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CHAPTER 18

CHAPTER 18. Cost Behavior & Cost-Volume-Profit Analysis. Cost Behavior. In planning, we must understand how costs behave. For example, do costs change as production activity changes or do they stay the same?

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CHAPTER 18

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  1. CHAPTER 18 Cost Behavior & Cost-Volume-Profit Analysis

  2. Cost Behavior • In planning, we must understand how costs behave. • For example, do costs change as production activity changes or do they stay the same? • __________– costs that increase as production activity increases (direct materials, direct labor) • __________– costs that stay the same over a range of activity levels (depreciation, rent) within a given time period.

  3. Variable Costs Total Variable Cost Graph Unit Variable Cost Graph $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $20 $15 $10 $5 Cost per Unit Total Costs 0 10 20 30 Units Produced (000) 0 10 20 30 Units Produced (000) Units Total Cost Produced Cost per Unit 5,000 $ 50,000 $10 10,000 100,000 10 15,000 150,000 10 20,000 200,000 10 25,000 250,000 10 30,000 300,000 10

  4. Fixed Costs Total Fixed Cost Graph Unit Fixed Cost Graph $150,000 $125,000 $100,000 $75,000 $50,000 $25,000 $1.50 $1.25 $1.00 $.75 $.50 $.25 Total Costs Cost per Unit 0 0 100 200 300 100 200 300 Units Produced (000) Units Produced (000) Units Total Cost Produced Cost per Unit 50,000 $75,000 $1.500 100,000 75,000 .750 150,000 75,000 .500 200,000 75,000 .375 250,000 75,000 .300 300,000 75,000 .250

  5. Relevant Range • Cost relationships remain stable only over some range of production activity. • Outside that range the relationships may change. • __________is the expected range of activity we are interested in. • We estimate the cost relationships within that range. • We cannot extrapolate outside the range.

  6. Cost Behavior • __________Costs • include both fixed and variable costs; we separate fixed from variable costs when perform cost-volume profit analysis. • __________Costs • fixed within a relevant range, but if total production increases significantly, total costs increase by a lump sum amount • __________Costs • increase at a non-constant rate as volume increases.

  7. Mixed Costs • Some costs have a _______component and a __________component. • We can separate mixed costs into the two components using the ________________. $ Total costs Equation of line : y = a + bx Slope = VC/unit FC activity

  8. Mixed Costs Total Mixed Cost Graph $40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 Mixed costs are sometimes called semivariable or semifixed costs. Total Costs Mixed costs are usually separated into their fixed and variable components for management analysis. 0 10 20 30 40 Total Machine Hours (000)

  9. Identifying and MeasuringCost Behavior The objective is to classifyall costs as either fixed or variable.

  10. Measuring Cost Behavior: Scatter Diagram … 20 * * * * * * * * Total Cost in1,000’s of Dollars * * 10 0 0 1 2 3 4 Activity, 1,000s of Units Produced • A __________of past cost behavior may be helpful in analyzing mixed costs. Draw a line through the plotted data points so that about equal numbers of points fall above and below the line. Estimated fixed cost = 10,000

  11. Measuring Cost Behavior: Scatter Diagram … Δin costΔin units 20 * * * * * * * * Total Cost in1,000’s of Dollars * * 10 0 0 1 2 3 4 Activity, 1,000s of Units Produced Variable Cost unit= Slope = Vertical distance is the change in cost. Horizontal distance is the change in activity.

  12. Measuring Cost BehaviorHigh/Low Method • Determine the __________by finding the slope • change in ____÷ change in _____ • (see prev. slide) • Determine the __________component • Using the high (or the low) point, plug in the cost (y), the activity (x), and the slope (VC/unit). • Solve for the y- intercept. • Given the equation of the cost line, we can now use it to predict cost over some range of activity.

  13. Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total Units Cost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level Lowest level Difference

  14. Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total UnitsCost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level Difference

  15. Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total UnitsCost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level 750 41,250 Difference

  16. Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total UnitsCost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level 750 41,250 Difference 1,350 $20,250 Difference in total cost Difference in production Variable cost per unit 1 =

  17. Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total UnitsCost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level 750 41,250 Difference 1,350 $20,250 Difference in total cost Difference in production $20,250 1,350 units Variable cost per unit 1 = = = $15

  18. Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total UnitsCost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level 750 41,250 Difference 1,350 $20,250 Difference in total cost Difference in production $20,250 1,350 units Variable cost per unit 1 = = = $15 Total cost Fixed cost Variable cost per unit Units of production 2 = – x

  19. Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total UnitsCost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level 750 41,250 Difference 1,350 $20,250 Difference in total cost Difference in production $20,250 1,350 units Variable cost per unit 1 = = = $15 Total cost Fixed cost Variable cost per unit Units of production 2 = – x = – = Highest level: $61,500 ( $15 x 2,100 ) $30,000

  20. Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total UnitsCost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level 750 41,250 Difference 1,350 $20,250 Difference in total cost Difference in production $20,250 1,350 units Variable cost per unit 1 = = = $15 Total cost Fixed cost Variable cost per unit Units of production 2 = – x = – = Highest level: $61,500 ( $15 x 2,100 ) $30,000 = – = Lowest level: $41,250 ( $15 x 750 ) $30,000

  21. Mixed Costs: High-Low Method Actual costs incurred Highest and lowest levels Production Total UnitsCost Production Total Units Cost June 1,000 $45,550 July 1,500 52,000 August 2,100 61,500 September 1,800 57,500 October 750 41,250 Highest level 2,100 $61,500 Lowest level 750 41,250 Difference 1,350 $20,250 Difference in total cost Difference in production $20,250 1,350 units Variable cost per unit 1 = = = $15 Total cost Fixed cost Variable cost per unit Units of production 2 = – x = – = Highest level: $61,500 ( $15 x 2,100 ) $30,000 = – = Lowest level: $41,250 ( $15 x 750 ) $30,000

  22. Cost-Volume-Profit & Breakeven Analysis • Given our fixed and variable costs, we can use CVP techniques to help predict our profit at various activity levels. • We define • __________= Sales – VC • __________= SP/unit – VC/unit • __________= CM/SP

  23. Related Questions • We can use this set of techniques to answer the following types of questions. • How many units do we need to sell to break even? • How much profit will we generate at a given level of sales? • If we want to earn a target profit, how many units do we need to sell? • If we change our sales price, what happens to our profitability?

  24. Computing Break-Even Point Contribution margin is amount by which revenue exceeds the variable costsof producing the revenue.

  25. Computing Break-Even Point P2 How much contribution margin must this company have to cover its fixed costs (break even)? Answer: $24,000

  26. Computing Break-Even Point P2 How many units must this company sell to cover its fixed costs (i.e. to break even)? Answer: $24,000 ÷ $30 per unit = 800 units

  27. Breakeven Sales • Sales = VC + FC + profit or • Profit = Sales – VC – FC • At breakeven, profit = 0 • 0 = (Sales – VC) – FC • 0 = CM - FC • CM = FC or • (CM/unit)(units) = FC • And Breakeven Units = FC/(CM/unit) • Or Breakeven in $ = FC/(CM ratio)

  28. Target Net Income • You can use the CVP idea to determine how much we can sell to earn a desired profit. • Profit = Sales – VC – FC • Profit + FC = Sales – VC = CM = CM/unit(units) • Target Salesunits= (FC + Profit) / CM/unit • Target Sales$ = (FC + Profit) / CM ratio

  29. __________is the amount by which sales can drop before the company incurs a loss. Margin of safety may be expressed as a percentage of expected sales. Margin of Safety Margin of safety Expected sales - Break-even salespercentage Expected sales = C3 Exh. 22-17

  30. Breakeven for Multiple Products • BEunits= FC/(CMcomposite), where • CMcomposite = [(%A)CMA+ (%B) CMB] • The number of units that we get will be a combined unit of A and B together. • You then have to determine the number of A and B each that are actually sold.

  31. Breakeven for Multiple Products - Example • If FC = $100,000 and CM(a) = $40 and CM(b) = $20, and we sell 3 times as many units of B as A, what is the BE point? • BEunits= 100,000/[(0.25)($40) + (0.75)($20)] = 4,000 units • A = (0.25)(4,000) or 1,000 units of A • B = (0.75)(4,000) or 3,000 units of B

  32. Operating Leverage Contribution margin Net income Degree of ____________________= A measure of the extent to which fixed costs are being used in an organization. A measure of how a percentage change in sales will affect profits.

  33. Contribution Margin Reporting • We can recast the income statement to highlight the contribution margin. • Sales • - VC • = CM • - FC • = operating income For Internal Reporting purposes only

  34. The End!! Now, let’s look at the quick studies!

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