Accounting Principles 8th Edition

1
Preview of Chapter 19
Financial and Managerial Accounting Weygandt
Kimmel Kieso
2
Cost Behavior Analysis

• Cost Behavior Analysis how costs react to
  changes in the level of business activity.
• Some costs change others remain the same.
• Activity levels (Activity Index) may be Sales
  Dollars, Occupancy, Covers, Miles,
  Classes
• Allows costs to be classified as variable,
  fixed, or mixed (part fixed part variable).

3
Cost Behavior Analysis
Variable Costs

• Costs that vary in total directly and
  proportionately with changes in the
  activity level.
• Activity up 10, then total variable costs go up
  10. Activity down 25, then total
  variable cost go down 25.
• Variable costs remain the same per unit
  regardless.
• Variable costs vary in total, stay the same per
  unit.

4
Cost Behavior Analysis
Illustration iMac uses a 10 camera. Activity
index is the of
computers produced. For each iMac iMac made
(per unit), the total cost of the camera
increases by 10. Total Cost of the cameras
will be 20,000 if 2,000 iMacs are
made, 100,000 when it makes
10,000.
5
Cost Behavior Analysis
Illustration iMac uses a 10 camera. Activity
index is the of
computers produced. For each iMac iMac made
(per unit), the total cost of the camera
increases by 10. Per Unit Cost of 10 for
each camera remains constant (the same) whether
2,000 or 10,000 iMacs are produced.
6
Cost Behavior Analysis
Variable Costs Behavior
7
Cost Behavior Analysis
Fixed Costs

• Costs that remain the same in total regardless of
  changes in the activity level.
• Per unit cost varies inversely with activity
  As volume goes up, unit cost goes
  down, As volume goes down,
  unit costs go up
• Examples
• Property taxes Insurance Rent
• Depreciation on buildings and equipment

8
Cost Behavior Analysis
Illustration Apple leases (rents) a factory
building at a cost of 10,000 per month.
Total fixed costs for the factory rent will
remain constant (the same) at every level of
activity. Ex manufacture 1 or
10,000 iMacs, the factory rent costs is 10,000.
9
Cost Behavior Analysis
Illustration Apple leases (rents) a factory
building at a cost of 10,000 per month.
Cost per unit decreases as activity increases.
When 2,000 iMacs
are made, the unit cost per iMac 5 (10,000
2,000). When 10,000 iMacs are made, the unit cost
1 (10,000 10,000).
10
Cost Behavior Analysis
Fixed Costs Behavior
11
Cost Behavior Analysis
Relevant Range

• Throughout the range of possible levels of
  activity, a straight-line relationship usually
  does not exist for either variable costs or fixed
  costs.
• Relationship between variable costs and changes
  in activity level is often curvilinear.
• For fixed costs, the relationship is also
  nonlinear some fixed costs will not change over
  the entire range of activities, while other fixed
  costs may change.

12
Cost Behavior Analysis
Relevant Range
13
Cost Behavior Analysis
Relevant Range Range of activity (how busy) a
company expects to operate during a year.
(normal or usual)
14
Cost Behavior Analysis
Mixed Costs

• Costs with both variable and fixed cost elements.

• Change in total but not proportionately with
  changes in activity.

Ex car rental
20 per day (fixed) PLUS
.10 per mile (variable)
15
Assume your weekly pay is based on of
everything that you sell.
Day Sold Earned
Mon 10 50
Tues 0 0
Wed 13 65
Thurs 0 0
Fri 17 85
Sat 24 120
Sun 21 105
16
Assume your weekly pay is based on salary
commission.
Day Sold Earned
Mon 10 70
Tues 0 20
Wed 13 85
Thurs 0 20
Fri 17 105
Sat 24 140
Sun 21 125
17
Cost Behavior Analysis
High-Low Method

• Mixed costs must be classified into their fixed
  and variable elements.
• High-Low uses the total costs incurred at both
  the high and the low levels of activity to
  classify mixed costs.
• The difference in costs between the high and low
  levels represents variable costs, since only
  variable costs change as activity levels change.

18
Cost Behavior Analysis
High-Low Method

• STEP 1 Determine variable cost per unit using
  formula

Day Sold Earned
Mon 10 70
Tues 0 20
Wed 13 85
Thurs 0 20
Fri 17 105
Sat 24 140
Sun 21 125
(High Low)
HighSold - LowSold

140 -20 120
20 -0 20
120 20
5 per unit
units
19
Cost Behavior Analysis
High-Low Method

• Illustration Metro Bus Co. has these
  maintenance costs and mileage data for its fleet
  of buses over a 6-month period.

20
Cost Behavior Analysis
High-Low Method
STEP 2 fixed cost - total variable cost at
either the high or low activity level.
21
Cost Behavior Analysis
High-Low Method
Maintenance costs 8,000 per month plus 1.10
per mile. (Represented by formula) Maintenance
costs Fixed costs (1.10 x Miles
driven) Ex At 45,000 miles, estimated
maintenance costs would be
8,000
Fixed
(1.10 x 45,000) 49,500
Variable
57,500
22
Cost Behavior Analysis
Mixed Costs Behavior
Note that costs START at 8,000
23
Byrnes Company accumulates the following data
concerning a mixed cost, using units produced as
the activity level.

1. Compute the variable and fixed cost elements
   using the high-low method.
2. Estimate the total cost if the company produces
   6,000 units.

24

1. Compute the variable and fixed cost elements
   using the high-low method.

Variable cost (14,740 - 11,100) / (9,800 -
7,000) 1.30 per unit Fixed cost 14,740 -
12,740 (1.30 x 9,800 units) 2,000 or 11,100
- 9,100 (1.30 x 7,000) 2,000
25

1. Estimate the total cost if the company produces
   6,000 units.

Total cost (6,000 units) 2,000 7,800 (1.30
x 6,000) 9,800
26
(No Transcript)
27
Cost-Volume-Profit Analysis

• Cost-volume-profit (CVP) analysis is the study of
  the effects of changes of costs and volume on a
  companys profits.
• Important in profit planning
• Critical factor in management decisions as
• Setting selling prices,
• Determining product mix, and
• Maximizing use of production facilities.

28
Cost-Volume-Profit Analysis
Basic Components
Illustration 19-9
29
Cost-Volume-Profit Analysis
Basic Components - Assumptions

• Behavior of both costs and revenues is linear
  throughout the relevant range of the activity
  index.
• All costs can be classified as either variable or
  fixed with reasonable accuracy.
• Changes in activity are the only factors that
  affect costs.
• All units produced are sold.
• When more than one type of product is sold, the
  sales mix will remain constant.

30
Traditional Income Statement (Revenue Expenses
Net Income) GAAP required for external
reporting
31
Cost-Volume-Profit Analysis
CVP Income Statement

• A statement for internal use.
• Classifies costs and expenses as fixed or
  variable.
• Reports contribution margin in the statement.
• Contribution margin amount of revenue remaining
  after deducting variable costs.
• Same net income as a traditional income statement.

32
(No Transcript)
33
(No Transcript)
34
Cost-Volume-Profit Analysis
CVP Income Statement

• Illustration Vargo Video produces a
  high-definition digital camcorder. Relevant data
  for June 2014 are as follows.

35
Cost-Volume-Profit Analysis
CVP Income Statement
Illustration The CVP income statement would be
36
Cost-Volume-Profit Analysis
Contribution Margin per Unit

• Contribution Margin must cover ALL fixed costs
  THEN profit (which is the contribution to net
  income).

37
Cost-Volume-Profit Analysis
Contribution Margin per Unit
Vargos CVP income statement assuming a zero net
income.
38
Cost-Volume-Profit Analysis
Contribution Margin per Unit
WHAT IF sell one more unit, (1,001 vs 1,000
units sold).
39

• Break-Even Point
• When Revenue exactly equals ALL costs
• (Revenue Variable Fixed Expenses
  Breakeven Point)
• Where loss ends and profit begins.
• The point at which a business, product or project
  becomes financially viable.
• Expressed as Dollars or Units.

40
Cost-Volume-Profit Analysis
Break-Even Analysis

• Process of finding the break-even point where
  total revenues equal total costs (both fixed and
  variable).
• Can be computed or derived
• from a mathematical equation,
• by using contribution margin, or
• from a cost-volume profit (CVP) graph.
• Expressed either in sales units or in sales
  dollars.

41
Break-Even Analysis
Mathematical Equation
Break-even occurs where total sales equal
variable costs plus fixed costs i.e., net income
is zero
Computation of break-even point in units.
Illustration 19-20
42
Cost-Volume-Profit Analysis
Contribution Margin Ratio

• Shows the percentage of each sales dollar
  available to apply toward fixed costs and
  profits.
• Formula for contribution margin ratio is

43
Cost-Volume-Profit Analysis
Contribution Margin Ratio
If current sales are 500,000 what is the effect
of a 100,000 (200-unit) increase in sales.
44
Break-Even Analysis
Contribution Margin Technique

• When the BEP in units is desired, contribution
  margin per unit is used in the following formula

45
Break-Even Analysis
Contribution Margin Technique

• When the BEP in dollars is desired, contribution
  margin ratio is used in the following formula

46
Break-Even Analysis
Graphic Presentation

• Because this graph also shows costs, volume, and
  profits, it is referred to as a
  cost-volume-profit (CVP) graph.

47
Cost-Volume-Profit Analysis
Target Net Income

• Sales necessary to achieve a specified income.
• Can be determined from any approaches used to
  determine break-even sales/units
• from a mathematical equation,
• by using contribution margin, or
• from a cost-volume profit (CVP) graph.

48
Cost-Volume-Profit Analysis
Target Net Income

• Sales necessary to achieve a specified level of
  income.

Mathematical Equation
Formula for required sales to meet target net
income.
49
Target Net Income
Mathematical Equation

• Using the formula for the break-even point,
  simply include the desired net income as a
  factor.

Illustration 19-25
50
Target Net Income
Contribution Margin Technique
To determine the required sales in units for
Vargo Video
Illustration 19-26
51
Target Net Income
Contribution Margin Technique
To determine the required sales in dollars for
Vargo Video
Illustration 19-27
52
Cost-Volume-Profit Analysis
Margin of Safety

• Difference between actual (or projected) sales
  and the sales at the break-even point.
• Measures the cushion if expected sales fail to
  materialize.
• May be expressed in dollars or as a ratio.
• Assuming actual/expected sales are 750,000

53
Cost-Volume-Profit Analysis
Margin of Safety Ratio

• Divide the margin of safety in by the actual
  or sales.
• Assuming actual/expected sales are 750,000

• The higher the dollars or , the greater the
  margin of safety.