1. Introduction to revenue, cost and profit terms Variable and fixed costs, cost-volume-profit analysis Pia Nylinder

2. Organization of the presentation
Variable cost
Fixed cost
Cost volume profit (CVP) analysis
Decision-making
Opportunity costs
Sunk costs

3. Variable and fixed costs

4. Principles of cost division
Cost terms and concepts
Activity level Variable and fixed costs
Cost assignment Direct and indirect costs
Decision making Relevant and irrelevant costs
Variable and fixed cost can be used in different situations
Cost volume profit analysis
Budgeting
Product costing

5. Activity level
Activity (volume) level = Activity (output) of an organization measured in quantity, time or value
Units of production or sales, hours worked, miles traveled
Industry Measure of activity
Airlines Passenger-kilometers
Automobiles Vehicles manufactured
Hospitals Patient-days
Hotels Rooms occupied
Consultancy firm Hours debited
Sales company Sales value/Number of customers

6. Variable costs
Variable Cost = A cost that varies in total when the volume of activity changes
Linearity of variable costs
Nonlinearity of variable costs (two types of nonlinierity)

7. Linearity of variable costs
Linear variable costs = Costs that in total vary in direct proportion to changes in the activity level
Total variable cost = Unit variable cost x Activity level
Unit variable cost = Total variable cost/Activity level
For example: Material cost in a manufacturing company, petrol in a transport company and sales commission in a sales company
Total variable cost
Cost per unit
Activity level
Activity level

8. Nonlinearity of variable costs
1. Nonlinear variable costs = Costs that in total decreases when the activity level increases
For example: Discount when purchasing material
Total variable cost
Cost per unit
Activity level
Activity level

9. Nonlinearity of variable costs
2. Nonlinear variable costs = Costs that in total increases when the activity level increases
For example: Overtime compensation
Total variable cost
Cost per unit
Activity level
Activity level

10. Fixed costs
Fixed costs
Step fixed costs (Semi-fixed)

11. Fixed costs
Fixed costs = A cost that remains constant in total when the level of activity changes for a specified time period
Unit fixed cost = Total fixed cost/Activity level
For example: Supervisors’ salaries, leasing charges for cars, rent for premises
Total fixed cost
Unit fixed cost
Activity level
Activity level

12. Fixed costs Two important assumptions Relevant range Time span
An output range of activity level that the firm expects to be operating within period of time
Time span
A cost is only fixed for a short period of time, for instance a month or a year

13. Activity level (Volume in Units)
Relevant Range – – –
40 000 –
Fixed Costs
Relevant Range
Activity level (Volume in Units)

14. Step fixed costs
Step fixed costs = A cost that is fixed within specified activity levels but that eventually increases or decreases by a constant amount at various critical activity levels
Unit fixed cost = Total fixed cost/Activity level
For example: Supervisors’ salaries, equipment costs, rent for premises
Total fixed costs
Unit fixed costs
Activity level
Activity level

15. Mixed costs (Semi-variable costs)
Mixed costs = A cost that include both a fixed and a variable component. Fixed cost that remains constant and variable cost when the activity level changes
Unit variable and fixed costs = Total variable and fixed costs/Activity level
For example: Electric utility charge (fixed service fee and variable charge per kilowatt hour used), car rental cost, commission cost
Total cost
Unit cost
Total variable cost
Total fixed cost
Activity level
Activity level

16. What happen when the volume increase (decrease)?
To conclude…
What happen when the volume increase (decrease)?
Total cost Cost per unit
Fixed costs
Unchanged
Decreases (increases)
Variable costs
Increase (decreases)
Unchanged
BRYGGA: Vad gör verksamhetsvolymen? Driver rörliga och därmed totala kostnader.

17. Cost volume profit (CVP) relationship

18. CVP-relationship
Examines what will happen to the financial results if a specific level of activity fluctuates
Study interrelationships of
prices
activity levels (volumes)
fixed and variable costs
profits
Vital information in decisions about e.g. price, market mix and product mix
Very simple and usable method

19. CVP-relationship Sensitivity analysis
Sensitivity analysis is a “what-if” technique that examines how a result will change if the original predicted data are not achieved or if an underlying assumption changes
A CVP-analysis can answer a lot of questions
What will happen to operating income if volume declines by 5%?
What will happen to operating income if variable costs increase by 10% per unit?
What operating income is expected when sales are units?
Suppose that fixed costs increased by $30,000. What are the new fixed costs? What is the new breakeven point?

20. CVP – Different approaches
Two main approaches to CVP-analysis:
Total revenue function
Contribution function
Both approaches can be performed with:
Equation method
Graph method

21. Total revenue function
Unit selling price x Units sold = Total revenue
Costs
Unit variable cost x Units sold = Total variable costs
Total variable cost + Total fixed costs = Total costs
Result
Total revenue – Total costs = Operating profit
Total revenue – Total variable costs – Total fixed costs = Operating profit
Unit selling price x Units sold - Unit variable cost x Units sold - Fixed costs = Operating profit

22. Total revenue functionKr
Total revenue
Total cost
Profit
Variable costs
Loss
Fixed costs
Units sold

23. Total revenue function – Break- even point
The break-even point states in units sold and total sales where the profit is equal to
zero
Total revenue – Total variable costs – Fixed costs = zero operating profit Kr
Break-even point in revenue (sales)
Total revenue
Break-even point
Total cost
Variable costs
Fixed costs
Break-even point in units
Units sold

24. Total revenue function – Safety of margin
Indicates by how much sales may decrease before a loss occurs
Can be expressed in actual units and actual sales
Margin of safety percentage

25. Total revenue function – Break- even point
The break-even point states in units sold and total sales where the profit is equal to
zero
Total revenue – Total variable costs – Fixed costs = 0 kr Kr
Break-even point in revenue (sales)
Total revenue
Total cost
Margin of safety
Variable costs
Fixed costs
Margin of safety
Break-even point in units
Units sold

26. Total revenue function – Break- even point
The break-even point states in units sold and total sales where the profit is equal to
zero
Total revenue – Total variable costs – Fixed costs = 0 kr Kr
Break-even point in revenue (sales)
Total revenue
Total cost
Margin of safety
Fixed costs
Variable costs
Margin of safety
Break-even point in units
Units sold

27. Total revenue function – Safety of margin
Units
Actual units - break-even units
Total sales
Actual total sales - break-even sales
Percentage
(Actual units – Break-even units)/Actual units
(Actual total sales – break-even sales)/Actual sales

28. CVP-relationship - Assumptions
Important assumptions of CVP-analysis
Change in costs varies in relation to one cost driver, i.e. activity level (sales volume)
Revenue per unit remains constant
Variable costs per unit remain constant
Total fixed costs remain constant
Costs can be divided in variable and fixed categories
Sales volume = Production volume
The behavior of total revenues and total costs is linear in relation to output units within the relevant range
Note: CVP-analysis can be used in companies with multiple products
Unit contribution margin is replaced with 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 volumes of the various products

29. Cost volume profit analysis – Example
A company has recently developed a new product. The new product is a book about management accounting and it will revolutionize the area. It contains new terms and concepts. The company is particularly interested in adopting the cost volume profit approach to decision-making. The accountant at the company has prepared the following information about price, costs and volume for one year:
Price per unit $40
Variable cost per unit $20
Fixed costs $
Sales volume units

30. Cost volume profit analysis – Example
What will the operating profit be if units are sold?
What will the operating profit be if the company spends an additional $ on a marketing campaign. They assume that the campaign will increase the sales volume with units.
If the company desire a profit of $ , how many units would have to be sold?
Determine the annual break-even point in units.
Suppose that the variable cost increases by 10 %. Compute the new break-even point.
Determine the margin of safety in units at a sales volume of units.

31. Cost volume profit analysis – Example
Sales volume Units
Sales price per unit $
Variable cost per unit $
Fixed cost per unit $
Total cost per unit $
Total revenue $
Total variable costs $
Total fixed costs $
Operating profit $
(Total costs )

32. CVP-graph - Exemple Kr 1 600 000 kr 1 400 000 kr 30 000 * 40 =
Number of units sold
30 000
40 000
Margin of safety = – = units

33. Contribution & Contribution per unit
Sales – variable costs= contribution
Revenue
Unit selling price x Units sold = Total revenue
Costs
Unit variable cost x Units sold = Total variable costs
Contribution
Total revenue – Total variable costs= Total contribution
Unit selling price x Units sold - Unit variable cost x Units sold = Total contribution
Unit selling price - Unit variable cost = Contribution per unit

34. Break-even, margin of safety and analysis
Break-even is where; Total revenue = Total costs Break even point (in units) = Fixed costs Contribution per unit Break even point (in sales value)= Break-even point (in units) * selling price per unit

35. Break-even Analysis
Fixed Costs = 50,000 Skr Price per unit = 5 Skr Variable Cost = 3 Skr Contribution = Breakeven Volume = Breakeven Skr =
Break-even point (in units) = Fixed costs Contribution
Break-even point (in sales) = Break-even point (in units) x Selling price per unit

36. Break-even Analysis
Fixed Costs = 50,000 Skr Price per unit = 5 Skr Variable Cost = 3 Skr Contribution = Breakeven Volume = Breakeven Skr =
Break-even point (in units) = Fixed costs Contribution
Break-even point (in sales) = Break-even point (in units) x Selling price per unit

37. Relevant costs for decision-making are:
Future expenditures unique to the decision alternatives under consideration.
Expected to occur in the future
Differ among marketing alternatives being considered
In general, opportunity costs are considered relevant costs

38. Sunk costs for decision-making are:
The direct opposite of relevant costs.
Past expenditures for a given activity
Typically irrelevant in whole or in part to future decisions
Examples of sunk costs:
Past marketing research and development expenditures
Last year’s advertising expense

39. When opportunity costs are relevant, an example:
The oportunity cost represent ”by the forgone potential benefit from the best rejected cource of action”
+ Selling price
Variable cost
Opportunity cost
= Operational profit or loss
Sid 178

40. Limiting factors
Avalable capacity Limited capacity

41. Decision-making when there is avalable capacity
Golvad AB incoming orders are decreasing. One day however, they get a offer from a man who want their help to instal hardwoodfloor in his house. The most he can pay is 7000 SKr (excluding VAT) for the work, including material, labor and travelexpeses. Should Golvad AB accept the offer? Costing (Golvad´s own calculation) +Labor (350 Skr * 10 h) 35oo Skr +Material cost 5000 Skr +Travelling costs 300 Skr +Profit margin 15% * Skr 525 Skr Priduction cost Skr

42. Decision-making when there is avalable capacity
Golvad AB incoming orders are decreasing. One day however, they get a offer from a man who want their help to instal hardwoodfloor in his house. The most he can pay is 7000 SKr (excluding VAT) for the work, including material, labor and travelexpeses. Should Golvad AB accept the offer? Costing (Golvad´s own calculation) +Labor (350 Skr * 10 h) 35oo Skr +Material cost 5000 Skr +Travelling costs 300 Skr +Profit margin 15% * Skr 525 Skr Priduction cost Skr

43. Decision-making when there is limited capacity
In a company is labour the limiting factor. The company have tro decide of they should concentrate their producton on product A or B. Contribution per unit A is 1200 SKr and for B 1500 Skr. The number of labour hours used for A is 30 minutes and for B 40 minutes. Which product should the company concentrate the production on in order to maximise their profit?

44. Decision-making when there is limited capacity
In a company is labour the limiting factor. The company have tro decide of they should concentrate their producton on product A or B. Contribution per unit A is 1200 SKr and for B 1500 Skr. The number of labour hours used for A is 30 minutes and for B 40 minutes. Which product should the company concentrate the production on in order to maximise their profit?

45. Decision-making when there is limited capacity
In a company is labour the limiting factor. The company have tro decide of they should concentrate their producton on product A or B. Contribution per unit A is 1200 SKr and for B 1500 Skr. The number of labour hours used for A is 30 minutes and for B 40 minutes. Which product should the company concentrate the production on in order to maximise their profit? Product A Product B The company should choose to procuce A. The contribution comes out ahead because it produces the highes contribution per scarce labour resourses.

46. Limiting factors (cont.)
We continue with the company in the last example. We know the contribution per limiting factor (labour hours). In order to count the total contribution we need to know how many units which can be produced. Suppose the capacity is 4000 labour hours = minutes (4000 hours * 60 minutes). The maximum products of A that can be produced is minutes / 30 minutes per unit = 8000 units. Product B can produce minutes/40 minutes per unit = units. Which product gives the best profit? The total contribution is counted as: Product A 1200 SKr * 8000 units = SKr Product B 1500 SKr * 6000 units = Skr The calculation shows that we should choose product A because it gives the best profit.