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# ACC101

C. Gomez

## Chapter 3 | Handout Set #1

Topic: CVP and Cost Concepts

CVP Analysis
Cost-volume-profit (CVP) Analysis is a tool used by managers in order to predict the:

Volume of activity

Costs to be incurred

Sales to be made

Profit to be received

## Components of CVP Analysis

[insert diagram/outline here]
A. Introduction
a. Cost behavior
b. Segregation techniques
c. Assumptions
Essentials of CVP
d. CMs
e. Expressing CVP Relationships
Assumptions
B. Break-even
a. CM
b. BEP
c. Target operating income
d. Target net income and income taxes
C. Using CVP analysis in decision making
a. Decision to advertise
b. Decision to reduce selling price
c. Sensitivity analysis
d. Margin of safety
e. Alternative fixed-cost/variable-cost structures
f. Operating leverage
D. Sales mix/multi-product break-even point

## Assumptions in CVP Analysis

1. A firms total revenue changes in direct proportion to changes in its unit sales volume. That is, the
average sale price per unit of product is constant. (Linear Relationship concept)
2. Total costs can be separated into fixed costs and variable costs.
3. Total variable costs change in direct proportion to changes in sales volume. That is, the average
variable cost per unit remains constant over the relevant range.
4. Total fixed costs (per month or per year) remain constant over the range of sales volume being
considered.
5. Sales mix remains constant over the range of sales volume being considered.
6. Sales volume equals production volume; that is, inventory levels remain constant.

Cost Behavior
Relevant Range
The band or level of activity where the cost concepts and the relationship of variable and fixed costs is
considered valid. There must exist a linear relationship between the cost and the corresponding activity
(cost driver).

## Classes of Cost based on behavior within the relevant range

1. Variable Cost - total cost that fluctuates proportionately to an increase or decrease in the level of
activity.
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ACC101
ACC 101 Cost Accounting
C. Gomez
Total Variable Cost variable

## Chapter 3 | Handout Set #1

Topic: CVP and Cost Concepts

## Unit Variable Cost

2. Fixed Cost total cost that remains the same as activity increases or decreases .
Total Fixed Cost fixed
Unit Fixed Cost - variable

## Unit Fixed cost

Note:
As the volume of sales increases/decreases:

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## VARIABLE COST PER UNIT remains the same

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ACC101
ACC 101 Cost Accounting
Chapter 3 | Handout Set #1
C. Gomez
Topic: CVP and Cost Concepts
3. Semi-variable cost costs that possess both the characteristics of fixed and variable costs. Also
known as mixed cost. Typical items would be taxi fares and electricity bills.

Y dependent variable
a constant
b constant slope
x independent variable
Total cost will always have a fixed cost component and a variable cost component where by fixed cost
is constant while variable cost is dependent on activity.
4. Step-fixed Cost typified by step increases in costs with changes in activity. An analogy that could be
used would be the application of the SSS Contribution table and bus fares.

Step-Variable Cost typified by small increases in costs with changes in activity. The increase in
variable cost is not constant but represented by small increments.

Curvilinear Cost a behavior pattern depicted by a curve graph with decreasing marginal cost at low
levels of activity until a relevant range is achieved and marginal costs will increase when the volume
breaches the relevant range.

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ACC101
ACC 101 Cost Accounting
C. Gomez

## Chapter 3 | Handout Set #1

Topic: CVP and Cost Concepts

Segregation Techniques
In CVP analysis, all costs must be classified as either FIXED or VARIABLE. Therefore, when a cost is
classified as MIXED, the objective is to segregate the FIXED component from the VARIABLE component.
1. Scatter diagrams
2. High-low method
3. Least-squares regression

High-Low Method

It is assumed that semi-variable costs have fixed and variable cost components. The fixed component
is considered the basic or minimum cost of just having a service ready and available for use. The
variable element varies in proportion to the amount of service that is consumed.

It is assumed that the Total Cost is a function (defined as resulting from) of level of activity. F (activity)
Since the total cost is composed of both fixed and variable costs, we could derive the equation:

## Total Cost = Fixed Cost + Variable Cost.

Variable Cost is a function of the level of activity whereby variable cost per unit is a constant:
Total Variable Cost = Variable Cost per unit * Level of Activity
Thus we could derive the function expressed as:
Total Cost = Fixed Cost + Variable Cost per unit * Level of Activity
Y
= a
+
bx
To be able to get the values of a & b, we get two representative points in the line and the
assumption in this theory is that the highest and lowest points are the representative points of the
total activity.

The High-Low point method makes use of the various levels of activity incurred for a certain type of
semi-variable cost. It is assumed that the highest and the lowest points possess the same amount of
total fixed costs (represented by Y) and same variable cost per unit (represented by X).

## An algebraic principle of solving equations with two variables will be used:

Total Semivariable Cost (Highest)
= a + b * Highest Activity
Total Semivariable Cost (Lowest)
= a + b * Lowest Activity
-------------------------------------------------------------------------------Difference in Cost
= 0 + b * Difference in Activity
b = Difference in Cost
Difference in Activity
b = Variable Cost per Unit
Substitute X in the equation and you will get a = Total Fixed Cost

***High-Low Point method is the simplest method but it relies heavily on the assumption that the other
data points lie on a straight line between the highest and lowest points. It defeats the sampling
objective by considering only two samples and entirely disregarding the rest of the samples.

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ACC101
ACC 101 Cost Accounting
C. Gomez

## Chapter 3 | Handout Set #1

Topic: CVP and Cost Concepts

Illustration
Given the following data for Ross Corporations utility costs for the year 2010
Month
January
February
March
April
May
June
July
August
September
October
November
December

Utility Cost
510,000.00
530,000.00
565,000.00
630,000.00
640,000.00
670,000.00
703,500.00
700,000.00
620,000.00
610,000.00
560,000.00
590,000.00

Activity
75,000
78,000
80,000
92,000
98,000
108,000
118,000
112,000
95,000
90,000
85,000
90,000

## REQUIRED: Using High-Low Technique, compute for:

1. Total fixed cost for any level of activity
2. Variable cost per unit
Variable Cost per unit = Difference in Cost of Highest and Lowest Activity
Difference in Activity
= P703,500 P510,000
118,000 75,000
= P4.50
Fixed Cost

## = P510,000 75,000*4.50 OR P703,500 118,000*4.50

= P172,500

Note:

The basis for choosing data for analysis should be the ACTIVITY and not the corresponding cost.

To determine the fixed cost, the data to be used should only be either the Highest or the Lowest
Activity and not any other data point for the assumption to hold.

A deficiency of the high-low method is that it ignores points except the highest and lowest. The
method is crude and will result in the least precise values, but it is the simplest segregation
technique.

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