Introduction to Cost Behavior and Cost-Volume Relationships

©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 2 - 1
Introduction to Management AccountingIntroduction to Management AccountingIntroduction to Management AccountingIntroduction to Management Accounting
Introduction to CostIntroduction to Cost
Behavior and Cost-Behavior and Cost-
Volume RelationshipsVolume Relationships
Introduction to CostIntroduction to Cost
Behavior and Cost-Behavior and Cost-
Volume RelationshipsVolume Relationships
Chapter 2Chapter 2

Cost Drivers and Cost BehaviorCost Drivers and Cost Behavior
Traditional View of Cost BehaviorTraditional View of Cost Behavior Activity-Based View of Cost BehaviorActivity-Based View of Cost Behavior
Resource AResource A
Cost Driver =Cost Driver =
Units ofUnits of
ResourceResource
OutputOutput
Units ofUnits of
ResourceResource
OutputOutput
Resource BResource B
Units ofUnits of
ResourceResource
OutputOutput
Units ofUnits of
ResourceResource
OutputOutput
Activity AActivity A
Units ofUnits of
Activity OutputActivity Output
Activity AActivity A
Units ofUnits of
Activity BActivity B
Units ofUnits of
Activity BActivity B
Units ofUnits of
Units ofUnits of
ResourceResource
OutputOutput
Units ofUnits of
ResourceResource
OutputOutput
Units ofUnits of
ResourceResource
OutputOutput
Units ofUnits of
ResourceResource
OutputOutput
Product or ServiceProduct or Service
Cost Driver = Units of FinalCost Driver = Units of Final
Cost Driver = Output of FinalCost Driver = Output of Final
LearningLearning
Objective 1Objective 1

Cost Drivers and Cost BehaviorCost Drivers and Cost Behavior
Cost behavior is how the activitiesCost behavior is how the activities
of an organization affect its costs.of an organization affect its costs.
Cost behavior is how the activitiesCost behavior is how the activities
of an organization affect its costs.of an organization affect its costs.
Any output measure that causesAny output measure that causes
the use of costly resourcesthe use of costly resources
is a cost driver.is a cost driver.
Any output measure that causesAny output measure that causes
the use of costly resourcesthe use of costly resources
is a cost driver.is a cost driver.

Value Chain Functions, Costs, and Cost DriversValue Chain Functions, Costs, and Cost Drivers
Value Chain Function and Example CostsValue Chain Function and Example Costs Example Cost DriversExample Cost Drivers
Research and development
•Salaries marketing research personnel Number of new
product proposals
costs of market surveys
•Salaries of product and process engineers Complexity of
proposed products
Design of products, services, and processes
•Salaries of product and process engineers Number of
engineering hours
•Cost of computer-aided design equipment Number of parts per
product
•Cost to develop prototype of product
Research and development
•Salaries marketing research personnel Number of new
product proposals
costs of market surveys
•Salaries of product and process engineers Complexity of
proposed products
Design of products, services, and processes
•Salaries of product and process engineers Number of
engineering hours
•Cost of computer-aided design equipment Number of parts per
product
•Cost to develop prototype of product

Production
•Labor wages Labor hours
•Supervisory salaries Number of people
supervised
•Maintenance wages Number of mechanic
hours
•Depreciation of plant and machinery Number of
machine hours
supplies
Energy cost Kilowatt hours
Marketing
•Cost of advertisements Number of
advertisements
Production
•Labor wages Labor hours
•Supervisory salaries Number of people
supervised
•Maintenance wages Number of mechanic
hours
•Depreciation of plant and machinery Number of
machine hours
supplies
Energy cost Kilowatt hours
Marketing
•Cost of advertisements Number of
advertisements

Value chain function and Example costsValue chain function and Example costs Example Cost DriversExample Cost Drivers
Distribution
•Wages of shipping personnel Labor hours
•Transportation costs including Weight of
items delivered
depreciation of vehicles and fuel
Customer service
•Salaries of service personnel Hours spent
servicing products
•Costs of supplies, travel Number of
service calls
Value chain function and Example costsValue chain function and Example costs Example Cost DriversExample Cost Drivers
Distribution
•Wages of shipping personnel Labor hours
•Transportation costs including Weight of
items delivered
depreciation of vehicles and fuel
Customer service
•Salaries of service personnel Hours spent
servicing products
•Costs of supplies, travel Number of
service calls

Variable and Fixed Cost BehaviorVariable and Fixed Cost Behavior
AA variable costvariable cost
changes in directchanges in direct
proportion to changesproportion to changes
in the cost-driver level.in the cost-driver level.
AA variable costvariable cost
changes in directchanges in direct
proportion to changesproportion to changes
in the cost-driver level.in the cost-driver level.
AA fixed costfixed cost isis
not immediatelynot immediately
affected by changesaffected by changes
in the cost-driver.in the cost-driver.
AA fixed costfixed cost isis
not immediatelynot immediately
affected by changesaffected by changes
in the cost-driver.in the cost-driver.
Think of variableThink of variable
costs on a per-unit basis.costs on a per-unit basis.
Think of variableThink of variable
costs on a per-unit basis.costs on a per-unit basis.
The per-unit variableThe per-unit variable
cost remains unchangedcost remains unchanged
regardless of changes inregardless of changes in
the cost-driver.the cost-driver.
The per-unit variableThe per-unit variable
cost remains unchangedcost remains unchanged
regardless of changes inregardless of changes in
the cost-driver.the cost-driver.
Think of fixed costsThink of fixed costs
on a total-cost basis.on a total-cost basis.
Think of fixed costsThink of fixed costs
on a total-cost basis.on a total-cost basis.
Total fixed costs remainTotal fixed costs remain
unchanged regardless ofunchanged regardless of
changes in the cost-driver.changes in the cost-driver.
Total fixed costs remainTotal fixed costs remain
unchanged regardless ofunchanged regardless of
changes in the cost-driver.changes in the cost-driver.
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Relevant RangeRelevant Range
The relevant range is the limitThe relevant range is the limit
of cost-driver activity level within which aof cost-driver activity level within which a
specific relationship between costsspecific relationship between costs
and the cost driver is valid.and the cost driver is valid.
The relevant range is the limitThe relevant range is the limit
of cost-driver activity level within which aof cost-driver activity level within which a
specific relationship between costsspecific relationship between costs
and the cost driver is valid.and the cost driver is valid.
Even within the relevant range, a fixedEven within the relevant range, a fixed
cost remains fixed only over a givencost remains fixed only over a given
period of time Usually the budget period.period of time Usually the budget period.
Even within the relevant range, a fixedEven within the relevant range, a fixed
cost remains fixed only over a givencost remains fixed only over a given
period of time Usually the budget period.period of time Usually the budget period.

Fixed Costs and Relevant RangeFixed Costs and Relevant Range
20 40 60 80 1020 40 60 80 10
$115,000$115,000
100,000100,000
60,00060,000
Total Cost-Driver Activity in ThousandsTotal Cost-Driver Activity in Thousands
of Cases per Monthof Cases per Month
TotalMoTotalMo
Relevant rangeRelevant range
$115,000$115,000
100,000100,000
60,00060,000
20 40 60 80 1020 40 60 80 10

CVP ScenarioCVP Scenario
Per Unit Percentage of SalesPer Unit Percentage of Sales
Selling priceSelling price $1.50$1.50 100%100%
Variable cost of each itemVariable cost of each item 1.201.20 8080
Selling price less variable costSelling price less variable cost $ .30$ .30 20%20%
Monthly fixed expenses:Monthly fixed expenses:
RentRent $3,000$3,000
Wages for replenishing andWages for replenishing and
servicingservicing 13,50013,500
Other fixed expensesOther fixed expenses 1,5001,500
Total fixed expenses per month $ 18,000Total fixed expenses per month $ 18,000
Per Unit Percentage of SalesPer Unit Percentage of Sales
Selling priceSelling price $1.50$1.50 100%100%
Variable cost of each itemVariable cost of each item 1.201.20 8080
Selling price less variable costSelling price less variable cost $ .30$ .30 20%20%
Monthly fixed expenses:Monthly fixed expenses:
RentRent $3,000$3,000
Wages for replenishing andWages for replenishing and
servicingservicing 13,50013,500
Other fixed expensesOther fixed expenses 1,5001,500
Total fixed expenses per month $ 18,000Total fixed expenses per month $ 18,000
Cost-volume-profit (CVP) analysis is the study of the effects of outputCost-volume-profit (CVP) analysis is the study of the effects of output
volume on revenue (sales), expenses (costs), and net income (net profit).volume on revenue (sales), expenses (costs), and net income (net profit).
Cost-volume-profit (CVP) analysis is the study of the effects of outputCost-volume-profit (CVP) analysis is the study of the effects of output
volume on revenue (sales), expenses (costs), and net income (net profit).volume on revenue (sales), expenses (costs), and net income (net profit).

Break-Even PointBreak-Even Point
The break-even point is the level of sales at whichThe break-even point is the level of sales at which
revenue equals expenses and net income is zero.revenue equals expenses and net income is zero.
The break-even point is the level of sales at whichThe break-even point is the level of sales at which
revenue equals expenses and net income is zero.revenue equals expenses and net income is zero.
SalesSales
- Variable expenses- Variable expenses
- Fixed expenses- Fixed expenses
Zero net income (break-even point)Zero net income (break-even point)
SalesSales
- Variable expenses- Variable expenses
- Fixed expenses- Fixed expenses
Zero net income (break-even point)Zero net income (break-even point)
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Contribution Margin MethodContribution Margin Method
$18,000 fixed costs ÷ $.30$18,000 fixed costs ÷ $.30
= 60,000 units (break even)= 60,000 units (break even)
$18,000 fixed costs ÷ $.30$18,000 fixed costs ÷ $.30
= 60,000 units (break even)= 60,000 units (break even)
Contribution marginContribution margin
Per UnitPer Unit
Selling priceSelling price $1.50$1.50
Variable costsVariable costs 1.201.20
Contribution marginContribution margin $ .30$ .30
Contribution marginContribution margin
Per UnitPer Unit
Contribution marginContribution margin $ .30$ .30
Contribution margin ratioContribution margin ratio
Per UnitPer Unit %%
Selling priceSelling price 100100
Variable costsVariable costs .80.80
Contribution marginContribution margin .20.20
Per UnitPer Unit %%

Contribution Margin MethodContribution Margin Method
$18,000 fixed costs$18,000 fixed costs
÷ 20% (contribution-margin percentage)÷ 20% (contribution-margin percentage)
= $90,000 of sales to break even= $90,000 of sales to break even
$18,000 fixed costs$18,000 fixed costs
÷ 20% (contribution-margin percentage)÷ 20% (contribution-margin percentage)
= $90,000 of sales to break even= $90,000 of sales to break even
60,000 units × $1.50 = $90,00060,000 units × $1.50 = $90,000
in sales to break evenin sales to break even
60,000 units × $1.50 = $90,00060,000 units × $1.50 = $90,000
in sales to break evenin sales to break even

Equation MethodEquation Method
Sales – variable expenses – fixed expenses = net incomeSales – variable expenses – fixed expenses = net income
$1.50N – $1.20N – $18,000 = 0$1.50N – $1.20N – $18,000 = 0
$.30N = $18,000$.30N = $18,000
N = $18,000 ÷ $.30N = $18,000 ÷ $.30
N = 60,000 UnitsN = 60,000 Units
Sales – variable expenses – fixed expenses = net incomeSales – variable expenses – fixed expenses = net income
$1.50N – $1.20N – $18,000 = 0$1.50N – $1.20N – $18,000 = 0
$.30N = $18,000$.30N = $18,000
N = $18,000 ÷ $.30N = $18,000 ÷ $.30
N = 60,000 UnitsN = 60,000 Units
Let N = number of unitsLet N = number of units
to be sold to break even.to be sold to break even.
Let N = number of unitsLet N = number of units
to be sold to break even.to be sold to break even.

Equation MethodEquation Method
S – .80S – $18,000 = 0S – .80S – $18,000 = 0
.20S = $18,000.20S = $18,000
S = $18,000 ÷ .20S = $18,000 ÷ .20
S = $90,000S = $90,000
S – .80S – $18,000 = 0S – .80S – $18,000 = 0
.20S = $18,000.20S = $18,000
S = $18,000 ÷ .20S = $18,000 ÷ .20
S = $90,000S = $90,000
Let S = sales in dollarsLet S = sales in dollars
needed to break even.needed to break even.
Let S = sales in dollarsLet S = sales in dollars
needed to break even.needed to break even.
Shortcut formulas:Shortcut formulas:
Break-even volume in units =Break-even volume in units = fixed expensesfixed expenses
unit contribution marginunit contribution margin
Break-even volume in sales =Break-even volume in sales = fixed expensesfixed expenses
contribution margin ratiocontribution margin ratio
Shortcut formulas:Shortcut formulas:
Break-even volume in units =Break-even volume in units = fixed expensesfixed expenses
unit contribution marginunit contribution margin
Break-even volume in sales =Break-even volume in sales = fixed expensesfixed expenses

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
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Target Net ProfitTarget Net Profit
Managers use CVP analysisManagers use CVP analysis
to determine the total sales,to determine the total sales,
in units and dollars, neededin units and dollars, needed
To reach a target net profit.To reach a target net profit.
Managers use CVP analysisManagers use CVP analysis
to determine the total sales,to determine the total sales,
in units and dollars, neededin units and dollars, needed
To reach a target net profit.To reach a target net profit.
Target salesTarget sales
–– variable expensesvariable expenses
–– fixed expensesfixed expenses
target net incometarget net income
Target salesTarget sales
–– variable expensesvariable expenses
–– fixed expensesfixed expenses
target net incometarget net income
$1,440 per month$1,440 per month
is the minimumis the minimum
acceptable net income.acceptable net income.
$1,440 per month$1,440 per month
is the minimumis the minimum
acceptable net income.acceptable net income.
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Target sales volume in units =Target sales volume in units =
(Fixed expenses + Target net income)(Fixed expenses + Target net income)
÷ Contribution margin per unit÷ Contribution margin per unit
Target sales volume in units =Target sales volume in units =
(Fixed expenses + Target net income)(Fixed expenses + Target net income)
÷ Contribution margin per unit÷ Contribution margin per unit
($18,000 + $1,440) ÷ $.30 = 64,800 units($18,000 + $1,440) ÷ $.30 = 64,800 units($18,000 + $1,440) ÷ $.30 = 64,800 units($18,000 + $1,440) ÷ $.30 = 64,800 units
Contribution margin per unitContribution margin per unit $ .30$ .30
Contribution margin per unitContribution margin per unit $ .30$ .30
Target sales dollars = sales price X sales volume in unitsTarget sales dollars = sales price X sales volume in units
Target sales dollars = $1.50 X 64,800 units = $97,200.Target sales dollars = $1.50 X 64,800 units = $97,200.
Target sales dollars = sales price X sales volume in unitsTarget sales dollars = sales price X sales volume in units
Target sales dollars = $1.50 X 64,800 units = $97,200.Target sales dollars = $1.50 X 64,800 units = $97,200.

Sales volume in dollars =Sales volume in dollars = 18,000 + $1,44018,000 + $1,440 = $97,200= $97,200
.20.20
Sales volume in dollars =Sales volume in dollars = 18,000 + $1,44018,000 + $1,440 = $97,200= $97,200
.20.20
Target sales volume in dollars =Target sales volume in dollars = Fixed expenses + target net incomeFixed expenses + target net income
Target sales volume in dollars =Target sales volume in dollars = Fixed expenses + target net incomeFixed expenses + target net income
Per UnitPer Unit %%
Per UnitPer Unit %%

Operating LeverageOperating Leverage
Operating leverage: a firm’s ratio of fixed costs to variable costs.Operating leverage: a firm’s ratio of fixed costs to variable costs.Operating leverage: a firm’s ratio of fixed costs to variable costs.Operating leverage: a firm’s ratio of fixed costs to variable costs.
Margin of safety = planned unit sales – break-even salesMargin of safety = planned unit sales – break-even sales
How far can sales fall below the planned level before losses occur?How far can sales fall below the planned level before losses occur?
Margin of safety = planned unit sales – break-even salesMargin of safety = planned unit sales – break-even sales
How far can sales fall below the planned level before losses occur?How far can sales fall below the planned level before losses occur?
Highly leveraged firms have high fixed costs and low variable costs.Highly leveraged firms have high fixed costs and low variable costs.
A small change in sales volume = a large change in net income.A small change in sales volume = a large change in net income.
Highly leveraged firms have high fixed costs and low variable costs.Highly leveraged firms have high fixed costs and low variable costs.
A small change in sales volume = a large change in net income.A small change in sales volume = a large change in net income.
Low leveraged firms have lower fixed costs and higher variable costs.Low leveraged firms have lower fixed costs and higher variable costs.
Changes in sales volume will have a smaller effect on net income.Changes in sales volume will have a smaller effect on net income.
Low leveraged firms have lower fixed costs and higher variable costs.Low leveraged firms have lower fixed costs and higher variable costs.
Changes in sales volume will have a smaller effect on net income.Changes in sales volume will have a smaller effect on net income.

Contribution MarginContribution Margin
and Gross Marginand Gross Margin
Sales price – Cost of goods sold = Gross marginSales price – Cost of goods sold = Gross marginSales price – Cost of goods sold = Gross marginSales price – Cost of goods sold = Gross margin
Sales price - all variable expenses = Contribution marginSales price - all variable expenses = Contribution marginSales price - all variable expenses = Contribution marginSales price - all variable expenses = Contribution margin
Per UnitPer Unit
Variable costs (acquisition cost)Variable costs (acquisition cost) 1.201.20
Contribution margin andContribution margin and
gross margin are equalgross margin are equal $ .30$ .30
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Contribution Margin and Gross MarginContribution Margin and Gross Margin
Contribution GrossContribution Gross
Margin MarginMargin Margin
Per UnitPer Unit Per UnitPer Unit
SalesSales $1.50$1.50 $1.50$1.50
Acquisition cost of unit soldAcquisition cost of unit sold 1.201.20 1.201.20
Variable commissionVariable commission .12.12
Total variable expenseTotal variable expense $1.32$1.32
Gross marginGross margin $.30$.30
Contribution GrossContribution Gross
Margin MarginMargin Margin
Per UnitPer Unit Per UnitPer Unit
SalesSales $1.50$1.50 $1.50$1.50
Acquisition cost of unit soldAcquisition cost of unit sold 1.201.20 1.201.20
Variable commissionVariable commission .12.12
Total variable expenseTotal variable expense $1.32$1.32
Gross marginGross margin $.30$.30
Suppose the firm had to pay a commission of $.12Suppose the firm had to pay a commission of $.12 per unit sold.per unit sold.Suppose the firm had to pay a commission of $.12Suppose the firm had to pay a commission of $.12 per unit sold.per unit sold.

Nonprofit ApplicationNonprofit Application
Suppose a city has a $100,000Suppose a city has a $100,000
lump-sum budget appropriationlump-sum budget appropriation
to conduct a counseling program.to conduct a counseling program.
Suppose a city has a $100,000Suppose a city has a $100,000
lump-sum budget appropriationlump-sum budget appropriation
to conduct a counseling program.to conduct a counseling program.
Variable costs per prescriptionVariable costs per prescription
is $400 per patient per day.is $400 per patient per day.
Variable costs per prescriptionVariable costs per prescription
is $400 per patient per day.is $400 per patient per day.
Fixed costs are $60,000 in theFixed costs are $60,000 in the
relevant range of 50 to 150 patients.relevant range of 50 to 150 patients.
Fixed costs are $60,000 in theFixed costs are $60,000 in the
relevant range of 50 to 150 patients.relevant range of 50 to 150 patients.

If the city spends the entire budgetIf the city spends the entire budget
appropriation, how many patientsappropriation, how many patients
can it serve in a year?can it serve in a year?
If the city spends the entire budgetIf the city spends the entire budget
appropriation, how many patientsappropriation, how many patients
can it serve in a year?can it serve in a year?
$100,000 = $400N + $60,000$100,000 = $400N + $60,000
$400N = $100,000 – $60,000$400N = $100,000 – $60,000
N = $40,000 ÷ $400N = $40,000 ÷ $400
N = 100 patientsN = 100 patients
$100,000 = $400N + $60,000$100,000 = $400N + $60,000
$400N = $100,000 – $60,000$400N = $100,000 – $60,000
N = $40,000 ÷ $400N = $40,000 ÷ $400

If the city cuts the total budgetIf the city cuts the total budget
Appropriation by 10%, how manyAppropriation by 10%, how many
Patients can it serve in a year?Patients can it serve in a year?
If the city cuts the total budgetIf the city cuts the total budget
Appropriation by 10%, how manyAppropriation by 10%, how many
Patients can it serve in a year?Patients can it serve in a year?
$90,000 = $400N + $60,000$90,000 = $400N + $60,000
$400N = $90,000 – $60,000$400N = $90,000 – $60,000
N = $30,000 ÷ $400N = $30,000 ÷ $400
$90,000 = $400N + $60,000$90,000 = $400N + $60,000
$400N = $90,000 – $60,000$400N = $90,000 – $60,000
N = $30,000 ÷ $400N = $30,000 ÷ $400
Budget after 10% CutBudget after 10% Cut
$100,000 X (1 - .1) = $90,000$100,000 X (1 - .1) = $90,000
Budget after 10% CutBudget after 10% Cut
$100,000 X (1 - .1) = $90,000$100,000 X (1 - .1) = $90,000

Sales Mix AnalysisSales Mix Analysis
Sales mix is the relative proportions orSales mix is the relative proportions or
combinations of quantities of productscombinations of quantities of products
that comprise total sales.that comprise total sales.
Sales mix is the relative proportions orSales mix is the relative proportions or
combinations of quantities of productscombinations of quantities of products
that comprise total sales.that comprise total sales.
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Ramos Company ExampleRamos Company Example
Sales in unitsSales in units 300,000300,000 75,00075,000 375,000375,000
Sales @ $8 and $5Sales @ $8 and $5 $2,400,000$2,400,000 $375,000$375,000 $2,775,000$2,775,000
Variable expensesVariable expenses
@ $7 and $3@ $7 and $3 2,100,0002,100,000 225,000225,000 2,325,0002,325,000
Contribution marginsContribution margins
@ $1 and $2@ $1 and $2 $ 300,000$ 300,000 $150,000$150,000 $ 450,000$ 450,000
Fixed expensesFixed expenses 180,000180,000
Net incomeNet income $ 270,000$ 270,000
Sales in unitsSales in units 300,000300,000 75,00075,000 375,000375,000
@ $7 and $3@ $7 and $3 2,100,0002,100,000 225,000225,000 2,325,0002,325,000
@ $1 and $2@ $1 and $2 $ 300,000$ 300,000 $150,000$150,000 $ 450,000$ 450,000
WalletsWallets
(W)(W)
Key CasesKey Cases
(K)(K) TotalTotal

Break-even point for a constant sales mixBreak-even point for a constant sales mix
of 4 units of W for every unit of K.of 4 units of W for every unit of K.
sales – variable expenses - fixed expenses = zero net incomesales – variable expenses - fixed expenses = zero net income
[$8(4K) + $5(K)] – [$7(4K) + $3(K)] – $180,000 = 0[$8(4K) + $5(K)] – [$7(4K) + $3(K)] – $180,000 = 0
32K + 5K - 28K - 3K - 180,000 = 032K + 5K - 28K - 3K - 180,000 = 0
6K = 180,0006K = 180,000
K = 30,000K = 30,000
W = 4K = 120,000W = 4K = 120,000
Break-even point for a constant sales mixBreak-even point for a constant sales mix
of 4 units of W for every unit of K.of 4 units of W for every unit of K.
sales – variable expenses - fixed expenses = zero net incomesales – variable expenses - fixed expenses = zero net income
[$8(4K) + $5(K)] – [$7(4K) + $3(K)] – $180,000 = 0[$8(4K) + $5(K)] – [$7(4K) + $3(K)] – $180,000 = 0
32K + 5K - 28K - 3K - 180,000 = 032K + 5K - 28K - 3K - 180,000 = 0
6K = 180,0006K = 180,000
K = 30,000K = 30,000
W = 4K = 120,000W = 4K = 120,000
Let K = number of units of K to break even, andLet K = number of units of K to break even, and
4K = number of units of W to break even.4K = number of units of W to break even.
Let K = number of units of K to break even, andLet K = number of units of K to break even, and
4K = number of units of W to break even.4K = number of units of W to break even.

If the company sells only key cases:If the company sells only key cases:
break-even point =break-even point = fixed expensesfixed expenses
contribution margin per unitcontribution margin per unit
== $$180,000180,000
$2$2
= 90,000 key cases= 90,000 key cases
If the company sells only key cases:If the company sells only key cases:
== $$180,000180,000
$2$2
= 90,000 key cases= 90,000 key cases
If the company sells only wallets:If the company sells only wallets:
== $$180,000180,000
$1$1
= 180,000 wallets= 180,000 wallets
If the company sells only wallets:If the company sells only wallets:
== $$180,000180,000
$1$1
= 180,000 wallets= 180,000 wallets

Suppose total salesSuppose total sales
were equal to thewere equal to the
budget of 375,000 units.budget of 375,000 units.
Suppose total salesSuppose total sales
were equal to thewere equal to the
budget of 375,000 units.budget of 375,000 units.
However, Ramos soldHowever, Ramos sold
only 50,000 key casesonly 50,000 key cases
And 325,000 wallets.And 325,000 wallets.
What is net income?What is net income?
However, Ramos soldHowever, Ramos sold
only 50,000 key casesonly 50,000 key cases
And 325,000 wallets.And 325,000 wallets.
What is net income?What is net income?

Ramos Company ExampleRamos Company Example
Sales in unitsSales in units 325,000 50,000325,000 50,000 375,000375,000
@ $7 and $3@ $7 and $3 2,275,0002,275,000 150,000150,000 2,425,0002,425,000
@ $1 and $2@ $1 and $2 $ 325,000$ 325,000 $100,000$100,000 $ 425,000$ 425,000
Sales in unitsSales in units 325,000 50,000325,000 50,000 375,000375,000
@ $7 and $3@ $7 and $3 2,275,0002,275,000 150,000150,000 2,425,0002,425,000
@ $1 and $2@ $1 and $2 $ 325,000$ 325,000 $100,000$100,000 $ 425,000$ 425,000
WalletsWallets
(W)(W)
Key CasesKey Cases
(K)(K) TotalTotal

Impact of Income TaxesImpact of Income Taxes
Suppose that a company earnsSuppose that a company earns
$480 before taxes and pays$480 before taxes and pays
income tax at a rate of 40%.income tax at a rate of 40%.
Suppose that a company earnsSuppose that a company earns
$480 before taxes and pays$480 before taxes and pays
income tax at a rate of 40%.income tax at a rate of 40%.
What is the after-tax income?What is the after-tax income?What is the after-tax income?What is the after-tax income?
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Target income before taxes =Target income before taxes = Target after-tax net incomeTarget after-tax net income
1 – tax rate1 – tax rate
Target income before taxes =Target income before taxes = $ 288$ 288 = $480= $480
1 – 0.401 – 0.40
Suppose the target net incomeSuppose the target net income
after taxes was $288.after taxes was $288.

Target sales – Variable expenses – Fixed expensesTarget sales – Variable expenses – Fixed expenses
= Target after-tax net income ÷ (1 – tax rate)= Target after-tax net income ÷ (1 – tax rate)
Target sales – Variable expenses – Fixed expensesTarget sales – Variable expenses – Fixed expenses
= Target after-tax net income ÷ (1 – tax rate)= Target after-tax net income ÷ (1 – tax rate)
$.50N – $.40N – $6,000 = $288 ÷ (1 – 0.40)$.50N – $.40N – $6,000 = $288 ÷ (1 – 0.40)
$.10N = $6,000 + ($288/.6)$.10N = $6,000 + ($288/.6)
$.06N = $3,600 + $288 = $3,888$.06N = $3,600 + $288 = $3,888
N = $3,888/$.06N = $3,888/$.06
N = 64,800 unitsN = 64,800 units
$.50N – $.40N – $6,000 = $288 ÷ (1 – 0.40)$.50N – $.40N – $6,000 = $288 ÷ (1 – 0.40)
$.10N = $6,000 + ($288/.6)$.10N = $6,000 + ($288/.6)
$.06N = $3,600 + $288 = $3,888$.06N = $3,600 + $288 = $3,888
N = $3,888/$.06N = $3,888/$.06
N = 64,800 unitsN = 64,800 units

Suppose target net income after taxes was $480Suppose target net income after taxes was $480Suppose target net income after taxes was $480Suppose target net income after taxes was $480
$.50N – $.40N – $6,000 = $480 ÷ (1 – 0.40)$.50N – $.40N – $6,000 = $480 ÷ (1 – 0.40)
$.10N = $6,000 + ($480/.6)$.10N = $6,000 + ($480/.6)
$.06N = $3,600 + $480 = $4080$.06N = $3,600 + $480 = $4080
N = $4,080 ÷ $.06N = $4,080 ÷ $.06
N = 68,000 unitsN = 68,000 units
$.50N – $.40N – $6,000 = $480 ÷ (1 – 0.40)$.50N – $.40N – $6,000 = $480 ÷ (1 – 0.40)
$.10N = $6,000 + ($480/.6)$.10N = $6,000 + ($480/.6)
$.06N = $3,600 + $480 = $4080$.06N = $3,600 + $480 = $4080
N = $4,080 ÷ $.06N = $4,080 ÷ $.06
N = 68,000 unitsN = 68,000 units

End of Chapter 2End of Chapter 2
The EndThe End

Introduction to Cost Behavior and Cost-Volume Relationships

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