Bkbm chap 2

©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 1

Introduction to Management Introduction to Management AccountingAccounting

Introduction to Introduction to Cost Behavior and Cost Behavior and

Cost-Volume Cost-Volume RelationshipsRelationships

Chapter 2Chapter 2


Cost Drivers and Cost Cost Drivers and Cost BehaviorBehavior

Traditional View of Cost Traditional View of Cost BehaviorBehavior

Activity-Based View of Cost Activity-Based View of Cost BehaviorBehavior

Resource AResource ACost Driver = Cost Driver =

Units of Units of ResourceResourceOutputOutput

Resource BResource BCost Driver = Cost Driver =


Activity AActivity ACost Driver = Cost Driver =

Units of Units of Activity OutputActivity Output

Activity BActivity BCost Driver = Cost Driver =

Units of Units of Activity OutputActivity Output

Resource BResource BCost Driver = Cost Driver =


Resource AResource ACost Driver = Cost Driver =


Product or ServiceProduct or ServiceCost Driver = Units of FinalCost Driver = Units of Final

Product or ServiceProduct or Service

Product or ServiceProduct or ServiceCost Driver = Output of FinalCost Driver = Output of Final

Product or ServiceProduct or Service

LearningLearningObjective 1Objective 1


Cost Drivers and Cost Behavior Cost Drivers and Cost Behavior

Cost behavior is how the activities Cost behavior is how the activities of an organization affect its costs.of an organization affect its costs.

Any output measure that causesAny output measure that causesthe use of costly resourcesthe use of costly resources

is a cost driver.is a cost driver.


Value Chain Functions, Costs, and Cost Value Chain Functions, Costs, and Cost DriversDrivers

Value Chain Function and Example CostsValue Chain Function and Example Costs Example Cost Example Cost DriversDriversResearch 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



Value Chain Function and Example CostsValue Chain Function and Example Costs Example Cost Example Cost DriversDriversProduction•Labor wages Labor hours •Supervisory salaries Number of people supervised•Maintenance wages Number of mechanic hours•Depreciation of plant and machinery Number of machine hours suppliesEnergy cost Kilowatt hours

Marketing•Cost of advertisements Number of advertisements•Salaries of marketing personnel, Sales dollars travel costs, entertainment costs



Value chain function and Example costsValue chain function and Example costs Example Example Cost DriversCost Drivers Distribution•Wages of shipping personnel Labor hours•Transportation costs including Weight of items delivered depreciation of vehicles and fuel

Customer service•Salaries of service personnel Hours spent servicing products•Costs of supplies, travel Number of service calls


Variable and Fixed Cost Variable and Fixed Cost BehaviorBehavior

A A variable costvariable cost changes in direct changes in direct

proportion to changes proportion to changes in the cost-driver level.in the cost-driver level.

A A fixed costfixed cost is is not immediately not immediately

affected by changes affected by changes in the cost-driver.in the cost-driver.

Think of variable Think of variable costs on a per-unit basis.costs on a per-unit basis.

The per-unit variable The per-unit variable cost remains unchanged cost remains unchanged regardless of changes in regardless of changes in

the cost-driver.the cost-driver.

Think of fixed costs Think of fixed costs on a total-cost basis.on a total-cost basis.

Total fixed costs remain Total fixed costs remain unchanged regardless of unchanged regardless of

changes in the cost-driver.changes in the cost-driver.



Relevant RangeRelevant Range

The relevant range is the limitThe relevant range is the limitof cost-driver activity level within which aof cost-driver activity level within which a

specific relationship between costsspecific relationship between costsand the cost driver is valid.and the cost driver is valid.

Even within the relevant range, a fixed Even within the relevant range, a fixed cost remains fixed only over a given cost remains fixed only over a given

period of time Usually the budget period.period of time Usually the budget period.


Fixed Costs and Relevant RangeFixed Costs and Relevant Range

20 40 60 80 10020 40 60 80 100

$115,000$115,000 100,000100,000

60,00060,000

Total Cost-Driver Activity in Thousands Total Cost-Driver Activity in Thousands of Cases per Monthof Cases per Month

Tota

l Mon

thly

Fix

ed

Tota

l Mon

thly

Fix

ed

Cost

sCo

sts

Relevant rangeRelevant range$115,000$115,000 100,000100,000

60,00060,000

20 40 60 80 10020 40 60 80 100


CVP ScenarioCVP Scenario

Per Unit Percentage of Per Unit Percentage of Sales Sales Selling priceSelling price $1.50 $1.50 100%100%Variable cost of each itemVariable cost of each item 1.20 1.20 8080Selling price less variable costSelling price less variable cost $ .30 $ .30 20%20%

Monthly fixed expenses:Monthly fixed expenses: RentRent $3,000 $3,000 Wages for replenishing andWages for replenishing and servicingservicing 13,500 13,500 Other fixed expenses Other fixed expenses 1,500 1,500Total fixed expenses per month $ 18,000Total fixed expenses per month $ 18,000

Cost-volume-profit (CVP) analysis is the study of the effects of output Cost-volume-profit (CVP) analysis is the study of the effects of output volume on revenue (sales), expenses (costs), and net income (net profit).volume on revenue (sales), expenses (costs), and net income (net profit).


Break-Even PointBreak-Even Point

The break-even point is the level of sales at which The break-even point is the level of sales at which revenue equals expenses and net income is zero.revenue equals expenses and net income is zero.

Sales Sales - Variable expenses- Variable expenses- Fixed expenses- Fixed expensesZero net income (break-even point)Zero net income (break-even point)



Contribution Margin MethodContribution Margin Method

$18,000 fixed costs ÷ $.30$18,000 fixed costs ÷ $.30= 60,000 units (break even)= 60,000 units (break even)

Contribution marginContribution margin Per UnitPer Unit

Selling priceSelling price $1.50 $1.50 Variable costsVariable costs 1.20 1.20 Contribution marginContribution margin $ .30 $ .30

Contribution margin ratioContribution margin ratioPer UnitPer Unit % %

Selling priceSelling price 100 100 Variable costsVariable costs .80 .80 Contribution marginContribution margin .20 .20


Contribution Margin MethodContribution Margin Method

$18,000 fixed costs$18,000 fixed costs÷ 20% (contribution-margin percentage)÷ 20% (contribution-margin percentage)

= $90,000 of sales to break even= $90,000 of sales to break even

60,000 units × $1.50 = $90,00060,000 units × $1.50 = $90,000in sales to break evenin sales to break even


Equation MethodEquation Method

Sales – variable expenses – fixed expenses = net incomeSales – variable expenses – fixed expenses = net income$1.50N – $1.20N – $18,000 = 0$1.50N – $1.20N – $18,000 = 0

$.30N = $18,000$.30N = $18,000N = $18,000 ÷ $.30N = $18,000 ÷ $.30N = 60,000 UnitsN = 60,000 Units

Let N = number of unitsLet N = number of unitsto be sold to break even.to be sold to break even.


Equation MethodEquation Method

S – .80S – $18,000 = 0S – .80S – $18,000 = 0.20S = $18,000.20S = $18,000

S = $18,000 ÷ .20S = $18,000 ÷ .20S = $90,000S = $90,000

Let S = sales in dollarsLet S = sales in dollarsneeded to break even.needed to break even.

Shortcut formulas:Shortcut formulas:Break-even volume in units = Break-even volume in units = fixed expensesfixed expenses unit contribution marginunit contribution margin

Break-even volume in sales = Break-even volume in sales = fixed expensesfixed expenses contribution margin ratio contribution margin ratio


Cost-Volume-Profit Graph

18,000 30,000

90,000

120,000 138,000

$150,000

0 10 20 30 40 50 60 70 80 90 100

Units (thousands)

Dol

lar

s

60,000 Total

Expenses

SalesNet Income

Area

Break-Even Point 60,000 units or

$90,000Net Loss Area

A

C

D

BFixed

Expenses

Variable Expense

s

Net Income



Target Net ProfitTarget Net Profit

Managers use CVP analysis Managers use CVP analysis to determine the total sales, to determine the total sales, in units and dollars, needed in units and dollars, needed To reach a target net profit.To reach a target net profit.

Target sales Target sales – – variable expenses variable expenses

– – fixed expenses fixed expenses target net incometarget net income

$1,440 per month $1,440 per month is the minimumis the minimum

acceptable net income.acceptable net income.



Target sales volume in units =Target sales volume in units =(Fixed expenses + Target net income)(Fixed expenses + Target net income)

÷ Contribution margin per unit÷ Contribution margin per unit

($18,000 + $1,440) ÷ $.30 = 64,800 units($18,000 + $1,440) ÷ $.30 = 64,800 units


Selling priceSelling price $1.50 $1.50 Variable costsVariable costs 1.20 1.20 Contribution margin per unitContribution margin per unit $ .30 $ .30

Target sales dollars = sales price X sales volume in unitsTarget sales dollars = sales price X sales volume in unitsTarget sales dollars = $1.50 X 64,800 units = $97,200.Target sales dollars = $1.50 X 64,800 units = $97,200.


Sales volume in dollars = Sales volume in dollars = 18,000 + $1,44018,000 + $1,440 = $97,200 = $97,200 .20.20


Target sales volume in dollars = Target sales volume in dollars = Fixed expenses + target net incomeFixed expenses + target net incomecontribution margin ratiocontribution margin ratio

Contribution margin ratioContribution margin ratioPer UnitPer Unit % %

Selling priceSelling price 100 100 Variable costsVariable costs .80 .80 Contribution marginContribution margin .20 .20


Operating LeverageOperating Leverage

Operating leverage: a firm’s ratio of fixed costs to variable costs. Operating leverage: a firm’s ratio of fixed costs to variable costs.

Margin of safety = planned unit sales – break-even sales Margin of safety = planned unit sales – break-even sales How far can sales fall below the planned level before losses occur?How far can sales fall below the planned level before losses occur?

Highly leveraged firms have high fixed costs and low 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.A small change in sales volume = a large change in net income.

Low leveraged firms have lower fixed costs and higher variable costs. Low leveraged firms have lower fixed costs and higher variable costs. Changes in sales volume will have a smaller effect on net income.Changes in sales volume will have a smaller effect on net income.


Contribution MarginContribution Marginand Gross Marginand Gross Margin

Sales price – Cost of goods sold = Gross marginSales price – Cost of goods sold = Gross margin

Sales price - all variable expenses = Contribution marginSales price - all variable expenses = Contribution margin

Per UnitPer UnitSelling priceSelling price $1.50$1.50Variable costs (acquisition cost)Variable costs (acquisition cost) 1.20 1.20Contribution margin and Contribution margin and gross margin are equalgross margin are equal $ .30$ .30



Contribution Margin and Gross Contribution Margin and Gross MarginMargin

Contribution Gross Contribution Gross Margin MarginMargin Margin Per UnitPer Unit Per Unit Per Unit

SalesSales $1.50$1.50 $1.50 $1.50 Acquisition cost of unit soldAcquisition cost of unit sold 1.201.20 1.20 1.20 Variable commissionVariable commission .12 .12Total variable expense Total variable expense $1.32$1.32Contribution marginContribution margin .18 .18 Gross marginGross margin $.30 $.30

Suppose the firm had to pay a commission of $.12Suppose the firm had to pay a commission of $.12 per unit sold. per unit sold.


Nonprofit ApplicationNonprofit Application

Suppose a city has a $100,000Suppose a city has a $100,000lump-sum budget appropriationlump-sum budget appropriation

to conduct a counseling program.to conduct a counseling program.

Variable costs per prescriptionVariable costs per prescriptionis $400 per patient per day.is $400 per patient per day.

Fixed costs are $60,000 in theFixed costs are $60,000 in therelevant range of 50 to 150 patients.relevant range of 50 to 150 patients.


If the city spends the entire budgetIf the city spends the entire budgetappropriation, how many patientsappropriation, how many patients

can it serve in a year?can it serve in a year?

$100,000 = $400N + $60,000$100,000 = $400N + $60,000$400N = $100,000 – $60,000$400N = $100,000 – $60,000

N = $40,000 ÷ $400N = $40,000 ÷ $400N = 100 patientsN = 100 patients




If the city cuts the total budgetIf the city cuts the total budgetAppropriation by 10%, how many Appropriation by 10%, how many

Patients can it serve in a year?Patients can it serve in a year?

$90,000 = $400N + $60,000$90,000 = $400N + $60,000$400N = $90,000 – $60,000$400N = $90,000 – $60,000

N = $30,000 ÷ $400N = $30,000 ÷ $400N = 75 patientsN = 75 patients

Budget after 10% CutBudget after 10% Cut$100,000 X (1 - .1) = $90,000$100,000 X (1 - .1) = $90,000


Sales Mix AnalysisSales Mix Analysis

Sales mix is the relative proportions orSales mix is the relative proportions orcombinations of quantities of productscombinations of quantities of products

that comprise total sales.that comprise total sales.




Ramos Company ExampleRamos Company Example

Sales in unitsSales in units 300,000300,000 75,000 75,000 375,000 375,000Sales @ $8 and $5Sales @ $8 and $5 $2,400,000 $2,400,000$375,000$375,000 $2,775,000$2,775,000Variable expensesVariable expenses @ $7 and $3@ $7 and $3 2,100,000 2,100,000 225,000 225,000 2,325,000 2,325,000 Contribution marginsContribution margins @ $1 and $2@ $1 and $2 $ 300,000$ 300,000$150,000$150,000 $ 450,000$ 450,000Fixed expensesFixed expenses 180,000 180,000 Net incomeNet income $ 270,000 $ 270,000

WalletsWallets(W)(W)

Key CasesKey Cases(K)(K) TotalTotal



Break-even point for a constant sales mix Break-even point for a constant sales mix of 4 units of W for every unit of K.of 4 units of W for every unit of K.

sales – variable expenses - fixed expenses = zero net incomesales – variable expenses - fixed expenses = zero net income[$8(4K) + $5(K)] – [$7(4K) + $3(K)] – $180,000 = 0 [$8(4K) + $5(K)] – [$7(4K) + $3(K)] – $180,000 = 0

32K + 5K - 28K - 3K - 180,000 = 032K + 5K - 28K - 3K - 180,000 = 06K = 180,000 6K = 180,000

K = 30,000K = 30,000W = 4K = 120,000 W = 4K = 120,000

Let K = number of units of K to break even, andLet K = number of units of K to break even, and4K = number of units of W to break even.4K = number of units of W to break even.



If the company sells only key cases:If the company sells only key cases:break-even point = break-even point = fixed expensesfixed expenses

contribution margin per unitcontribution margin per unit = = $$180,000180,000

$2$2 = 90,000 key cases = 90,000 key cases

If the company sells only wallets:If the company sells only wallets:break-even point = break-even point = fixed expensesfixed expenses

contribution margin per unitcontribution margin per unit = = $$180,000180,000

$1$1 = 180,000 wallets = 180,000 wallets



Suppose total sales Suppose total sales were equal to the were equal to the

budget of 375,000 units.budget of 375,000 units.

However, Ramos sold However, Ramos sold only 50,000 key casesonly 50,000 key casesAnd 325,000 wallets.And 325,000 wallets.What is net income?What is net income?



Ramos Company ExampleRamos Company Example

Sales in unitsSales in units 325,000 50,000 325,000 50,000 375,000 375,000 Sales @ $8 and $5Sales @ $8 and $5 $2,600,000 $2,600,000 $250,000 $250,000 $2,850,000 $2,850,000 Variable expensesVariable expenses @ $7 and $3@ $7 and $3 2,275,000 2,275,000 150,000 150,000 2,425,000 2,425,000 Contribution marginsContribution margins @ $1 and $2@ $1 and $2 $ 325,000 $ 325,000 $100,000 $100,000 $ 425,000 $ 425,000 Fixed expensesFixed expenses 180,000 180,000 Net incomeNet income $ 245,000 $ 245,000

WalletsWallets(W)(W)

Key CasesKey Cases(K)(K) TotalTotal


Impact of Income TaxesImpact of Income Taxes

Suppose that a company earnsSuppose that a company earns$480 before taxes and pays$480 before taxes and paysincome tax at a rate of 40%.income tax at a rate of 40%.

What is the after-tax income?What is the after-tax income?




Target income before taxes = Target income before taxes = Target after-tax net incomeTarget after-tax net income 1 – tax rate1 – tax rate

Target income before taxes = Target income before taxes = $ 288 $ 288 = $480 = $480 1 – 0.40 1 – 0.40

Suppose the target net incomeSuppose the target net incomeafter taxes was $288.after taxes was $288.



Target sales – Variable expenses – Fixed expensesTarget sales – Variable expenses – Fixed expenses= Target after-tax net income ÷ (1 – tax rate)= Target after-tax net income ÷ (1 – tax rate)

$.50N – $.40N – $6,000 = $288 ÷ (1 – 0.40)$.50N – $.40N – $6,000 = $288 ÷ (1 – 0.40)$.10N = $6,000 + ($288/.6)$.10N = $6,000 + ($288/.6)

$.06N = $3,600 + $288 = $3,888 $.06N = $3,600 + $288 = $3,888 N = $3,888/$.06 N = $3,888/$.06 N = 64,800 unitsN = 64,800 units



Suppose target net income after taxes was $480Suppose target net income after taxes was $480

$.50N – $.40N – $6,000 = $480 ÷ (1 – 0.40)$.50N – $.40N – $6,000 = $480 ÷ (1 – 0.40)$.10N = $6,000 + ($480/.6) $.10N = $6,000 + ($480/.6)

$.06N = $3,600 + $480 = $4080$.06N = $3,600 + $480 = $4080N = $4,080 ÷ $.06 N = $4,080 ÷ $.06 N = 68,000 unitsN = 68,000 units


End of Chapter 2End of Chapter 2

The EndThe End

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