Kế toán tài chính 2 - Chapter 23: Cost behavior analysis

Chapter 23Cost Behavior AnalysisMultimedia Slides by: Gail A. Mestas, MAcc, New Mexico State UniversityLearning ObjectivesDefine cost behavior and explain how managers use this concept in the management cycle.Identify variable, fixed, and mixed costs, and separate mixed costs into their variable and fixed components.Define cost-volume-profit (C-V-P) analysis and discuss how managers use it as a tool for planning and control.Copyright © Houghton Mifflin Company. All rights reserved.Learning Objectives (cont’d)Define breakeven point and use contribution margin to determine a company’s breakeven point for multiple products.Use C-V-P analysis to project profitability of products and services.Copyright © Houghton Mifflin Company. All rights reserved.Cost Behavior and the Management CycleObjective 1Define cost behavior and explain how managers use this concept in the management cycleCopyright © Houghton Mifflin Company. All rights reserved.Cost Behavior and the Management CycleCost behaviorThe way costs respond to changes in volume or activityIs a factor in almost every decision managers makeUsed to analyze alternative courses of actionSelect the course that will Generate income for ownersMaintain liquidity for creditorsCopyright © Houghton Mifflin Company. All rights reserved.The Use of Cost Behavior in the Management CyclePlanningManagers use cost behavior to determineNumber of units or services that must be sold to generate targeted amount of profitHow changes in planned operating, investing, and financing activities will affect operating incomeCopyright © Houghton Mifflin Company. All rights reserved.Planning (cont’d)Manufacturing companiesDecide how to adjust output to meet changing sales demandService OrganizationsDetermine the optimal mix of services offeredDecide whether to charge by the service provided or a flat monthly feeCopyright © Houghton Mifflin Company. All rights reserved.ExecutingManagers determine how decisions about current operating, investing, and financing activities affect operating incomeMust understand and anticipate cost behaviorManufacturing companiesUnderstand the changes that will result in income from a decision to buy new, more productive manufacturing equipmentCopyright © Houghton Mifflin Company. All rights reserved.Reviewing and ReportingVariable costing income statementsUsed to analyze how changes in cost and sales affect the profitability of Product linesSales territoriesCustomersDepartments Other segmentsCopyright © Houghton Mifflin Company. All rights reserved.Reviewing and Reporting (cont’d)Other reports based on cost behaviorUsed to decide whether toEliminate a product lineAccept a special orderOutsource servicesCopyright © Houghton Mifflin Company. All rights reserved.DiscussionWhat is cost behavior?Cost behavior is the way costs respond to changes in volume or activityCopyright © Houghton Mifflin Company. All rights reserved.The Behavior of CostsObjective 2Identify variable, fixed, and mixed costs, and separate mixed costs into their variable and fixed componentsCopyright © Houghton Mifflin Company. All rights reserved.The Behavior of CostsCost behavior can be observedAs it relates to products and servicesIn selling, administrative, and general activitiesIf managers can predict how costs will behave, then costs become manageableCopyright © Houghton Mifflin Company. All rights reserved.The Behavior of Costs (cont’d)Variable costsVary with volume or operating activityFixed costs Remain fixed as volume changesMixed costsExhibit characteristics of both variable and fixed costsCopyright © Houghton Mifflin Company. All rights reserved.Variable Costs are total costs that change in direct proportion to changes in productive output or any other measure of volumeCopyright © Houghton Mifflin Company. All rights reserved.Variable Costs (cont’d)Variable cost Total cost of tires is a variable cost because it changes in direct proportion to the number of vehicles producedOn a per unit basis, a variable cost remains constantCopyright © Houghton Mifflin Company. All rights reserved.Variable Costs (cont’d)Variable costTotal cost of tires is a variable cost because it changes in direct proportion to the number of vehicles producedThe cost of tires may vary depending on the number purchased if discounts apply for large purchasesOn a per unit basis, a variable cost remains constantCopyright © Houghton Mifflin Company. All rights reserved.Examples of Variable, Fixed, and Mixed CostsCopyright © Houghton Mifflin Company. All rights reserved.Operating Capacity is the upper limit of an organization’s productive output capacity, given its existing resourcesAny increase in volume or activity over operating capacity requires additional expenditures for buildings, machinery, personnel, and operationsCopyright © Houghton Mifflin Company. All rights reserved.Operating Capacity (cont’d)Can be expressed in several ways, includingTotal labor hoursTotal machine hoursTotal units of outputFor purposes of the following discussion, assume that operating capacity is constant and that all activities occur within the limits of current operating capacityCopyright © Houghton Mifflin Company. All rights reserved.Operating Capacity (cont’d)Three common measures (or types) of operating capacityTheoretical capacityAlso called ideal capacityPractical capacityNormal capacityCopyright © Houghton Mifflin Company. All rights reserved.Theoretical (Ideal) Capacity is the maximum production output for a given period in which all machinery and equipment are operating at optimum speed, without interruptionNo company ever actually operates at such an ideal levelLong-term goal in a JIT operating environmentApproach theoretical capacity through continuous improvementCopyright © Houghton Mifflin Company. All rights reserved.Practical Capacity is theoretical capacity reduced by normal and expected work stoppagesWork stoppagesMachine breakdownsDowntime for retooling, repairs, and maintenanceEmployees’ breaksNot realistic when planning operationsCopyright © Houghton Mifflin Company. All rights reserved.Normal Capacity is the average annual level of operating capacity needed to meet expected sales demandUsed to plan operationsIs a realistic measure of what an organization is likely to produce, not what it can produceCopyright © Houghton Mifflin Company. All rights reserved.Normal Capacity (cont’d)Relate variable costs to an appropriate measure of normal capacityOperating costs can be related toMachine hours usedTotal units producedSales commissions can be related toTotal sales dollarsCopyright © Houghton Mifflin Company. All rights reserved.Normal Capacity (cont’d)Two reasons to select basis for measuring the activity of variable cost carefullyAn appropriate activity base simplifies cost planning and controlMany variable costs must be combined (aggregated) with the same activity baseSo that costs can be analyzed in a reasonable wayProvides information for predicting future costsCopyright © Houghton Mifflin Company. All rights reserved.Normal Capacity (cont’d)General guide for selecting an activity baseRelate costs to their most logical or causal factorExampleMachinery setup costs should be considered variable in relation to the number of setups needed for a particular jobAllows machinery setup costs to be budgeted and controlled more effectivelyCopyright © Houghton Mifflin Company. All rights reserved.Linear Relationships and the Relevant RangeEach unit of output requires $2.50 of labor costTotal labor costs grow in direct proportion to the increase in units of outputUnitsLabor CostCopyright © Houghton Mifflin Company. All rights reserved.Other Variable Cost Behavior Patterns: Nonlinear RelationshipsGraph ABehavior of power costs as usage increases and unit cost of power consumption fallsGraph BBehavior of rental costs when each additional hour of computer usage costs more than the previous hourGraph CShows how labor costs vary as efficiency increases or decreasesCopyright © Houghton Mifflin Company. All rights reserved.Linear Relationships and the Relevant Range (cont’d)All costs must be included in an analysis if the results are to be usefulVariable costs with linear relationshipsEasy to analyzeVariable costs with nonlinear relationshipsMore difficult to analyzeLinear approximationMethod to convert nonlinear variable costs into linear variable costsRelies on the concept of relevant rangeCopyright © Houghton Mifflin Company. All rights reserved.Linear Relationships and the Relevant Range (cont’d)Relevant RangeThe span of activity in which a company expects to operateWithin that range, it is assumed that both total fixed costs and per unit variable costs are constantUnder that assumption, many nonlinear costs can be estimated using the linear approximation approachThese costs can be treated as part of the other variable costsCopyright © Houghton Mifflin Company. All rights reserved.The Relevant Range and Linear ApproximationCopyright © Houghton Mifflin Company. All rights reserved.Linear Relationships and the Relevant RangeLinear approximationIs not a precise measureAllows the inclusion of nonlinear variable costs in cost behavior analysisLoss of accuracy is not significantHelps accomplish the goal of estimating costs and preparing budgetsCopyright © Houghton Mifflin Company. All rights reserved.Fixed Costs are total costs that remain constant within a relevant range of volume or activityThis is the range in which actual operations are likely to occurFixed costs behave differently from variable costsCopyright © Houghton Mifflin Company. All rights reserved.Fixed Costs (cont’d)According to economic theoryAll costs tend to be variable in the long runA cost is only fixed within a limited periodA one-year period is usually considered for management purposesFixed costs are expected to remain constant within that periodCopyright © Houghton Mifflin Company. All rights reserved.Fixed Costs (cont’d)The Manufacturer of aluminum cans needs one supervisor for an 8-hour work shift. Production can range from zero to 500,000 units per month per shift. The supervisor’s salary is $4,000 per monthThe relevant range is from zero to 500,000 unitsAny output above 500,000 units would require another work shift and another supervisorIf another shift is added, the new fixed cost remains constant in total within the new relevant rangeCopyright © Houghton Mifflin Company. All rights reserved.Fixed Costs (cont’d)Fixed unit costs vary inversely with activity or volumeOn a per unit basis, fixed costs go down as volume goes upAt 600,000 units, the activity is above the relevant range, which means another shift must be added and another supervisor hiredCopyright © Houghton Mifflin Company. All rights reserved.A Common Fixed Cost Behavior PatternCopyright © Houghton Mifflin Company. All rights reserved.Mixed Costs have both variable and fixed componentsPart of a mixed cost changes with volume or usagePart is fixed over a particular periodCopyright © Houghton Mifflin Company. All rights reserved.Behavior Patterns of Mixed CostsCopyright © Houghton Mifflin Company. All rights reserved.Mixed CostsFor planning and control purposes, mixed costs must be divided into their variable and fixed componentsThese components can then be grouped with other variable and fixed costs for analysisCopyright © Houghton Mifflin Company. All rights reserved.Mixed Costs (cont’d)Four methods used to separate mixed costs into variable and fixed componentsEngineering methodScatter diagram method High-low methodStatistical methodMultiple approaches are often used because the results yielded by these methods are likely to differCopyright © Houghton Mifflin Company. All rights reserved.The Engineering Methodof separating costs measures the work required by performing step-by-step analysis of tasks, costs, and processes involvedIs generally used to estimate the cost of activities and new productsCopyright © Houghton Mifflin Company. All rights reserved.The Engineering MethodExampleU.S. Postal serviceConducts studies of how many letters a postal worker should be able to deliver on a particular mail route within a certain periodThis type of analysis sometimes called a time and motion studyIs expensiveVery detailedRequires the expertise of engineers to determine the cost of a new product or activity for which no prior data existsCopyright © Houghton Mifflin Company. All rights reserved.The Scatter Diagram Method plots past costs and related measures of volume in a scatter diagramCopyright © Houghton Mifflin Company. All rights reserved.The Scatter Diagram Method (cont’d)Scatter diagramA chart of plotted points that helps determine whether a linear relationship exists between a cost item and its related activity measureIs a form of linear approximationIf a linear relationship can be suggested, a cost line can be imposed on the data byVisual meansStatistical analysisCopyright © Houghton Mifflin Company. All rights reserved.The Scatter Diagram Method (cont’d)Piedmont Corporation’s Park Division incurred the following machine hours and electricity costs last yearCopyright © Houghton Mifflin Company. All rights reserved.Scatter Diagram of Machine Hours and Electricity CostsCopyright © Houghton Mifflin Company. All rights reserved.The Scatter Diagram Method (cont’d)The diagram suggest a linear relationship between machine hours and electricity costsA line is added to the diagram to represent the linear relationshipEstimated fixed electricity costOccurs at the point where the line intersects the vertical axisVariable cost per unitCan be estimated by determining the slope of the lineCopyright © Houghton Mifflin Company. All rights reserved.The High-Low Method identifies a linear relationship between activity level and cost by analyzing the highest and lowest volumes in an accounting period and their related costsIs a common, simple methodSomewhat crudeCopyright © Houghton Mifflin Company. All rights reserved.The High-Low Method (cont’d)Three stepsCalculate the variable cost per activity baseCalculate the total fixed costsCalculate the formula to estimate the total costs within the relevant rangeCopyright © Houghton Mifflin Company. All rights reserved.The High-Low Method (cont’d)Step 1Calculate the variable cost per activity baseSelect the periods of highest and lowest activity within the accounting periodFind the difference between the highest and lowest amounts for both machine hours and their related electricity costsCopyright © Houghton Mifflin Company. All rights reserved.The High-Low Method (cont’d)Copyright © Houghton Mifflin Company. All rights reserved.Variable cost per machine hourDifference in cost divided by difference in machine hoursThe High-Low Method (cont’d)The variable cost per machine hour will be used to calculate total fixed costs in Step 2 and total cost per month in Step 3Copyright © Houghton Mifflin Company. All rights reserved.The High-Low Method (cont’d)Step 2Calculate the total fixed costsSelect the information from the month with either the highest or lowest volumeCopyright © Houghton Mifflin Company. All rights reserved.The High-Low Method (cont’d)DecemberTotal Costs = $24,700Total Variable Costs = 6,450 MH x $2.75 per MHAugustTotal Costs = $23,600Total Variable Costs = 6,050 MH x $2.75 per MH You can check your answer by recalculating total fixed costs using the month with the lowest activityThe total fixed costs in Step 2 will be used to calculate total cost per month in Step 3Copyright © Houghton Mifflin Company. All rights reserved.The High-Low Method (cont’d)Step 3Calculate the formula to estimate the total costs within the relevant rangeFrom Step 2From Step 1Copyright © Houghton Mifflin Company. All rights reserved.The High-Low Method (cont’d)The cost formula will work only within the relevant rangeIn this case, for amounts between 6,050 and 6,450 machine hoursTo estimate electricity costs for amounts outside of this range, a new formula must be calculatedCopyright © Houghton Mifflin Company. All rights reserved.Statistical MethodsRegression analysisMathematically describes the relationship between costs and activitiesAll data observations are usedResulting linear equation is more representative of cost behavior than either the high-low or scatter diagram methodsCopyright © Houghton Mifflin Company. All rights reserved.Statistical Methods (cont’d)Simple regression analysisOverhead costs are predicted using one activityMachine hours to predict electricity costsMultiple regression analysisOverhead costs are predicted using more than one activityMachine hours and labor hours to predict electricity costsBoth activities affect overheadCopyright © Houghton Mifflin Company. All rights reserved.DiscussionWhat are the three steps in the high-low method of determining the fixed and variable components of mixed costs?Step 1Calculate the variable cost per activity base Step 2Calculate total fixed costs Step 3Calculate the formula to estimate total costs within the relevant rangeCopyright © Houghton Mifflin Company. All rights reserved.Cost-Volume-Profit AnalysisObjective 3Define cost-volume-profit (C-V-P) analysis and discuss how managers use it as a tool for planning and controlCopyright © Houghton Mifflin Company. All rights reserved.Cost-Volume-Profit Analysis is an examination of the cost behavior patterns that underlie the relationships among cost, volume of output, and profitCopyright © Houghton Mifflin Company. All rights reserved.Cost-Volume-Profit Analysis (cont’d)Usually applies to a single product, product line, or division of a companyTherefore, the term profit is usedOnly part of an entire company’s operating incomeIn cases involving the income statement of an entire companyThe term operating income is more appropriateIn the context of C-V-P analysis, both mean the same thingCopyright © Houghton Mifflin Company. All rights reserved.Cost-Volume-Profit Analysis (cont’d)C-V-P is a tool forShort-range planningCalculate net income when sales volume is knownDecide the level of sales needed to reach a targeted amount of incomeBudgetingControlCompare actual costs with expected costsMeasure the effects of alternate courses of actionChanging variable or fixed costsExpanding or contracting sales volumeIncreasing or decreasing selling pricesCopyright © Houghton Mifflin Company. All rights reserved.Cost-Volume-Profit Analysis (cont’d)Useful only under certain conditions and when certain assumptions hold trueThe behavior of variable and fixed costs can be measured accuratelyCosts and revenues have a close linear approximationEfficiency and productivity hold steady within the relevant range of activityCopyright © Houghton Mifflin Company. All rights reserved.Cost-Volume-Profit Analysis (cont’d)Cost and price variable also do not change during the period being plannedThe sales mix does not change during the period being plannedProduction and sales volume are roughly equalIf one or more of these conditions and assumptions are absent, the C-V-P analysis may be misleadingCopyright © Houghton Mifflin Company. All rights reserved.DiscussionWhat are some ways that managers use C-V-P analysis as a tool for planning?Managers can use C-V-P to calculate net income when sales volume is known, decide the level of sales needed to reached a targeted amount of net income, and for budgeting purposesCopyright © Houghton Mifflin Company. All rights reserved.Breakeven AnalysisObjective 4Define breakeven point and use contribution margin to determine a company’s breakeven point for multiple productsCopyright © Houghton Mifflin Company. All rights reserved.Breakeven Analysis uses the basic elements of cost-volume-profit analysis to determine the breakeven pointBreakeven pointThe point at whichTotal revenues equal total costsThe company begins to earn a profitCopyright © Houghton Mifflin Company. All rights reserved.Breakeven Analysis (cont’d)Margin of safetyThe number of sales units or amount of sales dollars by which actual sales can fall below planned sales without resulting in a lossCopyright © Houghton Mifflin Company. All rights reserved.Breakeven Analysis (cont’d)General equation for finding the breakeven pointCopyright © Houghton Mifflin Company. All rights reserved.Breakeven Analysis (cont’d)Valley Metal Products, Inc. makes ornamental iron plant stands. Variable costs are $50 per unit, and fixed costs average $20,000 per year. Each plant stand sells for $90Compute the breakeven point for plant stands in sales units, where x equals sales unitsCompute the breakeven point in sales dollarsCopyright © Houghton Mifflin Company. All rights reserved.Breakeven Analysis (cont’d)Valley Metal Products, Inc. makes ornamental iron plant stands. Variable costs are $50 per unit, and fixed costs average $20,000 per year. Each plant stand sells for $90Compute the breakeven point using a scatter graphCopyright © Houghton Mifflin Company. All rights reserved.Breakeven Analysis (cont’d)The graph has five partsHorizontal axis for units of outputVertical axis for dollars of revenueA horizontal line running from the vertical axis at the level of fixed costsCopyright © Houghton Mifflin Company. All rights reserved.Breakeven Analysis (cont’d)A total cost lineBegins where the fixed costs line crosses the vertical axis and slopes upward to the rightSlope depends on variable cost per unitCopyright © Houghton Mifflin Company. All rights reserved.Breakeven Analysis (cont’d)A total revenue lineBegins at the origin of the vertical and horizontal axes and slopes upward to the rightSlope depends on the selling price per unitCopyright © Houghton Mifflin Company. All rights reserved.Breakeven Analysis (cont’d)Revenues equal total costsAt the point at which the total revenue line crosses the total cost lineCopyright © Houghton Mifflin Company. All rights reserved.Breakeven Analysis (cont’d)Breakeven pointFound by extending lines from this point to the axesValley Metal Products will break even when it has sold 500 plant stands for $45,000Copyright © Houghton Mifflin Company. All rights reserved.Using Contribution Margin to Determine the Breakeven PointContribution margin (CM)Is the amount that remains after all variable costs are subtracted from salesA product line’s contribution margin represents its net contribution to paying off fixed costs and earning a profitProfit is what remains after fixed costs are paid and subtracted from contribution marginCopyright © Houghton Mifflin Company. All rights reserved.Using Contribution Margin to Determine the Breakeven Point (cont’d)Breakeven point (BE)Can be expressed as the point whereContribution margin minus total fixed costs equals zeroContribution margin equals fixed costsCopyright © Houghton Mifflin Company. All rights reserved.Using Contribution Margin to Determine the Breakeven Point (cont’d)Compute the breakeven point in units for Valley Metal ProductsCopyright © Houghton Mifflin Company. All rights reserved.Using Contribution Margin to Determine the Breakeven Point (cont’d)Compute the breakeven point in sales dollars by multiplying BE in units by the selling price (SP) per unitCopyright © Houghton Mifflin Company. All rights reserved.Using Contribution Margin to Determine the Breakeven Point (cont’d)Compute the breakeven point in sales dollars using the CM Ratio* Difference due to rounding upCopyright © Houghton Mifflin Company. All rights reserved.The Breakeven Point for Multiple ProductsTo calculate the breakeven point for each product, its unit contribution must be weighted by the sales mixSales mixProportion of each product's unit sales relative to the organization’s total unit salesCopyright © Houghton Mifflin Company. All rights reserved.The Breakeven Point for Multiple Products (cont’d)Valley Metal Products sells two types of plant stands: a floor stand model and a smaller tabletop model. The company sells 500 stands, of which 300 are floor stand models and 200 are tabletop modelsDetermine the sales mixFor every three floor stands sold, 2 tabletop models are soldThe sales mix is 3:2or,Of the 500 units sold, 60% (300 ÷ 500) are floor stands and 40% (200 ÷ 500) are tabletop modelsCopyright © Houghton Mifflin Company. All rights reserved.The Breakeven Point for Multiple Products (cont’d)Valley Metal Products sells two types of plant stands: a floor stand model and a smaller tabletop model. The company sells 500 stands, of which 300 are floor stand models and 200 are tabletop models. Total fixed costs are $32,000Step 1Compute the weighted-average contribution marginMultiply the contribution margin for each product by its percentage of the sales mixCopyright © Houghton Mifflin Company. All rights reserved.The Breakeven Point for Multiple Products (cont’d)Valley Metal Products sells two types of plant stands: a floor stand model and a smaller tabletop model. The company sells 500 stands, of which 300 are floor stand models and 200 are tabletop models. Total fixed costs are $32,000Step 2Calculate the weighted-average breakeven pointDivide total fixed costs by the weighted-average contribution marginCopyright © Houghton Mifflin Company. All rights reserved.The Breakeven Point for Multiple Products (cont’d)Valley Metal Products sells two types of plant stands: a floor stand model and a smaller tabletop model. The company sells 500 stands, of which 300 are floor stand models and 200 are tabletop models. Total fixed costs are $32,000Step 3Calculate the breakeven point for each productMultiply the weighted-average breakeven point by each product’s percentage of sales mixCopyright © Houghton Mifflin Company. All rights reserved.The Breakeven Point for Multiple Products (cont’d)Valley Metal Products sells two types of plant stands: a floor stand model and a smaller tabletop model. The company sells 500 stands, of which 300 are floor stand models and 200 are tabletop models. Total fixed costs are $32,000VerifyDetermine the contribution margin of each product and subtract the total fixed costsCopyright © Houghton Mifflin Company. All rights reserved.DiscussionWhat is the general equation for finding the breakeven point in units?Sales – Variable Costs – Fixed Costs = 0, or, S – VC – FC = 0 The breakeven point is the point at which total revenues equal total costs Copyright © Houghton Mifflin Company. All rights reserved.Using C-V-P Analysis to Plan Future Sales, Costs, and ProfitsObjective 5Use C-V-P analysis to project profitability of products and servicesCopyright © Houghton Mifflin Company. All rights reserved.Using C-V-P Analysis to Plan Future Sales, Costs, and ProfitsPrimary goal of a business venture is to generate profits, not to break evenTo estimate the profitability of a ventureAdjust C-V-P analysis for targeted profitDifferent scenarios can be analyzed for the amount of profit or loss they might generateCopyright © Houghton Mifflin Company. All rights reserved.Applying C-V-P to a Manufacturing BusinessVan Bryce, the president of Valley Metal Products, has set this year’s profit goal for plant stands at $4,000. All previous data for the company remains the sameCalculate how many plant stands must be sold to reach the targeted profit (P)Copyright © Houghton Mifflin Company. All rights reserved.Applying C-V-P to a Manufacturing BusinessVan Bryce, the president of Valley Metal Products, has set this year’s profit goal for plant stands at $4,000. All previous data for the company remains the sameCheck the answer by inserting all known data into the equationCopyright © Houghton Mifflin Company. All rights reserved.Applying C-V-P to a Manufacturing Business (cont’d)The contribution margin approach can also be used for profit planningAdd the targeted profit to the numerator of the contribution margin breakeven equationCopyright © Houghton Mifflin Company. All rights reserved.Applying C-V-P to a Manufacturing Business (cont’d)Contribution income statementsPrepared for internal useAre useful in planning and making decisions about operationsCopyright © Houghton Mifflin Company. All rights reserved.Applying C-V-P to a Manufacturing Business (cont’d)Focus of contribution margin statementCost behavior, not cost functionCosts related to production, selling, and administrationVariable costs are subtracted from sales to determine total contribution marginFixed costs are subtracted from contribution margin to determine operating incomeVan Bryce wants his company’s planning team to consider three alternatives to the original plan shown in the contribution income statementCopyright © Houghton Mifflin Company. All rights reserved.Alternative 1: Decrease Variable Costs, Increase Sales VolumeThe planning team estimated what operating income would be if the company purchased and used aluminum rather than iron to make plant stands. If aluminum were used, direct materials costs per unit would decrease by $3. If the aluminum were painted to meet the needs of a new customer group, sales volume would increase by 10 percentDetermine the estimated operating income for this alternativeA decrease in direct materials costs of $3 results in an $1,800 increase in total CM and operating income ($3 x 600)Copyright © Houghton Mifflin Company. All rights reserved.Alternative 1: Decrease Variable Costs, Increase Sales VolumeThe planning team estimated what operating income would be if the company purchased and used aluminum rather than iron to make plant stands. If aluminum were used, direct materials costs per unit would decrease by $3. If the aluminum were painted to meet the needs of a new customer group, sales volume would increase by 10 percentDetermine the estimated operating income for this alternativeA sales increase of 60 units (.10 x 600) increases the total CM and operating income by $2,580 ($43 x 60)Copyright © Houghton Mifflin Company. All rights reserved.Alternative 1: Decrease Variable Costs, Increase Sales VolumeThe planning team estimated what operating income would be if the company purchased and used aluminum rather than iron to make plant stands. If aluminum were used, direct materials costs per unit would decrease by $3. If the aluminum were painted to meet the needs of a new customer group, sales volume would increase by 10 percentDetermine the estimated operating income for this alternativeCopyright © Houghton Mifflin Company. All rights reserved.Alternative 2: Increase Fixed Costs, Increase Sales VolumeThe planning team estimated what operating income would be if the company increased advertising costs instead of changing the direct materials. The Marketing Department suggested that a $500 increase in advertising costs would increase sales volume by 5 percentDetermine the estimated operating income for this alternativeAdditional advertising costs affects both sales volume and fixed costsCopyright © Houghton Mifflin Company. All rights reserved.Alternative 2: Increase Fixed Costs, Increase Sales VolumeSales volume increases 30 units (.05 x 600), which increases the total CM and operating income by $1,200 ($40 x 30 units)The planning team estimated what operating income would be if the company increased advertising costs instead of changing the direct materials. The Marketing Department suggested that a $500 increase in advertising costs would increase sales volume by 5 percentDetermine the estimated operating income for this alternativeCopyright © Houghton Mifflin Company. All rights reserved.Alternative 2: Increase Fixed Costs, Increase Sales VolumeFixed costs increase from $20,000 to $20,500, which decreases operating income by $500The planning team estimated what operating income would be if the company increased advertising costs instead of changing the direct materials. The Marketing Department suggested that a $500 increase in advertising costs would increase sales volume by 5 percentDetermine the estimated operating income for this alternativeCopyright © Houghton Mifflin Company. All rights reserved.Alternative 2: Increase Fixed Costs, Increase Sales VolumeThe planning team estimated what operating income would be if the company increased advertising costs instead of changing the direct materials. The Marketing Department suggested that a $500 increase in advertising costs would increase sales volume by 5 percentDetermine the estimated operating income for this alternativeCopyright © Houghton Mifflin Company. All rights reserved.Alternative 3: Increase Selling Price, Decrease Sales VolumeThe planning team evaluated the impact of a $10 increase in selling price on the company’s operating income. The team believes that competitors are selling the same product at a lower price and that sales volume will decrease by 15 percent if the selling price is raised to $10Determine how this alternative affects operating incomeA sales decrease of 90 units (.15 x 600) decreases the sales revenue by $3,000 [(600 x $90) – (510 x 100)]Copyright © Houghton Mifflin Company. All rights reserved.Alternative 3: Increase Selling Price, Decrease Sales VolumeThe planning team evaluated the impact of a $10 increase in selling price on the company’s operating income. The team believes that competitors are selling the same product at a lower price and that sales volume will decrease by 15 percent if the selling price is raised to $10Determine how this alternative affects operating incomeA sales decrease of 90 units (.15 x 600) decreases variable costs by $4,500 ($90 x 50)Copyright © Houghton Mifflin Company. All rights reserved.Alternative 3: Increase Selling Price, Decrease Sales VolumeThe planning team evaluated the impact of a $10 increase in selling price on the company’s operating income. The team believes that competitors are selling the same product at a lower price and that sales volume will decrease by 15 percent if the selling price is raised to $10Determine how this alternative affects operating incomeCopyright © Houghton Mifflin Company. All rights reserved.Comparative Summary of Alternatives at Valley Metal Products, Inc.Copyright © Houghton Mifflin Company. All rights reserved.Comparative SummaryDetermining which alternative to chooseAlternative 1Results in the highest operating income of the three alternativesAlternative 2Highest breakeven pointMore units must be sold to cover increased fixed costsAlternative 3Lowest breakeven pointCompany will begin generating income more quickly than with other alternativesCopyright © Houghton Mifflin Company. All rights reserved.Applying C-V-P Analysis to a Service BusinessThe manager of the Appraisal Department at Edmunds Mortgage Company estimates that over the next year her department will perform an average of 100 appraisals per month. The company charges $400 per appraisal. Variable costs are $160 for professional labor and $99 for a county survey map. Monthly service overhead costs were highest in March (180 appraisals at $23,380) and lowest in February (98 appraisals at $20,018)Estimate service overhead costsStep 1 – Calculate the variable service overhead cost per appraisalCopyright © Houghton Mifflin Company. All rights reserved.Applying C-V-P Analysis to a Service Business (cont’d)Estimate service overhead costsStep 2 – Calculate the total fixed service overhead costsUse data for MarchThe manager of the Appraisal Department at Edmunds Mortgage Company estimates that over the next year her department will perform an average of 100 appraisals per month. The company charges $400 per appraisal. Variable costs are $160 for professional labor and $99 for a county survey map. Monthly service overhead costs were highest in March (180 appraisals at $23,380) and lowest in February (98 appraisals at $20,018)Copyright © Houghton Mifflin Company. All rights reserved.Applying C-V-P Analysis to a Service Business (cont’d)Estimate service overhead costsStep 3 – Calculate the total service overhead costs for one monthThe manager of the Appraisal Department at Edmunds Mortgage Company estimates that over the next year her department will perform an average of 100 appraisals per month. The company charges $400 per appraisal. Variable costs are $160 for professional labor and $99 for a county survey map. Monthly service overhead costs were highest in March (180 appraisals at $23,380) and lowest in February (98 appraisals at $20,018)Copyright © Houghton Mifflin Company. All rights reserved.Applying C-V-P Analysis to a Service Business (cont’d)Estimate service overhead costsStep 4 – Calculate the total service overhead costs for one month assuming that 100 appraisals will be madeThe manager of the Appraisal Department at Edmunds Mortgage Company estimates that over the next year her department will perform an average of 100 appraisals per month. The company charges $400 per appraisal. Variable costs are $160 for professional labor and $99 for a county survey map. Monthly service overhead costs were highest in March (180 appraisals at $23,380) and lowest in February (98 appraisals at $20,018)Copyright © Houghton Mifflin Company. All rights reserved.Determining the Breakeven PointThe variable rate of $300 includes the $41 variable service OH rate plus $160 direct professional labor and $99 county survey map feeCopyright © Houghton Mifflin Company. All rights reserved.Determining the Effect of a Change in Operating CostsThe Appraisal Department performs an average of 100 appraisals per month and its estimated breakeven point is 160 appraisals. Increasing the appraisal fee is not an option because of strong competition. The manager has determined that costs must be reduced by improving appraiser’s scheduling to reduce travel time. She estimates this could reduce travel time by 50 percent, cutting the professional labor cost to $80 per appraisal. The new process will also increase fixed costs by $200 per monthDetermine the new breakeven pointCopyright © Houghton Mifflin Company. All rights reserved.Determining the Effect of a Change in Operating Costs (cont’d)How many appraisals would the department have to be perform each month to achieve a targeted profit of $18,000 per month? Copyright © Houghton Mifflin Company. All rights reserved.DiscussionIf a company sells its product for $10 per unit, variable costs are $2 per unit, and fixed costs are $10,000 per month, how many units would it need to sell to achieve a profit of $20,000 per month? Copyright © Houghton Mifflin Company. All rights reserved.Time for ReviewDefine cost behavior and explain how managers use this concept in the management cycleIdentify variable, fixed, and mixed costs, and separate mixed costs into their variable and fixed componentsDefine cost-volume-profit (C-V-P) analysis and discuss how managers use it as a tool for planning and controlCopyright © Houghton Mifflin Company. All rights reserved.And FinallyDefine breakeven point and use contribution margin to determine a company’s breakeven point for multiple productsUse C-V-P analysis to project profitability of products and servicesCopyright © Houghton Mifflin Company. All rights reserved.