Financial and Managerial Accounting Wild, Shaw, and Chiappetta Fifth Edition Wild, Shaw, and Chiappetta Fifth Edition Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin
Chapter 18 Cost Behavior and Cost-Volume-Profit Analysis 18-2
Conceptual Learning Objectives C1: Describe different types of cost behavior in relation to production and sales volume. C2: Describe several applications of cost- volume-profit analysis. 18-3
A1: Compute the contribution margin and describe what it reveals about a company’s cost structure. A2: Analyze changes in sales using the degree of operating leverage. Analytical Learning Objectives 18-4
P1: Determine cost estimates using the scatter diagram, high-low, and regression methods of estimating costs. P2: Compute the break-even point for a single product company. P3: Graph costs and sales for a single product company. P4: Compute the break-even point for a multiproduct company. Procedural Learning Objectives 18-5
CVP analysis is used to answer questions such as: What sales volume is needed to earn a target income? What is the change in income if selling prices decline and sales volume increases? How much does income increase if we install a new machine to reduce labor costs? Will income change if we change the sales mix of our products or services? CVP analysis is used to answer questions such as: What sales volume is needed to earn a target income? What is the change in income if selling prices decline and sales volume increases? How much does income increase if we install a new machine to reduce labor costs? Will income change if we change the sales mix of our products or services? Questions Addressed by Cost-Volume-Profit Analysis C1 18-6
Cost Behavior Summary C1 18-7
Mixed costs contain a fixed portion that is incurred even when the facility is unused, and a variable portion that increases with usage. Example: monthly electric utility charge Fixed service fee Variable charge per kilowatt hour used Mixed Costs C1 18-8
Activity Cost Total cost remains constant within a narrow range of activity. Step-Wise Costs C1 18-9
The objective is to classify all costs as either fixed or variable. Identifying and Measuring Cost Behavior P1 When presented with a mixed cost, the fixed and variable components must be separated
We have just seen one of the basic CVP relationships – the break-even computation. Break-even point in units = Fixed costs Contribution margin per unit Computing The Break-Even Point (Exhibit 18.11) Unit sales price less unit variable cost ($30 in previous example) P
Sales Number of Units Produced Costs and Revenue in Dollars Starting at the origin, draw the sales line with a slope equal to the unit sales price. Preparing a Cost-Volume- Profit Chart Break- even Point Total costs Total fixed costs P
A limited range of activity called the relevant range, where CVP relationships are linear. 4 Unit selling price remains constant. 4 Unit variable costs remain constant. 4 Total fixed costs remain constant. Production = Sales (no inventory changes). Assumptions of CVP Analysis C
Break-even formulas may be adjusted to show the sales volume needed to earn any amount of income. Unit sales = Fixed costs + Target income Contribution margin per unit Dollar sales = Fixed costs + Target income Contribution margin ratio Computing Sales for a Target Income C
The CVP formulas may be modified for use when a company sells more than one product. The unit contribution margin is replaced with the contribution margin for a composite unit. A composite unit is composed of specific numbers of each product in proportion to the product sales mix. Sales mix is the ratio of the sales volumes for the various products. Computing Multiproduct Break-Even Point P
The extent, or relative size, of fixed costs in the total cost structure of an organization. A measure of how a percentage change in sales will affect profits. Total contribution margin (in dollars) Pretax income Operating Leverage (Exhibit 18.31) A2 Degree of operating leverage = 18-16
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