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Cost Behavior

Cost Behavior. Cost Volume Profit Analysis Chapter M3. Cost Behavior. Refers to the manner in which a cost changes as a related activity changes Activity Bases Relevant range. Cost Classification. Variable Costs Costs that vary in proportion to changes in the level of activity

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Cost Behavior

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  1. Cost Behavior Cost Volume Profit Analysis Chapter M3

  2. Cost Behavior • Refers to the manner in which a cost changes as a related activity changes • Activity Bases • Relevant range

  3. Cost Classification • Variable Costs • Costs that vary in proportion to changes in the level of • activity • Such as • Direct Materials • Direct Labor

  4. Cost Classification • Fixed Costs • Costs that remain the same in total dollar amounts as the • level of activity changes. • salaries

  5. Cost Classification • Mixed Costs • Has characteristics of both a variable and a fixed cost. • Could behave as a fixed cost for part of the relevant range and then variable cost

  6. Cost estimation techniques Steps Find the highest and lowest level of production Find the difference in total cost from highest to lowest level of production Find the difference in total units from highest to lowest level of production Variable cost per unit Difference in Total cost Difference in Total units Find fixed cost by solving this equation Total cost = Fixed cost plus Variable cost High-Low Method

  7. Example 1 High: Aug 2,100 units Low: Oct 750 units Diff 1,350 High: Aug $61,500 Oct $41,250 Diff 20,250

  8. Variable cost = Diff in TC Diff in units =$20,250 1,350 = $15 per unit • Total cost = FC + VC • $61,500 = FC + ($15 *2,100 units) • $61,500 = FC + 31,500 • FC = $30,000

  9. Example 2

  10. Example 2 • High Sept 3,000 $50,000 • Low Aug 1,500 $35,000 • Diff 1,500 15,000 • Variable cost per unit • $15,000/1,500 = $10 per unit • Total cost = FC + VC • $50,000 = FC + (3,000 units * $10) • FC = $20,000

  11. Cost-Volume-Profit Relationship • Is the systematic examination of the relationships among selling prices, sales, and production volume, costs, expenses and profits • Provides management with useful information for decision making

  12. Contribution Margin = Sales – Variable Costs Contribution margin ratio Sales – VC Sales Unit Contribution margin Sales per unit - VC per unit Contribution Margin Concept

  13. Example 3 • The company has sales of $1,000,000, variable costs of $800,000. Compute the contribution margin and the contribution margin ratio • CM = Sales – VC = $1,000,000 - $800,000 =$200,000 • CM ratio = Sales – VC/Sales = 200,000/1000000 = 20%

  14. Example 4 • The company has sales of $800,000, variable costs of $600,000. Compute the contribution margin and contribution margin ratio • CM = sales – VC = $800 - $600 = $200 • CM ratio = CM/Sales = 200/800 = 25%

  15. Cost Volume Profit Analysis To determine the units of sales necessary to achieve the break even point in operations To determine the units of sales necessary to achieve a target or desired profit

  16. Break-Even Point • Is the level of operations at which a business’ revenues and expired costs are exactly equal • No income or loss • BEP = Fixed Costs Unit Contribution Margin

  17. Break Even Point • Example 5: Suppose that selling price is $35, variable cost is $15 and fixed costs are $90,000. What is break even point? • BEP = fixed costs Unit contribution margin (Sales – VC) = $90,000 $35 - $15 = 4,500 units

  18. Break even point • Check • Sales = FC + VC • ($35 * 4,500 units) = $90,000 + ($25 * 4,500) • $157,500 = $90,000 + $67,500

  19. Example 6 • Suppose that selling price is $45, variable cost is $30 and fixed costs are $60,000. What is break even point? • BEP = Fixed cost Unit CM = $60,000 $45-30 = 4,000 units

  20. Graphical Total Cost Costs Variable costs Fixed Costs Units 0

  21. Graphical – Break even point Sales $ Total costs Profit Break even point Sales = TC Loss Units 0

  22. Changes in fixed costs Increase in fixed costs Increases BEP Decrease in fixed cost Decrease BEP Changes in Variable cost Increase in variable cost Increases BEP Decreases in variable cost Decreases BEP Changes in Selling Price Increase in SP Decrease BEP Decrease in SP Increase in BEP Effect of Changes on BEP

  23. Desired Profit • Firms would like to earn a profit and not just to break even • BEP = FC + Desired Profit Unit CM

  24. Example 5: • Suppose that selling price is $45, variable cost is $30, and fixed costs are $60,000. The company wants a desired profit of $45,000. What is BEP? • BEP = FC +  Unit CM = $60,000 + $45,000 = $105,000 = 7,000 $45- $30 $15

  25. Example 5: • Check • Sales – ( FC + VC) = Desired profit • ($45 * 7,000) – {$60,000 – ($30 *7,000) = • $315,000 – (60,000 + 210,000) = • $45,000

  26. Example 6: • Suppose that selling price is $25, variable cost is $15 and fixed costs are $90,000. The company wants a desired profit of $10,000. What is break even point? • BEP = FC + Desired Profit Unit CM = $90,000 + $10,000 $10 = 10,000 units

  27. Sales Mix Consideration • More than one product is sold at varying selling prices • Products often have different unit variable costs • Products have different contribution margin • Sales volume necessary must a mix of both products

  28. Example 6: • Cascade Co produces two products Yuk and Gunk. Yuk has a selling price of $90, variable cost of $70 and is 80% of total sales. Gunk has a selling price of $140, variable cost of $95, and is 20% of total sales. Fixed costs are $200,000. What is the break even point for the sales mix?

  29. Example 6: $25

  30. Example 6: BEP = Fixed Costs = $200,000 Sales mix CM $25 BEP = 8,000 units Of what products: YUK: 8,000 units * 80% = 6,400 units GUK: 8,000 units * 20% = 1,600 units

  31. Example 7: • ABC Company has two products Y and X. Y has a selling price of $100, variable costs of $60 and is 70% of total sales. X has a selling price of $50, variable cost of $25. Fixed costs are $248,500. What is BEP?

  32. Example 7: $35.50

  33. Example 7: • BEP = Fixed cost Sales mix CM = $248,500 $35.50 = 7,000 units Y: 7,000 units * 70% = 4,900 units X: 7,000 units * 30% = 2,100 units

  34. Margin of Safety • Indicates possible decrease in sales that may occur before an operating loss occurs. • Ms = S – Sat BEP Sales

  35. Margin of Safety • If sales are $400,000 and sales at break even are $300,000 what is margin of safety? • Ms = Sales – Sales BEP = $400 - $300 Sales $400 = 25%

  36. Operating Leverage • Relative mix of business variable costs and fixed costs • Contribution margin Income from operations • High = large fixed costs • Low – small fixed costs

  37. Remember • Get detailed handouts at • http://faculty.mdc.edu/mmari • Homework assigned in class.

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