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
18–21
Analytical objectives:
A1. Compute the contribution margin and
6, 7, 8
18-5, 18–21
18-8, 18–27
18-1, 18-4,
AA 18–3,
Procedural objectives:
15, 16
18–15
18–10
18-3
P5. Compute unit cost and income under
P1. Determine cost estimates using the
scatter diagram, high-low, and
regression methods of estimating
13
18-3, 18-4
18-4, 18–5,
18-6, 18-7
18-2
*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
Variable Costs
0:59
Step-wise Costs
1:06
Curvilinear Costs
1:00
Describe several applications of cost-volume-profit analysis.
Margin of Safety
0:50
1:52
0:56
1:38
1:06
18-2
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.
Hints/Guided Examples
Please note that the Guided Examples are labeled as “Hints” in Connect assignments. The animated PowerPoints without
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
18-3
Contribution Margin and Break-Even Point
1:58
Margin of Safety
Composite Units
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
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
methods of estimating costs.
Measuring Cost Behavior
0:19
Scatter Diagram
2:18
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
0:35
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.
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.
C. Variable Costs
1. Variable costs change in proportion to changes in volume of activity.
D. Mixed Costs
1. Include both fixed and variable cost components.
2. When volume and cost are graphed, the mixed cost is represented by a straight line with an
E. Step-wise Costs
1. Fixed within a relevant range of the current production volume. If production volume expands
F. Curvilinear (or Nonlinear) Costs
1. Increase at a non-constant rate as volume increases.
2. When volume and costs are graphed, curvilinear costs appear as a curved line that starts at
Financial and Managerial Accounting, 8e
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.
B. High-low Method
1. Step 1: Identify the highest and lowest volume levels. Note that these may not be the highest or
lowest level of costs.
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.
C. Least-Squares Regression⎯computation details covered in advanced cost accounting courses.
Financial and Managerial Accounting, 8e
18-6
III. Break-Even Analysis
A. Contribution Margin
1. Computed as total sales minus total variable costs.
2. The amount by which a product’s unit selling prices exceeds its total unit variable cost. This
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.
sales price per unit.
C. Break-Even Point
1. Break-even point
a. Sales level at which company neither earns a profit nor incurs a loss.
D. Contribution Margin Income Statement Method (Exhibit 18.13)
1. Differs from a conventional income statement in two ways:
i. Classifies costs and expenses as variable and fixed
E. Margin of safety can be expressed in units, dollars, or as a percent of predicted level of sales. It is the
excess of expected sales over break-even sale. It is the amount that sales can drop before the
company incurs a loss.
1. Expected Unit Sales Expected Sales Dollars
Financial and Managerial Accounting, 8e
18-7
F. Cost-Volume-Profit Chart (also called a break-even graph or chart) (Exhibit 18.14)
1. Horizontal axis⎯number of units produced and sold (volume)
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
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.
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)
Financial and Managerial Accounting, 8e
18-8
2. Sales (in units) required for target income equals
3. Can also use the contribution margin income statement to compute sales for a target income
(exhibit 18.24).
C. Evaluating Strategies⎯knowing the effects of changing some estimates used in CVP analysis by
substituting new estimated amounts (in total or per unit as appropriate) in the related formula can
be helpful in making predictions. Can also use the contribution margin income statement.
D. Sales Mix and Break-Even ⎯Modify basic CVP analysis when company produces and sells
several products.
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
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.
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.
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.
Financial and Managerial Accounting, 8e
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 #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
(a) Determine the current break-even point in units and dollars.
Financial and Managerial Accounting, 8e
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.
Financial and Managerial Accounting, 8e
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
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
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
Financial and Managerial Accounting, 8e
18–13
Chapter 18 Solution: Alternate Demo Problem
Problem #2
Selling Price per Composite Unit
Variable Cost per Composite Unit
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
Composite Units to sell to achieve target Income:
1,200
Composite Contribution Margin
Number of units of each product to sell for target income