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Cost Behavior
Cost Volume Profit Analysis
Chapter M3
Cost Behavior
Refers to the manner in which a cost changes as a related activity changes– Activity Bases– Relevant range
Cost Classification
Variable Costs•Costs that vary in proportion to changes in the level of activity•Such as
•Direct Materials•Direct Labor
Units Produced
DM per unit
Total DM Costs
5,000 units $10 $50,000
10,000 $10 $100,000
15,000 $10 $150,000
Cost Classification
Fixed Costs•Costs that remain the same in total dollar amounts as the level of activity changes.•salaries
# of Bottles
Total Salary
Salary per Bottle
50,000 $75,000 $1.50
100,000 $75,000 $0.75
150,000 $75,000 $0.50
Cost Classification
Mixed Costs– Has characteristics of both a variable and a fixed
cost.– Could behave as a fixed cost for part of the relevant
range and then variable cost
High-Low Method
Cost estimation techniques
Steps– Find the highest and
lowest level of production– Find the difference in total
cost from highest to lowest level of production
– Find the difference in total units from highest to lowest level of production
– Variable cost per unit Difference in Total cost
Difference in Total units
– Find fixed cost by solving this equation
– Total cost = Fixed cost plus Variable cost
Example 1
Month Production Total Cost
June 1,000 $45,550
July 1,500 $52,000
Aug 2,100 $61,500
Sept 1,800 $57,500
Oct 750 $41,250
High: Aug 2,100 unitsLow: Oct 750 unitsDiff 1,350
High: Aug $61,500 Oct $41,250 Diff 20,250
Variable cost = Diff in TC Diff in units =$20,250 1,350 = $15 per unit Total cost = FC + VC $61,500 = FC + ($15 *2,100 units) $61,500 = FC + 31,500 FC = $30,000
Example 2
Month Production Total Cost
June 2,500 $45,000
July 2,000 $40,000
Aug 1,500 $35.000
Sept 3,000 $50,000
Oct 1,800 $38,000
Example 2
High Sept 3,000 $50,000 Low Aug 1,500 $35,000 Diff 1,500 15,000 Variable cost per unit $15,000/1,500 = $10 per unit Total cost = FC + VC $50,000 = FC + (3,000 units * $10) FC = $20,000
Cost-Volume-Profit Relationship
Is the systematic examination of the relationships among selling prices, sales, and production volume, costs, expenses and profits
Provides management with useful information for decision making
Contribution Margin Concept
Contribution Margin =
Sales – Variable Costs Contribution margin ratio
Sales – VC
Sales Unit Contribution margin
Sales per unit
- VC per unit
Example 3
The company has sales of $1,000,000, variable costs of $800,000. Compute the contribution margin and the contribution margin ratio
CM = Sales – VC = $1,000,000 - $800,000
=$200,000 CM ratio = Sales – VC/Sales = 200,000/1000000
= 20%
Example 4
The company has sales of $800,000, variable costs of $600,000. Compute the contribution margin and contribution margin ratio
CM = sales – VC = $800 - $600 = $200 CM ratio = CM/Sales = 200/800 = 25%
Cost Volume Profit Analysis
To determine the units of sales necessary to achieve the break even point in operations
To determine the units of sales necessary to achieve a target or desired profit
Break-Even Point
Is the level of operations at which a business’ revenues and expired costs are exactly equal
No income or loss BEP = Fixed Costs
Unit Contribution Margin
Break Even Point
Example 5: Suppose that selling price is $35, variable cost is $15 and fixed costs are $90,000. What is break even point?
BEP = fixed costs Unit contribution margin (Sales – VC) = $90,000 $35 - $15 = 4,500 units
Break even point
Check Sales = FC + VC ($35 * 4,500 units) = $90,000 + ($25 * 4,500) $157,500 = $90,000 + $67,500
Example 6
Suppose that selling price is $45, variable cost is $30 and fixed costs are $60,000. What is break even point?
BEP = Fixed cost Unit CM = $60,000 $45-30 = 4,000 units
Graphical
Fixed Costs
0
Costs
Units
Variable costsTotal Cost
Graphical – Break even point
$
Units0
Total costs
Sales
Break even pointSales = TC
Profit
Loss
Effect of Changes on BEP
Changes in fixed costs– Increase in fixed costs
Increases BEP
– Decrease in fixed cost Decrease BEP
Changes in Variable cost– Increase in variable cost
Increases BEP
– Decreases in variable cost Decreases BEP
Changes in Selling Price– Increase in SP
Decrease BEP
– Decrease in SP Increase in BEP
Desired Profit
Firms would like to earn a profit and not just to break even
BEP = FC + Desired Profit
Unit CM
Example 5:
Suppose that selling price is $45, variable cost is $30, and fixed costs are $60,000. The company wants a desired profit of $45,000. What is BEP?
BEP = FC + Unit CM = $60,000 + $45,000 = $105,000 = 7,000 $45- $30 $15
Example 5:
Check Sales – ( FC + VC) = Desired profit ($45 * 7,000) – {$60,000 – ($30 *7,000) = $315,000 – (60,000 + 210,000) = $45,000
Example 6:
Suppose that selling price is $25, variable cost is $15 and fixed costs are $90,000. The company wants a desired profit of $10,000. What is break even point?
BEP = FC + Desired Profit
Unit CM
= $90,000 + $10,000
$10
= 10,000 units
Sales Mix Consideration
More than one product is sold at varying selling prices
Products often have different unit variable costs
Products have different contribution margin
Sales volume necessary must a mix of both products
Example 6:
Cascade Co produces two products Yuk and Gunk. Yuk has a selling price of $90, variable cost of $70 and is 80% of total sales. Gunk has a selling price of $140, variable cost of $95, and is 20% of total sales. Fixed costs are $200,000. What is the break even point for the sales mix?
Example 6:
Product Selling Price
Variable Cost
CM Sales
%
Sales mix CM
Yuk $90 $70 $20 80% $16
Gunk $140 $95 $45 20% $9
$25
Example 6:
BEP = Fixed Costs = $200,000 Sales mix CM $25BEP = 8,000 units
Of what products:
YUK: 8,000 units * 80% = 6,400 unitsGUK: 8,000 units * 20% = 1,600 units
Example 7:
ABC Company has two products Y and X. Y has a selling price of $100, variable costs of $60 and is 70% of total sales. X has a selling price of $50, variable cost of $25. Fixed costs are $248,500. What is BEP?
Example 7:
Product Selling Price
Variable Cost
CM Sales
%
Sales mix CM
Y $100 $60 $40 70% $28
X $50 $25 $25 30% $7.50
$35.50
Example 7:
BEP = Fixed cost
Sales mix CM
= $248,500
$35.50
= 7,000 units
Y: 7,000 units * 70% = 4,900 units
X: 7,000 units * 30% = 2,100 units
Margin of Safety
Indicates possible decrease in sales that may occur before an operating loss occurs.
Ms = S – Sat BEP
Sales
Margin of Safety
If sales are $400,000 and sales at break even are $300,000 what is margin of safety?
Ms = Sales – Sales BEP = $400 - $300
Sales $400
= 25%
Operating Leverage
Relative mix of business variable costs and fixed costs
Contribution margin
Income from operations High = large fixed costs Low – small fixed costs
Remember
Get detailed handouts at http://faculty.mdc.edu/mmari Homework assigned in class.