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- 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
- 36. The End End of Chapter 2

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