CHAPTER 12
MANAGERIAL ACCOUNTING
AND COST-VOLUMEPROFIT RELATIONSHIPS
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Learning Objectives
1. What is the managerial planning and
control cycle?
2. What are the major differences
between financial accounting and
managerial accounting?
3. What is the difference between
variable and fixed cost behavior
patterns, and what simplifying
assumptions are made in this
classification method?
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Learning Objectives
4. Why are fixed costs expressed on a per
unit of activity basis misleading, and why
may this result in faulty decisions?
5. What kinds of costs are likely to have a
variable cost behavior pattern, and what
kinds of costs are likely to have a fixed
costs behavior pattern?
6. How can the high-low method be used to
determine the cost formula for a cost that
has a mixed behavior pattern?
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Learning Objectives
7. What is the difference between the
traditional income statement format
and the contribution statement
format?
8. What is the importance of using the
contribution margin format to analyze
the impact of cost and sales volume
changes on operating income?
9. How is the contribution margin ratio
calculated, and how can it be used in
CVP analysis?
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Learning Objectives
10. How can changes in sales mix affect
the projections using CVP analysis?
11. What are the meaning and
significance of the break-even point,
and how is the break-even point
calculated?
12. What is the concept of operating
leverage?
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Learning Objective 1
• What is the managerial
planning and control cycle?
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Managerial Accounting
Contrasted to Financial
Accounting
• Managerial accounting supports the
internal planning decision made by
management
• Financial accounting has more of a
score-keeping, historical orientation
• Planning is a key part of the
management process
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Strategic,
Operational, and
Financial Planning
Implement Plans
Planning and Control Cycle
Performance
Analysis:
Plans vs.
Actual Results
(Controlling)
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Data Collection and
Performance Feedback
Executing
Operational
Activities
(Managing)
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Planning and Control
• The management process consists of
planning, organizing, and controlling an
entity’s activities
• Control provides feedback in which
actual results are compared to planned
results, and if a variance exists, the plan
or actions or both are changed
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Learning Objective 2
• What are the major differences
between financial accounting
and managerial accounting?
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Managerial Accounting
• Emphasis is on the future
• Concerned with units within the
organization
• Reports issued frequently and promptly
• Relevance more important than reliability
• No reporting standards
• Intended to management’s use
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Financial Accounting
• Intended for external investors and creditors
• Deals with the past – historical
• Reports are prepared for the company as a
whole
• Reports are issued monthly – a week or more
after the end of the month
• High accuracy is desired
• Generally Accepted Accounting Standards are
used for reports
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The Management Accountant
• Works extensively with people in other
functions of the organization
• Helps develop production standards
• Helps production people interpret
production reports
• Helps marketing and sales predict future
sales
• Aids in the information system development
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Learning Objective 3
• What is the difference between
variable and fixed cost behavior
patterns, and what simplifying
assumptions are made in this
classification method?
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Cost Classifications
• Different costs for different purposes:
–Relationship between total cost and volume
of activity
–Relationship to product or activity
–For cost accounting purposes
–Time frame perspective
–Other analytical purposes
• These classifications are not mutually
exclusive
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Relationship of Total Cost
to Volume of Activity
• The relationship of total cost to volume of
activity describes the cost behavior pattern
• A variable cost changes in TOTAL as the
volume of activity changes
• A fixed cost does NOT change in TOTAL as the
volume of activity changes
• Variable cost example is raw materials
• Fixed cost example is depreciation
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Graphical Representation
Variable costs
Total activity
(units)
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Fixed costs
Total activity
(units)
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Semivariable Costs
• Some costs have components of both
fixed and variable costs
• A cost formula for such a cost is:
Total cost = Fixed cost + Variable cost
or
Total cost = Fixed cost + (Variable rate per
unit X Activity)
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Learning Objective 4
• Why are fixed costs expressed
on a per unit of activity basis
misleading, and why may this
result in faulty decisions?
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Fixed Cost Unitization
• Do NOT unitize fixed expenses
because they do not behave on a per
unit basis
• Dividing fixed expenses by activity
level will give varying results
depending on the activity level
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Learning Objective 5
• What kinds of costs are likely to
have a variable cost behavior
pattern, and what kinds of costs
are likely to have a fixed cost
behavior pattern?
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Cost Behavior Pattern
• Two assumptions made in determining cost
behavior patterns:
– The behavior pattern is true only within a
relevant range
– The behavior pattern is assumed to be linear in
the relevant range
• The relevant range is the level of activity over
which a particular pattern exists
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Learning Objective 6
• How can the high-low method
be used to determine the cost
formula for a cost that has a
mixed behavior pattern?
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The High-Low Method
• A cost behavior pattern can be analyzed
using a technique that employs a
scattergram to identify high and low costvolume data
• A scattergram is a graph with total units
produced as the horizontal axis and cost
as the vertical axis
• Points are plotted on the graph for various
production levels and costs
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Steps in Using the HighLow Method
1. Identify the high and low cost-volume
points
2. Compute the variable rate by using the
following formula:
Variable rate =
High cost – Low cost
High activity – Low activity
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Steps in Using the High-Low
Method
3. Compute the fixed rate by using the
following formula and inserting the
variable rate computed above and
either the high activity level or the low
activity level
Total cost = Fixed cost + Variable cost
Total cost = Fixed cost + (Activity level
x Variable rate)
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Learning Objective 7
• What is the difference between
the traditional income statement
format and the contribution
statement format?
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Modified Income
Statement Format
• Referred to as the contribution margin
format
• Classifies costs according to their
behavior
• Revenues and operating income are the
same as under the traditional format of
revenues minus cost of goods sold, etc.
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Contribution Margin Format
•
Revenues
- Variable expenses
= Contribution margin
- Fixed expenses
= Operating income
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XX
XX
XX
XX
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Learning Objective 8
• What is the importance of using
the contribution margin format to
analyze the impact of cost and
sales volume changes on
operating income?
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Contribution Margin
• Contribution margin is the amount that is
available to cover fixed expenses and
operating income
• The traditional approach does not consider
cost behavior patterns
• The contribution margin approach avoids
the errors that may result from viewing
fixed costs on a per unit approach
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Learning Objective 9
• How is the contribution
margin ratio calculated, and
how can it be used in CVP
analysis?
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Contribution Margin Ratio
• Contribution margin ratio is the ratio
of contribution margin to revenues
• Using either total dollars or dollars
per unit, divide the contribution
margin by the revenue
• The result is a percentage
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Contribution Margin
Model
Per unit X Volume = Total
Revenue
$XX
Variable expenses
XX
Contribution margin $XX
Fixed expenses
Operating income
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x
XX
%
= $XX X%
XX
$XX
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Using the Contribution
Margin Model
• Steps in using the model are as follows:
–Express revenue, variable expense, and
contribution on a per unit basis
–Multiply the contribution per unit by the
volume to get the total contribution margin
–Subtract fixed expenses from the total
contribution margin to get operating income
(Fixed expenses are NOT unitized!)
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Contribution Margin in Action
• Four relationships to notice as you study:
–Revenue - Variable expenses =
Contribution margin
–Contribution margin / Revenue =
Contribution margin ratio
–Total contribution margin depends on the
volume of activity
–Contribution margin must cover fixed
expenses before an operating income is
earned
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Learning Objective 10
• How can changes in sales
mix affect the projections
using CVP analysis?
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Multiple Products and Sales
Mix Considerations
• When using the contribution margin
model with more than one product, the
sales mix must be considered
• Sales mix is the relative proportion of total
sales accounted for by different products
• Different products usually have different
contribution margins
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Learning Objective 11
• What are the meaning and
significance of the break-even
point, and how is the breakeven point calculated?
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Break-Even Point Analysis
• Break-even point is usually expressed as
the amount of revenue that must be
realized in order to have neither a profit
nor a loss
• Expresses minimum target revenue
• Use the contribution margin model to
determine the break-even point by setting
operating income to zero
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Break-Even Point Formulas
• Total revenues at break-even =
•
Fixed expenses
Contribution margin ratio
• Volume in units at bread-even =
Fixed expenses
Contribution margin per unit
• Volume in units at break-even =
Total revenues required
Revenue per unit
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Target Operating Income
• The revenues and units necessary may be
determined as follows:
• Total revenues for desired level of operating
income =
• Fixed expenses + Desired operating income
Contribution margin ratio
• Volume in units for desired level of operating
income =
• Fixed expenses + Desired operating income
Contribution margin per unit
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Break-Even Graph
Total revenues
Break-even point
Profit
Total expenses
Variable expenses
Loss
Fixed expense
Sales volume in units
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Learning Objective 12
• What is the concept of
operating leverage?
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Operating Leverage
• Operating income will change
proportionately more than changes in
revenues because fixed expenses do not
change with changes in volume
• This magnification effect on operating
income due to a change in revenues is
called operating leverage
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Operating Leverage Effects
• The higher a firm’s contribution margin
ratio, the greater its operating leverage
• High operating leverage increases the
risk that a small percentage decline in
revenues will cause a large percentage
decline in operating income
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