Cost Bhavioral Analysys

7/28/2019 Cost Bhavioral Analysys

1/43

Northwest College for Advanced Learning 2013; Confidential (for internal use only)

Northwest College for Advanced Learning 2013; Confidential (for internal use only) 11

Example of Managerial Decision

A customer offers to buy electrical engines from your

company. They are of an old design and a slight modification

to its electricity intake is needed to make them work. You have

plenty of those old engines in stock and have no prospect ofbeing able to sell themto anyone else. Their scrap value isnegligible. Both the workers and the supervisors of your

factory are paid fixed monthly salaries. You expect to have

some spare production capacity over the coming weeks. The

material cost of one old engine was $500. To manufacture thealtered design specified in the order, you would have to modify

some of your production machinery. An engineer would have

to work on it for eight hours

and use materials worth $30,000. The customer offers to pay

$300 per engine after the alterations have been made.


2/43



Managerial Decision

Is it worth considering this order? What further information doyou require to decide whether you should accept the order?

A typical mistake would be to turn the order down because theselling price is lower than the production cost. In fact, the

production cost is a sunk cost, hence irrelevant to the decision.

However, $30,000 is an emerging cost, hence relevant to thedecision. You should accept the order only if the emerging

revenues cover the emerging cost and this happens if the orderis in excess of 100 engines. $30,000 / $300 = 100. Beforeaccepting the order you will also have to check that yourworkers and supervisors have enough spare productioncapacity available to fulfill the order.


3/43



Managerial Decision

be influenced by a managerial decision are irrelevant tothat decision. However, there are other costs that will notactually materialise and yet are relevant to the decision-

making process. These are opportunity costs. If wedefine cost as any decrease in wealth brought about by adecision to use a particular resource or set of resources,

by measuring the decrease in wealth by reference to thenext best alternative, we are effectively using the

economic concept of opportunity cost. Economists defineopportunity cost as the benefits foregone by not adoptingthe next best alternative, where benefits can relate to

any economic benefit, not only cash.


4/43



4

Module 7: Cost Behavior & Cost-Volume-

Profit AnalysisACG 2071

Created by: M. MariFall 2007-1


5/43



Cost-Volume-Profit Analysis (CVP)

Which helps them predict how changes in costs and

sales levels affect income

CVP analysis involves computing the sales level at

which a company neither earns an income nor incurs

a lossbreak even point


6/43



Cost Behavior

refers to the manner in which a cost changes as a

related activity changes.

Activity basesactivities that are thought to cause

the cost to be incurred.

Relevant rangerange of activity over which the

changes in the cost that are of interest.


7/43Northwest College for Advanced Learning 2013; Confidential (for internal use only)Northwest College for Advanced Learning 2013; Confidential (for internal use only) 77

Cost Classifications

Three types

Variable Cost

Fixed Cost Mixed Cost


8/43Northwest College for Advanced Learning 2013; Confidential (for internal use only)Northwest College for Advanced Learning 2013; Confidential (for internal use only)

Variable costs

costs that vary in

proportion to changes

in the level of activity.

Direct materials

Direct labor

Units Produced Direct Materialsper unit

Total DirectMaterial Costs

5,000 units $10 $ 50,000

10,000 units $10 100,000

15,000 units $10 150,000


9/43Northwest College for Advanced Learning 2013; Confidential (for internal use only)Northwest College for Advanced Learning 2013; Confidential (for internal use only)

Fixed Costs

costs that remain the

same in total dollar

amounts as the level of

activity changes.

Number of Bottles Total Salary forSupervisor

Salary per bottleproduced

50,000 $75,000 $1.50

100,000 $75,000 $0.75

150,000 75,000 $0.50



Mixed Costs has characteristics of both a variable and a fixed cost.

Could behave as a fixed costs for part of the relevant range and

then variable cost



Contribution Margin Concept

Contribution margin = SalesVariable costs

Contribution margin ratio =

SalesVariable costs

Sales Is most useful when the increase or decrease in sales

volume is measured in sales dollars

Unit contribution margin

= Sales price per unitVariable costper unit



Example

The Company has sales of $1,000,000, variable costs of$800,000. The company sold 50,000 units. Compute thecontribution margin and the contribution margin ratio.

Contribution margin = SalesVariable cost

= $1,000,000 - $800,000 = $200,000

Contribution margin ratio = (SalesVC)/Sale

= $4



= (1,000,000800,000)/1,000,000

= 20%

Unit Contribution margin = Contribution margin

Units sold

= $200,000

50,000



Break-even Analysis to determine the units of sales necessary to achieve the break even

pint in operations

to determine the units of sales necessary to achieve a target or

desired profit



Break-Even Point

Is the level of operations at which a businesss

revenues and expired costs are exactly equal?

A business will have neither an income nor a loss

from operations.



Break Even Point

RevenuesExpenses


17/43

Northwest College for Advanced Learning 2013; Confidential (for internal use only)Northwest College for Advanced Learning 2013; Confidential (for internal use only) 1717

Break even formula

BEP = Fixed Costs__________



18/43


Example

Suppose that selling price is $25, variable cost $15 and fixedcosts are $90,000. What is break even point?

BEP = Fixed costs / Unit Contribution Margin

= $90,000/ (2515) = $90,000/$10 = 9,000 units

At sales level of 9,000 units will result in no gain or loss to thecompany.


19/43


Example

Proof:

Sales: ($25 X 9,000) $225,000

Variable cost: ($15 x 9,000) 135.000

Contribution margin 90,000

Fixed costs

90,000 Operating income -0-


20/43


Changes in fixed costs

Example: Suppose that selling price is $25, variable cost $15

and fixed costs are $90,000. What is break even point if fixed

costs increase to $100,000?

BEP = Fixed costs/ Unit Contribution margin

= $100,000/ (25-15) = 10,000 units

Due to an increase in fixed costs from $90,000 to $100,000,

break even point increased


21/43


Changes in variable costs

Example: Suppose that selling price is $25, variable cost$15 and fixed costs are $90,000. What is break even pointif variable costs decrease to $10?


= $90,000/ (25-10) = 6,000 units

Due to a decrease in variable costs from $15 to $10,break even point decreased to 6,000 units from9,000 units or a decrease of 3,000 units


22/43


Changes in selling price

Example: Suppose that selling price is $25, variable cost$15 and fixed costs are $90,000. What is break even pointif selling price increase to $30?


= $90,000/ (30-15) = 6,000 units

Due to an increase in sales price from $25 to $30,break even point decreased to 6,000 units from9,000 units or a decrease of 3,000 units.


23/43


Desired or Target Profit

BEP = Fixed costs + Desired Profit


Example: Suppose that selling price is $45, variable cost $30, andfixed costs are $60,000. The company wants a desired profitof $45,000. What is break even point?

BEP = Fixed costs + Desired profit/ Unit Contribution margin

= ($60,000)/ (45-30) = 4,000 units


24/43


Desired or Target Profit

BEP = Fixed costs + Desired profit/ UnitContribution margin

= ($60,000 + $45,000)/ (45-30) = 7,000 units

To create $45,000 of profit, must sell 7,000 units or3,000 more than break even point


25/43


Charts

Costs

Units

Fixed costs

Variable

Total cost


26/43


Graphical Break even point

$

Units0

Total costs

Sales

Break even point

Sales = TC

Profit

Loss


27/43

Northwest College for Advanced Learning 2013; Confidential (for internal use only)Northwest College for Advanced Learning 2013; Confidential (for internal use only)

Sales Mix Consideration

More than one product is

sold at varying selling

prices

Products often havedifferent unit variable costs

Products have different

contribution margin

Sales volume necessary

must a mix of both

products


28/43


Example 6:

Cascade Co produces two products Yuk and Gunk.

Yuk has a selling price of $90 per unit and variable

cost of $70. Gunk has a selling price of $140 andvariable cost of $95. Fixed costs are $200,000.

Gunks sales are approximately 80% of total sales

for the company. What is the break even point for

the sales mix?


29/43


Example 6:

Product SellingPrice

VariableCost

ContributionMargin

Sales

%

Sales mixContribution

Margin

Yuk $90 $70 $20 80% $16

Gunk $140 $95 $45 20% $9

Sales mix $25


30/43


Example 6:BEP = Fixed Costs

Sales mix CM

= $200,000

$25

BEP = 8,000 units

Of what products:

YUK: 8,000 units * 80% = 6,400 units

GUK: 8,000 units * 20% = 1,600 units


31/43


Example 7:

ABC Company has two products Y and X. Y has a

selling price of $100 and variable costs of $60. It is

70% of total sales. X has a selling price of $50 andvariable cost of $25. Fixed costs are $248,500.

What is BEP?


32/43


Margin of Safety

Indicates possible

decrease in sales that

may occur before an

operating loss occurs.

Margin of Safety =

SalesSales at BEP

Sales


33/43


Margin of Safety

If sales are $400,000 and sales at break even are

$300,000 what is margin of safety?

Ms = SalesSales BEP = $400 - $300

Sales $400

= 25%


34/43


High-Low Method Cost estimation techniques

Steps

1. Find the highest and lowest

level of production

2. Find the difference in total

cost from highest to lowest

level of production

3. Find the difference in total

units from highest to lowest

level of production

4. Variable cost per unit

Difference in Total cost

Difference in Total units

5. Find fixed cost by solving this

equation

Total cost = Fixed cost plus

Variable cost


35/43


Example 1

Month Production Total Cost

June 1,000 $45,550July 1,500 $52,000

Aug 2,100 $61,500

Sept 1,800 $57,500Oct 750 $41,250


36/43


Example

Step 1: Find highest and lowest level of production.

Month Units Total Cost

High August 2,100 $61,500

Low October 750 $41,250

Step 2: Get the difference

Difference 1,350 $20,250


37/43


Example continued

Step 3: Compute Variable cost per unit

Variable cost = Difference in Total Cost

Difference in Units

=$20,250

1,350


38/43


= $15 per unit

Total cost = FC + VC

$61,500 = FC + ($15 *2,100 units)

$61,500 = FC + 31,500

FC = $30,000


39/43


Example Contd

Step 4: Compute Fixed costs

Total cost = Fixed Costs + Variable Cost

using the data at 2,100 units of production, we

solve for fixed costs

$61,500 = FC + ($15 *2,100 units)

$61,500 = FC + 31,500

FC = $30,000


40/43


Example Continued

Given the information in the prior slide, what is the

total cost at 2,000 units of output?

Total cost = Fixed costs + Variable costs

Total cost = $30,000 + ($15 X 2,000)

Total cost = $60,000


41/43


Example 2

Month Production Total Cost

June 2,500 $45,000July 2,000 $40,000

Aug 1,500 $35.000

Sept 3,000 $50,000Oct 1,800 $38,000What is the variable cost per unit and fixed cost?


42/43


Operating Leverage

o The relative mix of a businesss variable costs andfixed costs is measured by the operating leverage

Since the difference between contribution marginand income from operations is fixed costs,companies with large amounts of fixed costs willgenerally have a high operating leverage. Indicates that a small increase in sales will yield a large

percentage increase in income from operations.

Low operating leverage Indicates that a large increase in sales is necessary to

significantly increase income from operations


43/43

Operating Leverage

Operating Leverage

= Contribution Margin

Income from operations

Cost Bhavioral Analysys

Documents