Financial and Managerial Accounting, 8e
18-1
CHAPTER 18
COST BEHAVIOR AND COST-VOLUME-PROFIT ANALYSIS
Related Assignment Materials
Student Learning Objectives
Discussion
Questions
Quick
Studies*
Exercises*
Problems*
AA and
BTN
Conceptual objectives:
C1. Describe different types of cost
behavior in relation to production and
sales volume.
1,2, 3, 5, 10,
12, 19
18-1, 18–2,
18-1, 18-2, 18-3
BTN 18-1,
BTN 18-3,
BTN 18-5
C2. Describe several applications of cost-
volume-profit analysis.
4, 9, 11, 21
18-7, 18–11,
18–13
18-12, 18–13,
18-14, 18–15,
18-17, 18–18,
18-19, 18–20,
18–21
18-4, 18–5,
BTN 18–2,
BTN 18-4
Analytical objectives:
A1. Compute the contribution margin and
describe what it reveals about a
company’s cost structure.
6, 7, 8
18-5, 18–21
18-8, 18–27
18-1, 18-4,
18-5, 18-6
AA 18–3,
BTN 18-5,
A2. Analyze changes in sales using the
degree of operating leverage.
17, 18
18–16
18-9, 18–24,
18–25
AA 18-2
Procedural objectives:
14, 20
18-9, 18-10,
18-9, 18-11,
18–16
and sales for a single product
company.
15, 16
18–15
18–10
18-3
P4. Compute the break-even point for a
multiproduct company.
20
18-22, 18–23
18-5, 18-7,
BTN 18-6
P5. Compute unit cost and income under
both absorption and variable costing
*See additional information on next page that pertains to these quick studies, exercises, and problems.
SP refers to the Serial Problem
AA refers to Accounting Analysis
Margin of Safety
0:50
1:52
0:56
1:38
1:06
Additional Information on Related Assignment Material
See Chapter 1 of the Instructor’s Resource Manual for more information on materials for this text available in
Connect.
Connect
Available on the instructor’s course-specific website, Connect:
• All numerical Quick Studies, all Exercises and Problems Set A.
o Connect also provides algorithmic versions for Quick Study, Exercises, and Problems.
• General Ledger Problems
• Excel Simulations
• LearnSmart/SmartBook
Hints/Guided Examples
Need-to-Know Videos
LO
Need–to-Know
Title
Time
C1
18-1
Classifying Costs
3:22
P1
18-2
High-Low Method
2:17
A1, P2
18-3
Contribution Margin and Break-Even Point
1:58
A1, C2
18-4
Contribution Margin, Target Income, and
Margin of Safety
4:17
P4
18-5
Contribution Margin and Break-Even Point,
Composite Units
2:32
P5
18-7
Computing Product Cost Per Unit
1:09
Concept Overview Videos
LO
Title
Time
C1
Describe different types of cost behavior in relation to production and sales
volume.
Cost-Volume-Profit Analysis
1:44
Fixed Costs
1:43
Variable Costs
0:59
Mixed Costs
0:56
Step-wise Costs
1:06
Curvilinear Costs
1:00
C2
Describe several applications of cost-volume-profit analysis.
Financial and Managerial Accounting, 8e
18-3
A1
Compute the contribution margin and describe what it reveals about a company’s
cost structure.
Contribution Margin and its Measures
0:53
Contribution Margin Income Statement
1:52
Contribution Margin
1:08
Analyze changes in sales using the degree of operating leverage.
0:59
1:38
Measuring Cost Behavior
0:19
Scatter Diagram
2:18
High-Low Method
2:09
Regression
0:38
Comparing Cost Estimation Methods
0:37
P2
Compute the break-even point for a single product company.
Break-Even Point
1:21
Formula Method
0:25
Contribution Margin Income Statement Method
0:29
P3
Interpret a CVP chart and graph costs and sales for a single product company.
Cost-Volume Profit Chart
2:59
Changes in Estimates
2:52
P4
Compute the break-even point for a multiproduct company.
Sales Mix and Break-Even
1:50
Multiple Product Break-Even Income
0:25
Assumptions in CVP Analysis
0:28
Absorption Costing and Variable Costing
Computing Unit Cost
Synopsis of Chapter Revision
NEW opener—Ellis Island Tropical Tea and entrepreneurial assignment.
Added margin graphs of fixed, variable, and mixed costs.
New Excel steps to create a line chart.
Moved details of creating scatter plot to chapter appendix, with Excel steps.
Revised discussion of scatter plots.
Financial and Managerial Accounting, 8e
18-4
Chapter Outline
I. Identifying Cost Behavior (CVP analysis)
A. Cost-volume-profit analysis is a tool to predict how changes in costs and sales levels affect profit
1. CVP uses four main components including: number of units sold; sales price per unit; variable
costs per unit; and fixed costs in total.
B. Fixed Costs
1. Total fixed costs remain unchanged in amount when volume of activity varies from period to
period within a relevant range.
2. The fixed cost per unit of output decreases as volume increases (and vice versa).
C. Variable Costs
1. Variable costs change in proportion to changes in volume of activity.
2. Variable cost per unit remains constant but the total amount of variable cost changes with the
level of production.
3. When production volume and cost are graphed, (Exhibit 18.2)
a. Variable cost is represented by a straight line starting at the zero cost level.
b. The straight line is upward (positive) sloping. The line rises as volume increases.
D. Mixed Costs
1. Include both fixed and variable cost components.
3. Mixed costs are often separated into fixed and variable components when included in a CVP
analysis.
E. Step-wise Costs
1. Fixed within a relevant range of the current production volume. If production volume expands
significantly, total costs go up by a lump-sum amount (stair-step cost).
2. Treated as either fixed or variable cost in CVP analysis; depends on width of range, and requires
judgment.
F. Curvilinear (or Nonlinear) Costs
1. Increase at a non-constant rate as volume increases.
3. Often treated as variable costs in CVP analysis within a relevant range.
18-5
II. Measuring Cost Behavior⎯After establishing that cost data are reliable and useful in predicting future
costs, three methods are commonly used to analyze past cost behavior. The goal is to develop a cost
equation.
A. Scatter Diagrams
1. Are graphs of unit volume and cost (Exhibit 18-5a).
2. Units are plotted on horizontal axis, cost on the vertical axis.
3. Each point reflects the cost and number of units for a prior period.
4. Estimated line of cost behavior⎯drawn with a line that best “fits” the points visually.
a. Intersection point of line on cost axis is at fixed cost amount.
b. The variable cost per unit of volume equals the slope of the line.
1. Step 1: Identify the highest and lowest volume levels. Note that these may not be the highest or
lowest level of costs.
2. Step 2: Compute the slope (variable cost per unit) using the high low volume levels
3. Step #3: Compute the estimated fixed costs by first computing the total variable costs at either
the high or low volume level and then subtracting that amount from the total costs at that volume
level. Use the cost equation.
Total costs = Fixed costs + variable cost per unit × #of units
4. Deficiency of high-low method⎯ignores all data points except the highest and lowest, resulting
in less precision.
C. Least-Squares Regression⎯computation details covered in advanced cost accounting courses.
1. Statistical method of identifying cost behavior.
18-6
III. Break-Even Analysis
A. Contribution Margin
3. Contribution margin per unit is computed as:
CM per unit = Selling price per unit – variable cost per unit
B. Contribution margin ratio
1. The percent of a unit’s selling price that exceeds total unit variable cost. Interpreted as what
proportion of each sales dollar remains after deducting total unit variable costs.
C. Break-Even Point
1. Break-even point
a. Sales level at which company neither earns a profit nor incurs a loss.
b. Can be expressed either in units or dollars of sales.
2. Computation of break-even point
1. Differs from a conventional income statement in two ways:
i. Classifies costs and expenses as variable and fixed
1. Expected Unit Sales Expected Sales Dollars
– Break-even Unit sales – Break-even Sales Dollars
Margin of safety (units) Margin of Safety (dollars)
2. Margin of Safety Rate (%) = Margin of Safety
Expected Sales
18-7
F. Cost-Volume-Profit Chart (also called a break-even graph or chart) (Exhibit 18.14)
3. Three steps:
a. Plot fixed costs on vertical axis; draw horizontal line at this level to show that FC remains
unchanged regardless of output volume.
b. Draw line reflecting total costs (variable costs plus fixed costs) for a relevant range of
volume levels.
i. Line starts at fixed costs on vertical axis.
c. Draw sales line.
4. The break-even point is at the intersection of total cost line and sales line.
5. On either side of break-even point, the area between sales line and total cost line at any specific
sales volume reflects the profit or loss expected at that point.
a. Volume levels to left of break-even point⎯area is amount of loss expected because the
total costs line is above the total sales line.
IV. Applying Cost-Volume-Profit Analysis ⎯Useful in helping managers forecast future sales or income.
A. Computing Income from Sales and Costs
1. Sales (# units sold × unit selling price)
– Variable Costs (# units sold × unit variable cost)
Contribution Margin
– Fixed Costs
Financial and Managerial Accounting, 8e
18-8
2. Sales (in units) required for target income equals
fixed costs + target pretax income
CM
3. Can also use the contribution margin income statement to compute sales for a target income
(exhibit 18.24).
1. Important assumption⎯Sales mix of the different products is known and remains constant.
2. Sales mix is the ratio (proportion) of the sales volumes for various products.
3. When companies sell more than one product or service, estimate break-even point by using a
composite unit.
a. Determine sales mix of various products.
b. Composite Unit—a specific number of units of each product in proportion to their expected
sales mix. Multi-product CVP treats this composite unit as a single product
c. Using sales mix, determine the selling price of a composite unit by multiplying the sales
mix ratio times the selling price of each product and then adding the totals for all of the
products.
h. To determine how many units of each product must be sold to break even, multiply the
number of units of each product in the composite (sales mix) by the break-even point in
composite units.
E. Assumptions in Cost-Volume-Profit Analysis
1. CVP analysis relies on several assumptions:
a. Costs can be classified as variable or fixed.
b. Costs are linear within the relevant range.
Financial and Managerial Accounting, 8e
18-9
V. Decision Analysis—Degree of Operating Leverage
A. Useful tool in assessing the effect of changes in the level of sales on income is the degree of
operating leverage computation.
B. Operating leverage is the extent, or relative size, of fixed costs in the total cost structure.
VI. Variable Costing and Performance Reporting—contribution margin income statement, also known
as a variable costing income statement.
A. Variable costing—only costs that change in total with changes in production levels are included in
product costs.
B. Includes direct materials, direct labor and variable overhead costs.
18–10
Chapter 18 Alternate Demo Problem
Problem #1
Trimble Company sells an electronic toy for $40. The variable cost is $24 per unit and
the fixed cost is $32,000 per year. Management is considering the following changes:
Alternative #1
Lease a new packaging machine for $4,000 per year, which will reduce variable cost by
$1 per unit.
Alternative #2
Alternative #3
Reduce fixed cost by 25 percent by moving to a lower rent location. This would have
the effect of increasing variable costs by 10 percent.
Required:
Consider and answer each of the following questions independently:
Round calculations to the nearest unit
18–11
Chapter 18 Alternative Demo Problem
Multi-product breakeven point
Problem #2
Handy Home sells window and doors in the ratio of 8:2 (windows:doors). The selling
price of each window is $200 and of each door is $500. The variable cost of a window is
$125 and of a door is $350. Fixed costs are $900,000.
Required:
1. Determine the contribution margin for one composite unit.
2. Compute the break-even point in composite units.
18–12
Chapter 18 Solution: Alternate Demo Problem
Problem #1
(a)
Break-even point (in units) = Fixed costs/CM per unit
$32,000/($40 per unit – $24 per unit) = 2,000 units
2,000 units × $40 per unit = $80,000 dollars
(or)
Break-even point (in dollars) = Fixed costs/CM ratio
$32,000/[($40 per unit –$16 per unit)/$40 per unit] = $80,000
$80,000 dollars/$40 per unit = 2,000 units
(b)
New fixed costs = $32,000 + $4,000 = $36,000
New CM = $40 per unit – $23 per unit = $17 per unit
($17 per unit × 3,200 units) – $36,000 = $18,400
(c)
Break-even point (in units) = Fixed costs/CM per unit
New fixed costs = $32,000 + $8,000 = $40,000
New CM = $44 per unit – $24 per unit = $20 per unit
$40,000/$20 per unit = 2,000 units
2,000 units × $44 per unit = $88,000
(d)
Break-even point (in units) = Fixed costs/CM per unit
New fixed costs = $32,000 – $8,000 = $24,000
New CM = $40 per unit – $26.40 per unit = $13.60 per unit
$24,000/$13.60 per unit = 1,765 units
1,765 units × $40 per unit = $70,600
(e)
Required sales (in units) = (Fixed costs + Target NI)/CM per unit
($24,000 + $23,600)/$13.60 per unit = 3,500 units
18–13
Chapter 18 Solution: Alternate Demo Problem
Problem #2
Selling Price per Composite Unit
Windows: 8 × $200
$1,600
Doors: 2 × $500
1,000
$2,600
Variable Cost per Composite Unit
Windows: 8 × $125
$1,000
Doors: 2 × $350
700
1,700
Composite Contribution Margin
$900
Breakeven point in Composite Units:
Fixed Costs
$900,000
=
1,000
Composite Contribution Margin
$900
Number of units of each product to sell to break even
Windows: 8 × 1,000
= 8,000
Doors: 2 × 1,000
= 2,000
Composite Units to sell to achieve target Income:
1,200
Composite Contribution Margin
Number of units of each product to sell for target income
= 9,600
= 2,400