1. COST BEHAVIOR & COST-VOLUME-PROFIT ANALYSIS CHAPTER 19 TEACHER VERSION

2. Knowing how cost behave enables management to estimate costs when evaluating alternative operating proposals. Read about Netflix on page 883. Why is it important for Netflix to understand how costs behave? Why would a hospital care?

3. THE BEHAVIOR DEPENDS ON: 1.Activity bases or activity drivers (what activity creates costs?) hospital wants to control patient food costs: estimate # of patients who stay overnight # treated does not = those who consume food 2.Relevant range once activity base is identified, food costs can be analyzed over the range of the number of patients who stay over in the hospital What activity base is the drive for the textbook expenditures?

4. VARIABLE COSTS Variable costs are costs that vary in proportion to changes in the level of activity. Cost per unit remains the same regardless of changes in the activity base. Total cost changes in proportion to changes in the activity base. LO 1

5. FIXED COSTS Fixed costs are costs that remain the same in total dollar amount as the activity base changes. Cost per unit changes inversely to changes in the activity base. Total cost remains the same regardless of changes in the activity base. LO 1

6. MIXED COSTS Mixed costs have characteristics of both a variable and a fixed cost. Mixed costs are sometimes called semi variable or semi fixed costs. Over one range of activity, the total mixed cost may remain the same. Over another range of activity, the mixed cost may change in proportion to changes in the level of activity. LO 1

7. MCDONALD’S List examples of: FIXED VARIABLE MIXED Identify the activity base for each variable cost.

8. ASSIGNMENTS: Exercise 19-1 page 913 Exercise 19-3 page 914 Exercise 19-4 page 914 Exercise 19-5 page 914

9. HIGH-LOW METHOD Separating mixed costs into fixed and variable components: Use the highest and lowest activity level to estimate the variable cost per unit and the fixed cost

10. Subtract the total variable costs from the total costs for the units produced. Fixed Cost using High Low Method Highest and Lowest Level June1,000$45,550 July1,50052,000 August2,10061,500 September1,80057,500 October75041,250 Fixed Cost = Total Costs – (Variable Cost per Unit x Units Produced) Fixed Cost = $61,500 – ($15* x 2,100 units) Fixed Cost = $61,500 – $31,500 Fixed Cost = $ 30,00030,000 Estimated total cost would be calculated as follows: Total Cost = ($15 x Units Produced) + $30,000 Total Cost = ($15 x 2,000) + $30,000 Total Cost = $30,000 + $30,000 Total Cost = $60,000 *Variable cost/unit was calculated on previous slide Total Cost = (VC/Unit x units produced) + FC

11. Cost/unit = (high cost – low cost)/(high unit – low unit) Total fixed cost = high cost – (cost/unit x high units) Assignments: pe 19-1a, page 911 exercises 19-7 and 19-8 page 914

13. CONTRIBUTION MARGIN o Amount of funds left from a sale after variable costs have been paid. o Used to pay the fixed costs of a business o Any contribution margin left represents profit o Contribution margin ratio tells what % of each sales $ is contribution margin o Unit contribution margin analyzes potential profit CONTRIBUTION MARGIN (CM) = SALES – VARIABLE COSTS CONTRIBUTION MARGIN RATIO (CMR) = CM/SALES UNIT CONTRIBUTION MARGIN (UCM) = SP/UNIT – VC/U CHANGE IN INCOME FROM OPERATIONS = CHANGE IN SALES UNITS x UCM

14. USE THE FOLLOWING DATA TO COMPUTE THE TOTAL CM, CMR, UCM. The total sales and cost information for Van Buren Company is based o the sale of 20,000 units: Instructions: compute the following 1.Total CM 2.CMR 3.Unit CM 4.Increase in net income form $50,00 increase in sales 5.Increase in net income form 1,000 unit increase in sales TotalPer Unit Sales$570,000$28.50 Variable Costs$387,600$19.38 Fixed Costs$140,000

15. BREAK-EVEN POINT Break-even point is the level of operations at which a company’s revenues and expenses are equal. Can be expressed in units or sales dollars.

18. ASSIGNMENTS pe 19-2a and b page 911 Pe 19-3 a and b page 911 Pe 19-4 a and b page 912 Exercise 19-9 page 915 Exercise 19-10 page 915-16 Exercise 19-12 page 916

20. ASSUMPTIONS OF COST- VOLUME-PROFIT ANALYSIS The primary assumptions are: total sales and total costs can be represented by straight lines Within the relevant range of operating activity, the efficiency of operations does not change Costs an be divided into fixed and variable components The sales mix is constant There is no change in the inventory quantities during the period

21. MARGIN OF SAFETY The margin of safety indicates the possible decrease in sales that may occur before an operating loss results. The margin of safety may be expressed in the following ways: Dollars of sales Units of sales Percent of current sales If sales are $250,000, the unit selling price is $25, and the sales at the break- even point are $200,000, the margin of safety is 20%, computed as follows: Margin of Safety = Sales – Sales at Break-Even Point Sales Margin of Safety = $250,000 – $200,000 $250,000 Margin of Safety = 20%

22. ASSIGNMENTS Pe 19-7a and b page 912-13 Exercise 19-23 page 919 Exercise 19-24 page 919 Problem 19-3a page 921 Problem 19-6a page 170 CP 19-3 page 926-27