Chapter 2: Part 2

Introduction to Cost Behavior

and Cost-Volume-Profit
Relationships

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 Chapter 2 Learning
Objectives
When you have finished studying this chapter,
you should be able to:
1. Explain how cost drivers affect cost behavior.
2. Show how changes in cost-driver levels affect
variable and fixed costs.
3. Explain step- and mixed-cost behavior.
4. Create a cost-volume-profit (CVP) graph and
understand the assumptions behind it.
5. Calculate break-even sales volume in total
dollars and total units.
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 Chapter 2 Learning Objectives

6. Calculate sales volume in total dollars and

total units to reach a target profit.
7. Additional uses of CVP analysis: Margin of
safety, operating leverage.
8. Differentiate between contribution margin and
gross margin.
9. . Sales-Mix Analysis.
10. Planning for non-profit organizations.

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 Learning
Objective 6
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 Revenue

– variable expenses
– fixed costs
= Target net income

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Target Net Profit

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 Quantity to achieve Target Net
Profit (Q Target Net Income)
Example: recall that SP = $1.5, UVC = $1.2 TFC = $18,000.
And $1,440 per month is the minimum Acceptable net income
(target net income).
What is the quantity to be sold to achieve this target net income?

Fixed Cost + Target net income

Target sales volume in
units (Q Target Net Income) =
Contribution margin per unit
18,000 + $ 1,440
Target sales volume in units = 64,800
(Q Target Net Income) = $ 0.3 units
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 Sales Revenues to achieve Target
Net Profit
Fixed Costs + Target net income
Target sales volume in pounds
(Sales Revenue to get target NI) =
Contribution margin ratio

Contribution margin ratio = UCM / SP = 0.3/1.5 = 20 %

Sales volume in dollars to achieve target NI =
= 18,000 + $1,440 = $97,200
0.20

OR
Target sales Revenues = Selling price X Q Target Net Income
Target sales Revenues = $1.50 X 64,800 units = $97,200.
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 Margin of Safety (MOS)

The margin of safety (MOS):

• It is defined as the excess of the budgeted or actual
sales of a company over the company's break-even
point. The margin of safety can be expressed as
units, pounds, or a percentage.
• MOS is one direct use of CVP analysis.
• It shows how far your sales are far from losses.
• It shows how far can sales fall below the planned
(or actual) level before losses occur.
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 Margin of Safety (MOS)
The MOS calculation allows management to assess
possible risks;
by determining how close to a dangerous level
the company is operating.
The lower the margin of safety, the more carefully
management must watch sales figures and control
costs so as not to generate a net loss

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 Margin of Safety (MOS)
The following formulas are applicable

Margin of safety
Planned (or actual ) units - QBEP
(MOS) in units =
Planned (or actual) sales revenue
MOS in pounds =
– Break-even in pounds
MOS in units or pounds
MOS % =
Planned (or actual) sales in units or
L.E

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 Margin of Safety (MOS)
Example: The break-even point for XYZ company is 5,000
units or L.E. 500,000 of sales. The income statement for the
company showed actual sales for the year ended
December,31,97, of 12,000 units or L.E. 1,200,000.
Required: Calculate MOS in units, pounds and
percentage
MOS in units = 12,000 – 5,000 = 7,000 units
MOS in pounds = 1,200,000(actual) – 500,000 (BEP) = L.E.
700.000
Percentage = 7,000 ÷ 12, 000
or 700,000 ÷ 1,200.000 = 58%
The margin of safety for XYZ is quite high since it is
operating far above its break-even point.
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 Learning
Objective 7
Contribution Margin
and Gross Margin

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 Contribution Margin
and Gross Margin
Sales revenue – Cost of goods sold = Gross margin
Sales revenue - all variable expenses = Contribution
margin
Example:
If selling price is 1.5, unit variable acquisition cost is 1.2,
calculate Contribution margin and gross margin
Note: Acquisition cost is part of the Cost of goods sold
Per Unit
Selling price
$1.50
- Variable costs (acquisition cost) (1.20)
Contribution margin and gross
Copyright margin
© 2014 are equal
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 Contribution Margin
and Gross Margin
Suppose the firm paid a commission of $0.12 per unit sold.
Note: Sales commission is variable non-manufacturing
cost
Contribution Gross

Margin Margin

Per Unit Per Unit

Sales
$1.50 $1.50
Acquisition cost of unit sold 1.20 (1.20)
Variable commission 0.12
Total variable costs (1.32)
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Required:
1. Formulate the cost function for Mfg COGS
2. Calculate quarterly BEP in units and in Dollars.
3. Calculate Safety margin in units for the first
quarter of the year once based on maximum capacity
and then based on actual sales.
4. Prepare income statement for the first Quarter of
the year to calculate Gross Margin.

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Solution:

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Solution:

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 Solution:
1. (QBEP) = TFC = 4000 = 12,500 units
UCM 0.32

BEP in $ = QBEP x Sp = 12,500 units x 1 $ = $ 12,500

OR

BEP in $ = TFC = 4000 = $12,500

CM % 32%

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 Solution:
2. Net Income = SR – TVC –TFC
= (SPxQ) – (UVCxQ) – TFC
= $1x45,000 - ($ o.68x45,000) - 4,000 = $ 10,400

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 Practice Questions
1. If the selling price per unit is LE 40, the variable cost per unit is
LE 24, and the fixed cost per unit is LE 12, then decreasing the
number of units by one hundred units will lead to decreasing
profit by….
A. LE 2 800 B. LE 40 000 C. LE 400 D. LE 1 600
2. If the sales price per unit is LE 10, the variable cost per unit is
LE 6, the targeted net income is 10% of sales revenue, and total of
the fixed costs is LE 60 000, then the units that must be sold are
…..
A. 10,000 units B. 8,000 units C. 15,000 units D. None of these

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 Practice Questions
3. Last month, the selling price per unit was LE 5, the variable
cost per unit was LE 3, and the total of the fixed costs was LE
50,000. Now, if the variable costs are to be increased by 20%,
while maintaining the original contribution margin ratio, the
selling price per unit would be increased to be ……
A. LE 5.5 B. LE 5 C. LE 6 D. None of these
4. In October, the number of units was 5000 units, the sales
revenue was LE 200 000, and total costs were LE 160 000
(including variable costs 75% of total costs). In November month,
management is going to get a profit of 30% of November sales
revenue; the number of units will be….
A. 10,000 units B. 2500 units C. 20,000 units D. None of these

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 Practice Questions
5. At 10 000 units, the sales revenue was LE 400 000, net income
was LE 120 000, total fixed costs are LE 40 000, the safety margin
ratio will be….
A. 25% B. 100% C. 50% D. None of these

6. Given a break‑even point of 50 000 units, the selling price is LE

50 and the contribution margin ratio is 20%, the total units that
must be sold to reach a net profit of LE 60 000 is ….
A. 6, 000 units B. 51,500 units C.56,000 units D. None of these

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 Practice Questions
7. If sales revenues are LE 50 000, and total costs are LE 45 000
(including LE 15 000 fixed costs), the management is going to
increase sales revenue by LE 100, then the net profit will be .…
A. LE 5 040 B. LE 40 C. LE 100 D. None of these

8. If the per-unit selling price is LE 50, total fixed costs is LE 220

000, the sales volume in pounds which achieves a net income of LE
180 000 is LE 1000 000. The unit variable cost is….
A. LE 15 B. LE 30 C. LE 35 D. None of these

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 Practice Questions
9. If the per-unit selling price is LE 100, the per-unit variable cost
is LE 60, and the sales revenue which generated a net profit of LE
60 000 is LE 800 000, then the per-unit fixed cost is ….
A. LE 32.5 B. LE 35 C. LE 30 D. None of these

10. If November's selling price of LE 50 will increase by 20% in

December while keeping November's contribution margin ratio,
where the actual per-unit variable costs of November is to be also
increased at the same time to be LE 42 in December, then the
variable cost per unit of November was….
A. LE 30 B. LE 35 C. LE 40 D. None of these

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 Practice Questions
True or False:
1. A company can lower its break-even point by reducing its total
fixed costs.
2. The variable portion of mixed cost remains constant per unit
with activity within the relevant range.
3. If the variable cost per unit increases and all other factors
remain constant, the Contribution Margin ratios will increase.
4. An increase in total variable costs usually indicates that the
cost-driver activity level is decreasing.

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 Answers

1 2 3 4 5 6 7 8 9 10
D D C A D C B B A B

1 2 3 4
T F F F

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