2022-06-29

Survey of Accounting
Second Edition
Kimmel ● Weygandt

Chapter 13
Cost-Volume-Profit
Prepared by

Coby Harmon
University of California, Santa Barbara
Westmont College
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Copyright ©2020 John Wiley & Sons, Inc.

Cost Behavior Analysis

Cost Behavior Analysis is the study of how specific costs

respond to changes in the level of business activity.
• Some costs change; others remain the same.
• Helps management plan operations and decide between
alternative courses of action.
• Applies to all types of businesses and entities.
• Starting point is measuring key business activities.

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Cost Behavior Analysis

Activity Levels
• Activity levels may be expressed in terms of:
o Sales dollars (retail company).
o Miles driven (trucking company).
o Room occupancy (hotel).
o Dance classes taught (dance studio).
• Many companies use more than one measurement base.

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Cost Behavior Analysis

Activity Index
• Changes in level or volume of activity should be correlated
with changes in costs.
• Activity level selected is called the activity index or driver.
• Activity index:
o Identifies activity that causes changes in behavior of costs.
o Allows costs to be classified as variable, fixed, or mixed.

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Cost Volume Profit (CVP)

Helps managers predict the impact of changes in costing and revenue on the net income of a
company, also known as break-even analysis. We can use CVP to answer various questions.
 What is the breakeven point?
 What is the profit or loss at a given sales volume?
 What impact will additional fixed costs and/or variable costs have on our breakeven point?

Classifying Costs by Variable or Fixed Behaviour

Variable costs are costs that change in relation to the change in production volume (for
companies that produce products) or that change in relation to the change in sales (for
companies that offer services). Direct materials are variable costs, because they increase or
decrease in direct proportion to the number of units produced. The variable cost per unit
does not change as production increase but total variable cost does.
Formula Variable cost per unit x Units = Total Variable Cost $VC x U = TVC
OR Revenue x Variable Cost % = Total Variable Costs $Rev x VC% = TVC
Example, the variable cost per unit is $5, calculate the total variable cost.

Units 10 75 100
Total Variable Cost

Fixed Costs - are costs that remain constant regardless of changes in sales volumes
within the relevant range is the range of production where cost behaviours remain the
same. When fixed costs are graphed, they represent a straight horizontal line. It should
be noted even though rent remains constant as production increases, the fixed cost
per unit decreases.
Example, if the fixed costs are $5,000 what are the fixed costs at sales volume (units)
at 100 units, 500 units, 5,000 units. Also determine the fixed cost per unit.
Units 100 500 5,000
Fixed Cost
Fixed cost per unit

Fixed Cost Total Variable

Cost
$ $

Units Units
Examples of fixed costs: rent, property taxes, insurance, depreciation. Any cost
that does not change with volume, in the relevant range

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Since costs can be classified as fixed or variable, we can determine total costs.

Formula Total Variable Costs + Fixed Costs = Total Cost TVC + FC = TC

($VC x U)
What would the total costs be at a sale volume of 2,000 plates, assume the
variable cost of $15 per units and the total fixed costs are $5,000.

Units

Also TC – FC = TVC 7
TC – TVC = FC

Cost Behavior Analysis

Review Question Answer
Variable costs are costs that:
a. Vary in total directly and proportionately with changes in the
activity level.
b. Remain the same per unit at every activity level.
c. Neither of the above.
d. Both (a) and (b) above.

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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.
• The range over which a company expects to operate during
a year is called the relevant range.
• Variable costs are typically linear within the relevant range.
• Total fixed costs remain constant within the relevant range.

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Relevant Range
Linear Behavior Within Relevant Range
Range of activity over which a company expects to operate
during a year. Variable cost per Fixed cost used
unit used

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Relevant Range
Review Question Answer
The relevant range is:
a. The range of activity in which variable costs will be
curvilinear.
b. The range of activity in which fixed costs will be
curvilinear.
c. The range over which the company expects to
operate during a year.
d. Usually from zero to 100% of operating capacity.

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Mixed Costs
• Costs that have both a variable element and a fixed
element.
• Change in total but not proportionately with changes in
activity level.
In order to use the CVP formulas
any mixed costs must be broken
down in the fixed and variable
components.

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DO IT! 1: Types of Costs

Helena Company, reports the following total costs at two levels of

production.
Classify each cost as variable, fixed, or mixed.

Classification Cost 10,000 Units 20,000 Units

Variable Direct materials $20,000 $40,000
Mixed Maintenance 8,000 10,000
Variable Direct labor 17,000 34,000
Variable Indirect materials 1,000 2,000
Fixed Depreciation 4,000 4,000
Mixed Utilities 3,000 5,000
Fixed Rent 6,000 6,000

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Mixed Costs Analysis

For purposes of cost-volume-profit analysis, mixed costs must

be classified into their fixed and variable elements.
High-Low Method
• High-Low Method uses total costs incurred at high and low
levels of activity to classify mixed costs into fixed and
variable components.
• Difference in costs between high and low levels represents
variable costs, since only variable-cost element can change
as activity levels change.

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High-Low Method
Formula for Variable Cost Per Unit Using High-Low
Method

CAUTION: Find the high activity and use that Cost

Find the low activity and use that Cost

DO NOT FIND THE HIGH COST AND TAKE THAT VOLUME

DO NOT FIND THE LOW COST AND TAKE THAT VOLUME

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High-Low Method
Assumed Maintenance Costs and Mileage Data

Illustration: Metro Transit Company has the following

maintenance costs and mileage data for its fleet of buses over a 6-
month period.

20,000 $30,000 50,000 $63,000

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High-Low Method Computation of Fixed Costs

We know TVC + FC = TC
It does not matter whether you use the High or Low to determine
the fixed costs. Determine the total fixed cost for Metro Transit

Total Variable Costs

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High-Low Method
Total Costs for 45,000 Miles
We can use that information of the variable cost per unit and fixed
cost to determine (estimate) the cost at any volume. If we expects
total miles to be 45,000 determine the estimated maintenance costs.
Remember to determine total costs it is the sum of total variable abd
fixed costs.
Formula

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High-Low Method
Scatter Plot for Metro Transit Company

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Mixed Costs
Review Question Answer
Mixed costs consist of a:
a. Variable cost element and a fixed cost element.
b. Fixed cost element and a controllable cost element.
c. Relevant cost element and a controllable cost
element.
d. Variable cost element and a relevant cost element.

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Cost-Volume-Profit Analysis

Cost-volume-profit (CVP) analysis is the study of the effects

of changes in costs and volume on a company’s profits.
• Important in profit planning.
• Critical factor in management decisions as:
o Setting selling prices.
o Determining product mix.
o Maximizing use of production facilities.

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Basic Components
Assumptions
1. Behavior of both costs and revenues is linear throughout
the relevant range of the activity index.
2. Costs can be classified accurately as either variable or
fixed.
3. Changes in activity are the only factors that affect costs.
4. All units produced are sold.
5. When more than one type of product is sold, the sales mix
will remain constant.

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CVP FORMULA SHEET

Explanation of items to be used in formulas:
x = sales volume in units
SP = Selling Price per unit
VC = Variable Cost per unit or (SP x VC%)
VC% = VC/SP or (1-CM%)
FC = Fixed Costs
CM = Contribution Margin (SP-VC) or (SP x (1-VC%)) = Answer in UNITS
CMR = Contribution Margin Ratio (CM/SP) or CM% = Answer in DOLLARS

TR = Total Revenue (SP x Units)

TVC = Total Variable Costs ($VC/unit x units) or (TR x VC%)
TCM = Total Revenue – Total Variable Costs (TR-TVC) or (TR x CMR)
TNI = Target Net Income
NI = (TR – TVC – FC) or (TR x CMR) – FC
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TR – TVC = TCM – FC = NI

CVP Income Statement

• A statement for internal use.
• CVP income statement classifies costs as fixed or variable
and computes a contribution margin.
• Contribution margin is the amount of revenue remaining
after deducting variable costs.
• Reports same net income as a traditional income
statement.

Formula Total Rev – Total VC = Total Contrib. Margin – FC = Operating income

TR – TVC = TCM – FC = OI

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CVP Income Statement

Vargo Electronics Company produces cell phones. Relevant data
for the cell phones sold by this company in June 2022 are as
follows. Unit selling price per unit $500 Total Monthly Fixed costs $200,000
Unit variable cost per unit $300 Units sold 1,600
Formula Total Rev – Total VC = Total Contrib. Margin – FC = Operating income
TR – TVC = TCM – FC = OI

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Breakeven Point
TR
TC
Breakeven point
FC where revenue
equals total costs

Breakeven (BE) formula

Formula for achieve a desired
If in units FC/CM = units Operating Profit (Target)
If in sales dollars FC/CMR = $ If in units (FC + TNI)/CM = units
If in sales dollars (FC + TNI)/CMR =
Formula to determine Net Income
$
TR – TVC = TCM – FC = NI
TR = SP x Units
TVC = (VC$ x Units) or (TR x VC%) 26
TCM = (TR – TVC) or (TR x CMR)
Breakeven point by equation (Spu) – (Vcu) – FC = $0

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Unit Contribution Margin

Breakeven in Units Selling Price (SP) $500
Variable Cost/unit (VC) $300 Fixed Costs $200,000
Contribution Margin per unit (CM)
Breakeven Point

Total Per Unit

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Breakeven by Equation
Breakeven in Units Selling Price (SP) $500
Variable Cost/unit (VC) $300 Fixed Costs $200,000
(Spu) – (VCu) – FC = NI

Total Per Unit

Sales (1,000 x $500) $500,000 $500
Variable costs (1,000 x $300) 300,000 300
Contribution margin (1,000 x $200) 200,000 $200
Fixed costs 200,000
Net income $ 0

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Contribution Margin Ratio

Breakeven in Dollars Selling Price (SP) $500
Variable Cost/unit (VC) $300 Fixed Costs $200,000
Contribution Margin Ratio (CMR)
Breakeven Point

Total Per Unit

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Determine the net income

Selling Price (SP) $450 Variable Cost Percentage 30%
Fixed Costs $20,000 per month
Determine the breakeven point in units for the year.
Formula

Determine the breakeven in sales dollars

Formula

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Determine the net income

Selling Price (SP) $500 Variable Cost/unit (VC) $300
Fixed Costs $200,000 Sales in units 1,500 units
Formula

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Break-Even Analysis
Review Question Answer
Gossen Company is planning to sell 200,000 pliers for
$4 per unit. The contribution margin ratio is 25%. If
Gossen will break even at this level of sales, what are
the fixed costs?
a. $100,000
b. $160,000
c. $200,000
d. $300,000

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DO IT! 4: Break-Even Analysis

Lombardi Company has a unit selling price of $400, variable
costs per unit of $240, and fixed costs of $180,000. Compute
the break-even point in units using (a) a mathematical
equation or formula and (b) Sales dollars required to break-
even.
a)

b)

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Target Net Income and Margin of Safety

Target Net Income (TNI)
• Level of sales necessary to achieve a target income. Ignore
income tax.
• Can be determined from each approach used to determine
break-even in
FC + TNI = Units
• units: CM
• Sales FC + TNI = Sales$
CMR

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Target Net Income

To determine required sales in units (a) and dollars (b) for
Douglas Electronics, selling price $500, variable costs, $175, fixed
costs for the year $299,250 and wished to have a target net income
of $120,000.
a)

b)

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Margin of Safety
• Difference between actual or expected sales and sales at break-even point.
• Measures “cushion” that a particular level of sales provides.
• May be expressed in dollars or as a ratio.
• Assuming actual/expected sales are $750,000:
In Dollars (use breakeven calculation from previous slide)
Actual Sales – Breakeven Sales = Margin of Safety in Dollars

In Units Actual Units – Breakeven Units = Margin of Safety in Units

Margin of Safety Ratio

Margin of Safety in Dollars = %
Actual Sales

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Regression Analysis

• While the high-low method works well, a weakness is that

it employs only a few data points and ignores the rest.
• If those two data points are representative of the entire data
set, then the high-low method provides reasonable results.
• If the high and low data points are not representative of the
rest of the data set, then the results are misleading.

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Regression Analysis
Scatter Plot for Metro Transit Company
While the high-low method works well, a weakness is that it
employs only a few data points and ignores the rest.

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Regression Analysis
High and Low Activity Levels
Illustration: Assume that Hanson Trucking Company has 12
months of maintenance cost data, as shown.

High activities and levels are in BLUE, low activities and levels
are in RED.
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High/Low Method
Illustration: Assume that Hanson Trucking Company has 12
months of maintenance cost data, as shown.

Variable cost per unit

Fixed costs

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Regression Analysis
Theory

• Regression analysis is a statistical approach that estimates

the cost equation by employing information from all data
points, not just highest and lowest ones.
• Regression analysis finds a cost equation that results in a
cost equation line that minimizes the sum of (squared)
distances from the line to data points.

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Regression Analysis
Intercept and Slope Functions
Illustration 13A.4, uses the A B C D

Intercept and Slope functions in 1 Month

Miles
Driven
Total
Cost

Excel to estimate the regression 2 January 20,000 $30,000

equation for the Hanson Trucking 3

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February
March
40,000
35,000
49,000
46,000
Company data. 5 April 50,000 63,000
6 May 30,000 42,000
Intercept: 7 June 43,000 52,000

=INTERCEPT(C2:C13,B2:B13) = 8 July 15,000 39,000

9 August 28,000 41,000
18,502 10 September 60,000 72,000

Slope: 11 October 55,000 67,000

12 November 19,000 29,000

=SLOPE(C2:C13,B2:B13) = 0.81 13 December 65,000 63,000

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Regression Analysis
Comparison of Cost Equations

The resulting cost equation is:

Compare this to the high-low cost equation:

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Regression Analysis
Scatter Plot and Cost Equation Lines
The intercept and slope differ significantly between the regression
equation (green) and the high-low equation (red).

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Regression Analysis
Limitations

While regression analysis usually provides more reliable estimates

of the cost equation, it does have limitations.
1. The regression approach applied above assumes a linear
relationship between the variables. If the actual relationship
differs significantly from linearity, then linear regression can
provide misleading results.
2. Regression estimates can be severely influenced by “outliers”—
data points that differ significantly from the rest of the
observations.
3. Regression estimation is most accurate when it is based on a
large number of data points.

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