Classification of Cost Behavior

1
Classification of Cost Behavior

• Variable costs that vary in proportion to
  changes in the level of activity
• Fixed costs that remain the same, in total
  dollar amount, as the level of activity changes
• Mixed costs that have characteristics of both a
  variable cost and a fixed cost

2
High-Low Method

• Estimation method used to split Mixed Costs
• into fixed and variable components
• Uses highest and lowest activity levels, and
• related costs, to estimate variable cost per unit
• and fixed cost component of mixed costs
• TC (VC x units of production) FC

3
Cost-Volume-Profit Analysis

• Systematic examination of the relationships
• among selling prices, sales and production
• volume, costs, expenses, and profits
• Provides management with useful information
• for decision making

4
Contribution Margin Concept (1)

• Contribution Margin - excess of sales revenues
  over
• variable costs

Useful in business planning because it gives
insight into the profit potential of a firm
5
Contribution Margin Concept (2)

• Contribution Margin Ratio (Profit-Volume Ratio)
• indicates the of each sales dollar available to
  cover
• Fixed Costs and to provide income from operations

Sales Variable costs Contribution margin ratio
--------------------------------

Sales 1,000,000 - 600,000 CMR
----------------------------------- 40
1,000,000
Measures the effect of an increase or decrease in
sales volume on income from operations most
useful when increase/decrease in sales volume is
measured in sales dollars
6
Contribution Margin Concept (3)

• Unit Contribution Margin sales price variable
  cost
• per unit of product

UCM unit selling price unit variable cost
8 20 -
12 Increase sales by 15,000 units 8 x 15,000
120,000 increase in income
Most useful when increase/decrease in sales
volume is measured in sales units
7
Mathematical Approach to Cost-Volume-Profit
Analysis (1)

• Uses equations to
• Determine the units of sales necessary to achieve
  the break-even point in operations
• Determine the units of sales necessary to achieve
  a target or desired profit

8
Break-Even Point (2)

• Level of operations where revenues and
• expenses are exactly equal (no income or loss)

Fixed costs Break-even sales (units)
-------------------------------
Unit contribution
margin 90,000 Break-even
sales (units) --------------------------------
9,000 units
10
Useful in business planning, especially when
expanding or decreasing operations
9
Target Profit (3)

• Profit desired by management can be
• estimated by modifying the Break-Even
• equation

Fixed costs Target
profit Sales (units) --------------------------
----------- Unit
contribution margin 200,000
100,000 Sales (units) -------------------------
------- 10,000 units
30
Useful in business planning since the goal of
most managers is to maximize profits