Chapter 6 Cost Behavior A Changes in Volume and Effect on Cost a Variable Cost in volume are costs that change in total in direct proportion to changes If units 0 Variable 0 i When volume goes up costs go up ii When volume goes down cost go down iii Variable cost Cost unit volume of units iv b Fixed Costs volume because of previous management decisions decisions i Committed Fixed Costs ii Discretionary Costs meaning that the costs are locked in annual costs due to current management are costs that do not change in total despite wide changes in iii Fixed Cost per Unit decreases as units increase are costs that change in total but not in direct proportion to c Mixed Costs changes in volume i Mixed Costs Variable Costs Fixed Costs fixed costs over a small range of activity then jump to a new d Fixed Costs level of fixed costs with moderate changes in volume do not fit a pattern and is fluid e Curvilinear Costs B Managers Determine Cost Behavior a Account Analysis ledger account as a variable fixed or mixed costs managers use their judgment to classify each general b Scatter Plots are used to help estimate variable and mixed costs fits a mixed costs line through the highest and i High Low Method lowest volume data points 1 slope variable cost unit c Regression Analysis cost equation that best fits the data by using all of the data points is a statistical procedure for determining the line and i R R2 values find least squared regression C Contribution Margin Income Statement organizes cost by behavior rather than function a NOT GAAP approved b Contribution Margin is equal to sales revenue minus variable expense Chapter 7 Cost Volume Profit Analysis A Benefits of Cost Volume Profit for Managers a Cost Volume Profit Analysis volume and profit or loss i Data Required 1 Sale Price 2 Volume expresses the relationships among cost 3 Variable Costs 4 Fixed Costs 5 Profit or Loss ii CVP Assumptions 1 Change in volume is only factor that affects cost 2 managers can classify each cost as either variable or fixed and they are linear throughout the model revenue are linear throughout the relevant range of volume 3 inventory levels will not change 4 5 Sales Mix sales is the combination to products that make up total a Remains unchanged iii Unit Contribution Margin 1 Contribution Margin income Statement costs by behavior rather than by function which separates a Can divide variable and fixed costs is the excess of sales revenue over 2 Contribution Marin variable expenses a How much revenue is left after variable to contribute towards fixed costs and profit 3 Contribution Margin per Unit or unit contribution margin is the excess of the selling price per unit over the variable cost of obtaining and selling each unit a How much profit each unit provides before fixed costs Contribution Margin Ratio Unit Contribution Marin Sales Price per Unit Contribution Margin Ratio Contribution Margin Sales Revenue 4 both formulas are equal 5 can not be used if number of units changes the sales level at which the operating income is 0 sales below B Break Even Point equals a loss and sales above equals a profit Income Statement Approach a Operating Income Sales Revenue Variable Expenses Fixed Expenses Operating Income Sales price unit units sold variable cost unit units sold fixed costs Operating Income Sales revenue Variable Expenses Fixed Expenses Sales in units fixed Expenses Operating Income Contribution Margin per Unit b Contribution Method c contribution Method Operating Income Sales revenue Variable Expenses Fixed Expenses Sales In Fixed Expenses Operating Income Contribution Margin Ratio C Using CVP for changing Business Conditions a Sensitivity Analysis a what if technique that asks what results will be if actual prices or costs change or if an underlying assumption such as sales mixes changes b Change in sales price D Indicators of Risk a Margin of Safety i Sales price Decreases Unit Contribution Margin Decreases Volume needed for break even increases ii Sales Price Increases Unit Contribution Margin Increases Volume needed for break even decreases c Changing Variable Cost i Variable Cost Increases Unit Contribution Margin Decreases Volume needed for break even increases ii Variable Cost Decreases Unit Contribution Increases Volume needed for break even decreases d Changing Fixed Costs i Fixed Costs Increase Volume needed for break even increaeases ii Fixed costs Decrease Volume needed for break even decreases is the excess of actual or expected sales over break even i Cushion or drop in sales that the company can absorb before incurring losses ii Margin of safety Expected sales in units break even in sales refers to the relative amount of fixed and variable costs b Operating Leverage that make up its total cost i high operating leverage means relatively more fixed costs than variable costs ii higher contribution margin ratios iii higher potential for risk reward iv Operating Leverage factor operating income is to change in volume tells us how responsive a company s 1 operating level factor Contribution Margin operating income Chapter 8 Short Term Business Decisions A How Do Managers Make Decisions a Relevant information i Is expected future data ii Differs among alternatives b Short Term Special Decisions B Special Orders Regular Pricing Decisions a Special Sales Order customer requests a one time order at a reduced sales price i Things Managers Must consider 1 2 Is there excess capacity to fill this order Is reduced sale price high enough to cover the incremental costs ii iii 3 Will special order affect regular sales in the long run If expected increase in revenue EXCEEDS expected increase in variable and fixed costs Accept the Special order If expected increase in revenue is less than expected increase in variable and fixed costs Reject the order b Regular Pricing Decisions i Things Managers Consider 1 What is our target profit 2 How much will customers pay 3 Are we price takers of price setters for this product ii Price Takers price that is given is price of market 1 Product lacks uniqueness 2 Heavy Competition 3 Pricing Approach emphasizes target costing a Target Costing b The price is set in market and the way to achieve desired profit is by cutting costs not raising prices MarketPrice Profit Trget TotalCost iii Price Setters price is set 1 unique product 2 Less Competition 3 Pricing approach emphasizes Cost Plus Pricing a Cost Plus Pricing Total Cost Desired Profit Cost Plus Price b Ability to raise
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