chapter 22-1 chapter 22 cost-volume-profit accounting principles, ninth edition

Chapter 22-1

Chapter 22

Cost-Volume-Profit

Accounting Principles, Ninth Edition

Chapter 22-2

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

1. Distinguish between variable and fixed costs.

2. Explain the significance of the relevant range.

3.3. Explain the concept of mixed costs.Explain the concept of mixed costs.

4.4. List the five components of cost-volume-profit List the five components of cost-volume-profit analysis.analysis.

5.5. Indicate what contribution margin is and how Indicate what contribution margin is and how it can be expressedit can be expressed

6.6. Identify the three ways to determine the Identify the three ways to determine the break-even point.break-even point.

Chapter 22-3

7.7. Give the formulas for Give the formulas for determining sales determining sales required to earn target required to earn target net incomenet income

8.8. Define margin of safety, Define margin of safety, and give the formulas and give the formulas for computing it.for computing it.

9.9. Describe the essential Describe the essential features of a cost-features of a cost-volume-profit income volume-profit income statement.statement.

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

Chapter 22-4

Preview of ChapterPreview of ChapterPreview of ChapterPreview of Chapter

To manage any business, you must understand:To manage any business, you must understand:

How costs respond to changes in sales volumeand

The effect of costs and revenues on profit

To understand cost-volume-profit (CVP), you To understand cost-volume-profit (CVP), you must know how costs behavemust know how costs behave

Chapter 22-5

Variable costsVariable costs

Fixed costsFixed costs

Relevant rangeRelevant range

Mixed costsMixed costs

Identifying Identifying variable and fixed variable and fixed costscosts

Basic componentsBasic components

CVP income CVP income statementstatement

Break-even analysisBreak-even analysis

Target net incomeTarget net income

Margin of safetyMargin of safety

Changes in business Changes in business environmentenvironment

CVP income CVP income statement revisitedstatement revisited

Cost Behavior Cost Behavior AnalysisAnalysis

Cost Behavior Cost Behavior AnalysisAnalysis

Cost-Volume-Cost-Volume-Profit AnalysisProfit AnalysisCost-Volume-Cost-Volume-Profit AnalysisProfit Analysis

Cost-Volume-ProfitCost-Volume-ProfitCost-Volume-ProfitCost-Volume-Profit

Chapter 22-6

Cost Behavior AnalysisCost Behavior AnalysisCost Behavior AnalysisCost Behavior Analysis

Cost Behavior Analysis is Cost Behavior Analysis is

the study of how specific costs the study of how specific costs respond to respond to changes in the level of changes in the level of business activity.business activity.

Some costs change; others remain the sameSome costs change; others remain the same

Helps management plan operations and decide Helps management plan operations and decide between alternative courses of actionbetween alternative courses of action

Applies to all types of businesses and entitiesApplies to all types of businesses and entities

LO 1: Distinguish between variable and fixed costs.LO 1: Distinguish between variable and fixed costs.

Chapter 22-7

Cost Behavior Analysis - continuedCost Behavior Analysis - continuedCost Behavior Analysis - continuedCost Behavior Analysis - continued

Starting point is Starting point is measuring key business activitiesmeasuring key business activities

Activity levels may be expressed in terms of:Activity levels may be expressed in terms of:Sales dollars (in a retail company)Sales dollars (in a retail company)Miles driven (in a trucking company)Miles driven (in a trucking company)Room occupancy (in a hotel)Room occupancy (in a hotel)Dance classes taught (by a dance studio)Dance classes taught (by a dance studio)

Many companies use more Many companies use more than one measurement basethan one measurement base


Chapter 22-8

Cost Behavior Analysis - continuedCost Behavior Analysis - continuedCost Behavior Analysis - continuedCost Behavior Analysis - continued

For an activity level to be useful: For an activity level to be useful:

Changes in the level or volume of Changes in the level or volume of activity activity should be correlated with should be correlated with changes in costschanges in costs

The activity level selected is called theThe activity level selected is called theactivity or volume indexactivity or volume index

The activity index:The activity index:Identifies the activity that causes changes in Identifies the activity that causes changes in the behavior of coststhe behavior of costsAllows costs to be classified according to their Allows costs to be classified according to their response to changes in activity as either:response to changes in activity as either:

Variable Costs Fixed Costs Mixed CostsVariable Costs Fixed Costs Mixed Costs


Chapter 22-9

Variable CostsVariable CostsVariable CostsVariable Costs

Costs that Costs that vary vary in totalin total directly and directly and proportionately with changes in the activity proportionately with changes in the activity levellevel

Example: If the activity level Example: If the activity level increasesincreases 10 10 percent, total variable costs percent, total variable costs increaseincrease 10 percent 10 percent

Example: If the activity level Example: If the activity level decreasesdecreases by 25 by 25 percent, total variable costs percent, total variable costs decreasedecrease by 25 by 25 percentpercent

Variable costs Variable costs remain constant per unit at remain constant per unit at every level of activity.every level of activity.


Chapter 22-10

Variable Costs – ExampleVariable Costs – ExampleVariable Costs – ExampleVariable Costs – Example

Damon Company manufactures radios that Damon Company manufactures radios that contain a $10 clockcontain a $10 clock

Activity index is the number of radios Activity index is the number of radios producedproduced

For each radio produced, the total cost of the For each radio produced, the total cost of the clocks increases by $10:clocks increases by $10:

If 2,000 radios are made, the total cost of the If 2,000 radios are made, the total cost of the clocks is $20,000 (2,000 X $10)clocks is $20,000 (2,000 X $10)

If 10,000 radios are made, the total cost of the If 10,000 radios are made, the total cost of the clocks is $100,000 (10,000 X $10)clocks is $100,000 (10,000 X $10)


Chapter 22-11

Variable Costs – GraphsVariable Costs – GraphsVariable Costs – GraphsVariable Costs – Graphs


Illustration 22-1

Chapter 22-12

Fixed CostsFixed CostsFixed CostsFixed Costs

Costs that Costs that remain the same in total regardless of changes in the activity level.regardless of changes in the activity level.

Per unit costPer unit cost variesvaries inversely with activity:with activity:As volume increases,

unit cost declines, and vice versa

Examples include:Examples include:Property taxesProperty taxesInsuranceInsuranceRentRentDepreciation on buildings and equipmentDepreciation on buildings and equipment


Chapter 22-13

Fixed Costs - ExampleFixed Costs - ExampleFixed Costs - ExampleFixed Costs - Example

Damon Company leases its productive facilities Damon Company leases its productive facilities for $10,000 per monthfor $10,000 per month

Total fixed costs of the facilities remain constant Total fixed costs of the facilities remain constant at all levels of activity - $10,000 per monthat all levels of activity - $10,000 per month

On a On a per unitper unit basis, the cost of rent decreases basis, the cost of rent decreases as as activity increases and vice versaactivity increases and vice versa

At 2,000 radios, the unit cost is At 2,000 radios, the unit cost is $5$5 ($10,000 ($10,000 ÷ 2,000 units)÷ 2,000 units)

At 10,000 radios, the unit cost is At 10,000 radios, the unit cost is $1$1 ($10,000 ($10,000 ÷ 10,000 ÷ 10,000

units)units)LO 1: Distinguish between variable and fixed costs.LO 1: Distinguish between variable and fixed costs.

Chapter 22-14

Fixed Costs - GraphsFixed Costs - GraphsFixed Costs - GraphsFixed Costs - Graphs


Illustration 22-2

Chapter 22-15

Relevant RangeRelevant RangeRelevant RangeRelevant Range

Throughout the range of possible levels of Throughout the range of possible levels of activity, a activity, a straight-line relationship usually does not exist for either variable costs or fixed for either variable costs or fixed costs costs

The relationship between variable costs and The relationship between variable costs and changes in activity level is often changes in activity level is often curvilinear

For fixed costs, the relationship is also For fixed costs, the relationship is also nonlinear – – some fixed costs will not change over the some fixed costs will not change over the entire entire range of activities while other fixed range of activities while other fixed costs may costs may changechange

LO 2: Explain the significance of the relevant range.LO 2: Explain the significance of the relevant range.

Chapter 22-16

Relevant Range - GraphsRelevant Range - GraphsRelevant Range - GraphsRelevant Range - Graphs


Illustration 22-3

Chapter 22-17

Relevant Range Relevant Range Relevant Range Relevant Range

Defined as the range of activity over which a Defined as the range of activity over which a companycompany expects to operate during a year

Within this range, a straight-line relationshipWithin this range, a straight-line relationship usually exists for both variable and fixed costsusually exists for both variable and fixed costs


Illustration 22-4

Chapter 22-18

Mixed CostsMixed CostsMixed CostsMixed Costs

Costs that have Costs that have both a variable a variable cost element cost element and a fixed a fixedcost elementcost element

Sometimes Sometimes calledcalledsemi variable cost

Change Change in total but not proportionately with changes inwith changes inactivity levelactivity level

LO 3: Explain the concept of mixed costs.LO 3: Explain the concept of mixed costs.

Illustration 22-5

Chapter 22-19

Mixed Costs: High–Low MethodMixed Costs: High–Low MethodMixed Costs: High–Low MethodMixed Costs: High–Low Method

Mixed costs must be classified into their Mixed costs must be classified into their fixed and and variable elements elements

One approach to separate the costs is called the One approach to separate the costs is called the high-low method

Uses the total costs incurred at both the high and Uses the total costs incurred at both the high and the low levels of activity to classify mixed coststhe low levels of activity to classify mixed costs

The difference in costs between the high and low The difference in costs between the high and low levels levels represents variable costs, since only variable costs change as activity levels changechange


Chapter 22-20

Mixed Costs: Mixed Costs: Steps in High–Low-Method Steps in High–Low-Method

Mixed Costs: Mixed Costs: Steps in High–Low-Method Steps in High–Low-Method

STEP 1: Determine variable cost per unit using the following formula:

STEP 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 level


Illustration 22-6

Chapter 22-21

Mixed Costs: Mixed Costs: High–Low-Method ExampleHigh–Low-Method Example


High Level of Activity:High Level of Activity: April $63,000 50,000 milesApril $63,000 50,000 milesLow Level of Activity: Low Level of Activity: January January 30,000 30,000 20,000 miles20,000 miles

Difference $33,000 30,000 Difference $33,000 30,000 milesmiles

Step 1:Step 1: Using the formula, variable costs per unit are Using the formula, variable costs per unit are $33,000 $33,000 30,000 = 30,000 = $1.10 variable cost $1.10 variable cost per mileper mile

Data for Metro Transit Company for 4 month period:


Illustration 22-7

Chapter 22-22



Step 2:Step 2: Determine the fixed costs by subtracting total Determine the fixed costs by subtracting total variable costs at variable costs at either the high or low the high or low

activity activity level from the total cost at that level from the total cost at that same levelsame level


Illustration 22-8

Chapter 22-23

Mixed Costs:Mixed Costs:High–Low-Method ExampleHigh–Low-Method Example

Mixed Costs:Mixed Costs:High–Low-Method ExampleHigh–Low-Method Example

Maintenance costs:Maintenance costs: $8,000 per month plus $1.10 per mile$8,000 per month plus $1.10 per mile

To determine maintenance costs at a particular To determine maintenance costs at a particular activity level:activity level:

1. multiply the activity level times the variable cost per unit

2. then add that total to the fixed cost

EXAMPLE: If the activity level is 45,000 miles, the If the activity level is 45,000 miles, the estimated maintenance costs would be $8,000 estimated maintenance costs would be $8,000 fixed and $49,500 variable ($1.10 X 45,000 fixed and $49,500 variable ($1.10 X 45,000 miles) for a total of $57,500.miles) for a total of $57,500.


chapter 22-1 chapter 22 cost-volume-profit accounting principles, ninth edition

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