1. Profit Planning and Decision Making
Chapter 4
Profit Planning and Decision Making

2. Major Topics in Chapter 4
Cost Behavior
Fixed, variable, mixed, and semi-variable costs
The importance of the relevant range
Break-Even Analysis
Contribution margin analysis for break-even and target profit levels.
Interpreting break-even charts
Finding the break-even point and target profit levels using formulas.
Uses, assumptions, and limitations

3. Topics to Skip in Chapter 4
Skip Cash Break-Even (pp )
Controllable vs. Non-Controllable Costs (p. 157)
Direct vs. Indirect Costs (pp )
Relevant costs (pp )
Break-even wedges (pp )

4. The Importance of Understanding Cost Behavior
If the behavior of costs can be understood, costs can be predicted at different levels of activity (operations)

5. Variable Costs – vary in direct proportion with changes in some activity.

6. An Example of Variable Cost
Note: the total long distance telephone bill is based on how many minutes are used.
Total Long Distance Telephone Bill
Minutes Talked

7. Per Minute Telephone Charge
Variable Cost Per Unit
The cost per long distance minute (unit) used is constant. For example, 5 cents per minute.
Per Minute Telephone Charge
Minutes Talked

8. Fixed Costs – remain constant at varying levels of some activity

9. An Example of Fixed Cost
Your monthly basic telephone bill probably does not change when you make more local calls.
Monthly Basic Telephone Bill
Number of Local Calls

10. Monthly Basic Telephone Bill per Local Call
Fixed Cost Per Unit
The average cost per local call decreases as more local calls are made.
Monthly Basic Telephone Bill per Local Call
Number of Local Calls

11. Trend Toward Fixed Costs
Increased automation.
Increase in salaried knowledge workers who are difficult to train and replace.
Implications
Managers are more “locked-in” with fewer decision alternatives.
Planning becomes more crucial because fixed costs are difficult to change with current operating decisions.

12. Types of Fixed Costs Fixed Costs Committed Discretionary Examples
Long-term, cannot be reduced in the short term.
Discretionary
May be altered in the short-term by current managerial decisions
Keep in mind that this depends on the time period under investigation – e.g. airline capacity.
Examples
Depreciation on Buildings and Equipment
Examples
Advertising and Research and Development

13. Mixed Costs: Contain an element of both fixed and variable cost – text classifies as ‘semi-variable’

14. Another Semi-Variable Cost Pattern
Total cost remains constant within a narrow range of activity.
Cost
Activity

15. Cost Behavior Patterns
It is important to understand how fixed and variable costs behave in total, and per unit.
Let’s pick up from where we left off in chapter 2 with an over view of cost behavior.

16. The Relevant Range
The range of activity for which estimates of cost are likely to be accurate.

18. Purpose of CVP
If we understand how costs and revenues behave – we can make predictions.
That is what CVP analysis is all about: how revenues, variable costs, and fixed costs interact over changes in sales volume.
CVP is built off of the Contribution Income Statement

19. The Contribution Format
An application of cost behavior is re-casting the income statement into a contribution format
The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs and provides for income.

20. The Contribution Format
Used primarily for external reporting.
Used primarily by management.

21. Simplified Example Assume the following facts for the hotdog stand:
Price of a hotdog (p): $ 1.00
Variable cost/dog (vc): $ 0.30
Fixed cost per month (FC): $50.00
Contribution margin approach illustrated

22. CVP Analysis Some acronyms: FC = fixed costs VC = variable costs
TC = total costs
CM = contribution margin
Q = #units (sold or produced)

23. Graphical Representation of CVP
Total cost vs. Total revenue (text)
CM vs. FC (not in text)

24. Assumptions of CVP [and limitations]
Selling price is constant throughout the entire relevant range.
Costs are linear throughout the entire relevant range.
Limitations
Classifying cost and revenue behavior is not easy.
Multiple product lines make CVP analysis tough.

25. Quick Review Question #1
At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Contribution Margin per unit is?
$65
$75
$175
$30

26. Quick Review Answer #1 $65 $75 $175 $30
At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Contribution margin per unit is?
$65
$75
$175
$30

27. Quick Review Question #2
At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Break-Even Point is?
1,000 units
1,083 units
2,000 units
None of these

28. Quick Review Answer #2 1,000 units 1,083 units 2,000 units
At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Break-Even Point is?
1,000 units
1,083 units
2,000 units
None of these

29. Quick Review Question #4
At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. What is profit expected to be?
Answer here: _________________

30. Quick Review Answer #4 Answer here: $143,000
At Winford Corp., the selling price per unit for lawn mowers is $120, variable cost per unit is $55. Fixed costs are $130,000. Expected sales are 4,200 units. What is profit expected to be?
Answer here: $143,000