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Managerial Accounting
Chapter 19
Cost Behavior and Cost-Volume-Profit Analysis
I) Introduction
A) CVP analysis is a means of predicting the effect of changes in costs and
sales level on the income of a business.
1. Can be used to answer "what-if" questions. (Evaluate alternative
strategies)
II) Analysis of cost behavior
A) How does the cost respond to changes in the level of activity
1. he activity base or activity driver must be identified.
2. For CVP, costs must be classified as either fixed or variable
B) Fixed costs
1. Remain unchanged in total amount over a wide range of production
levels.
2. Examples - rent, insurance, depreciation
3. Total amount is fixed, so per unit amount will decrease as number of
units increase.
C) Variable costs
1. Change directly and proportionately with changes in activity level
2. Are constant on a per unit basis.
D) Behavior of costs is assumed to be linear (straight-line)
1. Stair step costs
2. Mixed (semivariable) costs
a. Changes with activity but not proportionately
b. Must be broken out into their "fixed" and "variable" component
i. High-low method -- simple technique used to estimate fixed and
variable component of mixed costs.
ii. Analyze historical data
Pick highest and lowest activity level
Variable cost per unit =
Change in costs
---------------------Change in activity
Fixed component =
total cost - (activity level X variable cost per unit)
E) Concept of relevant range
1. Lends credibility to cost linearity assumption used in CVP analysis
III) CVP Analysis
A) Note Assumptions of CVP.
1. Behavior of revenues and costs are linear within relevant range.
2. All costs can be classified as fixed or variable.
3. Change in activity is the only factor affecting costs.
4. Production equals sales.
5. Sales mix is constant.
B) Breakeven point -- level of activity where the company has no profit or
loss
1. Expressed in units
Fixed costs
--------------------------------Unit contribution Margin
a. Unit contribution margin = Unit Selling price - Unit Variable cost
2. Expressed in dollars
Unit breakeven point x
Unit selling price or
Fixed costs
---------------------------------Contribution margin ratio
a. Contribution margin ratio=
Unit contribution margin
-------------------------------Unit selling price
b. Or, contribution margin ratio =
Sales- Variable costs
---------------------------Sales
3. Expressed graphically in a CVP graph.
4. Might also see a profit-volume chart which focuses on profits at
various activity levels.
C) Multiproduct setting
1. Remember CVP assumes a constant sales mix
2. Breakeven sales can be computed for a mix of two or more products
by determining the weighted average contribution margin of all the
products.
3. Fixed Costs
----------------------------------------------- = Breakeven Composite Units
Weighted Unit Contribution Margin
D) Margin of safety -- extent to which sales could decrease and still not lose
money (still breakeven)
1. Actual sales - breakeven sales
2. Express as ratio: (Sales - Breakeven sales / Sales)
3. Express in units
E) Operating leverage--a measure of the impact of changes in sales on
changes in operating income.
1. Contribution margin
---------------------------Operating income
2. Measures the relative mix of a business’s variable and fixed costs.
F) CVP can be used to see how many units must be sold to achieve a target
operating income
1. Fixed costs + target profit
--------------------------------------------------------------unit contribution margin
G) CVP can help management to respond to changes in business conditions.
1. What would happen to profitability if we automated a certain process.
H) Note CVP income statement format.
IV) Variable costing
A) Absorption (full) costing -- all manufacturing costs are absorbed into the
product. (DM, DL, and FO)
B) Variable costing -- only DM, DL, and Variable FO are product costs.
1. If units produced equals units sold, the two methods yield the same
results.
2. If units produced is greater than units sold, full absorption costing will
show a higher net income -- more costs are "absorbed" into
inventory.
3. If units sold is greater than units produced, variable costing will show a
higher net income--lower inventory costs get assigned to COGS.