Cost Behavior and CostVolume-Profit Analysis

Cost
Cost Behavior
Behavior

Variable
Variable Cost
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 $10 per unit (a variable cost).

Variable
Variable Cost
Cost

Total Costs

Total Variable Cost Graph

$300,000
$250,000
$200,000
$150,000
$100,000
$50,000

0 10 20 30
Units Produced
(in thousands)

Variable
Variable Cost
Cost
Unit Variable Cost Graph
Cost per Unit

$20
$15
$10
$5
0

10 20 30
Units Produced
(000)

$300,000
$250,000
$200,000
$150,000
$100,000
$50,000

Cost per Unit

Total Costs

Variable
Variable Cost
Cost

0
10
20
30
Units Produced (000)
Number of
Units
Produced

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

$20
$15
$10
$5
0

10
20
30
Units Produced (000)

Direct
Materials
Cost per Unit

Total Direct
Materials
Cost

$10
10
10
10
10
10

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

Fixed
Fixed Costs
Costs
The production
supervisor for Minton
Inc.s Los Angeles plant
is Jane Sovissi. She is
paid $75,000 per year.
The plant produces from
50,000 to 300,000
bottles of perfume.

La Fleur

Fixed
Fixed Costs
Costs
Number of
Bottles
Produced

Total Salary
for Jane
Sovissi

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

$75,000
75,000
75,000
75,000
75,000
75,000

Salary per
Bottle
Produced
$1.500
0.750
0.500
0.375
0.300
0.250

Fixed Costs
Unit Fixed Cost Graph

$150,000
$125,000
$100,000
$75,000
$50,000
$25,000

Cost per Unit

Total Costs

Total Fixed Cost Graph

0
100 200 300
Bottles Produced (000)
Number of
Bottles
Produced

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

$1.50
$1.25
$1.00
$.75
$.50
$.25
0

100 200 300

Units Produced (000)

Total Salary
for Jane
Sovissi

Salary per
Bottle
Produced

$75,000
75,000
75,000
75,000
75,000
75,000

$1.500
0.750
0.500
0.375
0.300
0.250

Simpson Inc. manufactures

sails using rented equipment.
The rental charges are
$15,000 per year, plus $1 for
each machine hour used over
10,000 hours.

Mixed
Mixed Costs
Costs

Total Costs

Total Mixed Cost Graph

$45,000
$40,000
$35,000
$30,000
$25,000
$20,000
$15,000
$10,000
$5,000
0

10 20
30
40
Total Machine Hours (000)

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

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

Low
High

High-Low Method
Actual costs incurred
ProductionTotal
(Units) Cost
June
July
August
September
October

1,000 $45,550
1,500 52,000
2,100 61,500
1,800 57,500
750 41,250

What month has

the highest level
of activity in
terms of cost?

Highest level of activity ($) minus

lowest level of activity ($)
Variable cost per unit = Highest level of activity (n) minus
lowest level of activity (n)

High-Low Method
Actual costs incurred
ProductionTotal
(Units) Cost
June
July
August
September
October

1,000 $45,550
1,500 52,000
2,100 61,500
1,800 57,500
750 41,250

What month has

the highest level
of activity in
terms of cost?

$61,500 minus lowest level of

activity ($)
Variable cost per unit = Highest level of activity (n) minus
lowest level of activity (n)

High-Low Method
Actual costs incurred
ProductionTotal
(Units) Cost
June
July
August
September
October

1,000 $45,550
1,500 52,000
2,100 61,500
1,800 57,500
750 41,250

For the highest

level of cost,
what is the level
of production?

$61,500 minus lowest level of

activity ($)
Variable cost per unit = Highest
of activity
(n) minus
2,100level
minus
lowest level
of
lowest activity
level of (n)
activity (n)

High-Low Method
Actual costs incurred
ProductionTotal
(Units) Cost
June
July
August
September
October

1,000 $45,550
1,500 52,000
2,100 61,500
1,800 57,500
750 41,250

Variable cost per unit =

What month has

the lowest level of
activity in terms
of cost?

$61,500 minus lowest level of

$61,500
$41,250
activity
($)
2,100 minus
2,100lowest
750level of
activity (n)

High-Low Method
Actual costs incurred
ProductionTotal
(Units) Cost
June
July
August
September
October

1,000 $45,550
1,500 52,000
2,100 61,500
1,800 57,500
750 41,250

What is the
variable cost per
unit?

$20,250
$57,500 $41,250
Variable cost per unit = $15
1,350
2,100
750

High-Low Method
Actual costs incurred
ProductionTotal
(Units) Cost
June
July
August
September
October

1,000 $45,550
1,500 52,000
2,100 61,500
1,800 57,500
750 41,250

Variable cost per unit = $15

What is the total

fixed cost (using the
highest level)?

Total cost = (Variable cost per unit x Units of production)

+ Fixed cost
$61,500 = ($15 x 2,100) + Fixed cost
$61,500 = ($15 x 2,100) + $30,000

High-Low Method
Actual costs incurred
ProductionTotal
(Units) Cost
June
July
August
September
October

1,000 $45,550
1,500 52,000
2,100 61,500
1,800 57,500
750 41,250

Variable cost per unit = $15

The fixed cost is

the same at the
lowest level.

Total cost = (Variable cost per unit x Units of production)

+ Fixed cost
$41,250 = ($15 x 750) + Fixed cost
$41,250 = ($15 x 750) + $30,000

Variable Costs

Fixed Costs

Unit costs remain the

sameTotal
per Units
unit Produced
regardless
Review
of activity.
Total costs
increase and
Per Unit Cost

increases
proportionately
Unit Variable
Costs
with activity level.

Total Costs

Total Fixed Costs

Unit costs increase

and decreases with
Total
Units Produced
activity
level.
Total
Unitcosts
Fixedremain
Costs the
same regardless of
activity.
Per Unit Cost

Total Costs

Total Variable Costs

Total Units Produced

Total Units Produced

Contribution Margin Income Statement

Sales (50,000 units)
Variable costs
Contribution margin
Fixed costs
Income from operations

The
The contribution
contribution
margin
margin isis
available
available to
to cover
cover
the
the fixed
fixed costs
costs
and
and income
income from
from
operations.
operations.
Contribution
$1,000,000
600,000
$ 400,000
300,000
$ 100,000

margin

FIXED
COSTS

Income from
Operations

Contribution Margin Income Statement

Sales (50,000 units)
Variable costs
Contribution margin
Fixed costs
Income from operations

Sales

Sales

$1,000,000
600,000
$ 400,000
300,000
$ 100,000

Variable
costs

Variable
costs

Income
from
operations

Fixed
+
costs

Contribution
margin

Contribution Margin Ratio

Sales (50,000 units)
Variable costs
Contribution margin
Fixed costs
Income from operations

$1,000,000
600,000
$ 400,000
300,000
$ 100,000

100%
60%
40%
30%
10%

Sales Variable costs

Contribution margin ratio =
Sales
$1,000,000 $600,000
Contribution margin ratio =
$1,000,000
Contribution margin ratio = 40%

Contribution Margin Ratio

Sales (50,000 units)
Variable costs
Contribution margin
Fixed costs
Income from operations

$1,000,000
600,000
$ 400,000
300,000
$ 100,000

100%
60%
40%
30%
10%

$20
12
$ 8

The
Thecontribution
contributionmargin
margincan
canbe
beexpressed
expressedthree
threeways:
ways:
1.1.Total
Totalcontribution
contributionmargin
marginin
indollars.
dollars.
3.3.Contribution
Contributionmargin
marginratio
ratio(percentage).
(percentage).
3.3.Unit
Unitcontribution
contributionmargin
margin(dollars
(dollarsper
perunit).
unit).

What
What isis the
the
break-even
break-even
point?
point?

Revenues

Break-even

Costs

Calculating
Calculating the
the Break-Even
Break-Even Point
Point
Sales (? units)
Variable costs
Contribution margin
Fixed costs
Income from operations

$
$
$

?
?
90,000
90,000
0

$25
15
$10

At
At the
the break-even
break-even point,
point, fixed
fixed
costs
costs and
and the
the contribution
contribution
margin
margin are
are equal.
equal.

Calculating
Calculating the
the Break-Even
Break-Even Point
Point

In
InUnits
Units

Sales($25
($25xx?9,000)
Sales
units)
$
Variablecosts
costs($15
($15xx?9,000)
Variable
units)
Contributionmargin
margin
Contribution
$
Fixedcosts
costs
Fixed
Incomefrom
fromoperations
operations
Income
$

$225,000
?
135,000
?
$90,000
90,000
90,000
90,000
$
00

$25
15
$10

$90,000
Fixed
costs
Break-even sales (units) = 9,000 units
$10 margin
Unit contribution

PROOF!
PROOF!

Calculating
Calculating the
the Break-Even
Break-Even Point
Point

In
InUnits
Units

Sales ($250 x ? units)

$
?
Variable costs ($145 x ? units)
?
Contribution margin
$
?
Fixed costs
840,000
Income from operations
$
0

$250
145
$105

$840,000
Fixed
costs
Break-even sales (units) = 8,000 units
$105 margin
Unit contribution
The unit selling price is $250 and unit variable
cost is $145. Fixed costs are $840,000.

Calculating
Calculating the
the Break-Even
Break-Even Point
Point

In
InUnits
Units

Sales ($25 x ? Next,

units) assume$ variable
?
$250
Variable costs Next,
($15 x ?assume
units) variable
?
145
150
isis increased
by
costs
increased
by $5.
Contributioncosts
margin
$
?$5. $100
$105
Fixed costs
840,000
Income from operations
$
0

$840,000
Fixed
costs
Break-even sales (units) = 8,400 units
$100 margin
Unit contribution
The unit selling price is $250 and unit variable
cost is $145. Fixed costs are $840,000.

Calculating
Calculating the
the Break-Even
Break-Even Point
Point

In
InUnits
Units

Sales
Variable costs
Contribution margin
Fixed costs
Income from operations

?
?
$
?
$600,000
$
0

$50
30
$20

$600,000
Fixed
costs
Break-even sales (units) = 30,000 units
$20 margin
Unit contribution
A firm currently sells their product at $50 per
unit and it has a related unit variable cost of
$30. The fixed costs are $600,000.

Calculating
Calculating the
the Break-Even
Break-Even Point
Point

In
InUnits
Units

Management
increases
the
Management
increases
the
Sales
$
?
selling
selling
price from
from$50
$50 to
to $60.
$60.
Variable
costs price
?
Contribution margin
Fixed costs
Income from operations

?
$600,000
$
0

$60
$50
30
$30
$20

$600,000
Fixed
costs
Break-even sales (units) = 20,000 units
$30 margin
Unit contribution

Summary
Summary of
of Effects
Effects of
of Changes
Changes on
on
Break-Even
Break-Even Point
Point

Target
Target Profit
Profit
Sales (? units)
Variable costs
Contribution margin
Fixed costs
Income from operations

?
?
$
?
200,000
$
0

In
In
Units
Units
$75
45
$35

Fixed costs are estimated at $200,000, and the

desired profit is $100,000. The unit selling
price is $75 and the unit variable cost is $45.
The firm wishes to make a $100,000 profit.

Target
Target Profit
Profit
Sales (? units)
Variable costs
Contribution margin
Fixed costs
Income from operations

?
?
$
?
200,000
$
0

In
In
Units
Units

Target
Target profit
profit isis
$75 here
used
used
here to
to refer
refer
45
to
to Income
Income from
from
$35
operations.
operations.

Fixed
costs + target
profit
$200,000
$100,000
Sales (units) = 10,000 units
Unit contribution
margin
$30

Target
Target Profit
Profit
Sales (10,000 units x $75)
$750,000
Variable costs (10,000 x $45) 450,000
Contribution margin
$300,000
Fixed costs
200,000
Income from operations
$100,000

$75
45
$30

Proof
Proof that
that sales
sales of
of 10,000
10,000 units
units
will
will provide
provide aa profit
profit of
of $100,000.
$100,000.

Graphic Approach to
Cost-Volume-Profit
Analysis

Sales and Costs ($000)

Cost-Volume-Profit Chart
$500
$450
$400
$350
$300
$250
$200
$150
$100
$ 50
0

Total Sales

Variable
Costs

60%
1

4
5
6
7
Units of Sales (000)

Unit
$$50
Unitselling
sellingprice
price
50
Unit
30
Unitvariable
variablecost
cost
30
Unit
Unitcontribution
contributionmargin
margin $$20
20
Total
$100,000
Totalfixed
fixedcosts
costs
$100,000

9 10

Sales and Costs ($000)

Cost-Volume-Profit Chart
$500
$450
$400
$350
$300
$250
$200
$150
$100
$ 50
0

Contribution
Margin

40%
60%
1

4
5
6
7
Units of Sales (000)

Unit
$$50
Unitselling
sellingprice
price
50 100%
Unit
30
Unitvariable
variablecost
cost
30 60%
Unit
Unitcontribution
contributionmargin
margin $$20
20 40%
Total
$100,000
Totalfixed
fixedcosts
costs
$100,000

9 10

Sales and Costs ($000)

Cost-Volume-Profit Chart
$500
$450
$400
$350
$300
$250
$200
$150
$100
$ 50
0

Total
Costs
Fixed Costs

4
5
6
7
Units of Sales (000)

Unit
$$50
Unitselling
sellingprice
price
50 100%
Unit
30
Unitvariable
variablecost
cost
30 60%
Unit
Unitcontribution
contributionmargin
margin $$20
20 40%
Total
$100,000
Totalfixed
fixedcosts
costs
$100,000

9 10

Sales and Costs ($000)

Cost-Volume-Profit Chart
$500
$450
$400
$350
$300
$250
$200
$150
$100
$ 50
0

Break-Even Point

4
5
6
7
Units of Sales (000)

Unit
$$50
Unitselling
sellingprice
price
50 100%
Unit
30
Unitvariable
variablecost
cost
30 60%
Unit
Unitcontribution
contributionmargin
margin $$20
20 40%
Total
$100,000
Totalfixed
fixedcosts
costs
$100,000

9 10

$100,000
= 5,000 units
$20

Sales and Costs ($000)

Cost-Volume-Profit Chart
$500
$450
$400
$350
$300
$250
$200
$150
$100
$ 50

Operating Profit Area

Operating Loss Area

0
Units of Sales (000)

Unit
$$50
Unitselling
sellingprice
price
50 100%
Unit
30
Unitvariable
variablecost
cost
30 60%
Unit
Unitcontribution
contributionmargin
margin $$20
20 40%
Total
$100,000
Totalfixed
fixedcosts
costs
$100,000

Operating Profit
(Loss) $000s

$100
$75
$50
$25
$ 0
$(25)
$(50)
$(75)
$(100)
1

Relevant
Relevant
range
range isis
8 10,000
9 10 units
10,000
units

Units of Sales (000s)

Sales
Sales(10,000
(10,000units
unitsxx$50)
$50)
Variable
Variablecosts
costs(10,000
(10,000units
unitsxx$30)
$30)
Contribution
Contributionmargin
margin(10,000
(10,000units
unitsxx$20)
$20)
Fixed
Fixedcosts
costs
Operating
Operatingprofit
profit

$500,000
$500,000
300,000
300,000
$200,000
$200,000
100,000
100,000
$100,000
$100,000

Operating Profit
(Loss) $000s

$100
$75
$50
$25
$ 0
$(25)
$(50)
$(75)
$(100)

Profit Line

Operating
profit
Operating
loss
1

Units of Sales (000s)

Maximum
loss
is
Maximum loss is
equal
to
Sales
units
equal(10,000
tothe
thetotal
total
Sales
(10,000
unitsxx$50)
$50)
fixed
Variable
costs
fixedcosts.
costs.
Variable
costs(10,000
(10,000units
unitsxx$30)
$30)
Contribution
Contributionmargin
margin(10,000
(10,000units
unitsxx$20)
$20)
Fixed
Fixedcosts
costs
Operating
Operatingprofit
profit

Maximum
Maximum
profit
profit within
within
the
the relevant
relevant
10 range.
range.
$500,000
$500,000
300,000
300,000
$200,000
$200,000
100,000
100,000
$100,000
$100,000

Operating Profit
(Loss) $000s

$100
$75
$50
$25
$ 0
$(25)
$(50)
$(75)
$(100)

Operating
profit
Operating
loss
1

Break-Even Point

9 10

Units of Sales (000s)

Sales
Sales(10,000
(10,000units
unitsxx$50)
$50)
Variable
Variablecosts
costs(10,000
(10,000units
unitsxx$30)
$30)
Contribution
Contributionmargin
margin(10,000
(10,000units
unitsxx$20)
$20)
Fixed
Fixedcosts
costs
Operating
Operatingprofit
profit

$500,000
$500,000
300,000
300,000
$200,000
$200,000
100,000
100,000
$100,000
$100,000

Sales Mix
Considerations

Cascade Company sold 8,000 units of Product A

and 2,000 units of Product B during the past year.
Cascade Companys fixed costs are $200,000.
Other relevant data are as follows:
Products
A
B
Sales
$ 90 $140
Variable costs
70
95
Contribution margin
$ 20 $ 45
Sales mix
80% 20%

Sales
SalesMix
Mix Considerations
Considerations

Sales
Variable costs
Contribution margin
Sales mix
Product contribution
margin

Products
A
B
$ 90 $140
70
95
$ 20 $ 45
80% 20%
$16

$ 9
$25

Fixed costs, $200,000

Sales
SalesMix
Mix Considerations
Considerations
Product contribution
margin

Products
A
B
$16
$ 9
$25

Break-even sales units

$200,000
$25
Fixed costs, $200,000

Sales
SalesMix
Mix Considerations
Considerations
Product contribution
margin

Products
A
B
$16
$ 9
$25

Break-even sales units

$200,000

= 8,000 units

$25
Fixed costs, $200,000

Sales
SalesMix
Mix Considerations
Considerations
Product contribution
margin

Products
A
B
$16
$ 9
$25

A: 8,000 units x Sales Mix (80%) =

B: 8,000 units x Sales Mix (20%) =

6,400
1,600

Product A Product B
Sales:
6,400 units x $90
1,600 units x $140
Total sales
Variable costs:
6,400 x $70
1,600 x $95
Total variable costs
Contribution margin
Fixed costs
Income from operations

$576,000
$576,000

$224,000
$224,000

$576,000
224,000
$800,000

$152,000
$152,000
$ 72,000

$448,000
152,000
$600,000
$200,000

$448,000
$448,000
$128,000

Break-even point
PROOF

Total

200,000
$
0

Margin
of Safety

Margin of Safety =

Sales Sales at break-even point

Margin of Safety =

Sales
$250,000 $200,000
$250,000

Margin of Safety = 20%

The margin of safety indicates the

possible decrease in sales that may occur
before an operating loss results.

Assumptions
Assumptions of
of Cost-Volume-Profit
Cost-Volume-Profit Analysis
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.