Cost Behavior and CVP Analysis: Key Concepts and Decision Rules

Cost Behavior Patterns

How costs behave in total and per unit.

Variable Cost

A cost that changes in total when activity changes, but stays the same per unit.

Fixed Cost

A cost that stays the same in total, but changes per unit as activity changes.

Mixed Cost

A cost that has both a fixed part and a variable part.

Cost-Volume-Profit Analysis

The study of the effects of changes in costs and sales volume on a company's profits.

Importance of Cost-Volume-Profit Analysis

Important in planning and decision making.

Usefulness of Cost-Volume-Profit Analysis

Useful in setting prices for products.

Cost-Volume-Profit Analysis break-even point

Helps determine breakeven point/ target profit.

Resource Utilization Cost-Volume-Profit Analysis

Allows for better use of resources (cost structure/operations).

CVP Component: Volume

Impacts both revenue and expenses.

CVP Component: Selling Price

Impacts revenue.

CVP Component: Variable Costs

Impacts expenses.

CVP Component: Fixed Costs

Impacts expenses.

CVP Component: Sales Mix

Impacts revenues and expenses.

CVP Income Statement: What elements combine on these statements?

Sales Revenue - Variable Costs = Contribution Margin - Fixed Costs = Net Income.

Sales Revenue

Total money from selling products.

Variable Costs

Costs that change with units (materials, commissions, etc.).

Contribution Margin

Amount left to cover fixed costs and profit (Selling price per unit - Variable costs).

Fixed Costs

Costs that stay the same (rent, salaries, etc.).

Net Income

Contribution Margin - Fixed Costs.

Incremental Analysis Decision Rule

If incremental analysis is greater than incremental cost you should accept.

Specific Decision Rule: Incremental Revenue

Incremental revenue is greater than incremental costs, accept.

Make or Buy Decision Rule

Choose the lower total relevant cost (pick the cheaper option).

Keep or Drop Segment Decision Rule

Segment savings is greater than lost contribution margin, drop.

Segment CM Decision Rule

If segment CM less than avoidable fixed costs, drop.

Sell or Process Further Decision Rule

Process further if extra revenue is greater than extra processing costs.

Use of Limited Resource Decision Rule

Choose product with highest CM per constrained resource.