1. Chapter 2 Introduction to Management Accounting Introduction to Cost Behavior and Cost-Volume Relationships
2. Cost Drivers and Cost Behavior Traditional View of Cost Behavior Activity-Based View of Cost Behavior Resource A Cost Driver = Units of Resource Output Resource B Cost Driver = Units of Resource Output Activity A Cost Driver = Units of Activity Output Activity B Cost Driver = Units of Activity Output Resource B Cost Driver = Units of Resource Output Resource A Cost Driver = Units of Resource Output Product or Service Cost Driver = Units of Final Product or Service Product or Service Cost Driver = Output of Final Product or Service Learning Objective 1
3. Cost Drivers and Cost Behavior Cost behavior is how the activities of an organization affect its costs. Any output measure that causes the use of costly resources is a cost driver.
4. Value Chain Functions, Costs, and Cost Drivers <ul><li>Value Chain Function and Example Costs Example Cost Drivers </li></ul><ul><li>Research and development </li></ul><ul><li>Salaries marketing research personnel Number of new product proposals </li></ul><ul><li>costs of market surveys </li></ul><ul><li>Salaries of product and process engineers Complexity of proposed products </li></ul><ul><li>Design of products, services, and processes </li></ul><ul><li>Salaries of product and process engineers Number of engineering hours </li></ul><ul><li>Cost of computer-aided design equipment Number of parts per product </li></ul><ul><li>Cost to develop prototype of product </li></ul><ul><li>for testing </li></ul>
5. Value Chain Functions, Costs, and Cost Drivers <ul><li>Value Chain Function and Example Costs Example Cost Drivers </li></ul><ul><li>Production </li></ul><ul><li>Labor wages Labor hours </li></ul><ul><li>Supervisory salaries Number of people supervised </li></ul><ul><li>Maintenance wages Number of mechanic hours </li></ul><ul><li>Depreciation of plant and machinery Number of machine hours </li></ul><ul><li>supplies </li></ul><ul><li>Energy cost Kilowatt hours </li></ul><ul><li>Marketing </li></ul><ul><li>Cost of advertisements Number of advertisements </li></ul><ul><li>Salaries of marketing personnel, Sales dollars </li></ul><ul><li>travel costs, entertainment costs </li></ul>
6. Value Chain Functions, Costs, and Cost Drivers <ul><li>Value chain function and Example costs Example Cost Drivers </li></ul><ul><li>Distribution </li></ul><ul><li>Wages of shipping personnel Labor hours </li></ul><ul><li>Transportation costs including Weight of items delivered </li></ul><ul><li>depreciation of vehicles and fuel </li></ul><ul><li>Customer service </li></ul><ul><li>Salaries of service personnel Hours spent servicing products </li></ul><ul><li>Costs of supplies, travel Number of service calls </li></ul>
7. Variable and Fixed Cost Behavior A variable cost changes in direct proportion to changes in the cost-driver level. A fixed cost is not immediately affected by changes in the cost-driver. Think of variable costs on a per-unit basis. The per-unit variable cost remains unchanged regardless of changes in the cost-driver. Think of fixed costs on a total-cost basis. Total fixed costs remain unchanged regardless of changes in the cost-driver. Learning Objective 2
8. Relevant Range The relevant range is the limit of cost-driver activity level within which a specific relationship between costs and the cost driver is valid. Even within the relevant range, a fixed cost remains fixed only over a given period of time Usually the budget period.
9. Fixed Costs and Relevant Range 20 40 60 80 100 $115,000 100,000 60,000 Total Cost-Driver Activity in Thousands of Cases per Month Total Monthly Fixed Costs $115,000 100,000 60,000 20 40 60 80 100 Relevant range
10. CVP Scenario Per Unit Percentage of Sales Selling price $1.50 100% Variable cost of each item 1.20 80 Selling price less variable cost $ .30 20% Monthly fixed expenses: Rent $3,000 Wages for replenishing and servicing 13,500 Other fixed expenses 1,500 Total fixed expenses per month $ 18,000 Cost-volume-profit (CVP) analysis is the study of the effects of output volume on revenue (sales), expenses (costs), and net income (net profit).
11. Break-Even Point The break-even point is the level of sales at which revenue equals expenses and net income is zero. Sales - Variable expenses - Fixed expenses Zero net income (break-even point) Learning Objective 3
12. Contribution Margin Method $18,000 fixed costs ÷ $.30 = 60,000 units (break even) Contribution margin Per Unit Selling price $1.50 Variable costs 1.20 Contribution margin $ .30 Contribution margin ratio Per Unit % Selling price 100 Variable costs .80 Contribution margin .20
13. Contribution Margin Method $18,000 fixed costs ÷ 20% (contribution-margin percentage) = $90,000 of sales to break even 60,000 units × $1.50 = $90,000 in sales to break even Or
14. Equation Method Sales – variable expenses – fixed expenses = net income $1.50N – $1.20N – $18,000 = 0 $.30N = $18,000 N = $18,000 ÷ $.30 N = 60,000 Units Let N = number of units to be sold to break even.
15. Equation Method S – .80S – $18,000 = 0 .20S = $18,000 S = $18,000 ÷ .20 S = $90,000 Let S = sales in dollars needed to break even. Shortcut formulas: Break-even volume in units = fixed expenses unit contribution margin Break-even volume in sales = fixed expenses contribution margin ratio
16. Cost-Volume-Profit Graph 18,000 30,000 90,000 120,000 138,000 $150,000 0 10 20 30 40 50 60 70 80 90 100 Units (thousands) Dollars 60,000 Total Expenses Sales Net Income Area Break-Even Point 60,000 units or $90,000 Net Loss Area A C D B Fixed Expenses Variable Expenses Net Income Learning Objective 4
17. Target Net Profit Managers use CVP analysis to determine the total sales, in units and dollars, needed To reach a target net profit. Target sales – variable expenses – fixed expenses target net income $1,440 per month is the minimum acceptable net income. Learning Objective 5
18. Target Net Profit Target sales volume in units = (Fixed expenses + Target net income) ÷ Contribution margin per unit ($18,000 + $1,440) ÷ $.30 = 64,800 units Selling price $1.50 Variable costs 1.20 Contribution margin per unit $ .30 Target sales dollars = sales price X sales volume in units Target sales dollars = $1.50 X 64,800 units = $97,200.
19. Target Net Profit Sales volume in dollars = 18,000 + $1,440 = $97,200 .20 Target sales volume in dollars = Fixed expenses + target net income contribution margin ratio Contribution margin ratio Per Unit % Selling price 100 Variable costs .80 Contribution margin .20 Or
20. Operating Leverage Operating leverage: a firm’s ratio of fixed costs to variable costs. Margin of safety = planned unit sales – break-even sales How far can sales fall below the planned level before losses occur? Highly leveraged firms have high fixed costs and low variable costs. A small change in sales volume = a large change in net income. Low leveraged firms have lower fixed costs and higher variable costs. Changes in sales volume will have a smaller effect on net income.
21. Contribution Margin and Gross Margin Sales price – Cost of goods sold = Gross margin Sales price - all variable expenses = Contribution margin Per Unit Selling price $1.50 Variable costs (acquisition cost) 1.20 Contribution margin and gross margin are equal $ .30 Learning Objective 6
22. Contribution Margin and Gross Margin Contribution Gross Margin Margin Per Unit Per Unit Sales $1.50 $1.50 Acquisition cost of unit sold 1.20 1.20 Variable commission .12 Total variable expense $1.32 Contribution margin .18 Gross margin $.30 Suppose the firm had to pay a commission of $.12 per unit sold.
23. Nonprofit Application Suppose a city has a $100,000 lump-sum budget appropriation to conduct a counseling program. Variable costs per prescription is $400 per patient per day. Fixed costs are $60,000 in the relevant range of 50 to 150 patients.
24. Nonprofit Application If the city spends the entire budget appropriation, how many patients can it serve in a year? $100,000 = $400N + $60,000 $400N = $100,000 – $60,000 N = $40,000 ÷ $400 N = 100 patients
25. Nonprofit Application If the city cuts the total budget Appropriation by 10%, how many Patients can it serve in a year? $90,000 = $400N + $60,000 $400N = $90,000 – $60,000 N = $30,000 ÷ $400 N = 75 patients Budget after 10% Cut $100,000 X (1 - .1) = $90,000
26. Sales Mix Analysis Sales mix is the relative proportions or combinations of quantities of products that comprise total sales. Learning Objective 7
27. Sales Mix Analysis Ramos Company Example Sales in units 300,000 75,000 375,000 Sales @ $8 and $5 $2,400,000 $375,000 $2,775,000 Variable expenses @ $7 and $3 2,100,000 225,000 2,325,000 Contribution margins @ $1 and $2 $ 300,000 $150,000 $ 450,000 Fixed expenses 180,000 Net income $ 270,000 Wallets (W) Key Cases (K) Total
28. Sales Mix Analysis Break-even point for a constant sales mix of 4 units of W for every unit of K. sales – variable expenses - fixed expenses = zero net income [$8(4K) + $5(K)] – [$7(4K) + $3(K)] – $180,000 = 0 32K + 5K - 28K - 3K - 180,000 = 0 6K = 180,000 K = 30,000 W = 4K = 120,000 Let K = number of units of K to break even, and 4K = number of units of W to break even.
29. Sales Mix Analysis If the company sells only key cases: break-even point = fixed expenses contribution margin per unit = $ 180,000 $2 = 90,000 key cases If the company sells only wallets: break-even point = fixed expenses contribution margin per unit = $ 180,000 $1 = 180,000 wallets
30. Sales Mix Analysis Suppose total sales were equal to the budget of 375,000 units. However, Ramos sold only 50,000 key cases And 325,000 wallets. What is net income?
31. Sales Mix Analysis Ramos Company Example Sales in units 325,000 50,000 375,000 Sales @ $8 and $5 $2,600,000 $250,000 $2,850,000 Variable expenses @ $7 and $3 2,275,000 150,000 2,425,000 Contribution margins @ $1 and $2 $ 325,000 $100,000 $ 425,000 Fixed expenses 180,000 Net income $ 245,000 Wallets (W) Key Cases (K) Total
32. Impact of Income Taxes Suppose that a company earns $480 before taxes and pays income tax at a rate of 40%. What is the after-tax income? Learning Objective 8
33. Impact of Income Taxes Target income before taxes = Target after-tax net income 1 – tax rate Target income before taxes = $ 288 = $480 1 – 0.40 Suppose the target net income after taxes was $288.
34. Impact of Income Taxes Target sales – Variable expenses – Fixed expenses = Target after-tax net income ÷ (1 – tax rate) $.50N – $.40N – $6,000 = $288 ÷ (1 – 0.40) $.10N = $6,000 + ($288/.6) $.06N = $3,600 + $288 = $3,888 N = $3,888/$.06 N = 64,800 units
35. Impact of Income Taxes Suppose target net income after taxes was $480 $.50N – $.40N – $6,000 = $480 ÷ (1 – 0.40) $.10N = $6,000 + ($480/.6) $.06N = $3,600 + $480 = $4080 N = $4,080 ÷ $.06 N = 68,000 units
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