1. Introduction to Cost Behavior and Cost-Volume Relationships
Chapter 2
Introduction to Cost Behavior
and Cost-Volume Relationships

2. Learning Objective 1
Explain how cost drivers
affect cost behavior.

3. Cost Behavior What is cost behavior?
It is how costs are related to, and affected
by, 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 salaries
Maintenance wages
Depreciation
Energy
Example cost drivers:
Labor hours
No. of people supervised
No. of mechanic hours
No. of machine hours
Kilowatt hours

6. Cost Drivers How well the accountant does at identifying
the most appropriate cost drivers determines
how well managers understand cost behavior
and how well costs are controlled.

7. Learning Objective 2
Show how changes in cost-driver
activity levels affect variable
and fixed costs.

8. Comparison of Variable and Fixed Costs
A variable cost is a cost that changes in direct
proportion to changes in the cost driver.
A fixed cost is not immediately affected
by changes in the cost driver.

9. Rules of Thumb Think of fixed costs as a total.
Total fixed costs remain unchanged
regardless of changes in cost-driver activity.

10. Rules of Thumb Think of variable costs on a per-unit basis.
The per-unit variable cost remains
unchanged regardless of changes
in the cost-driver activity.

11. Relevant Range
This 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 Costs
Relevant Range
, , , ,500
Volume in Units

13. Learning Objective 3
Calculate break-even sales
volume in total dollars
and total units.

14. Cost-Volume-Profit Analysis (CVP)
What is cost-volume-profit analysis?
It is the study of the effects of output
volume on revenue (sales), expenses
(costs), and net income (net profit).

15. CVP Scenario Per Unit Percentage Selling price $5 100
Variable cost
Difference $
Total monthly fixed expenses = $8,000
Rent $2,000
Labor $5,500
Other $ 500

16. Break-Even (BE) Point
The break-even point is the level of sales at which revenue equals expenses and net income is zero.

17. Margin of Safety
The 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 margin
Equation

19. Contribution Margin Technique – to find BE in Units
Per Unit
Selling price $5
Variable cost
Contribution margin $1
$8,000 ÷ $1 = 8,000 units
i.e. Fixed Cost ÷ Contribution per unit

20. Contribution Margin Technique - to find BE in $
8,000 units × $5.00 = $40,000
i.e. BE point in units x Selling price per unit OR
$8,000 ÷ 20% = $40,000
i.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 = $8,000
N = $8,000 ÷ $1
N = 8,000 Units

23. Equation Technique - to find BE in $
Let S = sales in dollars needed to break even
S – 0.80S – $8,000 = 0
.20S = $8,000
S = $8,000 ÷ .20
S = $40,000

24. Learning Objective 4
Create a cost-volume-profit
graph and understand the
assumptions behind it.

25. Cost-Volume-Profit Graph
Break even sales point
8,000 units or $40,000
Sales revenue line
Total expense line
Fixed expense line

26. Learning Objective 5
Calculate sales volume in total
dollars and total units to reach
a target profit.

27. Target Net Profit Managers can also use CVP analysis to determine the
total sales, in units and
dollars, needed to
reach a target
net profit.

28. Target Net Profit Contribution Margin Technique
Target sales volume in units =
Fixed expenses + Target net income
Contribution margin per unit

29. Target Net Profit Equation Technique Target sales – Variable expenses
– Fixed expenses
= Target net income

30. Operating Leverage
The 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 6
Calculate contribution
margin 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 over
all variable costs.

33. Learning Objective 7
Explain the effects of sales
mix 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 Example
Selling price: $90
Less variable cost:
Equals contribution margin per dress: $58
Fixed 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 = $11
What 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 packages
1,200 × 2 = 2,400 blouses
1,200 × 1 = 1,200 dresses
Total units = 3,600

39. Effects of Sales Mix on Income
What is the breakeven in dollars?
2,400 blouses × $30 = $ 72,000
1,200 dresses × $90 = ,000
$180,000

40. Effects of Sales Mix on Income
What is the weighted-average budgeted
contribution 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 units
3,600 × 1/3 = 1,200 dresses
3,600 × 2/3 = 2,400 blouses

42. Effects of Sales Mix on Income
Sales mix can be stated in sales dollars:
Dresses Blouses
Sales price $90 $60
Variable costs
Contribution margin $58 $22
Contribution margin ratio % %

43. Effects of Sales Mix on Income
Assume the sales mix in dollars is 60% dresses
and 40% blouses.
Weighted contribution would be:
64.4% × 60% = 38.64% dresses
36.6% × 40% = 14.64% blouses
53.28%

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 8
Compute cost-volume-profit
relationships on an after-tax
basis.

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 + $96,000
Q = $147,030 ÷ $58
Q = 2,535 dresses

48. Target Net Income and Income Taxes
Revenues (2,535 × $90) $228,150
Variable costs (2,535 × $32) ,120
Contribution margin: $147,030
Fixed costs: ,000
Operating income: $ 51,030
Income taxes: ($51,030 × .30) ,309
Net income $ 35,721
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