Cost Volume Profit Analysis

Cost Classifications for
Predicting Cost Behavior

How a cost will react to
changes in the level of
business activity.
Total variable costs

change when activity
changes.
Total fixed costs remain

unchanged when activity
changes.
How a cost will react to
changes in the level of
business activity.
Total variable costs

change when activity
changes.
Total fixed costs remain

unchanged when activity
changes.

Total Variable Cost
Your total long distance telephone bill is
based on how many minutes you tal.
Minutes Talked
T
o
t
a
l

L
o
n
g

D
i
s
t
a
n
c
e
T
e
l
e
p
h
o
n
e

B
i
l
l

Variable Cost Per !nit
Minutes Talked
P
e
r

M
i
n
u
t
e
T
e
l
e
p
h
o
n
e

C
h
a
r
g
e
The cost per long distance minute taled is
constant. "or e#ample$ %& cents per minute.

Total "i#ed Cost
Your monthly basic telephone bill probably
does not change when you mae more local
calls.
Number of Local Calls
M
o
n
t
h
l
y

B
a
s
i
c

T
e
l
e
p
h
o
n
e

B
i
l
l

"i#ed Cost Per !nit
Number of Local Calls
M
o
n
t
h
l
y

B
a
s
i
c

T
e
l
e
p
h
o
n
e

B
i
l
l

p
e
r

L
o
c
a
l

C
a
l
l
The average cost per local call decreases as more
local calls are made.

Cost Classifications for
Predicting Cost Behavior
Behavior of Cost (within the relevant range)
Cost In Total Per Unit
Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wie ranges
of activity.
!i"e Total fi"e cost remains !i"e cost per unit goes
the same even when the own as activity level goes up.
activity level changes.

The 'ctivity Base
# measure of the
event that causes
the incurrence of a
variable cost $ a
cost river
# measure of the
event that causes
the incurrence of a
variable cost $ a
cost river
Units
produced
Units
produced
Miles
driven
Miles
driven
Labor
hours
Labor
hours
Machine
hours
Machine
hours

(tep)Variable Costs
#ctivity
C
o
s
t
Total cost remains
constant within a
narrow range of
activity.
Total cost remains
constant within a
narrow range of
activity.

(tep)Variable Costs
#ctivity
C
o
s
t
Total cost increases to a
new higher cost for the
ne"t higher range of
activity.
Total cost increases to a
new higher cost for the
ne"t higher range of
activity.

elevant
ange
# straight line
closely
appro"imates a
curvilinear
variable cost
line within the
relevant range.
# straight line
closely
appro"imates a
curvilinear
variable cost
line within the
relevant range.
#ctivity
T
o
t
a
l

C
o
s
t
!conomist"s
Curvilinear Cost
#unction
The *inearity 'ssumption and
the +elevant +ange
$ccountant"s %traight&Line
$ppro'imation (constant
unit variable cost)
Exh.
5-4

Cost Behavior
%erchanisers
Cost of &oos 'ol
%erchanisers
Cost of &oos 'ol
%anufacturers
(irect %aterial) (irect
*abor) an Variable
%anufacturing +verhea
%anufacturers
(irect %aterial) (irect
*abor) an Variable
%anufacturing +verhea
%erchanisers an
%anufacturers
'ales commissions an
shipping costs
%erchanisers an
%anufacturers
'ales commissions an
shipping costs
'ervice +rgani,ations
'upplies an travel
'ervice +rgani,ations
'upplies an travel
-"amples of normally variable costs
-"amples of normally variable costs
-"amples of normally fi"e costs
-"amples of normally fi"e costs
%erchanisers) manufacturers) an
service organi,ations
.eal estate ta"es) Insurance) 'ales salaries
(epreciation) #vertising
%erchanisers) manufacturers) an
service organi,ations
.eal estate ta"es) Insurance) 'ales salaries
(epreciation) #vertising

-"amples
#vertising an
.esearch an
(evelopment
-"amples
#vertising an
.esearch an
(evelopment
-"amples
(epreciation on
Builings an
-/uipment
-"amples
(epreciation on
Builings an
-/uipment
Types of "i#ed Costs
(iscretionary
%ay be altere in the
short0term by current
managerial ecisions
(iscretionary
%ay be altere in the
short0term by current
managerial ecisions
Committe
*ong0term) cannot be
reuce in the short
term.
Committe
*ong0term) cannot be
reuce in the short
term.

.
e
n
t

C
o
s
t

i
n

T
h
o
u
s
a
n
s

o
f

(
o
l
l
a
r
s

1 2)111 3)111 4)111
.ente #rea ('/uare !eet)
1
41
51
"i#ed Costs and +elevant +ange
61
.elevant
.ange
Total cost oesn7t
change for a wie
range of activity)
an then 8umps to a
new higher cost for
the ne"t higher
range of activity.
Total cost oesn7t
change for a wie
range of activity)
an then 8umps to a
new higher cost for
the ne"t higher
range of activity.
Exh.
5-6

!i"e %onthly
Utility Charge
Variable
Cost per 9:
#ctivity (9ilowatt
;ours)
T
o
t
a
l

U
t
i
l
i
t
y

C
o
s
t
<
=
' mi#ed cost has both fi#ed and variable
components. Consider the e#ample of utility cost.
' mi#ed cost has both fi#ed and variable
components. Consider the e#ample of utility cost.
,i#ed Costs
T
o
t
a
l

m
i
"
e

c
o
s
t

Total Per Unit
'ales (>11 bi?es) 3>1)111 @ >11 @
*essA variable e"penses 2>1)111 411
Contribution margin 211)111 311 @
*essA fi"e e"penses B1)111
Cet operating income 31)111 @
:IC( BIC=C*- C+.
Contribution Income 'tatement
!or the %onth of Dune
The Basics of Cost)Volume)
Profit -CVP. 'nalysis
Contribution %argin (C%) is the amount remaining
from sales revenue after variable e"penses have been
eucte.

Total Per Unit
'ales (>11 bi?es) 3>1)111 @ >11 @
:IC( BIC=C*- C+.
C% goes to cover fi"e e"penses. C% goes to cover fi"e e"penses.

Total Per Unit
'ales (>11 bi?es) 3>1)111 @ >11 @
:IC( BIC=C*- C+.
#fter covering fi"e costs) any remaining C%
contributes to income.

The Contribution 'pproach
"or each additional unit /ind sells$ 01&&
more in contribution margin will help to
cover fi#ed e#penses and profit.

2ach month /ind must generate at least
03&$&&& in total C, to brea even.

4f /ind sells 5&& units

in a month$ it will be
operating at the brea)even point.

Total Per Unit
'ales (E12 bi?es) 311)>11 @ >11 @
*essA variable e"penses 231)411 411
Contribution margin B1)311 311 @
Cet operating income 311 @
:IC( BIC=C*- C+.
4f /ind sells one more bie -5&% bies.$ net
operating income will increase by 01&&.

CVP +elationships in 6raphic "orm
Viewing CVP relationships in a graph is often helpful.
Consider the following information for /ind Co.7
Income
411 units
Income
E11 units
Income
>11 units
'ales 2>1)111 @ 311)111 @ 3>1)111 @
*essA variable e"penses 61)111 231)111 2>1)111
Contribution margin 51)111 @ B1)111 @ 211)111 @
*essA fi"e e"penses B1)111 B1)111 B1)111
Cet operating income (31)111) @ 0 @ 31)111 @

&
*+,+++
-++,+++
-*+,+++
.++,+++
.*+,+++
/++,+++
/*+,+++
0++,+++
0*+,+++
& -++ .++ /++ 0++ *++ 1++ 2++ 3++
CVP 6raph
!i"e e"penses
Units
D
o
l
l
a
r
s
Total -"penses
Total 'ales

&
*+,+++
-++,+++
-*+,+++
.++,+++
.*+,+++
/++,+++
/*+,+++
0++,+++
0*+,+++
& -++ .++ /++ 0++ *++ 1++ 2++ 3++
Units
D
o
l
l
a
r
s
CVP 6raph
Brea?0even point
P
r
o
f
i
t

#
r
e
a
*
o
s
s

#
r
e
a

Contribution ,argin +atio
The contribution margin ratio is7
"or /ind Bicycle Co. the ratio is7
@ B1)111
@311)111
F E1G
Total C%
Total sales
C% .atio F

8r$ in terms of units$ the contribution margin ratio
is7
"or /ind Bicycle Co. the ratio is7
@311
@>11
F E1G
Unit C%
Unit selling price
C% .atio F

't /ind$ each 0%.&& increase in sales revenue
results in a total contribution margin
increase of 5&9.
4f sales increase by 0:&$&&&$ what will be the
4f sales increase by 0:&$&&&$ what will be the
increase in total contribution margin;
increase in total contribution margin;

E11 Bi?es >11 Bi?es
'ales 311)111 @ 3>1)111 @
*essA variable e"penses 231)111 2>1)111
Contribution margin B1)111 211)111
*essA fi"e e"penses B1)111 B1)111
Cet operating income 0 @ 31)111 @
# @>1)111 increase in sales revenue

Changes in "i#ed Costs and (ales
Volume
/ind is currently selling :&& bies per month. The
company<s sales manager believes that an
increase of 0%&$&&& in the monthly advertising
budget would increase bie sales to :5& units.

(hould we authori=e the re>uested increase in the
advertising budget;

Current 'ales
(>11 bi?es)
Pro8ecte
'ales ( >E1
bi?es)
'ales 3>1)111 @ 3H1)111 @
*essA variable e"penses 2>1)111 253)111
Contribution margin 211)111 21B)111
*essA fi"e e"penses B1)111 61)111
Cet operating income 31)111 @ 2B)111 @
Volume
'ales increase by @31)111) but net
operating income ecrease by @3)1114 4
'ales increase by @31)111) but net
operating income ecrease by @3)1114 4
@B1)111 I @21)111 avertising F @61)111
@B1)111 I @21)111 avertising F @61)111

Volume
The (hortcut (olution
The (hortcut (olution
Increase in C% (E1 units < @311) B)111 @
Increase in avertising e"penses 21)111
(ecrease in net operating income (3)111) @

Brea)2ven 'nalysis
Brea)even analysis can be approached in
three ways7
%. 6raphical analysis.
1. 2>uation method.
?. Contribution margin method.

2>uation ,ethod
Profits F 'ales $ (Variable e"penses I !i"e e"penses)
'ales F Variable e"penses I !i"e e"penses I Profits
+.
#t the brea?0even point
profits e/ual ,ero.

Brea)2ven 'nalysis
Here is the information from /ind Bicycle Co.7
Total Per Unit Percent
'ales (>11 bi?es) 3>1)111 @ >11 @ 211G
*essA variable e"penses 2>1)111 411 51G
Contribution margin 211)111 @ 311 @ E1G

2>uation ,ethod

/e calculate the brea)even point as follows7
@>11J F @411J I @B1)111 I @1
:hereA
J F Cumber of bi?es sol
@>11 F Unit selling price
@411 F Unit variable e"pense
@B1)111 F Total fi"e e"pense

2>uation ,ethod

/e calculate the brea)even point as follows7
@>11J F @411J I @B1)111 I @1
@311J F @B1)111
J F @B1)111 K @311 per bi?e
J F E11 bi?es

2>uation ,ethod

We can also use the following equation to compute
the break-even point in sales dollars.

< F 1.51< I @B1)111 I @1
:hereA
< F Total sales ollars
1.51 F Variable e"penses as a G of sales
@B1)111 F Total fi"e e"penses

2>uation ,ethod
< F 1.51< I @B1)111 I @1
1.E1< F @B1)111
< F @B1)111 K 1.E1
< F @311)111

We can also use the following equation to compute
the break-even point in sales dollars.

Contribution ,argin ,ethod
The contribution margin method is a variation
of the e>uation method.
!i"e e"penses
Unit contribution margin
F
Brea?0even point
in units sol
!i"e e"penses
C% ratio
F
Brea?0even point in
total sales ollars

Target Profit 'nalysis
(uppose /ind Co. wants to now how many bies
must be sold to earn a profit of 0%&&$&&&.
/e can use our CVP formula to determine the sales
volume needed to achieve a target net profit figure.

The CVP 2>uation
@>11J F @411J I @B1)111 I @211)111
@311J F @2B1)111
J F 611 bi?es

The CVP 2>uation
@>11J F @411J I @B1)111 I @211)111
@311J F @2B1)111
J F 611 bi?es

Cost Volume Profit Analysis

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Cost Volume Profit Analysis

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Cost Classifications for

Predicting Cost Behavior

Total variable costs

Total fixed costs remain

Total variable costs

Total fixed costs remain

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