Financial and Managerial
Accounting
Wild, Shaw, and Chiappetta
Fifth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 18
Cost Behavior and
Cost-Volume-Profit
Analysis
Conceptual Learning
Objectives
C1: Describe different types of cost
behavior in relation to production and
sales volume.
C2: Describe several applications of costvolume-profit analysis.
18-3
Analytical Learning 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.
18-4
Procedural Learning
Objectives
P1: Determine cost estimates using the
scatter diagram, high-low, and
regression methods of estimating
costs.
P2: Compute the break-even point for a
single product company.
P3: Graph costs and sales for a single
product company.
P4: Compute the break-even point for a
multiproduct company.
18-5
C1
Questions Addressed by
Cost-Volume-Profit Analysis
CVP analysis is used to answer questions
such as:
 What sales volume is needed to earn a
target income?
 What is the change in income if selling
prices decline and sales volume
increases?
 How much does income increase if we
install a new machine to reduce labor
costs?
 Will income change if we change the
sales mix of our products or services?
18-6
C1
Total Fixed Cost
Total fixed costs remain unchanged
when activity changes.
Monthly Basic
Telephone Bill
$
Number of Local Calls
Your monthly basic
telephone bill probably
does not change when
you make more local calls.
18-7
C1
Fixed Cost per Unit
Your average cost per
local call decreases as
more local calls are made.
Monthly Basic Telephone
Bill per Local Call
Fixed costs per unit decline
as activity increases.
$
Number of Local Calls
18-8
C1
Total Variable Cost
Total Long Distance
Telephone Bill
Total variable costs change
when activity changes.
$
# Minutes Talked
Your total long distance
telephone bill is based
on how many minutes
you talk.
18-9
C1
Variable Cost per Unit
Variable costs per unit do not change
as activity increases.
The cost per long distance
minute talked is constant.
For example, 7
cents per minute.
Per Minute
Telephone Charge
$
Minutes Talked
18-10
C1
Cost Behavior Summary
Summary of Variable and Fixed Cost Behavior
Cost
In Total
Per Unit
Variable
Changes as activity level
changes.
Remains the same over wide
ranges of activity.
Fixed
Remains the same even
when activity level changes.
Dereases as activity level
increases.
18-11
C1
Mixed Costs
Mixed costs contain a fixed portion that
is incurred even when the facility is
unused, and a variable portion that
increases with usage.
Example: monthly electric utility
charge
 Fixed service fee
 Variable charge per
kilowatt hour used
18-12
C1
Step-Wise Costs
Cost
Total cost remains
constant within a
narrow range of
activity.
Activity
18-13
P1
Identifying and Measuring
Cost Behavior
The objective
is to classify
all costs as
either fixed or
variable.
When presented
with a mixed
cost, the fixed
and variable
components
must be
separated.
18-14
P1
The High-Low Method
The following relationships between units
produced and costs are observed:
High activity level
Low activity level
Change
Units
67,500
17,500
50,000
Cost
$ 29,000
$ 20,500
$ 8,500
Using these two levels of activity, we can compute:
 The variable cost per unit.
 The total fixed cost.
18-15
P1
The High-Low Method (Exhibit 18.6)
High activity level
Low activity level
Change
Units
67,500
17,500
50,000

Δ
Unit variable cost =
Δ

Fixed cost = Total cost – Total variable cost
Cost
$ 29,000
$ 20,500
$ 8,500
$8,500
in cost
= 50,000 = $0.17 /unit
in units
Fixed cost = $29,000 – ($0.17 per unit × 67,500 units)
Fixed cost = $29,000 – $11,475 = $17,525
18-16
P2
Using Break-Even Analysis
The break-even point (expressed in
units of product or dollars of sales) is
the sales level at which a company
neither earns a profit nor incurs a
loss.
18-17
A1
Computing The
Break-Even Point
Sales Revenue (2,000 units)
Less: Variable costs
Contribution margin
Less: Fixed costs
Net income
Total
$ 200,000
140,000
$ 60,000
24,000
$ 36,000
Unit
$ 100
70
$ 30
Contribution margin is amount by which revenue
exceeds the variable costs of producing the revenue.
18-18
A1
Understanding the
Contribution Margin
Sales Revenue (2,000 units)
Less: Variable costs
Contribution margin
Less: Fixed costs
Net income
Total
$ 200,000
140,000
$ 60,000
24,000
$ 36,000
Unit
$ 100
70
$ 30
How much contribution margin must this company
have to cover its fixed costs (break even)?
Answer: $24,000
18-19
P2
Computing The
Break-Even Point
Sales revenue (2,000 units)
Less: Variable costs
Contribution margin
Less: Fixed costs
Net income
Total
$ 200,000
140,000
$ 60,000
24,000
$ 36,000
Unit
$ 100
70
$ 30
How many units must this company sell to cover its
fixed costs (break even)?
Answer: $24,000 ÷ $30 per unit = 800 units
18-20
P2
Computing The
Break-Even Point (Exhibit 18.11)
We have just seen one of the basic CVP
relationships – the break-even
computation.
Break-even point in units =
Fixed costs
Contribution margin per unit
Unit sales price less unit variable cost
($30 in previous example)
18-21
P2
Computing The
Break-Even Point (Exhibit 18.12)
The break-even formula may also be
expressed in sales dollars.
Break-even point in dollars =
Fixed costs
Contribution margin ratio
Unit contribution margin
Unit sales price
18-22
P2
Computing the
Margin of Safety
Margin of safety is the amount by which
sales can drop before the company
incurs a loss.
Margin of safety may be expressed as a
percentage of expected sales.
Margin of safety
percentage
=
Expected sales - Break-even sales
Expected sales
18-23
Preparing a Cost-VolumeProfit Chart
 Plot total fixed costs on the vertical axis.
Costs and Revenue
in Dollars
P3
Total fixed costs
Total costs
 Draw the total cost line with a slope
equal to the unit variable cost.
Number of Units Produced
18-24
P3
Preparing a Cost-VolumeProfit Chart
 Starting at the origin, draw the sales line
Sales
Costs and Revenue
in Dollars
with a slope equal to the unit sales price.
Total fixed costs
Total costs
Breakeven
point
Number of Units Produced
18-25
C2
Assumptions of CVP Analysis
 A limited range of activity called the relevant
range, where CVP relationships are linear.
 Unit selling price remains constant.
 Unit variable costs remain constant.
 Total fixed costs remain constant.
 Production = Sales (no inventory changes).
18-26
C2
Computing Income
from Expected Sales
Did someone say income?
Sales
– Variable costs
Contribution margin
– Fixed costs
Income (pretax)
18-27
C2
Computing Sales (Dollars) for a
Target Net Income
Target net income is income after income tax. But we
can use target income before tax in our calculations.
Target income before tax (Target pretax income) =
Net income (after tax) + Income taxes paid on the pretax income
18-28
C2
Computing Sales (Dollars) for a
Target Net Income
To convert target net income to
pretax income, use the following
formula:
Target after-tax net income
=
Target pretax Income
1 - Tax rate
18-29
C2
Computing Sales for a
Target Income
Break-even formulas may be adjusted to
show the sales volume needed to earn
any amount of income.
Dollar sales at
Fixed costs + Target pretax income
target after-tax =
Contribution margin ratio
income
Unit sales at
Fixed costs + Target pretax income
target after-tax =
Contribution margin per unit
income
18-30
C2
Sensitivity Analysis
The basic CVP relationships may be used
to analyze a number of situations such as
changing sales price, changing variable
cost, or changing fixed cost.
This sensitivity analysis can be
used to generate different sets of
revenue and cost estimates that
are optimistic, pessimistic, and
most likely.
18-31
P4
Computing Multiproduct
Break-Even Point
The CVP formulas may be modified for use when a company
sells more than one product.
 The unit contribution margin is replaced with the
contribution margin for a composite unit.
 A composite unit is composed of specific numbers of
each product in proportion to the product sales mix.
 Sales mix is the ratio of the sales volumes for the
various products.
18-32
P4
Computing Multiproduct
Break-Even Point
The resulting break-even formula
for composite unit sales is:
Break-even point
in composite units
=
Fixed costs
Contribution margin
per composite unit
A composite unit is composed of
specific numbers of each
product in proportion to the
product sales mix.
18-33
A2
Operating Leverage
The extent, or relative size, of fixed costs in the
total cost structure of an organization.
A measure of how a percentage change in
sales will affect profits.
Degree of operating leverage = Total contribution margin (in dollars)
Pretax income
18-34
End of Chapter 18
18-35