1. Cost Behavior and Cost-Volume-Profit Analysis
Chapter 11

2. Cost Behavior
Cost behavior is the manner in which a cost changes as some related activity changes
An understanding of cost behavior is necessary to plan and control costs
A 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 activity
Materials, fuel, etc.
Fixed cost
Cost is constant in total, but varies inversely with changes in activity
Salaries, 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 ranges
Supervision costs, labor costs, etc.
Mixed cost
Cost has both a fixed and a variable component
Utility 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 Behavior
Mixed costs must be separated into their fixed and variable components in order to predict changes in the cost
High-low method
Simple regression
Multiple 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 points
Dividing the incremental cost by the incremental units of activity gives the variable cost per unit of activity
The variable cost per unit is substituted into the cost formula to determine the fixed cost
Total cost = fixed cost + variable cost per unit * number of units of activity

7. Cost Behavior

8. Applications of Cost Behavior Concepts
Contribution margin
Excess of sales over variable costs
Contribution is the incremental amount of each sale that is available to cover fixed costs and provide a profit
Knowing the contribution margin allows us to predict changes in net income that will result from a change in sales volume

9. Applications of Cost Behavior Concepts

10. Applications of Cost Behavior Concepts
Contribution margin percentage
Proportion of each sales dollar that is available to cover fixed costs and provide a profit
If sales increase by $100,000, profit will increase by $40,000 ($100,000 * 40%)
Contribution margin per unit
Dollar amount that each unit contributes toward covering fixed costs and providing a profit
If 50 more units are sold, profit will increase by $20,000 (50 units * $400)

11. Applications of Cost Behavior Concepts
Breakeven point
Volume of sales needed to earn no profit or no loss
Revenues = total costs
Fixed cost + target profit
Contribution margin per unit = number of units
Contribution margin percentage = dollars of sales

12. Applications of Cost Behavior Concepts
The breakeven formulas allow us to play “what if” games
What happens if
Sales price is increased (or decreased)
Variable costs are replaced by fixed costs
Volume increases
Additional amounts spent on advertising will increase sales volume
Etc.

13. Applications of Cost Behavior Concepts
Margin of safety
The excess of current sales volume over the breakeven point
In units
Current unit sales – breakeven unit sales
In percentage
(Current sales – breakeven sales) / current sales
The sales figures may be in dollars or units

14. Applications of Cost Behavior Concepts
Operating leverage
Measures the relative mix of fixed and variable costs
Contribution margin / operating income
Can determine the change in operating income that will result from a change in sales by multiplying the % change in sales by the operating leverage
High operating leverage implies high risk, high reward

15. Applications of Cost Behavior Concepts
Breakeven calculations in a multi-product environment
Assume the mix of products sold remains constant
Determine 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

16. Applications of Cost Behavior Concepts