Cost Behavior and Cost-Volume-Profit Analysis
Cost Behavior and Cost-Volume-Profit Analysis
Chapter Overview
Source: Wild and Shaw Financial and Managerial Accounting 2025 Release.
Rights: © McGraw HILL LLC. Reproduction or distribution prohibited without consent.
Learning Objectives
Conceptual Objectives
C1: Describe different types of cost behavior in relation to production and sales volume.
C2: Describe several applications of cost-volume-profit analysis.
Analytical Objectives
A1: Compute the contribution margin and describe what it reveals about a company’s cost structure.
A2: Analyze changes in sales using the degree of operating leverage.
Procedural Objectives
P1: Estimate costs using the scatter diagram, high-low method, and regression.
P2: Compute the break-even point for a single-product company.
P3: Compute the break-even point for a multiproduct company.
P4: Compute unit cost and income under both absorption and variable costing (Appendix 18B).
Identifying Cost Behavior
Cost-Volume-Profit Analysis: Useful for making predictions in business decisions, including:
Number of units needed to break even.
Sales volume required to achieve target income.
Income change implications from purchasing machinery.
Income changes with sales price declines and increased sales volume.
Income changes from adjustments in sales mix of products/services.
Types of Costs
Fixed Costs
Definition: Total fixed costs remain constant regardless of production volume.
Behavior: Unit fixed costs decrease as the volume of production increases.
Variable Costs
Definition: Total variable costs change in proportion to changes in production volume.
Behavior: Unit variable costs remain constant as volume changes.
Mixed Costs
Definition: Mixed costs contain both fixed and variable cost components. They do not reach zero at zero production due to the fixed component and increase as volume increases.
Step-Wise Costs
Definition: Costs that remain constant within certain production volume ranges but jump to a higher level when a threshold is passed.
Example: In a tutoring center:
1-10 students → cost = $500 (one instructor)
11-20 students → cost = $1,000 (two instructors)
21-30 students → cost = $1,500 (three instructors).
Summary: Costs exhibit a stair-step pattern.
Mixed Costs (or Semi-variable Costs)
Definition: Combine fixed and variable components.
Example: Monthly cell phone bill with a fixed fee and variable usage charges.
Summary: Costs consist of a fixed base plus a variable per-unit component.
Cost Estimation Methods
Measuring Cost Behavior
Cost-Volume-Profit (CVP) analysis identifies fixed/variable cost components.
Three methods for estimating costs:
Scatter Diagram: Visual representation of cost behavior.
High-Low Method: Uses the highest and lowest levels of activity to find estimates.
Regression Analysis: More sophisticated, often used with computational tools.
Scatter Diagram
Purpose: Provides visual insight into cost behavior based on activity levels.
High-Low Method
Definition: A technique that estimates cost equations by identifying the highest and lowest activity volumes.
Formula: The relationship between units produced and total cost is summarized as:
Total cost = Fixed costs + (Variable cost per unit × Units produced).
Example: Total cost = $14,125 + $0.25 per unit produced.
Regression Analysis
Definition: A statistical method using all data points to estimate cost behavior; often implemented in spreadsheet software.
Break-Even Analysis
Break-Even Point (BEP)
Definition: The sales level at which total sales equal total costs, resulting in zero net income.
Presentation: Can be expressed in either units or dollars.
Methods to Find BEP:
Formula method.
Contribution margin income statement method.
Cost-volume-profit (CVP) chart.
Formula Method
Break-Even in Units: BEU = rac{ ext{Fixed Costs}}{ ext{Selling Price per Unit} - ext{Variable Cost per Unit}}
Break-Even in Dollars: BED = BEU imes ext{Selling Price per Unit}
Contribution Margin Income Statement Method
Purpose: Another way to determine BEP by analyzing contributions of sales.
Cost-Volume-Profit (CVP) Chart
Description: A graphical representation showing the relationships among cost, volume, and profit.
Applications of Cost-Volume-Profit Analysis
Margin of Safety
Definition: The difference between actual sales and break-even sales, indicating how much sales can drop before a company reaches its break-even point.
Computing Income from Expected Sales and Costs
Utilization: Understanding expected income based on varying sales and cost scenarios.
Target Income Calculations
For Dollars: Calculating necessary sales to achieve a specified income target.
For Units: Finding the number of units that need to be sold to reach the desired income.
Contribution Margin Income Statement
Purpose: Highlighting the impact of sales and cost allocations on profitability.
Evaluating Business Strategies
Utilization: Applying CVP analysis to assess different business strategies and their financial implications.
Multiproduct Break-Even Analysis
Sales Mix in Break-Even Calculations
CVP formulas adapt when companies offer multiple products:
Use weighted-average contribution margin per unit instead of single unit contributions.
Sales Mix: Proportion of total sales attributable to each product.
Weighted-Average Contribution Margin per Unit
Calculating Contribution Margin: Identifying overall contribution margin across multiproduct sales scenarios.
Weighted-Average Break-Even in Unit Sales
Adapt the break-even calculations to reflect multiproduct scenarios.
Assumptions in CVP Analysis
Costs classified distinctly as variable or fixed.
Linear cost relationships within the relevant range.
Assumes all produced units are sold (constant inventory).
Sales mix remains stable during analysis.
Other Concepts
Big Data
Definition: Refers to extensive datasets that are complex and sizable, often involving millions of data entries.
Three Vs:
Volume: Large amounts of generated data.
Velocity: The speed at which data is created and processed.
Variety: Multiple forms of data types, both structured and unstructured.
Machine Learning and Artificial Intelligence
Application: Used by managerial accountants to analyze and derive insights from big data.
Machine Learning Defined: A subset of AI allowing systems to learn from data using algorithms and statistical models, aiding quick understanding of cost behavior and sales options.
Degree of Operating Leverage
Definition
A measure of how changes in sales levels will affect income, indicating the risk and return associated with business operations.
Operating Leverage Analysis
Examining how operational changes impact financial outcomes based on degree of operating leverage calculations.
Appendices
Appendix 18A: Using Excel for Cost Estimation
Example Calculation: Monthly dataset depicting units produced and corresponding total costs.
Excel Functions: Demonstration of intercept and slope calculations for estimating costs.
Appendix 18B: Variable Costing and Performance Reporting
Variable Costing Defined: Treats only costs that fluctuate with production levels as product costs.
Expenses Included: Direct materials, direct labor, and variable overhead; fixed costs excluded from product costs.
GAAP Compliance: Requires absorption costing to include fixed overhead, reflecting all production costs.
Computing Unit Cost
Understanding how to compute costs under different costing methods and implications for income statements.
Income Reporting
Information on income under variable and absorption costing methodologies, including conversion methods between the two.
Conclusion of Chapter 18
The chapter encapsulates essential concepts in cost behavior analysis, CVP analysis applications, and various techniques for estimating costs and break-even points for both single and multiproduct scenarios. Focus on understanding these principles is key for effective financial management in any business.