ACCT 202: Managerial Accounting

Chapter 5
Cost-Volume-Profit

10/26/2022
Learning Objectives

1 Explain variable, fixed, and mixed costs and the relevant range.

2 Apply the high-low method to determine the components of

mixed costs.

3 Prepare a CVP income statement to determine contribution

margin.

4 Compute the break-even point using three approaches.

5 Determine the sales required to earn target net income and

determine margin of safety.

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Cost Behavior
• Cost behavior analysis is the study of how specific costs respond
to changes in the level of business activity.

• The activity levels may be expressed in terms of:

▫ Sales dollars (in a retail company)
▫ Miles driven (in a trucking company)
▫ Room occupancy (in a hotel)
▫ Dance classes taught (by a dance studio)

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Cost Behavior (cont’d)
• Changes in the level or volume of activity should be correlated with
changes in costs.

• The activity index should be the activity that causes changes in the
behavior of costs.
▫ Allows costs to be classified as variable, fixed, or mixed.

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Cost Behavior (cont’d)
• Variable costs
▫ Costs that vary in total directly and proportionately with changes in the
activity level.

• Example: Your total texting bill is based on how many texts you
send.
Total Texting Bill

Number of Texts Sent

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Cost Behavior (cont’d)
• Variable costs per unit
▫ Variable costs remain the same per unit at every level of activity

• Example: The cost per text sent is constant at 5 cents per text
message.

Cost Per Text Sent

Number of Texts Sent

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Cost Behavior (cont’d)
• Fixed costs
▫ Costs that remain the same in total regardless of changes in the activity
level within a relevant range.

• Example: Your monthly contract fee for your cell phone is fixed for the
number of monthly minutes in your contract (for calls). The monthly
contract fee does not change based on the number of calls you make.
Monthly Cell Phone
Contract Fee

Number of Minutes Used

Within Monthly Plan
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Cost Behavior (cont’d)
• Fixed costs per unit
▫ Fixed cost per unit varies inversely with activity: As volume increases,
unit cost declines, and vice versa.

• Example: Within the monthly contract allotment, the average fixed

cost per cell phone call made decreases as more calls are made.

Monthly Cell Phone Fee

per Minute

Number of Minutes Used

Within Monthly Plan
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Cost Behavior (cont’d)
• Fixed costs and relevant range

90
Rent Cost in Thousands of

The relevant range of

Relevant activity for a fixed cost
60
Range is the range of activity
Dollars

over which the graph

of the cost is flat.
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0
0 1,000 2,000 3,000
Rented Area (Square Feet)

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Cost Behavior (cont’d)
• Mixed costs
▫ Costs that have both a variable element and a fixed element.
Y = a + bX
Y: Total cost
Y
X: Activity level
a: Fixed cost
b: Variable cost per unit
Total Utility Cost

cost
i xed
mal
ot
T slope
b Variable Cost

a
X Fixed Cost
Activity (Kilowatt Hours)

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Exercise 1
When total purchases of raw material exceed 30,000 units in any one period
then all units purchased, including the initial 30,000, are invoiced at a lower
cost per unit.
Which of the following graphs is consistent with the behavior of the total
materials cost in a period? 

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 12

Exercise 2
The High-Low Method
• The high-low method uses the total costs incurred at the high and
the low levels of activity to classify mixed costs into fixed and
variable components.

• The difference in costs between the high and low levels represents
variable costs, since only variable-cost element can change as
activity levels change.

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The High-Low Method (cont’d)
• STEP 1: Determine variable cost per unit using the following formula:

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The High-Low Method (cont’d)
• Example: Metro Transit Company has the following maintenance
costs and mileage data for its fleet of buses over a 6-month period.
Month Miles Driven Total Cost
January 20,000 $30,000
February 40,000 48,000
March 21,000 29,000
April 50,000 63,000
May 30,000 42,000
June 43,000 61,000

(63,000 - 30,000) $33,000

Variable costs per unit = = $1.10
(50,000 - 20,000) 30,000

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The High-Low Method (cont’d)
• STEP 2: Determine the fixed cost by subtracting the total variable
cost at either the high or the low activity level from the total cost at
that activity level.

• Example:

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The High-Low Method (cont’d)
• Maintenance costs are therefore $8,000 per month of fixed costs
plus $1.10 per mile of variable costs.

• This is represented by the following formula:

Maintenance costs = $8,000 + ($1.10 x Miles driven)

• Another example, at 45,000 miles, estimated maintenance costs

would be:
Fixed
$ 8,000
Variable ($1.10 x 45,000)

49,500
$57,500
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Exercise 3
• Byrnes Company accumulates the following data concerning a
mixed cost, using units produced as the activity level.

a) Compute the variable- and fixed-cost elements using the high-low

method.
b) Estimate the total cost if the company produces 8,000 units.

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Exercise 4
The following information for advertising and sales has been established over the past
six months:
Month Sales revenueAdvertising exp.
$’000 $’000
1 155 3
2 125 2.5
3 200 6
4 175 5.5
5 150 4.5
6 225 6.5
Using the High – Low method which of the following is correct equation for linking
advertising and sales from the above data?

A. Sale revenue = 62,500 + (25 x advertising expenditure)

B. advertising expenditure = -2,500 + (0.04 x Sale revenue)
C. Sale revenue = 95,000 + (20 x advertising expenditure)
D. advertising expenditure = -4,750 + (0.05 x Sale revenue)

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Exercise 5

The following production and total cost information relates to a single product organisation
for the last three months:
Month Production Total cost
units $
1 1,200 66,600
2 900 58,200
3 1,400 68,200
The variable cost per unit is constant up to a production level of 2,000 units per month but
a step up of $6,000 in the monthly total fixed cost occurs when production reaches 1,100
units per month.
What is the total cost for a month when 1,000 units are produced?
A. $54,200
B. $55,000
C. $59,000
D. $ 60,200

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Cost-Volume-Profit Analysis
• Cost-volume-profit (CVP) analysis is the study of the effects of
changes in costs and volume on a company’s profits.
▫ Important in profit planning.
▫ Critical factor in management decisions such as
 Determining product mix, and
 Maximizing use of production facilities.

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Cost-Volume-Profit Analysis (cont’d)
• CVP income statement
▫ A statement for internal use.
▫ Classifies costs and expenses as fixed or variable.

• Different from the traditional income statement, a CVP income

statement reports contribution margin (CM) in the body of the
statement.

Contribution margin = Total Sales – Total Variable Costs

The Contribution Margin (CM) tells us the amount generated

from operations that “contributes” toward paying fixed costs.

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Example (cont’d)
• The CVP income statement for Vargo Video Company therefore
would be reported as follows:

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Cost-Volume-Profit Analysis (cont’d)
• Unit contribution margin (UCM)

Unit Contribution margin = Unit Selling Price – Unit Variable Costs

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Cost-Volume-Profit Analysis (cont’d)
• Contribution margin ratio
▫ Shows the percentage of each sales dollar available to apply toward
fixed costs and profits.

Unit Contribution Margin

Contribution margin Ratio =
Unit Selling Price

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Break-Even Analysis
• Process of finding the break-even point level of activity at which
total revenues equal total costs (both fixed and variable).

• Computation of break-even point in units:

Required Sales - Variable Costs - Fixed Costs = Net Income

$500Q - $300Q - $200,000 = $0

($500 - $300)Q - $200,000 = $0
UCM*Q - FC = $0

Q = FC $200,000 =
UCM
= $200
1,000 units

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Break-Even Analysis (cont’d)
• Computation of break-even point in dollars:

FC
$ = = $200,000 = $500,000
CMR 40%

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Break-Even Analysis (cont’d)
• Graphic presentation:

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Exercise 6

• Spencer Kars provides shuttle service between four hostels near a

medical center and an international airport. Spencer Kars uses two
10-passenger vans to offer 12 round trips per day. A recent month’s
activity in the form of a cost-volume-profit income statement is shown
as below.
Fare revenues (1,500 fares)   $36,000
Variable costs    
Fuel $5,040  
Tolls and parking 3,100  
Maintenance 860 9,000
Contribution margin   27,000
Fixed costs    
Salaries 15,700  
Depreciation 1,300  
Insurance 1,000 18,000
Net income   $9,000

▫ Calculate the break-even point in (1) number of fares and (2) dollars .
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Target Net Income
• Target net income is the level of sales necessary to achieve a
specified income.

• Computation of target net income in units:

Required Sales - Variable Costs - Fixed Costs = Net Income

$500Q - $300Q - $200,000 = $120,000

($500 - $300)Q - $200,000 = $120,000
UCM*Q - FC = $120,000

Q = FC + Target Income = $200,000 + $120,000 = 1,600 units

UCM $200

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Target Net Income (cont’d)
• Computation of target net income in dollars:

$ = FC + Target Income = $200,000 + $120,000 = $800,000

CMR 40%

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Target Net Income (cont’d)
• Graphic presentation
▫ Suppose Vargo Video sells 1,400 camcorders. The illustration shows that
a vertical line drawn at 1,400 units intersects the sales line at $700,000
and the total cost line at $620,000. The difference between the two
amounts represents the net income (profit) of $80,000.

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Margin of Safety
• The margin of safety in dollars (MSD) is the excess of budgeted (or
actual) sales over the break-even volume of sales:

Margin of safety in dollars (MSD) = Total sales - Break-even sales

• Assuming actual/expected sales are $750,000:

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Margin of Safety (cont’d)
• Or, the margin of safety can also be expressed as ratio (MSR):

Margin of safety ratio (MSR) = MSD / sales

• Assuming actual/expected sales are $750,000:

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Exercise 7
• Zootsuit Inc. makes travel bags that sell for $56 each. For the
coming year, management expects fixed costs to total $320,000 and
variable costs to be $42 per unit. Compute the following:
a) break-even point in dollars using the contribution margin (CM) ratio.
b) the margin of safety in dollars assuming actual sales are $1,382,400

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Exercise 8

The following breakeven chart has been drawn showing lines for total cost (TC), total
variable cost (TVC), total fixed cost (TFC) and total sales revenue (TSR):
What is the margin of safety at the 1,700 units level of activity?
TSR
A. 200 units
B. 300 units $
TC
C. 500 units
D. 1,025 units

TVC

TFC

0 675 1,200 1,500 1,700 Units

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Exercise 9
The following represents a profit / volume graph for an organisation:
At the specific levels of activity indicated, what do the lines depicted
as `T' and `V' represent?
Line T Line V
A. Loss Profit
B. Loss Contribution
C. Total fixed cost Profit
D. Total fixed cost Contribution

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Exercise 10
A company sells a single product which has a contribution of £27 per
unit and a contribution to sales ratio of 45%. This period it forecast to
sell 1,000 units giving it a margin of safety of £13,500 in sales revenue
terms. What are the company’s total fixed costs per period?
A. £6,075
B. £7,425
C. £13,500
D. £20,925
 

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Exercise 11

A company manufactures one product which it sells for £40 per unit.
The product has a contribution to sales ratio of 40%. Monthly total
fixed costs are £60,000. At the planned level of activity for next month,
the company has a margin of safety of £64,000 expressed in terms of
sales value.
What is the planned activity level (in units) for next month?
A. A 3,100
B. B 4,100
C. C 5,350
D. D 7,750

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