Decision Making Using Cost Concepts and

CVP Analysis
CA Final: Paper 5: Advanced Management
Accounting
Chapter 2
Arijit Chakraborty, FCA

Learning Objectives

1. Understand the concept and types of cost and

their behaviour
2. Learn the concept of Break even point, Marginal
costing and profitability analysis

Learning objectives Decision making

CVP analysis
and its strategic
role

CVP analysis for

BEP planning

CVP analysis for

revenue & cost
planning

Sensitivity
analysis when
sales are
uncertain

Multi-product
situation & CVP
analysis

Multiple cost
driver situation

Use in decision
making

Limitations and
effect on
interpretation of
results

Abbreviations
USP

Unit selling price

UVC

Unit variable costs

UCM

Unit contribution margin

CM%

Contribution margin percentage

FC

Fixed costs

Quantity of output (units sold or produced)

OI

Operating income

TOI

Target operating income

TNI

Target net income

Module Summary
Cost/volume/profit (CVP) relationships and break-even analysis
break-even chart low fixed costs, high variable costs
break-even chart high fixed costs, low variable costs
contribution break-even chart
profit volume (PV) chart , CVP and break-even analysis
limitations of CVP and break-even analysis
multiple product break-even analysis

Learning Objectives (1)

explain cost/volume/profit (CVP) relationships and
break-even analysis
identify the limitations of CVP analysis
outline the more recently developed techniques of
activity based costing (ABC), and throughput
accounting (TA)
identify the conditions appropriate to the use of life
cycle costing

Introduction to types of costs

Background
Types of costs and their behaviour
Relevant costs

18-8

Module Outline & Applications

What is CVP analysis?
The break-even point
Graphing CVP relationships
Target net profit
Using CVP analysis for management decisions
CVP analysis with multiple products
Including income taxes in CVP analysis
Practical issues in CVP analysis
An activity-based approach to CVP analysis
Financial planning models

Marginal Costing - Introduction

Under Marginal costing the product

price is determined on the basis of
Variable cost of the product. Such
price is selected for the purpose of
penetration pricing where the
minimum sale price = variable cost.

As the sale price is very low

management is always anxious
about the recovery of fixed overhead.
So they want to calculate the volume
of sales at which fixed cost will be
recovered , profit will arise & the
safety margin of the organization , as
well as different short-term decision
are to be taken by the management.

10

Nature of absorption vs. Marginal

costing
Marginal costing is not a distinct method of costing like job costing, process
costing, operating costing, etc. but a special technique used for marginal
decision making. Marginal costing is used to provide a basis for the
interpretation of cost data to measure the profitability of different products,
processes and cost centre in the course of decision making. It can, therefore,
be used in conjunction with the different methods of costing such as job
costing, process costing, etc., or even with other technique such as standard
costing or budgetary control.

In marginal costing, cost ascertainment in made on the basis of the nature of

cost. It gives consideration to behaviour of costs. In other words, the technique
has developed from a particular concept and expression of the nature and
behaviour of costs and their effect upon the profitability of an undertaking.

11

CVP - Overview
Cost-volume-profit analysis , as the name suggests, is the
analysis of three variable viz., cost, volume and profit. Such an
analysis explores the relationship existing amongst costs,
revenue, activity levels and the resulting profit. It aims at
measuring variations of cost with volume. In the profit planning of
a business, cost-volume-profit (C-V-P) relationship is the most
significant factor.

The CVP analysis is an extension of marginal costing. It makes

use of principles of marginal costing. It is an important tool of
planning. It is quite useful in making short run decisions.

12

Cost concepts
Relevant cost vs. non-relevant cost
Sunk cost / Historical cost
Avoidable cost
Notional cost
Opportunity cost
Out of pocket cost
Discretionary cost

13

Cost concepts Cont..

Shutdown cost
Engineered cost
Inventoriable cost
Period cost
Differential cost
incremental cost
Period cost Limiting Factor

14

Cost Behavior
How costs change in response to changes in
volume
Variable costs
Fixed costs
Mixed costs

Types of Costs

Variable
Fixed
Mixed

Variable costs
costs that vary in proportion to changes in the
level of activity.
Direct materials
Direct labor
Units Produced

Direct Materials
per unit

Total Direct
Material Costs

5,000 units

$10

$ 50,000

10,000 units

$10

100,000

15,000 units

$10

150,000

17

Variable Costs
Change in total in direct proportion to changes in volume
Total variable costs = variable cost per unit of activity x volume of
activity
Examples
Materials and parts
Manufacturing labour
Machine Time (electricity used by equipment in the manufacturing process).

Total Variable Costs

Total Sales
Commissions

$2,500
$2,000
$1,500
$1,000
$500
$0
$0

$10,000 $20,000 $30,000 $40,000

Total Sales
Assume we pay sales commissions of 5% on all sales. The cost of
sales commissions increase proportionately with increases in sales
18

19

Fixed Costs
Do not change over wide ranges of volume
Eg - Depreciation on equipment
costs that remain the same in total dollar amounts as the level of activity
changes.
Examples:
Rent
Insurance
Administrative labour
Wages paid to managers or secretaries (ie employees not directly involved in the
manufacture of the product or provision of the service).

Fixed Costs

Number of Bottles

Total Salary for

Supervisor

Salary per bottle

produced

50,000

$75,000

$1.50

100,000

$75,000

$0.75

150,000

75,000

$0.50

Total Sales Salaries

Total Fixed Costs

$2,500
$2,000
$1,500
$1,000
$500
$0
$0

$10,000 $20,000 $30,000 $40,000

Total Sales
Assume we pay our sales staff a salary of $2,000 per month.
If a sales person makes sales of $500, he gets paid $2,000
salary. If he has sales of $100,000, he get paid $2,000 salary
21

22

Mixed Costs
Contain both variable and fixed components
A mixed cost has elements of both fixed and variable costs.
MC has characteristics of both a variable and a fixed cost.
Could behave as a fixed costs for part of the relevant range and then
variable cost

For our next example : Assume we pay our sales staff,

$2,000 plus 5% commission on each sales dollar.

Sales Compensation

Mixed Costs
$4,500
$4,000
$3,500
$3,000
$2,500
$2,000
$1,500
$1,000
$500
$0
$0

$10,000 $20,000 $30,000 $40,000

Total Sales
23

Sales Compensation

Mixed Costs
$4,500
$4,000
$3,500
$3,000
$2,500

Variable

$2,000
$1,500
$1,000
$500
$0

Fixed

$0

$10,000 $20,000 $30,000 $40,000

Total Sales
24

Objective 2
Forecast costs using cost equations

25

26

Cost Equation
Total costs =
Total variable costs + Total fixed costs
y = vx + f

y = total cost
v = variable cost per unit of activity (slope)
x = volume of activity (x)
f = fixed cost over a given period of time
(vertical y intercept)

27

Marginal Cost & Relevant Range

Band of volume where total fixed costs remain constant
and variable cost per unit remains constant.

Outside the relevant range, the cost either increases or

decreases

Other Cost Behaviors

Step costs fixed over small range of activity, then
jump to new fixed level
$60,000

Total Costs

$45,000
$30,000
$15,000
$0

Number of Units
28

Other Cost Behaviors

Curvilinear Costs
$60,000

Total Costs

$45,000
$30,000
$15,000
$0

Numbr of Units

29

Economists Cost and Revenue

Curves

Cost/Volume/Profit (CVP) Relationships

and Break-Even Analysis (1)
Cost/volume/profit (CVP) analysis may be used
to determine the break-even position of a business
to provide sensitivity analyses on the impact on the
business of changes to any of the variables used to
calculate break-even
the break-even point is the level of activity at which
there is neither profit nor loss

Cost/Volume/Profit (CVP) Relationships

and Break-Even Analysis (2)
There are three fundamental cost/revenue
relationships that form the basis of CVP analysis
total costs = variable costs + fixed costs
contribution = total revenue - variable costs
profit (or operating income) = total revenue - total
costs
the slopes of the total cost lines in the following two
charts represent the unit variable costs

Break-Even Chart Low Fixed Costs,

High Variable Costs

Break-Even Chart High Fixed Costs,

Low Variable Costs

PV Ratio & Contribution Break-Even

Chart

Break-even / Profit Volume (PV) Chart

37

Break-even Chart
Analysis
Advantages
Disadvantages

The Break-Even Point (1)

profit = contribution fixed costs
and at the break-even point profit is zero and so
profit = contribution fixed costs = zero

or

contribution = fixed costs

it follows therefore that the
number of units at the break-even point
x contribution per unit = fixed costs

or

number of units at break-even = fixed costs /

contribution per unit

The Break-Even Point (2)

The number of units at the break-even point x selling price per

unit is the break-even Rs sales value, so
Rs sales value at break-even point
=
fixed costs
x selling price per unit
contribution per unit
selling price per unit = total sales revenue
contribution per unit
total contribution
which is the reciprocal of the contribution to sales ratio %, so
Rs sales value at break-even point
=
fixed costs
contribution to sales ratio %

The Break-Even Point (3)

the term margin of safety is used to
define the difference between the breakeven point and an anticipated or existing
level of activity above that point
the margin of safety measures the
extent to which anticipated or existing
activity can fall before a profitable
operation turns into a loss-making one

Limitations of CVP Analysis

the many limitations to CVP analysis are related to the
assumptions on which it is based to consider break-even,
decision-making, or sales pricing
the main assumptions are:
output is the only factor affecting costs
cost and revenue behaviour is linear
there is a single product
costs are easily split into variable and fixed, which are constant

42

Limitations of Marginal Costing

Unrealistic Assumption
Incomplete Information
Imperfect Managerial Tool

43

Application of CVP Analysis

Expand or Contract
Export V/s Local Sale
Make or Buy
Pricing Decision
Product Mix
Price Mix
Shut down or Continue

Multiple Product Break-Even Analysis

where a business offers a range of products or services, the

weighted average contribution may be used to calculate the
selling prices required to achieve targeted profit levels, and
revised break-even volumes and sales values resulting from
changes to variable costs and fixed costs

Key Terminology: Breakeven Analysis

Break even point-the point at which a company makes neither
a profit or a loss.
Contribution per unit-the sales price minus the variable cost
per unit. It measures the contribution made by each item of
output to the fixed costs and profit of the organisation.
Margin of safety-a measure in which the budgeted volume of
sales is compared with the volume of sales required to break
even
Marginal Cost cost of producing one extra unit of output

Margin of Safety
The difference between budgeted or actual sales and the

breakeven point
The margin of safety may be expressed in units or
revenue terms
Shows the amount by which sales can drop before a loss
will be incurred

Objective 3
Determine cost behavior using account analysis, the
high-low
method, and regression analysis

47

48

High-Low Method
Method to separate mixed costs into variable and fixed
components

Select the highest level and the lowest level of activity over a
period of time

49

Regression Analysis
Statistical procedure to find the line that best fits data
Uses all data points
Results in equation of line and an R-square value

50

Objective 4
Prepare contribution margin income statements for
service firms and merchandising firms

51

Traditional Income Statement

Sales
- Cost of Goods Sold
Gross Margin

- Selling,general & administrative costs

Operating Income

52

Contribution Margin Income

Statement
Sales
- Variable Costs

Contribution Margin
- Fixed Costs
Operating Income

53

Contribution Margin Income

Statement

Predict how changes in volume

will affect operating income

54

A Ltd
Income Statement
For the year ending 20XX
Revenue:
Sales Revenue
Rental Revenue
Lessor Revenue
Total Revenue
Less: Cost of Goods Sold
Gross Margin
Less Operating Costs:
Depreciation
Employee Salary expenses
Musician wages
Lease
Total operating costs
Operating Income

$34,000
22,000
40,000
$96,000
(9,500)
$86,500
$ 4,000
30,000
25,000
12,000
71,000
$15,500

55

E6-25

A Ltd.
Contribution Margin Income Statement
For the year ending 20XX

Revenue:
Sales Revenue
Rental Revenue
Lessor Revenue
Total Revenue
Less: Variable Costs
Cost of Goods Sold
Musician wages
Total Variable costs
Contribution Margin
Less Fixed Costs:
Depreciation
Employee Salary expenses
Lease
Total fixed costs
Operating Income

$34,000
22,000
40,000
$96,000
$ 9,500
25,000
(34,500)
$61,500
$ 4,000
30,000
12,000
(46,000)
$15,500

56

Analysis
The contribution margin income statement is a better
management tool than the traditional income statement.
If A Ltds volume remains in the same relevant range, it
can easily be seen that fixed expenses will be $46,000.
It also follows that revenue and variable costs will
increase in direct proportion to changes in volume. The
traditional income statement does not provide any
information on cost behavior.

57

Concepts for Decision making using

CVP
Further
processing of
product

Dropping or
adding product
line

Profit
optimisation in
limiting factor
condition

Optimising
investment plan

Decision making
using cash flow
technique

Shut down and

divestment
decision

58

Decision making using CVP Cont..

Divestment
strategies

Pricing strategy

Offer
acceptance and
tender
submission

Make or buy

Export order
quotation

Expand or
contract

Product and
price mix
decision

59

Objective 5
Use variable costing to prepare contribution margin
income statements for manufacturers

60

Variable Costing
Assigns only variable manufacturing costs to products
Direct materials
Direct labor
Variable manufacturing overhead

Fixed manufacturing overhead = period cost

Contribution margin income statements
For internal management decisions

61

Absorption Costing
Required by GAAP for external reporting
Assign all manufacturing costs to product

Direct materials
Direct labor
Variable manufacturing overhead
Fixed manufacturing overhead

Traditional income statement

62

Marginal costing

A TECHNIQUE USED IN DECISION MAKING

- If the volume of output increases, the average cost per unit
will decrease. Conversely, if the output is reduced, the
average cost per unit will go up

CVP Analysis
a method for analysing how operating and marketing decisions
affect net income
CVP model:
Profit = Revenue Total cost
= Q x SPU Q x VCU - FC

64

CVP analysis
WHAT IF?
Change in:
Output level

Behaviour of:

Selling price

Total revenue

VC per unit

Total cost

And/or fixed cost of a product

Operating income

65

Applications of CVP Analysis

Setting prices for products and services
New product/service introduction
Replacing a machine
Make or buy
What if analysis

66

Strategic role of CVP analysis

Cost leadership firms compete by increasing volume to achieve low per unit
operating cost- predict effect of volume on profit and risk of increasing FC
Early stage of cost life cycle- predict the profitability of the product
Use in target costing profitability of alternative designs
Later phases of life cycle- mfg. stage- evaluate most profitable mfg. process
Helps in strategic positioning - differentiation- assessing desirability of new features
- cost leadership- low cost operating means

67

Effect of opportunity cost in break

even analysis
When for a new proposal/alternative use current income
will be lost or additional cost is to be incurred then these
are known as opportunity cost of the new proposal. In
other word the minimum price for the new proposal =
variable cost of the alternative + lost income under
present situation +discretionary fixed cost (if any).

The Lost income is generally loss of contribution

68

Some terms
Operating income =
Gross operating
revenue COGS
and operating costs

Net income =
operating income +
net non-operating
revenues income
tax

Contribution margin
= contribution
margin per unit X
No. of units sold

BEP
Equation method:
Revenue-variable cost fixed cost = operating income
[SP X Q] [VCU X Q]- FC = Operating income
At BEP, operating income = Zero

70

BEP
Contribution margin method: rearranging the equation
[SP X Q]- [VCU X Q] FC = OI
Or, [SP-VCU] X Q = FC + OI
At BEP, [SP-VCU] X Q = FC
i.e., CMU X Q = FC
Hence, Q = FC / CMU (in terms of number)
Q = FC / PV ratio (in terms of revenue)

71

PV ratio
PV ratio = CMU/SP
a % figure
a rate of profitability

Uses of PV ratio:

1- P/V ratio = Variable cost ratio

Sales X P/V ratio = Gross contribution
Determining the sales mix
BEP = FC / PV Ratio
[FC+ Target Profit ] / PV ratio gives the volume of output to
be sold to earn a desired level of output

72

Improving PV ratio
Improvement in P/V ratio will mean more profit

reduce variable cost

increase selling price
product mix to change in favour of high P/V ratio products
Change in FC?

73

Assumptions

Volume is the revenue

and cost driver

Total cost can be

segregated into fixed
and variable
components

Selling price, VC per

unit and fixed cost are
known and constant
within relevant range
and time

Total revenue and

cost are linear
functions of volume
within relevant range
and time

Applicable to single
product or multiproduct situation with
constant sales mix as
volume changes

74

Concept revision

What is margin
of safetys
significance?

MOS v. size of
fixed cost: risk

Larger angle of
incidence: what
does it imply?

BEP point shift

up and down:
what does it
mean?

Monopoly- plant
efficiency v.
angle of
incidence

Competitionplant efficiency
v. angle of
incidence

75

Target operating income

Means a target contribution margin
Q = [Fixed cost + Target OI] / CMU
Understanding impact of IT:
Target net income:
= Target OI- Target OI X Tax rate
So, Target OI = Target NI / [1 tax rate]
Hence, Q = [FC + Target NI / [1 tax rate]]

/CMU

76

Improving MOS
Reduce FC
Increase sales volume
Selling more profitable products
Reduce VC
Increase in selling price in case of demand inelastic products

77

Operating leverage
Mohit wants to sell 40 units @Rs.200/unit with purchase cost of
Rs.120/unit
Cost options:
Option-I
Option-II
Option-III
Rs.2000 FC Rs.800 FC + 15% of Revenue
25% of Revenue
OI: Rs.1200
Rs.1200
Rs.1200
BEP: 25 units
16 units
0 units
MOS= 15 units
24 units
40 units
If no. of units sold drops to 20 units: option I will give operating loss.
If no. of units sold is 60, option I will give highest OI of Rs.2800.

Cont.
Learning:
Moving from I to III: Mohit faces less risk of loss when demand is
low, but looses opportunity for higher OI when demand is high.
Choice of cost structure: confidence in demand projection and
ability to bear loss
- Operating leverage measures this risk-return trade-off

Cont..
- Operating leverage describes the effects that fixed costs have on
changes in OI as changes in sales volume happens, and, hence in
contribution margin.
- High FC and lower VC means, higher operating leverage: small
increase in sales results in large increase in OI and small decrease
means large decrease in OI leading to greater risk of operating loss.
- At a given level of sales: degree of operating leverage =
contribution margin / operating income

Cont..
1. CMU
2. CM
3. OI

Option-I
Rs.80
Rs.3200
Rs.1200

Degree of
Operating leverage
[DOL]

2.67

Option-II
Rs.50
Rs.2000
Rs.1200
1.67

Option-III
Rs.30
Rs.1200
Rs.1200
1.00

DOL is specific to a given level of sales as starting point. If

the starting point changes, DOL changes
Interpretation: Change of sales by 50% would change the OI
under option-I by 50% X 2.67, i.e., by 133%

Concept in action
Influencing cost structures to manage the risk-return
trade-off at amazon.com
- Amazon.com- virtual model- no warehousing and
inventory cost, but cost of books is high
Barnes & Noble- brick & mortar model- purchased from
publishers with lower cost- high fixed cost
Amazon went for acquisition of distribution centres
(increased FC, Operating Leverage, risk, but lower VC)

Effect of time

Whether a cost is fixed or not, depends on:

Relevant range
Time horizon
Decision in hand

Limiting Factor
Constraints
Contribution per unit of the limiting factor
Multiple limiting factors

Contribution margin v. gross margin

Contribution income
statement
Revenues
100
VC of goods sold
60
Variable operating
Cost
15
Contribution margin
25
Less: FC
5
Operating income
20

Gross margin income

statement
Revenues
100
Cost of goods sold
60
Gross margin
40
Operating cost[15+5]
20
Operating income
20

CVP Analysis
Marginal costing as a traditional technique is still a powerful
element within management accounting:
* Superb short-term planning and analytical tool
* Places emphasis on contribution margin of
products/services
* Effective when coupled with sensitivity analysis
In todays world, many experts feel the name should be changed
to CAP analysis (Cost-Activity-Profit)
Knowledge of the assumptions is essential to use of this
technique

CVP 86

COST-VOLUME-PROFIT
Traditional Format

Total
Revenue

Total $

Total Costs

Breakeven
Point

Total Variable
Costs

Total Fixed
Costs

Level of Activity

CVP 87

Cvp Analysis Advantages

Assists in
establishing prices
of products.

Assists in analyzing
the impact that
volume has on
short-term profits.

Assists in focusing
on the impact that
changes in costs
(variable and fixed)
have on profits.

Assists in analyzing
how the mix of
products affects
profits.

88

Price Fixation
Price below the Total Cost
Special Markets & Customers
Selling Price below Marginal Cost

CVP 89

CVP ANALYSIS Additional Items

Break-even considerations
Target income goals

CVP 90

Limitations of CVP Analysis

Requires accurate knowledge of revenue and cost amounts and
behavior patterns
Identification of fixed and variable components

Linear revenue and cost functions

Integration of concept of relevant range

No change in inventories
Constant sales mix

CVP 91

Three Methods of Using the CVP

Model
Operating Income Approach
Contribution Approach
Graphical Approach

CVP 92

CVP Definitions

Contribution margin
Revenue Variable costs

Contribution margin ratio

Contribution margin / Revenue
These items may be computed
either in total or per unit

CVP 93

CVP Example
Assume the following:

Sales (400 Microwaves)

Less: Variable Expenses
Contribution Margin

Total
Per unit %of Sales
$200,000 $500
100%
120,000
300
60%
$ 80,000 $200
40%

Less Fixed Expenses

Net Income

70,000
$10,000

1. What is the break-even point?

2. How much sales-revenue must be generated to earn before-tax profit $30,000?
3. How much sales-revenue must be generated to earn an after-tax profit of $30,000 and
a 40% marginal tax rate?

CVP 94

The Operating Income Approach for

Breakeven Point
Sales - Variable costs - Fixed Costs = Net Income
Sales-Revenue Method:
100%(Sales)- 60%(Sales) - $70,000 =0 (at BEP)
.4 (Sales) = $70,000
Sales = $175,000
Units-Sold Method:
Let x = Number of microwaves at the break-even
point
$500(x) - $300(x) - $70,000 = 0 (at BEP)
$200 (x) = $70,000
x = 350 microwaves

The Contribution Approach for

Breakeven Point

CVP 95

Sales-Revenue Method:
BEP (Revenue $) = (Fixed Costs + Net Income)/Contribution Ratio
= $70,000 + 0/.40
= $175,000
Units-Sold Method:
BEP (Revenue Units) = (Fixed Costs + Net Income)/Contribution
per microwave
= $70,000 + 0/$200 per microwave
= 350 units

CVP 96

The Operating Income Approach for

Targeted Pre-tax Income
Sales - Variable costs - Fixed Costs = Net Income
Sales-Revenue Method:
100%(Sales)- 60%(Sales) - $70,000 = $30,000
.4 (Sales) = $100,000
Sales = $250,000
Units-Sold Method:
Let x = Number of microwaves
$500(x) - $300(x) - $70,000 = $30,000
$200 (x) = $100,000
x = 500 microwaves

CVP 97

C-V-P and
Targeted After-Tax Profits
Sales - Variable costs - Fixed Costs = Net Income/ (1-tax rate)
Sales-Revenue Method:
100%(Sales)- 60%(Sales) - $70,000 = $30,000/(1-.4)
.4 (Sales) = $120,000
Sales = $300,000
Units-Sold Method:
Let x = Number of microwaves
$500(x) - $300(x) - $70,000 = $30,000/(1-.4)
$200 (x) = $120,000
x = 600 microwaves

CVP 98

COST-PROFIT-VOLUME
Contribution Margin Format

Total
Revenue
Total Costs

Total $
Breakeven
Point

Total Fixed
Costs

Total Variable
Costs
Contribution
Margin

Level of Activity

CVP 99

A Multiple-Product Example
Assume the following:
Regular
Unit of Sales
Sales Price per Unit
Sales Revenue
Less: Variable Expenses
Contribution Margin
Less Fixed Expenses
Net Income

400
$500
$200,000
120,000
$ 80,000

Deluxe Total Percent

200
$750
$150,000
60,000
$ 90,000

600
---------$350,000 100.0%
180,000 51.4
$170,000 48.6%
130,000
$ 40,000

1. What is the break-even point?

2. How much sales-revenue of each product must be
generated to earn a before-tax profit $50,000?

Recap CVP Analysis

Learning Objectives:

Themes:
Identify common cost behavior patterns.

Its all about how costs change in

total with respect to changes in
activity.

Estimate the relation between cost and

activity using account analysis, the highlow method, and scattergraphs.
Perform cost-volume-profit-analysis for
single products.

C-V-P-A is linear.
Perform cost-volume-profit-analysis for
multiple products.

One must be able to put all costs

into either variable or fixed cost
categories.

Discuss the effect of operating leverage.

Use the contribution margin per unit of the
constraint to analyze situations involving a
resource constraint.

Common Cost Behavior Patterns

To perform CostVolume-ProfitAnalysis (C-V-P-A),
you need to know
how costs behave
when business
activity (production
volume, sales
volume) changes.

Related Learning Objectives:

1.
Identify common cost
behavior patterns.
2.
Estimate the relation
between cost and activity
using account analysis, the
high-low method, and
scattergraphs.
3.
Perform cost-volume-profitanalysis for single products.
4.
Perform cost-volume-profitanalysis for multiple
products.
5.
Discuss the effect of
operating leverage.
6.
Use the contribution margin
per unit of the constraint to
analyze situations involving a
resource constraint.

Variable Costs
By definition, Variable Costs are costs that
change (in total) in response to changes
in volume or activity. It is assumed, too,
that the relationship between variable
costs and activity is proportional. That is, if
production volume increases by 10%,
then variable costs in total will rise by
10%. Examples include direct labor, raw
materials and sales commissions.

Fixed Costs

By definition, Fixed Costs are

costs that do not change (in
total) in response to changes in
volume or activity. Examples
include depreciation,
supervisory salaries and
maintenance expenses.

Mixed Costs
Mixed Costs are costs that contain
both a variable cost element and a
fixed cost element. These costs are
sometimes referred to as semivariable costs. An example would
be a salespersons salary where
she receives a base salary plus
commissions.

105

Review Points

Concepts
Useful Equations

106

Thank You