Chapters 4 and 5

VariableFixed Mixed Copyright (c) 2009 Prentice Hall. All rights reserved3

 Total variable costs change in direct proportion to changes in the volume of activity ◦ If activity increases, so does the cost  Unit variable cost remains constant Copyright (c) 2009 Prentice Hall. All rights reserved4 Units produced Direct materials cost per unit Total direct materials cost 100$25$2, $255, $257, $2510, $2512,500

Copyright (c) 2009 Prentice Hall. All rights reserved5

 Do not change over wide ranges in volume  Examples: ◦ Straight-line depreciation ◦ Salaries  Fixed cost per unit is inversely proportional to activity ◦ The more activity, the less the fixed cost per unit Copyright (c) 2009 Prentice Hall. All rights reserved6

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 Have both a fixed and variable component  Example: ◦ Utilities that charge a set fee per month, plus a charge for usage Copyright (c) 2009 Prentice Hall. All rights reserved8

9 Variable Fixed Copyright (c) 2009 Prentice Hall. All rights reserved

 The manager of Swift Car Inspection reviewed his monthly operating costs for the past year. His costs ranged from $4,400 for 1,400 inspections to $4,000 for 900 inspections. To determine the variable cost per unit, the change in cost, $400, is divided by the 500-unit change in inspections. The result is a variable cost per inspection of 80 cents. Copyright (c) 2009 Prentice Hall. All rights reserved10

Copyright (c) 2009 Prentice Hall. All rights reserved11 Variable cost per unit Change in total cost Change in activity $4,400 - $4,000 1, Variable cost per unit $0.80 per inspection

Copyright (c) 2009 Prentice Hall. All rights reserved12 Total fixed costs Total mixed cost minus Total variable cost $4,000 minus 900 inspections x $0.80 Total fixed costs $3,280 Total fixed costs

Copyright (c) 2009 Prentice Hall. All rights reserved13 Number of inspections $0.80 per inspection Total mixed cost $3,280 $0.80 per inspection 1,000 inspections $3,280 $4,080

 Band of volume: ◦ Where total fixed costs remain constant and variable cost per unit remains constant  Outside the relevant range, costs can differ 14Copyright (c) 2009 Prentice Hall. All rights reserved

Costs can be classified as fixed or variable. Volume is only factor that affects costs. Fixed costs don’t change. 16Copyright (c) 2009 Prentice Hall. All rights reserved

 Sales level at which operating income is zero ◦ Sales above breakeven result in a profit ◦ Sales below breakeven result in a loss  Two methods: ◦ Income statement approach ◦ Contribution margin approach 17Copyright (c) 2009 Prentice Hall. All rights reserved

18 Sales – Variable costs – Fixed costs = Operating income Selling price per unit x units sold Variable cost per unit x units sold Fixed costs Operating income Set to zero Solve for units sold

Copyright (c) 2009 Prentice Hall. All rights reserved19 Sales revenue per unit Variable costs per unit Contribution margin per unit Fixed costs Contribution margin per unit Breakeven point in units

Copyright (c) 2009 Prentice Hall. All rights reserved20 Sales revenue Contribution margin ratio Contribution margin Fixed costs Contribution margin ratio Breakeven point in sales dollars

Copyright (c) 2009 Prentice Hall. All rights reserved22 Fixed costs + Desired operating income Contribution margin ratio Target sales in dollars

23 Breakeven point Profit Loss Copyright (c) 2009 Prentice Hall. All rights reserved

 Management tool to predict how changes in sale prices, cost or volume affects profits  “What-if?” analysis 24Copyright (c) 2009 Prentice Hall. All rights reserved

25 Change selling price Change in variable costs Change in fixed costs All would impact breakeven point

Copyright (c) 2009 Prentice Hall. All rights reserved26 CauseEffectResult ChangeContribution margin Breakeven point Selling price increasesIncreaseDecrease Selling price decreasesDecreaseIncrease Variable cost per unit increasesDecreaseIncrease Variable cost per unit decreasesIncreaseDecrease Fixed costs increaseNo effectIncrease Fixed costs decreaseNo effectDecrease

 Excess of expected sales over breakeven sales  Cushion company can absorb without incurring a loss Copyright (c) 2009 Prentice Hall. All rights reserved27 Expected sales in units Breakeven sales in units Margin of safety in units Expected sales in dollars Breakeven sales in dollars Margin of safety in dollars

 Country Road Driving School charges $230 per student to prepare and administer written and behind-the-wheel driving tests. Variable costs of $70 per student include trainers’ wages, study materials, and gasoline. Annual fixed costs of $112,000 include the training facility and fleet of cars. Copyright (c) 2009 Prentice Hall. All rights reserved28

Copyright (c) 2009 Prentice Hall. All rights reserved29 Sales price per unit Variable costs per unit Contribution margin per unit Fixed costs Contribution margin per unit Breakeven point in units $230$70$160 $112,000 $ students

Copyright (c) 2009 Prentice Hall. All rights reserved30 Decreased Sales price per unit Variable costs per unit Decreased Contribution margin per unit Fixed costs Contribution margin per unit New Breakeven point in units $200 $70 $130 $112,000 $ students

Copyright (c) 2009 Prentice Hall. All rights reserved31 Sales price per unit Decreased variable costs per unit Increased Contribution margin per unit Fixed costs Contribution margin per unit New Breakeven point in units $50 $180 $112,000 $ students $230

Copyright (c) 2009 Prentice Hall. All rights reserved32 Sales price per unit Variable costs per unit Contribution margin per unit Decreased fixed costs Contribution margin per unit Breakeven point in units $230$70$160 $102,000 $ students

Sli de Variable Costing

Sli de  Inventory costs include : -direct materials used -direct labor incurred -both fixed & variable manufacturing overhead  Required by GAAP for external reporting purposes Learning objective 1: Explain the difference between full (absorption) and variable costing

Sli de Learning objective 1: Explain the difference between full (absorption) and variable costing

Sli de  Inventory costs includes: -Direct materials used -Direct labor incurred -Variable manufacturing overhead  Fixed manufacturing overhead treated as a period cost  Helpful for internal decision making  Not allowed for GAAP reporting Learning objective 1: Explain the difference between full (absorption) and variable costing

Sli de Learning objective 1: Explain the difference between full (absorption) and variable costing

Sli de Treatment of fixed manufacturing overhead ◦ Under full costing, it is included in inventory and expensed when the product is sold ◦ Under variable costing, it is considered a period cost and expensed in the period incurred. Learning objective 1: Explain the difference between full (absorption) and variable costing

Sli de Learning objective 2: Prepare an income statement using variable costing.

Sli de Learning objective 2: Prepare an income statement using variable costing.

Slide 5-41 Summit Manufacturing, Inc. produces snow shovels. The selling price is $25. Costs are: Sales are 38,500 snow shovels. Calculate net income using variable cost. Learning objective 3: Discuss the effect of production on full and variable costing income.

Sli de  Units produced = units sold No difference in net income  Units produced greater than units sold Full costing yields higher net income  Units Produced less than units sold Variable costing yields higher net income Learning objective 3: Discuss the effect of production on full and variable costing income.