Chapter Six

Cost Behavior Patterns and

CPV Analysis
Cost Behavior Patters
Management accounting systems record the cost of
resources acquired and track their subsequent
usage.
Costs may be classified according to functions – such
as manufacturing, administrative, general or
selling – important for external reporting
Cost behaviour refers to the classification of costs
according to their behavioural pattern, that is, the
way costs change as volume of production output
(activity) changes.
 Cost classification as Behaviors
1. Fixed costs :- a cost that can not be varied or
changed as the volume of out put is changed
or varied. (rent, deprecation, wage ----)
Other name for this cost can be non-variable
costs, stand-by costs, period costs, or
capacity costs.
Fixed cost can be classified as
A. Total fixed cost
B. Unit fixed costs
Cont-------
2. Variable cost :- are costs which fluctuate, in
total, in direct proportion to the volume of
output or sales.( DM cost, DL cost , supplies ,
commission ----)
Total Variable cost = Unit variable cost * Volume
Variable costs can be
A. Total Variable cost
B. Unit Variable cost
 Cont-------
3. Semi-Variable (Mixed costs) :-are a combination
of fixed and variable costs and are, thus, also
known as “mixed costs.” Such costs are neither
perfectly variable nor absolutely fixed in relation
to changes in the volume of output.
Utility bills, such as power costs, telephone
charges, repairs and maintenance costs, etc.
Total Mixed cost= FC+ Unit Variable cost *Volume
Total costs in an organizations
An organization’s total costs consist of the sum
of its fixed costs, variable costs, and mixed
costs. The behavioural pattern for Total Cost is
developed by combining fixed, variable, and
mixed costs.
Total cost = Total Fixed cost + Total Variable cost
 Segregation of Semi-variable cost
Segregation of semi-variable costs into fixed and
variable elements is very important for profit
planning, effective cost control, fixation of
selling price, break-even analysis, leverage
analysis, framing of budgets, proper
absorption of overheads, and helpful in
decision making.
Cont--------
Methods of cost segregations
1. The Comparison Method
2. High and Low Point or Range Method
3. The Equation Method
4. The Average method
5. The Method of Least Squares
6. The Analytical Approach
Examples
From the following month-wise information in respect of
semi-variable costs of a firm, segregate the cost into fixed and
variable elements.
Production Semi-variable Cost
(Units) (Dollar)
• January, 2016 200 2,000
• February 150 1,750
• March 250 2,250
• April 300 2,500
• May 400 3,000
• June 500 3,500
The Importance of CPV Analysis
Cost-Volume-Profit (CVP) analysis is a technique
used to analyze (examine) the relationships
between volume of output, total costs, total
revenues, and profits.
Questions raised by managers and its solutions
1. At what level of sales does the firm cover its cost
2. If selling price , cost , volume of production
changes what will the change to profit.
3. In order to earn certain profit, what will be the
sales volume of the firm.
Break even point analysis
Break even point can be analysis in the following
methods
1. Equation method
BEP= Total fixed cost
Selling price – Variable cost
2. Contribution Method
BEP= Total fixed cost
Unit contribution Method
Cont--------
Targeted operating profit
1. Before tax
Target volume = Fixed costs_+ Operating Income
(Number of Units) Unit contribution margin
2. After tax
Operating Income = Target Net Income
(1 - Tax rate)
Cont--------
Example
Total fixed cost 200,000.00
Unit selling price 140.00
Variable cost 100.00
Targeted profit 60,000.00
Tax rate on profit 40%
Compute Break even point in all methods
Pricing Decisions
Fixing of selling prices is one of the most
important functions of management. Profits
could be maximized either by reduction and
control over costs or by increasing the sales
value through increase in sales volume or prices
The selling price should don’t be below the
variable (marginal) cost.
Selling price below the Marginal Cost
• To introduce a new product
in the market.
• To popularize a particular
product.
• To explore foreign markets.
• To eliminate the competitor
from the market.
• To help the sale of joint
products.
• To avoid the retrenchment
of workers.
• To dispose off the product
of perishable nature.
• To utilize idle capacity.
• To keep plant and
machinery in the running
condition.
• To retain old customers and
prevent loss of future
orders.
• To avoid extra loss by
closing down the business.
• To dispose of surplus stocks.
 Alternative Pricing Approaches

• There are three major influences of pricing

decisions: Customers, Competitors, and Costs.
The starting point for pricing decision can be:
• Market based
• Cost-based (also called Cost-Plus)
The general formula for setting price under cost plus
is:
Cost base $X
Mark up Y
Prospective selling price $ X+Y
Cont------
• Cost-Plus Pricing and RRR Pricing
The commonest pricing technique is probably still Cost-
Plus pricing based on absorption (full) costing. The
total cost of producing one unit of product at the
firm’s normal capacity level is calculated, and a
percentage markup is added.
Percentage of= Resources employed x Required Rate
Mark up in Dollars of Return (RRR)
Units of Output Cost x Sales Volume
Cont-------
Total cost Spend 500,000.00
Required rate of return 15%
Units out put cost 60.00
Sales Volume 5,000 units
% of mark up price ?
Cont-------
Percentage of = $500,000 x 0.15 x 100
Mark up $60 x 5,000 units
= 25%
Proof
Required rate of return = $500,000 x 0.15 = $ 75,000
(+)Total cost = $60 x 5,000 units = 300,000
= Required sales value $375,000
Required profit per tracker = $75,000 ÷ 5,000 units = $15
Cont-----
Thus, required profit of $15 per unit expressed as a percentage of the
cost per unit is 25% (being $15/ $60 x 100 = 25%).
Accordingly, the mark up on cost is 25% and the price calculation is
shown below:
Price calculation for Tracker Bicycle
The selling price per Tracker will be:
Total cost of unit ---------------------- $ 60
Plus: mark up 25% -------------------- 15
$75
In total figures the company shows:
Sales ------------------------------------------------- $375,000
Total cost of Goods ($60 x 5,000 units) ----- (300,000)
Net profit -------------------------------------------- $ 75,000