University:
California State University, Northridge
Course:
ACCT 230 | Introduction to Managerial Accounting
Academic year:

2024
Views:

356

Pages:

21
Author:

Putbourrydpe

Chapter 5 Cost-Volume-Profit Relationships Preview of Chapter 5 COST-VOLUMEPROFIT RELATIONSHIPS Cost Behavior Analysis • Variable Costs • Fixed Costs • Relevant Range • Mixed Costs • Identifying Variable and Fixed Costs Preview of Chapter 5 COST-VOLUMEPROFIT RELATIONSHIPS Cost-Volume-Profit Analysis • Basic Components • Contribution Margin • Break-Even Analysis • Margin of Safety • Target Net Income • Changes in Business Environment • CVP Income Statement Cost Behavior Analysis  Cost behavior analysis is the study of how specific costs respond to changes in the level of activity within a company.  The starting point in cost behavior analysis is measuring the key activities in the company’s business.  Activity levels may be expressed in terms of – – – – sales dollars (retail company), miles driven (trucking company), room occupancy (hotel), or number of dance classes taught (dance studio). Cost Behavior Analysis  For an activity level to be useful in cost behavior analysis, there should be correlation between changes in the level or volume of activity and changes in the costs.  The activity level selected is referred to as the activity (or volume) index.  The activity index identifies the activity that causes changes in the behavior of costs. Study Objective 1 Distinguish between variable and fixed costs. Variable Costs Variable costs are costs that vary in total directly and proportionately with changes in the activity level. A variable cost may also be defined as a cost that remains the same per unit at every level of activity. Variable Costs  Damon Company manufactures radios that contain a $10 digital clock. The activity index is the number of radios produced. As each radio is manufactured, the total cost of the clocks increases by $10. (b) (a) Unit Variable Costs (Digital Clocks) Cost (000) $100 80 60 40 20 Illustration 5-1 0 0 2 4 6 8 10 Radios produced in (000) Cost (per unit) Total Variable Costs (Digital Clocks) $25 20 15 10 5 0 0 2 4 6 8 10 Radios produced in (000) Fixed Costs Fixed costs are costs that remain the same in total regardless of changes in the activity level. Since fixed costs remain constant in total as activity changes, fixed costs per unit vary inversely with activity. As volume increases, unit cost declines and vice versa. Fixed Costs  Damon Company leases all of its productive facilities at a cost of $10,000 per month. Total fixed costs of the facilities will remain constant at every level of activity. Cost (000) $25 20 15 10 5 Illustration 5-2 0 0 2 4 6 8 10 Radios produced in (000) (b) Fixed Costs Per Unit (Rent Expense) Cost (per unit) (a) Total Fixed Costs (Rent Expense) $5 4 3 2 1 0 0 2 4 6 8 10 Radios produced in (000) Study Objective 2 Explain the meaning and importance of the relevant range. Nonlinear Behavior of Variable and Fixed Costs Cost ($) Cost ($) In the previous two slides, the assumption was made that total variable costs and total fixed costs were linear, and straight lines were used to represent both types of costs. A straight-line relationship does not usually exist for variable costs throughout the entire range of activity. In the real world, the (a) Total (b) relationship between Variable Costs Total Fixed Costs Curvilinear Nonlinear variable cost behavior and changes in the activity level is often curvilinear, as shown in part (a) on the right. The behavior of total fixed costs through all levels of activity is shown in 0 20 40 60 80 100 0 20 40 60 80 100 part (b). Illustration 5-3 Activity level (%) Activity level (%) Linear Behavior Within Relevant Range Operating at zero or at 100% capacity is the exception for most companies. Companies usually operate over a narrower range – such as 40-80% of capacity. The relevant range of the activity index is the range over which a company expects to operate during a year. Total Variable Costs Curvilinear (b) Total Fixed Costs Nonlinear Relevant Range Illustration 5-4 Relevant Range Cost ($) Cost ($) Within this range, as shown in both diagrams to the right, a straight-line relationship normally exists for both fixed and variable costs. (a) 0 20 40 60 80 100 Activity level (%) 0 20 40 60 80 100 Activity level (%) Study Objective 3 Explain the concept of mixed costs. Mixed Costs Mixed costs contain both a variable cost element and a fixed cost element. Sometimes called semivariable costs, mixed costs change in total but not proportionately with changes in the activity level. Behavior of a Mixed Cost The rental of a U-Haul truck is a good example of a mixed cost. $200 150 Cost Local rental terms for a U-Haul truck are $50 per day plus $.50 per mile. The per diem charge is a fixed cost with respect to miles driven, while the mileage charge is a variable cost. The graphic presentation of the rental cost for a one-day rental is shown on the right. 100 Variable Cost Element 50 Fixed Cost Element 0 0 50 100 150 200 Miles 250 300 Illustration 5-5 Mixed Cost Classification for CVP Analysis  In CVP analysis, it is assumed that mixed costs must be classified into their fixed and variable elements.  Firms usually ascertain variable and fixed costs on an aggregate basis at the end of a time period, using the company’s past experience with the behavior of the mixed cost at various activity levels.  The high-low method is a mathematical method that uses the total costs incurred at the high and low levels of activity. The High-Low Method The steps in calculating fixed and variable costs under this method are as follows: 1 Determine variable cost per unit from the following formula: Change in Total Costs ÷ High minus Low Activity Level = Variable Cost per Unit Illustration 5-6 2 Determine the fixed cost by subtracting the total variable cost at either the high or the low activity level from the total cost at that activity level. The High-Low Method: Step 1 To illustrate, assume that Metro Transit Company has the following maintenance costs and mileage data for its fleet of busses over a 4-month period: Month January February Miles Driven 20,000 40,000 Total Cost $30,000 $48,000 Month March April Miles Driven 35,000 50,000 Total Cost $49,000 $63,000 Illustration 5-7 The high and low levels of activity are 50,000 miles in April and 20,000 miles in January. The difference in maintenance costs at these levels is $33,000 ($63,000-$30,000) and the difference in miles is 30,000 (50,000 - 20,000). Therefore, for Metro Transit, variable cost per unit is $1.10, computed as follows: $33,000 ÷ 30,000 = $1.10 The High-Low Method: Step 2 Metro Transit Company would compute the fixed portion of its maintenance costs as shown below: Total Cost Less: Variable costs (50,000 x $1.10) (20,000 x $1.10) Total fixed costs Activity Level High Low $63,000 $30,000 55,000 $ 8,000 22,000 $ 8,000 Illustration 5-8 Maintenance costs are therefore $8,000 per month plus $1.10 per mile. For example at 45,000 miles, estimated maintenance costs would be $49,500 variable (45,000 x $1.10), and $8,000 fixed. The High-Low Method  The high-low method generally produces a reasonable estimate for analysis.  However, it does not produce a precise measurement of the fixed and variable elements in a mixed cost because other activity levels are ignored in the computation. !