Types of Cost Behaviour

SHORT NOTE
COST 2
CHAPETER 1
Variable & Fixed Cost

Behaviour & Patterns
Cost behaviour refers to how a cost will react or respond to
changes in the level of business activity.
the behaviour of cost depend on cost drivers and its relevant
Range.
CVP analysis helps managers to understand the interrelationship
between cost, volume, and profit.
Types of cost behaviour

Variable Cost - is a cost that changes in direct proportion to
changes in the cost driver.
Fixed Cost- is a cost that remains constant over a given period
called relevant range.
Relevant Range: is the limit of cost driver activity with in
which a specific relation ship b/n the cost & the cost driver is
valid.
Cost-volume-profit (CVP) analysis is a technique that examines
changes in profits in response to changes in sales volumes,
costs, and prices.
The unit selling price, unit variable costs, and total fixed costs
are known and constant.
sales mix is constant. Sales mix is the relative proportion of

quantities of products or services that make up total revenue.
CONTRIBUTION MARGIN VS
GROSS MARGIN
Contribution margin can be expressed in three ways: in total, on
a per unit basis, and as percentage of revenues .
1 Total CM= Total revenue – Total VC
2 CM per unit= Unit selling price – VC per unit
3 CM ratio or percentage = Total CM/Total sales or

CM ratio or percentage = Unit CM÷ Unit Selling
Price
Profit = Total revenue - Total costs
Profit = Total revenue - Total variable costs - Total

fixed costs Profit = P.Q -V.Q-FC
P=sales price per unit

V=Variable cost per unit
Q=units sold
FC=Fixed cost per period
Variable cost ratio is the percentage of variable cost in

sales.
Variable cost ratio= Total VC /Total sales or

Variable cost ratio = Unit variable cost/Unit sales price
Break Even Analysis Uses
& Techniques
CVP analysis can be used to examine how various
alternatives that a decision maker is considering affect
operating income.
The break-even point is frequently one point of interest

in this analysis.
Break-even point (BEP) can be defined as the point

where total sales revenue equals total costs, i.e., total
variable cost plus total fixed costs.
It is a point where the total contribution margin equals

total fixed expenses. Stated differently, it is a point
where the operating income is zero.
There are three ways to compute the BEP

1) Equation technique,
2) Contribution margin technique and
3) Graphical method.
1 Equation Technique
It is the most general form of break-even analysis that
may be adapted to any conceivable cost-volume-profit
situation.
Income (or profit) is equal to sales revenue minus
expenses.
Revenues - Variable costs - Fixed costs = Operating

income
Revenues= Selling price (SP) x Quantity of units sold (Q)
Variable costs =Variable cost per unit (VCU)x Quantity
of units sold (Q)
Selling Price * Quantity of Units Sold - Variable Cost

per unit * Quantity of Unit Sold -Fixed Cost = operating
income
2 Contribution Margin Technique

The contribution margin technique is merely a short
version of the equation technique.
BEP units = Total fixed costs/CM per unit

BEP revenues = Total fixed costs/CM Ratio or
BEP revenues = BEP units x Selling price
3 Graphical Method
In the graphical method we plot the total costs and

revenue lines to obtain their point of intersection, which
is the break-even point.
Total costs line is the sum of the fixed costs and the
variable costs.
Total Revenue Line is line representing total sales birrs
at the activity you have selected.
The break-even point is where the total revenues line and
the total costs line intersect. This is where total revenues
just equal total costs.
Question and answer
Q2
1 Equation Method
Net Income (NI) = PQ – VQ – FC
Net Income = Total revenue – Total variable expense –

Total fixed cost
2 Contribution Margin Method

BEP (in units) = Fixed expenses/CM per unit
BEP (in BIRRS) = Fixed expenses/CM ratio
3 graphical method
The total costs at this output level are BR. 1,140,000=
BR. 240,000 + (20,000 X BR. 45).
MARGIN OF SAFETY
The margin of safety is the excess of budgeted (or actual)
sales over the break-even volume of sales.
It states the amount by which sales can drop before
losses begin to be incurred.
Margin of safety= Total sales - Break even Sales

Margin of safety ratio = Margin of safety/Total sales
Sensitivity Analysis
Cost Volume Profit analysis, sensitivity analysis
examines how
operating income (or the break-even point) changes if the
predicted data for selling price, variable costs per unit,
fixed costs, or units sold are not achieved.
The sensitivity to various possible outcomes broadens

managers' perspectives as to what might actually occur
before they make cost commitments.
TARGET PROFIT ANALYSIS

Target sales (in units)=Total Fixed Costs+Target
Profit /CM per unit
Target sales (in dollars) = Total Fixed Costs+ Target
profit /CM Ratio
the target profit indicates the level of activity or dollar
sales amount at which total contribution margin equals
total fixed costs plus the desired profit amount.
IMPACT OF TAXES ON CVP

ANALYSIS
a profit level on an after-tax basis, it is necessary to first
convert the after-tax profit-to-profit before-tax
NIBT=NIAT/1-t
*NIBT=net income before tax
T=tax rate
“t”& NIAT are the prevailing company tax rate and net
income after taxes, respectively
In the general case the CVP equation could be presented
as:
P1Q1 + P2Q2+...+PnQn – V1Q1 – V2Q2-...VnQn-FC = NI
where
P1 = Selling price per unit of product 1
Q1 = Number units of 1 produced and sold
V1 = Unit variable cost of product 1
FC = Fixed Cost per Period
NI = Net Income
In a multi product firm, break-even analysis is somewhat

more complex. The reason is that different products will
have different selling prices, different costs, and
different contribution margins. Using contribution
margin approach, the computation of the break-even
point (BEP) in multi product firm
BEP (in units) = Total fixed expenses/*Weighted

average CM
BEP (in BIRRS) = Total Fixed Expenses/CM ratio
Note: *Weighted average unit contribution margin is
the average of the several products’ unit contribution
margins, weighted by the relative sales proportion of
each product For a company with more than one
product, sales mix is the relative combination in which a
company’s products are sold.
Different products have different selling prices, cost
structures, and contribution margins.

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SHORT NOTE

Variable & Fixed Cost

Types of cost behaviour

sales mix is constant. Sales mix is the relative proportion of

2 CM per unit= Unit selling price – VC per unit

3 CM ratio or percentage = Total CM/Total sales or

Profit = Total revenue - Total costs

Profit = Total revenue - Total variable costs - Total

P=sales price per unit

Variable cost ratio is the percentage of variable cost in

Variable cost ratio= Total VC /Total sales or

The break-even point is frequently one point of interest

Break-even point (BEP) can be defined as the point

It is a point where the total contribution margin equals

There are three ways to compute the BEP

Revenues - Variable costs - Fixed costs = Operating

Selling Price * Quantity of Units Sold - Variable Cost

2 Contribution Margin Technique

BEP units = Total fixed costs/CM per unit

In the graphical method we plot the total costs and

Question and answer

Net Income = Total revenue – Total variable expense –

2 Contribution Margin Method

Margin of safety= Total sales - Break even Sales

The sensitivity to various possible outcomes broadens

TARGET PROFIT ANALYSIS

IMPACT OF TAXES ON CVP

In a multi product firm, break-even analysis is somewhat

BEP (in units) = Total fixed expenses/*Weighted

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