Professional Documents
Culture Documents
Prepared by
Karleen Nordquist..
The College of St. Benedict...
and St. John’s University...
with contributions by
Marianne Bradford..
The University of Tennessee...
Gregory K. Lowry….
Macon Technical Institute…..
Cost-Volume-Profit Relationships
Preview of Chapter 5
COST-VOLUME-
Cost Behavior Analysis
PROFIT
• Variable Costs
RELATIONSHIPS
• Fixed Costs
• Relevant Range
• Mixed Costs
• Identifying Variable and Fixed
Costs
Preview of Chapter 5
Cost-Volume-Profit Analysis
COST-VOLUME-
• Basic Components
PROFIT
• Contribution Margin
RELATIONSHIPS
• Break-Even Analysis
• Margin of Safety
• Target Net Income
• Changes in Business
Environment
• CVP Income Statement
Cost Behavior Analysis
§ Cost behavior analysis is the study of how specific
costs respond to changes in the level of activity within
a company.
§ The starting point in cost behavior analysis is
measuring the key activities in the company’s
business.
§ Activity levels may be expressed in terms of
– sales dollars (retail company),
– miles driven (trucking company),
– room occupancy (hotel), or
– number of dance classes taught (dance studio).
Cost Behavior Analysis
§ For an activity level to be useful in cost
behavior analysis, there should be correlation
between changes in the level or volume of
activity and changes in the costs.
§ The activity level selected is referred to as the
activity (or volume) index.
§ The activity index identifies the activity that
causes changes in the behavior of costs.
Study Objective 1
$100 $25
80
60 15
40 10
20 5
0 0
0 2 4 6 8 10 0 2 4 6 8 10
Illustration 5-1 Radios produced in (000) Radios produced in (000)
Fixed Costs
Fixed costs are costs that remain the same in
total regardless of changes in the activity level.
$25 $5
20 4
15 3
10 2
5 1
0 0
0 2 4 6 8 10 0 2 4 6 8 10
Radios produced in (000) Radios produced in (000)
Illustration 5-2
Study Objective 2
Cost ($)
part (a) on the right. The
behavior of total fixed
costs through all levels
of activity is shown in
0 20 40 60 80 100 0 20 40 60 80 100
part (b). Illustration 5-3 Activity level (%) Activity level (%)
Linear Behavior Within
Relevant Range
Operating at zero or at 100% capacity is the exception for most
companies. Companies usually operate over a narrower range – such
as 40-80% of capacity. The relevant range of the activity index is the
range over which a company expects to operate during a year.
(a) Total (b)
Within this range, as Variable Costs Total Fixed Costs
Curvilinear Nonlinear
shown in both
diagrams to the right, a Relevant
Range
Relevant
Range
straight-line
Cost ($)
Cost ($)
relationship normally
exists for both fixed
and variable costs.
0 20 40 60 80 100 0 20 40 60 80 100
Illustration 5-4 Activity level (%) Activity level (%)
Study Objective 3
Cost
100
driven, while the mileage Variable Cost Element
charge is a variable cost.
50
The graphic presentation of Fixed Cost Element
the rental cost for a one-day 0
rental is shown on the right. 0 50 100 150 200
Miles
250 300
Illustration 5-5
Mixed Cost Classification
for CVP Analysis
§ In CVP analysis, it is assumed that mixed costs
must be classified into their fixed and variable
elements.
§ Firms usually ascertain variable and fixed costs on
an aggregate basis at the end of a time period,
using the company’s past experience with the
behavior of the mixed cost at various activity levels.
§ The high-low method is a mathematical method
that uses the total costs incurred at the high and low
levels of activity.
The High-Low Method
The steps in calculating fixed and variable costs
under this method are as follows:
1 Determine variable cost per unit from the following
formula:
Change in High minus Low Variable Cost
Total Costs ÷ Activity Level = per Unit
Illustration 5-6
Illustration 5-10
Study Objective 5
Contribution
Sales
- Variable Costs = Margin
Contribution Contribution
Margin per Unit ÷ Unit Selling Price = Margin Ratio
Illustration 5-14
Break-Even Analysis:
Mathematical Equation for Dollars
The break-even point in dollars is found by
expressing variable costs as a percentage of unit
selling price.
§ For Vargo Video, the percentage is 60% ($300 ÷
$500). Sales must be $500,000 for Vargo Video to
break even. The computation to determine sales
dollars at the break-even point is:
X = .60X + $200,000
.40X = $200,000
X = $500,000
where:
X = sales dollars at the break-even point
.60 = variable costs as a percentage of unit selling price
$200,000 = total fixed costs
Illustration 5-15
Break-Even Analysis:
Mathematical Equation for Units
The break-even point in units can be computed
directly from the mathematical equation by using
unit selling prices and unit variable costs. Vargo
must sell 1,000 units to break even. The
computation is:
$500X = $300X + $200,000
$200X = $200,000
X = 1,000 units
where:
X = sales volume
$500 = unit selling price
$300 = variable cost per unit
$200,000 = total fixed costs
Illustration 5-16
Break-Even Analysis:
Mathematical Equation Proof
Illustration 5-16
Break-Even Analysis:
CM Technique for Units
Because we know that CM equals total revenues less
variable costs, it follows that at the break-even point,
contribution margin must equal total fixed costs.
When the CM per unit is used, the formula to compute
break-even point in units is shown below:
§ Once again, the CM per unit for Vargo Video is $200.
recorded on the 200 400 600 800 1000 1200 1400 1600 1800
vertical axis. Units of Sales Illustration 5-20
Study Objective 7
Target
Required Variable Fixed
Sales = Costs + Costs + Net
Income
Illustration 5-23
Illustration 5-30
Traditional versus CVP
Income Statement
§ The CVP income statement and the traditional
income statement based on this data are shown
side-by-side on the next slide.
§ Note that net income is the same ($120,000) in
both of the statements.
§ The major difference is the format for the
expenses.
§ Also, the traditional statement shows gross profit,
whereas the CVP statement shows contribution
margin.
Traditional versus CVP
Income Statement
VARGO VIDEO COMPANY
Income Statement
For the Month Ended June 30, 1999
Traditional Format CVP Format
Sales $ 800,000 Sales $ 800,000
Cost of goods sold 520,000 Variable expenses
Gross profit 280,000 Cost of goods sold $ 400,000
Operating expenses Selling expenses 60,000
Selling expenses $ 100,000 Administrative expenses 20,000
Administrative expenses 60,000 Total variable expenses 480,000
Total operating expenses 160,000 Contribution margin 320,000
Net income $ 120,000 Fixed expenses
Cost of goods sold 120,000
Selling expenses 40,000
Administrative expenses 40,000
Total fixed expenses 200,000
Net income $ 120,000
Illustration 5-31
Appendix 5A
Variable Costing
Appendix 5A
Study Objective 10
Illustration 5A-2
=
Units Produced = Units Sold
>
Units Produced > Units Sold
<
Units Produced < Units Sold
Illustration 5A-5
Rationale for Variable
Costing
§ The rationale for variable costing focuses on the
purpose of fixed manufacturing costs, which is
to have productive facilities available for use.
§ Defenders of absorption costing justify the
assignment of fixed manufacturing overhead
costs to inventory on the basis that these costs are
as much a cost of getting a product ready for sale
as direct materials or direct labor.
§ The use of variable costing in product costing is
acceptable only for internal use by management.
Copyright
Copyright © 1999 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that named 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.
Chapter 5
Cost-Volume-Profit Relationships