Ch2 Lecture W-Examples

Copyright 2014 Pearson Education, Inc.
publishing as Prentice Hall
2-1
Chapter 2
Introduction to Cost Behavior

and Cost-Volume-Profit
Relationships
Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall
2-2
Chapter 2 Learning Objectives

When you have finished studying this chapter, you
should be able to:
1. Explain how cost drivers affect cost behavior.
2. Show how changes in cost-driver levels affect
variable and fixed costs.
3. Explain step- and mixed-cost behavior.
4. Create a cost-volume-profit (CVP) graph and
understand the assumptions behind it.
5. Calculate break-even sales volume in total dollars
and total units.
2-3
Chapter 2 Learning Objectives
6. Calculate sales volume in total dollars and total

units to reach a target profit.
7. Differentiate between contribution margin and
gross margin.
8. Explain the effects of sales mix on profits
(Appendix 2A).
9. Compute cost-volume-profit (CVP) relationships on
an after-tax basis (Appendix 2B).
2-4
Cost Drivers and Cost Behavior

Cost drivers are measures
of activities that require
the use of resources
and thereby cause costs.
Cost behavior is how the
activities of an
organization affect its costs.
2-5
Learning
Objective 1
Cost Drivers and Cost Behavior
2-6
Value Chain Functions, Costs, and Cost Drivers

Value Chain Function
Example Cost Drivers
And Resource Costs

Research and development
Salaries of sales personnel
Number of new product proposals
costs of market surveys

Salaries of product and process
Complexity of proposed products
engineers
Design of products, services, and
processes
Salaries of product and process
Number of engineering hours
engineers
Cost of computer-aided design
equipment used to develop
Number of distinct parts per

product
prototype of product for testing

2-7

and Resource Costs
Production
Labor wages
Supervisory salaries
Maintenance wages
Depreciation of plant and machinery,
supplies
Energy cost
Marketing
Cost of advertisements
Salaries of marketing personnel,
travel costs, entertainment costs
Labor hours
Number of people supervised
Number of mechanic hours
Number of machine hours
Kilowatt hours
Number of advertisements
Sales dollars
2-8

And Resource Costs
Distribution
Wages of shipping personnel
Labor hours
Transportation costs including
Weight of items delivered
depreciation of vehicles and fuel
Customer service
Salaries of service personnel
Costs of supplies, travel
Hours spent servicing products

Number of service calls
2-9
Learning
Objective 2
Variable and Fixed Cost Behavior
A variable cost
changes in direct
proportion to changes
in the cost-driver level.
Think of variable
costs on a per-unit basis.
The per-unit variable
cost remains unchanged
regardless of changes in
the cost-driver.
A fixed cost is
not immediately
affected by changes
in the cost-driver level.
Think of fixed costs

on a total-cost basis.
Total fixed costs remain

unchanged regardless of
changes in the cost-driver.
2 - 10
Cost Behavior of Variable and Fixed
2 - 11
Cost Behavior: Further Considerations
Cost behavior depends on the decision

context, the circumstances surrounding
the decision for which the cost will be
used.
Cost behavior also depends on
management decisionsmanagement
choices determine cost behavior.
2 - 12
Relevant Range
The relevant range is the limit
of cost-driver activity level within which a
specific relationship between costs
and the cost driver is valid.
Even within the relevant range, a fixed

cost remains fixed only over a given
period of timeusually the budget period.
2 - 13
Fixed Costs and Relevant Range
2 - 14
HWK 2-A1
Copyright 2011 Pearson Education, Inc., Publishing as Prentice Hall.

15
HWK 2-A1: PART 1
What resources are available?
Labor - Fixed
Cleaning Supplies - Variable
16
HWK 2-A1: PART 2
17
Step- and Mixed-Cost

Behavior Patterns
Learning
Objective 3
Step cost:
A cost that changes
abruptly at different
intervals of activity
because the
resources and their
costs come in
indivisible chunks.
Mixed Cost:
A cost that contains
elements of both
fixed- and variablecost behavior
2 - 18
Step-Cost Behavior
Step cost treated as a fixed cost
Step cost treated as a variable cost
2 - 19
Learning
Objective 4
Cost-volume-profit (CVP)
analysis
Managers trying to evaluate the effects of

changes in volume of goods or services produced
might be interested in upward changes such as
increased sales expected from increases in
promotion or advertising.
AND
Managers might be interested in downward
changes such as decreased sales expected due to
a new competitor entering the market or due to a
decline in economic conditions.
2 - 20
CVP Scenario
Cost-volume-profit (CVP) analysis is the study of the
effects of output volume on revenue (sales), expenses
(costs), and net income (net profit).
Per Unit
Selling price
Variable cost of each item
Selling price less variable cost
$1.50
1.20
$ .30
Percentage of
Sales
100%
80
20%
Monthly fixed expenses:

Rent
$3,000
Wages for replenishing and
servicing
13,500
Other fixed expenses
1,500
Total fixed expenses per month $18,000
2 - 21
Cost-Volume-Profit Graph
$150,000
138,000
Dollar
s
120,000
Net Income
Area D
90,000
Total
60,000Expenses
B
18,000
0
10
20
Break-Even
Point 60,000
units
or
$90,000
Net
Loss
Area
30,000
30
40
50
Sale
s
60
70
80
90 100
Net
Income
Variable
Expense
s
Fixed
Expenses
Units (thousands)
2 - 22
SOLUTION 2-33
BE
Cost Volume-Profit
graph for case 2
$80,000
Using the graph, the

estimated breakeven
point in total units sold
is about 80,000.
The estimated net
income for 100,000
units sold is $80,000
($1,000,000 $920,000).
23
SOLUTION 2-34
BE
Cost Volume-Profit graph

for case 4
$88,000
Using the graph, the

estimated breakeven point
in total units sold is about
60,000 (actual breakeven
volume is 58,800).
The estimated net loss for
50,000 units sold is
$88,000 (revenue of
$1,500,000 total cost of
$1,588,000 or CM of
$500,000 less fixed cost of
$588,000).
24
Learning
Objective 5
Break-Even Point
The break-even point is the level of sales at which

revenue equals expenses and net income is zero.
Sales
- Variable expenses
- Fixed expenses
Zero net income (break-even point)
2 - 25
Contribution Margin Method
Contribution margin
Contribution margin ratio
Per Unit
Per Unit
%
Selling price
$1.50
Selling price
100
Variable costs
1.20Variable costs
80
Contribution margin
$ .30Contribution margin
20
$18,000 fixed costs $.30 =

60,000 units (break even)
2 - 26
Contribution Margin Method
60,000 units $1.50 (Sales Price) = $90,000

in sales to break even
$18,000 fixed costs

20% (contribution-margin percentage)
= $90,000 of sales to break even
2 - 27
Equation Method
Let N = number of units
to be sold to break even.
Variable
Fixed
Sales Expenses Expenses = net income
$1.50N $1.20N $18,000 = 0
$.30N = $18,000
N = $18,000 $.30
N = 60,000 Units
2 - 28
Equation Method
Let S = sales in dollars
needed to break even.
S .80S $18,000 = 0
.20S = $18,000
S = $18,000 .20
S = $90,000
Shortcut formulas:
Break-even
=
fixed expenses
= $18,000 =
volume in units
unit contribution margin
.30
60,000
Break-even
=
fixed expenses
= $18,000 = $90,000
volume in sales
contribution margin ratio
.2
2 - 29
CHAPTER 2
Objectives
5. Calculate break-even sales volume in total

dollars & total units
Possible Question:
Abbott Company sells desks at $480 per desk. The variable costs are $372 per
desk. Total fixed costs for the period are $456,840. The break-even volume in
dollars is ________.

30
Learning
Objective 6
Target Net Profit

Managers use CVP analysis
to determine the total sales,
in units and dollars, needed
to reach a target net profit.
Target sales
variable expenses
fixed expenses
target net income
$1,440 per month

is the minimum
acceptable
net income.
2 - 31
Target Net Profit

Target sales volume in units =
(Fixed expenses + Target net income)
Contribution margin per unit
Selling price
Variable costs
Contribution margin per unit
$1.50
1.20
$ .30
($18,000 + $1,440) $.30 = 64,800 units

Target sales dollars = sales price X sales volume in units
Target sales dollars = $1.50 X 64,800 units = $97,200.
2 - 32
Target Net Profit

Contribution margin ratio
Per Unit
%
Selling price
100
Variable costs
80
Contribution margin 20
Target sales volume in dollars =
Fixed expenses + target net income
contribution margin ratio
Sales volume in dollars =
18,000 + $1,440 = $97,200
.20
2 - 33
Nonprofit Application
Suppose a city has a $100,000
lump-sum budget appropriation
to conduct a counseling program.
Variable costs per prescription
are $400 per patient per day.
Fixed costs are $60,000 in the
relevant range of 50 to 150 patients.
2 - 34
If the city spends the entire budget
appropriation, how many patients
can it serve in a year?
Variable + Fixed
Sales
= expenses + expenses
$100,000 =
$400N + $60,000
$400N = $100,000 $60,000
N = $40,000 $400
N = 100 patients
2 - 35
If the city cuts the total budget appropriation by
10%, how many patients can it serve in a year?
Budget after 10% Cut
$100,000 X (1 - .1) = $90,000
Variable
+ Fixed
Sales
= expenses + expenses
$90,000 = $400N + $60,000
$400N = $90,000 $60,000
N = $30,000 $400
N = 75 patients
2 - 36
Operating Leverage
Low leveraged firms have lower fixed costs
and higher variable costs.
Changes in sales volume will have a
smaller effect on net income.
Margin of safety = planned unit sales

break-even sales. How far can sales fall
below the planned level before losses occur?
2 - 37
Operating Leverage
Operating leverage:
a firms ratio of fixed costs to variable costs.
Highly leveraged firms have high fixed costs

and low variable costs. A small change in sales
volume = a large change in net income.
2 - 38
PROBLEM 2-42 16TH ED

2- 38 Motel 6 pioneered the economy-lodging brand in 1962. It
now has 91,000 rooms in 1,000 locations (average is 91 rooms) in
the United States and Canada. Suppose a particular Motel 6 has
annual fixed costs of $1.2 million for its 100-room motel, average
daily room rents of $ 50, and average variable costs of $10 for each
room rented. It operates 365 days per year.
1. How much revenue on rooms will Motel 6 generate
( a) if the motel is completely full through-out the entire year and
( b) if the motel is half full?
2. Compute the break- even point in number of rooms rented. What
percentage occupancy for the year is needed to break even?
39
PROBLEM 2-38 CONTINUED

What we know
Fixed Cost = $1,200,000
Capacity = 100 rooms
Price of Room = $50
Variable Costs = $10/room rented
Operation = 365 days
Profit = Revenue Cost
40
SOLUTION 2-38 1A
( a) if the motel is completely full through-out the entire year
Full through-out the entire year = 100 rooms rented x 365 days
= 36,500 rooms rented
Revenue = Price x Units
Revenue = 36,500 rooms rented x $50 per room rented
= $1,825,000

41
SOLUTION 2-38 1B
( a) if the motel is half full through-out the entire year
Half full through-out the entire year = 50 rooms rented x 365 days
= 18,250 rooms rented
Revenue = Price x Units
Revenue = 18,250 rooms rented x $50 per room rented
= $ 912,500
Shortcut: $1,825,000 x50%

42
SOLUTION 2-38 2
Profit = Revenue Cost
*Profit = zero for break even
0 = Revenue Cost
= (Price x Units sold) (Fixed cost + Variable costs)
=($50 x ##) - ($1,200,000 + $10 x ## )
=$50 x ## - $1,200,000 - $10 x ##
= ##($50-$10) - $1,200,000
$1,200,000 = ##($40)
30,000 = ## rooms rented
Ans. 30,000 rooms rented

43
SOLUTION 2-38 2 CONTINUED

% Occupancy for year = Used / Total Capacity
= 30,000 rooms rented / 36,500 rooms rented
= 82.2%
*For the A: Is this a good number? Explain.

44
Learning
Objective 7
Contribution Margin
and Gross Margin
2 - 45
Contribution Margin
and Gross Margin
Sales price Cost of goods sold = Gross margin
Sales price - all variable expenses =

Contribution margin
Per Unit
Selling price
$1.50
Variable costs (acquisition cost) 1.20
Contribution margin and
gross margin are equal
$ .30
2 - 46
Contribution Margin and Gross Margin
Suppose the firm paid a commission of $.12 per unit sold.
Contribution Gross
Margin
Margin
Per Unit
Per Unit
Sales
$1.50
$1.50
Acquisition cost of unit sold
1.20
1.20
Variable commission
.12
Total variable expense
$1.32
Contribution margin
.18
Gross margin
$.30
2 - 47
HWK 2-32
48
HWK 2-32
49
Learning
Objective 8
Appendix 2A
Sales Mix Analysis
Sales mix is the relative proportions or

combinations of quantities of products
that comprise total sales.
If the proportions of the mix change,
the cost-volume-profit relationships
also change.
2 - 50
Sales Mix Analysis

Ramos Company Example
Wallets
(W)
Key Cases
(K)
Sales in units
300,000
75,000
Sales @ $8 and $5
$2,400,000 $375,000
Variable expenses
@ $7 and $3
2,100,000
225,000
Contribution margins
@ $1 and $2
$ 300,000 $150,000
Fixed expenses
Net income
Total
375,000
$2,775,000
2,325,000
$
450,000
180,000
$ 270,000
2 - 51
Sales Mix Analysis

Let K = number of units of K to break even, and
4K = number of units of W to break even.
Break-even point for a constant sales mix of 4 units of W
for every unit of K.
sales variable fixed
= zero net income
expense expenses
[$8(4K) + $5(K)] [$7(4K) + $3(K)] $180,000 = 0
32K + 5K - 28K - 3K - 180,000 = 0
6K = 180,000
K = 30,000
W = 4K = 120,000
30,000K + 120,000W = 150,000 total units (K + W).
2 - 52
Sales Mix Analysis

If the company sells only key cases:
break-even point =
fixed expenses
contribution margin per unit
=
$180,000
$2
= 90,000 key cases
If the company sells only wallets:

break-even point =
fixed expenses
contribution margin per unit
=
$180,000
$1
= 180,000 wallets
2 - 53
Sales Mix Analysis

Suppose total sales
were equal to the
budget of 375,000 units.
However, Ramos sold
only 50,000 key cases
And 325,000 wallets.
What is net income?
2 - 54
Sales Mix Analysis

Ramos Company Example
Wallets Key Cases
(W)
(K)
Total
Sales in units
Sales @ $8 and $5
Variable expenses
@ $7 and $3
Contribution margins
@ $1 and $2
Fixed expenses
Net income
325,000
$ 2,600,000
2,275,000
$
325,000
50,000
375,000
$250,000 $2,850,000
150,000
2,425,000
$100,000 $
425,000
180,000
$ 245,000
2 - 55
Learning
Objective 9
Impact of Income Taxes
Income taxes do not affect the break-even point.

There is no income tax at a level of zero income.
Income taxes affect the calculation of the volume
required to achieve a specified after-tax target
profit.
Suppose that a company earns $1,440 before

Taxes and pays income tax at a rate of 40%.
2 - 56
Suppose the target net income after taxes was $864
Target income before taxes = Target after-tax net income

1 tax rate
Target income before taxes = $ 864 = $1,440

1 0.40
2 - 57

Target sales - Variable expenses - Fixed expenses
= Target after-tax net income (1 tax rate)
$1.50N - $1.20N - $18,000 = $864 (1 0.40)

$.30N = $18,000 + ($864/.6)
$.18N = $10,800 + $864 = $11,664
N = $11,664/$.18
N = 64,800 units
2 - 58
Suppose target net income after taxes was $1,440
$1.50N - $1.20N - $18,000 = $1,440 (1 0.40)

$.30N = $18,000 + ($1,440/.6)
$.18N = $10,800 + $1,440 = $12,240
N = $12,240/$.18
N = 68,000 units
2 - 59
All rights reserved. No part of this publication

may be reproduced, stored in a retrieval system,
or transmitted, in any form or by any means,
electronic, mechanical, photocopying, recording,
or otherwise, without the prior written permission
of the publisher. Printed in the United States of
America.
2 - 60

Ch2 Lecture W-Examples

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Ch2 Lecture W-Examples

Uploaded by

Copyright:

Available Formats

Copyright 2014 Pearson Education, Inc.

publishing as Prentice Hall

Introduction to Cost Behavior

Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall

Chapter 2 Learning Objectives

Chapter 2 Learning Objectives

6. Calculate sales volume in total dollars and total

Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall

Cost Drivers and Cost Behavior

Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall

Cost Drivers and Cost Behavior

Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall

Value Chain Functions, Costs, and Cost Drivers

Example Cost Drivers

And Resource Costs

Number of new product proposals

costs of market surveys

Complexity of proposed products

Number of engineering hours

Number of distinct parts per

prototype of product for testing

Value Chain Functions, Costs, and Cost Drivers

Value Chain Function

Example Cost Drivers

Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall

Value Chain Functions, Costs, and Cost Drivers

Value Chain Function

Example Cost Drivers

Hours spent servicing products

Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall

Variable and Fixed Cost Behavior

Think of fixed costs

Total fixed costs remain

Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall

Cost Behavior of Variable and Fixed

Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall

Cost Behavior: Further Considerations

Cost behavior depends on the decision

Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall

Even within the relevant range, a fixed

Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall

Fixed Costs and Relevant Range

Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall

Copyright 2011 Pearson Education, Inc., Publishing as Prentice Hall.

HWK 2-A1: PART 1

What resources are available?

Copyright 2011 Pearson Education, Inc., Publishing as Prentice Hall.

HWK 2-A1: PART 2

Copyright 2011 Pearson Education, Inc., Publishing as Prentice Hall.

Step- and Mixed-Cost

Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall

Step cost treated as a variable cost

Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall

Managers trying to evaluate the effects of

Monthly fixed expenses:

Using the graph, the

Cost Volume-Profit graph

Copyright 2011 Pearson Education, Inc., Publishing as Prentice Hall.

Using the graph, the

The break-even point is the level of sales at which

Copyright 2014 Pearson Education, Inc. publishing as Prentice Hall

Contribution Margin Method

$18,000 fixed costs $.30 =