Download Analysis and Interpretation of Financial Statements

Decision Making Using Cost Concepts and
CVP Analysis
CA Final: Paper 5: Advanced Management
Accounting
Chapter 2
Arijit Chakraborty, FCA
2
Learning Objectives
1. Understand the concept and types of cost and
their behaviour
2. Learn the concept of Break even point, Marginal
costing and profitability analysis
Learning objectives – Decision making
CVP analysis
and its strategic
role
CVP analysis for
BEP planning
CVP analysis for
revenue & cost
planning
Sensitivity
analysis when
sales are
uncertain
Multi-product
situation & CVP
analysis
Multiple cost
driver situation
Use in decision
making
Limitations and
effect on
interpretation of
results
Abbreviations
USP
Unit selling price
UVC
Unit variable costs
UCM
Unit contribution margin
CM%
Contribution margin percentage
FC
Fixed costs
Q
Quantity of output (units sold or produced)
OI
Operating income
TOI
Target operating income
TNI
Target net income
Module Summary
Cost/volume/profit (CVP) relationships and break-even analysis
break-even chart – low fixed costs, high variable costs
break-even chart – high fixed costs, low variable costs
contribution break-even chart
profit volume (PV) chart , CVP and break-even analysis
limitations of CVP and break-even analysis
multiple product break-even analysis
Learning Objectives (1)
explain cost/volume/profit (CVP) relationships and
break-even analysis
identify the limitations of CVP analysis
outline the more recently developed techniques of
activity based costing (ABC), and throughput
accounting (TA)
identify the conditions appropriate to the use of life
cycle costing
7
Introduction to types of costs
•
•
•
Background
Types of costs and their behaviour
Relevant costs
18-8
Module Outline & Applications
What is CVP analysis?
The break-even point
Graphing CVP relationships
Target net profit
Using CVP analysis for management decisions
CVP analysis with multiple products
Including income taxes in CVP analysis
Practical issues in CVP analysis
An activity-based approach to CVP analysis
Financial planning models
9
Marginal Costing - Introduction
Under Marginal costing the product
price is determined on the basis of
Variable cost of the product. Such
price is selected for the purpose of
penetration pricing where the
minimum sale price = variable cost.
As the sale price is very low
management is always anxious
about the recovery of fixed overhead.
So they want to calculate the volume
of sales at which fixed cost will be
recovered , profit will arise & the
safety margin of the organization , as
well as different short-term decision
are to be taken by the management.
10
Nature of absorption vs. Marginal
costing
Marginal costing is not a distinct method of costing like job costing, process
costing, operating costing, etc. but a special technique used for marginal
decision making. Marginal costing is used to provide a basis for the
interpretation of cost data to measure the profitability of different products,
processes and cost centre in the course of decision making. It can, therefore,
be used in conjunction with the different methods of costing such as job
costing, process costing, etc., or even with other technique such as standard
costing or budgetary control.
In marginal costing, cost ascertainment in made on the basis of the nature of
cost. It gives consideration to behaviour of costs. In other words, the technique
has developed from a particular concept and expression of the nature and
behaviour of costs and their effect upon the profitability of an undertaking.
11
CVP - Overview
Cost-volume-profit analysis , as the name suggests, is the
analysis of three variable viz., cost, volume and profit. Such an
analysis explores the relationship existing amongst costs,
revenue, activity levels and the resulting profit. It aims at
measuring variations of cost with volume. In the profit planning of
a business, cost-volume-profit (C-V-P) relationship is the most
significant factor.
The CVP analysis is an extension of marginal costing. It makes
use of principles of marginal costing. It is an important tool of
planning. It is quite useful in making short run decisions.
12
Cost concepts
Relevant cost vs. non-relevant cost
Sunk cost / Historical cost
Avoidable cost
Notional cost
Opportunity cost
Out of pocket cost
Discretionary cost
13
Cost concepts Cont..
Shutdown cost
Engineered cost
Inventoriable cost
Period cost
Differential cost
incremental cost
Period cost – Limiting Factor
14
Cost Behavior
How costs change in response to changes in
volume
• Variable costs
• Fixed costs
• Mixed costs
Types of Costs
Variable
Fixed
Mixed
Variable costs
costs that vary in proportion to changes in the
level of activity.
• Direct materials
• Direct labor
Units Produced
Direct Materials
per unit
Total Direct
Material Costs
5,000 units
$10
$ 50,000
10,000 units
$10
100,000
15,000 units
$10
150,000
17
Variable Costs
Change in total in direct proportion to changes in volume
Total variable costs = variable cost per unit of activity x volume of
activity
Examples
• Materials and parts
• Manufacturing labour
• Machine Time (electricity used by equipment in the manufacturing process).
Total Variable Costs
Total Sales
Commissions
$2,500
$2,000
$1,500
$1,000
$500
$0
$0
$10,000 $20,000 $30,000 $40,000
Total Sales
Assume we pay sales commissions of 5% on all sales. The cost of
sales commissions increase proportionately with increases in sales
18
19
Fixed Costs
Do not change over wide ranges of volume
Eg - Depreciation on equipment
costs that remain the same in total dollar amounts as the level of activity
changes.
Examples:
• Rent
• Insurance
• Administrative labour
• Wages paid to managers or secretaries (ie employees not directly involved in the
manufacture of the product or provision of the service).
Fixed Costs
Number of Bottles
Total Salary for
Supervisor
Salary per bottle
produced
50,000
$75,000
$1.50
100,000
$75,000
$0.75
150,000
75,000
$0.50
Total Sales Salaries
Total Fixed Costs
$2,500
$2,000
$1,500
$1,000
$500
$0
$0
$10,000 $20,000 $30,000 $40,000
Total Sales
Assume we pay our sales staff a salary of $2,000 per month.
If a sales person makes sales of $500, he gets paid $2,000
salary. If he has sales of $100,000, he get paid $2,000 salary
21
22
Mixed Costs
Contain both variable and fixed components
A mixed cost has elements of both fixed and variable costs.
MC has characteristics of both a variable and a fixed cost.
• Could behave as a fixed costs for part of the relevant range and then
variable cost
For our next example : Assume we pay our sales staff,
$2,000 plus 5% commission on each sales dollar.
Sales Compensation
Mixed Costs
$4,500
$4,000
$3,500
$3,000
$2,500
$2,000
$1,500
$1,000
$500
$0
$0
$10,000 $20,000 $30,000 $40,000
Total Sales
23
Sales Compensation
Mixed Costs
$4,500
$4,000
$3,500
$3,000
$2,500
Variable
$2,000
$1,500
$1,000
$500
$0
Fixed
$0
$10,000 $20,000 $30,000 $40,000
Total Sales
24
Objective 2
Forecast costs using cost equations
25
26
Cost Equation
Total costs =
Total variable costs + Total fixed costs
y = vx + f
y = total cost
v = variable cost per unit of activity (slope)
x = volume of activity (x)
f = fixed cost over a given period of time
(vertical y intercept)
27
Marginal Cost & Relevant Range
Band of volume where total fixed costs remain constant
and variable cost per unit remains constant.
Outside the relevant range, the cost either increases or
decreases
Other Cost Behaviors
Step costs – fixed over small range of activity, then
jump to new fixed level
$60,000
Total Costs
$45,000
$30,000
$15,000
$0
Number of Units
28
Other Cost Behaviors
Curvilinear Costs
$60,000
Total Costs
$45,000
$30,000
$15,000
$0
Numbr of Units
29
Economist’s Cost and Revenue
Curves
Cost/Volume/Profit (CVP) Relationships
and Break-Even Analysis (1)
Cost/volume/profit (CVP) analysis may be used
to determine the break-even position of a business
to provide sensitivity analyses on the impact on the
business of changes to any of the variables used to
calculate break-even
the break-even point is the level of activity at which
there is neither profit nor loss
Cost/Volume/Profit (CVP) Relationships
and Break-Even Analysis (2)
There are three fundamental cost/revenue
relationships that form the basis of CVP analysis
total costs = variable costs + fixed costs
contribution = total revenue - variable costs
profit (or operating income) = total revenue - total
costs
the slopes of the total cost lines in the following two
charts represent the unit variable costs
Break-Even Chart – Low Fixed Costs,
High Variable Costs
Break-Even Chart – High Fixed Costs,
Low Variable Costs
PV Ratio & Contribution Break-Even
Chart
Break-even / Profit Volume (PV) Chart
37
Break-even Chart
• Analysis
• Advantages
• Disadvantages
The Break-Even Point (1)
profit = contribution – fixed costs
and at the break-even point profit is zero and so
profit = contribution – fixed costs = zero
or
contribution = fixed costs
it follows therefore that the
number of units at the break-even point
x contribution per unit = fixed costs
or
number of units at break-even = fixed costs /
contribution per unit
The Break-Even Point (2)
•
The number of units at the break-even point x selling price per
unit is the break-even Rs sales value, so
Rs sales value at break-even point
=
fixed costs
x selling price per unit
contribution per unit
selling price per unit = total sales revenue
contribution per unit
total contribution
which is the reciprocal of the contribution to sales ratio %, so
Rs sales value at break-even point
=
fixed costs
contribution to sales ratio %
The Break-Even Point (3)
the term ‘margin of safety’ is used to
define the difference between the breakeven point and an anticipated or existing
level of activity above that point
the margin of safety measures the
extent to which anticipated or existing
activity can fall before a profitable
operation turns into a loss-making one
Limitations of CVP Analysis
the many limitations to CVP analysis are related to the
assumptions on which it is based to consider break-even,
decision-making, or sales pricing
the main assumptions are:
output is the only factor affecting costs
cost and revenue behaviour is linear
there is a single product
costs are easily split into variable and fixed, which are constant
42
Limitations of Marginal Costing
• Unrealistic Assumption
• Incomplete Information
• Imperfect Managerial Tool
43
Application of CVP Analysis
• Expand or Contract
• Export V/s Local Sale
• Make or Buy
• Pricing Decision
• Product Mix
• Price Mix
• Shut down or Continue
Multiple Product Break-Even Analysis
where a business offers a range of products or services, the
weighted average contribution may be used to calculate the
selling prices required to achieve targeted profit levels, and
revised break-even volumes and sales values resulting from
changes to variable costs and fixed costs
Key Terminology: Breakeven Analysis
Break even point-the point at which a company makes neither
a profit or a loss.
Contribution per unit-the sales price minus the variable cost
per unit. It measures the contribution made by each item of
output to the fixed costs and profit of the organisation.
Margin of safety-a measure in which the budgeted volume of
sales is compared with the volume of sales required to break
even
Marginal Cost – cost of producing one extra unit of output
Margin of Safety
• The difference between budgeted or actual sales and the
breakeven point
• The margin of safety may be expressed in units or
revenue terms
• Shows the amount by which sales can drop before a loss
will be incurred
Objective 3
Determine cost behavior using account analysis, the
high-low
method, and regression analysis
47
48
High-Low Method
Method to separate mixed costs into variable and fixed
components
Select the highest level and the lowest level of activity over a
period of time
49
Regression Analysis
Statistical procedure to find the line that best fits data
Uses all data points
Results in equation of line and an R-square value
50
Objective 4
Prepare contribution margin income statements for
service firms and merchandising firms
51
Traditional Income Statement
Sales
- Cost of Goods Sold
• Gross Margin
- Selling,general & administrative costs
• Operating Income
52
Contribution Margin Income
Statement
Sales
• - Variable Costs
Contribution Margin
- Fixed Costs
• Operating Income
53
Contribution Margin Income
Statement
Predict how changes in volume
will affect operating income
54
A Ltd
Income Statement
For the year ending 20XX
Revenue:
Sales Revenue
Rental Revenue
Lessor Revenue
Total Revenue
Less: Cost of Goods Sold
Gross Margin
Less Operating Costs:
Depreciation
Employee Salary expenses
Musician wages
Lease
Total operating costs
Operating Income
$34,000
22,000
40,000
$96,000
(9,500)
$86,500
$ 4,000
30,000
25,000
12,000
71,000
$15,500
55
E6-25
A Ltd.
Contribution Margin Income Statement
For the year ending 20XX
Revenue:
Sales Revenue
Rental Revenue
Lessor Revenue
Total Revenue
Less: Variable Costs
Cost of Goods Sold
Musician wages
Total Variable costs
Contribution Margin
Less Fixed Costs:
Depreciation
Employee Salary expenses
Lease
Total fixed costs
Operating Income
$34,000
22,000
40,000
$96,000
$ 9,500
25,000
(34,500)
$61,500
$ 4,000
30,000
12,000
(46,000)
$15,500
56
Analysis
The contribution margin income statement is a better
management tool than the traditional income statement.
If A Ltd’s volume remains in the same relevant range, it
can easily be seen that fixed expenses will be $46,000.
It also follows that revenue and variable costs will
increase in direct proportion to changes in volume. The
traditional income statement does not provide any
information on cost behavior.
57
Concepts for Decision making using
CVP
Further
processing of
product
Dropping or
adding product
line
Profit
optimisation in
limiting factor
condition
Optimising
investment plan
Decision making
using cash flow
technique
Shut down and
divestment
decision
58
Decision making using CVP Cont..
Divestment
strategies
Pricing strategy
Offer
acceptance and
tender
submission
Make or buy
Export order
quotation
Expand or
contract
Product and
price mix
decision
59
Objective 5
Use variable costing to prepare contribution margin
income statements for manufacturers
60
Variable Costing
Assigns only variable manufacturing costs to products
• Direct materials
• Direct labor
• Variable manufacturing overhead
Fixed manufacturing overhead = period cost
Contribution margin income statements
• For internal management decisions
61
Absorption Costing
Required by GAAP for external reporting
Assign all manufacturing costs to product
•
•
•
•
Direct materials
Direct labor
Variable manufacturing overhead
Fixed manufacturing overhead
Traditional income statement
62
Marginal costing
A TECHNIQUE USED IN DECISION MAKING
- If the volume of output increases, the average cost per unit
will decrease. Conversely, if the output is reduced, the
average cost per unit will go up
CVP Analysis
a method for analysing how operating and marketing decisions
affect net income
CVP model:
Profit = Revenue – Total cost
= Q x SPU – Q x VCU - FC
64
CVP analysis
WHAT IF?
Change in:
Output level
Behaviour of:
Selling price
Total revenue
VC per unit
Total cost
And/or fixed cost of a product
Operating income
65
Applications of CVP Analysis
Setting prices for products and services
New product/service introduction
Replacing a machine
Make or buy
What if analysis
66
Strategic role of CVP analysis
Cost leadership firms compete by increasing volume to achieve low per unit
operating cost- predict effect of volume on profit and risk of increasing FC
Early stage of cost life cycle- predict the profitability of the product
Use in target costing – profitability of alternative designs
Later phases of life cycle- mfg. stage- evaluate most profitable mfg. process
Helps in strategic positioning• - differentiation- assessing desirability of new features
• - cost leadership- low cost operating means
67
Effect of opportunity cost in break
even analysis
When for a new proposal/alternative use current income
will be lost or additional cost is to be incurred then these
are known as opportunity cost of the new proposal. In
other word the minimum price for the new proposal =
variable cost of the alternative + lost income under
present situation +discretionary fixed cost (if any).
The Lost income is generally loss of contribution
68
Some terms
Operating income =
Gross operating
revenue – COGS
and operating costs
Net income =
operating income +
net non-operating
revenues – income
tax
Contribution margin
= contribution
margin per unit X
No. of units sold
BEP
Equation method:
Revenue-variable cost – fixed cost = operating income
[SP X Q] – [VCU X Q]- FC = Operating income
At BEP, operating income = “Zero”
70
BEP
Contribution margin method: rearranging the equation
[SP X Q]- [VCU X Q] –FC = OI
Or, [SP-VCU] X Q = FC + OI
At BEP, [SP-VCU] X Q = FC
i.e., CMU X Q = FC
Hence, Q = FC / CMU (in terms of number)
Q = FC / PV ratio (in terms of revenue)
71
PV ratio
PV ratio = CMU/SP
• a % figure
• a rate of profitability
Uses of PV ratio:
•
•
•
•
•
1- P/V ratio = Variable cost ratio
Sales X P/V ratio = Gross contribution
Determining the sales mix
BEP = FC / PV Ratio
[FC+ Target Profit ] / PV ratio gives the volume of output to
be sold to earn a desired level of output
72
Improving PV ratio
Improvement in P/V ratio will mean more profit
•
•
•
•
reduce variable cost
increase selling price
product mix to change in favour of high P/V ratio products
Change in FC?
73
Assumptions
Volume is the revenue
and cost driver
Total cost can be
segregated into fixed
and variable
components
Selling price, VC per
unit and fixed cost are
known and constant
within relevant range
and time
Total revenue and
cost are linear
functions of volume
within relevant range
and time
Applicable to single
product or multiproduct situation with
constant sales mix as
volume changes
74
Concept revision
What is margin
of safety’s
significance?
MOS v. size of
fixed cost: risk
Larger angle of
incidence: what
does it imply?
BEP point shift –
up and down:
what does it
mean?
Monopoly- plant
efficiency v.
angle of
incidence
Competitionplant efficiency
v. angle of
incidence
75
Target operating income
Means a target contribution margin
Q = [Fixed cost + Target OI] / CMU
Understanding impact of IT:
Target net income:
= Target OI- Target OI X Tax rate
So, Target OI = Target NI / [1 – tax rate]
Hence, Q = [FC + Target NI / [1 – tax rate]]
/CMU
76
Improving MOS
Reduce FC
Increase sales volume
Selling more profitable products
Reduce VC
Increase in selling price in case of demand inelastic products
77
Operating leverage
Mohit wants to sell 40 units @Rs.200/unit with purchase cost of
Rs.120/unit
Cost options:
Option-I
Option-II
Option-III
Rs.2000 FC Rs.800 FC + 15% of Revenue
25% of Revenue
OI: Rs.1200
Rs.1200
Rs.1200
BEP: 25 units
16 units
0 units
MOS= 15 units
24 units
40 units
If no. of units sold drops to 20 units: option I will give operating loss.
If no. of units sold is 60, option I will give highest OI of Rs.2800.
Cont…….
Learning:
Moving from I to III: Mohit faces less risk of loss when demand is
low, but looses opportunity for higher OI when demand is high.
Choice of cost structure: confidence in demand projection and
ability to bear loss
- Operating leverage measures this risk-return trade-off
Cont……..
- Operating leverage describes the effects that fixed costs have on
changes in OI as changes in sales volume happens, and, hence in
contribution margin.
- High FC and lower VC means, higher operating leverage: small
increase in sales results in large increase in OI and small decrease
means large decrease in OI leading to greater risk of operating loss.
- At a given level of sales: degree of operating leverage =
contribution margin / operating income
Cont…..
1. CMU
2. CM
3. OI
Option-I
Rs.80
Rs.3200
Rs.1200
Degree of
Operating leverage
[DOL]
2.67
Option-II
Rs.50
Rs.2000
Rs.1200
1.67
Option-III
Rs.30
Rs.1200
Rs.1200
1.00
DOL is specific to a given level of sales as starting point. If
the starting point changes, DOL changes
Interpretation: Change of sales by 50% would change the OI
under option-I by 50% X 2.67, i.e., by 133%
Concept in action
Influencing cost structures to manage the risk-return
trade-off at amazon.com
- Amazon.com- virtual model- no warehousing and
inventory cost, but cost of books is high
Barnes & Noble- brick & mortar model- purchased from
publishers with lower cost- high fixed cost
Amazon went for acquisition of distribution centres
(increased FC, Operating Leverage, risk, but lower VC)
Effect of time
Whether a cost is fixed or not, depends on:
• Relevant range
• Time horizon
• Decision in hand
Limiting Factor
Constraints
Contribution per unit of the limiting factor
Multiple limiting factors
Contribution margin v. gross margin
Contribution income
statement
Revenues
100
VC of goods sold
60
Variable operating
Cost
15
Contribution margin
25
Less: FC
5
Operating income
20
Gross margin income
statement
Revenues
100
Cost of goods sold
60
Gross margin
40
Operating cost[15+5]
20
Operating income
20
CVP Analysis
Marginal costing as a traditional technique is still a powerful
element within management accounting:
* Superb short-term planning and analytical tool
* Places emphasis on contribution margin of
products/services
* Effective when coupled with “sensitivity analysis”
In today’s world, many experts feel the name should be changed
to CAP analysis (Cost-Activity-Profit)
Knowledge of the assumptions is essential to use of this
technique
CVP 86
COST-VOLUME-PROFIT
Traditional Format
Total
Revenue
Total $
Total Costs
Breakeven
Point
Total Variable
Costs
Total Fixed
Costs
Level of Activity
CVP 87
Cvp Analysis Advantages
Assists in
establishing prices
of products.
Assists in analyzing
the impact that
volume has on
short-term profits.
Assists in focusing
on the impact that
changes in costs
(variable and fixed)
have on profits.
Assists in analyzing
how the mix of
products affects
profits.
88
Price Fixation
• Price below the Total Cost
• Special Markets & Customers
• Selling Price below Marginal Cost
CVP 89
CVP ANALYSIS Additional Items
Break-even considerations
Target income goals
CVP 90
Limitations of CVP Analysis
Requires accurate knowledge of revenue and cost amounts and
behavior patterns
• Identification of fixed and variable components
Linear revenue and cost functions
• Integration of concept of “relevant range”
No change in inventories
Constant sales mix
CVP 91
Three Methods of Using the CVP
Model
Operating Income Approach
Contribution Approach
Graphical Approach
CVP 92
CVP Definitions
Contribution margin
• Revenue – Variable costs
Contribution margin ratio
• Contribution margin / Revenue
• These items may be computed
either in total or per unit
CVP 93
CVP Example
Assume the following:
Sales (400 Microwaves)
Less: Variable Expenses
Contribution Margin
Total
Per unit %of Sales
$200,000 $500
100%
120,000
300
60%
$ 80,000 $200
40%
Less Fixed Expenses
Net Income
70,000
$10,000
1. What is the break-even point?
2. How much sales-revenue must be generated to earn before-tax profit $30,000?
3. How much sales-revenue must be generated to earn an after-tax profit of $30,000 and
a 40% marginal tax rate?
CVP 94
The Operating Income Approach for
Breakeven Point
Sales - Variable costs - Fixed Costs = Net Income
Sales-Revenue Method:
100%(Sales)- 60%(Sales) - $70,000 =0 (at BEP)
.4 (Sales) = $70,000
Sales = $175,000
Units-Sold Method:
Let x = Number of microwaves at the break-even
point
$500(x) - $300(x) - $70,000 = 0 (at BEP)
$200 (x) = $70,000
x = 350 microwaves
The Contribution Approach for
Breakeven Point
CVP 95
Sales-Revenue Method:
BEP (Revenue $) = (Fixed Costs + Net Income)/Contribution Ratio
= $70,000 + 0/.40
= $175,000
Units-Sold Method:
BEP (Revenue Units) = (Fixed Costs + Net Income)/Contribution
per microwave
= $70,000 + 0/$200 per microwave
= 350 units
CVP 96
The Operating Income Approach for
Targeted Pre-tax Income
Sales - Variable costs - Fixed Costs = Net Income
Sales-Revenue Method:
100%(Sales)- 60%(Sales) - $70,000 = $30,000
.4 (Sales) = $100,000
Sales = $250,000
Units-Sold Method:
Let x = Number of microwaves
$500(x) - $300(x) - $70,000 = $30,000
$200 (x) = $100,000
x = 500 microwaves
CVP 97
C-V-P and
Targeted After-Tax Profits
Sales - Variable costs - Fixed Costs = Net Income/ (1-tax rate)
Sales-Revenue Method:
100%(Sales)- 60%(Sales) - $70,000 = $30,000/(1-.4)
.4 (Sales) = $120,000
Sales = $300,000
Units-Sold Method:
Let x = Number of microwaves
$500(x) - $300(x) - $70,000 = $30,000/(1-.4)
$200 (x) = $120,000
x = 600 microwaves
CVP 98
COST-PROFIT-VOLUME
Contribution Margin Format
Total
Revenue
Total Costs
Total $
Breakeven
Point
Total Fixed
Costs
Total Variable
Costs
Contribution
Margin
Level of Activity
CVP 99
A Multiple-Product Example
Assume the following:
Regular
Unit of Sales
Sales Price per Unit
Sales Revenue
Less: Variable Expenses
Contribution Margin
Less Fixed Expenses
Net Income
400
$500
$200,000
120,000
$ 80,000
Deluxe Total Percent
200
$750
$150,000
60,000
$ 90,000
600
---------$350,000 100.0%
180,000 51.4
$170,000 48.6%
130,000
$ 40,000
1. What is the break-even point?
2. How much sales-revenue of each product must be
generated to earn a before-tax profit $50,000?
Recap – CVP Analysis
Learning Objectives:
Themes:
Identify common cost behavior patterns.
It’s all about how costs change in
total with respect to changes in
activity.
Estimate the relation between cost and
activity using account analysis, the highlow method, and scattergraphs.
Perform cost-volume-profit-analysis for
single products.
C-V-P-A is linear.
Perform cost-volume-profit-analysis for
multiple products.
One must be able to put all costs
into either variable or fixed cost
categories.
Discuss the effect of operating leverage.
Use the contribution margin per unit of the
constraint to analyze situations involving a
resource constraint.
Common Cost Behavior Patterns
To perform CostVolume-ProfitAnalysis (C-V-P-A),
you need to know
how costs behave
when business
activity (production
volume, sales
volume…) changes.
Related Learning Objectives:
1.
Identify common cost
behavior patterns.
2.
Estimate the relation
between cost and activity
using account analysis, the
high-low method, and
scattergraphs.
3.
Perform cost-volume-profitanalysis for single products.
4.
Perform cost-volume-profitanalysis for multiple
products.
5.
Discuss the effect of
operating leverage.
6.
Use the contribution margin
per unit of the constraint to
analyze situations involving a
resource constraint.
Variable Costs
By definition, Variable Costs are costs that
change (in total) in response to changes
in volume or activity. It is assumed, too,
that the relationship between variable
costs and activity is proportional. That is, if
production volume increases by 10%,
then variable costs in total will rise by
10%. Examples include direct labor, raw
materials and sales commissions.
Fixed Costs
By definition, Fixed Costs are
costs that do not change (in
total) in response to changes in
volume or activity. Examples
include depreciation,
supervisory salaries and
maintenance expenses.
Mixed Costs
Mixed Costs are costs that contain
both a variable cost element and a
fixed cost element. These costs are
sometimes referred to as semivariable costs. An example would
be a salesperson’s salary where
she receives a base salary plus
commissions.
105
Review Points
• Concepts
• Useful Equations
106
Thank You