Module 7: Cost Behavior & CostVolumeProfit Analysis
ACG 2071
Created by: M. Mari
Fall 2007-1
Cost-Volume-Profit Analysis (CVP)
Which helps them predict how changes in
costs and sales levels affect income
 CVP analysis involves computing the sales
level at which a company neither earns an
income nor incurs a loss – break even
point

Cost Behavior
refers to the manner in which a cost
changes as a related activity changes.
 Activity bases – activities that are thought
to cause the cost to be incurred.
 Relevant range – range of activity over
which the changes in the cost that are of
interest.

Cost Classifications

Three types
Variable Cost
 Fixed Cost
 Mixed Cost

Variable costs

costs that vary in
proportion to changes
in the level of activity.


Direct materials
Direct labor
Units Produced
Direct Materials
per unit
Total Direct
Material Costs
5,000 units
$10
$ 50,000
10,000 units
$10
100,000
15,000 units
$10
150,000
Fixed Costs

costs that remain the
same in total dollar
amounts as the level
of activity changes.
Number of Bottles
Total Salary for
Supervisor
Salary per bottle
produced
50,000
$75,000
$1.50
100,000
$75,000
$0.75
150,000
75,000
$0.50
Mixed Costs

has characteristics of both a variable and a
fixed cost.

Could behave as a fixed costs for part of the
relevant range and then variable cost
Contribution Margin Concept

Contribution margin = Sales – Variable costs

Contribution margin ratio =
Sales – Variable costs
Sales
 Is
most useful when the increase or decrease in
sales volume is measured in sales dollars

Unit contribution margin
= Sales price per unit – Variable cost
per unit
Example

The Company has sales of $1,000,000, variable costs of $800,000.
The company sold 50,000 units. Compute the contribution margin
and the contribution margin ratio.

Contribution margin = Sales – Variable cost
= $1,000,000 - $800,000 = $200,000









Contribution margin ratio = (Sales – VC)/Sales
= (1,000,000 – 800,000)/1,000,000
= 20%
Unit Contribution margin = Contribution margin
Units sold
= $200,000
50,000
= $4
Break-even Analysis


to determine the units of sales necessary to
achieve the break even pint in operations
to determine the units of sales necessary to
achieve a target or desired profit
Break-Even Point
Is the level of operations at which a
business’s revenues and expired costs are
exactly equal?
 A business will have neither an income nor
a loss from operations.

Break Even Point
Revenues
Expenses
Break even formula

BEP =
Fixed Costs__________
Unit contribution margin
Example


Suppose that selling price is $25, variable cost $15 and fixed costs
are $90,000. What is break even point?
BEP = Fixed costs / Unit Contribution Margin
= $90,000/ (25 – 15) = $90,000/$10 = 9,000 units

At sales level of 9,000 units will result in no gain or loss to the
company.

Proof:
Sales: ($25 X 9,000)
Variable cost: ($15 x 9,000)
Contribution margin
Fixed costs
Operating income





$225,000
135.000
90,000
90,000
-0-
Changes in fixed costs

Example: Suppose that selling price is
$25, variable cost $15 and fixed costs are
$90,000. What is break even point if fixed
costs increase to $100,000?
BEP = Fixed costs/ Unit Contribution margin
= $100,000/ (25-15) = 10,000 units
Due to an increase in fixed costs from $90,000 to $100,000,
break even point increased
Changes in variable costs




Example: Suppose that selling price is $25, variable
cost $15 and fixed costs are $90,000. What is break
even point if variable costs decrease to $10?
BEP = Fixed costs/ Unit Contribution margin
= $90,000/ (25-10) = 6,000 units
Due to a decrease in variable costs from $15 to
$10, break even point decreased to 6,000 units
from 9,000 units or a decrease of 3,000 units
Changes in selling price




Example: Suppose that selling price is $25, variable
cost $15 and fixed costs are $90,000. What is break
even point if selling price increase to $30?
BEP = Fixed costs/ Unit Contribution margin
= $90,000/ (30-15) = 6,000 units
Due to an increase in sales price from $25 to
$30, break even point decreased to 6,000 units
from 9,000 units or a decrease of 3,000 units.
Desired or Target Profit
BEP = Fixed costs + Desired Profit
Unit contribution margin
Example: Suppose that selling price is $45, variable cost $30, and
fixed costs are $60,000. The company wants a desired profit of
$45,000. What is break even point?

BEP = Fixed costs + Desired profit/ Unit Contribution margin
= ($60,000)/ (45-30) = 4,000 units

BEP = Fixed costs + Desired profit/ Unit Contribution margin
= ($60,000 + $45,000)/ (45-30) = 7,000 units

To create $45,000 of profit, must sell 7,000 units or 3,000 more than
break even point
Charts
Costs
Total cost
Variable
Fixed costs
Units
Graphical – Break even point
$
Profit
Sales
Total costs
Break even point
Sales = TC
Loss
0
Units
Sales Mix Consideration




More than one product is
sold at varying selling
prices
Products often have
different unit variable
costs
Products have different
contribution margin
Sales volume necessary
must a mix of both
products
Example 6:

Cascade Co produces two products Yuk
and Gunk. Yuk has a selling price of $90
per unit and variable cost of $70. Gunk has
a selling price of $140 and variable cost of
$95. Fixed costs are $200,000. Gunk’s
sales are approximately 80% of total sales
for the company. What is the break even
point for the sales mix?
Example 6:
Product
Yuk
Gunk
Sales
mix
Selling
Price
Variable
Cost
Contribution
Margin
Sales
%
Sales mix
Contribution
Margin
$90
$70
$20
80%
$16
$140
$95
$45
20%
$9
$25
Example 6:
BEP = Fixed Costs
Sales mix CM
= $200,000
$25
BEP = 8,000 units
Of what products:
YUK: 8,000 units * 80% = 6,400 units
GUK: 8,000 units * 20% = 1,600 units
Example 7:

ABC Company has two products Y and X.
Y has a selling price of $100 and variable
costs of $60. It is 70% of total sales. X has
a selling price of $50 and variable cost of
$25. Fixed costs are $248,500. What is
BEP?
Margin of Safety

Indicates possible
decrease in sales that
may occur before an
operating loss occurs.
Margin of Safety =
Sales – Sales at BEP
Sales
Margin of Safety

If sales are $400,000 and sales at break
even are $300,000 what is margin of
safety?

Ms = Sales – Sales BEP = $400 - $300
Sales
$400
= 25%
High-Low Method


Cost estimation
techniques
Steps
1. Find the highest and
lowest level of
production
2. Find the difference in
total cost from highest
to lowest level of
production
3. Find the difference in
total units from highest
to lowest level of
production
4. Variable cost per unit

Difference in Total cost
Difference in Total units
5. Find fixed cost by
solving this equation

Total cost = Fixed cost
plus Variable cost
Example 1
Month
Production
Total Cost
June
1,000
$45,550
July
1,500
$52,000
Aug
2,100
$61,500
Sept
1,800
$57,500
Oct
750
$41,250
Example

Step 1: Find highest and lowest level of production.
Month
High
August
Low
October
Units
Total Cost
2,100
$61,500
750
$41,250
Step 2: Get the difference
Difference
1,350
$20,250
Example continued
Step 3: Compute Variable cost per unit
 Variable cost = Difference in Total Cost
Difference in Units
=$20,250
1,350




= $15 per unit
Total cost = FC + VC
$61,500 = FC + ($15 *2,100 units)
$61,500 = FC + 31,500
FC = $30,000
Example Cont’d
Step 4: Compute Fixed costs
 Total cost = Fixed Costs + Variable Cost
 using the data at 2,100 units of
production, we solve for fixed costs
$61,500 = FC + ($15 *2,100 units)
$61,500 = FC + 31,500
FC = $30,000

Example Continued

Given the information in the prior slide,
what is the total cost at 2,000 units of
output?
Total cost = Fixed costs + Variable costs
Total cost = $30,000 + ($15 X 2,000)
Total cost = $60,000
Example 2
Month
June
July
Aug
Sept
Oct
Production
2,500
2,000
1,500
3,000
1,800
Total Cost
$45,000
$40,000
$35.000
$50,000
$38,000
What is the variable cost per unit and fixed cost?
Operating Leverage
o

The relative mix of a business’s variable costs
and fixed costs is measured by the operating
leverage
Since the difference between contribution margin
and income from operations is fixed costs,
companies with large amounts of fixed costs will
generally have a high operating leverage.


Indicates that a small increase in sales will yield a
large percentage increase in income from operations.
Low operating leverage

Indicates that a large increase in sales is necessary to
significantly increase income from operations
Operating Leverage

Operating Leverage
= Contribution Margin
Income from operations