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Cost-Volume-Profit
ASSIGNMENT CLASSIFICATION TABLE
Study Objectives
Questions
Brief
Exercises
1.
Distinguish between
variable and fixed costs.
1, 2, 3, 6
1, 2, 3, 4,
5, 6
2.
4, 5
3.
6, 7, 8
1, 3, 4, 5
1, 3, 4,
5, 6
4.
5.
10, 11, 17
6, 7
6.
12, 13, 14
8, 9
7.
16
10, 12
14, 15
2A, 5A
2B, 5B
8.
15
11
16
2A, 4A, 5A
2B, 4B, 5B
Exercises
A
Problems
B
Problems
1A
1B
1A
1B
5-1
Description
Difficulty
Level
Time
Allotted (min.)
1A
Simple
2030
2A
Moderate
3040
3A
Simple
2030
4A
Moderate
2030
5A
Moderate
2030
1B
Simple
2030
2B
Moderate
3040
3B
Simple
2030
4B
Moderate
2030
5B
Moderate
2030
5-2
5-3
* 8.
* 5.
* 7.
* 4.
* 3.
* 6.
E5-7
* 2.
E5-4
E5-1
E5-16
P5-2A
P5-4B
P5-5B
P5-5B
Managerial Analysis
Ethics Case
All About You
P5-4A
P5-5A
P5-5A
P5-5B
E5-12 P5-2A
E5-14 P5-2B
E5-15
Q5-16
BE5-10
BE5-12
Q5-15
BE5-11
P5-3A
P5-4A
P5-3B
P5-4B
P5-5A
E5-16
P5-1A
P5-2A
P5-1B
P5-2B
E5-10
E5-11
E5-12
E5-13
E5-14
Q5-13
BE5-8
BE5-9
E5-8
E5-9
P5-2B
P5-1B
P5-3A
P5-3B
P5-4A
P5-5A
P5-4B
P5-5B
BE5-3
E5-3
P5-1A
Evaluation
BE5-6
P5-1A
P5-2A
P5-1B
P5-2B
E5-5
E5-6
Synthesis
E5-10
E5-11
E5-12
E5-13
Q5-11
Q5-17
BE5-6
BE5-7
E5-8
E5-9
Q5-8
BE5-4
BE5-5
BE5-2
E5-2
Analysis
E5-3
E5-6
P5-1A
P5-1B
Application
BE5-1 E5-5
E5-1
E5-2
Communication
Q5-12
Q5-14
Q5-10
Q5-9
Q5-6
Q5-7
BE5-1
Q5-4
Q5-5
Q5-1
Q5-2
Q5-3
Q5-6
Knowledge Comprehension
* 1.
Study Objective
Correlation Chart between Blooms Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems
STUDY OBJECTIVES
1.
2.
3.
4.
5.
6.
7.
8.
DEFINE MARGIN OF SAFETY, AND GIVE THE FORMULAS FOR COMPUTING IT.
5-4
CHAPTER REVIEW
Cost Behavior Analysis
1.
Cost behavior analysis is the study of how specific costs respond to changes in the level of
business activity. A knowledge of cost behavior helps management plan operations and decide
between alternative courses of action.
2.
The activity index identifies the activity that causes changes in the behavior of costs; examples
include direct labor hours, sales dollars, and units of output. Once an appropriate activity index is
chosen, costs can be classified as variable, fixed or mixed.
(S.O. 1) Variable costs are costs that vary in total directly and proportionately with changes in
the activity level. Examples of variable costs include direct materials and direct labor, cost of
goods sold, sales commissions, and freight-out. A variable cost may also be defined as a cost that
remains the same per unit at every level of activity.
4.
Fixed costs are costs that remain the same in total regardless of changes in the activity level.
Examples include property taxes, insurance, rent, supervisory salaries, and depreciation. Fixed
costs per unit vary inversely with activity; as volume increases, unit cost declines and vice versa.
Relevant Range
5.
(S.O. 2) The range over which a company expects to operate during the year is called the
relevant range. Within the relevant range a straight-line relationship exists for both variable
and fixed costs.
Mixed Costs
6.
(S.O. 3) Mixed costs are costs that contain both a variable element and a fixed element; they
increase in total as the activity level increases, but not proportionately. For purposes of CVP
analysis, mixed costs must be classified into their fixed and variable elements.
7.
The high-low method uses the total costs incurred at the high and low levels of activity. The
difference in costs represents variable costs, since only the variable cost element can change as
activity levels change.
8.
The steps in computing fixed and variable costs under the high-low method are:
a. Determine variable cost per unit from the following formula:
Change in
Total Costs
b.
Variable Cost
per Unit
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.
Cost-Volume-Profit Analysis
9.
(S.O. 4) Cost-volume-profit (CVP) analysis is the study of the effects of changes in costs and
volume on a companys profits. It is a critical factor in such management decisions as profit
planning, setting selling prices, determining product mix, and maximizing use of production
facilities.
5-5
10.
CVP analysis considers the interrelationships among the following components: (a) volume or
level of activity, (b) unit selling prices, (c) variable cost per unit, (d) total fixed costs, and (e) sales
mix.
Contribution Margin
12.
(S.O. 5) Contribution margin is the amount of revenue remaining after deducting variable costs.
The formula for contribution margin per unit is:
Unit Selling
Price
13.
Unit Variable
Costs
Contribution
Margin per Unit
Contribution margin per unit indicates the amount available to cover fixed costs and contribute to
income. The formula for the contribution margin ratio is:
Contribution
Margin Per Unit
Unit Selling
Price
Contribution
Margin Ratio
The ratio indicates the portion of each sales dollar that is available to apply to fixed costs and to
contribute to income.
Break-Even Analysis
14.
(S.O. 6) The break-even point is the level of activity at which total revenue equals total costs
(both fixed and variable). Knowledge of the break-even point is useful to management when it
decides whether to introduce new product lines, change sales prices on established products, or
enter new market areas.
15.
16.
Under the contribution margin technique, the break-even point can be computed by using
either the contribution margin per unit or the contribution margin ratio.
17.
Contribution
Margin per Unit
5-6
Break-even
Point in Units
18.
19.
Contribution
Margin Ratio
Break-even
Point in Dollars
A chart (or graph) can also be used as an effective means to determine and illustrate the breakeven point. A cost-volume-profit (CVP) graph is as follows:
Dollars (000)
Sales Line
900
Total Cost Line
800
700
600
Break-even Point
Variable Costs
500
400
300
200
100
0
Fixed Costs
200 400 600 800 1000 1200 1400 1600 1800
Units of Sales
(S.O. 7) Target net income is the income objective for individual product lines. The follow-ing
equation is used to determine target net income sales:
Required Sales = Variable Costs + Fixed Costs + Target Net Income
Margin of Safety
21.
(S.O. 8) Margin of safety is the difference between actual or expected sales and sales at the
break-even point.
a. The formula for stating the margin of safety in dollars is:
Actual (Expected)
Sales
b.
Break-even
Sales
Margin of Safety
in Dollars
Actual (Expected)
=
Sales
Margin of
Safety Ratio
The higher the dollars or the percentage, the greater the margin of safety.
5-7
LECTURE OUTLINE
A.
TEACHING TIP
Use ILLUSTRATION 5-1 to define and graphically illustrate variable and fixed
cost classifications. Emphasize total cost behavior with changes in activity levels,
then demonstrate unit cost behavior with activity level changes. Point out that
for internal analysis of operations by management, having costs classified into
variable and fixed classifications facilitates CVP analysis.
3. Variable costs are costs that vary in total directly and proportionately
with changes in the activity level. A variable cost remains the same per
unit at every level of activity.
4. Fixed costs are costs that remain the same in total regardless of changes
in the activity level.
a.
b.
5-8
5. The relevant range is the range of activity over which a company expects
to operate during a year. It is important in CVP analysis because the
behavior of costs is assumed to be linear (straight-line) throughout the
relevant range. Although the linear relationship may not be completely
realistic, the linear assumption produces useful data for CVP analysis as
long as the level of activity remains within the relevant range.
6. Mixed costs are costs that contain both a variable element and a fixed
element. Mixed costs change in total but not proportionately with changes
in the activity level.
a.
TEACHING TIP
Use ILLUSTRATION 5-2 to define and graphically illustrate the mixed costs
classification. Point out that for CVP analysis, the variable and fixed elements of
a mixed cost should be separated using a method such as the high-low method.
b.
B.
The high-low method uses the total costs incurred at the high and
low levels of activity. The difference in costs between the high and
low levels represents variable costs, since only the variable cost
element can change as activity levels change. Fixed costs are
determined by subtracting the total variable cost at either the high
or low activity level from the total cost at that activity level.
Cost-Volume-Profit Analysis.
1. Cost-volume-profit (CVP) analysis is the study of the effects of changes
in costs and volume on a companys profits. CVP analysis is important in
profit planning. It is useful in setting selling prices, determining product
mix, and maximizing use of production facilities.
5-9
TEACHING TIP
ILLUSTRATION 5-3 lists the basic components and assumptions that underlie
CVP analysis.
2. CVP analysis considers the interrelationships among the following
components:
a.
b.
c.
d.
e.
Sales mix.
b.
c.
d.
e.
When more than one type of product is sold, the sales mix will
remain constant (the percentage that each product represents of
total sales will stay the same).
5-10
TEACHING TIP
C.
a.
b.
Break-even Analysis.
1. At the break-even point, the company will realize no income but will
suffer no loss.
2. Knowledge of the break-even point is useful to management when it
decides whether to introduce new product lines, change sales prices on
established products, or enter new market areas.
3. The break-even point can be:
a.
TEACHING TIP
b.
TEACHING TIP
TEACHING TIP
b.
c.
Graphic presentation: In the profit area of the CVP graph, the distance
between the sales line and the total cost line at any point equals net
income. A company can find required sales by analyzing the differences between the two lines until the desired net income is found.
5-12
TEACHING TIP
b.
5-13
20 MINUTE QUIZ
Circle the correct answer.
True/False
1.
The range over which a company is expected to operate is called the relevant range of
the activity index.
True
2.
3.
False
In a CVP income statement, contribution margin is reported in the body of the statement.
True
10.
False
If the unit contribution margin is $300 and fixed costs are $240,000 then the break-even
point in units would be 800 units.
True
9.
False
Sales mix is the percentage that each product represents of total sales.
True
8.
False
The contribution margin is the amount of revenue remaining after deducting fixed costs.
True
7.
False
If revenue = $80 and variable cost = 40% of revenue, then contribution margin = $48.
True
6.
False
5.
False
Variable costs are costs that remain the same per unit at every level of activity.
True
4.
False
False
Margin of safety is the difference between actual sales and contribution margin.
True
False
5-14
Multiple Choice
1.
2.
Mixed costs may be separated into fixed costs and variable costs by using
a. the relevant range method.
b. the high-low method.
c. the contribution margin method.
d. all of the above.
3.
If the unit selling price is $500, the unit variable cost is $300, and the total monthly fixed
costs are $300,000, then the contribution margin ratio is
a. 30%.
b. 40%.
c. 50%.
d. 60%.
4.
If activity level increases 25% and a specific cost increases from $40,000 to $50,000, this
cost would be classified as a
a. variable cost.
b. mixed cost.
c. fixed cost.
d. none of the above.
5.
If total fixed costs are $900,000 and variable costs as a percentage of unit selling price
are 40%, then the break-even point in dollars is
a. $1,500,000.
b. $360,000.
c. $2,250,000.
d. not determinable with the information given.
5-15
ANSWERS TO QUIZ
True/False
1.
2.
3.
4.
5.
True
False
True
False
True
6.
7.
8.
9.
10.
False
True
True
True
False
Multiple Choice
1.
2.
3.
4.
5.
c.
b.
b.
a.
a.
5-16
ILLUSTRATION 5-1
COST CLASSIFICATIONSVARIABLE AND FIXED COSTS
VARIABLE COST
Cost
UNIT COST BEHAVIOR: Variable cost per unit remains constant for
all activity levels.
FIXED COST
Cost
Activity
UNIT COST BEHAVIOR: Fixed cost per unit varies inversely with
changes in activity levels.
Note: Cost behavior assumptions are valid only in the relevant range.
5-17
ILLUSTRATION 5-2
COST CLASSIFICATIONMIXED COSTS
MIXED COST
Cost
EXAMPLE
High
Change
in
activity
level
5,000 hours
Low
Jan.
Feb.
Mar.
Apr.
May
June
Machine
Hours
5,000
8,000
4,000
6,000
3,000
6,500
Power
Costs
$ 800
1,100
700
$500
900
600
950
Change
in costs
High Low
Activity Levels
5,000
Variable Cost
per Unit
$.10 per hour
Activity Level
High
Low
$1,100
$600
Total cost
Less: Variable cost
8,000 $.10 =
800
3,000 $.10 =
300
Total fixed cost
$ 300
$300
Power costs are $300 per month plus $.10 per hour.
5-18
ILLUSTRATION 5-3
BASIC COMPONENTS AND ASSUMPTIONS THAT
UNDERLIE CVP ANALYSIS
INTERRELATIONSHIPS AMONG THE BASIC COMPONENTS
3.
4.
5.
Sales mix.
5-19
ILLUSTRATION 5-4
CONTRIBUTION MARGIN
CONTRIBUTION MARGIN: REVENUE REMAINING AFTER
DEDUCTING VARIABLE COSTS
Example:
Selling price
Variable costs
Contribution margin
Per
Unit
$25
15
$10
100%
60%
40%
Unit Selling
Price
$25
Unit Variable
Costs
$15
Contribution
Margin Per Unit
$10
Contribution
Margin Per Unit
$10
Unit Selling
Price
$25
5-20
Contribution
Margin Ratio
40%
ILLUSTRATION 5-5
BREAK-EVEN ANALYSISEQUATION APPROACH
EXAMPLE:
Per
Unit
%
$25 100%
15
60%
$10
40%
$100,000
Selling price
Variable costs
Contribution margin
Fixed costs
5-21
ILLUSTRATION 5-6
BREAK-EVEN ANALYSISCONTRIBUTION
MARGIN TECHNIQUE
EXAMPLE:
Per
Unit
%
$25 100%
60%
15
40%
$10
$100,000
Selling price
Variable costs
Contribution margin
Fixed costs
Fixed
Costs
Contribution
Margin Ratio
$100,000
.40
Break-even Point
in Dollars
$250,000
Fixed
Costs
$100,000
Contribution
Margin per Unit
$10
5-22
Break-even Point
in Units
10,000 units
ILLUSTRATION 5-7
CVP GRAPH
Sales
Line
450
400
Profit
Area
350
Dollars (000)
300
Break-even
Point
250
200
150
Loss
Area
Variable
Costs
Fixed
Cost
Line
100
Fixed
Costs
50
0
Total
Cost
Line
2,000
6,000
10,000
14,000
Units of Sales
5-23
18,000
ILLUSTRATION 5-8
TARGET NET INCOME
Fixed Costs +
Target Income
$140,000
Contribution
Margin per Unit
$10
Required Sales
in Units
14,000 units
Required Sales
in Dollars
$350,000
Fixed Costs +
Target Income
$140,000
Contribution
Margin Ratio
.40
5-24