Week3 Lecture - Introduction To Cost Behaviour CVP Relationships

Introduction to Cost Behaviour and CostVolume Relationships
Week 3 (Chp 2)
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2-1
Cost Behaviour
It is how the activities of an organisation affect its costs.
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
2-2
Cost Drivers
Any output measure that causes the use of costly resources is a cost driver.
2-3
Examples of Value Chain Functions, Costs, and Cost Drivers

Value Chain Function and Example Costs Research and development Salaries of marketing research personnel, costs of of market surveys Production Labour wages Marketing Cost of advertisements Distribution Wages of shipping personnel Customer service Salaries of service personnel Example Cost Drivers Number of new product proposals
Labour hours Number of advertisements
Labour hours
Hours spent servicing products
2-4
Comparing Variable and Fixed Costs

A variable cost changes in direct proportion to changes in the cost-driver level.
A fixed cost is not immediately affected by changes in the cost-driver level.
2-5
Rules of Thumb
Think of fixed costs as a total.
Total fixed costs remain unchanged regardless of changes in cost-driver activity.
2-6
Rules of Thumb
Think of variable costs on a per-unit basis.
The per-unit variable cost remains unchanged regardless of changes in the cost-driver activity.
2-7
Relevant Range
The relevant range specifies the limits of cost-driver activity within which a specific relationship between a cost and its cost driver will be valid.
Relevant Range
2-8
Relevant Range
$115,000 100,000
Fixed Costs
60,000
Relevant range
20
40
60
80
100
2-9
Volume in Thousands of Units

Cost-Volume-Profit Analysis (CVP)

What is cost-volume-profit analysis? It is the study of the effects of output volume on revenue (sales), expenses (costs), and net income (net profit).
2 - 10
CVP Scenario
Selling price Variable cost of each item Selling price less variable cost Monthly fixed expenses: Rent Wages Other Total fixed expenses Percentage Per Unit of Sales $.50 100% .40 80 $.10 20%
$1,000 4,500 500 $6,000

2 - 11
Break-Even Point ContributionMargin and Equation Methods

The break-even point is the level of sales at which revenue equals expenses and net income is zero.
2 - 12
Break-Even Point ContributionMargin and Equation Methods
Contribution margin Equation
2 - 13
Contribution Margin Method

Per Unit Selling price Variable costs Contribution margin $.50 .40 $.10
$6,000 fixed costs $.10 = 60,000 units (break even)
2 - 14
Contribution Margin Method

60,000 units $.50 = $30,000 of sales to break even)
2 - 15
Equation Method
Net income equals zero at the break-even point.
Sales
= Variable expenses Fixed expenses Zero net income (break-even point)
2 - 16
Equation Method
Let N = number of units to be sold to break even. $.50N $.40N $6,000 = 0 $.10N = $6,000 N = $6,000 $.10 N = 60,000 Units
2 - 17
Equation Method
Let S = sales in dollars needed to break even. S .80S $6,000 = 0 .20S = $6,000 S = $6,000 .20 S = $30,000
2 - 18
Cost-Volume-Profit Graph
$60000 Ringgit (RM) $50000 $40000 $30000 Break-even sales point 60,000 units or $30,000
$20000
$10000 0 0 10 20 30 40 50 60 70 80 90 100 Units (thousands)
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 19
Fixed expense line
Sales Mix Analysis

Sales mix is the relative proportions or combinations of quantities of products that comprise total sales.
2 - 22
Sales Mix Analysis

Ramos Company Example
Wallets (W)
Sales in units Sales @ $8 and $5 Variable expenses @ $7 and $3 Contribution margins @ $1 and $2 Fixed expenses Net income
Key Cases (K)
Total 375,000 $2,775,000 2,325,000 $ 450,000 180,000 $ 270,000

2 - 23
300,000 75,000 $2,400,000 $375,000 2,100,000 $ 300,000 225,000 $150,000
Sales Mix Analysis

Assume a constant mix of 4 units of W for every unit of K (One package)
What is the contribution margin of the mix?
2 - 24
Sales Mix Analysis

Wallets (W)
Key Cases (K)
Total 375,000 $2,775,000 2,325,000 $ 450,000 180,000 $ 270,000

2 - 25
300,000 75,000 $2,400,000 $375,000 2,100,000 $ 300,000 225,000 $150,000
Sales Mix Analysis

Assume a constant mix of 4 units of W for every unit of K. What is the contribution margin of the mix? (4 $1) + (1 $2) = $6
2 - 26
Sales Mix Analysis

Wallets (W)
Key Cases (K)
Total 375,000 $2,775,000 2,325,000 $ 450,000 180,000 $ 270,000

2 - 27
300,000 75,000 $2,400,000 $375,000 2,100,000 $ 300,000 225,000 $150,000
Sales Mix Analysis

$180,000 fixed costs $6 = 30,000 packages What is the breakeven in units? 30,000 4 30,000 1 Total units 120,000 W 30,000 K 150,000
2 - 28
Sales Mix Analysis

Suppose total sales were equal to the budget of 375,000 units.
However, Ramos sold only 50,000 key (K) cases. What is the net income?
2 - 29
Sales Mix Analysis

Wallets (W)
Key Cases (K)
Total 375,000 $2,850,000 2,425,000 $ 425,000 180,000 $ 245,000

2 - 30
325,000 50,000 $2,600,000 $250,000 2,275,000 $ 325,000 150,000 $100,000
Target Net Profit
Managers can also use CVP analysis to determine the total sales, in units and dollars, needed to reach a target net profit.
2 - 31
Target Net Profit

$480 per month is the minimum acceptable net income.
Target sales Variable expenses Fixed expenses = Target net income
S 0.80S $6,000 = $480 .20S = $6,480 S = $6,480 .20 S = $32,400

2 - 32
Target Net Profit

Target sales volume in units = (Fixed expenses + Target net income) Contribution margin per unit
($6,000 + 480) $.10 = 64,800 units
2 - 33
CVP Analysis and Computer-Based Spreadsheets

The use of spreadsheets simplifies the examination of multiple changes in key factors in a CVP model.
Use of these models is a cost-benefit issue.
2 - 34
Additional Uses of Cost-Volume Analysis

Best cost structure
Operating leverage
Margin of safety
2 - 35
Operating Leverage
$60000 Ringgit (RM) $50000 $40000 $30000
$20000
$10000 0 0 10 20 30 40 50 60 70 80 90 100 Units (thousands)
Contribution Margin and Gross Margin

Gross margin = Sales price Cost of goods sold
Contribution margin = Sales price All variable expenses
2 - 37

Per Unit Selling price $.50 Variable costs (acquisition cost) .40 Contribution margin and gross margin are equal $.10 Suppose that the firm had to pay a commission of 4 per unit sold.

What are the margins? Per Unit Selling price $.50 Acquisition cost .40 Commission .04 Contribution margin $.06 Gross margin Per Unit $.50 .40
$.10
2 - 39
Nonprofit Application
Suppose a city has a $100,000 lump-sum budget appropriation to conduct a counseling program. Variable costs per prescription is $400 per patient per day. Fixed costs are $60,000 in the relevant range of 50 to 150 patients.
Nonprofit Application
If the city spends the entire budget appropriation, how many patients can it serve in a year? $100,000 = $400N + $60,000 $400N = $100,000 $60,000 N = $40,000 $400 N = 100 patients
For extra exercise

2-A1 Cost-Volume-Profits and Vending Machines (page 68) & 2-B1 Basic CVP (page 69) Answer will be discussed next week during lecture (if time permits).
2 - 42

Week3 Lecture - Introduction To Cost Behaviour CVP Relationships

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Introduction to Cost Behaviour and CostVolume Relationships

Examples of Value Chain Functions, Costs, and Cost Drivers

Labour hours Number of advertisements

Comparing Variable and Fixed Costs

A fixed cost is not immediately affected by changes in the cost-driver level.

Think of fixed costs as a total.

Total fixed costs remain unchanged regardless of changes in cost-driver activity.

Think of variable costs on a per-unit basis.

Volume in Thousands of Units

Cost-Volume-Profit Analysis (CVP)

$1,000 4,500 500 $6,000

Break-Even Point ContributionMargin and Equation Methods

Break-Even Point ContributionMargin and Equation Methods

Contribution margin Equation

Contribution Margin Method

$6,000 fixed costs $.10 = 60,000 units (break even)

Contribution Margin Method

Fixed expense line

Sales Mix Analysis

Sales Mix Analysis

Key Cases (K)

Total 375,000 $2,775,000 2,325,000 $ 450,000 180,000 $ 270,000

300,000 75,000 $2,400,000 $375,000 2,100,000 $ 300,000 225,000 $150,000

Sales Mix Analysis

What is the contribution margin of the mix?

Sales Mix Analysis

Key Cases (K)

Total 375,000 $2,775,000 2,325,000 $ 450,000 180,000 $ 270,000

300,000 75,000 $2,400,000 $375,000 2,100,000 $ 300,000 225,000 $150,000

Sales Mix Analysis

Sales Mix Analysis

Key Cases (K)

Total 375,000 $2,775,000 2,325,000 $ 450,000 180,000 $ 270,000

300,000 75,000 $2,400,000 $375,000 2,100,000 $ 300,000 225,000 $150,000

Sales Mix Analysis

Sales Mix Analysis

Sales Mix Analysis

Key Cases (K)

Total 375,000 $2,850,000 2,425,000 $ 425,000 180,000 $ 245,000

325,000 50,000 $2,600,000 $250,000 2,275,000 $ 325,000 150,000 $100,000

Target Net Profit

Target Net Profit

Target sales Variable expenses Fixed expenses = Target net income

S 0.80S $6,000 = $480 .20S = $6,480 S = $6,480 .20 S = $32,400

Target Net Profit

($6,000 + 480) $.10 = 64,800 units

CVP Analysis and Computer-Based Spreadsheets

Use of these models is a cost-benefit issue.

Additional Uses of Cost-Volume Analysis

Contribution Margin and Gross Margin

Contribution margin = Sales price All variable expenses

Contribution Margin and Gross Margin

Contribution Margin and Gross Margin

For extra exercise

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