1. Previous Lecture Chapter 17: Accounting Systems For Measuring Costs
Cost Accounting Systems
Basic Cost Accounting Procedures
Job Order Costing
The Job Cost Sheet
Job Order Costing : Document Flow Summary
Flow of Costs in Job Costing

2. Previous Lecture Closing Under- or Over applied Manufacturing Overhead
Flow of Costs in Job Costing
Process Costing
Comparing Job and Process Costing
Job and Process Costing
Job and Process Costing Similarities
Work in Process Accounts -The Key to Process Costing

3. Previous Lecture Computing Unit Cost
Computing and Using Equivalent Units of Production
Cost Per Equivalent Unit
Equivalent Units

4. Cost-Volume-Profit Analysis
Chapter 19 2

5. Questions Addressed by Cost-Volume-Profit Analysis
CVP analysis is used to answer questions such as:
How much must I sell to earn my desired income?
How will income be affected if I reduce selling prices to increase sales volume?
What will happen to profitability if I expand capacity?

6. Cost Behavior

7. Variable Cost
Jason Inc. produces stereo sound systems under the brand name of J-Sound. The parts for the stereo are purchased from an outside supplier for $10 per unit (a variable cost).

8. Total Variable Cost Graph
$300,000
$250,000
$200,000
$150,000
$100,000
$50,000
Total Costs
Units Produced (in thousands)

9. Unit Variable Cost Graph
$20
$15
$10 $5
Cost per Unit
Units Produced (000)

10. Direct Materials Cost per Unit Total Direct Materials Cost
Variable Cost
$300,000
$250,000
$200,000
$150,000
$100,000
$50,000
$20
$15
$10 $5
Cost per Unit
Total Costs
Units Produced (000)
Units Produced (000)
Number of
Units Produced
Direct Materials Cost per Unit
Total Direct Materials Cost
5,000 units $10 $ 50,000
10, l00,000
15, ,000
20, ,000
25, ,000
30, ,000

11. Fixed Costs
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 perfume.
La Fleur

12. Total Salary for Jane Sovissi Salary per Bottle Produced
Fixed Costs
$75,000/50,000= $1.5
Number of
Bottles Produced
Total Salary for Jane Sovissi
Salary per Bottle Produced
50,000 bottles $75,000 $1.500
100, ,
150, ,
200, ,
250, ,
300, ,

13. Total Salary for Jane Sovissi Salary per Bottle Produced
Fixed Costs
Total Fixed Cost Graph
Unit Fixed Cost Graph
$150,000
$125,000
$100,000
$75,000
$50,000
$25,000
$1.50
$1.25
$1.00
$.75
$.50
$.25
Total Costs
Cost per Unit
Bottles Produced (000)
Units Produced (000)
Number of
Bottles Produced
Total Salary for Jane Sovissi
Salary per Bottle Produced
50,000 bottles $75,000 $1.500
100, ,
15, ,
20, ,
25, ,
30, ,

14. Mixed Costs
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.

15. Mixed costs are sometimes called semivariable or semifixed costs.
Total Mixed Cost Graph
$45,000
$40,000
$35,000
$30,000
$25,000
$20,000
$15,000
$10,000
$5,000
Mixed costs are usually separated into their fixed and variable components for management analysis.
Total Costs
Total Machine Hours (000)

16. Mixed Costs
The high-low method is a simple way to separate mixed costs into their fixed and variable components.
Low
High

17. What month has the highest level of activity in terms of cost?
High-Low Method
Actual costs incurred
Production Total
(Units) Cost
What month has the highest level of activity in terms of cost?
June 1,000 $45,550
July 1,500 52,000
August 2,100 61,500
September 1,800 57,500
October ,250
Highest level of activity ($) minus lowest level of activity ($)
Variable cost per unit =
Highest level of activity (n) minus lowest level of activity (n)

18. What month has the highest level of activity in terms of cost?
High-Low Method
Actual costs incurred
Production Total
(Units) Cost
What month has the highest level of activity in terms of cost?
June 1,000 $45,550
July 1,500 52,000
August 2,100 61,500
September 1,800 57,500
October ,250
$61,500 minus lowest level of activity ($)
Variable cost per unit =
Highest level of activity (n) minus lowest level of activity (n)

19. For the highest level of cost, what is the level of production?
High-Low Method
Actual costs incurred
Production Total
(Units) Cost
For the highest level of cost, what is the level of production?
June 1,000 $45,550
July 1,500 52,000
August 2,100 61,500
September 1,800 57,500
October ,250
$61,500 minus lowest level of activity ($)
Variable cost per unit =
2,100 minus lowest level of activity (n)
Highest level of activity (n) minus lowest level of activity (n)

20. What month has the lowest level of activity in terms of cost?
High-Low Method
Actual costs incurred
Production Total
(Units) Cost
What month has the lowest level of activity in terms of cost?
June 1,000 $45,550
July 1,500 52,000
August 2,100 61,500
September 1,800 57,500
October ,250
$57,500 – $41,250
$61,500 minus lowest level of activity ($)
Variable cost per unit =
2,100 minus lowest level of activity (n)
2,100 – 750

21. What is the variable cost per unit?
High-Low Method
Actual costs incurred
Production Total
(Units) Cost
What is the variable cost per unit?
June 1,000 $45,550
July 1,500 52,000
August 2,100 61,500
September 1,800 57,500
October ,250
$20,250
1,350
$15
$57,500 – $41,250
Variable cost per unit =
2,100 – 750

22. High-Low Method
Actual costs incurred
Production Total
(Units) Cost
Variable cost per unit = $15
What is the total fixed cost (using the highest level)?
June 1,000 $45,550
July 1,500 52,000
August 2,100 61,500
September 1,800 57,500
October ,250
Total cost = (Variable cost per unit x Units of production) Fixed cost
$61, = ($15 x 2,100) + Fixed cost
$61, = ($15 x 2,100) + $30,000

23. High-Low Method The fixed cost is the same at the lowest level.
Actual costs incurred
Production Total
(Units) Cost
Variable cost per unit = $15
The fixed cost is the same at the lowest level.
June 1,000 $45,550
July 1,500 52,000
August 2,100 61,500
September 1,800 57,500
October ,250
Total cost = (Variable cost per unit x Units of production) Fixed cost
$41, = ($15 x 750) + Fixed cost
$41, = ($15 x 750) + $30,000

24. Variable Costs Fixed Costs
Total Variable Costs
Total Fixed Costs
Total Costs
Total Costs
Total costs increase and decreases with activity level.
Unit costs remain the same per unit regardless of activity.
Total Units Produced
Review
Total Units Produced
Unit costs remain the same regardless of activity.
Total costs increase and decreases proportionately with activity level.
Unit Fixed Costs
Unit Variable Costs
Per Unit Cost
Per Unit Cost
Total Units Produced
Total Units Produced

25. Total cost remains constant within a narrow range of activity.
Stair-Step Costs
Total cost remains constant within a narrow range of activity.
Cost
Activity

26. Stair-Step Costs
Total cost increases to a new higher cost for the next higher range of activity.
Cost
Activity

27. Curvilinear Cost Function
Curvilinear Costs
Curvilinear Cost Function
Relevant Range
Total Cost
A straight line closely (constant unit variable cost) approximates a curvilinear variable cost line within the relevant range.
Volume of Output

28. Cost Behavior Summary

29. Cost-Volume-Profit
Relationships

30. Contribution Margin Income Statement
The contribution margin is available to cover the fixed costs and income from operations.
Sales (50,000 units) $1,000,000
Variable costs ,000
Contribution margin $ 400,000
Fixed costs ,000
Income from operations $ 100,000
Contribution margin
FIXED COSTS
Income from Operations

31. Contribution Margin Income Statement
Sales (50,000 units) $1,000,000
Variable costs ,000
Contribution margin $ 400,000
Fixed costs ,000
Income from operations $ 100,000
Income
from
operations
Variable
costs
Fixed
costs
Sales = + +
Sales
Variable
costs
Contribution
margin – =

32. Contribution Margin Ratio
Sales (50,000 units) $1,000,000
Variable costs ,000
Contribution margin $ 400,000
Fixed costs ,000
Income from operations $ 100,000
100%
60%
40%
30%
10%
Sales – Variable costs
Sales
Contribution margin ratio =
Contribution margin ratio =
$1,000,000 – $600,000
$1,000,000
Contribution margin ratio =
40%

33. Contribution Margin Ratio
Sales (50,000 units) $1,000,000
Variable costs ,000
Contribution margin $ 400,000
Fixed costs ,000
Income from operations $ 100,000
100%
60%
40%
30%
10%
$20 12
$ 8
The contribution margin can be expressed three ways:
1. Total contribution margin in dollars.
3. Contribution margin ratio (percentage).
3. Unit contribution margin (dollars per unit).

34. Cost-Volume-Profit (CVP) Analysis
Let’s extend our knowledge of cost behavior to CVP analysis.

35. Computing Break-Even Point
The break-even point (expressed in units of product or dollars of sales) is the unique sales level at which a company neither earns a profit nor incurs a loss.

36. Computing Break-Even Point
Contribution margin is amount by which revenue exceeds the variable costs of producing the revenue.

37. Computing Break-Even Point
How much contribution margin must this company have to cover its fixed costs (break even)?

38. Computing Break-Even Point
How much contribution margin must this company have to cover its fixed costs (break even)?
Answer: $30,000

39. Computing Break-Even Point
How many units must this company sell to cover its fixed costs (break even)?

40. Computing Break-Even Point
How many units must this company sell to cover its fixed costs (break even)?
Answer: $30,000 ÷ $20 per unit = 1,500 units

41. Formula for Computing Break-Even Sales (in Units)
We have just seen one of the basic CVP relationships – the break-even computation.
Break-even point in units =
Fixed costs
Contribution margin per unit
Unit sales price less unit variable cost ($20 in previous example)

42. Formula for Computing Break-Even Sales (in Dollars)
The break-even formula may also be expressed in sales dollars.
Fixed costs
Break-even point in dollars =
Contribution margin ratio
Unit sales price Unit variable cost

43. Computing Break-Even Sales Question 1
ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to break even?
a ,000 units
b ,000 units
c ,000 units
d ,667 units

44. Computing Break-Even Sales Question 1
ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to break even?
a ,000 units
b ,000 units
c ,000 units
d ,667 units
Unit contribution = $ $3.00 = $2.00
Fixed costs Unit contribution
$200,000 $2.00 per unit =
= 100,000 units

45. Computing Break-Even Sales Question 2
Use the contribution margin ratio formula to determine the amount of sales revenue ABC must have to break even. All information remains unchanged: fixed costs are $200,000; unit sales price is $5.00; and unit variable cost is $3.00.
a. $200,000
b. $300,000
c. $400,000
d. $500,000

46. Computing Break-Even Sales Question 2
Use the contribution margin ratio formula to determine the amount of sales revenue ABC must have to break even. All information remains unchanged: fixed costs are $200,000; unit sales price is $5.00; and unit variable cost is $3.00.
a. $200,000
b. $300,000
c. $400,000
d. $500,000
Unit contribution = $ $3.00 = $2.00
Contribution margin ratio = $2.00 ÷ $5.00 = .40
Break-even revenue = $200,000 ÷ .4 = $500,000

47. Costs and Revenue in Dollars
Preparing a CVP Graph
Starting at the origin, draw the total revenue line with a slope equal to the unit sales price.
Revenue
Total fixed cost
Total fixed cost extends horizontally from the vertical axis.
Costs and Revenue in Dollars
Volume in Units

48. Costs and Revenue in Dollars
Preparing a CVP Graph
Draw the total cost line with a slope equal to the unit variable cost.
Revenue
Break-even Point
Profit
Costs and Revenue in Dollars
Total cost
Loss
Total fixed cost
Volume in Units

49. Computing Sales Needed to Achieve Target Operating Income
Break-even formulas may be adjusted to show the sales volume needed to earn any amount of operating income.
Fixed costs + Target income
Unit sales =
Contribution margin per unit
Fixed costs + Target income
Dollar sales =
Contribution margin ratio

50. Computing Sales Needed to Achieve Target Operating Income
ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to earn operating income of $40,000?
a ,000 units
b ,000 units
c ,000 units
d ,000 units

51. Computing Sales Needed to Achieve Target Operating Income
ABC Co. sells product XYZ at $5.00 per unit. If fixed costs are $200,000 and variable costs are $3.00 per unit, how many units must be sold to earn operating income of $40,000?
a ,000 units
b ,000 units
c ,000 units
d ,000 units
= 120,000 units
Unit contribution = $ $3.00 = $2.00
Fixed costs + Target income Unit contribution
$200,000 + $40, $2.00 per unit

52. What is our Margin of Safety?
Margin of safety is the amount by which sales may decline before reaching break-even sales:
Margin of safety provides a quick means of estimating operating income at any level of sales:
Margin of safety = Actual sales - Break-even sales
Operating Margin Contribution Income of safety margin ratio = ×

53. What is our Margin of Safety?
Oxco’s contribution margin ratio is 40 percent. If sales are $100,000 and break-even sales are $80,000, what is operating income?
Operating Margin Contribution Income of safety margin ratio = ×
Operating Income
= $20,000 × = $8,000

54. What Change in Operating Income Do We Anticipate?
Once break-even is reached, every additional dollar of contribution margin becomes operating income:
Oxco expects sales to increase by $15,000. How much will operating income increase?
Change in Change in Contribution operating income sales volume margin ratio = ×
Change in operating income
= $15,000 × = $6,000

55. End of Today’s Session