Accounting principles 8th weygars kieso kimmel chapter 22

Chapter
22-1


CHAPTER 22

COST - VOLUME PROFIT
Accounting Principles, Eighth Edition
Chapter
22-2


Study
Study Objectives
Objectives

Chapter
22-3

1.

Distinguish between variable and fixed costs.

2.

Explain the significance of the relevant range.

3.

Explain the concept of mixed costs.

4.

List the five components of cost-volume-profit
analysis.

5.

Indicate what contribution margin is and how it
can be expressed

6.

Identify the three ways to determine the
break-even point.


Study
Study Objectives
Objectives

Chapter
22-4

7.

Give the formulas for
determining sales required
to earn target net income

8.

Define margin of safety,
and give the formulas for
computing it.

9.

Describe the essential
features of a cost-volumeprofit income statement.


Preview
Preview of
of Chapter
Chapter
To manage any business, you must understand:
How costs respond to changes in sales volume
and
The effect of costs and revenues on profit
To understand cost-volume-profit (CVP), you must
know how costs behave

Chapter
22-5


Cost-Volume-Profit
Cost-Volume-Profit

Chapter

22-6

Cost
CostBehavior
Behavior
Analysis
Analysis

Cost-VolumeCost-VolumeProfit
ProfitAnalysis
Analysis

Variable costs
Fixed costs

Basic components
CVP income statement

Relevant range
Mixed costs

Break-even analysis
Target net income

Identifying
variable and fixed
costs

Margin of safety
Changes in business

environment
CVP income statement
revisited


Cost
Cost Behavior
Behavior Analysis
Analysis
Cost Behavior Analysis is
the study of how specific costs respond to
changes in the level of business activity.
Some costs change; others remain the same
Helps management plan operations and decide
between alternative courses of action
Applies to all types of businesses and entities
Chapter
22-7

LO 1: Distinguish between variable and fixed costs.


Cost
Cost Behavior
Behavior Analysis
Analysis -- continued
continued
Starting point is measuring key business activities
Activity levels may be expressed in terms of:
Sales dollars (in a retail company)

Miles driven (in a trucking company)
Room occupancy (in a hotel)
Dance classes taught (by a dance studio)
Many companies use more
than one measurement base

Chapter
22-8

LO 1: Distinguish between variable and fixed costs.


Cost
Cost Behavior
Behavior Analysis
Analysis -- continued
continued
For an activity level to be useful:

Changes in the level or volume of activity
should be correlated with changes in costs
The activity level selected is called the
activity or volume index
The activity index:
Identifies the activity that causes changes in
the behavior of costs
Allows costs to be classified according to their
response to changes in activity as either:
Variable Costs
Chapter

22-9

Fixed Costs

Mixed Costs

LO 1: Distinguish between variable and fixed costs.


Variable
Variable Costs
Costs
Costs that vary in total directly and
proportionately with changes in the activity level
Example: If the activity level increases 10 percent,
total variable costs increase 10 percent
Example: If the activity level decreases by 25
percent, total variable costs decrease by 25
percent
Variable costs remain constant per unit at every
level of activity.
Chapter
22-10

LO 1: Distinguish between variable and fixed costs.


Variable
Variable Costs
Costs –– Example

Example
Damon Company manufactures radios that
contain a $10 clock
Activity index is the number of radios produced
For each radio produced, the total cost of the
clocks increases by $10:
If 2,000 radios are made, the total cost of the clocks
is $20,000 (2,000 X $10)
If 10,000 radios are made, the total cost of the clocks
is $100,000 (10,000 X $10)

Chapter
22-11

LO 1: Distinguish between variable and fixed costs.


Variable
Variable Costs
Costs –– Graphs
Graphs

Chapter
22-12

LO 1: Distinguish between variable and fixed costs.


Fixed
Fixed Costs

Costs
Costs that remain the same in total regardless of
changes in the activity level.
Per unit cost varies inversely with activity:
As volume increases,
unit cost declines, and vice versa
Examples include:
Property taxes
Insurance
Rent
Depreciation on buildings and equipment
Chapter
22-13

LO 1: Distinguish between variable and fixed costs.


Fixed
Fixed Costs
Costs -- Example
Example
Damon Company leases its productive facilities for
$10,000 per month
Total fixed costs of the facilities remain constant
at all levels of activity - $10,000 per month
On a per unit basis, the cost of rent decreases as
activity increases and vice versa
At 2,000 radios, the unit cost is $5
($10,000 ÷ 2,000 units)
At 10,000 radios, the unit cost is $1

($10,000 ÷ 10,000 units)
Chapter
22-14

LO 1: Distinguish between variable and fixed costs.


Fixed
Fixed Costs
Costs -- Graphs
Graphs

Chapter
22-15

LO 1: Distinguish between variable and fixed costs.


Let’s
Let’s Review
Review
Variable costs are costs that:
a. Vary in total directly and proportionately with
changes in the activity level.
level
b. Remain the same per unit at every activity level.
c.

Neither of the above.

d. Both (a) and (b) above.

Chapter
22-16

LO 1: Distinguish between variable and fixed costs.


Relevant
Relevant Range
Range
Throughout the range of possible levels of activity,
a straight-line relationship usually does not exist
for either variable costs or fixed costs
The relationship between variable costs and
changes in activity level is often curvilinear
For fixed costs, the relationship is also nonlinear –
some fixed costs will not change over the entire
range of activities while other fixed costs may
change
Chapter
22-17

LO 2: Explain the significance of the relevant range.


Relevant
Relevant Range
Range -- Graphs
Graphs

Chapter
22-18

LO 2: Explain the significance of the relevant range.


Relevant
Relevant Range
Range
Defined as the range of activity over which a
company expects to operate during a year
Within this range, a straight-line relationship
usually exists for both variable and fixed costs

Chapter
22-19

LO 2: Explain the significance of the relevant range.


Let’s
Let’s Review
Review
The relevant range is:
a. The range of activity in which variable costs will
be curvilinear.
curvilinear
b. The range of activity in which fixed costs will be
curvilinear.

c.

The range over which the company expects to
operate during a year.

d. Usually from zero to 100% of operating capacity.

Chapter
22-20

LO 2: Explain the significance of the relevant range.


Mixed
Mixed Costs
Costs
Costs that have
both a variable
cost element
and a fixed
cost element
Sometimes called
semivariable cost

Change in total
but not
proportionately
with changes in
activity level
Chapter

22-21

LO 3: Explain the concept of mixed costs.


Mixed
Mixed Costs:
Costs: High–Low
High–Low Method
Method
Mixed costs must be classified into their fixed
and variable elements
One approach to separate the costs is called the
high-low method
Uses the total costs incurred at both the high and
the low levels of activity to classify mixed costs

The difference in costs between the high and low
levels represents variable costs, since only
variable costs change as activity levels change
Chapter
22-22

LO 3: Explain the concept of mixed costs.


Mixed
Mixed Costs:
Costs:
Steps

Steps in
in High–Low-Method
High–Low-Method
STEP 1: Determine variable cost per unit using the
following formula:

STEP 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 level
Chapter
22-23

LO 3: Explain the concept of mixed costs.


Mixed
Mixed Costs:
Costs:
High–Low-Method
High–Low-Method Example
Example
Data for Metro Transit Company for 4 month period:

High Level of Activity:
Low Level of Activity:

April
January
Difference

$63,000
30,000
$33,000

50,000 miles
20,000 miles
30,000 miles

Step 1: Using the formula, variable costs per unit are
$33,000 ÷ 30,000 = $1.10 variable cost per mile
Chapter
22-24

LO 3: Explain the concept of mixed costs.


Mixed
Mixed Costs:
Costs:
High–Low-Method
High–Low-Method Example
Example
Step 2: Determine the fixed costs by subtracting total
variable costs at either the high or low activity
level from the total cost at that same level

Chapter
22-25

LO 3: Explain the concept of mixed costs.