Managerial Accounting

Eighth Edition

Weygandt Kimmel Kieso

Chapter 5

Cost-Volume-Profit
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Chapter Outline
Learning Objectives
LO 1 Explain variable, fixed, and mixed costs and the relevant
range.
LO 2 Apply the high-low method to determine the components of
mixed costs.
LO 3 Prepare a CVP income statement to determine contribution
margin.
LO 4 Compute the break-even point using three approaches.
LO 5 Determine the sales required to earn target net income and
determine margin of safety.

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Cost Behavior Analysis

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

Cost Behavior Analysis is the study of how specific costs

respond to changes in the level of business activity.
• Some costs change; others remain the same.
• Helps management plan operations and decide between
alternative courses of action.
• Applies to all types of businesses and entities.
• Starting point is measuring key business activities.

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Cost Behavior Analysis (1 of 2)
Cost Behavior Analysis is the study of how specific costs
respond to changes in the level of business activity.
• Activity levels may be expressed in terms of:
o Sales dollars (in a retail company)
o Miles driven (in a trucking company)
o Room occupancy (in a hotel)
o Dance classes taught (by a dance studio)
• Many companies use more than one measurement base.

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Cost Behavior Analysis (2 of 2)
Cost Behavior Analysis is the study of how specific costs
respond to changes in the level of business activity.
• Changes in the level or volume of activity should be
correlated with changes in costs.
• Activity level selected is called activity or volume index.
• Activity index:
o Identifies the activity that causes changes in the behavior
of costs.
o Allows costs to be classified as variable, fixed, or mixed.

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Variable Costs (1 of 4)
• Costs that vary in total directly and proportionately with
changes in the activity level.
o Example: If the activity level increases 10 percent,
total variable costs increase 10 percent.
o Example: If the activity level decreases by 25 percent,
total variable costs decrease by 25 percent.
• Variable costs remain the same per unit at every level of
activity.

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Variable Costs (2 of 4)
Illustration: Damon Company
manufactures tablet computers that
contain a $10 camera. The activity index
is the number of tablets produced. As
Damon manufactures each tablet, the total
cost of the cameras used increases by $10.
As part (a) of ILLUSTRATION 5.1
shows, total cost of the cameras will be
$20,000 if Damon produces 2,000 tablets,
and $100,000 when it produces 10,000
tablets. We also can see that a variable
cost remains the same per unit as the level
of activity changes.
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Variable Costs (3 of 4)
Illustration: Damon Company
manufactures tablet computers that
contain a $10 camera. The activity index
is the number of tablets produced. As
Damon manufactures each tablet, the total
cost of the cameras used increases by $10.
As part (b) of ILLUSTRATION 5.1
shows, the unit cost of $10 for the camera
is the same whether Damon produces
2,000 or 10,000 tablets.

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Variable Costs (4 of 4)

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Fixed Costs (1 of 6)
• Costs that remain the same in total regardless of
changes in the activity level within a relevant range.
• Fixed cost per unit cost varies inversely with activity:
As volume increases, unit cost declines, and vice versa
• Examples:
o Property taxes
o Insurance
o Rent
o Supervisory salaries
o Depreciation on buildings and equipment
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Fixed Costs (2 of 6)
Illustration: Damon Company leases
its productive facilities at a cost of
$10,000 per month. Total fixed costs
of the facilities will remain constant at
every level of activity, as part (a) of
Illustration 5.2 shows.

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Fixed Costs (3 of 6)
Illustration: Damon Company leases its
productive facilities at a cost of $10,000
per month. Total fixed costs of the
facilities will remain constant at every
level of activity. But, on a per unit basis,
the cost of rent will decline as activity
increases, as part (b) of Illustration 5.2
shows. At 2,000 units, the unit cost per
tablet computer is $5 ($10,000 ÷ 2,000).
When Damon produces 10,000 tablets,
the unit cost of the rent is only $1 per
tablet ($10,000 ÷ 10,000).

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Fixed Costs (4 of 6)

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Fixed Costs (5 of 6)
Question
Variable costs are costs that:
a. Vary in total directly and proportionately with changes in the
activity level.
b. Remain the same per unit at every activity level.
c. Neither of the above.
d. Both (a) and (b) above.

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Fixed Costs (6 of 6)
Question
Variable costs are costs that:
a. Vary in total directly and proportionately with changes in the
activity level.
b. Remain the same per unit at every activity level.
c. Neither of the above.
d. Answer: Both (a) and (b) above.

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Relevant Range (1 of 5)
• Throughout the range of possible levels of activity, a straight-
line relationship usually does not exist for either variable costs or
fixed costs.
• Relationship between variable costs and changes in activity level
is often curvilinear.
• For fixed costs, the relationship is Helpful Hint
also nonlinear – some fixed costs Fixed costs that may be changed
will not change over the entire by managers include research,
such as new product
range of activities, while other development, and management
fixed costs may change. training programs.

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Relevant Range (2 of 5)

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Relevant Range (3 of 5)
Range of activity over which a company expects to
operate during a year.

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Relevant Range (4 of 5)
Question
The relevant range is:
a. The range of activity in which variable costs will be curvilinear.
b. The range of activity in which fixed costs will be curvilinear.
c. The range over which the company expects to operate during a
year.
d. Usually from zero to 100% of operating capacity.

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Relevant Range (5 of 5)
Question
The relevant range is:
a. The range of activity in which variable costs will be curvilinear.
b. The range of activity in which fixed costs will be curvilinear.
c. Answer: The range over which the company expects to operate
during a year.
d. Usually from zero to 100% of operating capacity.

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Mixed Costs
• Costs that have both a variable element and a fixed element.
• Change in total but not proportionately with changes in
activity level.

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Do It! 1: Types of Costs
Helena Company, reports the following total costs at two levels of
production.
Classify each cost as variable, fixed, or mixed.

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High-Low Method

LEARNING OBJECTIVE 2
Apply the high-low method to determine the
components of mixed costs.

• 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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High-Low Method (1 of 7)
Step 1: Determine variable cost per unit using the following
formula:

Change in
Total Costs at High ÷ High minus Low = Variable Cost
versus Low Activity Level Activity Level per Unit

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High-Low Method (2 of 7)
Illustration: Metro Transit Company has the following
maintenance costs and mileage data for its fleet of buses over a
6-month period.
Blank

Month Miles Total Month Miles Total

Driven Cost Driven Cost
January 20,000 $30,000 April 50,000 $63,000
February 40,000 48,000 May 30,000 42,000
March 35,000 49,000 June 43,000 61,000

Change in Costs (63,000 − 30,000) $33,000

= $1.10 cost per unit
High minus Low (50,000 − 20,000) 30,000

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High-Low Method (3 of 7)
Step 2: Determine the total 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.

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High-Low Method (4 of 7)
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 × Miles driven)
Example: At 45,000 miles, estimated maintenance costs would be:

Fixed $ 8,000
Variable ($1.10× 45,000) 49,500
$57,500

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High-Low Method (5 of 7)

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High-Low Method (6 of 7)
Question
Mixed costs consist of a:
a. Variable cost element and a fixed cost element.
b. Fixed cost element and a controllable cost element.
c. Relevant cost element and a controllable cost element.
d. Variable cost element and a relevant cost element.

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High-Low Method (7 of 7)
Question
Mixed costs consist of a:
a. Answer: Variable cost element and a fixed cost element.
b. Fixed cost element and a controllable cost element.
c. Relevant cost element and a controllable cost element.
d. Variable cost element and a relevant cost element.

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Do It! 2: High-Low Method (1 of 4)
Byrnes Company accumulates the following data concerning a
mixed cost, using units produced as the activity level.
Units Produced Total Cost
March 9,800 $14,740
April 8,500 13,250
May 7,000 11,100
June 7,600 12,000
July 8,100 12,460

(a) Compute the variable- and fixed-cost elements using this method.
(b) Using the information from part (a), write the cost formula.
(c) Estimate the total cost if the company produces 8,000 units.
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Do It! 2: High-Low Method (2 of 4)
Units Produced Total Cost
March 9,800 $14,740
April 8,500 13,250
May 7,000 11,100
June 7,600 12,000
July 8,100 12,460

(a) Compute the variable- and fixed-cost elements using this method.
($14, 740  $11,100)
Variable cost:  $1.30 per unit
(9,800  7, 000)
Fixed cost: $14,740 − $12,740 ($1.30 × 9,800 units) = $2,000
or $11,100 − $9,100 ($1.30 × 7,000) = $2,000
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Do It! 2: High-Low Method (3 of 4)
Units Produced Total Cost
March 9,800 $14,740
April 8,500 13,250
May 7,000 11,100
June 7,600 12,000
July 8,100 12,460

(b) Using the information from your answer to part (a), write
the cost formula.
Cost = $2,000 + ($1.30 × units produced)

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Do It! 2: High-Low Method (4 of 4)
Units Produced Total Cost
March 9,800 $14,740
April 8,500 13,250
May 7,000 11,100
June 7,600 12,000
July 8,100 12,460

(c) Estimate the total cost if the company produces 8,000 units.
Total cost (8,000 units):
$2,000 + $10,400 ($1.30 × 8,000) = $12,400

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