© 2007 Pearson Education Canada Slide 2-1
Cost Behaviourand Cost-Volume
Relationships
2
© 2007 Pearson Education Canada Slide 2-2
Cost Behaviour
Cost Driver• an activity which influences how a cost is incurred• kilometers traveled is a cost driver for gasoline costs
Volume
Volume
$
$
Variable Cost• a cost which changes in direct proportion
to changes in the cost driver• is constant per unit as volume changes
Fixed Cost• a cost which is not influenced by changes
in the cost driver over the relevant range• per unit fixed costs change as volume
changes
© 2007 Pearson Education Canada Slide 2-3
Cost-Volume-Profit Analysis
• the study of the relationships between revenues, costs, volume and profits
Contribution Margin per unit Contribution Margin %
(or CM per unit) (or CM%)= Revenue per unit = CM per unit / revenue per
unit- variable cost per unit = $0.10 / $0.50
= $0.50 - $0.40 = 20%= $0.10 per unit
Break-Even Point in Units Break-Even Point in Dollars= Fixed costs / CM per unit = Fixed costs / CM%= $6,000 / $0.10 = $6,000 / 20%= 60,000 units = $30,000
© 2007 Pearson Education Canada Slide 2-4
Cost-Volume-Profit Graph
Sales
Total Expenses
Relevant Rangeof volume
Volume
$ Break-evenPoint
Net lossarea
Net incomearea
© 2007 Pearson Education Canada Slide 2-5
Changes in Model Factors
$
Volume
Sales
Expenses
Basic Model
$
Volume
Sales
Expenses
Decrease Variable Costs
$
Volume
Sales
Expenses
Increase Fixed Costs
$
Volume
Sales
Expenses
Decrease Fixed Costs
© 2007 Pearson Education Canada Slide 2-6
Target Net Income and Income Taxes
Target Sales in Units Target Sales in Dollars= (Fixed costs + Target income) = (Fixed costs + Target income) / CM per unit / CM%= ($6,000 + $480) / $0.10 = ($6,000 + $480) / 20%= 64,800 units = $32,400
Income Taxes• note that income taxes are neither a variable nor a fixed cost• convert desired after-tax net income to its before-tax equivalent before
adding into the target sales formula
Target income before income taxes= Target after-tax net income / (1 - tax rate)= $288 / (1 - .40)= $288 / .6= $480
© 2007 Pearson Education Canada Slide 2-7
Sales Mix Analysis
• Sales mix is defined as the relative proportions or combinations of quantities of different products that comprise total sales
• If the proportions of the mix change, the cost-volume-profit relationships also change
• A breakeven point is unique to a given sales mix
© 2007 Pearson Education Canada Slide 2-8
Cost-Volume-Profit AnalysisMultiple Product Situations
Sales Mix in units
• relative mix based on the # of units sold
• A = 40%; B = 60%
Sales Mix in dollars
• relative mix based on the $ value of sales
• A = 25%; B = 75%
Average contribution margin per unit= ($CM A x SM% units A ) + ($CM B x SM% units B )
Average contribution margin percentage= (CM% A x SM% $ A ) + (CM% B x SM% $ B )
Break-even point in units Break-even point in dollars
= Fixed costs / Average CM per Unit = Fixed Costs / Average CM %
A $5
A$5
B$10
B$10
B$10
© 2007 Pearson Education Canada Slide 2-9
Operating Leverage
$ Sales
Volume
$
Volume
Sales
TotalExpenses
High Operating Leverage
High Fixed / Low Variable Costs
Higher Break-even PointGreater Risk
Greater Potential Returns
Low Operating Leverage
Low Fixed / High Variable Costs
Lower Break-even Point
Reduced RiskLower Potential Returns
TotalExpenses
© 2007 Pearson Education Canada Slide 2-10
Contribution Margin vs. Gross Margin
• Contribution margin is the difference between sales and variable costs
• Gross margin is the difference between sales and cost of goods sold
• Cost of goods sold is the cost of the merchandise that is acquired or manufactured and then resold