chapter 18. identify how changes in volume affect costs

Chapter 18

Identify how changes in volume affect costs

Total variable costs change in direct proportion to changes in the volume of activity◦ If activity increases, so does the cost

Unit variable cost remains constant


Units produce

d

Direct materials cost per

unit

Total direct

materials cost

100 $25 $2,500

200 $25 5,000

300 $25 7,500

400 $25 10,000

500 $25 12,500

Do not change over wide ranges in volume Examples:

◦ Straight-line depreciation◦ Salaries

Fixed cost per unit is inversely proportional to activity◦ The more activity, the less the fixed cost per unit


Have both a fixed and variable component Example:

◦ Utilities that charge a set fee per month, plus a charge for usage


$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$4,500

$0 $10,000 $20,000 $30,000 $40,000

Total Sales

Sal

es C

om

pen

sati

on

9

Variable

Fixed

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

10Copyright (c) 2009 Prentice Hall. All rights reserved


Change in total cost

Change in activity

Total mixed cost

Total variable cost

Variable cost per

unit

Total fixed costs

minus #2#2

#1#1


Number of units

Variable cost per

unit

Total mixed cost

Total fixed costs


Variable cost per unit

Change in total cost

Change in activity

$4,400 - $4,000

1400 - 900



$0.80 per inspection$0.80 per inspection


Total fixed costs

Total mixed cost

minus

Total variable cost

$4,000

minus

900 inspections x $0.80

Total fixed costs

$3,280$3,280Total fixed costs


Number of inspections

$0.80 per inspection

Total mixed cost

$3,280

$0.80 per inspection$0.80 per inspection

1,000 inspections

1,000 inspections

$3,280

$4,080$4,080

Band of volume: ◦ Where total fixed costs remain constant and

variable cost per unit remains constant Outside the relevant range, costs can differ


Use CVP analysis to compute breakeven points

Sales level at which operating income is zero◦ Sales above breakeven result in a profit◦ Sales below breakeven result in a loss

Two methods:◦ Income statement approach◦ Contribution margin approach


Copyright (c) 2009 Prentice Hall. All rights reserved21

Sales – Variable costs – Fixed costs = Operating income

Sales – Variable costs – Fixed costs = Operating income

Selling price per

unit x units sold

Selling price per

unit x units sold

Variable cost per unit x

units sold

Variable cost per unit x

units sold

Fixed costsFixed costs

Operating incomeOperating income

Set to zero

Solve for units sold


Sales revenue per unit

Variable costs per

unit

Contribution margin per unit




Breakeven point in

units

Breakeven point in

units


Sales revenue

Contribution margin

ratio

Contribution margin

Fixed costs

Contribution margin ratio

Breakeven point in sales

dollars

Use CVP analysis for profit planning, and graph the CVP relations


Fixed costs + Desired operating income

Contribution margin ratio

Target sales in dollars

Target sales in dollars

$0

$5,000

$10,000

$15,000

$20,000

0 500 1,000 1,500

Volume of Units

Do

llars

Revenues

26

•

$0

$5,000

$10,000

$15,000

$20,000

0 500 1,000 1,500

Volume of Units

Do

lla

rs

RevenuesFixed costs

27

28

$0

$5,000

$10,000

$15,000

$20,000

0 500 1,000 1,500

Volume of Units

Do

lla

rs RevenuesFixed costsTotal cost

$0

$5,000

$10,000

$15,000

$20,000

0 500 1,000 1,500

Volume of Units

Do

llars

29

Breakeven point

Profit

Loss

Use CVP methods to perform sensitivity analysis

Management tool to predict how changes in sale prices, cost or volume affects profits

“What if?” analysis



All would impact breakeven point


Cause Effect Result

Change Contribution margin

Breakeven point

Selling price increases Increase Decrease

Selling price decreases Decrease Increase

Variable cost per unit increases Decrease Increase

Variable cost per unit decreases

Increase Decrease

Fixed costs increase No effect Increase

Fixed costs decrease No effect Decrease

Excess of expected sales over breakeven sales

Cushion company can absorb without incurring a loss


Expected sales in units

Expected sales in units

Breakeven sales in unitsBreakeven

sales in units

Margin of safety in

units

Margin of safety in

units

Expected sales in dollars

Breakeven sales in dollars

Margin of safety in dollars


Sales price per unit

Variable costs per

unit

Contribution margin per

unit




Breakeven point in

units

Breakeven point in

units

$230 $70 $160

$112,000

$160

700 students


Decreased Sales price

per unit

Decreased Sales price

per unit

Variable costs per

unit

Variable costs per

unit

Decreased Contribution margin per

unit

Decreased Contribution margin per

unit




New Breakeven point in

units


units

$200$200 $70 $130$130

$112,000

$130

862 students




Decreased variable costs per

unit

Decreased variable costs per

unit

Increased Contribution margin per

unit

Increased Contribution margin per

unit





units


units

$50$50 $180$180

$112,000

$180

623 students

$230



Variable costs per

unit

Contribution margin per

unit

Decreased fixed costsDecreased fixed costs



Breakeven point in

units

Breakeven point in

units

$230 $70 $160

$102,000$102,000

$160

638 students

Calculate the breakeven point for multiple product lines or services

Selling prices and variable costs differ for each product◦ Different contribution to profits

Weighted-average contribution margin computed

Sales mix provides weights◦ Combination of products that make up total sales


Calculate weighted average contribution margin per unit


Product A Product B Total

Sales price per unit $100 $150

Variable cost per unit 58 60

Contribution margin per unit 42 90

Sales mix per unit 5 3 8

Contribution margin 210 270 480

Weighted average contribution margin $60

A company has two products with the sales prices and variable costs per unit indicated

in the table

The sales mix weight is multiplied by the

product’s contribution margin

Last year, the company sold 5,000 units of A and 3,000 units of B. This results in a sale

mix of 5:3

The sales mix weights are added as well as

the products’ contribution margins

$480 divided by 8 results in a weighted average contribution

margin of $60

Calculate breakeven point for the package of products



Weighted average contribution margin per unit

Weighted average contribution margin per unit

$600,000

$60

10,000 units

assumed

Calculate the breakeven point for each product line◦ Multiply the package breakeven point by each

product line’s proportion of the sales mix


Breakeven point Product A

10,000 x 5/8 6,250 units

Breakeven point Product B

10,000 x 3/8 3,750 units

chapter 18. identify how changes in volume affect costs

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