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CVP Analysis
Cost-volume-profit (CVP) Analysis is a tool used by managers in order to predict the:
Volume of activity
Costs to be incurred
Sales to be made
Profit to be received
Cost Behavior
Relevant Range
The band or level of activity where the cost concepts and the relationship of variable and fixed costs is
considered valid. There must exist a linear relationship between the cost and the corresponding activity
(cost driver).
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ACC101
ACC 101 Cost Accounting
C. Gomez
Total Variable Cost variable
2. Fixed Cost total cost that remains the same as activity increases or decreases .
Total Fixed Cost fixed
Unit Fixed Cost - variable
Note:
As the volume of sales increases/decreases:
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ACC101
ACC 101 Cost Accounting
Chapter 3 | Handout Set #1
C. Gomez
Topic: CVP and Cost Concepts
3. Semi-variable cost costs that possess both the characteristics of fixed and variable costs. Also
known as mixed cost. Typical items would be taxi fares and electricity bills.
Y dependent variable
a constant
b constant slope
x independent variable
Total cost will always have a fixed cost component and a variable cost component where by fixed cost
is constant while variable cost is dependent on activity.
4. Step-fixed Cost typified by step increases in costs with changes in activity. An analogy that could be
used would be the application of the SSS Contribution table and bus fares.
Step-Variable Cost typified by small increases in costs with changes in activity. The increase in
variable cost is not constant but represented by small increments.
Curvilinear Cost a behavior pattern depicted by a curve graph with decreasing marginal cost at low
levels of activity until a relevant range is achieved and marginal costs will increase when the volume
breaches the relevant range.
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ACC101
ACC 101 Cost Accounting
C. Gomez
Segregation Techniques
In CVP analysis, all costs must be classified as either FIXED or VARIABLE. Therefore, when a cost is
classified as MIXED, the objective is to segregate the FIXED component from the VARIABLE component.
1. Scatter diagrams
2. High-low method
3. Least-squares regression
High-Low Method
It is assumed that semi-variable costs have fixed and variable cost components. The fixed component
is considered the basic or minimum cost of just having a service ready and available for use. The
variable element varies in proportion to the amount of service that is consumed.
It is assumed that the Total Cost is a function (defined as resulting from) of level of activity. F (activity)
Since the total cost is composed of both fixed and variable costs, we could derive the equation:
Variable Cost is a function of the level of activity whereby variable cost per unit is a constant:
Total Variable Cost = Variable Cost per unit * Level of Activity
Thus we could derive the function expressed as:
Total Cost = Fixed Cost + Variable Cost per unit * Level of Activity
Y
= a
+
bx
To be able to get the values of a & b, we get two representative points in the line and the
assumption in this theory is that the highest and lowest points are the representative points of the
total activity.
The High-Low point method makes use of the various levels of activity incurred for a certain type of
semi-variable cost. It is assumed that the highest and the lowest points possess the same amount of
total fixed costs (represented by Y) and same variable cost per unit (represented by X).
***High-Low Point method is the simplest method but it relies heavily on the assumption that the other
data points lie on a straight line between the highest and lowest points. It defeats the sampling
objective by considering only two samples and entirely disregarding the rest of the samples.
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ACC101
ACC 101 Cost Accounting
C. Gomez
Illustration
Given the following data for Ross Corporations utility costs for the year 2010
Month
January
February
March
April
May
June
July
August
September
October
November
December
Utility Cost
510,000.00
530,000.00
565,000.00
630,000.00
640,000.00
670,000.00
703,500.00
700,000.00
620,000.00
610,000.00
560,000.00
590,000.00
Activity
75,000
78,000
80,000
92,000
98,000
108,000
118,000
112,000
95,000
90,000
85,000
90,000
Note:
The basis for choosing data for analysis should be the ACTIVITY and not the corresponding cost.
To determine the fixed cost, the data to be used should only be either the Highest or the Lowest
Activity and not any other data point for the assumption to hold.
A deficiency of the high-low method is that it ignores points except the highest and lowest. The
method is crude and will result in the least precise values, but it is the simplest segregation
technique.
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