Chapter 18 Slides MSRE

18-1
COST-VOLUME-
PROFIT
Accounting, Fifth Edition

18-2
Learning Objectives
After studying this chapter, you should be able to:
1. Distinguish between variable and fixed costs.
2. Explain the significance of the relevant range.
3. Explain the concept of mixed costs.
4. List the five components of cost-volume-profit analysis.
5. Indicate what contribution margin is and how it can be expressed.
6. Identify the three ways to determine the break-even point.
7. Give the formulas for determining sales required to earn target net
income.
8. Define margin of safety, and give the formulas for computing it.
18-3
Preview of Chapter 18
Accounting
Fifth Edition
Kimmel Weygandt Kieso
18-4
Cost Behavior Analysis
Cost Behavior Analysis is the study of how specific costs

respond to changes in the level of business activity.
 Some costs change; others remain the same.
 Helps management plan operations and decide between

alternative courses of action.
 Applies to all types of businesses and entities.
 Starting point is measuring key business activities.
18-5 LO 1 Distinguish between variable and fixed costs.

Variable Costs
 Costs that vary in total directly and proportionately with
changes in the activity level.
► Example: If the activity level increases 10 percent, total

variable costs increase 10 percent.
► Example: If the activity level decreases by 25 percent,

total variable costs decrease by 25 percent.
 Variable costs remain the same per unit at every level of

activity.

Illustration 18-1
Variable Costs Behavior of total and
unit variable costs

Fixed Costs
 Costs that remain the same in total regardless of
changes in the activity level.
 Per unit cost varies inversely with activity: As volume

increases, unit cost declines, and vice versa
 Examples:
► Property taxes
► Insurance
► Rent
► Depreciation on buildings and equipment

Illustration 18-2
Fixed Costs Behavior of total and
unit fixed costs

Relevant Range
 Throughout the range of possible levels of activity,
a straight-line relationship usually does not exist for
either variable costs or fixed costs.
 Relationship between variable costs and changes in

activity level is often curvilinear.
 For fixed costs, the relationship is also nonlinear –

some fixed costs will not change over the entire range
of activities, while other fixed costs may change.
18-10 LO 2 Explain the significance of the relevant range.

Illustration 18-3
Relevant Range Nonlinear behavior of
variable and fixed costs

Relevant Range – Range of activity over which

a company expects to operate during a year. Illustration 18-4
Linear behavior within
relevant range

Mixed Costs
Costs that have

both a variable
cost element
and a fixed
cost element.
Sometimes called
semivariable cost.
Change in total
but not
proportionately
Illustration 5-5
with changes in
activity level.
18-13 SO 3: Explain the concept of mixed costs.

Mixed Costs
The total mixed cost line can be expressed

as an equation: Y = a + bX
Where: Y = The total mixed cost.

a = The total fixed cost (the
Y vertical intercept of the line).
b = The variable cost per unit of
Total Utility Cost
activity (the slope of the line).

X = The level of activity.
Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours) Utility Charge
18-14
High-Low Method
 Mixed costs must be classified into their fixed and
variable elements.
 High-Low Method uses the total costs incurred at both

the high and the low levels of activity to classify mixed
costs.
 The difference in costs between the high and low levels

represents variable costs, since only variable costs
change as activity levels change.
18-15 LO 3 Explain the concept of mixed costs.

High-Low Method
Illustration: Metro Transit Company has the following
maintenance costs and mileage data for its fleet of buses
over a 6-month period.
Illustration 18-7
Change in Costs (63,000 - 30,000) $33,000 $1.10

= cost per
High minus Low (50,000 - 20,000) 30,000
unit

High-Low Method
STEP 1: Determine variable cost per unit using the
following formula:
Illustration 18-6

High-Low Method
STEP 2: Determine the fixed cost by subtracting the total
variable cost at either the high or the low activity level from
the total cost at that level.
Illustration 18-8
18-18 LO 3
High-Low Method
Maintenance costs are therefore $8,000 per month plus
$1.10 per mile. This is represented by the following formula:
Maintenance costs = Fixed costs + ($1.10 x Miles driven)
Example: At 45,000 miles, estimated maintenance costs

would be:
Fixed $ 8,000
Variable ($1.10 x 45,000) 49,500
$57,500

Illustration 18-9
Scatter plot for Metro
Transit Company

Cost-Volume-Profit Analysis
CVP Income Statement

 A statement for internal use.
 Classifies costs and expenses as fixed or variable.
 Reports contribution margin in the body of the

statement.
► Contribution margin – amount of revenue remaining
after deducting variable costs.
 Reports the same net income as a traditional income

statement.
18-21 LO 5 Indicate what contribution margin is and how it can be expressed.

Used primarily for Used primarily by
external reporting. management.
18-22

Illustration: Vargo Video produces a high-definition digital
camcorder with 15x optical zoom and a wide-screen, high-
resolution LCD monitor. Relevant data for the camcorders
sold by this company in June 2014 are as follows.
Illustration 18-11


Illustration: The CVP income statement for Vargo Video
therefore would be reported as follows.
Illustration 18-12
18-24 LO 5
Contribution Margin per Unit

 Contribution margin is available to cover fixed costs
and to contribute to income.
 Formula for contribution margin per unit and the

computation for Vargo Video are:
Illustration 18-13


Vargo’s CVP income statement assuming a zero net income.
Illustration 18-14


Assume that Vargo sold one more camcorder, for a total of
1,001 camcorders sold. Illustration 18-15

Contribution Margin Ratio

 Shows the percentage of each sales dollar available
to apply toward fixed costs and profits.
 Formula for contribution margin ratio and the

computation for Vargo Video are:
Illustration 18-17


Assume current sales are $500,000, what is the effect of a
$100,000 (200-unit) increase in sales?
Illustration 18-16


Assume Vargo Video’s current sales are $500,000 and it wants
to know the effect of a $100,000 (200-unit) increase in sales.
Illustration 18-18

Break-Even Analysis
 Process of finding the break-even point level of activity
at which total revenues equal total costs (both fixed
and variable).
 Can be computed or derived

► from a mathematical equation,
► by using contribution margin, or
► from a cost-volume profit (CVP) graph.
 Expressed either in sales units or in sales dollars.
18-31 LO 6 Identify the three ways to determine the break-even point.

Mathematical Equation
Break-even occurs where total sales equal variable costs plus
fixed costs; i.e., net income is zero
Computation of
break-even
point in units.
Illustration 18-20
18-32
LO 6
Contribution Margin Technique

 When the BEP in units is desired, contribution margin
per unit is used in the following formula which shows
the computation for Vargo Video:
Illustration 18-21


 When the BEP in dollars is desired, contribution
margin ratio is used in the following formula which
shows the computation for Vargo Video:
Illustration 18-22

Break-Even Analysis
Graphic
Presentation
Because this graph
also shows costs,
volume, and profits, it
is referred to as a
cost-volume-profit
(CVP) graph.
Illustration 18-23

Target Net Income

 Level of sales necessary to achieve a specified
income.
 Can be determined from each of the approaches used

to determine break-even sales/units:
► from a mathematical equation,
► by using contribution margin, or
► from a cost-volume profit (CVP) graph.
 Expressed either in sales units or in sales dollars.
LO 7 Give the formulas for determining sales

18-36
required to earn target net income.
Target Net Income

Sales necessary to achieve a specified level of income.
Formula for required sales to meet target net income.
Illustration 18-24

18-37
Using the formula for the break-even point, simply include
the desired net income as a factor.
Illustration 18-25
18-38 LO 7

To determine the required sales in units for Vargo Video:
Illustration 18-26

18-39

To determine the required sales in dollars for Vargo Video:
Illustration 18-27

18-40
Margin of Safety
 Difference between actual or expected sales and sales
at the break-even point.
 Measures the “cushion” that management has if expected
sales fail to materialize.
 May be expressed in dollars or as a ratio.
 Assuming actual/expected sales are $750,000:
Illustration 18-28
18-41 LO 8 Define margin of safety, and give the formulas for computing it.
Margin of Safety
 Computed by dividing the margin of safety in dollars by
the actual or expected sales.
 Assuming actual/expected sales are $750,000:
Illustration 18-29
 The higher the dollars or percentage, the greater the

margin of safety.
18-42 LO 8 Define margin of safety, and give the formulas for computing it.
Copyright
“Copyright © 2013 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no responsibility for
errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.”
18-43

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18-1

Accounting, Fifth Edition

After studying this chapter, you should be able to:

1. Distinguish between variable and fixed costs.

2. Explain the significance of the relevant range.

3. Explain the concept of mixed costs.

4. List the five components of cost-volume-profit analysis.

5. Indicate what contribution margin is and how it can be expressed.

6. Identify the three ways to determine the break-even point.

Cost Behavior Analysis is the study of how specific costs

 Some costs change; others remain the same.

 Helps management plan operations and decide between

 Applies to all types of businesses and entities.

 Starting point is measuring key business activities.

18-5 LO 1 Distinguish between variable and fixed costs.

► Example: If the activity level increases 10 percent, total

► Example: If the activity level decreases by 25 percent,

 Variable costs remain the same per unit at every level of

18-6 LO 1 Distinguish between variable and fixed costs.

18-7 LO 1 Distinguish between variable and fixed costs.

 Per unit cost varies inversely with activity: As volume

18-8 LO 1 Distinguish between variable and fixed costs.

18-9 LO 1 Distinguish between variable and fixed costs.

 Relationship between variable costs and changes in

 For fixed costs, the relationship is also nonlinear –

18-10 LO 2 Explain the significance of the relevant range.

18-11 LO 2 Explain the significance of the relevant range.

Relevant Range – Range of activity over which

18-12 LO 2 Explain the significance of the relevant range.

Costs that have

18-13 SO 3: Explain the concept of mixed costs.

The total mixed cost line can be expressed

Where: Y = The total mixed cost.

activity (the slope of the line).

 High-Low Method uses the total costs incurred at both

 The difference in costs between the high and low levels

18-15 LO 3 Explain the concept of mixed costs.

Change in Costs (63,000 - 30,000) $33,000 $1.10

18-16 LO 3 Explain the concept of mixed costs.

18-17 LO 3 Explain the concept of mixed costs.

Maintenance costs = Fixed costs + ($1.10 x Miles driven)

Example: At 45,000 miles, estimated maintenance costs

18-19 LO 3 Explain the concept of mixed costs.

18-20 LO 3 Explain the concept of mixed costs.

CVP Income Statement

 Classifies costs and expenses as fixed or variable.

 Reports contribution margin in the body of the

 Reports the same net income as a traditional income

18-21 LO 5 Indicate what contribution margin is and how it can be expressed.

CVP Income Statement

18-23 LO 5 Indicate what contribution margin is and how it can be expressed.

CVP Income Statement

Contribution Margin per Unit

 Formula for contribution margin per unit and the

18-25 LO 5 Indicate what contribution margin is and how it can be expressed.

Contribution Margin per Unit

18-26 LO 5 Indicate what contribution margin is and how it can be expressed.

Contribution Margin per Unit

18-27 LO 5 Indicate what contribution margin is and how it can be expressed.

Contribution Margin Ratio

 Formula for contribution margin ratio and the

18-28 LO 5 Indicate what contribution margin is and how it can be expressed.

Contribution Margin Ratio