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Module 7: Cost Behavior & Cost-Volume-Profit Analysis
ACG 2071
Created by: M. Mari
Fall 2007-1
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Cost-Volume-Profit Analysis (CVP)
Which helps them predict how changes incosts and sales levels affect income
CVP analysis involves computing the saleslevel at which a company neither earns anincome nor incurs a loss – break evenpoint
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Cost Behavior
refers to the manner in which a costchanges as a related activity changes.
Activity bases – activities that are thoughtto cause the cost to be incurred.
Relevant range – range of activity overwhich the changes in the cost that are ofinterest.
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Cost Classifications
Three types Variable Cost
Fied Cost
!ied Cost
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Variable costs
costs that vary inproportion to changesin 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
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i!ed Costs
costs that remain thesame in total dollaramounts as the level
of activity changes.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 $0.50
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Mi!ed Costs
has characteristics of both a variable and afied cost. Could behave as a fied costs for part of the
relevant range and then variable cost
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Contribution Margin Concept
Contribution mar"in " #ales – Variable costs
Contribution mar"in ratio "
#ales – Variable costs #ales
Is most useful when the increase or decrease in sales
volume is measured in sales dollars #nit contribution mar"in
" #ales price per unit – Variable cost per unit
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$!am%le
The Company has sales of $%&'''&'''& variable costs of $(''&'''.The company sold )'&''' units. Compute the contribution margin andthe contribution margin ratio.
Contribution margin " #ales – Variable cost
" $%&'''&''' * $(''&''' " $+''&'''
Contribution margin ratio " ,#ales – VC-#ales " ,%&'''&''' – (''&'''-%&'''&''' " +'/
0nit Contribution margin " Contribution margin 0nits sold " $+''&''' )'&''' " $1
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Brea-even Analysis
to determine the units of sales necessary toachieve the break even pint in operations
to determine the units of sales necessary toachieve a target or desired profit
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Brea-$ven Point
2s the level of operations at which abusiness3s revenues and epired costs areeactly e4ual5
6 business will have neither an income nora loss from operations.
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Brea $ven Point
Revenues Expenses
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Brea even formula
B$P ' i!ed Costs
#nit contribution mar"in
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$!am%le
#uppose that selling price is $+)& variable cost $%) and fied costsare $7'&'''. What is break even point5
89P " Fied costs 0nit Contribution !argin " $7'&''' ,+) – %)- " $7'&'''$%' " 7&''' units
6t sales level of 7&''' units will result in no gain or loss to thecompany.
Proof:
#ales: ,$+) ; 7&'''- $++)&''' Variable cost: ,$%) 7&'''- %<).''' Contribution margin 7'&''' Fied costs 7'&''' =perating income *'*
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Changes in fied costs
$!am%le: #uppose that selling price is$+)& variable cost $%) and fied costs are$7'&'''. What is break even point if fied
costs increase to $%''&'''5
BEP = Fixed costs/ Unit Contribution margin
= $100,000/ !"#1" = 10,000 units
%ue to an increase in &ixed costs &rom $'0,000 to $100,000,
brea( even point increased
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Changes in !ariable costs
$!am%le: #uppose that selling price is $+)& variablecost $%) and fied costs are $7'&'''. What is breakeven point if variable costs decrease to $%'5
89P " Fied costs 0nit Contribution margin
" $7'&''' ,+)*%'- " >&''' units
?ue to a decrease in variable costs from $%) to$%'& break even point decreased to >&''' unitsfrom 7&''' units or a decrease of <&''' units
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Changes in selling price
$!am%le: #uppose that selling price is $+)& variablecost $%) and fied costs are $7'&'''. What is breakeven point if selling price increase to $<'5
89P " Fied costs 0nit Contribution margin
" $7'&''' ,<'*%)- " >&''' units
?ue to an increase in sales price from $+) to$<'& break even point decreased to >&''' unitsfrom 7&''' units or a decrease of <&''' units.
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esired or *ar"et Profit
89P " Fied costs @ ?esired Profit 0nit contribution margin
$!am%le: #uppose that selling price is $1)& variable cost $<'& andfied costs are $>'&'''. The company wants a desired profit of
$1)&'''. What is break even point5
89P " Fied costs @ ?esired profit 0nit Contribution margin " ,$>'&'''- ,1)*<'- " 1&''' units
89P " Fied costs @ ?esired profit 0nit Contribution margin " ,$>'&''' @ $1)&'''- ,1)*<'- " A&''' units
To create $45,000 of rofit, must sell !,000 units or ",000 more thanbrea# even oint
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Charts
Costs
Units
Fixed costs
)ariab*e
+ota* cost
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+ra%hical , Brea even %oint
$
Units0
+ota* costs
a*es
Brea( even point
a*es = +C
Pro&it
-oss
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ales Mi! Consideration
!ore than one product issold at varying sellingprices
Products often have
different unit variablecosts
Products have differentcontribution margin
#ales volume necessarymust a mi of bothproducts
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$!am%le .:
Cascade Co produces two products Bukand unk. Buk has a selling price of $7'per unit and variable cost of $A'. unk
has a selling price of $%1' and variablecost of $7). Fied costs are $+''&'''.unk3s sales are approimately ('/ of
total sales for the company. What is thebreak even point for the sales mi5
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$!am%le .:
Product ellin"Price
VariableCost
ContributionMar"in
ales
/
ales mi!Contribution
Mar"in
Buk $7' $A' $+' ('/ $%>
unk $%1' $7) $1) +'/ $7
#alesmi
012012
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$!am%le .:
BEP = Fixed Costs
a*es mix C.
= $!00,000
$!"
BEP = ,000 units
Of what products:
U2 ,000 units 3 04 = 5,600 units
7U2 ,000 units 3 !04 = 1,500 units
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$!am%le 7:
68C Company has two products B and ;.B has a selling price of $%'' and variablecosts of $>'. 2t is A'/ of total sales. ;
has a selling price of $)' and variablecost of $+). Fied costs are $+1(&)''.What is 89P5
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Mar"in of afety
2ndicates possibledecrease in sales thatmay occur before an
operating loss occurs.
!argin of #afety "
#ales – #ales at 89P #ales
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Mar"in of afety
2f sales are $1''&''' and sales at breakeven are $<''&''' what is margin ofsafety5
!s " #ales – #ales 89P " $1'' * $<''
#ales $1''
" +)/
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$!am%le 6
!onth Production Total Cost
Dune %&''' $1)&))'Duly %&)'' $)+&'''
6ug +&%'' $>%&)''
#ept %&('' $)A&)''=ct A)' $1%&+)'
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$!am%le
te %& 'ind highest and lowest level of roduction(
Month #nits *otal Cost
Eigh 6ugust +&%'' $>%&)''
ow =ctober A)' $1%&+)'
Step 2: Get the difference
?ifference %&<)' $+'&+)'
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$!am%le continued
te "& )omute *ariable cost er unit Variable cost " ?ifference in Total Cost
?ifference in 0nits
"$+'&+)'
%&<)'
" $%) per unit Total cost " FC @ VC $>%&)'' " FC @ ,$%) G+&%'' units- $>%&)'' " FC @ <%&)'' FC " $<'&'''
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$!am%le Contd
te 4& )omute 'i+ed costs
Total cost " Fied Costs @ Variable Cost
using the data at +&%'' units ofproduction& we solve for fied costs
$>%&)'' " FC @ ,$%) G+&%'' units-
$>%&)'' " FC @ <%&)'' FC " $<'&'''
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$!am%le Continued
iven the information in the prior slide&what is the total cost at +&''' units ofoutput5
Total cost " Fied costs @ Variable costs
Total cost " $<'&''' @ ,$%) ; +&'''-
Total cost " $>'&'''
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$!am%le 1
!onth Production Total Cost
Dune +&)'' $1)&'''Duly +&''' $1'&'''
6ug %&)'' $<).'''
#ept <&''' $)'&'''=ct %&('' $<(&'''89at is t9e variab*e cost per unit and &ixed cost:
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8%eratin" 4evera"e
o The relative mi of a business3s variable costsand fied costs is measured by the operatingleverage
#ince the difference between contribution marginand income from operations is fied costs&companies with large amounts of fied costs willgenerally have a high operating leverage. 2ndicates that a small increase in sales will yield a
large percentage increase in income from operations. ow operating leverage
2ndicates that a large increase in sales is necessary tosignificantly increase income from operations
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8%eratin" 4evera"e
=perating everage
" Contribution !argin
2ncome from operations