, you should be able to: • Classify costs as variable costs, fixed costs, or mixed costs.. • Using a cost-volume-profit chart and a profit-

Cost Behavior and

11

Learning Objectives

After studying this chapter, you should be able to:

• Classify costs as variable costs, fixed costs, or mixed

costs.

• Compute the contribution margin, the contribution

margin ratio, and the unit contribution margin.

• Determine the break-even point and sales necessary

to achieve a target profit

• Using a cost-volume-profit chart and a profit-volume

chart, determine the break-even point and sales

necessary to achieve a target profit.

• Compute the break-even point for a company selling

more than one product, the operating leverage, and the margin of safety

Learning

Objective 1

Classify costs as variable costs, fixed

costs, or mixed costs

Cost Behavior

• Refers to the manner in which a cost changes as a

related _ changes Can be , _, or _

• Two factors to consider:

• _ – activities thought to relate to the cost incurred (e.g., food service costs

change with the number of hospital patients)

• _ – changes in cost are of

interest

Cost Behavior: Variable Costs

• Costs that in proportion to changes in the activity level.

Cost Behavior: Variable Costs

Exhibit 1: Variable Cost Graphs

Cost Behavior: Fixed Costs

• Costs that remain the same in _ over the relevant range of activity, but changes with the level of activity.

Cost Behavior: Fixed Costs

Exhibit 2: Fixed Cost Graphs

Cost Behavior: Mixed Costs

• Mixed costs share

High-Low Method

• Total maintenance cost

at highest and lowest

levels of production.

• Total maintenance costs during the last five months.

High-Low Method

Cost-Volume-Profit Analysis

• The systematic examination of the relationships

among selling prices, sales and production volume, costs, expenses, and profits

• Provides management with useful information for

Contribution Margin Income

Statement

Exhibit 4: Contribution Margin Income Statement

Contribution Margin Ratio

• The contribution margin ratio is the percentage

Contribution Margin Ratio

Variable costs = ¢60 Contribution margin = ¢40 or

40% of every dollar in sales

Contribution Margin Ratio

• 60% of $80,000 increase in sales will go to variable costs and the remaining 40% will go to contribution margin.

• The increase in contribution margin will flow to income from operations as fixed costs do not change with increase in

sales.

Unit Contribution Margin

• Useful when an increase/decrease in _ is measured in units (not dollars)

Unit Contribution Margin =

_ –

Unit Contribution Margin

Sales Price/Unit $20

Unit Variable Cost 12

Unit Contribution Margin $ 8

• If sales increases by 15,000 units, from 50,000 units

to 65,000 units:

Learning

Objective 3

Determine the break-even point and sales necessary

to achieve a target profit

per unit

Selling price per unit Variable cost Variable cost per unit per unit

Contribution Margin per unit

Contribution Margin per unit

$10

$

Break-Even Point

$90,000/$10 = 9,000 units needed to break even

Effect of Changes in Fixed

Costs

There is a _

relationship between total fixed costs and units

Effect of Changes in Fixed

Costs

How would a $100,000 increase in fixed costs affect the break-even sales units?

ITEM NOW PROPOSED CHANGE

Variable Cost per Unit $70 $70 Same Unit Contribution Margin $20 $20 Same Fixed Costs $600,000 $700,000 $100,000 Break-Even Sales (units) 30,000 35,000 5,000 unit

Now: $600,000/$20 UCM = 30,000 break-even Proposed: $700,000/$20 UCM = 35,000 break-even

Effect of Changes in Unit

Variable Costs

There is a _

relationship between unit variable cost and _ units

Effect of Changes in Unit

Variable Costs

How would an extra 2% commission (increase in variable cost per unit) affect the break-even sales units?

ITEM NOW PROPOSED CHANGE

Variable Cost per Unit $145 $150 2% of sales Unit Contribution Margin $105 $100 $5 per unit Fixed Costs $840,000 $840,000 Same Break-Even Sales (units) 8,000 8,400 400 units

Now: $840,000/$105 UCM = 8,000 break-even Proposed: $840,000/$100 UCM = 8,400 break-even

Effect of Changes in Unit Selling

Price

There is an _ relationship between unit selling price and units

Effect of Changes in Unit Selling

Price

How would a $10 price increase affect the

break-even sales units?

ITEM NOW PROPOSED CHANGE

Variable Cost per Unit $30 $30 Same Unit Contribution Margin $20 $30 $10 Fixed Costs $600,000 $600,000 Same

Now: $600,000/$20 UCM = 30,000 break-even Proposed: $600,000/$30 UCM = 20,000 break-even

Target Profit

• To find units needed to attain a certain target

profit, add the _ to the _

_ in the break-even formula

+ UCM Break-Even Sales (Units) =

Calculating Sales (units)

= units

Target Profit = $100,000 Fixed Costs = $200,000

Selling price Per unit

Selling price Per unit

Contribution Margin per unit

Contribution Margin per unit

Variable Cost Per unit

Variable Cost Per unit

$75

$30

$45

=

Verification of Units Required to

Achieve Target Profit

Target Profit

• Cost-volume-profit charts assist management in understanding relationships among costs, sales, and operating profit or loss.

• We’ll construct a CVP chart assuming:

• $50 selling price

• $30 unit variable cost

• $20 unit contribution margin

• $100,000 in fixed costs

Cost-Volume-Profit (CVP) Chart

Exhibit 5: Cost-Volume-Profit Chart

Cost-Volume-Profit (CVP) Chart

When fixed costs decrease by $20,000, break-even

decreases to 4,000 units ($200,000).

Cost-Volume-Profit (CVP) Chart

Exhibit 6: Revised Cost-Volume-Profit Chart

• $30 unit variable cost

• $20 unit contribution margin

• $100,000 in fixed costs

Maximum loss is $100,000 in fixed costs (if no sales) Assume maximum profit is $100,000 (based on 10,000

maximum sales).

Profit-Volume Chart

Exhibit 7: Profit-Volume Chart

Sales Mix Considerations

• Most businesses sell more than one product,

and each product contributes differently to

overall profit

• Sales mix is the relative distribution of sales

among the various products sold.

• The sales volume necessary to break even when more than one product is sold depends on the

sales mix

Sales Mix

Assume Burr Company sold 8,000 units of

Product A and 2,000 units of Product B last year

Sales Mix

• Combining individual unit information to represent one single product – Product E

• Assuming fixed costs are $200,000, 8,000 units of

Product E are needed to break even ($200,000/$25) But how many of Products A and B does that mean?

Sales Mix

• Product A: 8,000 × 80% = 6,400 units

• Product B: 8,000 × 20% = 1,600 units

Break-even point

• Managers use operating leverage to measure how

changes in _ affect changes in income from

operations

• The relative mix of _ and _ costs is

measured by operating leverage.

Operating Leverage =

• Sales would have to drop by more than 20% before an

operating loss would result.

– Margin of Safety (%) =

End of Chapter 11