Managerial Accounting
Weygandt, Kieso, & Kimmel
Prepared by
Karleen Nordquist..
The College of St. Benedict...
and St. John’s University...
with contributions by
Marianne Bradford..
The University of Tennessee...
Gregory K. Lowry….
Macon Technical Institute…..
John Wiley & Sons, Inc.
Chapter 5
Cost-Volume-Profit Relationships
Chapter 5
Cost-Volume-Profit Relationships
After studying this chapter, you should be able to:
1 Distinguish between variable and fixed costs.
2 Explain the meaning and importance of the relevant
range.
3 Explain the concept of mixed costs.
4 State the five components of cost-volume-profit
analysis.
5 Indicate the meaning of contribution margin and the
ways it may be expressed.
Chapter 5
Cost-Volume-Profit Relationships
After studying this chapter, you should be able to:
6 Identify the three ways that the break-even point may
be determined.
7 Define margin of safety and give the formulas for
computing it.
8 Give the formulas for determining sales required to
earn target net income.
9 Describe the essential features of a cost-volumeprofit income statement.
Preview of Chapter 5
COST-VOLUMEPROFIT
RELATIONSHIPS
Cost Behavior Analysis
• Variable Costs
• Fixed Costs
• Relevant Range
• Mixed Costs
• Identifying Variable and Fixed
Costs
Preview of Chapter 5
COST-VOLUMEPROFIT
RELATIONSHIPS
Cost-Volume-Profit Analysis
• Basic Components
• Contribution Margin
• Break-Even Analysis
• Margin of Safety
• Target Net Income
• Changes in Business
Environment
• CVP Income Statement
Cost Behavior Analysis
 Cost behavior analysis is the study of how specific
costs respond to changes in the level of activity within
a company.
 The starting point in cost behavior analysis is
measuring the key activities in the company’s
business.
 Activity levels may be expressed in terms of
–
–
–
–
sales dollars (retail company),
miles driven (trucking company),
room occupancy (hotel), or
number of dance classes taught (dance studio).
Cost Behavior Analysis
 For an activity level to be useful in cost
behavior analysis, there should be correlation
between changes in the level or volume of
activity and changes in the costs.
 The activity level selected is referred to as the
activity (or volume) index.
 The activity index identifies the activity that
causes changes in the behavior of costs.
Study Objective 1
Distinguish between variable and
fixed costs.
Variable Costs
Variable costs are costs that vary in total
directly and proportionately with changes in the
activity level.
A variable cost may also be defined as a cost
that remains the same per unit at every level
of activity.
Variable Costs
 Damon Company manufactures radios that contain a $10 digital
clock. The activity index is the number of radios produced. As
each radio is manufactured, the total cost of the clocks increases
by $10.
(b)
(a)
Unit Variable Costs
(Digital Clocks)
Cost (000)
$100
80
60
40
20
Illustration 5-1
0
0 2 4 6 8 10
Radios produced in (000)
Cost (per unit)
Total Variable Costs
(Digital Clocks)
$25
20
15
10
5
0
0 2 4 6 8 10
Radios produced in (000)
Fixed Costs
Fixed costs are costs that remain the same in
total regardless of changes in the activity level.
Since fixed costs remain constant in total as
activity changes, fixed costs per unit vary
inversely with activity. As volume increases,
unit cost declines and vice versa.
Fixed Costs
 Damon Company leases all of its productive facilities at a cost of
$10,000 per month. Total fixed costs of the facilities will
remain constant at every level of activity.
Cost (000)
$25
Illustration 5-2
20
15
10
(b)
Fixed Costs Per Unit
(Rent Expense)
Cost (per unit)
(a)
Total
Fixed Costs (Rent
Expense)
$5
4
3
2
5
1
0
0 2 4 6 8 10
Radios produced in (000)
0
0 2 4 6 8 10
Radios produced in (000)
Study Objective 2
Explain the meaning and
importance of the relevant range.
Nonlinear Behavior of
Variable and Fixed Costs
Cost ($)
Cost ($)
In the previous two slides, the assumption was made that total variable costs
and total fixed costs were linear, and straight lines were used to represent
both types of costs. A straight-line relationship does not usually exist for
variable costs throughout the entire range of activity.
In the real world, the
(a)
Total
(b)
relationship between
Variable Costs
Total Fixed Costs
Curvilinear
Nonlinear
variable cost behavior
and changes in the
activity level is often
curvilinear, as shown in
part (a) on the right. The
behavior of total fixed
costs through all levels
of activity is shown in
0 20 40 60 80 100
0 20 40 60 80 100
part (b).
Illustration 5-3
Activity level (%)
Activity level (%)
Linear Behavior Within
Relevant Range
Operating at zero or at 100% capacity is the exception for most
companies. Companies usually operate over a narrower range – such
as 40-80% of capacity. The relevant range of the activity index is the
range over which a company expects to operate during a year.
(a)
(b)
Total Fixed Costs
Nonlinear
Relevant
Range
0
Illustration 5-4
Relevant
Range
Cost ($)
Cost ($)
Within this range, as
shown in both
diagrams to the right, a
straight-line
relationship normally
exists for both fixed
and variable costs.
Total
Variable Costs
Curvilinear
20 40 60 80 100
Activity level (%)
0
20 40 60 80 100
Activity level (%)
Study Objective 3
Explain the concept of mixed costs.
Mixed Costs
Mixed costs contain both a variable cost
element and a fixed cost element.
Sometimes called semivariable costs, mixed
costs change in total but not proportionately
with changes in the activity level.
Behavior of a Mixed Cost
The rental of a U-Haul truck is a good example of a mixed cost.
$200
150
Cost
Local rental terms for a
U-Haul truck are $50 per
day plus $.50 per mile. The
per diem charge is a fixed
cost with respect to miles
driven, while the mileage
charge is a variable cost.
The graphic presentation of
the rental cost for a one-day
rental is shown on the right.
100
Variable Cost Element
50
Fixed Cost Element
0
0
50
100
150 200
Miles
250
300
Illustration 5-5
Mixed Cost Classification
for CVP Analysis
 In CVP analysis, it is assumed that mixed costs
must be classified into their fixed and variable
elements.
 Firms usually ascertain variable and fixed costs on
an aggregate basis at the end of a time period,
using the company’s past experience with the
behavior of the mixed cost at various activity levels.
 The high-low method is a mathematical method
that uses the total costs incurred at the high and low
levels of activity.
The High-Low Method
The steps in calculating fixed and variable costs
under this method are as follows:
1 Determine variable cost per unit from the following
formula:
Change in
Total Costs

High minus Low
Activity Level
=
Variable Cost
per Unit
Illustration 5-6
2 Determine the fixed cost by subtracting the total
variable cost at either the high or the low activity level
from the total cost at that activity level.
The High-Low Method:
Step 1
To illustrate, assume that Metro Transit Company has the
following maintenance costs and mileage data for its fleet of
busses over a 4-month period:
Month
January
February
Miles Driven
20,000
40,000
Total Cost
$30,000
$48,000
Month
March
April
Miles Driven
35,000
50,000
Total Cost
$49,000
$63,000
Illustration 5-7
The high and low levels of activity are 50,000 miles in April
and 20,000 miles in January. The difference in maintenance
costs at these levels is $33,000 ($63,000-$30,000) and the
difference in miles is 30,000 (50,000 - 20,000). Therefore,
for Metro Transit, variable cost per unit is $1.10, computed as
follows:
$33,000  30,000 = $1.10
The High-Low Method:
Step 2
Metro Transit Company would compute the fixed portion of
its maintenance costs as shown below:
Total Cost
Less: Variable costs
(50,000 x $1.10)
(20,000 x $1.10)
Total fixed costs
Activity Level
High
Low
$63,000 $30,000
55,000
$ 8,000
22,000
$ 8,000
Illustration 5-8
Maintenance costs are therefore $8,000 per month plus
$1.10 per mile. For example at 45,000 miles, estimated
maintenance costs would be $49,500 variable (45,000 x
$1.10), and $8,000 fixed.
The High-Low Method
 The high-low method generally produces
a reasonable estimate for analysis.
 However, it does not produce a precise
measurement of the fixed and variable
elements in a mixed cost because other
activity levels are ignored in the
computation.
!
Study Objective 4
State the five components of costvolume-profit analysis.
Cost-Volume Profit Analysis
 Cost-volume-profit (CVP) analysis is the study of the
effects of changes of costs and volume on a company’s
profits.
 CVP analysis involves a consideration of the
interrelationships among the following components:
– Volume or activity level
– Unit selling price
– Variable cost per unit
– Total fixed costs
– Sales mix
CVP Assumptions
The following assumptions underlie each CVP
application: When these assumptions are not valid, the
results of CVP analysis may be inaccurate.
1 The behavior of both costs and revenues is linear
throughout the relevant range of the activity index.
2 All costs can be classified as either variable or fixed
with reasonable accuracy.
3 Changes in activity are the only factors that affect costs.
4 All units produced are sold.
5 When more than one type of product is sold, total sales
will be in a constant sales mix.
CVP Analysis
In CVP analysis applications, the term cost includes
manufacturing costs plus selling and administrative
expenses.
 We will use Vargo Video Company as an example.
Relevant data for the VCRs made by this company are as
follows:
Unit selling price
Unit variable costs
Total monthly fixed costs
$500
$300
$200,000
Illustration 5-10
Study Objective 5
Indicate the meaning of contribution
margin and the ways it may be
expressed.
Contribution Margin
One of the key relationships in CVP analysis is contribution
margin (CM). Contribution margin is the amount of
revenue remaining after deducting variable costs. The
CM is then available to cover fixed costs and to contribute
income for the company.
 For example, assume that Vargo Video sells 1,000 VCRs in
one month, sales are $500,000 (1,000 x $500) and variable
costs are $300,000 (1,000 x $300). Thus, contribution margin
is $200,000, computed as follows:
Sales
$500,000
Illustration 5-11
-
Variable Costs
=
Contribution
Margin
-
$300,000
=
$200,000
Unit Contribution Margin
Views differ as to the best way to express contribution
margin (CM). Some favor a per unit basis.
 At Vargo Video, the contribution margin per unit is
$200.
Illustration 5-12
Unit Selling Price
$500
-
Unit Variable
Cost
=
Contribution
Margin per Unit
-
$300
=
$200
 CM per unit indicates that for every VCR sold, Vargo
Video will have $200 to cover fixed costs and contribute
to income.
Contribution Margin Ratio
Others prefer to use a contribution margin ratio.
 At Vargo Video, the contribution margin ratio is
40%.
Contribution
Margin per Unit
$200
Illustration 5-13

Unit Selling Price
=
Contribution
Margin Ratio

$500
=
40%
 The CM ratio means that 40 cents of each sales dollar
($1 x 40%) is available to apply to fixed costs and to
contribute to income.
Study Objective 6
Identify the three ways that the breakeven point may be determined.
Break-Even Analysis
 The second key relationship in CVP analysis
is the break-even point, which is the level of
activity where total revenues equals total
costs, both fixed and variable.
 Since no income is involved when the breakeven point is the objective, the analysis is
often referred to as break-even analysis.
Break-Even Analysis
 The break-even point can be:
– Computed from a mathematical equation.
– Computed by using contribution margin.
– Derived from a CVP graph.
 The break-even point can be expressed in
either sales dollars or sales units.
Break-Even Analysis:
Mathematical Equation
In its simplest form, the equation for breakeven sales is:
Break-even Sales
=
Variable Costs
+
Fixed Costs
Illustration 5-14
Break-Even Analysis:
Mathematical Equation for Dollars
The break-even point in dollars is found by
expressing variable costs as a percentage of unit
selling price.
 For Vargo Video, the percentage is 60% ($300  $500).
Sales must be $500,000 for Vargo Video to break even.
The computation to determine sales dollars at the
break-even point is:
where:
X = .60X + $200,000
.40X = $200,000
X = $500,000
X = sales dollars at the break-even point
.60 = variable costs as a percentage of unit selling price
$200,000 = total fixed costs
Illustration 5-15
Break-Even Analysis:
Mathematical Equation for Units
The break-even point in units can be computed
directly from the mathematical equation by using
unit selling prices and unit variable costs. Vargo
must sell 1,000 units to break even. The
computation is:
$500X = $300X + $200,000
$200X = $200,000
X = 1,000 units
where:
X = sales volume
$500 = unit selling price
$300 = variable cost per unit
$200,000 = total fixed costs
Illustration 5-16
Break-Even Analysis:
Mathematical Equation Proof
The accuracy of the previous computations can be
proved as follows:
Sales (1,000 x $500)
Total costs:
Variable (1,000 x $300)
Fixed
Net Income
$500,000
$300,000
200,000
500,000
$ -0-
Illustration 5-16
Break-Even Analysis:
CM Technique for Units
Because we know that CM equals total revenues less
variable costs, it follows that at the break-even point,
contribution margin must equal total fixed costs.
When the CM per unit is used, the formula to compute
break-even point in units is shown below:
 Once again, the CM per unit for Vargo Video is $200.
Fixed Costs
$200,000

Contribution
Margin per Unit
=
Break-even Point
in Units

$200
=
1,000
Break-Even Analysis:
CM Technique for Dollars
When the CM ratio is used, the formula to
compute break-even point in dollars is shown
below:
 Again, the CM ratio for Vargo Video is 40%.
Fixed Costs
$200,000

Contribution
Margin Ratio
=
Break-even Point
in Dollars

40%
=
$500,000
Break-Even Analysis:
Graphic Presentation
 An effective way to derive the break-even
point is to prepare a break-even graph.
 The graph is referred to as a cost-volumeprofit (CVP) graph since it shows costs,
volume, and profits.
Break-Even Analysis:
Graphic Presentation
The construction of the graph, using the Vargo Video Company
data, is as follows:
1 Plot the total revenue line starting at the zero activity level.
2 Plot the total fixed cost by a horizontal line.
3 Plot the total cost line starting at the fixed cost line at zero
activity and increasing the amount by the variable cost at each
level of activity.
4 Determine the break-even point from the intersection of the total
cost line and the total revenue line.
In addition to identifying the break-even point, the CVP graph
shows both the net income and net loss areas. Thus, the amount
of income or loss at each level of sales can be derived from the
total sales and total cost lines.
CVP Graph
Sales Line
$900
Profit
Area
700
Break-even Point
Dollars (000)
In the graph to the
right, sales volume
is shown on the
horizontal axis.
This axis needs to
extend to the
maximum level of
expected sales.
Both total revenues
(sales) and total
costs (fixed plus
variable) are
recorded on the
vertical axis.
Total Cost
Line
600
500
400
300
200
100
Fixed Cost
Line
Loss
Area
200 400 600 800 1000 1200 1400 1600 1800
Units of Sales
Illustration 5-20
Study Objective 7
Define margin of safety and give the
formulas for computing it.
Margin of Safety
The margin of safety is another relationship that
may be calculated in CVP analysis. Margin
of safety is the difference between actual or
expected sales and sales at the break-even
point
This relationship measures the “breathing room”
or “cushion” that management has in order to
break even if actual sales fail to materialize.
Margin of Safety
The margin of safety may be expressed in dollars or as a ratio.
 Assuming that actual (expected) sales for Vargo Video are
$750,000, the computations are:
Margin of Safety in Dollars
Actual (Expected)
Sales
$750,000
-
Break-even Sales
=
Margin of Safety
in Dollars
-
$500,000
=
$250,000
=
Margin of Safety
Ratio
=
33%
Margin of Safety Ratio
Margin of Safety
in Dollars

Actual (Expected)
Sales
$250,000

$750,000
Study Objective 8
Give the formulas for determining
sales required to earn target net
income.
Target Net Income
 Management usually sets an income objective
for individual product lines. This objective,
called target net income, is extremely useful to
management because it indicates the sales
necessary to achieve a specified level of income.
 The amount of sales necessary to achieve target
net income can be determined from each of the
approaches used in determining break-even
sales.
Target Net Income:
Mathematical Equation
We know that at the break-even point no profit or loss
results for the company. By adding a factor for target
net income to the break-even equation, we obtain the
formula shown below for determining required sales.
Required
Sales
=
Variable
Costs
+
Fixed
Costs
+
Target
Net
Income
Illustration 5-23
Required sales may be expressed in either sales dollars or
sales units.
Target Net Income:
Mathematical Equation
Assuming the target net income is $120,000 for Vargo Video,
the computation of required sales in dollars is as follows:
where:
X = .60X + $200,000 + $120,000
.40X = $320,000
X = $800,000
X = required sales
.60 = variable costs as a percentage of unit selling price
$200,000 = total fixed costs
$120,000 = target net income
Illustration 5-24
The sales volume in units at the target income level is found
by dividing the sales dollars by the unit selling price.
$800,000  $500 = $1,600
Target Net Income:
CM Technique
As in the case of break-even sales, the sales
required to meet a target net income can be
computed in either dollars or units.
 The formula using the CM ratio for Video Vargo
is as follows:
Required Sales
=
Fixed Costs +
Target Net
Income
$320,000
=
40%

Contribution
Margin Ratio

$800,000
Target Net Income:
Graphic Presentation
 A CVP graph can also be used to derive the
sales required to meet target net income.
 In the profit area of the graph, the distance
between the sales line and the total cost line at
any point equals net income. Required sales
are found by analyzing the differences
between the two lines until the desired net
income is found.
CVP and Changes in the
Business Environment
 Business conditions change rapidly and management
must respond intelligently to these changes.
 CVP analysis can be used in responding to change.
 The original VCR sales and cost data for Vargo Video
Company are shown below.
Unit selling price
Unit variable cost
Total fixed costs
Break-even sales
$
500
$
300
$ 200,000
$ 500,000
or 1,000 units
Illustration 5-26
CVP and Changes in the
Business Environment: Case I
 A competitor is offering a 10% discount on the selling price of its
VCRs. Management must decide whether or not to offer a similar
discount.
 Question: What effect will a 10% discount on selling price have on
the break-even point for VCRs?
 Answer: A 10% discount on selling price reduces the selling price
per unit to $450 [$500 – ($500 x 10%)]. Variable cost per unit
remains unchanged at $300. Therefore, the contribution margin per
unit is $150. Assuming no change in fixed costs, break-even sales
are 1,333 units, calculated as follows:
Fixed Costs
÷
Contribution Margin per Unit
=
Break-even Sales
$ 200,000
÷
$ 150
=
1,333 units (rounded)
Illustration 5-27
CVP and Changes in the
Business Environment: Case II
 Management invests in new robotic equipment that will significantly
lower the amount of direct labor required to make the VCRs. It is
estimated that total fixed costs will increase 30% and that variable
cost per unit will decrease 30%.
 Question: What effect will the new equipment have on the sales
volume required to break even?
 Answer: Total fixed costs become $260,000 [$200,000 + ($200,000
x 30%)], and variable cost per unit is now $210 [$300 – ($300,000 x
30%)]. The new break-even point about 900 units, calculated as
follows:
Fixed Costs
÷
Contribution Margin per Unit
=
Break-even Sales
$ 260,000
÷
($500 - $210)
=
900 units (rounded)
Illustration 5-28
CVP and Changes in the
Business Environment: Case III
 An increase in the price of raw materials will increase the unit variable cost of
VCRs by an estimated $25. Management is striving to hold the line on the
selling price of the VCRs, and plans a cost-cutting program that will save
$17,500 in fixed costs per month. Vargo Video Company is currently realizing
monthly net income of $80,000 on sales of 1,400 VCRs.
 Question: What increase in sales will be needed to to maintain the same level
of net income?
 Answer: The variable cost per unit increases to $325 ($300 + $25), and fixed
costs are reduced to $182,500 ($200,000 – $17,500). Because of the change in
variable cost, the variable cost becomes 65% of sales ($325 ÷ $500). Using the
equation for target net income, required sales are calculated to be $750,000, as
follows:
Required Sales = Variable Costs + Fixed Costs + Target Net Income
X = .65X + $182,500 + $80,000
.35X = $262,500
X = $750,000
Illustration 5-29
Study Objective 9
Describe the essential features of a
cost-volume-profit income statement.
CVP Income Statement
 The CVP income statement classifies costs
and expenses as variable or fixed and
specifically reports contribution margin in the
body of the statement.
 The CVP income statement format is
sometimes called the contribution margin
format.
 This format is for internal management use
only.
CVP Income Statement
 For purposes of illustrating the CVP income
statement, assume that Vargo Video Company
reaches its target net income of $120,000. From an
analysis of the transactions, the following
information is obtained on the $680,000 of costs
that were incurred in June:
Cost of goods sold
Selling expenses
Administrative expenses
Variable
Fixed
Total
$ 400,000
60,000
20,000
$ 120,000
40,000
40,000
$ 520,000
100,000
60,000
$ 480,000
$ 200,000
$ 680,000
Illustration 5-30
Traditional versus CVP
Income Statement
 The CVP income statement and the traditional
income statement based on this data are shown
side-by-side on the next slide.
 Note that net income is the same ($120,000) in
both of the statements.
 The major difference is the format for the
expenses.
 Also, the traditional statement shows gross profit,
whereas the CVP statement shows contribution
margin.
Traditional versus CVP
Income Statement
VARGO VIDEO COMPANY
Income Statement
For the Month Ended June 30, 1999
Traditional Format
Sales
$ 800,000
Cost of goods sold
520,000
Gross profit
280,000
Operating expenses
Selling expenses
$ 100,000
Administrative expenses
60,000
Total operating expenses
160,000
Net income
$ 120,000
CVP Format
Sales
$ 800,000
Variable expenses
Cost of goods sold
$ 400,000
Selling expenses
60,000
Administrative expenses 20,000
Total variable expenses
480,000
320,000
Contribution margin
Fixed expenses
Cost of goods sold
120,000
Selling expenses
40,000
Administrative expenses 40,000
Total fixed expenses
200,000
Net income
$ 120,000
Illustration 5-31
Appendix 5A
Variable Costing
Appendix 5A
Study Objective 10
Explain the difference between
absorption costing and variable
costing.
Absorption versus Variable
Costing
 All manufacturing costs are charged to and absorbed by
the product under full or absorption costing. This is how
costs were handled in previous chapters.
 Under variable costing only direct materials, direct labor,
and variable manufacturing overhead costs are considered
product costs. Fixed manufacturing overhead costs are
recognized as period costs when incurred.
 The difference between absorption costing and variable
costing is graphically shown below.
Absorption Costing
Product Cost
Fixed
Manufacturing
Overhead
Variable Costing
Period Cost
Illustration 5A-1
Absorption versus Variable
Costing: An Illustration
 As an illustration, Premium Products Corporation manufactures
a polyurethane sealant called Fix-it for car windshields.
Relevant data for Fix-it in January 1996, the first month of
production, is as follows:
– Selling Price: $20 per unit.
– Units: Produced 30,000; sold 20,000; beginning inventory
zero.
– Variable unit costs: Manufacturing $9 (direct materials $5,
direct labor $3, and variable overhead $1) and selling and
administrative expenses $2.
– Fixed costs: Manufacturing overhead $120,000, and selling
and administrative expenses $15,000.
Absorption versus Variable
Costing: Unit Production Cost
 The per unit production cost under each costing
approach is:
Absorption
Type of Cost
Costing
$ 5
Direct materials
3
Direct labor
1
Variable manufacturing overhead
4
Fixed manufacturing overhead ($120,000 ÷ 30,000 units produced)
Total unit cost
$ 13
Variable
Costing
$ 5
3
1
0
$ 9
Illustration 5A-2
 The difference in total unit cost of $4 ($13 - $9)
occurs because fixed manufacturing costs are a
product cost under absorption costing and a
period cost under variable costing.
Absorption versus Variable
Costing: Effects on Income
 The income statements under the two costing
approaches are shown on the next two slides.
 Income from operations under absorption costing is
$40,000 higher than under variable costing ($85,000
– $45,000). There is a $40,000 difference in the
ending inventories ($130,000 under absorption
costing and $90,000 under variable costing).
 Under absorption costing, $40,000 of the fixed
overhead costs have been deferred to a future
period as a product cost.
Absorption Costing Income
Statement
PREMIUM PRODUCTS COMPANY
Income Statement
For the Month Ended January 31, 1999
(Absorption Costing)
Sales (20,000 units X $20)
Cost of goods sold
Inventory, January 1
Cost of goods manufactured (30,000 units X $13)
Cost of goods available for sale
Inventory, January 31 (10,000 units X $13)
Cost of goods sold (20,000 units X $13)
Gross profit
Selling and administrative expenses
(Variable 20,000 units X $2 + fixed $15,000)
Income from operations
$ 400,000
$
–0–
390,000
390,000
130,000
260,000
140,000
55,000
$ 85,000
Illustration 5A-3
Variable Costing Income
Statement
PREMIUM PRODUCTS COMPANY
Income Statement
For the Month Ended January 31, 1999
(Variable Costing)
Sales (20,000 units X $20)
Variable expenses
Variable cost of goods sold
Inventory, January 1
Variable manufacturing costs (30,000 units X $9)
Cost of goods available for sale
Inventory, January 31 (10,000 units X $9)
Variable cost of goods sold
Variable selling and administrative expenses
(20,000 units X $2)
Total variable expenses
Contribution margin
Fixed expenses
Manufacturing overhead
Selling and administrative expenses
Total fixed expenses
Income from operations
$ 400,000
–0–
270,000
270,000
90,000
180,000
40,000
220,000
180,000
120,000
15,000
135,000
$ 45,000
Illustration
5A-4
Summary of Income Effects
Circumstances
Income Under
Absorption Costing
Variable Costing
=
Units Produced = Units Sold
>
Units Produced > Units Sold
<
Units Produced < Units Sold
Illustration 5A-5
Rationale for Variable
Costing
 The rationale for variable costing focuses on the
purpose of fixed manufacturing costs, which is
to have productive facilities available for use.
 Defenders of absorption costing justify the
assignment of fixed manufacturing overhead
costs to inventory on the basis that these costs are
as much a cost of getting a product ready for sale
as direct materials or direct labor.
 The use of variable costing in product costing is
acceptable only for internal use by management.
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Chapter 5
Cost-Volume-Profit Relationships