Slide 1Assumptions underlying SCVP analysisCost BehaviorDetermine Cost BehaviorDetermine Cost BehaviorDetermine Cost BehaviorHigh-Low Method for splitting Mixed CostsContribution Income StatementSlide 9CM Ratio and Unit CMBreak-Even PointHow managers use the BE PointHow price and cost changes affect the BE pointTarget ProfitBreak-Even Point - more than one productCost Behavior andSales-Cost-Volume-Profit AnalysisChapter 11A200 – Survey of AccountingUniversity of TennesseeFall 20152Assumptions underlying SCVP analysis1. Costs can be accurately divided into fixed and variable components(see slide #7)2. Businesses can predict future costs with a cost formula because total costs can be computed using the equation of a line (see slide #7): Equation of a line: Y = mX + b Cost Formula: TC = (VC/u. x Units) + FC Variable cost per unit (VC/u.) is the slope, the change amount Fixed cost (FC) is the y-intercept, the constant3. Operating efficiency is a constant (no downtime, no overtime)4. The sales mix is constant (see slide #15)5. Inventory quantities don’t change during the period (the business sells all the units it produces)3 Cost BehaviorHow costs change when business activity (volume) changes in the relevant range: When volume increases When volume decreasesVariable Costs: total amount increases total amount decreases per unit amount is constant per unit amount is constantFixed Costs: total amount is constant total amount is constant per unit amount decreases per unit amount increasesMixed Costs: total amount increases total amount decreases per unit amount decreases per unit amount increasesBusiness activity: Units produced and sold (Volume) Relevant range: The normal range of operations4Determine Cost Behavior Business Activity Cost Cost (Volume) in total per unit . 100 units $ 60.00 $0.60 per unit 200 units $120.00 $0.60 per unit 400 units $240.00 $0.60 per unit 800 units $480.00 $0.60 per unit The behavior of this cost is: ______________________Predict future costs:What will the total cost be if we produce and sell 325 units? What will the total cost be if we produce and sell 650 units? What will the total cost be if we produce and sell 700 units?5Determine Cost Behavior Business Activity Cost Cost (Volume) in total per unit . 100 units $200.00 $2.00 per unit 200 units $200.00 $1.00 per unit 400 units $200.00 $0.50 per unit 800 units $200.00 $0.25 per unitThe behavior of this cost is: ______________________Predicting future costs:What will the total cost be if the business produces 325 units? What will the total cost be if the business produces 650 units? What will the total cost be if the business produces 700 units?6Determine Cost Behavior Business Activity Cost Cost (Volume) in total per unit . 100 units $140.00 $1.40 per unit 200 units $220.00 $1.10 per unit 400 units $380.00 $0.95 per unit 800 units $700.00 $0.88 per unitThe behavior of this cost is: ______________________Predict future costs:What will the total cost be if the business produces 325 units? What will the total cost be if the business produces 650 units? What will the total cost be if the business produces 700 units? Develop the cost formula (TC = VC + FC) by splitting Mixed costs into their variable and fixed components, using the High-Low Method7 High-Low Method for splitting Mixed CostsVariable cost per unit = Δ Cost = (Highest total cost – Lowest total cost) Δ Volume (Highest units – Lowest units) = ( $700.00 - $140.00 ) = $0.80 per unit (800 units – 100 units) Fixed cost in total = Total Cost – Variable Cost = $700.00 – (800 units x $0.80 per unit) = $700.00 - $640.00 = $ 60.00Cost Formula: TC = FC + VC TC = $60.00 + $0.80 per unitWhat will the total cost be if the business produces 325 units? What will the total cost be if the business produces 650 units? What will the total cost be if the business produces 700 units?8Contribution Income StatementLink Company Traditional Income Statement (sorts costs by function: product or period)Sales Revenue $5,000 Cost of Goods Sold (product costs) (3,000) (60% variable, 40% fixed)Gross Profit 2,000Operating Expenses (period costs)Selling Expenses ( 750) (46.7%variable, 53.3% fixed)Administrative Expenses ( 700) (14.3% variable, 85.7% fixed)Income from Operations (profit) $ 550Link Company Contribution Income Statement (sorts costs by behavior: variable or fixed)Sales Revenue $5,000Variable Costs (vary with volume) Variable portion of COGS Exp. (1,800)Variable portion of Selling Exp. ( 350)Variable portion of Admin. Exp. ( 100)Contribution Margin 2,750 (amount available to cover FC and get to profit)Fixed Costs (do not vary with volume)Fixed portion of COGS Exp. (1,200) Fixed portion of Selling Exp. ( 400)Fixed portion of Admin. Exp. ( 600)Income from Operations (profit) $ 5509Contribution Margin Ratio (CM Ratio) and Unit Contribution Margin (Unit CM)Link Company’s Contribution Income Statement Link produced and sold 100 units of a single product (Volume = 100 u.) Total % of Sales Per UnitSales Revenue $5,000 100.0% $50.00/u.Variable Costs (vary with volume) Variable portion of COGS Expense (1,800) 36.0% 18.00/u.Variable portion of Selling Expense ( 350) 7.0% 3.50/u.Variable portion of Admin. Expense ( 100) 2.0% 1.00/uContribution Margin 2,750 55.0% $27.50/u. CM Ratio