Introduction to Cost

Behaviour and Cost-

Volume Relationships

Week 3 (Chp 2)

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2-1
 Cost Behaviour

ItIt is
is how
how the
the activities
activities of of an
an
organisation
organisation affect
affect its
its costs.
costs.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2-2
 Cost Drivers

Any
Any output
output measure
measure thatthat causes
causes
the
the use
use of of costly
costly resources
resources
is
is aa cost
cost driver.
driver.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2-3
 Examples of Value Chain
Functions, Costs, and Cost Drivers
Value Chain Function
and Example Costs Example Cost Drivers
Research and development
· Salaries of marketing research Number of new product proposals
personnel, costs of
of market surveys
Production
· Labour wages Labour hours
Marketing
· Cost of advertisements Number of advertisements
Distribution
· Wages of shipping personnel Labour hours
Customer service
· Salaries of service personnel Hours spent servicing products
©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2-4
 Comparing
Variable and Fixed Costs

AA variable
variable cost
cost changes
changes in in direct
direct proportion
proportion
to
to changes
changes in
in the
the cost-driver
cost-driver level.
level.

AA fixed
fixed cost
cost is
is not
not immediately
immediately affected
affected
by
by changes
changes in in the
the cost-driver
cost-driver level.
level.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2-5
 Rules of Thumb

Think
Think of
of fixed
fixed costs
costs as
as aa total.
total.

Total
Total fixed
fixed costs
costs remain
remain unchanged
unchanged
regardless
regardless ofof changes
changes in in cost-driver
cost-driver activity.
activity.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2-6
 Rules of Thumb

Think
Think of
of variable
variable costs
costs on
on aa per-unit
per-unit basis.
basis.

The
The per-unit
per-unit variable
variable cost
cost remains
remains
unchanged
unchanged regardless
regardless ofof changes
changes
in
in the
the cost-driver
cost-driver activity.
activity.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2-7
 Relevant Range

The
The relevant
relevant range
range specifies
specifies the
the limits
limits
of
of cost-driver
cost-driver activity
activity within
within which
which aa
specific
specific relationship
relationship between
between aa cost
cost
and
and its
its cost
cost driver
driver will
will be
be valid.
valid.

Relevant Range

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2-8
 Relevant Range
$115,000
100,000
Fixed Costs

Relevant
60,000
range

0 20 40 60 80 100
Volume in Thousands of Units
©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2-9
 Cost-Volume-Profit
Analysis (CVP)

What
What is
is cost-volume-profit
cost-volume-profit analysis?
analysis?

ItIt is
is the
the study
study of
of the
the effects
effects of
of output
output
volume
volume on on revenue
revenue (sales),
(sales), expenses
expenses
(costs),
(costs), andand net
net income
income (net
(net profit).
profit).

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 10
 CVP Scenario
Percentage
Per Unit of Sales
Selling
Selling price
price $.50
$.50 100%
100%
Variable
Variable cost
cost of
of each
each item
item .40
.40 80
80
Selling
Selling price
price less
less variable
variable cost
cost $.10
$.10 20%
20%

Monthly
Monthly fixed
fixed expenses:
expenses:
Rent
Rent $1,000
$1,000
Wages
Wages 4,500
4,500
Other
Other 500
500
Total
Total fixed
fixed expenses
expenses $6,000
$6,000
©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 11
 Break-Even Point – Contribution-
Margin and Equation Methods
The
The break-even
break-even point
point is
is the
the level
level
of
of sales
sales at
at which
which revenue
revenue equals
equals
expenses
expenses and and net
net income
income is is zero.
zero.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 12
 Break-Even Point – Contribution-
Margin and Equation Methods

Contribution
Contribution margin
margin

Equation
Equation

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 13
 Contribution Margin
Method

Per
Per Unit
Unit
Selling
Selling price
price $.50
$.50
Variable
Variable costs
costs .40
.40
Contribution
Contribution margin
margin $.10
$.10

$6,000
$6,000 fixed
fixed costs
costs ÷÷ $.10
$.10
== 60,000
60,000 units
units (break
(break even)
even)

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 14
 Contribution Margin
Method

60,000
60,000 units
units ×× $.50
$.50 == $30,000
$30,000
of
of sales
sales to
to break
break even)
even)

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 15
 Equation Method

Net
Net income
income equals
equals zero
zero at
at the
the break-even
break-even point.
point.

Sales
Sales

– Variable
Variable expenses
expenses

– Fixed
Fixed expenses
expenses

= Zero
Zero net
net income
income (break-even
(break-even point)
point)
©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 16
 Equation Method

Let
Let N
N == number
number of of units
units
to
to be
be sold
sold to
to break
break even.
even.

$.50N
$.50N –– $.40N
$.40N –– $6,000
$6,000 == 00
$.10N
$.10N == $6,000
$6,000
NN == $6,000
$6,000 ÷÷ $.10
$.10
N
N == 60,000
60,000 Units
Units

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 17
 Equation Method

Let
Let SS == sales
sales in
in dollars
dollars
needed
needed to to break
break even.
even.

SS –– .80S
.80S –– $6,000
$6,000 == 00
.20S
.20S == $6,000
$6,000
SS == $6,000
$6,000 ÷÷ .20
.20
SS == $30,000
$30,000

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 18
 Cost-Volume-Profit Graph
Break-even sales point
$60000 60,000 units or $30,000
ine
Ringgit (RM)

$50000 l
n ue
e
$40000 rev
a les
S
$30000
li ne
n s e
$20000 pe
e x
ot al
$10000 T Fixed expense line

0
0 10 20 30 40 50 60 70 80 90 100
Units (thousands)

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 19
 Sales Mix Analysis

Sales
Sales mix
mix is
is the
the relative
relative proportions
proportions or
or
combinations
combinations of of quantities
quantities of
of products
products
that
that comprise
comprise total
total sales.
sales.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 22
 Sales Mix Analysis
Ramos Company Example
Wallets Key Cases
(W) (K) Total
Sales
Sales in
inunits
units 300,000
300,000 75,000
75,000 375,000
375,000
Sales
Sales @@$8$8and
and$5
$5 $2,400,000
$2,400,000 $375,000
$375,000 $2,775,000
$2,775,000
Variable
Variableexpenses
expenses
@@$7$7and
and$3$3 2,100,000
2,100,000 225,000
225,000 2,325,000
2,325,000
Contribution
Contributionmargins
margins
@@$1$1and
and$2$2 $$ 300,000
300,000 $150,000
$150,000 $$ 450,000
450,000
Fixed
Fixedexpenses
expenses 180,000
180,000
Net
Netincome
income $$ 270,000
270,000

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 23
 Sales Mix Analysis

Assume
Assume aa constant
constant mix
mix of
of 44 units
units
of
of W
W for
for every
every unit
unit of
of KK
(One
(One package)
package)

What
What is
is the
the contribution
contribution margin
margin of
of the
the mix?
mix?

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 24
 Sales Mix Analysis
Ramos Company Example
Wallets Key Cases
(W) (K) Total
Sales
Sales in
inunits
units 300,000
300,000 75,000
75,000 375,000
375,000
Sales
Sales @@$8$8and
and$5
$5 $2,400,000
$2,400,000 $375,000
$375,000 $2,775,000
$2,775,000
Variable
Variableexpenses
expenses
@@$7$7and
and$3$3 2,100,000
2,100,000 225,000
225,000 2,325,000
2,325,000
Contribution
Contributionmargins
margins
@@$1$1and
and$2$2 $$ 300,000
300,000 $150,000
$150,000 $$ 450,000
450,000
Fixed
Fixedexpenses
expenses 180,000
180,000
Net
Netincome
income $$ 270,000
270,000

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 25
 Sales Mix Analysis

Assume
Assume aa constant
constant mix
mix of
of 44 units
units
of
of W
W for
for every
every unit
unit of
of K.K.

What
What is
is the
the contribution
contribution margin
margin of
of the
the mix?
mix?

(4
(4 ×× $1)
$1) ++ (1
(1 ×× $2)
$2) == $6
$6

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 26
 Sales Mix Analysis
Ramos Company Example
Wallets Key Cases
(W) (K) Total
Sales
Sales in
inunits
units 300,000
300,000 75,000
75,000 375,000
375,000
Sales
Sales @@$8$8and
and$5
$5 $2,400,000
$2,400,000 $375,000
$375,000 $2,775,000
$2,775,000
Variable
Variableexpenses
expenses
@@$7$7and
and$3$3 2,100,000
2,100,000 225,000
225,000 2,325,000
2,325,000
Contribution
Contributionmargins
margins
@@$1$1and
and$2$2 $$ 300,000
300,000 $150,000
$150,000 $$ 450,000
450,000
Fixed
Fixedexpenses
expenses 180,000
180,000
Net
Netincome
income $$ 270,000
270,000

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 27
 Sales Mix Analysis

$180,000
$180,000 fixed
fixed costs
costs ÷÷ $6
$6 == 30,000
30,000 packages
packages

What
What is
is the
the breakeven
breakeven in
in units?
units?

30,000
30,000 ×× 44 120,000
120,000 WW
30,000
30,000 ×× 11 30,000
30,000 KK
Total
Total units
units 150,000
150,000

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 28
 Sales Mix Analysis

Suppose
Suppose total
total sales
sales were
were equal
equal
to
to the
the budget
budget ofof 375,000
375,000 units.
units.

However,
However, Ramos
Ramos sold
sold only
only 50,000
50,000 key
key (K)
(K) cases.
cases.

What
What is
is the
the net
net income?
income?

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 29
 Sales Mix Analysis
Ramos Company Example
Wallets Key Cases
(W) (K) Total
Sales
Sales in
inunits
units 325,000
325,000 50,000
50,000 375,000
375,000
Sales
Sales @@$8$8and
and$5
$5 $2,600,000
$2,600,000 $250,000
$250,000 $2,850,000
$2,850,000
Variable
Variableexpenses
expenses
@@$7$7and
and$3$3 2,275,000
2,275,000 150,000
150,000 2,425,000
2,425,000
Contribution
Contributionmargins
margins
@@$1$1and
and$2$2 $$ 325,000
325,000 $100,000
$100,000 $$ 425,000
425,000
Fixed
Fixedexpenses
expenses 180,000
180,000
Net
Netincome
income $$ 245,000
245,000

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 30
 Target Net Profit

Managers
Managers can can also
also use
use
CVP
CVP analysis
analysis to to determine
determine
the
the total
total sales,
sales, in
in units
units
and
and dollars,
dollars, needed
needed to to
reach
reach aa target
target net
net profit.
profit.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 31
 Target Net Profit

$480
$480 per
per month
month is
is the
the minimum
minimum
acceptable
acceptable net
net income.
income.

Target
Target sales
sales SS –– 0.80S
0.80S –– $6,000
$6,000 == $480
$480
–– Variable
Variable expenses
expenses .20S
.20S == $6,480
$6,480
–– Fixed
Fixed expenses
expenses SS == $6,480
$6,480 ÷÷ .20
.20
== Target
Target net
net income
income SS == $32,400
$32,400

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 32
 Target Net Profit

Target
Target sales
sales volume
volume in
in units
units ==
(Fixed
(Fixed expenses
expenses ++ Target
Target net
net income)
income)
÷÷ Contribution
Contribution margin
margin per
per unit
unit

($6,000
($6,000 ++ 480)
480) ÷÷ $.10
$.10 == 64,800
64,800 units
units

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 33
 CVP Analysis and Computer-Based
Spreadsheets

The
The use
use of
of spreadsheets
spreadsheets simplifies
simplifies
the
the examination
examination of of multiple
multiple changes
changes
in
in key
key factors
factors in
in aa CVP
CVP model.
model.

Use
Use of
of these
these models
models is
is aa cost-benefit
cost-benefit issue.
issue.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 34
 Additional Uses of Cost-Volume
Analysis

Best
Best cost
cost structure
structure

Operating
Operating leverage
leverage

Margin
Margin of
of safety
safety

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 35
 Operating Leverage
l ine
n ue
$60000 ve
r e
a les
Ringgit (RM)

$50000 S
e n s e line
xp
$40000 Total e

$30000
li ne
e n se
$20000 xp
al e
T ot
$10000
0
0 10 20 30 40 50 60 70 80 90 100
Units (thousands)

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 36
 Contribution Margin
and Gross Margin

Gross
Gross margin
margin
== Sales
Sales price
price –– Cost
Cost of
of goods
goods sold
sold

Contribution
Contribution margin
margin
== Sales
Sales price
price –– All
All variable
variable expenses
expenses

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 37
 Contribution Margin
and Gross Margin

Per
Per Unit
Unit
Selling
Selling price
price $.50
$.50
Variable
Variable costs
costs (acquisition
(acquisition cost)
cost) .40
.40
Contribution
Contribution margin
margin and
and
gross
gross margin
margin are
are equal
equal $.10
$.10

Suppose
Suppose that
that the
the firm
firm had
had to
to pay
pay
aa commission
commission ofof 44¢¢ per
per unit
unit sold.
sold.

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 38
 Contribution Margin
and Gross Margin

What
What are
are the
the margins?
margins?

Per
Per Unit
Unit Per
Per Unit
Unit
Selling
Selling price
price $.50
$.50 $.50
$.50
Acquisition
Acquisition cost
cost .40
.40 .40
.40
Commission
Commission .04
.04
Contribution
Contribution margin
margin $.06
$.06
Gross
Gross margin
margin $.10
$.10

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 39
 Nonprofit Application

Suppose
Suppose aa city
city has
has aa $100,000
$100,000
lump-sum
lump-sum budget
budget appropriation
appropriation
to
to conduct
conduct aa counseling
counseling program.
program.

Variable
Variable costs
costs per
per prescription
prescription
is
is $400
$400 per
per patient
patient per
per day.
day.

Fixed
Fixed costs
costs are
are $60,000
$60,000 inin the
the
relevant
relevant range
range of
of 50
50 to
to 150
150 patients.
patients.
©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 40
 Nonprofit Application

IfIf the
the city
city spends
spends the the entire
entire budget
budget
appropriation,
appropriation, how how many
many patients
patients
can
can itit serve
serve in
in aa year?
year?

$100,000
$100,000 == $400N
$400N ++ $60,000
$60,000
$400N
$400N == $100,000
$100,000 –– $60,000
$60,000
N
N == $40,000
$40,000 ÷÷ $400
$400
N
N == 100
100 patients
patients

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 41
 For extra exercise…

2-A1 Cost-Volume-Profits and Vending

Machines (page 68) &
2-B1 Basic CVP (page 69)
Answer will be discussed next week
during lecture (if time permits).

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 2 - 42