AC239AC239Managerial AccountingManagerial Accounting

Seminar 5Seminar 5Jim Eads, CPA, MST, MSFJim Eads, CPA, MST, MSF

Cost Behavior andCost Behavior andCost-Volume-Profit AnalysisCost-Volume-Profit Analysis

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CostsCosts

Cost behaviorCost behavior refers to the way a cost refers to the way a cost changes in relation to activity changes. changes in relation to activity changes.

Activity baseActivity base (or (or activity driversactivity drivers) is ) is the metric used to evaluate cost the metric used to evaluate cost changes. changes.

Relevant range Relevant range is the range of activity is the range of activity over which the changes in the cost are over which the changes in the cost are of interest.of interest.

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CostsCosts

Variable costsVariable costs are costs that vary are costs that vary in proportion to changes in the in proportion to changes in the level of activity.level of activity.

Fixed costsFixed costs are costs that are are costs that are unaffected by the level of activity.unaffected by the level of activity.

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Total Variable Cost Total Variable Cost GraphGraph

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Unit Variable Cost Unit Variable Cost GraphGraph

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Variable CostVariable Cost

Jason Inc. produces stereo sound Jason Inc. produces stereo sound systems under the brand name of systems under the brand name of J-Sound. The parts for the J-Sound J-Sound. The parts for the J-Sound stereos are purchased from stereos are purchased from outside suppliers for $10 per unit outside suppliers for $10 per unit (a variable cost) and assembled (a variable cost) and assembled in Jason Inc.’s Waterloo plant. in Jason Inc.’s Waterloo plant.

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Fixed CostFixed Cost

The production supervisor for The production supervisor for Minton Inc.’s Los Angeles plant is Minton Inc.’s Los Angeles plant is Jane Sovissi. She is paid $75,000 Jane Sovissi. She is paid $75,000 per year. The plant produces per year. The plant produces from 50,000 to 300,000 bottles of from 50,000 to 300,000 bottles of La Fleur Perfume.La Fleur Perfume.

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Mixed CostMixed Cost

Mixed costMixed cost (sometimes called (sometimes called semivariablesemivariable or or semifixedsemifixed costs) is costs) is a cost with characteristics of both a a cost with characteristics of both a variable and a fixed cost. Over one variable and a fixed cost. Over one range of activity, the total mixed cost range of activity, the total mixed cost may remain the same. Over another may remain the same. Over another range of activity, the mixed cost may range of activity, the mixed cost may change in proportion to changes in change in proportion to changes in level of activity.level of activity.

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Mixed CostMixed Cost

Simpson Inc. manufactures sails Simpson Inc. manufactures sails using rented equipment. The using rented equipment. The rental charges are $15,000 per rental charges are $15,000 per year, plus $1 for each machine year, plus $1 for each machine hour used over 10,000 hours.hour used over 10,000 hours.

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Mixed CostMixed Cost

The The High-low methodHigh-low method is a simple is a simple cost estimate technique that may be cost estimate technique that may be used for separating mixed costs into used for separating mixed costs into their fixed and variable components.their fixed and variable components.

Based on formula:Based on formula:Total Costs = Total Variable Costs + Total Costs = Total Variable Costs +

Total Fixed CostsTotal Fixed Costs

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High – Low MethodHigh – Low Method

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Month Units Total CostJune 1,000 $45,550July 1,500 52,000August 2,100 61,500September 1,800 57,500October 750 41,250

Highest units – lowest units = 2,100 – 750 = 1,350.Highest units cost – lowest units cost = $61,500 - $41,250 = $20,250.Variable cost/unit = $20,250 / 1,350 = $15.00 per unitTotal cost = total variable cost + total fixed cost$61,500 = (2,100 x $15) + total fixed cost$61,500 = $31,500 + total fixed cost$61,500 - $31,500 = total fixed cost$30,000 = total fixed cost

Cost BehaviorCost Behavior Total fixed costs do not vary Total fixed costs do not vary

with levels of productionwith levels of production– Fixed costs per unit decline with Fixed costs per unit decline with

increased productionincreased production Total variable costs vary with Total variable costs vary with

levels of productionlevels of production– Variable costs per unit do not Variable costs per unit do not

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Cost-Volume-ProfitCost-Volume-Profit

Cost-volume-profit analysisCost-volume-profit analysis is is the systematic examination of the the systematic examination of the relationships among selling relationships among selling prices, sales and production prices, sales and production volume, costs, expenses, and volume, costs, expenses, and profits.profits.

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Contribution MarginContribution Margin

Contribution marginContribution margin is the is the excess of sales revenues over excess of sales revenues over variable costs. It contributes first variable costs. It contributes first toward covering fixed costs, then toward covering fixed costs, then contributes to profit.contributes to profit.

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Contribution MarginContribution MarginSales (50,000 units) $1,000,000 100% $20Variable Costs 600,000 60% $12Contribution margin $400,000 40% $8Fixed costs 300,000 30%Income from operations

$100,000 10%

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Contribution Margin Ratio = (sales – variable costs) / sales = ($1,000,000 - $600,000) / $1,000,000 = 40%

Unit Contribution Margin = sales price per unit – variable cost per unit = ($1,000,000 / 50,000) – ($600,000 / 50,000) = $8

Unit Contribution Margin = (sales – total variable cost) / units = ($1,000,000 - $600,000) / 50,000 = $8

Break-Even PointBreak-Even Point

Break-even point:Break-even point: the level of the level of operations at which a business’s operations at which a business’s revenues and costs are exactly revenues and costs are exactly equal. equal.

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Break-Even PointBreak-Even Point

Barker Corporation’s fixed costs are Barker Corporation’s fixed costs are estimated to be $90,000. The unit estimated to be $90,000. The unit contribution margin is calculated as contribution margin is calculated as follows:follows:

Break-even sales = fixed costs / unit contribution marginBreak-even sales = fixed costs / unit contribution margin $90,000 / $10 = 9,000 units$90,000 / $10 = 9,000 unitsTotal revenue = $25 x 9,000 = $225,000Total revenue = $25 x 9,000 = $225,000Total cost = ($15 x 9,000) + $90,000 = $225,000Total cost = ($15 x 9,000) + $90,000 = $225,000

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Unit selling price $25Unit variable cost 15Unit contribution margin

$10

Break-Even PointBreak-Even Point If fixed costs increaseIf fixed costs increase

– Break-even point increasesBreak-even point increases If variable costs increaseIf variable costs increase

– Break-even point increasesBreak-even point increases If sales price increasesIf sales price increases

– Break-even point decreasesBreak-even point decreases

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Example Exercise 21-3Example Exercise 21-3(page 932)(page 932)

Nicholas Enterprises sells a product Nicholas Enterprises sells a product for $60 per unit. The variable cost for $60 per unit. The variable cost is $35 per unit, while fixed costs is $35 per unit, while fixed costs are $80,000.are $80,000.

Determine the (a) break-even point Determine the (a) break-even point in sales units, and (b) break-even in sales units, and (b) break-even point if the selling price were point if the selling price were increased to $67 per unit.increased to $67 per unit.

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Example Exercise 21-3Example Exercise 21-3(page 932)(page 932)

a. Contribution margin per unit = a. Contribution margin per unit = $60 sales price - $35 variable cost = $25$60 sales price - $35 variable cost = $25Break-even units = fixed costs / Break-even units = fixed costs / unit contribution margin =unit contribution margin =$80,000 / $25 = 3,200 units$80,000 / $25 = 3,200 units

Test:Test:Revenue = 3,200 x $60 = $192,000Revenue = 3,200 x $60 = $192,000Costs = (3,200 x $35) + $80,000 = $192,000Costs = (3,200 x $35) + $80,000 = $192,000

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Example Exercise 21-3Example Exercise 21-3(page 932)(page 932)

b. Contribution margin per unit =b. Contribution margin per unit =$67 sales price - $35 variable cost = $32$67 sales price - $35 variable cost = $32Break-even units = fixed costs / Break-even units = fixed costs / unit contribution margin =unit contribution margin =$80,000 / $32 = 2,500 units$80,000 / $32 = 2,500 units

Test:Test:Revenue = 2,500 x $67 = $167,500Revenue = 2,500 x $67 = $167,500Costs = (2,500 x $35) + $80,000 = $167,500Costs = (2,500 x $35) + $80,000 = $167,500

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Break-Even Sales Break-Even Sales VolumeVolume

The sales volume required to earn a The sales volume required to earn a target profit is determined by target profit is determined by modifying the break-even modifying the break-even equation.equation.

Sales in units = (fixed costs + target Sales in units = (fixed costs + target profit) / unit contribution marginprofit) / unit contribution margin

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Example Exercise 21-4Example Exercise 21-4(page 932)(page 932)

The Forest Company sells a product The Forest Company sells a product for $140 per unit. The variable cost for $140 per unit. The variable cost is $60 per unit, and fixed costs are is $60 per unit, and fixed costs are $240,000.$240,000.

Determine the (a) break-even point in Determine the (a) break-even point in sales units, and (b) break-even sales units, and (b) break-even point in sales units if the company point in sales units if the company desires a target profit of $50,000.desires a target profit of $50,000.

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Example Exercise 21-4Example Exercise 21-4(page 932)(page 932)

a. Contribution margin per unit = a. Contribution margin per unit = $140 sales price - $60 variable cost = $80$140 sales price - $60 variable cost = $80Break-even units = fixed costs / Break-even units = fixed costs / unit contribution margin =unit contribution margin =$240,000 / $80 = 3,000 units$240,000 / $80 = 3,000 units

Test:Test:Revenue = 3,000 x $140 = $420,000Revenue = 3,000 x $140 = $420,000Costs = (3,000 x $60) + $240,000 = $420,000Costs = (3,000 x $60) + $240,000 = $420,000

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Example Exercise 21-4Example Exercise 21-4(page 932)(page 932)

b. Contribution margin per unit = b. Contribution margin per unit = $140 sales price - $60 variable cost = $80$140 sales price - $60 variable cost = $80

Break-even units at $50,000 profit = Break-even units at $50,000 profit = fixed costs + target profit / fixed costs + target profit / unit contribution margin =unit contribution margin =($240,000 + $50,000) / $80 = 3,625 units($240,000 + $50,000) / $80 = 3,625 units

Test:Test:Revenue = 3,625 x $140 = $507,500Revenue = 3,625 x $140 = $507,500Costs = (3,625 x $60) + $240,000 = $457,500Costs = (3,625 x $60) + $240,000 = $457,500Profit = $507,500 - $457,500 = $50,000Profit = $507,500 - $457,500 = $50,000

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Questions?Questions?

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One last thought….One last thought….

Make sure you read through Make sure you read through Chapter 22 through page 937 Chapter 22 through page 937 beforebefore next week’s seminar. next week’s seminar.

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