- Act 220 1st EditionExam # 2 Study Guide Chapter 5: Cost-Volume-Profit Analysis Define and provide examples for the different costs behaviors (i.e. fixed costs, variable costs, mixed costs and step costs).Fixed Costs (FC): Costs that do NOT vary in total with changes in production volume Rent, depreciation (straight line), long term salaries, lease expense, property taxeso Regardless of how much I sell I STILL HAVE to pay these expensesEQUATION: FC/ unit = (Total FC) / (# of units produced)Variable Costs (VC): Costs that vary DIRECTLY with changes in volume Direct material, direct labor, electricity (only a small percentage), gas costso Joe calls and needs you to make 50 more products (sales change and VC)EQUATION: Total VC = (# of units produced)*(price/unit VC)Mixed Costs (MC): Costs that are part FC and VC Phone bills, cable bills, maintenance fees at factoryEQUATION: Total MC = (Total FC + Total VC)Step Costs (SC): Costs remain fixed within a relevant range In ACT 220 only 90 students can register for each section; if I want to add 1 more person I would have to open a new section for another 90 people despite only one person being in the class.Define relevant range, then interpret its meaning. Relevant Range: The volume range where the properties of FC and VC hold true AND it is the volume the firm expects to operate at  In other words, the values we’ve found for VC and FC are currently based on a set range of volume (i.e. I know VC= $3/unit and FC= $120,000 if we produce upto 50,000 units)Interpretation: For any unit produced past our current planned capacity (i.e. 50,001 units or more) then we need to recalculate the values for FC and VC for accuracy FC are always the SAME in total, but vary per unit produced o For example, I know I HAVE to pay a FC=$120,000, BUT if I sell 2 units each unit will have a $60,000 FC… or if I decide to sell 4 units each unit will have a $30,000 FCWhat are the two methods used to measure a firm’s FC and VC?1. High-Low Method2. Scatter Diagram3. Regression Analysis Define the purpose of a Scatter Diagram, indicate how to utilize this information, and finally relate this information to the basic line equation (y=mx+b).Purpose: Splits MC into FC and VC. Used to plot the data for costs at different levels of activity (number of units produced). First, pick one data point (mid point of the data) then draw a linear (straight) line interesting the y-axis. Basic Line Equation (y=mx+b): The variable in the equation are: “b”= Fixed Costs, the point where the linear line intersects (crosses) the y-axis (at 0 units produced you still owe the same amount of FC, remember this is how much you have to pay regardless of production); “m” = Variable Costs, the slope of this line is constant, for each additional unit your variable costs will increase the same amount (i.e. rise over run); “x” = Number of Units Produced, this is the number of units you will produce for the period (usually a given value); “y” = Total Costs at a Certain x-number of UnitsExplain the purpose of the High-Low Method, and then list each step this method uses. Purpose: The purpose of this method is identical to the Scatter Diagram; the ONLY difference is this method uses TWO points rather than just one point. The two points we use are the highest and the lowest of the activity level (# of units), then draw a straight line between these points (the variables are the same as above). Steps:1. Find the HIGHEST and the LOWEST ACTIVITY level and then record the amount of activityand the corresponding cost. 2. Find the unit VC or in other words, find the slope (rise over run). EQUATION: Slope= (Change in Cost/ Change in Activity Level) = $ per 1 unit3. Solve for Fixed Costs (“b”). Choose either the highest or the lowest data point (does not matter which just stay consistent). Then, plugin: the slope found in step 2, the cost and activity level from the chosen data into y = mx+b. Solve for “b.”4. Rewrite cost equation. Use the value found for “b” and the value of the slope to rewrite the cost equation (i.e. y = $3.50x + $50,000).  Use this equation to find the costs associated with a certain level of production (i.e. How much it cost to produce 10,000 units given the following cost information).What is Regression Analysis and what is its purpose? Purpose: Most effective and preferred method for determining FC and VCRegression Analysis: Analyzes all data points using Excel or another software application (does the computations for you). The y-intercept: FC and the variable “b” in the basic line equation; the x-intercept: The slope of the given data and the variable “m” in the basic line equation; R-Squared Statistic: measures the percent of variance in the dependent variable (total production costs) explained by the independent variable.Explain Cost-Volume-Profit Analysis (CVP), as well as a CVP Chart.Cost-Volume-Profit Analysis: Also known as the “Break-Even Analysis”, determines what effects any changes in the company’s sales price (what happens if prices change?), sales volume, variable product cost, fixed costs and sales mix (how much of each product should I sell?)Cost-Volume-Profit Chart: This is a chart graphically represents the relationships between sales price, sales volume, variable production costs, fixed costs and sales mix. Where the total costs and sales lines cross is the break-even point.Jkhjhjkhjkhjkhjkhjkhjkhjkhjkhjdasjl What is a Contribution Margin?Contribution Margin: The amount where sales revenue leftover after deducting variable costs from sales (the amount remaining will “CONTRIBUTE” to covering FC and then operating profit for the company)CM on a Per Unit Basis (Income Statement Explanation): Using the income statement provided above in red: Sales = Sales Unit Price (we charge each customer $6/ unit); VC = VC unit price (the amount it takes us as a company to produce is $4/ unit).What is does the income statement for the CVP look like (also known as the contribution margin income statement)? Look at the differences between this income statement and the one from previous chapters. CVP Income Statement: CVP Income Statement:Sales (S)-Less Variable Costs (VC)Contribution Margin (CM)-Less Fixed Costs (FC) NET INCOMEIncome Statement in Depth: When using a traditional income statement---Sales Revenue – Total VC (Costs of goods sold, S&A Costs) = Contribution Margin – Total FC (Cost