Objectives:

 Classify cost by their behavior as variable cost, fixed cost or mixed

cost.
Compute the contribution margin, the contribution margin ratio, and
the unit contribution margin, and explain how they may be useful to
managers.
 Using the unit contribution margin, determine the break-even point
and the volume necessary to achieve a target profit.
 Using a cost-volume-profit chart and a profit-volume chart,
determine the break-even point and the volume necessary to achieve a
target profit.
Calculate the break-even point for a business selling more than one
product.
Compute the margin of safety and the operating leverage, and explain
how managers use these concepts.
List the assumptions underlying cost-volume-profit analysis.
 Cost Behavior
 Refers to the manner in which a cost changes as a related
activity changes.
Two factors to considered to understand cost behavior:
1. Activity bases – activities that are thought to cause the
cost to be incurred.
2. Relevant range – specify the range of activity over which
the changes in the cost are of interest.

Three of the most common classification of cost

behavior are:
1. Variable Cost
2. Fixed Cost
3. Mixed Cost
1. Variable cost – are cost that vary in proportion
to changes in the level of activity .
Example:
Assume that Jason Inc. Produces stereo sound systems under the brand
name of J-Sound. The parts for the stereo system are purchased from outside
suppliers for $10 per unit and are assembled in Jason Inc’s Waterloo plant. The
direct materials cost for Model JS-12 for the relevant range of 5,000 to 30,000
units of production are show below.

Variable cost are the same per unit, while the total variable cost changes in
proportion to changes in the activity base.
Example of variable cost, along with their related
bases for various of business:
 2. Fixed Cost – are cost that remain the same in
total dollar amount as the level of activity
changes.
Example of fixed cost and their activity bases for a variety of business as follows:
3. Mixed Cost – has characteristic of both a
variable and a fixed cost.
Example:
Assume that Simpson Inc. Manufactures sails, using
rented machinery. The rental charges are $15,000 per
year, plus $1 for each machine hour used over 10,000
hours. If the machinery is used 8,000 hours, the total
rental charge is $15,000. If the machinery is used 20,000
hours, the total rental charge is $ 25,00.

 The rental charges are a fixed cost up to 10,000 hours

and a variable cost thereafter.
High-low method – is a cost estimation technique
that may be used in separating the fixed and
variable component in mixed cost.
To illustrate, assume that the Equipment Maintenance Department of Kason
Inc. Incurred the following cost during the past five months:
 Variable cost per unit = Difference in total cots $ 20,250 = $ 15
Difference in Production 1,350 units

Total Cost = (variable cost per unit X units of production) + Fixed cost

Highest Level:
$61,500 = ($15 X 2,100 units) + Fixed Cost
$61,500 = 31,500 + Fixed Cost
$30,00 = Fixed Cost

Lowest Level:
$41,250 = ($15 X 750 units) + Fixed Cost
$41,250 = 11,250 + Fixed Cost
$30,000 = Fixed Cost
Cost Volume Profit Relationship
 Is the systematic examination of the relationships
among selling prices, sales and production
volume, cost, expenses, and profits.
 Provides management with useful information for
decision making.
 For example, cost-volume-profit analysis may be
used in setting selling prices, selecting the mix
of products to sell, choosing among marketing
strategies, and analyzing the effects of changes
in cost on profits.
Contribution Margin Concept
 The excess of sales revenues over variable cost.
 To illustrate, the income statement of Lambert Inc.
has been prepared in a contribution margin format as
shown below

Contribution Margin Income Statement

Sales $1,000,000
Variable cost 600,000
Contribution margin 400,000
Fixed costs 300,000
Income from operation $100,000
Contribution Margin Ratio
 Sometimes called Profit-Volume Ratio
 Indicates the percentage of each sales dollar available
to cover the fixed cost and to provide income from
operations
For Lambert Inc,. The contribution margin ratio is 40%,
as computed below.
Contribution margin ratio = Sales – Variable Cost
Sales
Contribution margin ratio = $1,000,000 - $600,000
$1,000,000
= 40%
 The contribution margin ratio measures the effect on
income from operations of an increase or a decrease in
sales volume.

For example, assume that the management of Lambert

Inc. is studying the effect of adding $80,000 in sales
orders.

Sales $1,080,000
Variable cost ($1,080,000 x 60%) 648,000
Contribution margin (($1,080,000 x 40%) $ 432,000
Fixed cost 300,000
Income from operations $ 132,000
Unit Contribution Margin
 is the dollars from each unit of sales available to cover
fixed costs and provide income from operations.
 Useful for analyzing the profit potential of proposed
projects.

For example:
If Lambert Inc.