IDENTIFYING COST BEHAVIOR PATTERNS

For each of the following situations, identify the graph that

illustrates the cost behavior pattern involved:
1. Cost of raw materials used
2. Electricity Bill a flat fixed charge, plus a variable cost after
a certain number of kilowatt hours are used.
3. City water bill, which is computed as follows:


First 1,000,000 gallons or less $1,000 flat fee
Next 10,000 gallons $0.003 per gallon used
Next 10,000 gallons $0.006 per gallon used
Next 10,000 gallons $0.009 per gallon used
Etc Etc
$900
$950
$1,000
$1,050
$1,100
$1,150
$1,200
0 1,000,000 1,010,000 1,020,000 1,030,000
City Water Bill
City Water Bill
IDENTIFYING COST BEHAVIOR PATTERNS
Rent on a factory building donated by the city,
where the agreement calls for a fixed fee
payment unless 200,000 labor-hours or more are
worked, in which case no rent need be paid.

Salaries of maintenance workers, where one
maintenance worker is needed for every 1,000
hours of machine-hours or less (that is, 0 to 1,000
hours require one maintenance worker, 1,001 to
2,000 requires two maintenance workers, etc.)
CONTRIBUTION FORMAT VS. TRADITIONAL
FORMAT OF INCOME STATEMENT
TRADITIONAL FORMAT CONTRIBUTION FORMAT
Sales Sales
- COGS - Variable expenses
= Gross Profit = Contribution Margin
- Selling & Administrative
Expenses
- Fixed Expenses
= Net Income = Net Income
Marwicks Pianos, Inc., purchases pianos from a large manufacturer
and sells them at the retail level. The pianos cost, on the average,
$2,450 each from the manufacturer. Marwicks Pianos, Inc., sells the
pianos to its customers at an average price of $3,125 each. The selling
and administrative costs that the company incurs in a typical month
are presented below:








During August, Marwicks Pianos, sold and delivered 40 pianos.
SELLING COSTS ADMINISTRATIVE COSTS
Advertising..$700 per month Executive salaries..$2,500 per month
Sales salaries and commissions..$950 per
month, plus 8% of sales
Insurance..$400 per month
Delivery of pianos to customers$30/piano sold Clerical..$1,000/month, plus
$20/piano sold
Utilities..$350 per month Depreciation of office
equipment....$300/month
Depreciation of sales facilities..$800/month
TRADITIONAL FORMAT
Sales $125,000
Less: Cost of Goods Sold $98,000
Gross Margin $27,000
Less: Operating Expenses
Selling $14,000
Administrative $5,000 $19,000
Net Income $8,000
CONTRIBUTION FORMAT INCOME
STATEMENT
Sales $125,000
Variable Expenses:
Variable production $98,000
Variable selling $11,200
Variable admin $800 $110,000
Contribution margin $15,000
Fixed Expenses:
Fixed selling $2,800
Fixed admin $4,200 $7,000
Net Operating Income $8,000
COST VOLUME PROFIT ANALYSIS
Cost-volume-profit analysis is based upon determining
the breakeven point of cost and volume of goods.
CVP Analysis can help answer questions like: what
products and services to offer and what prices to
charge, etc.
It can be useful for managers making short-term
economic decisions.
Running this analysis involves using several equations
using price, cost and other variables and plotting them
out on an economic graph.


COST VOLUME PROFIT ANALYSIS
CVP analysis has following assumptions:
All cost can be categorized as variable or fixed.
Sales price per unit, variable cost per unit and
total fixed cost are constant.
All units produced are sold.

CONTRIBUTION INCOME STATEMENT FOR ABC
COMBANY
Total Per Unit
Sales* $100,000 $250
Variable Expenses $60,000 150
Contribution margin $40,000 $100
Fixed Expenses: $35,000
Net Operating Income $5,000


*400 SPEAKERS SOLD
CONTRIBUTION INCOME STATEMENT
If 1 speakers is sold!!
Total Per Unit
Sales $250 $250
Variable Expenses: $150 150
Contribution margin $100 $100
Fixed Expenses: $35,000
Net Operating Income $(34,900)
CONTRIBUTION INCOME STATEMENT
If 2 speakers are sold!
Total Per Unit
Sales $500 $250
Variable Expenses: $300 150
Contribution margin $200 $100
Fixed Expenses: $35,000
Net Operating Income $(34,800)

CONTRIBUTION INCOME STATEMENT
Sales of 350 Speakers
Total Per Unit
Sales $87,500 $250
Variable Expenses $52,500 150
Contribution margin $35,000 $100
Fixed Expenses: $35,000
Net Operating Income $ 0


CONTRIBUTION INCOME STATEMENT
Sales of 351 Speakers
Total Per Unit
Sales $87,750 $250
Variable Expenses $52,650 150
Contribution margin $35,100 $100
Fixed Expenses: $35,000
Net Operating Income $ 100

Once the break even point has been reached, net
operating income will increase by the amount of the unit
contribution margin for each additional unit sold.
Volume
(400
speakers)
Sales Volume
(425 speakers)
Difference
(25
speakers)
Per Unit
Sales* $100,000 $106,250 $6,250 $250
Variable
expenses**
60,000 63,750 3,750 150
Contribution
Margin
40,000 42,500 2,500 $100
Fixed Expense 35,000 35,000 0
Net operating
income
$5,000 $7,500 $2,500
*Sales= Price Volume: $250 400 = $100,000
**Variable expense = Variable expense per speaker Volume:
$150 400 = $60,000
SUMMARY
If sales are zero, loss would equal fixed expenses.
Each unit sold reduces the loss by the amount of
unit contribution margin.
After reaching break-even point, each additional
unit sold increases the company's profit by the
amount of the unit contribution margin.
CVP RELATIONSHIPS IN GRAPHIC FORM
$0
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
$140,000
$160,000
0 100 200 300 400 500 600 700 800
Fixed Expense
Total Sales Revenue
Total Expense
CONTRIBUTION MARGIN RATIO
CM Ratio = Total Contribution Margin
Total Sales
OR

CM Ratio = Unit Contribution Margin
Unit selling price



CONTRIBUTION MARGIN RATIO
Total Per Unit % of sales
Sales* $100,000 $250 100%
Variable Expenses $60,000 150 60%
Contribution margin $40,000 $100 40%
Fixed Expenses: $35,000
Net Operating Income $5,000

*400 SPEAKERS SOLD


$30,000 increase in sales?
Present Expected Increase % of sales
Sales $100,000* $130,000 $30,000 100%
Variable
expenses
60,000** 78,000 18,000 60%
Contribution
Margin
40,000 52,000 12,000 40%
Fixed Expense 35,000 35,000 0
Net operating
income
$5,000 $17,000 $12,000
*Sales= Price Volume: $250 400 = $100,000
**Variable expense = Variable expense per speaker Volume:
$150 400 = $60,000 OR
60% of sales

APPLICATIONS OF CVP CONCEPTS
Changes in Fixed Cost & Sales Volume
Change in Variable Costs & Sales Volume
Changes in Fixed Cost, Sales Price, & Sales
Volume
Changes in Variable Cost, Fixed Cost, and Sales
Volume
Change in Selling Price
CHANGES IN FIXED COST & SALES VOLUME
Current
Sales
Sales with
Additional
Advertising Budget
Difference % of Sales
Sales $100,000 $130,000 $30,000 100%
Variable
Expenses
(60,000) 78,000* 18,000 60%
Contribution
Margin
40,000 52,000 12,000 40%
Fixed
Expenses
(35,000) 45,000** 10,000
Net Operating
Income
$5,000 7,000 2,000


*520 units $150 per unit = $78,000
**35,000 + additional $10,000 monthly advertising budget = $45,000.
ALTERNATIVE SOLUTION 1
Expected total contribution margin:
$130,000 40% CM ratio
$52,000
Present total contribution margin
$100,000 40% CM ratio
40,000
Incremental contribution margin 12,000
Change in fixed expenses
Less incremental advertising expense
10,000
Increased net operating income $2,000
ALTERNATIVE SOLUTION 2
Incremental contribution margin:
$30,000 40% CM ratio. $12,000

Less Incremental advertising expense. 10,000
Increased net operating margin.. $ 2,000