Cost Volume Profit

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CHapter 16
THE BEHAVIOR OF COSTS

Changes from the Twelfth Edition

All changes to Chapter 16 were minor.

Approach

We have retained our approach of putting all C-V-P topics in a single chapter because many schools’ marketing and management accounting core courses start simultaneously, and marketing likes to have break-even analysis covered early in the management accounting course. Also, if there are students in the course with work experience or, in the case of MBA courses, with some undergraduate cost accounting background, they will want to raise right away the more detailed and subtle cost behavior issues. Nevertheless, we have structured the chapter so that instructors wishing to retain the approach used in some earlier editions can do so simply by assigning only the sections preceding ''Cost Assumptions" initially. Then the rest of the chapter can be assigned just before Chapter 26.

One of the common sources of confusion about fixed costs and variable costs is the fact that fixed costs are fixed in total but vary per unit, whereas variable costs vary in total, but are fixed per unit. It is important, therefore, that the discussion always be clear as to whether the context is total cost or unit cost. When talking about unit costs, I try to remember always to precede "fixed" with the adjective average.

The text takes the view that items of cost can be classified as essentially fixed, variable, semivariable, or step-function, and that semivariable costs can be classified into fixed and variable components. Students who wish to nitpick can point out items of cost for which these simple linear relationships do not hold, even within a relevant range, but the importance of these items should be played down. In practice, it is often sufficiently accurate to use only the fixed/variable dichotomy, especially for time horizons of a year or less. The student should not get the impression that the linear relationships described in the chapter are a gross oversimplification; they in fact fit many real-life situations within relevant (i.e., normal operating) ranges.

Cases

Hospital Supply, Inc., deals primarily with differential cost and revenue analysis. It is placed here for the instructor who wishes to alert students at the outset of the management accounting course that the full cost constructions studied in Chapters 17-19 are not useful for some kinds of management decisions.

Prestige Telephone Company requires a student to understand the economics of a business, to use that understanding to forecast the potential change in income that would occur if various courses of action were selected, and to consider alternate reporting systems that can be used to highlight the factors that are important to management.

Bill French is a case on the construction of a profitgraph, raising practical problems about the validity of the data used for this purpose in a multi-product setting.

Problems

Problem 16-1

a. and b.

Problem 16-2: Doyle's Candy Company

a. Break-even volume = Fixed costs / Unit contribution
= $1,056,000 / $9.60 - $5.76
= $1,056,000 / $3.84 = 275,000 boxes

b. Current contribution margin percentage = $3.84 / $9.60 = 40%. In general, abbreviating contribution margin percentage as CMP, we have:

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Solving for UR, this becomes:

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With a l5% increase in variable production costs (to $5.52, giving total UVC of $6.48), the selling price per box is:

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c. Projected income statement:

|Revenues (390,000 x $9.60) |$3,744,000 | |Variable costs (390,000 x $5.76) | 2,246,400 | |Contribution |1,497,600 | |Fixed costs...
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