20-1 Copyright Houghton Mifflin Company. All rights reserved. Chapter 20 Cost-Volume-Profit Analysis and Variable Costing Belverd E. Needles, Jr. Marian

20-20-11Copyright Houghton Mifflin Company. All rights reserved.

Chapter 20Chapter 20Cost-Volume-Profit Analysis Cost-Volume-Profit Analysis

and Variable Costingand Variable Costing

Belverd E. Needles, Jr.Belverd E. Needles, Jr.

Marian PowersMarian Powers

Sherry K. MillsSherry K. Mills

Henry R. AndersonHenry R. Anderson- - - - - - - - - - -- - - - - - - - - - -

Multimedia Slides by:Multimedia Slides by:

Dr. Paul J. RobertsonDr. Paul J. RobertsonNew Mexico State UniversityNew Mexico State University

Steve LeaskSteve LeaskNew Mexico State UniversityNew Mexico State University


The Behavior of The Behavior of Variable CostsVariable Costs

OBJECTIVE 2OBJECTIVE 2

Identify specific types of variable Identify specific types of variable and fixed cost behavior, and define and fixed cost behavior, and define and discuss the relationships of and discuss the relationships of operating capacity and relevant operating capacity and relevant range to cost behavior.range to cost behavior.


Cost BehaviorCost Behavior» Cost behavior refers to how costs Cost behavior refers to how costs

change in relation to volume or change in relation to volume or activity.activity. Some costs vary with volume or Some costs vary with volume or

operating activity.operating activity.

Others remain fixed as volume Others remain fixed as volume changes.changes.

Some costs exhibit characteristics Some costs exhibit characteristics between these two extremes.between these two extremes.


Variable CostsVariable Costs

» Total costs that change in direct Total costs that change in direct

proportion to changes in productive proportion to changes in productive

output are called output are called variable costs.variable costs.

On a per unit basis, however, variable On a per unit basis, however, variable

costs remain constant as volume costs remain constant as volume

changes.changes.


Variable CostsVariable Costs

Examples of variable costs:Examples of variable costs:

Direct materials.Direct materials.

Direct and indirect labor (hourly).Direct and indirect labor (hourly).

Operating supplies.Operating supplies.

Sales commissions.Sales commissions.


Examples of Variable, Examples of Variable, Fixed, and Mixed CostsFixed, and Mixed Costs

Manufacturing CompanyDesk Manufacturer

VariableCost

FixedCost

MixedCost

Direct materialsDirect labor (hourly)Indirect labor (hourly)Operating suppliesSmall tools

Depreciation, machinery & buildingInsurance premiumsLabor (salaried)Supervisory salariesProperty taxes

Electrical powerTelephoneHeat



Service CompanyBank

VariableCost

FixedCost

MixedCost

Computer equipmentleasing (based onusage)Computer operators(hourly)Operating suppliesData storage disks

Depreciation, furniture & fixturesInsurance premiumsSalaries: Programmers Systems designers Bank administratorsRent, buildings




Merchandising CompanyDepartment Store

VariableCost

FixedCost

MixedCost

Merchandise to sellSales commissionsShelf stockers(hourly)

Depreciation, buildingInsurance premiumsBuyers (salaried)Supervisory salariesProperty taxes (onequipment & building)



CapacityCapacity

» Capacity can be expressed in Capacity can be expressed in

several ways, including:several ways, including:

Total labor hours.Total labor hours.

Total machine hours.Total machine hours.

Total units of output.Total units of output.


CapacityCapacity» Operating CapacityOperating Capacity: Maximum : Maximum

productive output and related costs, productive output and related costs, given existing resources.given existing resources.

» Theoretical Capacity:Theoretical Capacity: Maximum Maximum productive output possible over a productive output possible over a given period of time. given period of time.

» Practical Capacity:Practical Capacity: Theoretical Theoretical capacity reduced by normal, capacity reduced by normal, expected work stoppages.expected work stoppages.


CapacityCapacity» Excess Capacity:Excess Capacity: Extra machinery Extra machinery

and equipment available when and equipment available when regular facilities are being repaired regular facilities are being repaired or when expected volume is greater.or when expected volume is greater.

» Normal Capacity:Normal Capacity: Average annual Average annual operating capacity needed to satisfy operating capacity needed to satisfy expected sales demand. expected sales demand.


Measures of CapacityMeasures of Capacity

» Each variable cost should be Each variable cost should be

related to an appropriate measure related to an appropriate measure

of capacity, but often more than of capacity, but often more than

one measure of capacity applies.one measure of capacity applies.


A Common Variable-Cost Behavior Pattern: Linear Relationship

A Common Variable-Cost Behavior Pattern: Linear Relationship

Lab

or

Co

st

Units

$2.50 per unit$2.50 per unit

$5

0

$10

$15

$20

0 1 2 3 4 5 6 7 8


Nonlinear Variable CostsNonlinear Variable Costs» Many costs vary with operating Many costs vary with operating

activity in a nonlinear fashion. activity in a nonlinear fashion. Costs of computer usage.Costs of computer usage.

Costs of power consumption.Costs of power consumption.

» Cost behavior of nonlinear costs can Cost behavior of nonlinear costs can be approximated within the relevant be approximated within the relevant range using a linear approximation range using a linear approximation technique.technique.


Relevant RangeRelevant Range

» The relevant range is the volume The relevant range is the volume

range within which actual range within which actual

operations are likely to occur.operations are likely to occur.


The Relevant Range and Linear Approximation

The Relevant Range and Linear Approximation

TotalCost

Volume

$ LinearApproximation

True BehaviorPattern

RelevantRelevantRangeRange

0


Fixed CostsFixed Costs» Fixed costs are costs that remain Fixed costs are costs that remain

constant within a relevant range of constant within a relevant range of volume or activity. Examples of fixed volume or activity. Examples of fixed costs are:costs are: Depreciation.Depreciation. Rent.Rent. Supervisory salaries.Supervisory salaries. Property taxes.Property taxes.

» Unit fixed costs vary inversely with Unit fixed costs vary inversely with changes in volume.changes in volume.


A Common Fixed-Cost Behavior Pattern

A Common Fixed-Cost Behavior Pattern

Units of Output

$2,000

0

$4,000

$6,000

$8,000

0 200,000 400,000 600,000 800,000

Original RelevantRange

New RelevantRange

Fix

ed O

verh

ead

Co

st

Fixed CostPattern


Mixed CostsMixed Costs


Define Define mixed cost,mixed cost, and use the and use the

high-low method to separate the high-low method to separate the

variable and fixed components variable and fixed components

of a mixed cost.of a mixed cost.


Mixed CostsMixed Costs

» Mixed costs have both variable and Mixed costs have both variable and fixed cost components.fixed cost components.

» Part of the cost changes with Part of the cost changes with volume or usage, and part of the volume or usage, and part of the cost is fixed over time.cost is fixed over time.


To

tal T

ele

ph

on

e C

os

t

Long Distance Calls

$

Behavior Patterns of Mixed Behavior Patterns of Mixed Costs: Telephone CostsCosts: Telephone Costs


To

tal M

ain

ten

an

ce C

ost

Maintenance Hours

$

Behavior Patterns of Mixed Behavior Patterns of Mixed Costs: Maintenance CostsCosts: Maintenance Costs


High-Low MethodHigh-Low Method

» A scatter diagram is a chart of A scatter diagram is a chart of

plotted points that helps determine plotted points that helps determine

if there is a linear relationship if there is a linear relationship

between a cost item and its related between a cost item and its related

activity measure.activity measure.


Cost-Volume-Profit AnalysisCost-Volume-Profit Analysis


Define Define cost-volume-profit analysiscost-volume-profit analysis

and discuss how managers use and discuss how managers use

this analysis.this analysis.


Cost-Volume-Profit AnalysisCost-Volume-Profit Analysis» Cost-volume-profit analysis is used Cost-volume-profit analysis is used

primarily as a planning and control primarily as a planning and control tool.tool. Projecting net income at different activity Projecting net income at different activity

levels.levels.

Measuring the performance of a Measuring the performance of a department within a company.department within a company.

Assisting in the analysis of decision Assisting in the analysis of decision alternatives.alternatives.


Cost-Volume-Profit AnalysisCost-Volume-Profit Analysis

The C-V-P FormulaThe C-V-P Formula

Sales Revenue

Fixed Costs

Total Variable Costs

S

VC

FC

S = VC + FC + Net IncomeS = VC + FC + Net Income


Breakeven AnalysisBreakeven Analysis


Compute a breakeven point in Compute a breakeven point in

units of output and in sales units of output and in sales

dollars, and prepare a dollars, and prepare a

breakeven graph.breakeven graph.


The Breakeven PointThe Breakeven Point» The breakeven point is the point of The breakeven point is the point of

zero profit.zero profit.

Breakeven units equal fixed costs Breakeven units equal fixed costs

divided by contribution margin per unit.divided by contribution margin per unit.

Breakeven dollars equal breakeven units Breakeven dollars equal breakeven units

times the selling price per unit.times the selling price per unit.


The Breakeven GraphThe Breakeven Graph» A standard breakeven graph has A standard breakeven graph has

five components.five components.

The horizontal axis (volume).The horizontal axis (volume).

The vertical axis (dollars).The vertical axis (dollars).

The fixed cost line.The fixed cost line.

The total cost line.The total cost line.

The total revenue line.The total revenue line.


The Breakeven GraphThe Breakeven Graph

» Normally, a loss area, profit area, Normally, a loss area, profit area,

and breakeven point will result.and breakeven point will result.

» At zero volume, net loss equals At zero volume, net loss equals

fixed costs.fixed costs.


Graphic Breakeven Analysis: Graphic Breakeven Analysis: Dakota Products, Inc.Dakota Products, Inc.

$60

$10

$20

$50

$40

$30

0 200 600400

Do

llar

s (i

n t

ho

usa

nd

s)

Units of Output

Fixed CostsUnit Breakeven

Sales Breakeven

Total RevenueLine

Total Cost Line

Loss Area

Net Income

Area

Variable Costs


Contribution MarginContribution Margin


Define Define contribution margincontribution margin and and

use the concept to determine a use the concept to determine a

company’s breakeven point for company’s breakeven point for

a single product and for a single product and for

multiple products.multiple products.


Contribution MarginContribution Margin

» Contribution margin equals sales Contribution margin equals sales

minus total variable costs.minus total variable costs.

CM = S - VCCM = S - VC

» Contribution margin per unit equals Contribution margin per unit equals

selling price minus variable cost per selling price minus variable cost per

unit.unit.


Contribution MarginContribution Margin» The breakeven point (in units) The breakeven point (in units)

equals fixed costs divided by the equals fixed costs divided by the contribution margin per unit.contribution margin per unit.

BE units = FC / CM per unitBE units = FC / CM per unit

» A sales mix is used to calculate the A sales mix is used to calculate the breakeven point for each product breakeven point for each product when an organization sells more when an organization sells more than one product.than one product.


Planning Future SalesPlanning Future Sales


Apply cost-volume-profit analysis Apply cost-volume-profit analysis

to estimated levels of future sales to estimated levels of future sales

and to changes in costs and and to changes in costs and

selling prices.selling prices.


Cost-Volume-Profit Cost-Volume-Profit » The contribution approach is The contribution approach is

extremely useful for profit planning.extremely useful for profit planning.

» Target sales in units = (FC + NI) / Target sales in units = (FC + NI) / (CM per unit).(CM per unit).

» Projected net income can be Projected net income can be calculated, assuming changes in calculated, assuming changes in volume, selling price, and/or costs.volume, selling price, and/or costs.


Assumptions Assumptions Underlying C-V-P AnalysisUnderlying C-V-P Analysis

1.1. The behavior of variable and fixed The behavior of variable and fixed costs can be measured accurately.costs can be measured accurately.

2.2. Costs and revenues have a close Costs and revenues have a close linear approximation.linear approximation.

3.3. Efficiency and productivity hold Efficiency and productivity hold steady within the relevant range of steady within the relevant range of activity.activity.


Assumptions Assumptions Underlying C-V-P AnalysisUnderlying C-V-P Analysis4.4. Cost and price variables hold Cost and price variables hold

steady during the period being steady during the period being planned.planned.

5.5. The product sales mix does not The product sales mix does not change during the period being change during the period being planned. planned.

6.6. Production and sales volume are Production and sales volume are roughly equal. roughly equal.

Documents

20-1 Copyright Houghton Mifflin Company. All rights reserved. Chapter 20 Cost-Volume-Profit Analysis and Variable Costing Belverd E. Needles, Jr. Marian