Introduction to Management Accounting
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 1
Introduction to Management Accounting
Chapter 2
Introduction to Cost
Behavior and Cost-Volume
Relationships
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 2
Learning
Objective 1
Cost Drivers and Cost Behavior
Traditional View of Cost Behavior
Resource A
Cost Driver =
Units of
Resource
Output
Resource B
Cost Driver =
Units of
Resource
Output
Product or Service
Cost Driver = Units of Final
Product or Service
Activity-Based View of Cost Behavior
Resource A
Cost Driver =
Units of
Resource
Output
Resource B
Cost Driver =
Units of
Resource
Output
Activity A
Cost Driver =
Units of
Activity Output
Activity B
Cost Driver =
Units of
Activity Output
Product or Service
Cost Driver = Output of Final
Product or Service
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 3
Cost Drivers and Cost Behavior
Any output measure that causes
the use of costly resources
is a cost driver.
Cost behavior is how the activities
of an organization affect its costs.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 4
Value Chain Functions, Costs, and Cost Drivers
Value Chain Function and Example Costs
Example Cost Drivers
Research and development
•Salaries marketing research personnel
Number of new product proposals
costs of market surveys
•Salaries of product and process engineers
Complexity of proposed products
Design of products, services, and processes
•Salaries of product and process engineers
Number of engineering hours
•Cost of computer-aided design equipment
Number of parts per product
•Cost to develop prototype of product
for testing
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 5
Value Chain Functions, Costs, and Cost Drivers
Value Chain Function and Example Costs
Production
•Labor wages
•Supervisory salaries
•Maintenance wages
•Depreciation of plant and machinery
supplies
Energy cost
Example Cost Drivers
Labor hours
Number of people supervised
Number of mechanic hours
Number of machine hours
Marketing
•Cost of advertisements
•Salaries of marketing personnel,
travel costs, entertainment costs
Number of advertisements
Sales dollars
Kilowatt hours
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 6
Value Chain Functions, Costs, and Cost Drivers
Value chain function and Example costs
Distribution
•Wages of shipping personnel
•Transportation costs including
depreciation of vehicles and fuel
Customer service
•Salaries of service personnel
products
•Costs of supplies, travel
Example Cost Drivers
Labor hours
Weight of items delivered
Hours spent servicing
Number of service calls
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 7
Learning
Objective 2
Variable and Fixed Cost Behavior
A variable cost
changes in direct
proportion to changes
in the cost-driver level.
A fixed cost is
not immediately
affected by changes
in the cost-driver.
Think of variable
costs on a per-unit basis.
Think of fixed costs
on a total-cost basis.
The per-unit variable
cost remains unchanged
regardless of changes in
the cost-driver.
Total fixed costs remain
unchanged regardless of
changes in the cost-driver.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 8
Relevant Range
The relevant range is the limit
of cost-driver activity level within which a
specific relationship between costs
and the cost driver is valid.
Even within the relevant range, a fixed
cost remains fixed only over a given
period of time Usually the budget period.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 9
Total Monthly Fixed Costs
Fixed Costs and Relevant Range
$115,000
100,000
60,000
20
40
60
80
100
20
40
60
80
Total Cost-Driver Activity in Thousands
of Cases per Month
100
Relevant range
$115,000
100,000
60,000
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 10
CVP Scenario
Cost-volume-profit (CVP) analysis is the study of the effects of output
volume on revenue (sales), expenses (costs), and net income (net profit).
Selling price
Variable cost of each item
Selling price less variable cost
Monthly fixed expenses:
Rent
Wages for replenishing and
servicing
Other fixed expenses
Total fixed expenses per month
Per Unit
$1.50
1.20
$ .30
Percentage of Sales
100%
80
20%
$3,000
13,500
1,500
$ 18,000
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 11
Learning
Objective 3
Break-Even Point
The break-even point is the level of sales at which
revenue equals expenses and net income is zero.
Sales
- Variable expenses
- Fixed expenses
Zero net income (break-even point)
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 12
Contribution Margin Method
Contribution margin
Per Unit
Selling price
$1.50
Variable costs
1.20
Contribution margin $ .30
Contribution margin ratio
Per Unit
%
Selling price
100
Variable costs
.80
Contribution margin .20
$18,000 fixed costs ÷ $.30
= 60,000 units (break even)
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 13
Contribution Margin Method
60,000 units × $1.50 = $90,000
in sales to break even
$18,000 fixed costs
÷ 20% (contribution-margin percentage)
= $90,000 of sales to break even
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 14
Equation Method
Let N = number of units
to be sold to break even.
Sales – variable expenses – fixed expenses = net income
$1.50N – $1.20N – $18,000 = 0
$.30N = $18,000
N = $18,000 ÷ $.30
N = 60,000 Units
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 15
Equation Method
Let S = sales in dollars
needed to break even.
S – .80S – $18,000 = 0
.20S = $18,000
S = $18,000 ÷ .20
S = $90,000
Shortcut formulas:
Break-even volume in units = fixed expenses
unit contribution margin
Break-even volume in sales = fixed expenses
contribution margin ratio
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 16
Cost-Volume-Profit Graph
Learning
Objective 4
A
$150,000
Net Income
138,000
120,000
Dollars
C
Sales
Net Income Area
D
90,000
Total
Expenses
60,000
Break-Even Point
60,000 units
or $90,000
Net Loss
Area
30,000
Variable
Expenses
B
18,000
Fixed Expenses
0
10
20
30
40
50
60
70
80
90 100
Units (thousands)
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 17
Learning
Objective 5
Target Net Profit
Managers use CVP analysis
to determine the total sales,
in units and dollars, needed
To reach a target net profit.
Target sales
– variable expenses
– fixed expenses
target net income
$1,440 per month
is the minimum
acceptable net income.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 18
Target Net Profit
Target sales volume in units =
(Fixed expenses + Target net income)
÷ Contribution margin per unit
Selling price
$1.50
Variable costs
1.20
Contribution margin per unit $ .30
($18,000 + $1,440) ÷ $.30 = 64,800 units
Target sales dollars = sales price X sales volume in units
Target sales dollars = $1.50 X 64,800 units = $97,200.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 19
Target Net Profit
Contribution margin ratio
Per Unit
%
Selling price
100
Variable costs
.80
Contribution margin .20
Target sales volume in dollars = Fixed expenses + target net income
contribution margin ratio
Sales volume in dollars = 18,000 + $1,440 = $97,200
.20
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 20
Operating Leverage
Operating leverage: a firm’s ratio of fixed costs to variable costs.
Highly leveraged firms have high fixed costs and low variable costs.
A small change in sales volume = a large change in net income.
Low leveraged firms have lower fixed costs and higher variable costs.
Changes in sales volume will have a smaller effect on net income.
Margin of safety = planned unit sales – break-even sales
How far can sales fall below the planned level before losses occur?
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 21
Learning
Objective 6
Contribution Margin
and Gross Margin
Sales price – Cost of goods sold = Gross margin
Sales price - all variable expenses = Contribution margin
Selling price
Variable costs (acquisition cost)
Contribution margin and
gross margin are equal
Per Unit
$1.50
1.20
$ .30
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 22
Contribution Margin and Gross Margin
Suppose the firm had to pay a commission of $.12 per unit sold.
Sales
Acquisition cost of unit sold
Variable commission
Total variable expense
Contribution margin
Gross margin
Contribution
Margin
Per Unit
$1.50
1.20
.12
Gross
Margin
Per Unit
$1.50
1.20
$1.32
.18
$.30
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 23
Nonprofit Application
Suppose a city has a $100,000
lump-sum budget appropriation
to conduct a counseling program.
Variable costs per prescription
is $400 per patient per day.
Fixed costs are $60,000 in the
relevant range of 50 to 150 patients.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 24
Nonprofit Application
If the city spends the entire budget
appropriation, how many patients
can it serve in a year?
$100,000 = $400N + $60,000
$400N = $100,000 – $60,000
N = $40,000 ÷ $400
N = 100 patients
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 25
Nonprofit Application
If the city cuts the total budget
Appropriation by 10%, how many
Patients can it serve in a year?
Budget after 10% Cut
$100,000 X (1 - .1) = $90,000
$90,000 = $400N + $60,000
$400N = $90,000 – $60,000
N = $30,000 ÷ $400
N = 75 patients
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 26
Learning
Objective 7
Sales Mix Analysis
Sales mix is the relative proportions or
combinations of quantities of products
that comprise total sales.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 27
Sales Mix Analysis
Ramos Company Example
Wallets
(W)
Sales in units
Sales @ $8 and $5
Variable expenses
@ $7 and $3
Contribution margins
@ $1 and $2
Fixed expenses
Net income
Key Cases
(K)
Total
300,000
$2,400,000
75,000
$375,000
375,000
$2,775,000
2,100,000
225,000
2,325,000
300,000
$150,000
$ 450,000
180,000
$ 270,000
$
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 28
Sales Mix Analysis
Let K = number of units of K to break even, and
4K = number of units of W to break even.
Break-even point for a constant sales mix
of 4 units of W for every unit of K.
sales – variable expenses - fixed expenses = zero net income
[$8(4K) + $5(K)] – [$7(4K) + $3(K)] – $180,000 = 0
32K + 5K - 28K - 3K - 180,000 = 0
6K = 180,000
K = 30,000
W = 4K = 120,000
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 29
Sales Mix Analysis
If the company sells only key cases:
break-even point =
fixed expenses
contribution margin per unit
= $180,000
$2
= 90,000 key cases
If the company sells only wallets:
break-even point =
fixed expenses
contribution margin per unit
= $180,000
$1
= 180,000 wallets
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 30
Sales Mix Analysis
Suppose total sales
were equal to the
budget of 375,000 units.
However, Ramos sold
only 50,000 key cases
And 325,000 wallets.
What is net income?
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 31
Sales Mix Analysis
Ramos Company Example
Wallets
(W)
Sales in units
Sales @ $8 and $5
Variable expenses
@ $7 and $3
Contribution margins
@ $1 and $2
Fixed expenses
Net income
Key Cases
(K)
325,000
50,000
$2,600,000 $250,000
2,275,000
Total
375,000
$2,850,000
150,000
2,425,000
$ 325,000 $100,000
$ 425,000
180,000
$ 245,000
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 32
Learning
Objective 8
Impact of Income Taxes
Suppose that a company earns
$480 before taxes and pays
income tax at a rate of 40%.
What is the after-tax income?
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 33
Impact of Income Taxes
Target income before taxes = Target after-tax net income
1 – tax rate
Suppose the target net income
after taxes was $288.
Target income before taxes =
$ 288 = $480
1 – 0.40
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 34
Impact of Income Taxes
Target sales – Variable expenses – Fixed expenses
= Target after-tax net income ÷ (1 – tax rate)
$.50N – $.40N – $6,000 = $288 ÷ (1 – 0.40)
$.10N = $6,000 + ($288/.6)
$.06N = $3,600 + $288 = $3,888
N = $3,888/$.06
N = 64,800 units
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 35
Impact of Income Taxes
Suppose target net income after taxes was $480
$.50N – $.40N – $6,000 = $480 ÷ (1 – 0.40)
$.10N = $6,000 + ($480/.6)
$.06N = $3,600 + $480 = $4080
N = $4,080 ÷ $.06
N = 68,000 units
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 36
The End
End of Chapter 2
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 37