Slide 1Slide 2Slide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Slide 15Slide 16Slide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23Slide 24Slide 25Slide 26Slide 27Slide 28Slide 29Slide 30Slide 31Slide 32Slide 33Slide 34Slide 35Slide 36Slide 37Slide 38Chapter 23Chapter 23Cost-Volume-Profit RelationshipsAdapted forAccounting 212CHAPTER 23 COST-VOLUME-PROFIT RELATIONSHIPSAfter studying this chapter, you should be able to: 11 Distinguish between variable and fixed costs. 22 Explain the significance of the relevant range. 33 Explain the concept of mixed costs. 44 List the five components of cost-volume-profit analysis. 55 Indicate what contribution margin is and how it may can expressed.CHAPTER 23 COST-VOLUME-PROFIT RELATIONSHIPSAfter studying this chapter, you should be able to: 66 Identify the three ways to determine the break-even point. 77 Define margin of safety and give the formulas for computing it. 88 Give the formulas for determining sales required to earn target net income. 99 Describe the essential features of a cost-volume-profit income statement.COST BEHAVIOR ANALYSIS• Cost behavior analysis is the study of how specific costs respond to changes in the level of business activity.• The starting point in cost behavior analysis is measuring the key business activities.• Activity levels may be expressed in terms of1)1) sales dollars – in a retail company,2) 2) miles driven – in a trucking company,3)3) room occupancy – in a hotel, or4)4) number of customers called on – by a salesperson.• The activity index identifies the activity that causes changes in the behavior of costs.BEHAVIOR OF TOTAL AND UNIT VARIABLE COSTSStudy Objective 1•Variable costs are costs that vary in total directly and proportionately with changes in the activity level. A variable cost may also be defined as a cost that remains the same per unit at every level of activity. Damon Company manufactures radios that contain a $10 digital clock. •The activity index is the number of radios produced. As each radio is manufactured, the total cost of the clocks increases by $10.•Fixed costs are costs that remain the same in total regardless of changes in the activity level. Since fixed costs remain constant in total as activity changes, therefore fixed costs per unit vary inversely with activity. •Damon Company leases all of its productive facilities at a cost of $10,000 per month. Totalfixed costs of the facilities will remain constant at every level of activity.BEHAVIOR OF TOTAL AND UNIT FIXED COSTS•A straight-line relationship does not usually exist for variable costs throughout the entire range of activity.•In the real world, the relationship between variable cost behavior and change in the activity level is often curvilinear, as shown in part a on the right. The behavior of total fixed costs through all levels of activity is shown in part b.NONLINEAR BEHAVIOR OF VARIABLE AND FIXED COSTSStudy Objective 2LINEAR BEHAVIOR WITHIN RELEVANT RANGEThe relevant range of the activity index is the range over which a company expects to operate during a year. Within this range, a straight-line relationship normally exists for both fixed and variable costs.BEHAVIOR OF A MIXED COSTStudy Objective 3Mixed costs contain both variable and fixed cost elements. Mixed (semi-variable) costs change in total but not proportionately with changes in the activity level. Local rental terms for a 17-foot U-Haul truck, including insurance, are $50 per day plus $.50 per mile. The per diem charge is a fixed cost with respect to miles driven, while the mileage charge is a variable cost. The graphic presentation of the rental cost for a one-day rental is shown below:FORMULA FOR VARIABLE COST PER UNIT USING HIGH-LOW METHOD÷ =Change in Total CostsHigh minus Low Activity LevelVariable Cost per Unit• In CVP analysis, it is assumed that mixed costs must be classified into their variable and fixed components.•Firms usually ascertain variable and fixed costs on an aggregate basis at the end of a time period, using the company’s past experience with the behavior of the mixed cost at various activity levels.• The high-low method uses the total costs incurred at the high and low levels of activity.• The steps in calculating fixed and variable costs under this method are as follows:•1)1) Determine variable cost per unit from the following formula:ASSUMED MAINTENANCE COSTS AND MILEAGE DATAAssume that Metro Transit Company has the maintenance costs and mileage data for its fleet of buses over a 4-month period as shown below. The high and low levels of activity are 50,000 miles in April and 20,000 miles in January. The maintenance costs at these 2 levels are $63,000 and $30,000, respectively. The difference in maintenance costs is $33,000 ($63,000 – $30,000) and the difference in miles is 30,000 (50,000 – 20,000). Therefore, variable cost per unit for Metro Transit Company is $1.10 ($33,000 / 30,000).HIGH-LOW METHOD COMPUTATION OF FIXED COSTS2) Determine the fixed cost by subtracting the total variable cost at either the high or low activity level from the total cost at that activity level. For Metro Transit Company, the calculations are as follows:•Cost-volume-profit (CVP) analysis is the study of the effects of changes of costs and volume on a company’s profits.•Cost-volume-profit (CVP) analysis is important in profit planning. •It also is a critical factor in management decisions.CVP ANALYSISStudy Objective 4The following assumptions underlie each CVP analysis:11 The behavior of both costs and revenues is linear throughout the relevant range of the activity index.22 All costs can be classified as either variable or fixed with reasonable accuracy.3 3 Changes in activity are the only factors that affect costs.44 All units produced are sold.55 When more than one type of product is sold, the sales mix will remain constant. Sales mix complicates CVP analysis because different products will have different cost relationships.COMPONENTS OF CVP ANALYSISCOMPONENTS OF CVP ANALYSISFORMULA FOR AND COMPUTATION OF CONTRIBUTION MARGINStudy Objective 5– =SalesVariable CostsContribution Margin$500,000 – $300,000 = $200,000• Contribution margin (CM) is one of the key relationships in CVP analysis and is the amount of revenue