Accounting Exam 3Chapter 11 NotesCost Behavior – A manner in which a cost changes as a related activity changes- This allows managers to predict profits as sales and production volumes changeUnderstanding the behavior of a cost depends on:1. Activity bases – an activity that causes the cost to change2. Relevant range – the range of activity over which changes in cost are of interest to managementCost are normally classified as variable costs, fixed costs, or mixed costsVariable Costs: Costs that vary in total dollar amount as the level of activity changed- When the activity base is units produced, DM, or DL costs they are normally classified asvariable costsCharacteristics of Variable costs:o Cost per unit remains the same regardless of changes in the activity baseo Total cost changes in proportion to changes in the activity base Look at graphs on page 433 of your bookFixed Costs: costs that remain the same in total dollar amount as the activity base changes - When the activity base is units produced, many FOH costs such as straight line depreciation are classified as fixed costs Characteristics of Fixed Costs:o Cost per unit changes inversely to changes in the activity baseo Total cost remains the same regardless of changes in the activity base Mixed Costs: costs that have characteristics of both a variable and a fixed cost (also called semivariable or semifixed)-Uses the high-low methodo High-low method – a technique that uses the highest and lowest total cost as a basis forestimating the variable cost per unit and the fixed cost component of a mixed cost-The total fixed cost does not change with changes in production -The change in total variable cost is the difference of the highest level cost – lowest level cost1Variable cost per unit = Difference in total cost Difference in production OrVariable cost per unit = (Highest cost - Lowest cost) (Highest units produced – lowest units produced)Fixed Cost = Total Cost – (Variable cost per unit X Units produced)Total Cost = (Variable cost per unit X Units produced) + Fixed costsVariable Costing: Often referred to as direct costing, it is a method of reporting variable and fixed costs that includes only the variable manufacturing costs in the cost of the product- Only variable manufacturing costs (DL, DM, FOH) are included in the product cost.- The fixed FOH is treated as an expense of the period of which it is incurred Cost-Volume-Profit RelationshipsCost-volume-profit analysis – the examination of the relationships among selling prices, sales and production volume, costs, expenses, and profits - Useful for managerial decision making Cost-volume-profit analysis is used to:1. Analyze the effects of changes in selling prices on profits2. Analyze the effects of changes in costs on profits3. Analyze the effects of changes in volume on profits 4. Setting selling prices5. Selecting the mix of products to sell6. Choosing among marketing strategies Contribution Margin – the excess of sales over variable costs - Shows insight into the profit potential of a company Contribution Margin = Sales – Variable costs- Any additional CM increases income from operations 2Contribution Margin Ratio – CM expressed as a ratio, sometimes called profit-volume ratio, the percentage of each sales dollar that is available to cover the fixed costs and provide income from operations - Useful in developing business strategiesContribution Margin Ratio = Contribution Margin SalesChange in income from operations = Change in sales dollars x CM ratioVariable costs as a percentage of sales = (100%-CM ratio) x SalesTotal CM = Sales x CM ratioUnit Contribution Margin: the dollars available from each unit of sales to cover fixed costs andprovide income from operationsUnit CM = Sales price per unit – Variable Cost per unitChange in income from operations = Change in sales units x Unit CMTotal CM = Units x Unit CMMathematical Approach to Cost-Volume-Profit AnalysisThe mathematical approach to cost-volume-profit analysis uses equations to determine:1. Sales necessary to break even2. Sales necessary to make a target or desired profit Revenues = Costs Break-Even Point – the level of operations at which a company’s revenues and expenses are equal- A company reports neither an income nor a loss from operations 3Break-Even PointBreak-Even Sales (units) = Fixed Costs UnitCMContribution Margin ration = Unit Contribution Margin Unit Selling Price**The break-even point is affected by changes in the fixed costs, unit variable costs, and the unitselling price** Effect of Changes in fixed costs – Changes in fixed costs affect the break-even point:1. Increases in fixed costs increase the break-even point2. Decreases in fixed costs decrease the break-even point Changes in Variable costs affect the break-even point as follows:1. Increases in unit variable costs increase the break-even point2. Decreases in unit variable costs decrease the break-even point Changes in unit selling price affect the break-even point as follows:1. Increases in the unit selling price decrease the break-even point 2. Decreases in the unit selling price increase the break-even point Target Profit- The goal of most companies is to make a profit and by modifying the break-evenequation, the sales required to earn a target or desired amount of profit may e computed Special Cost-volume-profit relationshipSales Mix Consideration - Many companies sell more than one product at different selling prices- These products normally have different variable costs, thus different CM - Break-even analysis can still be performed by considering the sales mix- Sales Mix – the relative distribution of sales among the products sold by a company (available for sale)**Go on page 452 to see how this process is done, it’s too hard to explain here**4Break-Even Sales (dollars) = Fixed Costs CM ratio Sales (Units) = Fixed Costs + Target Profit Unit Contribution Margin Sales (dollars) = Fixed Costs + Target Profit Contribution Margin