Presentation on theme: "Cost Behavior and Cost-Volume-Profit Analysis"— Presentation transcript:
1 Cost Behavior and Cost-Volume-Profit Analysis Chapter 11
2 Cost BehaviorCost behavior is the manner in which a cost changes as some related activity changesAn understanding of cost behavior is necessary to plan and control costsA relevant range is the range over which we are interested in the cost’s behavior
3 Cost Behavior Variable cost Fixed cost Cost is constant on a per unit basis, but the total cost varies directly with changes in activityMaterials, fuel, etc.Fixed costCost is constant in total, but varies inversely with changes in activitySalaries, property taxes, straight-line depreciation, etc.
4 Cost Behavior Step cost Mixed cost Cost which is fixed over small ranges of activity, but varies across wider rangesSupervision costs, labor costs, etc.Mixed costCost has both a fixed and a variable componentUtility costs in which you pay a fixed amount to have the service available to you, and a variable charge based on how much you use the utility; rental costs in which you pay a fixed amount per period plus a variable amount based on usage, etc.
5 Cost BehaviorMixed costs must be separated into their fixed and variable components in order to predict changes in the costHigh-low methodSimple regressionMultiple regression
6 Cost Behavior High-low method Compares the points of highest and lowest activities, and their related costs, and calculates the formula for a straight line connecting the two pointsDividing the incremental cost by the incremental units of activity gives the variable cost per unit of activityThe variable cost per unit is substituted into the cost formula to determine the fixed costTotal cost = fixed cost + variable cost per unit * number of units of activity
8 Applications of Cost Behavior Concepts Contribution marginExcess of sales over variable costsContribution is the incremental amount of each sale that is available to cover fixed costs and provide a profitKnowing the contribution margin allows us to predict changes in net income that will result from a change in sales volume
10 Applications of Cost Behavior Concepts Contribution margin percentageProportion of each sales dollar that is available to cover fixed costs and provide a profitIf sales increase by $100,000, profit will increase by $40,000 ($100,000 * 40%)Contribution margin per unitDollar amount that each unit contributes toward covering fixed costs and providing a profitIf 50 more units are sold, profit will increase by $20,000 (50 units * $400)
11 Applications of Cost Behavior Concepts Breakeven pointVolume of sales needed to earn no profit or no lossRevenues = total costsFixed cost + target profitContribution margin per unit = number of unitsContribution margin percentage = dollars of sales
12 Applications of Cost Behavior Concepts The breakeven formulas allow us to play “what if” gamesWhat happens ifSales price is increased (or decreased)Variable costs are replaced by fixed costsVolume increasesAdditional amounts spent on advertising will increase sales volumeEtc.
13 Applications of Cost Behavior Concepts Margin of safetyThe excess of current sales volume over the breakeven pointIn unitsCurrent unit sales – breakeven unit salesIn percentage(Current sales – breakeven sales) / current salesThe sales figures may be in dollars or units
14 Applications of Cost Behavior Concepts Operating leverageMeasures the relative mix of fixed and variable costsContribution margin / operating incomeCan determine the change in operating income that will result from a change in sales by multiplying the % change in sales by the operating leverageHigh operating leverage implies high risk, high reward
15 Applications of Cost Behavior Concepts Breakeven calculations in a multi-product environmentAssume the mix of products sold remains constantDetermine the contribution margin for a “basket” of goods (the normal sales mix)Calculate the breakeven point as the number of “baskets” needed to break even