© 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