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Accounting Principles II – Cost-Volume-Profit Relationships

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    Study Guide Accounting Principles II – Cost - Volume - Profit Relationships 1. Cost Behavior Cost behavior explains how a cost changes when the level of activity changes. Activity can mean units produced, units sold, hours worked, or services provided. Some costs stay the same , while others increase or decrease as activity changes. Understanding cost behavior helps managers: • Prepare budgets • Make forecasts • Estimate profits • Choose between different business options 1. Fixed Costs Fixed costs remain the same in total , no matter how many units are produced or sold. • The total fixed cost does not change • The fixed cost per unit changes as activity changes For example, if production increases, the fixed cost is spread over more units, so the cost per unit decreases . Example of a Fixed Cost Straight - line depreciation is a fixed cost.

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    Study Guide A machine may be used to produce 1,000 units or 10,000,000 units in a month, but the depreciation expense stays the same because it depends on time , not usage. 2. Variable Costs Variable costs change in total when activity changes. • The cost per unit stays the same • The total cost increases or decreases with activity Example of a Variable Cost Direct materials are a variable cost. If: • One chair requires 1 yard of fabric • Fabric costs $5 per yard Then: • 1 chair costs $5

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    Study Guide • 10 chairs cost $50 • 100 chairs cost $500 The cost per unit stays at $5, but the total cost rises as more chairs are made. Comparing Fixed and Variable Costs Graphically When shown on a graph: • Total fixed costs appear as a flat horizontal line • Total variable costs slope upward as activity increases

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    Study Guide 3. Mixed Costs Mixed costs contain both fixed and variable components . Example of a Mixed Cost A phone plan charges: • $1,000 for the first 800 calls • $0.10 per call after 800 calls If a company makes 2,000 calls in March: • Extra calls = 1,200 • Extra cost = 1,200 × $0.10 = $120 • Total cost = $1,120 Because mixed costs behave like both fixed and variable costs, they must be separated into two parts before analysis.

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    Study Guide 4. Methods Used to Analyze Mixed Costs To separate mixed costs, companies use past data and the following methods: Scatter Diagram Method A scatter diagram plots: • Activity on the horizontal (x) axis • Cost on the vertical (y) axis Each dot represents one observation. A line is drawn through the points to estimate the cost pattern. • Where the line meets the vertical axis = fixed cost • The slope of the line = variable cost per unit Example

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    Study Guide Using two data points: • 36,000 gallons → $14,000 • 60,000 gallons → $20,000 Change in cost = $6,000 Change in activity = 24,000 gallons Variable cost per unit = $0.25 Estimated fixed cost = $5,000 High – Low Method The high – low method uses only: • The highest activity level • The lowest activity level

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