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Chapter 8:
Cost Behavior and Break-Even Analysis

Fixed, Variable, and
Semivariable Costs (1 of 4)

  • Distinguishing between fixed, variable, and semivariable costs is important because this knowledge is a basic working tool in financial management.

Fixed, Variable, and
Semivariable Costs (2 of 4)

  • Fixed Costs are those costs that do not vary in total when activity levels (or volume) of operations change.

(Examine the examples in the chapter.)

Fixed, Variable, and
Semivariable Costs (3 of 4)

  • Variable Costs are those costs that vary in direct proportion when activity levels (or volume) of operations change.

(Examine the examples in the chapter.)

Fixed, Variable, and
Semivariable Costs (4 of 4)

  • Semivariable Costs vary when the activity levels (or volume) of operations change, but not in direct proportion.
  • The most frequent pattern of semivariable costs is the step pattern.

(Examine the examples in the chapter.)

Analyze Mixed Costs

  • The Manager needs to know how to analyze mixed costs because they occur so often.

Analyze Mixed Costs by
Two Simple Methods

  • The Predominant Characteristics Method:
    The manager judges whether the cost is more fixed or more variable.
  • The Step Method:
    The manager examines the “steps” in the step pattern of a fixed cost and decides whether the pattern appears to be more fixed or more variable.
  • Both of these methods are judgmental.

Analyze Mixed Costs Through the
High–Low Method

  • Cost is examined at its high level and its low level.
  • Obtain the difference in cost between the high and low levels; divide the amount of change in the activity (or volume).

(Examine the examples in the chapter.)

Analyze Mixed Costs by the
Scatter Graph Method

  • The Scatter Graph finds the Mixed Cost’s average rate of variability more accurately.
  • Use a graph to plot all points of data—cost on vertical axis and volume on horizontal axis of the graph.
  • Fit a regression line to the plotted points.
  • The average fixed cost is found at the point where the regression line intersects with the cost axis.

(Examine the examples in the chapter.)

Understand Computation
of the Contribution Margin

  • The Contribution Margin equals Variable Cost deducted from net revenues.
  • The answer is the Contribution Margin, so called because it contributes to fixed costs and profits.

(Examine the examples in the chapter.)

Contribution Margin:
Example 8B (1 of 2)

  • Examine Table 8-1, which contains Operating Room Fixed and Variable Costs.
  • We can see that the total costs are $,1,217,756.
  • Of this amount, $600,822 is designated as variable cost and $616,934 is designated as fixed ($529,556 + $87,378 = $616,934).
  • For purposes of our example, assume the Operating Room revenue amounts to $1,260,000.

Contribution Margin:
Example 8B (2 of 2)

  • The contribution margin is computed as follows:

  • Thus $659,178 is available to contribute to fixed costs and to profit.
  • In this example, fixed costs are $616,934, so there is an amount left to contribute toward profit.

Contribution Margin:
Practice Exercise 8-2 (1 of 2)

  • Assumptions: Greenside Clinic has revenue totaling $3,500,000.
  • Of this amount, 40 percent is variable cost and 60 percent is fixed cost.
  • Step 1. Divide costs into variable and fixed.
  • In this case $3,450,000 times 40 percent equals $1,380,000 variable cost and $3,450,000 times 60 percent equals $2,070,000 fixed cost.

Contribution Margin:
Practice Exercise 8-2 (2 of 2)

  • Step 2. Compute the contribution margin:

Contribution Margin:
Assignment Exercise 8-2.1 (1 of 2)

  • Assumptions: The Mental Health program for the Community Center has just completed its fiscal year end.
  • The Program Director determines that his program has revenue for the year of $1,210,000.
  • He believes his variable expense amounts to $205,000 and he knows his fixed expense amounts to $1,100,000.

Contribution Margin:
Assignment Exercise 8-2.1 (2 of 2)

  • Required: Compute the contribution margin for the Community Mental Health program.

______________

______________

______________

______________

______________

Revenue

Less Variable Cost

Contribution Margin

Less Fixed Cost

Operating Profit (Loss)

Computation:

$1,210,000

($205,000)

$1,005,000

($1,100,000)

($95,000)

Contribution Margin:
Assignment Exercise 8-2.2

  • What does the result tell us about the program?

The contribution margin of $1,005,000 does not cover the fixed costs of $1,100,000.

There is an overall loss in the program of $95,000.

The fixed cost is very high, making it imperative that sufficient revenue levels be achieved.

The Cost-Volume-Profit (CVP)
Ratio or Breakeven Point

  • The Breakeven Point is the point when the contribution margin equals the fixed costs.
  • Loss equals a loss
  • More equals a profit
  • Thus, Breakeven Point

(Examine the examples in the chapter.)

Figure 8-6 Cost-Volume-Profit (CVP) Chart for a Wellness Clinic.

Courtesy of Resource Group, Ltd., Dallas, Texas

Compute the Profit-Volume (PV) Ratio

  • If the contribution margin is expressed as a percentage of net revenues, it is often called the Profit-Volume Ratio.
  • A PV chart needs only 2 lines to show the effect of changes in volume.

(See example and explanation in the chapter.)

Figure 8-7 Profit-Volume (PV) Chart for a Wellness Clinic.

Courtesy of Resource Group, Ltd., Dallas, Texas

CPV–PV Practice Exercise 8-3

  • Assumptions: The Mental Health program for the Community Center has just completed its fiscal year end.
  • The Program Director determines that his program has revenue for the year of $1,210,000.
  • He believes his variable expense amounts to $205,000 and he knows his fixed expense amounts to $1,100,000.

CPV–PV Practice Exercise 8-3

$100.00

16.94

$83.06

90.91

$7.85

=PV or CM Ratio

100.00%

16.94%

83.06%

90.91%

7.85%

$1,210,000

(205,000)

$1,005,000

(1,100,000)

$95,000

Revenue

Less variable cost

Contribution margin

Less fixed cost

Operating (loss)

Per-Visit

Percent

Amount

CPV–PV Assignment
Exercise 8-3

  • Assumptions: Greenside Clinic has revenue totaling $3,500,000.
  • Of this amount, 40 percent is variable cost and 60 percent is fixed cost. The clinic had 35,000 visits.

$100.00

–39.43

$60.57

–59.14

$1.43

= PV or CM Ratio

100.00%

–39.43%

60.57%

–59.14%

1.43%

$3,510,000

(1,380,000)

$2,120,000

(2,070,000)

$50,000

Revenue

Less variable cost

Contribution margin

Less fixed cost

Operating profit (loss)

Per-Visit

Percent

Amount

Understand Further Use of the Contribution Margin

  • Contribution Margins are also useful in showing measures of profitability in a simple, easy-to-understand manner.

(For example, see the DRG matrix in Figure 8-8.)