chapters 4 and 5. variablefixed mixed copyright (c) 2009 prentice hall. all rights reserved3

Chapters 4 and 5

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

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The manager of Swift Car Inspection reviewed his monthly operating costs for the past year. His costs ranged from $4,400 for 1,400 inspections to $4,000 for 900 inspections. To determine the variable cost per unit, the change in cost, $400, is divided by the 500-unit change in inspections. The result is a variable cost per inspection of 80 cents.



Variable cost per unit

Change in total cost

Change in activity

$4,400 - $4,000

1,400 - 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

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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


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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


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

23

Breakeven point

Profit

Loss

Copyright (c) 2009 Prentice Hall. All rights reserved

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

Country Road Driving School charges $230 per student to prepare and administer written and behind-the-wheel driving tests. Variable costs of $70 per student include trainers’ wages, study materials, and gasoline. Annual fixed costs of $112,000 include the training facility and fleet of cars.



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

33

Variable CostingVariable CostingVariable CostingVariable Costing

34

Inventory costs include: -direct materials used -direct labor incurred -both fixed & variable manufacturing overhead

Required by GAAP for external reporting purposes

Learning objective 1: Explain the difference between full (absorption) and variable costing

35


36

Inventory costs includes:-Direct materials used-Direct labor incurred-Variable manufacturing overhead

Fixed manufacturing overhead treated as a period cost

Helpful for internal decision making Not allowed for GAAP reporting


37


38

Treatment of fixed manufacturing overhead

◦ Under full costing, it is included in inventory and expensed when the product is sold

◦ Under variable costing, it is considered a period cost and expensed in the period incurred.


39

Learning objective 2: Prepare an income statement using variable costing.

40

Learning objective 2: Prepare an income statement using variable costing.

41

Summit Manufacturing, Inc. produces snow shovels. The selling price is $25. Costs are:

Full Cost Unit Cost 13 Variable Unit Cost 9 Fixed Overhead 168,000 Variable Selling & Admin 1 Fixed Selling & Admin 152,000

Sales are 38,500 snow shovels. Calculate net income using variable cost.

Sales 38,500 X 25 962,500 Variable Cost of Sales 38,500 X 9 346,500 Variable Selling & Admin 152,000 + 38,500 X 1 38,500 Fixed Overhead 168,000 Fixed Selling and Admin 152,000 Net Income 257,500

Learning objective 3: Discuss the effect of production on full and variable costing income.

42

Units produced = units soldNo difference in net income

Units produced greater than units soldFull costing yields higher net income

Units Produced less than units soldVariable costing yields higher net income

Learning objective 3: Discuss the effect of production on full and variable costing income.

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