Lecture Accounting principles (8th edition) – Chapter 22: Cost-volume-profit
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Chapter
22-1
CHAPTER 22
COST - VOLUME PROFIT
Accounting Principles, Eighth Edition
Chapter
22-2
Study Objectives
Study Objectives
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 costvolumeprofit analysis.
5.
Indicate what contribution margin is and how it can be
expressed
6.
Identify the three ways to determine the breakeven point.
Chapter
22-3
Study Objectives
Study 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
costvolumeprofit income
statement.
Preview of Chapter
Preview of 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 costvolumeprofit (CVP), you must know how costs
behave
Chapter
22-5
CostVolumeProfit
CostVolumeProfit
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 Behavior Analysis
Cost Behavior Analysis
Cost Behavior Analysis is
the study of how specific costs respond to
the level of business activity.
changes in
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 Behavior Analysis continued
Cost Behavior Analysis 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 Behavior Analysis continued
Cost Behavior Analysis continued
For an activity level to be useful:
Changes in the level or volume of activity
correlated with changes in costs
should be
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 Fixed Costs Mixed Costs
Chapter
22-9
LO 1: Distinguish between variable and fixed costs.
Variable Costs
Variable 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 Costs – Example
Variable Costs – 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 Costs – Graphs
Variable Costs – Graphs
Chapter
22-12
LO 1: Distinguish between variable and fixed costs.
Fixed Costs
Fixed Costs
Costs that remain the same in total
regardless of changes in the
Costs that
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 Costs Example
Fixed Costs Example
Damon Company leases its productive facilities for $10,000 per
month
Total fixed costs of the facilities remain constant
activity $10,000 per month
at all levels of
On a per unit basis, the cost of rent decreases as
increases and vice versa
activity
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 Costs Graphs
Fixed Costs Graphs
Chapter
22-15
LO 1: Distinguish between variable and fixed costs.
Let’s Review
Let’s Review
Variable costs are costs that:
a.
Vary in total directly and proportionately with changes in the
activity level.
activity 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 Range
Relevant Range
Throughout the range of possible levels of activity, a straightline
Throughout the range of possible levels of activity, a
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
is often
For fixed costs, the relationship is also nonlinear
– some fixed
For fixed costs, the relationship is also
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 Range Graphs
Relevant Range Graphs
Chapter
22-18
LO 2: Explain the significance of the relevant range.
Relevant Range
Relevant Range
Defined as the range of activity over which a company expects to
operate during a year
Within this range, a straightline relationship usually exists for both
variable and fixed costs
Chapter
22-19
LO 2: Explain the significance of the relevant range.
Let’s Review
Let’s Review
The relevant range is:
a.
The range of activity in which variable costs will be curvilinear.
The range of activity in which variable costs will be 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 Costs
Mixed Costs
Costs that have
both a variable cost
element
and a fixed
cost element
Sometimes called
semivariable cost
Change in total but
Change
not proportionately
with changes in
activity level
Chapter
22-21
LO 3: Explain the concept of mixed costs.
Mixed Costs: High–Low Method
Mixed Costs: High–Low Method
Mixed costs must be classified into their fixed
and variable
Mixed costs must be classified into their
and
elements
One approach to separate the costs is called the highlow method
One approach to separate the costs is called the
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
The difference in costs between the high and low levels
variable costs, since only variable costs change as activity
levels change
Chapter
22-22
LO 3: Explain the concept of mixed costs.
Mixed Costs:
Mixed Costs:
Steps in High–LowMethod
Steps in High–LowMethod
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 Costs:
Mixed Costs:
High–LowMethod Example
High–LowMethod Example
Data for Metro Transit Company for 4 month period:
High Level of Activity: April $63,000 50,000 miles
Low Level of Activity: January 30,000 20,000 miles
Difference $33,000 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 Costs:
Mixed Costs:
High–LowMethod Example
High–LowMethod Example
Step 2: Determine the fixed costs by subtracting total
variable costs at either
the high or low activity
variable costs at
from the total cost at that same level
Chapter
22-25
level
LO 3: Explain the concept of mixed costs.
