C213 - Accounting for Decision Makers 10+
C-V-P analysis is useful to managers in: Evaluating decisions Planning All of these are correct Controlling decisions
All of these are correct
What are the total costs for a company with per-unit variable costs of $12 and total fixed costs of $51,000 if it sells 8,000 units of product? $125,000 $96,000 $147,000 $51,000
Answer: $147,000 Total costs: $51,000 + (8,000 x $12) = $147,000
Wimmer Company makes swimming suits and wants to analyze its mixed costs. The diagram below shows a scattergraph representing Wimmer's mixed costs for the previous five months. A scattergraph of Wimmer Company swimsuit sales. Using the graph above, determine Wimmer's variable cost rate. $2.50 $2.00 $1.00 $1.25
Answer: $2.00 Variable cost rate: ($600 - $400) / (100 - 0) = $2.00
XYZ Company generally produces between 200 and 350 units of product. Its fixed costs, within this relevant range, are $50,000. Its variable costs at 250 units of production are $10 per unit. What are the fixed costs per unit at 250 and 300 units of production, respectively? (Round to the nearest dollar.) $250 and $143 Answer cannot be determined from data given $200 and $167 $10 and $200
Answer: $200 and $167 Fixed costs per unit at 250 units: $50,000 / 250 = $200 Fixed costs per unit at 300 units: $50,000 / 300 = $167
Wimmer Company makes swimming suits and wants to analyze its mixed costs. The diagram below shows a scattergraph representing Wimmer's mixed costs for the previous five months. A scattergraph of Wimmer Company swimsuit sales. Using the graph above, determine the amount of Wimmer's fixed costs. $400 $475 $600 $650
Answer: $400
When using the scattergraph method to analyze mixed costs, the regression line should be visually fit to: Maximize the average distance between all the data points and the regression line Go through the highest and the lowest points Go through the cost axis at 0 Minimize the average distance between all the data points and the regression line
Answer: Minimize the average distance between all the data points and the regression line
The scattergraph method is a useful tool for: Working outside the relevant range Separating mixed costs into their variable and fixed components Analyzing abrupt changes in cost behavior Determining the break-even point
Answer: Separating mixed costs into their variable and fixed components
Another name for the scattergraph method of analyzing mixed costs is the: Engineering method High-low method Regression analysis method Visual-fit method
Answer: Visual-fit method
Type of CVP Analysis?
Breakeven Analysis:
Examples of Mixed Cost:
Electricity cost in a factory: There is some cost of electricity even if you don't make anything Salespersons' salary cost in a company that pays both a base salary plus commission Some cell phone bills: Fixed monthly charge plus additional charges if you go over some minute limit or text limit Some retail rental costs such as in a shopping mall: There is a minimum rental charge plus additional rental amounts depending on the level of retail sales in the story
Variable costs DO NOT change. T/F
False - Variable costs change
Fixed Cost per Unit formula
Fixed Cost per Unit = Fixed Cost / # of units
Total Fixed Costs vs. Fixed Costs per Unit
Fixed costs remain constant regardless of changes in sales or production volume while fixed costs per unit will decrease as sales or production volume increases. Fixed costs represent expenses such as salaries, rent, utilities, telephone, and other operating expenses. These remain virtually the same regardless of sales volume.
Cost-Volume-Profit (CVP) Analysis determines?
How much does our profit (or loss) vary depending on our level of sales?
Why do we care about Mixed Costs?
In order to perform an accurate C-V-P analysis, you have to know which costs will change as the level of activity changes.
Why do we care about Mixed Cost?
In order to perform an accurate CVP analysis, you have to know which costs will change as the level of activity changes.
C-V-P analysis, while useful for several purposes, is primarily useful in: Controlling decisions Financing decisions Planning Evaluating decisions
Planning
Examples of Fixed Costs
Rent for restaurant
Slope = Variable Cost per Unit
Rise over Run or: Rise (dollars) _______________________ Run (hours)
Measuring the level of activity
Sales volume (output measure) Production volume (output measure) Labor hours worked (input measure) Machine hours used (input measure)
Two common techniques for analyzing mixed costs are:
Scattergraph method High-low method
Scattergraph and High-Low Comparison
Scattergraph: * Uses all the data * NOT mathematically precise High-Low: * Mathematically precise * Only uses two data points
Slope =
Slope = Variable Cost per Unit
In a Mixed Cost table, the dollars goes on which axis?
The "X" axis.
Fixed cost:
The Y-intercept of the total cost line
The slope on the Variable Cost table is?
The amount per unit
Relevant Range
The range of activity within which assumptions about variable and fixed cost behavior are valid.
Variable cost per hour:
The slope of the total cost line
Regression Line
The straight line that best fits among all of the data points. * In this case, the regression line gives an estimate of the total electricity cost of any number of direct labor hours.
The slope of the Mixed Cost table tells you what?
The variable cost
Which of the following items is NOT a key factor involved in cost-volume-profit (C-V-P) analysis? Fixed and variable costs Time value of money The mix of products sold Sales revenue
Time value of money
Purpose of the Scattergraph Method
To separate a mixed cost into its FIXED and VARIABLE components. These FIXED and VARIABLE costs are then included in a CVP Analysis. These are only ESTIMATES!
Compute Fixed Cost
Total Cost = Variable + Fixed Fixed = Total Cost - Variable
Many people (most people?) just don't think of using DATA in making decisions. T/F
True
Mixed costs have both a fixed and a variable component. T/F
True
Mixed costs must be separated into their variable and fixed components. T/F
True
Once the regression line has been fitted through the data points, the scattergraph method does not depend any longer on the data points to estimate fixed and variable costs. Cost estimations are entirely based on points along the regression line. True/False
True
Once you have selected the high and low activity levels to use in the high-low method, don't use any other activity levels or costs than these two data points to calculate the fixed costs. True/False
True
Stepped costs increase with the level of activity but in steps instead of smoothly. T/F
True
The purpose of Scattergraph and High-Low methods is to separate a mixed cost into its FIXED and Variable components. T/F
True
The scattergraph method involves visually fitting a straight line (the regression line) through data points plotted on a graph. True/False
True
With both methods, where the line intercepts the cost axis represents the fixed cost, and the slope of the line represents the variable cost per unit. True/False
True
With the high-low method, the high and the low levels of activity are used to define an estimate of the total cost line. True/False
True
Fixed Costs do not change. T/F
True - Fixed costs do not change.
CVP Analysis: Basic Cost Behavior has 2 types, what are they?
Variable Costs Fixed Costs
The CVP question is always the same:
What happens to my costs as this level of activity changes?
Examples of CVP analysis:
When planning on opening a scuba shop in the mall, how many customers will I need to be served each month to break even and be able to pay the monthly store rental? How will the profits of a bookstore be affected if the store raises its prices by 10%, resulting in a reduction of 2% in the number of books sold? By how much will the profits of a discount electronics store change if a $100,000 advertising campaign increases the number of computers sold by 13%?
Example of Variable Costs
meat for hamburger restaurant
cost behavior
the way in which a cost reacts to changes in the level of activity
Stepped fixed costs
things that can only be bought in distinct chunks
The two basic cost behavior patterns are:
variable → variable in total, fixed per unit fixed → fixed in total, variable per unit
Variable Cost Relevant Range
when the total cost line is straight
Cost-volume-profit (CVP) analysis
•A technique of analyzing the effects of changes in an organization's volume of activity on its costs, revenue, and profit •Ex: How raising ticket prices will affect the Red Sox's profits
Basic Cost Behavior
"Behavior" with respect to changes in the volume of activity. If sales go up, what happens to each one of my costs?
Contribution Margin per Person for charity event?
$18,000 for the car _____________________________________________ Contribution Margin per Person ($250 - $40 per person) $18,000 / $210 per person = 86 people to breakeven
Fixed cost
* Constant as the number of units increases or decreases * Fixed cost per unit decreases as the number of units increases
Limitations of the Scattergraph Method
* It isn't exact * Two different people won't get EXACTLY the same numbers for fixed cost and variable cost per unit Yes, but: * It is a quick and useful tool * It can be made mathematically precise, if desired.
Key factors involved in C-V-P analysis are:
* Revenues from the sales prices charged for goods and services * Fixed and variable costs * Sales volume * Mix of products * Resulting profits
Other examples of Variable Costs:
* Wood cost for wooden table maker * Metal cost for automotive company * Direct labor cost in a company with a strict schedule in which workers are paid only for the actual umber of units they produce * Salespersons' salary cost in a company that pays strictly on commissions
Other examples of Mixed Costs
* electricity in a factory * salesperson's salary plus a commission * some cell phone bills
Variable Cost
* variable costs per unit is constant total variable cost increases * proportionately as the number of units increases
What are the 3 approaches of Mixed Cost Analysis?
1. Detailed, invoice by invoice categorization 2. Scattergraph method, a visual approach 3. High low method, a computational approach
Mixed Cost Analysis: 3 Approches
1. Detailed, invoice by invoice categorization 2. Scattergraph method, a visual approach 3. High-low method, or computational approach
Steps in the Scattergraph Method
1. Draw the empty graph with the costs ($ amount) on the y-axis and the level of activity on the x-axis 2. Plot the data 3. Draw the "regression line" 4. Compute the slope of the regression line 5. Identify the y-intercept which is the fixed cost
Steps in the HIGH-LOW Method
1. Identify the highest and the lowest levels of activity 2. Compute the increase in cost from the lowest level of activity to the highest. Also compute the increase in activity level from the low to the high. 3. Compute the slope (rise over run) 4. Compute Fixed Cost using: Total Cost= Variable + Fixed
Example of Breakeven Analysis:
Charity banquet and raffle * The raffle was a brand new care costing $18,000 * The caterer charged $40 per person * The charity sold tickets to the banquet for $250 Questions: 1. How many people had to attend the banquet in order for the charity to breakeven? 2. Do you think the charity performed the breakeven calculation?
Mixed Costs examples
Consider an automobile dealership. The rent is $4,000 plus 1% of sales per month. This is a common rental agreement for store locations in a mall. * What is the rent cost if the dealership has sales of $0? ( $4,000+($0x0.01)=$4,000 rent cost * What is the rent cost if the dealership has sales of $500,000? ($4,000+($500,000 x 0.01)=$9,000
Variable Costs
Costs that INCREASE the more you make or sell
Fixed Costs
Costs that STAY THE SAME the more you make or sell
Mixed Costs
Costs that contain both a variable- and a fixed-cost element and change in total but not proportionately with changes in the activity level.
A Huge benefit of financial analysis in general and CVP Analysis in particular is that it can?
Counteract the natural over-optimism of entrepreneurs.