Presentation on theme: "Introduction to Cost Behavior and Cost-Volume Relationships"— Presentation transcript:
1 Introduction to Cost Behavior and Cost-Volume Relationships Chapter 2Introduction to Cost Behaviorand Cost-Volume Relationships
2 Learning Objective 1Explain how cost driversaffect cost behavior.
3 Cost Behavior What is cost behavior? It is how costs are related to, and affectedby, the activities of an organization.
4 Cost Drivers What are cost drivers? Output measures of resources and activities are called cost drivers.
5 Cost Drivers Production Example Example costs: Labor wages Supervisory salariesMaintenance wagesDepreciationEnergyExample cost drivers:Labor hoursNo. of people supervisedNo. of mechanic hoursNo. of machine hoursKilowatt hours
6 Cost Drivers How well the accountant does at identifying the most appropriate cost drivers determineshow well managers understand cost behaviorand how well costs are controlled.
7 Learning Objective 2Show how changes in cost-driveractivity levels affect variableand fixed costs.
8 Comparison of Variable and Fixed Costs A variable cost is a cost that changes in directproportion to changes in the cost driver.A fixed cost is not immediately affectedby changes in the cost driver.
9 Rules of Thumb Think of fixed costs as a total. Total fixed costs remain unchangedregardless of changes in cost-driver activity.
10 Rules of Thumb Think of variable costs on a per-unit basis. The per-unit variable cost remainsunchanged regardless of changesin the cost-driver activity.
11 Relevant RangeThis rule of thumb holds true only within reasonable limits.The relevant range is the limit of cost-driver activity within which a specific relationship between costs and the cost driver is valid.
12 Relevant Range – $16,000 – $12,000 – Fixed Costs $8,000 – $4,000 $16,000 –$12,000 –$8,000 –$4,000–Fixed CostsRelevant Range, , , ,500Volume in Units
13 Learning Objective 3Calculate break-even salesvolume in total dollarsand total units.
14 Cost-Volume-Profit Analysis (CVP) What is cost-volume-profit analysis?It is the study of the effects of outputvolume on revenue (sales), expenses(costs), and net income (net profit).
16 Break-Even (BE) PointThe break-even point is the level of sales at which revenue equals expenses and net income is zero.
17 Margin of SafetyThe margin of safety shows how far sales can fall below the planned level before losses occur.Planned unit sales–Break-even unit sales=Margin of safety
18 Break-Even Point Techniques There are two basic techniques for computing break-even point:Contribution marginEquation
19 Contribution Margin Technique – to find BE in Units Per UnitSelling price $5Variable costContribution margin $1$8,000 ÷ $1 = 8,000 unitsi.e. Fixed Cost ÷ Contribution per unit
20 Contribution Margin Technique - to find BE in $ 8,000 units × $5.00 = $40,000i.e. BE point in units x Selling price per unitOR$8,000 ÷ 20% = $40,000i.e. Fixed Cost ÷ Contribution to Sales ratio
21 Equation Technique Net income equals zero at the break-even point. Sales–Variable expenses–Fixed expenses=Zero net income (break-even point)
22 Equation Technique – to find BE in Units Let N = number of units to be sold to break even$5N – $4N – $8,000 = 0$1N = $8,000N = $8,000 ÷ $1N = 8,000 Units
23 Equation Technique - to find BE in $ Let S = sales in dollars needed to break evenS – 0.80S – $8,000 = 0.20S = $8,000S = $8,000 ÷ .20S = $40,000
24 Learning Objective 4Create a cost-volume-profitgraph and understand theassumptions behind it.
25 Cost-Volume-Profit Graph Break even sales point8,000 units or $40,000Sales revenue lineTotal expense lineFixed expense line
26 Learning Objective 5Calculate sales volume in totaldollars and total units to reacha target profit.
27 Target Net Profit Managers can also use CVP analysis to determine the total sales, in units anddollars, needed toreach a targetnet profit.
28 Target Net Profit Contribution Margin Technique Target sales volume in units =Fixed expenses + Target net incomeContribution margin per unit
29 Target Net Profit Equation Technique Target sales – Variable expenses – Fixed expenses= Target net income
30 Operating LeverageThe ratio of fixed to variable costs is called operating leverage.In high leveraged companies, small changes in sales volume result in large changes in net income.Companies with less leverage are not affected as much by changes in sales volume.
31 Learning Objective 6Calculate contributionmargin and gross margin.
32 Contribution Margin and Gross Margin Gross margin (which is also called gross profit)is the excess of sales over the cost of goods sold.Contribution margin is the excess of sales overall variable costs.
33 Learning Objective 7Explain the effects of salesmix on profits.
34 Effects of Sales Mix on Income Sales mix is the combination of products that a business sells.
35 Effects of Sales Mix on Income Avisha’s Dresses ExampleSelling price: $90Less variable cost:Equals contribution margin per dress: $58Fixed costs = $96,000
36 Effects of Sales Mix on Income Assume that Avisha is considering selling blouses.This will not require any additional fixed costs.She expects to sell 2 blouses at $30 each for every dress she sells.The variable cost per blouse is $19.What is the new breakeven point?
37 Effects of Sales Mix on Income Contribution margin per blouse: $30 – $19 = $11What is the contribution margin of the mix?$58 + (2 × $11) =$58 + $22 = $80
38 Effects of Sales Mix on Income $96,000 fixed costs ÷ $80 = 1,200 packages1,200 × 2 = 2,400 blouses1,200 × 1 = 1,200 dressesTotal units = 3,600
39 Effects of Sales Mix on Income What is the breakeven in dollars?2,400 blouses × $30 = $ 72,0001,200 dresses × $90 = ,000$180,000
40 Effects of Sales Mix on Income What is the weighted-average budgetedcontribution margin?Dresses: 1 × $58+Blouses: 2 × $11=$80 ÷ 3 = $26.67
41 Effects of Sales Mix on Income The break even point for the two products is:$96,000 ÷ $ = 3,600 units3,600 × 1/3 = 1,200 dresses3,600 × 2/3 = 2,400 blouses
42 Effects of Sales Mix on Income Sales mix can be stated in sales dollars:Dresses BlousesSales price $90 $60Variable costsContribution margin $58 $22Contribution margin ratio % %
43 Effects of Sales Mix on Income Assume the sales mix in dollars is 60% dressesand 40% blouses.Weighted contribution would be:64.4% × 60% = 38.64% dresses36.6% × 40% = 14.64% blouses53.28%
44 Effects of Sales Mix on Income Break even sales dollars is $96,000 ÷ 53.28%= $180,000 (rounding)$180,000 × 60% = $108,000 dress sales$180,000 × 40% = $ 72,000 blouse sales
45 Learning Objective 8Compute cost-volume-profitrelationships on an after-taxbasis.
46 Target Net Income and Income Taxes Management of Avisha’s Dresses would like to earn an after-tax income of $35,721.The tax rate is 30%.What is the target operating income?Target operating income = Target net income ÷ (1 – tax rate)TOI = $35,721 ÷ (1 – 0.30)TOI = $51,030
47 Target Net Income and Income Taxes How many units must she sell?Revenues – Variable costs – Fixed costs = Target net income ÷ (1 – tax rate)$90Q – $32Q – $96,000 = $35,721 ÷ 0.70$58Q = $51,030 + $96,000Q = $147,030 ÷ $58Q = 2,535 dresses
48 Target Net Income and Income Taxes Revenues (2,535 × $90) $228,150Variable costs (2,535 × $32) ,120Contribution margin: $147,030Fixed costs: ,000Operating income: $ 51,030Income taxes: ($51,030 × .30) ,309Net income $ 35,721THE END