ACC10007 Lecture Notes - Lecture 10: Variable Cost, Fixed Cost
Accounting for Decision Making Lecture 10
Cost Volume Profit Analysis
Cost Behavior pattern
Cost behaviour is the relationship between a cost and the level of activity
Consider
Variable costs
Fixed costs
Step-fixed costs
Semi-variable costs
Understanding cost behaviour can assist with cost estimation
Estimating costs
Y = mX + c
Where Y = estimated total cost
m = variable cost per unit of activity (the slope of the line)
X = the level of activity (volume)
c = fixed cost component (the intercept on the vertical axis)
Variable Costs
Total Variable costs change in direct proportion to changes in the level of activity.
Variable cost per unit remains constant regardless of the level of activity
The variable cost per unit is the slope (m) of the cost line in the following cost function:
Y = mX + c
Variable costs can be depicted as a linear straight line
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Variable cost per unit remains constant at $100
Total variable cost varies with volume
Fixed costs
As activity increases or decreases total fixed costs stay constant
As activity level changes the allocated fixed cost per unit changes
The fixed cost is the vertical axis intercept (c) of the cost line in the following cost
function:
Y = mX + c
Note: Fixed cost per unit is often calculated to use in product costing but is of limited use
in other management decision making. Fixed costs do not vary with the level of
activity within the relevant range
Semi-variable costs have both fixed and variable elements
Stepped fixed costs remain fixed over a range of activity levels but jump to a different amount
for levels outside that range
Cost Behavior Examples
Variable cost - Raw Materials - driven by production volume. Total variable cost varies
directly in proportion to changes in the level of production volume
Fixed cost - Lease of Premises – total fixed cost is constant regardless of changes in
activity levels
Semi-variable cost - Operating Delivery Trucks – fixed lease cost plus running costs
(eg petrol used per km travelled)
Cost behavior or relevant Range
Relevant Range
The range of activity over which a particular cost behaviour pattern can be assumed to be valid
Outside the relevant range of activity, the expected behaviour of costs may change
Cost Volume Profit
Understanding the relationship between Cost, Volume & Profit can improve decision making
CVP Analysis
For short-term operating decisions, managers may need to answers questions like:
How many units do we need to sell to breakeven?
If we want to make a profit of $X, how many units would we need to sell?
What is the impact of a given increase or decrease in variable and/or fixed costs on breakeven
point?
What is the impact of a given increase or decrease in price on profit?
For CVP analysis, which can be used to answer these questions, we make assumptions about
how costs behave in a business
Terminology and Abbreviations
CM = Contribution Margin
SP = Selling Price
VC = Variable Cost
FC = Fixed Cost
$pu = $ Per Unit
B/e = Breakeven
PBT = Profit before tax
T = Total SR = Sales Revenue
FORMULAS
Contribution Margin $per unit
= Selling Price – Variable Cost $pu
CM = SP - VC
Contribution Margin Ratio
= Contribution Margin / Selling Price
CM ratio = CM / SP
Breakeven in units
= Fixed Costs / Contribution Margin $per unit
B/e (units) = FC / CM $pu
Breakeven in sales dollars
= Fixed Costs / Contribution Ratio
B/e (sales $) = FC / CM ratio
Units to earn a Target Profit
= (Fixed Costs + Target Profit before tax)/CM per unit
(FC + Target PBT) / CM
Document Summary
Cost behaviour is the relationship between a cost and the level of activity. Understanding cost behaviour can assist with cost estimation. Where y = estimated total cost m = variable cost per unit of activity (the slope of the line) X = the level of activity (volume) c = fixed cost component (the intercept on the vertical axis) Total variable costs change in direct proportion to changes in the level of activity. Variable cost per unit remains constant regardless of the level of activity. The variable cost per unit is the slope (m) of the cost line in the following cost function: Variable costs can be depicted as a linear straight line. Variable cost per unit remains constant at . As activity increases or decreases total fixed costs stay constant. As activity level changes the allocated fixed cost per unit changes. The fixed cost is the vertical axis intercept (c) of the cost line in the following cost function:
