PLANNING AND

MANAGEMENT
CONTROL
SYSTEMS
Maurizio Massaro

Chapter 18
Cost Behavior and
Cost-Volume-Profit Analysis
Chapter 18

Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
 Chapter 18 Learning Objectives

CONCEPTUAL
C1 Describe different types of cost behavior in relation to production and sales volume.
C2 Describe several applications of cost-volume-profit analysis.

ANALYTICAL
A1 Compute the contribution margin and describe what it reveals about a company’s cost structure.
A2 Analyze changes in sales using the degree of operating leverage.

PROCEDURAL
P1 Determine cost estimates using the scatter diagram, high-low, and regression methods of
estimating costs.
P2 Compute the break-even point for a single product company.
P3 Interpret a CVP chart and graph costs and sales for a single-product company.
P4 Compute the break-even point for a multiproduct company.
P5 Appendix 18B—Compute unit cost and income under both absorption and variable costing.

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 Learning Objective C1

Describe different types of cost

behavior in relation to
production and sales volume.

4
 Identifying Cost Behavior
Managers use cost-volume-profit analysis to make
predictions such as:
– How many units must we sell to break-even?
– How much does income increase if we install a new
machine to reduce labor costs?
– What is the change in income if selling prices decline
and sales volume increases?
– How will income change if we change the sales mix of
our products or services?
– What sales volume is needed to earn a target income?
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Learning Objective C1: Describe different types of cost behavior in relation to production and sales volume.
 Fixed Costs
Exhibit
18.2

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Learning Objective C1: Describe different types of cost behavior in relation to production and sales volume.
 Variable Costs
Exhibit
18.2

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Learning Objective C1: Describe different types of cost behavior in relation to production and sales volume.
 Mixed Costs
Exhibit
18.2

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Learning Objective C1: Describe different types of cost behavior in relation to production and sales volume.
 Step-Wise Costs Exhibit
18.3

Total cost increases to a new higher cost for the next higher range of
activity, but remains constant within a range of activity.

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Learning Objective C1: Describe different types of cost behavior in relation to production and sales volume.
 Curvilinear Costs Exhibit
18.3

Costs that increase when activity

increases, but in a nonlinear manner.
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Learning Objective C1: Describe different types of cost behavior in relation to production and sales volume.
 Let’s see if you got it
Cost-volume-profit analysis is used to determine
the number of units must be sold to break even
A. True (T)
B. False

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 Learning Objective P1

Determine cost estimates using

the scatter diagram, high-low, and
regression methods of estimating
costs.

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 Measuring Cost Behavior
The objective is to classify all costs as either fixed
or variable. We will look at three methods:
1. Scatter diagram
2. High-low method
3. Regression

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Learning Objective P1: Determine cost estimates using the scatter diagram, high-low, and regression methods of estimating costs.
 Scatter Diagrams
Exhibit
18.5

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Learning Objective P1: Determine cost estimates using the scatter diagram, high-low, and regression methods of estimating costs.
 The High-Low Method (1 of 2) Exhibit
18.4
The following relationships between units
produced and total cost are observed:

Using these two levels of volume, compute:

 the variable cost per unit.
 the total fixed cost.

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Learning Objective P1: Determine cost estimates using the scatter diagram, high-low, and regression methods of estimating costs.
 The High-Low Method (2 of 2)
Units Cost
High volume level - November 67,500 $ 31,000
Low volume level - June 17,500 18,500
Change in activity 50,000 $ 12,500

Exhibit
18.6

Exhibit
18.7

Total cost = $14,125 + $0.25 per unit produced

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Learning Objective P1: Determine cost estimates using the scatter diagram, high-low, and regression methods of estimating costs.
 Regression
Regression is usually covered in advanced
cost accounting courses. It is commonly
used with spreadsheet programs or
calculators.

The objective of the cost

analysis remains the
same: determination of
total fixed cost and the
variable unit cost.
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Learning Objective P1: Determine cost estimates using the scatter diagram, high-low, and regression methods of estimating costs.
An example in excel

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 Comparison of Cost Estimation
Methods Exhibit
18.8

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Learning Objective P1: Determine cost estimates using the scatter diagram, high-low, and regression methods of estimating costs.
 Let’s see if you got it
• The following information is available for a company’s cost of sales
over the last five months:
• Jan: Units sold 400; Cost of sales 31,000
• Feb: Units sold 800; cost of sales 37,000
• Mar: Units sold 1,600; cost of sales 49,000
• Apr: Units sold 2,400; cost of sales 61,000
• Using the high low method, the estimated variable cost of sales per
unit sold is:
• $25.42
• $77.50
• $15.00 (T)
• $30.62
Change in cost/Change in units(61,000-31,000)/(2,400-400)=15.00

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 Learning Objective A1

Compute the contribution margin

and describe what it reveals about
a company’s cost structure.

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 Contribution Margin and Its
Exhibit
Measures 18.9

Exhibit
18.10

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Learning Objective A1: Compute the contribution margin and describe what it reveals about a company’s cost structure.
 Learning Objective P2

Compute the break-even point

for a single product company.

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 Break-Even Point
• Sales level at which total sales equal total
costs.
• Company neither earns a profit nor incurs
a loss.
• Can be expressed in units or dollars of
sales.
• Three methods to find break-even point:
• Formula
• Contribution margin income statement
• Cost-volume-profit chart
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Learning Objective P2: Compute the break-even point for a single product company.
 Formula Method
Exhibit
18.11

Exhibit
18.12

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Learning Objective P2: Compute the break-even point for a single product company.
 Contribution margin income
statement method
Exhibit
18.13

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Learning Objective P2: Compute the break-even point for a single product company.
 Let’s see if you got it
Mason Company manufactures and sells shoelaces
for $2.00 per pair. Its variable cost per unit is $1.70.
mason’s total fixed costs are $10,500. how many
pairs must Mason sell to break even?
A. 5,250
B. 6,176
C. 35,000 (T)
D. 52,500
E. 61,760
=10,500/(2.00-1.70)=35,000

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 Learning Objective P3

Interpret a CVP chart and graph

costs and sales for a single
product company.

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 Graphing – Cost-volume-profit Chart
Exhibit
18.14

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Learning Objective P3: Interpret a CVP chart and graph costs and sales for a single product company.
 Changes in Estimates
Exhibit
18.15

Exhibit
18.16

Exhibit
18.17

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Learning Objective P3: Interpret a CVP chart and graph costs and sales for a single product company.
 Learning Objective C2

Describe several applications

of cost-volume-profit analysis.

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 Computing the Margin of Safety

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Learning Objective P2: Compute the break-even point for a single product company.
 Computing Income
from Sales and Costs
Exhibit
18.19

Exhibit
18.20

Exhibit
18.21

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Learning Objective C2: Describe several applications of cost-volume-profit analysis.
 Computing Sales
for a Target Income (1 of 3) Exhibit
18.22

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Learning Objective C2: Describe several applications of cost-volume-profit analysis.
 Computing Sales
for a Target Income (2 of 3) Exhibit
18.23

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Learning Objective C2: Describe several applications of cost-volume-profit analysis.
 Computing Sales
for a Target Income (3 of 3) Exhibit
18.24

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Learning Objective C2: Describe several applications of cost-volume-profit analysis.
 Evaluating Strategies
Exhibit
18.25

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Learning Objective C2: Describe several applications of cost-volume-profit analysis.
 Let’s see if you got it
Alvarex company0s break-even point in units is 1,000. The
sales price per unit is $10 and the variable cost per unit is
$7. If the company sells 2,500 units, what will net income
be?
A. $4,500 (T)
B. $ 7,500
C. $ 17,000
D. $ 35,000
E. $ 3,000
Net income = contribution margin* units sold in excell of
break even unit = ($ 10- $ 7)*(2,500-1,000) = $ 4,500

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 Learning Objective P4

Compute the break-even point

for a multiproduct company.

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 Sales Mix and Break-Even (1 of 5)
The CVP formulas can be modified for use
when a company sells more than one product.
▪ The unit contribution margin is replaced with the
contribution margin for a composite unit.
▪ A composite unit is composed of specific numbers
of each product in proportion to the product sales
mix.
▪ Sales mix is the ratio of the volumes of the various
products.
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Learning Objective P4: Compute the break-even point for a multiproduct company.
 Sales Mix and Break-Even (2 of 5)
The resulting break-even formula
for composite unit sales is:
Break-even point Fixed costs
= Contribution margin
in composite units
per composite unit

Continue
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Learning Objective P4: Compute the break-even point for a multiproduct company.
 Sales Mix and Break-Even (3 of 5)
Hair-Today offers three cuts as shown below. Annual fixed
costs are $192,000. Compute the break-even point in
composite units and in number of units for each haircut at the
given sales mix.

Haircuts
Basic Ultra Budget
Selling Price $ 20.00 $ 32.00 $ 16.00
Variable Cost 13.00 18.00 8.00
Unit Contribution $ 7.00 $ 14.00 $ 8.00
Sales Mix Ratio 4 2 1

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Learning Objective P4: Compute the break-even point for a multiproduct company.
 Sales Mix and Break-Even (4 of 5)

Haircuts
Basic Ultra Budget
Selling Price $ 20.00 $ 32.00 $ 16.00
Sales Mix Ratio 4.00 2.00 1.00
Selling Price/cut $ 80.00 $ 64.00 $ 16.00
Total Selling Price/Composite Unit $ 160.00

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Learning Objective P4: Compute the break-even point for a multiproduct company.
 Sales Mix and Break-Even (5 of 5)
Haircuts
Basic Ultra Budget
Variable Costs $ 13.00 $ 18.00 $ 8.00
Sales Mix Ratio 4.00 2.00 1.00
Selling Price/cut $ 52.00 $ 36.00 $ 8.00
Total Variable Cost/Composite Unit $ 96.00

Exhibit
18.28

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Learning Objective P4: Compute the break-even point for a multiproduct company.
 Computing a Multiproduct
Break-Even Point (1 of 2)
Exhibit
18.29

Break-even point Fixed costs

= Contribution margin
in composite units
per composite unit

Break-even point $192,000

= $64.00 per
in composite units
composite unit
Break-even point = 3,000 composite units
in composite units
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Learning Objective P4: Compute the break-even point for a multiproduct company.
 Computing a Multiproduct
Break-Even Point (2 of 2)
Sales Composite
Product Mix Cuts Haircuts
Basic 4 × 3,000 = 12,000
Ultra 2 × 3,000 = 6,000
Budget 1 × 3,000 = 3,000
7 x 3,000 21,000

46
Learning Objective P4: Compute the break-even point for a multiproduct company.
 Multiproduct Break-Even
Income Statement Exhibit
18.30

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Learning Objective P4: Compute the break-even point for a multiproduct company.
 Assumptions in Cost-Volume-
Profit Analysis
CVP analysis relies on several assumptions:
•Costs can be classified as variable or fixed
•Costs are linear within the relevant range
•All units produced are sold
•Sales mix is constant

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Learning Objective A2: Analyze changes in sales using the degree of operating leverage.
 Let’s see if you got it
Mott Company's sales mix is 3 units of A, 2 units of B, and
1 unit of C. Selling prices for each product are $20, $30,
and $40, respectively. Variable costs per unit are $12,
$18, and $24, respectively. Fixed costs are $320,000.
What is the break-even point in composite units?
A. 4,000 composite units
B. 1,111 composite units
C. 5,000 composite units (T)
D. 2,666 composite units
E. 1,600 composite units
3*(20-12)+2*(30-18)+1*(40-24)=64->320,000/64=5,000

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 Learning Objective A2

Analyze changes in sales using

the degree of operating
leverage.

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 Degree of Operating Leverage
A measure of the extent to which fixed costs
are being used in an organization.

A measure of how a percentage change in

sales will affect profits.

Exhibit
18.32

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Learning Objective A2: Analyze changes in sales using the degree of operating leverage.
 Operating Leverage
Rydell Company
Sales (1,200 units) $120,000
Less: variable expenses 84,000
Contribution margin 36,000
Less: fixed expenses 24,000
Pretax income $ 12,000

Exhibit
18.32

If Rydell increases sales by 10 percent, what will the

percentage increase in income be?

Exhibit
18.33

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Learning Objective A2: Analyze changes in sales using the degree of operating leverage.
 Let’ see if you got it
Filder production reports the following
information:
• Total contribution margin=$ 32,000
• Total fixed costs = $ 28,000
If sales increase by 6% what is the expected
percentage increase in pretax income
Degree of operating leverage = 32,000/(32,000-
28,000) = 8-> 6% increase in saales will result in
48% increase in income (6%*8)
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Appendix 18A: Using Excel to
For Cost Estimation

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 Learning Objective P5

Compute unit cost and income

under both absorption and
variable costing.

55
 Appendix 18B: Variable Costing and
Performance Reporting
• Contribution margin income statement is also known as
variable costing income statement.
• Variable costing—only costs that change in total with
changes in production levels are included in product costs.
• Includes: direct materials, direct labor, and variable
overhead.
• Fixed overhead costs excluded from product costs.
• GAAP requires absorption costing—includes direct
materials, direct labor, and all overhead (variable and
fixed).
Exhibit
18B.1

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Learning Objective P5: Compute unit cost and income under both absorption and variable costing.
End of Chapter 18

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