Cost Volume Profit AnalysisCost Behavior

Cost BehaviorUnderstanding cost behavior enables managers to anticipate changes in cost when the organizations level of activity changesCost predictions facilitate planning, cost management and decision making.

Cost Behavior in Other IndustriesExamples of variable costs

Examples of fixed costsCost Behavior in Other Industries

Fixed MonthlyUtility ChargeVariable Utility ChargeActivity (Kilowatt Hours) Total Utility CostTotal semivariable costSemivariable Cost

Relevant RangeCost predictions should be confined to the relevant range , which is the range of activity expected for the organization.

Curvilinear CostCurvilinearCost FunctionActivity

Account-Classification MethodHigh-Low MethodLeast-Squares Regression MethodCost Estimation

CVP AnalysisStudies the effect of output volume on sales, costs and profitTo apply CVP analysis ,managers usually resort to some simplifying assumptionsThe major simplification is to classify costs as either variable or fixed with respect to single measure of volume of output activity

CVP statementSales

Less: Variable Cost_________ Contribution Less: Fixed Cost ____________ Profit

Break - Even PointBEP is the level of sales where Revenue equals ExpensesAt BEP sales , there is no profit or lossBEP in units = Fixed Expenses

Contribution per unit BEP in Value= Fixed Expenses Contribution Margin Ratio

Contribution Margin RatioContribution Margin ratio = Contribution

Sales

Target Net Profit Sales to earn target profit =

Fixed exp +target profit Contribution per unit

CVP analysis with multiple productsSales Mix is assumed to be constantBEP = Fixed Expenses

Weighted average contribution per unit or Fixed Expenses Weighted average contribution margin ratio

*C

AssumptionsTotal costs and total revenue are linear functions of outputSingle product or constant sales mix Expenses can be categorized as variable and fixedApplies to a short term time horizon to relevant range only

Operating LeverageContribution Income statement also discloses cost structure relative proportion of fixed and variable costO L is greatest in firms with a large proportion of fixed costs, low variable cost resulting in high contribution ratio, higher BEP ,lower safety margin.

Operating LeverageA firm with a high O L can generate a large percentage of increase in net income from a relatively small percentage of increase in sales revenueO L factor = Contribution Margin

Net Income

Absorption CostingFull costingCOGS = Unit sold* Standard absorption manufacturing cost per unitStandard absorption manufacturing cost= Variable mftg. cost per unit+ Predetermined Fixed manufacturing OH per unitInventory of FG also valued at Standard absorption manufacturing cost including fixed OH.

Variable CostingMarginal CostingInventory valued at only variable manufacturing costFixed Manufacturing OH is fully expensed and not carried in inventory

Differences in Reported profits under two methodsWhen production and sales volume are same, no change in profitsWhen inventory exists, difference in profits= Change in inventory units*Fixed OH absorption rateWhen inventory increases, more profit under absorption costing and vice versa

*C