Cost Behavior and
Cost-Volume-Profit Analysis
Chapter 11
Cost Behavior

Cost behavior is the manner in which a cost
changes as some related activity changes

An understanding of cost behavior is
necessary to plan and control costs

A relevant range is the range over which we
are interested in the cost’s behavior
Cost Behavior

Variable cost

Cost is constant on a per unit basis, but the total
cost varies directly with changes in activity


Materials, fuel, etc.
Fixed cost

Cost is constant in total, but varies inversely with
changes in activity

Salaries, property taxes, straight-line depreciation, etc.
Cost Behavior

Step cost

Cost which is fixed over small ranges of activity,
but varies across wider ranges


Supervision costs, labor costs, etc.
Mixed cost

Cost has both a fixed and a variable component

Utility costs in which you pay a fixed amount to have the
service available to you, and a variable charge based on
how much you use the utility; rental costs in which you
pay a fixed amount per period plus a variable amount
based on usage, etc.
Cost Behavior

Mixed costs must be separated into their
fixed and variable components in order to
predict changes in the cost

High-low method

Simple regression

Multiple regression
Cost Behavior

High-low method

Compares the points of highest and lowest
activities, and their related costs, and calculates the
formula for a straight line connecting the two points

Dividing the incremental cost by the incremental
units of activity gives the variable cost per unit of
activity

The variable cost per unit is substituted into the
cost formula to determine the fixed cost

Total cost = fixed cost + variable cost per unit * number of
units of activity
Cost Behavior
High point $
Low point
Difference $
Cost
18,000
12,000
6,000
Units of
activity
10,000
6,000
4,000
$6,000 / 4,000 = $1.50 per unit
At the low point:
$12,000 = Fixed cost + $1.50 per unit * 6,000 units
$3,000 = Fixed cost
Total cost = $3,000 + $1.50 per unit * number of units
Applications of Cost Behavior Concepts

Contribution margin

Excess of sales over variable costs

Contribution is the incremental amount of each
sale that is available to cover fixed costs and
provide a profit

Knowing the contribution margin allows us to
predict changes in net income that will result from
a change in sales volume
Applications of Cost Behavior Concepts
Sales
Variable costs
Contribution margin
Fixed costs
Net income
Total
Percentage Per unit*
$ 1,000,000
100% $
1,000
600,000
60%
600
$
400,000
40% $
400
300,000
$
100,000
* - assume 1,000 units are sold
Applications of Cost Behavior Concepts

Contribution margin percentage

Proportion of each sales dollar that is available to
cover fixed costs and provide a profit


If sales increase by $100,000, profit will increase by
$40,000 ($100,000 * 40%)
Contribution margin per unit

Dollar amount that each unit contributes toward
covering fixed costs and providing a profit

If 50 more units are sold, profit will increase by $20,000
(50 units * $400)
Applications of Cost Behavior Concepts

Breakeven point

Volume of sales needed to earn no profit or no
loss

Revenues = total costs
Fixed cost + target profit
Contribution margin per unit = number of units
Fixed cost + target profit
Contribution margin percentage = dollars of sales
Applications of Cost Behavior Concepts

The breakeven formulas allow us to play
“what if” games

What happens if

Sales price is increased (or decreased)

Variable costs are replaced by fixed costs

Volume increases

Additional amounts spent on advertising will increase
sales volume

Etc.
Applications of Cost Behavior Concepts

Margin of safety

The excess of current sales volume over the
breakeven point

In units


Current unit sales – breakeven unit sales
In percentage

(Current sales – breakeven sales) / current sales

The sales figures may be in dollars or units
Applications of Cost Behavior Concepts

Operating leverage

Measures the relative mix of fixed and variable
costs

Contribution margin / operating income

Can determine the change in operating income
that will result from a change in sales by
multiplying the % change in sales by the operating
leverage

High operating leverage implies high risk, high
reward
Applications of Cost Behavior Concepts

Breakeven calculations in a multi-product
environment



Assume the mix of products sold remains
constant
Determine the contribution margin for a “basket”
of goods (the normal sales mix)
Calculate the breakeven point as the number of
“baskets” needed to break even
Applications of Cost Behavior Concepts
Product
Laptops
Printers
Scanners
Normal
Contribution
Total
sales mix
per unit
contribution
6 $
70 $
420
2
30
60
1
20
20
$
500
If fixed costs are $800,000, the breakeven point is
$800,000 / 500 = 1,600 "baskets"
9,600 laptops
3,200 printers
1,600 scanners