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Cost Behavior
Cost Behavior
1. Variable Cost – varies proportionately in total but remains constant on a per unit
basis.
a. True variable costs – proportionately variable (ex. Raw material) amount
used directly increases as production increases by the same percentage.
b. Step variable costs – costs obtainable in large segments (ex. Labor costs of
maintenance workers) and that increase or decrease in response to fairly
wide changes in activity levels.
NOTE: these costs are constant for a certain activity level (relevant range)
and then vary in a step like fashion as volume increases.
2. Fixed Costs – remain constant in total but vary inversely on a per unit basis (if
production increases, then per unit cost decreases; if production decreases, then
per unit cost increases)
c. Semi variable or Mixed Costs – contains both variable and fixed costs
elements
- at certain levels of activity mixed costs display the same
characteristics as a fixed cost
- at certain levels they display same characteristic as a variable
cost
- (examples: electricity, heat, telephone, maintenance, car rental,
copy machine rental)
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3. Three Methods of breaking mixed costs down into their fixed and variable
elements
Fixed Cost Element = Total Cost (at high point) – Variable Cost Element
NOTE: You can also use the low point and arrive at the same fixed cost element.
Since fixed costs do not change in total within the relevant range of activity, this would
result in the same answer.
Graph Analysis
- cost is always plotted on the vertical axis and represented by the
letter “Y”
- cost is known as the dependent variable, since the amount of cost
incurred during a period depends upon the level of activity or
volume.
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a. Contribution Margin
(1) Sales – Variable Expenses = Contribution Margin
(2) The amount remaining from sales revenues after variable
expenses have been deducted that can be used to contribute
toward the recovery of fixed expenses and then toward profit for
the period.
e. Sunk Cost – already incurred and cannot be changed by any decision made
now or in the future. An irrelevant cost in decision-making.
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Cost – Volume – Profit (CVP) Analysis
3. Contribution Margin Ratio (CM Ratio) / Profit Volume Ratio (P/V Ratio)
4. Operating Leverage – measure of the extent to which fixed costs are being used in
an organization
a. If high operating leverage exists (a high proportion of fixed costs in
relation to variable costs) then profits will be very sensitive to changes in
sales
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5. Break Even Analysis
a. Break Even point – the point where the total sales revenue equals total
expenses (fixed and variable)
Or
The point where the total contribution margin equals the total fixed
expenses.
Fixed Expenses ÷ (1) Unit Contribution Margin = Break Even Point (Units)
Or
Fixed Expenses ÷ (2) CM Ratio = Break Even Point (Dollars)
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6. Target Net Profit Analysis
a. CVP Equation
Sales = Variable Expenses + Fixed Expenses + Profits
7. Margin of Safety
a. Excess of budgeted (or actual) sales over the break-even volume of sales
b. Indicates the range that sales can drop before losses are incurred.
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