Cost Behavior

Variable Cost
Jason Inc. produces stereo sound systems under the brand name of J-Sound. The parts for the stereo are purchased from an outside supplier for Rs10 per unit (a variable cost).

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Variable Cost
Total Variable Cost Graph
Rs300,000 Rs250,000 Rs200,000 Rs150,000 Rs100,000 Rs50,000

Total Costs

0 10 20 30 Units Produced (in thousands)

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Variable Cost
Unit Variable Cost Graph
Rs20

Cost per Unit

Rs15

Rs10
Rs5

10 20 30 Units Produced (000)

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Variable Cost
Rs300,000 Rs250,000 Rs200,000 Rs150,000 Rs100,000 Rs50,000 0 10 20 30 Units Produced (000) Number of Units Produced Direct Materials Cost per Unit Total Direct Materials Cost Cost per Unit

Total Costs

Rs20 Rs15 Rs10 Rs5 0 10 20 30 Units Produced (000)

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5,000 units 10,000 15,000 20,000 25,000 30,000

Rs10 10 10 10 10 10

Rs 50,000 l00,000 150,000 200,000 250,000 300,000

Fixed Costs
The production supervisor for Minton Inc.s Los Angeles plant is Jane Sovissi. She is paid Rs75,000 per year. The plant produces from 50,000 to 300,000 bottles of perfume.

La Fleur

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Fixed Costs
Number of Bottles Produced 50,000 bottles 100,000 150,000 200,000 250,000 300,000 Total Salary for Jane Sovissi Rs75,000 75,000 75,000 75,000 75,000 75,000 Salary per Bottle Produced Rs1.500 0.750 0.500 0.375 0.300 0.250

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Fixed Costs
Total Fixed Cost Graph
Rs150,000 Rs125,000 Rs100,000 Rs75,000 Rs50,000 Rs25,000 0 100 200 300 Bottles Produced (000) Number of Bottles Produced Total Salary for Jane Sovissi

Unit Fixed Cost Graph

Rs1.50 Rs1.25 Rs1.00 Rs.75 Rs.50 Rs.25 0 100 200 300 Units Produced (000) Cost per Unit

Total Costs

Salary per Bottle Produced

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50,000 bottles 100,000 15,000 20,000 25,000 30,000

Rs75,000 75,000 75,000 75,000 75,000 75,000

Rs1.500 0.750 0.500 0.375 0.300 0.250

Simpson Inc. manufactures sails using rented equipment. The rental charges are Rs15,000 per year, plus Rs1 for each machine hour used over 10,000 hours.
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Mixed Costs
Total Mixed Cost Graph
Rs45,000 Rs40,000 Rs35,000 Rs30,000 Rs25,000 Rs20,000 Rs15,000 Rs10,000 Rs5,000 0 10 20 30 40 Total Machine Hours (000)

Mixed costs are sometimes called semivariable or semifixed costs. Mixed costs are usually separated into their fixed and variable components for management analysis.

Total Costs

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Mixed Costs
The high-low method is a simple way to separate mixed costs into their fixed and variable components.

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High-Low Method
Actual costs incurred

Production Total (Units) Cost(Rs)

June July August September October 1,000 1,500 2,100 1,800 750 45,000 52,000 61,500 57,500 41,250

What month has the highest level of activity in terms of cost?

Highest level of activity (Rs) minus lowest level of activity (Rs) Variable cost per unit = Highest level of activity (n) minus lowest level of activity (n) LESTER MARTINO

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Contribution Margin Income Statement

Sales (50,000 units) Variable costs Total Contribution Fixed costs Profit Rs1,000,000 600,000 Rs 400,000 300,000 Rs 100,000

The Total Contribution is available to cover the fixed costs and Profit .

Contribution

FIXED COSTS

Profit
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Contribution Margin Ratio

Sales (50,000 units) Variable costs Contribution margin Fixed costs Income from operations Rs1,000,000 600,000 Rs 400,000 300,000 Rs 100,000

100% 60% 40% 30% 10%

Sales Variable costs Contribution margin ratio = Sales Rs1,000,000 600,000 Contribution margin ratio = Rs1,000,000 Contribution margin ratio = 40%
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Summary of Effects of Changes on Break-Even Point

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Target Profit
Sales (? units) Variable costs Contribution margin Fixed costs Income from operations Rs ? ? Rs ? 200,000 Rs 0

In Units

Rs75 45 Rs30

Fixed costs are estimated at Rs200,000, and the desired profit is Rs100,000. The unit selling price is Rs75 and the unit variable cost is Rs45. The firm wishes to make a Rs100,000 profit.
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Target Profit
Sales (? units) Variable costs Contribution margin Fixed costs Income from operations Rs ? ? Rs ? 200,000 Rs 0

In Units

Target profit is Rs75 used here to refer 45 to Income from Rs30 operations.

Fixed costs ++desired profit Rs200,000 Rs100,000 Sales (units) = 10,000 units Unit contribution Rs30 margin

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Target Profit
Sales (10,000 units x Rs75) Rs750,000 Variable costs (10,000 x Rs45) 450,000 Contribution margin Rs300,000 Fixed costs 200,000 Income from operations Rs100,000

Rs75 45 Rs30

Proof that sales of 10,000 units will provide a profit of Rs100,000.

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Graphic Approach to Cost-Volume-Profit Analysis

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Margin of Safety
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Margin of Safety = Margin of Safety =

Sales Sales at break-even point Sales Rs250,000 Rs200,000 Rs250,000

Margin of Safety = 20%

The margin of safety indicates the possible decrease in sales that may occur before an operating loss results.
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Assumptions of Cost-Volume-Profit Analysis

The reliability of cost-volume-profit analysis depends upon several assumptions. 1. Total sales and total costs can be represented by straight lines. 2. Within the relevant range of operating activity, the efficiency of operations does not change. 3. Costs can be accurately divided into fixed and variable components. 4. The sales mix is constant. 5. There is no change in the inventory quantities during the period.
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