1. 19-1 Cost Behavior Analysis … how costs react to changes in the level of business activity.   Some costs change; others remain the same.   Note “cost per unit” versus “total costs”   Activity levels (Activity Index) may be: Sales Dollars, % Occupancy, # Covers, # Miles, # Classes   Allows c osts to be classified as: variable, fixed, or mixed (part fixed part variable). Cost Behavior Analysis

2. 19-2 Variable Costs Slurpee Mix Cup Lid Straw Fixed Costs Slurpee Machine

3. 19-3 Variable Costs Slurpee Mix Cup Lid Straw Total Costs … vary directly and proportionately with changes in activity level. Unit Costs … remain the same (constant) regardless. Variable costs vary in total, stay the same per unit.

4. 19-4 Variable Cost Behavior Analysis Variable Costs “Behavior”

5. 19-5 Fixed Costs Slurpee Machine Total Costs … remain the same regardless of changes in the activity level. Unit Costs … varies inversely with activity: Fixed costs are constant in total, vary per unit.

6. 19-6 Illustration: Apple leases a factory building at $10,000 per month. “Total Fixed Cost” for the Factory Rent will be: * $10,000 if 2,000 iPhones made, * $10,000 if 10,000 iPhones made. Fixed Cost Behavior Analysis (Activity Index)

7. 19-7 Illustration: Apple leases a factory building at $10,000 per month. “Fixed Cost Per Unit” for the Factory Rent will be: * $5 per unit if 2,000 iPhones made, * $1 per unit if 10,000 iPhones made. Fixed Cost Behavior Analysis (Activity Index) * Calculations: $10,000 total cost ÷ 2,000 iPhones = $5 per iPhone $10,000 total cost ÷ 10,000 iPhones = $1 per iPhone

8. 19-8 Fixed Cost Behavior Analysis Fixed Costs “Behavior”

9. 19-9 Relevant Range The range of activity (“how busy”) a company expects to operate during a year. (the norm or usual) “Technically” all costs are variable if you ignore relevant range. Ex: Variable Cost per Unit (Slurpee Straw) If: I buy 1,000,000 straws I may pay 1¢ cent per straw. But If: I buy 10,000,000 straws I may pay ½ ¢ cent per straw. (due to a volume purchase discount).

10. 19-10   Costs with both variable and fixed cost elements. Mixed Costs Mixed Cost Behavior Analysis  Change in total … but not proportionately with changes in activity. Ex : car rental: $20 per day (fixed) PLUS.10 per mile (variable)

11. 19-11 High-Low Method (applies only to mixed costs)  Must be classified into fixed and variable elements.  High-Low uses the total costs incurred at both the high and the low levels of activity to classify mixed costs.  The difference in costs between the high and low levels represents variable costs, since only variable costs change as activity levels change. Mixed Cost Behavior Analysis

12. 19-12 Assume your weekly pay is based on: salary (fixed) + commission (variable). What part is “salary” (fixed) and What part is “commission” (variable) Day# Sold$ Earned Mon1070 Tues020 Wed1385 Thurs020 Fri17105 Sat24140 Sun21125 Mixed Cost Behavior Analysis

13. 19-13 STEP 1: Determine variable cost per unit using formula: Mixed Cost Behavior Analysis High-Low Method Day# Sold$ Earned Mon1070 Tues020 Wed1385 Thurs020 Fri17105 Sat24140 Sun21125 140 -20 120 20 -0 20 120 20 = $5 per unit (High$ – Low$)HighSold - LowSold $ units

14. 19-14 Illustration: Metro Bus Co. has these maintenance costs and mileage data for its fleet of buses over a 6-month period. Mixed Cost Behavior Analysis High-Low Method

15. 19-15 STEP 1: Determine variable cost per unit using formula: Mixed Cost Behavior Analysis High-Low Method high - low costs high – low volume (activity)

16. 19-16 STEP 2: fixed cost - total variable cost Mixed Cost Behavior Analysis High-Low Method at either the high or low activity level.

17. 19-17 Maintenance costs = $8,000 per month plus $1.10 per mile. (Represented by formula): Maintenance costs = Fixed costs + ($1.10 x Miles driven) Ex: At 45,000 miles, estimated maintenance costs would be: Fixed $ 8,000 Variable ($1.10 x 45,000) 49,500 $57,500 Cost Behavior Analysis High-Low Method

18. 19-18 (a)Compute the variable and fixed cost elements using the high- low method. Fixed cost: $14,740 - $12,740 ($1.30 x 9,800 units) = $2,000 or $11,100 - $9,100 ($1.30 x 7,000) = $2,000 Variable cost: ($14,740 - $11,100) / (9,800 - 7,000) = $1.30 per unit Byrnes Company accumulates the following data concerning a mixed cost, using units produced as the activity level.

19. 19-19 (b)Estimate the total cost if the company produces 6,000 units. Total cost (6,000 units): $2,000 + $7,800 ($1.30 x 6,000) = $9,800

20. 19-20

21. 19-21 Cost-volume-profit (CVP) analysis is the study of the effects of changes of costs and volume on a company’s profits.   Important in profit planning   Critical factor in management decisions as ► ► Setting selling prices, ► ► Determining product mix, and ► ► Maximizing use of production facilities. Cost-Volume-Profit Analysis

22. 19-22 Cost-Volume-Profit Analysis Basic Components

23. 19-23 Traditional Income Statement (Revenue – Expenses = Net Income) GAAP required for external reporting

24. 19-24 Contribution margin – amount of revenue remaining after deducting variable costs. CVP Income Statement   Same net income as a traditional income statement.   For internal use only … not for public (per GAAP)   Classifies costs & expenses as fixed or variable.   Reports contribution margin in the statement.

25. 19-25

26. 19-26

27. 19-27 Cost-Volume-Profit Analysis Ex: Vargo Video produces camcorders. Relevant data for June: CVP Income Statement

28. 19-28  Contribution Margin must cover ALL fixed costs THEN profit (which is the “contribution” to net income). Cost-Volume-Profit Analysis Contribution Margin per Unit

29. 19-29 Break-Even Point When Revenue exactly equals ALL costs (Revenue – Variable – Fixed Expenses = Breakeven Point) Where loss ends and profit begins. The point at which a business, product or project becomes financially viable. Expressed as “Dollars” or “Units”.

30. 19-30 Cost-Volume-Profit Analysis CVP Income Statement

31. 19-31   Process of finding the break-even point where total revenues equal total costs (both fixed and variable).   Can be computed or derived ► ► from a mathematical equation, ► ► by using contribution margin, or ► ► from a cost-volume profit (CVP) graph.   Expressed either in sales units or in sales dollars. Cost-Volume-Profit Analysis Break-Even Analysis

32. 19-32 Computation of break-even point in units. Break-Even Analysis Mathematical Equation Break-even occurs where total sales equal variable costs plus fixed costs; i.e., net income is zero

33. 19-33  Shows the percentage of each sales dollar available to apply toward fixed costs and profits.  Formula for contribution margin ratio is: Cost-Volume-Profit Analysis Contribution Margin Ratio

34. 19-34 If current sales are $500,000 what is the effect of a $100,000 (200-unit) increase in sales. Cost-Volume-Profit Analysis Contribution Margin Ratio

35. 19-35   When the Break-Even point in units is desired, contribution margin per unit is used: Break-Even Analysis Contribution Margin Technique

36. 19-36   When the Break-Even point in dollars is desired, contribution margin ratio is used: Break-Even Analysis Contribution Margin Technique

37. 19-37 Break-Even Analysis Mathematical Equation Using the formula for the break-even point, simply include the desired net income as a factor.

38. 19-38 Illustration 19-26 Target Net Income To determine the required sales in units for Vargo Video: Contribution Margin Technique

39. 19-39 Illustration 19-27 Target Net Income To determine the required sales in dollars for Vargo Video: Contribution Margin Technique

40. 19-40   Difference between actual (or projected) sales and the sales at the break-even point.   Measures the “cushion” if expected sales fail to materialize.   May be expressed in dollars or as a ratio.   Assuming actual/expected sales are $750,000: Cost-Volume-Profit Analysis Margin of Safety

41. 19-41   Divide the margin of safety in $$ by the actual or sales.   Assuming actual/expected sales are $750,000:  The higher the dollars or %, the greater the margin of safety. Cost-Volume-Profit Analysis Margin of Safety Ratio