AC239 Managerial Accounting Seminar 5 Jim Eads, CPA, MST, MSF Cost Behavior and Cost-Volume-Profit Analysis 1

Costs Cost behavior refers to the way a cost changes in relation to activity changes. Activity base (or activity drivers) is the metric used to evaluate cost changes. Relevant range is the range of activity over which the changes in the cost are of interest. 2

Costs Variable costs are costs that vary in proportion to changes in the level of activity. Fixed costs are costs that are unaffected by the level of activity. 3

Total Variable Cost Graph 4

Unit Variable Cost Graph 5

Variable Cost Jason Inc. produces stereo sound systems under the brand name of J- Sound. The parts for the J-Sound stereos are purchased from outside suppliers for $10 per unit (a variable cost) and assembled in Jason Inc.’s Waterloo plant. 6

Fixed Cost The production supervisor for Minton Inc.’s Los Angeles plant is Jane Sovissi. She is paid $75,000 per year. The plant produces from 50,000 to 300,000 bottles of La Fleur Perfume. 7

Mixed Cost Mixed cost (sometimes called semivariable or semifixed costs) is a cost with characteristics of both a variable and a fixed cost. Over one range of activity, the total mixed cost may remain the same. Over another range of activity, the mixed cost may change in proportion to changes in level of activity. 8

Mixed Cost Simpson Inc. manufactures sails using rented equipment. The rental charges are $15,000 per year, plus $1 for each machine hour used over 10,000 hours. 9

Mixed Cost The High-low method is a simple cost estimate technique that may be used for separating mixed costs into their fixed and variable components. Based on formula: Total Costs = Total Variable Costs + Total Fixed Costs 10

High – Low Method 11 MonthUnitsTotal Cost June1,000$45,550 July1,50052,000 August2,10061,500 September1,80057,500 October75041,250 Highest units – lowest units = 2,100 – 750 = 1,350. Highest units cost – lowest units cost = $61,500 - $41,250 = $20,250. Variable cost/unit = $20,250 / 1,350 = $15.00 per unit Total cost = total variable cost + total fixed cost $61,500 = (2,100 x $15) + total fixed cost $61,500 = $31,500 + total fixed cost $61,500 - $31,500 = total fixed cost $30,000 = total fixed cost

Cost Behavior Total fixed costs do not vary with levels of production Total fixed costs do not vary with levels of production –Fixed costs per unit decline with increased production Total variable costs vary with levels of production Total variable costs vary with levels of production –Variable costs per unit do not vary 12

Cost-Volume-Profit Cost-volume-profit analysis is the systematic examination of the relationships among selling prices, sales and production volume, costs, expenses, and profits. 13

Contribution Margin Contribution margin is the excess of sales revenues over variable costs. It contributes first toward covering fixed costs, then contributes to profit. 14

Contribution Margin Sales (50,000 units)$1,000,000100%$20 Variable Costs600,00060%$12 Contribution margin$400,00040%$8 Fixed costs300,00030% Income from operations$100,00010% 15 Contribution Margin Ratio = (sales – variable costs) / sales = ($1,000,000 - $600,000) / $1,000,000 = 40% Unit Contribution Margin = sales price per unit – variable cost per unit = ($1,000,000 / 50,000) – ($600,000 / 50,000) = $8 Unit Contribution Margin = (sales – total variable cost) / units = ($1,000,000 - $600,000) / 50,000 = $8

Break-Even Point Break-even point: the level of operations at which a business’s revenues and costs are exactly equal. 16

Break-Even Point Barker Corporation’s fixed costs are estimated to be $90,000. The unit contribution margin is calculated as follows: Break-even sales = fixed costs / unit contribution margin $90,000 / $10 = 9,000 units $90,000 / $10 = 9,000 units Total revenue = $25 x 9,000 = $225,000 Total cost = ($15 x 9,000) + $90,000 = $225, Unit selling price$25 Unit variable cost15 Unit contribution margin$10

Break-Even Point If fixed costs increase If fixed costs increase –Break-even point increases If variable costs increase If variable costs increase –Break-even point increases If sales price increases If sales price increases –Break-even point decreases 18

Example Exercise 21-3 (page 932) Nicholas Enterprises sells a product for $60 per unit. The variable cost is $35 per unit, while fixed costs are $80,000. Determine the (a) break-even point in sales units, and (b) break-even point if the selling price were increased to $67 per unit. 19

Example Exercise 21-3 (page 932) a. Contribution margin per unit = $60 sales price - $35 variable cost = $25 Break-even units = fixed costs / unit contribution margin = $80,000 / $25 = 3,200 units Test: Revenue = 3,200 x $60 = $192,000 Costs = (3,200 x $35) + $80,000 = $192,000 20

Example Exercise 21-3 (page 932) b. Contribution margin per unit = $67 sales price - $35 variable cost = $32 Break-even units = fixed costs / unit contribution margin = $80,000 / $32 = 2,500 units Test: Revenue = 2,500 x $67 = $167,500 Costs = (2,500 x $35) + $80,000 = $167,500 21

Break-Even Sales Volume The sales volume required to earn a target profit is determined by modifying the break-even equation. Sales in units = (fixed costs + target profit) / unit contribution margin 22

Example Exercise 21-4 (page 932) The Forest Company sells a product for $140 per unit. The variable cost is $60 per unit, and fixed costs are $240,000. Determine the (a) break-even point in sales units, and (b) break-even point in sales units if the company desires a target profit of $50,

Example Exercise 21-4 (page 932) a. Contribution margin per unit = $140 sales price - $60 variable cost = $80 Break-even units = fixed costs / unit contribution margin = $240,000 / $80 = 3,000 units Test: Revenue = 3,000 x $140 = $420,000 Costs = (3,000 x $60) + $240,000 = $420,000 24

Example Exercise 21-4 (page 932) b. Contribution margin per unit = $140 sales price - $60 variable cost = $80 Break-even units at $50,000 profit = fixed costs + target profit / unit contribution margin = ($240,000 + $50,000) / $80 = 3,625 units Test: Revenue = 3,625 x $140 = $507,500 Costs = (3,625 x $60) + $240,000 = $457,500 Profit = $507,500 - $457,500 = $50,000 25

Questions? 26

One last thought…. Make sure you read through Chapter 22 through page 937 before next week’s seminar. 27