CH 13

Survey of Accounting
Second Edition
Kimmel ● Weygandt
Chapter 13
Cost-Volume-Profit
Prepared by
Coby Harmon
University of California, Santa Barbara
Westmont College
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Copyright ©2020 John Wiley & Sons, Inc.
Chapter Outline
Learning Objectives
LO 1 Explain variable, fixed, and mixed costs and the relevant
range.
LO 2 Apply the high-low method to determine the components of
mixed costs.
LO 3 Prepare a CVP income statement to determine contribution
margin.
LO 4 Compute the break-even point using three approaches.
LO 5 Determine the sales required to earn target net income and
determine margin of safety.
Copyright ©2020 John Wiley & Sons, Inc. 2
Learning Objective 1
Explain Variable, Fixed, and Mixed
Costs and the Relevant Range
LO 1 Copyright ©2020 John Wiley & Sons, Inc. 3

Cost Behavior Analysis
Cost Behavior Analysis is the study of how specific costs

respond to changes in the level of business activity.
• Some costs change; others remain the same.
• Helps management plan operations and decide between
alternative courses of action.
• Applies to all types of businesses and entities.
• Starting point is measuring key business activities.

Activity Levels
• Activity levels may be expressed in terms of:
o Sales dollars (retail company).
o Miles driven (trucking company).
o Room occupancy (hotel).
o Dance classes taught (dance studio).
• Many companies use more than one measurement base.

Activity Index
• Changes in level or volume of activity should be correlated
with changes in costs.
• Activity level selected is called the activity index or driver.
• Activity index:
o Identifies activity that causes changes in behavior of costs.
o Allows costs to be classified as variable, fixed, or mixed.

Variable Costs
• Costs that vary in total directly and proportionately with

changes in the activity level.
o Example: If activity level increases 10 percent, total
variable costs increase 10 percent.
o Example: If activity level decreases by 25 percent, total
variable costs decrease by 25 percent.
• Variable costs remain the same per unit at every level of
activity.

Variable Costs
Behavior of Total Variable Costs
Illustration: Damon Company
manufactures tablet computers that
contain cameras that cost $10. The
activity index is the number of tablet
computers produced. As Damon
manufactures each tablet, the total cost of
cameras installed in tablets increases by
$10. As part (a) of Illustration 13.1
shows, total cost of the cameras will be
$20,000 (2,000 × $10) if Damon
produces 2,000 tablets, and $100,000
when it produces 10,000 tablets.

Variable Costs
Behavior of Unit Variable Costs
Illustration: Damon Company

manufactures tablet computers that
contain cameras that cost $10. The
activity index is the number of tablet
computers produced. As Damon
manufactures each tablet, the total cost
of cameras installed in tablets increases
by $10. As part (b) of Illustration 13.1
shows, the unit cost of $10 for the
camera is the same whether Damon
produces 2,000 or 10,000 tablets.

Variable Costs
Summary

Fixed Costs
• Costs that remain the same in total regardless of changes

in the activity level within a relevant range.
• Fixed cost per unit cost varies inversely with activity: As
volume increases, unit cost declines, and vice versa.
• Examples:
o Property taxes
o Supervisory salaries
o Insurance
o Rent
o Depreciation on buildings and equipment
Fixed Costs
Behavior of Total Fixed Costs
Illustration: Damon Company leases its productive facilities at a
cost of $10,000 per month. Total fixed costs of the facilities will
remain constant at every level of activity, as part (a) of
Illustration 13.2 shows.

Fixed Costs
Behavior of Unit Fixed Costs
Illustration: Damon Company leases its
productive facilities at a cost of $10,000
per month. Total fixed costs of the
facilities will remain constant at every
level of activity. But, on a per unit basis,
the cost of rent will decline as activity
increases, as part (b) of
Illustration 13.2 shows. At 2,000 units,
the unit cost per tablet computer is $5
($10,000 ÷ 2,000). When Damon
produces 10,000 tablets, the unit cost of
the rent is only $1 per tablet ($10,000 ÷
10,000).

Fixed Costs
Summary

Review Question
Variable costs are costs that:
a. Vary in total directly and proportionately with changes in
the activity level.
b. Remain the same per unit at every activity level.
c. Neither of the above.
d. Both (a) and (b) above.

Review Question Answer
Variable costs are costs that:
a. Vary in total directly and proportionately with changes in the
activity level.
b. Remain the same per unit at every activity level.
c. Neither of the above.

Relevant Range
• Throughout the range of possible levels of activity, a

straight-line relationship usually does not exist for either
variable costs or fixed costs.
• Relationship between variable costs and changes in activity
level is often curvilinear.
• The range over which a company expects to operate during
a year is called the relevant range.
• Variable costs are typically linear within the relevant range.
• Total fixed costs remain constant within the relevant range.

Relevant Range
Nonlinear Behavior of Variable and Fixed Costs

Relevant Range
Linear Behavior Within Relevant Range
Range of activity over which a company expects to operate
during a year.

Relevant Range
Review Question
The relevant range is:
a. The range of activity in which variable costs will be
curvilinear.
b. The range of activity in which fixed costs will be
curvilinear.
c. The range over which the company expects to operate
during a year.
d. Usually from zero to 100% of operating capacity.

Relevant Range
The relevant range is:
a. The range of activity in which variable costs will be
curvilinear.
b. The range of activity in which fixed costs will be
curvilinear.
c. The range over which the company expects to
operate during a year.
d. Usually from zero to 100% of operating capacity.

Mixed Costs
• Costs that have both a variable element and a fixed
element.
• Change in total but not proportionately with changes in
activity level.

DO IT! 1: Types of Costs
Helena Company, reports the following total costs at two levels of

production.
Classify each cost as variable, fixed, or mixed.
Classification Cost 10,000 Units 20,000 Units

Variable Direct materials $20,000 $40,000
Mixed Maintenance 8,000 10,000
Variable Direct labor 17,000 34,000
Variable Indirect materials 1,000 2,000
Fixed Depreciation 4,000 4,000
Mixed Utilities 3,000 5,000
Fixed Rent 6,000 6,000

Apply the High-Low Method to
Determine the Components of Mixed
Costs

Mixed Costs Analysis
For purposes of cost-volume-profit analysis, mixed costs

must be classified into their fixed and variable elements.
High-Low Method
• High-Low Method uses total costs incurred at high and low
levels of activity to classify mixed costs into fixed and
variable components.
• Difference in costs between high and low levels represents
variable costs, since only variable-cost element can change
as activity levels change.

High-Low Method
Formula for Variable Cost Per Unit Using High-Low
Method

High-Low Method
Assumed Maintenance Costs and Mileage Data
Illustration: Metro Transit Company has the following

maintenance costs and mileage data for its fleet of buses over a 6-
month period.

High-Low Method
Change in Costs
month period.

High-Low Method
Change in Volume and Variable Cost Per Unit
month period.

High-Low Method
Computation of Fixed Costs
Illustration: Determine the total fixed cost for Metro Transit by
subtracting the total variable cost at either the high or the low
activity level from the total cost at that activity level.

High-Low Method
Total Costs for 45,000 Miles
Maintenance costs are therefore $8,000 per month of fixed costs
plus $1.10 per mile of variable costs. This is represented by the
following formula:
Maintenance costs = $8,000 + ($1.10 x Miles driven)
Example: At 45,000 miles, estimated maintenance costs would be:
Fixed $ 8,000
Variable ($1.10 x 45,000) 49,500
$57,500

High-Low Method
Scatter Plot for Metro Transit Company

Mixed Costs
Review Question
Mixed costs consist of a:

a. Variable cost element and a fixed cost element.
b. Fixed cost element and a controllable cost element.
c. Relevant cost element and a controllable cost element.
d. Variable cost element and a relevant cost element.

Mixed Costs
Mixed costs consist of a:
a. Variable cost element and a fixed cost element.
b. Fixed cost element and a controllable cost element.
c. Relevant cost element and a controllable cost
element.
d. Variable cost element and a relevant cost element.

Importance of Identifying Variable and Fixed Costs
American Airlines
Why is it important to segregate mixed costs into variable and

fixed elements?
If American Airlines is to make a profit when it reduces all
domestic fares by 30%, what reduction in costs or increase in
passengers will be required?
Answer: To make a profit when it cuts domestic fares by 30%,
American Airlines will have to increase the number of
passengers or cut its variable costs for those flights. Its fixed
costs will not change.

Importance of Identifying Variable and Fixed Costs
Ford Motor Company
Why is it important to segregate mixed costs into variable and

fixed elements?
If Ford Motor Company meets workers’ demands for higher
wages, what increase in sales revenue will be needed to
maintain current profit levels?
Answer: Higher wages at Ford Motor Company will increase
the variable costs of manufacturing automobiles. To maintain
present profit levels, Ford will have to cut other variable or
fixed costs, sell more automobiles, or increase the price of its
automobiles.

DO IT! 2: High-Low Method
Byrnes Company accumulates the following data concerning a

mixed cost, using units produced as the activity level.
Units Produced Total Cost
March 9,800 $14,740
April 8,500 13,250
May 7,000 11,100
June 7,600 12,000
July 8,100 12,460
a. Compute variable and fixed cost elements using this method.

b. Using information from part (a), write the cost formula.
c. Estimate total cost if the company produces 8,000 units.
Solution for Part a
March 9,800 $14,740
April 8,500 13,250
May 7,000 11,100
June 7,600 12,000
July 8,100 12,460
a. Compute variable and fixed cost elements using this method.

Variable cost: ($14,740 - $11,100) / (9,800 - 7,000) = $1.30 per
unit
Fixed cost: $14,740 - $12,740 ($1.30 x 9,800 units) = $2,000
or $11,100 - $9,100 ($1.30 x 7,000) = $2,000

Solution for Part b
March 9,800 $14,740
April 8,500 13,250
May 7,000 11,100
June 7,600 12,000
July 8,100 12,460
b. Using information from part (a), write the cost formula.

Cost = $2,000 + ($1.30 × units produced)

Solution for Part c
March 9,800 $14,740
April 8,500 13,250
May 7,000 11,100
June 7,600 12,000
July 8,100 12,460
c. Estimate the total cost if the company produces 8,000 units.

Total cost (8,000 units):
$2,000 + $10,400 ($1.30 x 8,000) = $12,400

Prepare a CVP Income Statement to
Determine Contribution Margin

Cost-Volume-Profit Analysis
Cost-volume-profit (CVP) analysis is the study of the effects

of changes in costs and volume on a company’s profits.
• Important in profit planning.
• Critical factor in management decisions as:
o Setting selling prices.
o Determining product mix.
o Maximizing use of production facilities.

Cost-Volume-Profit Analysis
Basic Components
ILLUSTRATION 13.10
Components of CVP analysis

Basic Components
Assumptions
1. Behavior of both costs and revenues is linear throughout
the relevant range of the activity index.
2. Costs can be classified accurately as either variable or
fixed.
3. Changes in activity are the only factors that affect costs.
4. All units produced are sold.
5. When more than one type of product is sold, the sales mix
will remain constant.

Basic Components
Review Question
Which of the following is not involved in CVP analysis
a. Sales mix
b. Unit selling prices
c. Fixed costs per unit
d. Volume or level of activity

Basic Components
Which of the following is not involved in CVP analysis
a. Sales mix
b. Unit selling prices
c. Fixed costs per unit
d. Volume or level of activity

CVP Income Statement
• A statement for internal use.

• CVP income statement classifies costs as fixed or variable
and computes a contribution margin.
• Contribution margin is the amount of revenue remaining
after deducting variable costs.
• Reports same net income as a traditional income
statement.

Relevant Data
Illustration: Vargo Electronics Company produces cell phones.
Relevant data for the cell phones sold by this company in June 2022
are as follows.
Unit selling price of cell phone $500

Unit variable costs* $300
Total monthly fixed costs** $200,000
Units sold 1,600
*Includes variable manufacturing costs and variable selling and administrative

expenses.
**Includes fixed manufacturing costs and fixed selling and administrative
expenses.

Solution
Illustration: The CVP income statement for Vargo Electronics
therefore would be reported as follows.

Unit Contribution Margin
Unit Contribution Margin

• Contribution margin is available to cover fixed costs and to
contribute to income.
• Formula for unit contribution margin and the computation for
Vargo Electronics are:

CVP Income Statement Selling 1,000 Cell
Phones
Vargo’s CVP income statement assuming a zero net income.

CVP Income Statement Selling 1,001 Cell
Phones
Assume that Vargo sold a total of 1,001 cell phones.

Contribution Margin Ratio
• Shows the percentage of each sales dollar available to apply

toward fixed costs and profits.
• Formula for contribution margin ratio and the computation
for Vargo Electronics are:

Percent of Sales Data
CVP income statement, with net income and percent of sales data.

Comparative Income Statements
Assume Vargo’s current sales are $500,000 and it wants to know the
effect of a $100,000 (200 unit) increase in sales.

Contribution Margin
Review Question
Contribution margin:
a. Is revenue remaining after deducting variable costs.
b. May be expressed as contribution margin per unit.
c. Is selling price less cost of goods sold.

Contribution Margin
Contribution margin:
a. Is revenue remaining after deducting variable costs.
b. May be expressed as contribution margin per unit.
c. Is selling price less cost of goods sold.

DO IT! 3: CVP Income Statement
Ampco Industries produces and sells a cell phone-operated

thermostat. Information regarding the costs and sales of thermostats
during September 2022 are provided below.
Unit selling price of thermostat $85

Unit variable costs $32
Total monthly fixed costs $190,000
Units sold 4,000
Prepare a CVP income statement for Ampco Industries for the

month of September. Provide per unit values and total values.

Heading


Sales

Variable Costs

Contribution Margin

Fixed Costs


Net Income

Compute the Break-Even Point Using
Three Approaches

Break-Even Analysis
• Process of finding break-even point level of activity at

which total revenues equal total costs (both fixed and
variable).
• Can be computed or derived
o from a mathematical equation,
o by using contribution margin, or
o from a cost-volume profit (CVP) graph.
• Expressed either in sales units or in sales dollars.

Mathematical Equation
Break-even occurs where total sales equal variable costs plus fixed
costs; i.e., net income is zero.

Contribution Margin Technique
• At the break-even point, contribution margin must equal

total fixed costs.
(CM = total revenues – variable costs)
• Break-even point can be computed using either
contribution margin per unit or contribution margin ratio.

Contribution Margin in Units
• When break-even-point in units is desired, contribution margin
per unit is used in the following formula which shows
computation for Vargo Electronics:
Fixed Costs ÷ Unit Contribution Margin = Break-Even Point in Units

$200,000 ÷ $200 = 1,000 Units

• When break-even-point in dollars is desired, contribution
margin ratio is used in the following formula which shows
computation for Vargo Electronics:
Fixed Costs ÷ Contribution Margin Ratio = Break-Even Point in Dollars

$200,000 ÷ 40% = $500,000

Graphic Presentation

Break-Even Analysis
Review Question
Gossen Company is planning to sell 200,000 pliers for $4 per
unit. The contribution margin ratio is 25%. If Gossen will
break even at this level of sales, what are the fixed costs?
a. $100,000
b. $160,000
c. $200,000
d. $300,000

Break-Even Analysis
Gossen Company is planning to sell 200,000 pliers for
$4 per unit. The contribution margin ratio is 25%. If
Gossen will break even at this level of sales, what are
the fixed costs?
a. $100,000
b. $160,000
c. $200,000
d. $300,000

DO IT! 4: Break-Even Analysis
Lombardi Company has a unit selling price of $400, variable

costs per unit of $240, and fixed costs of $180,000. Compute
the break-even point in units using (a) a mathematical
equation and (b) contribution margin per unit.

costs per unit of $240, and fixed costs of $180,000. Compute the
break-even point in units using (a) a mathematical equation and
(b) contribution margin per unit.

Mathematical Equation Data

Solving for Break-Even Point

Solution Using Mathematical Equation

Contribution Margin Per Unit

Break-Even Point in Units Formula


Solution Using Contribution Margin Per Unit

Determine the Sales Required to Earn Target
Net Income and Determine Margin of Safety

Target Net Income and Margin of Safety
Target Net Income

• Level of sales necessary to achieve a target income.
• Can be determined from each approach used to determine
break-even sales/units:
o from a mathematical equation,
o by using contribution margin technique, or
o from a cost-volume profit (CVP) graph
• Expressed either in sales units or in sales dollars.

Target Net Income
Formula for required sales to meet target net income.
Sales − Variable Costs − Fixed Costs = Target Net Income

Desired Net Income of $120,000
Break-even point formula including desired net income of
$120,000.

Target Net Income
Sales in Units
To determine required sales in units for Vargo Electronics using the
unit contribution margin:
(Fixed Costs + Target Net Income) ÷ Unit Contribution Margin = Sales in Units
($200,000 + $120,000) ÷ $200 = 1,600 units

Target Net Income
Sales in Dollars
To determine required sales in dollars for Vargo Electronics using
the contribution margin ratio:
(Fixed Costs + Target Net Income) ÷ Contribution Margin Ratio = Sales in Dollars
($200,000 + $120,000) ÷ 40% = $800,000

Target Net Income
Graphic Presentation
Suppose Vargo Electronics
sells 1,400 cell phones.
ILLUSTRATION 13.23
shows that a vertical line
drawn at 1,400 units
intersects the sales line at
$700,000 and the total cost
line at $620,000. The
difference between the two
amounts represents the net
income (profit) of $80,000.

Target Net Income
Review Question
The mathematical equation for computing required sales to
obtain target net income is:
Required sales =
a. Variable costs + Target net income
b. Variable costs + Fixed costs + Target net income
c. Fixed costs + Target net income
d. No correct answer is given

Target Net Income
The mathematical equation for computing required sales to
obtain target net income is:
Required sales =
a. Variable costs + Target net income
b. Variable costs + Fixed costs + Target net income
c. Fixed costs + Target net income
d. No correct answer is given

Margin of Safety
• Difference between actual or expected sales and sales at

break-even point.
• Measures “cushion” that a particular level of sales provides.
• May be expressed in dollars or as a ratio.
• Assuming actual/expected sales are $750,000:
Actual (Expected) Sales − Break-Even Sales = Margin of Safety in Dollars

$750,000 − $500,000 = $250,000
ILLUSTRATION 13.28

Margin of Safety Ratio
• Computed by dividing margin of safety in dollars by actual (or

expected) sales.
• Higher dollars or percentage, greater margin of safety.
• Assuming actual/expected sales are $750,000:
Margin of Safety In Dollars ÷ Actual (Expected) Sales = Margin of Safety Ratio

$250,000 ÷ $750,000 = 33%
ILLUSTRATION 13.29
Formula for margin of safety ratio

DO IT! 5: Break-Even, Margin of Safety,
and Target Net Income
Zootsuit Inc. makes travel bags that sell for $56 each. For the
coming year, management expects fixed costs to total
$320,000 and variable costs to be $42 per unit. Compute the
following:
a. Break-even point in dollars using the contribution margin
(CM) ratio.
b. Margin of safety and margin of safety ratio assuming
actual sales are $1,382,400.
c. Sales dollars required to earn net income of $410,000.

DO IT! 5: Break-Even, Margin of Safety, and
Target Net Income
break-even point in dollars using the contribution margin
(CM) ratio.
Contribution margin ratio =
Break-even sales in dollars =

Target Net Income
Contribution Margin Ratio Solution
(CM) ratio.
Contribution margin ratio = [($56 − $42) ÷ $56] = 25%
Break-even sales in dollars =

Target Net Income
Break-Even Sales in Dollars Solution
(CM) ratio.
Contribution margin ratio = [($56 − $42) ÷ $56] = 25%
Break-even sales in dollars = $320,000 ÷ 25% = $1,280,000

Target Net Income
Margin of Safety
margin of safety and margin of safety ratio assuming
Margin of safety =
Margin of safety ratio =

Target Net Income
Margin of Safety Solution
Margin of safety = $1,382,400 − $1,280,000 = $102,400
Margin of safety ratio =

Target Net Income
Margin of Safety Ratio Solution
Margin of safety = $1,382,400 − $1,280,000 = $102,400
Margin of safety ratio = $102,400 ÷ $1,382,400 = 7.4%

Sales in Dollars
sales dollars required to earn net income of $410,000.
Sales in dollars =

Sales in Dollars Solution
sales dollars required to earn net income of $410,000.
Sales in dollars = ($320,000 + $410,000) ÷ 25% = $2,920,000

Describe How Regression Analysis is Used
to Classify Mixed Costs

Regression Analysis
• While the high-low method works well, a weakness is that

it employs only a few data points and ignores the rest.
• If those two data points are representative of the entire data
set, then the high-low method provides reasonable results.
• If the high and low data points are not representative of the
rest of the data set, then the results are misleading.

Regression Analysis
Scatter Plot for Metro Transit Company
While the high-low method works well, a weakness is that it
employs only a few data points and ignores the rest.

Regression Analysis
High and Low Activity Levels
Illustration: Assume that Hanson Trucking Company has 12
months of maintenance cost data, as shown.
High activities and levels are in BLUE, low activities and levels
are in RED.
Regression Analysis
Variable Cost Per Unit
Illustration: Assume that Hanson Trucking Company has 12
months of maintenance cost data, as shown.
Variable cost per unit =

($63,000 - $39,000) / (65,000 - 15,000) = $0.48
Regression Analysis
Total Fixed Costs
Total variable cost = number of miles x cost per mile.

At the low activity level of 15,000 miles, total variable cost is
$7,200 (15,000 × $0.48).
To determine fixed costs, subtract total variable costs at the low
activity level from the total cost at the low activity level.
Fixed costs = $39,000 − ($0.48 × 15,000) = $31,800

Regression Analysis
Theory
• Regression analysis is a statistical approach that estimates

the cost equation by employing information from all data
points, not just highest and lowest ones.
• Regression analysis finds a cost equation that results in a
cost equation line that minimizes the sum of (squared)
distances from the line to data points.

Regression Analysis
Intercept and Slope Functions
Illustration 13A.4, uses the A B C D
Miles Total
Intercept and Slope functions in 1 Month Driven Cost
Excel to estimate the regression 2 January 20,000 $30,000

3 February 40,000 49,000
equation for the Hanson Trucking 4 March 35,000 46,000
Company data. 5 April 50,000 63,000

6 May 30,000 42,000
Intercept: 7 June 43,000 52,000
8 July 15,000 39,000
=INTERCEPT(C2:C13,B2:B13) = 9 August 28,000 41,000
18,502 10 September 60,000 72,000

11 October 55,000 67,000
Slope: 12 November 19,000 29,000
13 December 65,000 63,000
=SLOPE(C2:C13,B2:B13) = 0.81 14

Regression Analysis
Comparison of Cost Equations
The resulting cost equation is:
Compare this to the high-low cost equation:

Regression Analysis
Scatter Plot and Cost Equation Lines
The intercept and slope differ significantly between the regression
equation (green) and the high-low equation (red).

Regression Analysis
Limitations
While regression analysis usually provides more reliable estimates

of the cost equation, it does have limitations.
1. The regression approach applied above assumes a linear
relationship between the variables. If the actual relationship
differs significantly from linearity, then linear regression can
provide misleading results.
2. Regression estimates can be severely influenced by “outliers”—
data points that differ significantly from the rest of the
observations.
3. Regression estimation is most accurate when it is based on a
large number of data points.

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Survey of Accounting

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Cost Behavior Analysis is the study of how specific costs

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• Costs that vary in total directly and proportionately with

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Illustration: Damon Company

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• Costs that remain the same in total regardless of changes

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• Throughout the range of possible levels of activity, a

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Helena Company, reports the following total costs at two levels of

Classification Cost 10,000 Units 20,000 Units

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For purposes of cost-volume-profit analysis, mixed costs

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Illustration: Metro Transit Company has the following

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Mixed costs consist of a:

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Why is it important to segregate mixed costs into variable and

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Why is it important to segregate mixed costs into variable and

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Byrnes Company accumulates the following data concerning a

a. Compute variable and fixed cost elements using this method.

a. Compute variable and fixed cost elements using this method.

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b. Using information from part (a), write the cost formula.

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c. Estimate the total cost if the company produces 8,000 units.

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Cost-volume-profit (CVP) analysis is the study of the effects

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• A statement for internal use.

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Unit selling price of cell phone $500

*Includes variable manufacturing costs and variable selling and administrative

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