© 2007 Pearson Education Canada Slide 2-1 Cost Behaviour and Cost-Volume Relationships 2

© 2007 Pearson Education Canada Slide 2-2 Cost Behaviour Cost Driver an activity which influences how a cost is incurred kilometers traveled is a cost driver for gasoline costs Volume $ $ Variable Cost a cost which changes in direct proportion to changes in the cost driver is constant per unit as volume changes Fixed Cost a cost which is not influenced by changes in the cost driver over the relevant range per unit fixed costs change as volume changes

© 2007 Pearson Education Canada Slide 2-3 Cost-Volume-Profit Analysis the study of the relationships between revenues, costs, volume and profits Contribution Margin per unit Contribution Margin % (or CM per unit) (or CM%) = Revenue per unit =CM per unit / revenue per unit - variable cost per unit=$0.10 / $0.50 = $ $0.40 =20% = $0.10 per unit Break-Even Point in UnitsBreak-Even Point in Dollars =Fixed costs / CM per unit=Fixed costs / CM% =$6,000 / $0.10=$6,000 / 20% =60,000 units=$30,000

© 2007 Pearson Education Canada Slide 2-4 Cost-Volume-Profit Graph Sales Total Expenses Relevant Range of volume Volume $Break-even Point Net loss area Net income area

© 2007 Pearson Education Canada Slide 2-5 Changes in Model Factors $ Volume Sales Expenses Basic Model $ Volume Sales Expenses Decrease Variable Costs $ Volume Sales Expenses Increase Fixed Costs $ Volume Sales Expenses Decrease Fixed Costs

© 2007 Pearson Education Canada Slide 2-6 Target Net Income and Income Taxes Target Sales in Units Target Sales in Dollars= (Fixed costs + Target income) / CM per unit/ CM% = ($6,000 + $480) / $0.10= ($6,000 + $480) / 20% = 64,800 units= $32,400 Income Taxes note that income taxes are neither a variable nor a fixed cost convert desired after-tax net income to its before-tax equivalent before adding into the target sales formula Target income before income taxes = Target after-tax net income / (1 - tax rate) = $288 / (1 -.40) = $288 /.6 = $480

© 2007 Pearson Education Canada Slide 2-7 Sales Mix Analysis Sales mix is defined as the relative proportions or combinations of quantities of different products that comprise total sales If the proportions of the mix change, the cost- volume-profit relationships also change A breakeven point is unique to a given sales mix

© 2007 Pearson Education Canada Slide 2-8 Cost-Volume-Profit Analysis Multiple Product Situations Sales Mix in units relative mix based on the # of units sold A = 40%; B = 60% Sales Mix in dollars relative mix based on the $ value of sales A = 25%; B = 75% Average contribution margin per unit = ($CM A x SM% units A ) + ($CM B x SM% units B ) Average contribution margin percentage = (CM% A x SM% $ A ) + (CM% B x SM% $ B ) Break-even point in unitsBreak-even point in dollars = Fixed costs / Average CM per Unit= Fixed Costs / Average CM % A $5 A $5 B $10 B $10 B $10

© 2007 Pearson Education Canada Slide 2-9 Operating Leverage $ Sales Volume $ Sales Total Expenses High Operating Leverage High Fixed / Low Variable Costs Higher Break-even Point Greater Risk Greater Potential Returns Low Operating Leverage Low Fixed / High Variable Costs Lower Break-even Point Reduced Risk Lower Potential Returns Total Expenses

© 2007 Pearson Education Canada Slide 2-10 Contribution Margin vs. Gross Margin Contribution margin is the difference between sales and variable costs Gross margin is the difference between sales and cost of goods sold Cost of goods sold is the cost of the merchandise that is acquired or manufactured and then resold