Cost Behavior and Sales Cost Volume Profit Analysis Chapter 11 A200 Survey of Accounting University of Tennessee Fall 2015 2 Assumptions underlying SCVP analysis 1 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 constant 3 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 Behavior How costs change when business activity volume changes in the relevant range When volume increases When volume decreases Variable Costs total amount increases total amount decreases per unit amount is constant per unit amount is constant Fixed Costs total amount is constant total amount is constant per unit amount decreases per unit amount increases Mixed Costs total amount increases per unit amount decreases total amount decreases per unit amount increases Business activity Units produced and sold Volume Relevant range The normal range of operations Determine Cost Behavior Business Activity Volume 100 units 200 units 400 units 800 units Cost in total 60 00 120 00 240 00 480 00 Cost per unit 0 60 per unit 0 60 per unit 0 60 per unit 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 4 5 Determine Cost Behavior Business Activity Volume Cost in total 100 units 200 units 400 units 800 units 200 00 200 00 200 00 200 00 Cost per unit 2 00 per unit 1 00 per unit 0 50 per unit 0 25 per unit The 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 Determine Cost Behavior Business Activity Volume Cost in total Cost per unit 100 units 200 units 400 units 800 units 140 00 220 00 380 00 700 00 1 40 per unit 1 10 per unit 0 95 per unit 0 88 per unit The 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 Method 6 7 High Low Method for splitting Mixed Costs Variable cost per unit Cost Highest total cost Lowest total cost 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 00 Cost Formula TC FC VC TC 60 00 0 80 per unit 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 8 Contribution Income Statement Link 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 2 000 Operating Expenses period costs Selling Expenses 750 Link Company Contribution Income Statement sorts costs by behavior variable or fixed Sales Revenue 5 000 Variable Costs vary with volume Variable portion of COGS Exp Variable portion of Selling Exp Variable portion of Admin Exp 1 800 350 100 Contribution Margin 2 750 amount available to cover FC and get to profit 46 7 variable 53 3 fixed Administrative Expenses 700 14 3 variable 85 7 fixed Income from Operations profit 550 Fixed Costs do not vary with volume Fixed portion of COGS Exp Fixed portion of Selling Exp Fixed portion of Admin Exp 1 200 400 600 Income from Operations profit 550 Contribution 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 Sales Revenue of Sales 5 000 100 0 Variable Costs vary with volume Variable portion of COGS Expense Variable portion of Selling Expense Variable portion of Admin Expense 1 800 350 100 Contribution Margin 2 750 CM Ratio Per Unit 50 00 u 36 0 7 0 2 0 55 0 18 00 u 3 50 u 1 00 u 27 50 u Unit CM Fixed Costs do not vary with volume Fixed portion of COGS Expense Fixed portion of Selling Expense Fixed portion of Admin Expense Income from Operations profit 1 200 400 600 550 2 200 Total Fixed Costs 9 10 CM Ratio and Unit CM The CM Ratio and the Unit CM are tools that help managers project future costs revenues and profits Change in unit volume x Unit CM Change in profit If Link Company s sales decrease by 20 units by how much will profit decrease Change in sales dollars x CM ratio Change in profit If Link Company s sales increase by 100 000 by how much will profit increase 11 Break Even Point How many units must Link Company make and sell to break even Total Fixed Costs Unit CM 2 200 27 50 u 80 units Proof Sales Revenue 80 units x 50 00 u 4 000 Variable Costs 80 units x 22 50 u 1 800 Contribution Margin 80 units x 27 50 u 2 200 Fixed Costs 2 200 Income from Operations 0 At the Break Even Point 1 Total Revenues Total Expenses 2 Contribution Margin Fixed Costs 3 Income from Operations 0 4 000 How managers use the BE Point The Breakeven Point helps managers answer questions to plan for the future 1 If Link Company is a start up company how many units must it sell to become profitable 2 If the market for Link s product is declining how far can sales fall before the company becomes unprofitable 3 If Link change its selling price its variable costs or its fixed costs how will profit be affected 12 13 How price and cost changes affect the BE point 1 What happens to the BEP if Fixed Costs change If FC increase we must sell more units to break even FC BE If FC decrease we can sell fewer units and still break even FC BE 2 What happens to the BEP if Variable Costs per …