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CHAPTER 22CHAPTER 22

COST COST -- VOLUME VOLUME --PROFITPROFIT

Accounting Principles, Eighth Edition

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S tu d y O b jec t i v e sS tu d y O b jec t i v e s

1. Distinguish between variable and fixed costs.2. Explain the significance of the relevant

range.3.3. Explain the concept of mixed costs.Explain the concept of mixed costs.4.4. List the five components of costList the five components of cost--volumevolume--

profit analysis.profit analysis.5.5. Indicate what contribution margin is and how Indicate what contribution margin is and how

it can be expressedit can be expressed6.6. Identify the three ways to determine the Identify the three ways to determine the

breakbreak--even point.even point.

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Study ObjectivesStudy ObjectivesStudy Objectives

7.7. Give the formulas for determining Give the formulas for determining sales required to earn target net sales required to earn target net incomeincome

8.8. Define margin of safety, and give Define margin of safety, and give the formulas for computing it.the formulas for computing it.

9.9. Describe the essential features of a Describe the essential features of a costcost--volumevolume--profit income profit income statement.statement.

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Preview of ChapterPreview of ChapterPreview of Chapter

To manage any business, you must understand:To manage any business, you must understand:

How costs respond to changes in sales volumeand

The effect of costs and revenues on profit

To understand costTo understand cost--volumevolume--profit (CVP), you must profit (CVP), you must know how costs behaveknow how costs behave

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Cost-Volume-ProfitCostCost--VolumeVolume--ProfitProfit

Co s t B eh av io r A n a l ys i s

C o s t B eh av io r C o s t B eh av io r A n a l ys i sA n a l ys i s

C o s t-V o lu m e-P r o f i t A n a l ys i sC o s tC o s t --V o lu m eV o lu m e --P r o f i t A n a l ys i sP r o f i t A n a l ys i s

Variable costsVariable costsFixed costsFixed costsRelevant rangeRelevant rangeMixed costsMixed costsIdentifying Identifying variable and fixed variable and fixed costscosts

Basic componentsBasic componentsCVP income statementCVP income statementBreakBreak--even analysiseven analysisTarget net incomeTarget net incomeMargin of safetyMargin of safetyChanges in business Changes in business environmentenvironmentCVP income statement CVP income statement revisitedrevisited

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Cost Behavior AnalysisCost Behavior AnalysisCost Behavior AnalysisCost Behavior Analysis is Cost Behavior Analysis is

the study of how specific costs respond to the study of how specific costs respond to changes in the level of business activity.changes in the level of business activity.

Some costs change; others remain the sameSome costs change; others remain the same

Helps management plan operations and decide Helps management plan operations and decide between alternative courses of actionbetween alternative courses of action

Applies to all types of businesses and entitiesApplies to all types of businesses and entities

LO 1: Distinguish between variable and fixed costs.LO 1: Distinguish between variable and fixed costs.

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Cost Behavior Analysis -continued

Cost Behavior Analysis Cost Behavior Analysis --continuedcontinued

Starting point is Starting point is measuring key business measuring key business activitiesactivities

Activity levels may be expressed in terms of:Activity levels may be expressed in terms of:Sales dollars (in a retail company)Sales dollars (in a retail company)Miles driven (in a trucking company)Miles driven (in a trucking company)Room occupancy (in a hotel)Room occupancy (in a hotel)Dance classes taught (by a dance studio)Dance classes taught (by a dance studio)

Many companies use more Many companies use more than one measurement basethan one measurement base

LO 1: Distinguish between variable and fixed costs.LO 1: Distinguish between variable and fixed costs.8

Cost Behavior Analysis - continuedCost Behavior Analysis Cost Behavior Analysis -- continuedcontinuedFor an activity level to be useful: For an activity level to be useful:

Changes in the level or volume of activity Changes in the level or volume of activity should be correlated with changes in costsshould be correlated with changes in costs

The activity level selected is called theThe activity level selected is called theactivity or volume indexactivity or volume index

The activity index:The activity index:Identifies the activity that causes changes in Identifies the activity that causes changes in the behavior of coststhe behavior of costsAllows costs to be classified according to Allows costs to be classified according to their response to changes in activity as their response to changes in activity as either:either:

Variable Costs Fixed Costs Mixed CostsVariable Costs Fixed Costs Mixed CostsLO 1: Distinguish between variable and fixed costs.LO 1: Distinguish between variable and fixed costs.

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Variable CostsVariable CostsVariable CostsCosts that Costs that vary vary in totalin total directly and directly and proportionately with changes in the activity levelproportionately with changes in the activity level

Example:Example: If the activity level If the activity level increasesincreases 10 10 percent, total variable costs percent, total variable costs increaseincrease 10 10 percent percent

Example: If the activity level Example: If the activity level decreasesdecreases by 25 by 25 percent, total variable costs percent, total variable costs decreasedecrease by 25 by 25 percentpercent

Variable costs Variable costs remain constant per unit at every remain constant per unit at every level of activity.level of activity.

LO 1: Distinguish between variable and fixed costs.LO 1: Distinguish between variable and fixed costs. 10

Variable Costs – ExampleVariable Costs Variable Costs –– ExampleExampleDamon Company manufactures radios that Damon Company manufactures radios that

contain a $10 clockcontain a $10 clock

Activity index is the number of radios producedActivity index is the number of radios produced

For each radio produced, the total cost of the For each radio produced, the total cost of the clocks increases by $10:clocks increases by $10:

If 2,000 radios are made, the total cost of the If 2,000 radios are made, the total cost of the clocks is $20,000 (2,000 X $10)clocks is $20,000 (2,000 X $10)

If 10,000 radios are made, the total cost of the If 10,000 radios are made, the total cost of the clocks is $100,000 (10,000 X $10)clocks is $100,000 (10,000 X $10)

LO 1: Distinguish between variable and fixed costs.LO 1: Distinguish between variable and fixed costs.

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Variable Costs – GraphsVariable Costs Variable Costs –– GraphsGraphs

LO 1: Distinguish between variable and fixed costs.LO 1: Distinguish between variable and fixed costs. 12

Fixed CostsFixed CostsFixed Costs

Costs that Costs that remain the same in total regardless of regardless of changes in the activity level.changes in the activity level.

Per unit costPer unit cost variesvaries inversely with activity:with activity:As volume increases,

unit cost declines, and vice versa

Examples include:Examples include:Property taxesProperty taxesInsuranceInsuranceRentRentDepreciation on buildings and equipmentDepreciation on buildings and equipment

LO 1: Distinguish between variable and fixed costs.LO 1: Distinguish between variable and fixed costs.

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Fixed Costs - ExampleFixed Costs Fixed Costs -- ExampleExampleDamon Company leases its productive facilities Damon Company leases its productive facilities for $10,000 per monthfor $10,000 per month

Total fixed costs of the facilities remain Total fixed costs of the facilities remain constant constant at all levels of activity at all levels of activity -- $10,000 $10,000 per monthper month

On a On a per unitper unit basis, the cost of rent decreases basis, the cost of rent decreases as as activity increases and vice versaactivity increases and vice versa

At 2,000 radios, the unit cost is At 2,000 radios, the unit cost is $5$5($10,000 ($10,000 ÷÷ 2,000 units)2,000 units)

At 10,000 radios, the unit cost is At 10,000 radios, the unit cost is $1$1($10,000 ($10,000 ÷÷ 10,000 units)10,000 units)LO 1: Distinguish between variable and fixed costs.LO 1: Distinguish between variable and fixed costs. 14

Fixed Costs - GraphsFixed Costs Fixed Costs -- GraphsGraphs

LO 1: Distinguish between variable and fixed costs.LO 1: Distinguish between variable and fixed costs.

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Variable costs are costs that:Variable costs are costs that:

a.a. Vary in total directly and proportionately with Vary in total directly and proportionately with changes in the activity levelchanges 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.

Let’s ReviewLetLet’’s Reviews Review

LO 1: Distinguish between variable and fixed costs.LO 1: Distinguish between variable and fixed costs. 16

Relevant RangeRelevant RangeRelevant Range

Throughout the range of possible levels of Throughout the range of possible levels of activity, a activity, a straight-line relationship usually does not exist for either variable costs or fixed for either variable costs or fixed costs costs

The relationship between variable costs and The relationship between variable costs and changes in activity level is often changes in activity level is often curvilinear

For fixed costs, the relationship is also For fixed costs, the relationship is also nonlinear –– some fixed costs will not change some fixed costs will not change over the entire over the entire range of activities while range of activities while other fixed costs may other fixed costs may changechange

LO 2: Explain the significance of the relevant range.LO 2: Explain the significance of the relevant range.

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Relevant Range - GraphsRelevant Range Relevant Range -- GraphsGraphs

LO 2: Explain the significance of the relevant range.LO 2: Explain the significance of the relevant range. 18

Relevant Range Relevant Range Relevant Range

Defined as the range of activity over which a Defined as the range of activity over which a company company expects to operate during a year

Within this range, a straightWithin this range, a straight--line relationship line relationship usually exists for both variable and fixed costsusually exists for both variable and fixed costs

LO 2: Explain the significance of the relevant range.LO 2: Explain the significance of the relevant range.

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The relevant range is:The relevant range is:

a.a. The range of activity in which variable costs will The range of activity in which variable costs will be curvilinearbe 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.

Let’s ReviewLetLet’’s Reviews Review

LO 2: Explain the significance of the relevant range.LO 2: Explain the significance of the relevant range. 20

Mixed CostsMixed CostsMixed Costs

Costs that have Costs that have both a variable a variable cost element cost element and a fixeda fixedcost elementcost element

Sometimes calledSometimes calledsemivariable cost

Change Change in total but not proportionatelywith changes inwith changes inactivity levelactivity level

LO 3: Explain the concept of mixed costs.LO 3: Explain the concept of mixed costs.

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Mixed Costs: High–Low MethodMixed Costs: HighMixed Costs: High––Low MethodLow Method

Mixed costs must be classified into their Mixed costs must be classified into their fixed and and variable elementselements

One approach to separate the costs is called One approach to separate the costs is called the the high-low method

Uses the total costs incurred at both the high Uses the total costs incurred at both the high and the low levels of activity to classify mixed and the low levels of activity to classify mixed costscosts

The difference in costs between the high and The difference in costs between the high and low levels low levels represents variable costs, since only variable costs change as activity levels changechange

LO 3: Explain the concept of mixed costs.LO 3: Explain the concept of mixed costs. 22

Mixed Costs: Steps in High–Low-MethodMixed Costs: Steps in HighMixed Costs: Steps in High––LowLow--MethodMethod

STEP 1: Determine variable cost per unit using the following formula:

STEP 2: Determine the fixed cost by subtracting the total variable cost at either the

high or the low activity level from the total cost at that level

LO 3: Explain the concept of mixed costs.LO 3: Explain the concept of mixed costs.

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Mixed Costs: High–Low-Method Example

Mixed Costs: Mixed Costs: HighHigh––LowLow--Method ExampleMethod Example

High Level of Activity:High Level of Activity: April $63,000 April $63,000 50,000 miles50,000 milesLow Level of Activity: Low Level of Activity: January January 30,000 30,000 20,000 miles20,000 miles

Difference $33,000 Difference $33,000 30,000 miles30,000 miles

Step 1:Step 1: Using the formula, variable costs per Using the formula, variable costs per unit areunit are

Data for Metro Transit Company for 4 month period:

LO 3: Explain the concept of mixed costs.LO 3: Explain the concept of mixed costs. 24

Mixed Costs: High–Low-Method ExampleMixed Costs: HighMixed Costs: High––LowLow--Method ExampleMethod Example

Step 2:Step 2: Determine the fixed costs by subtracting total Determine the fixed costs by subtracting total variable costs at variable costs at either the high or low the high or low

activity activity level from the total cost at that level from the total cost at that same levelsame level

LO 3: Explain the concept of mixed costs.LO 3: Explain the concept of mixed costs.

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Mixed Costs:High–Low-Method ExampleMixed Mixed Costs:HighCosts:High––LowLow--Method ExampleMethod Example

Maintenance costs:Maintenance costs:$8,000 per month plus $1.10 per mile$8,000 per month plus $1.10 per mile

To determine maintenance costs at a particular To determine maintenance costs at a particular activity level:activity level:

1. multiply the activity level times the variable cost per unit

2. then add that total to the fixed cost

EXAMPLE: If the activity level is 45,000 miles, If the activity level is 45,000 miles, the estimated maintenance costs would be the estimated maintenance costs would be $8,000 fixed and $49,500 variable ($1.10 X $8,000 fixed and $49,500 variable ($1.10 X 45,000 miles) for a total of $57,500.45,000 miles) for a total of $57,500.

LO 3: Explain the concept of mixed costs.LO 3: Explain the concept of mixed costs. 26

Mixed costs consist of a:Mixed costs consist of a:a.a. Variable cost element and a fixed cost elementVariable 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.

Let’s ReviewLetLet’’s Reviews Review

LO 3: Explain the concept of mixed costs.LO 3: Explain the concept of mixed costs.

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Cost-Volume-Profit AnalysisCostCost--VolumeVolume--Profit AnalysisProfit Analysis

Study of the Study of the effects of changes of costs and volume on a companyon a company’’s profitss profits

A critical factor in management A critical factor in management decisionsdecisions

Important in profit planningImportant in profit planning

LO 4: List the five components of costLO 4: List the five components of cost--volumevolume--profit analysis.profit analysis. 28

Cost-Volume-Profit AnalysisCostCost--VolumeVolume--Profit AnalysisProfit Analysis

CVP analysis considers the CVP analysis considers the interrelationships among five basic interrelationships among five basic componentscomponents

LO 4: List the five components of costLO 4: List the five components of cost--volumevolume--profit analysis.profit analysis.

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Assumptions Underlying CVP Analysis

Assumptions Underlying CVP Assumptions Underlying CVP AnalysisAnalysis

•• Behavior of both costs and revenues is Behavior of both costs and revenues is linearthroughout the throughout the relevant range of the activity indexof the activity index

•• All costs can be classified as either All costs can be classified as either variable or fixedwith reasonable accuracy with reasonable accuracy

•• Changes in Changes in activity are the only factors that affect are the only factors that affect costscosts

•• All units All units produced are sold•• When more than one type of product is sold, the When more than one type of product is sold, the

sales mix will remain constant

LO 4: List the five components of costLO 4: List the five components of cost--volumevolume--profit analysis.profit analysis. 30

Which of the following is Which of the following is NOTNOT involved in involved in CVP analysis?CVP analysis?

a.a. Sales mixSales mix.

b. Unit selling prices.

c. Fixed costs per unit.

d. Volume or level of activity.

Let’s ReviewLetLet’’s Reviews Review

LO 4: List the five components of costLO 4: List the five components of cost--volumevolume--profit analysis.profit analysis.

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CVP Income StatementCVP Income StatementCVP Income StatementA statement for internal useClassifies costs and expenses as fixed or variable Reports contribution margin in the body of the statement.

Contribution margin –amount of revenueremaining afterdeducting variable costs

Reports the same netincome as a traditionalincome statementincome statement

LO 5: Indicate what contribution margin is and how it can be exLO 5: Indicate what contribution margin is and how it can be expressed.pressed. 32

CVP Income Statement - ExampleCVP Income Statement CVP Income Statement -- ExampleExampleVargoVargo Video Company produces DVD Video Company produces DVD players. players. Relevant data for June 2008: Relevant data for June 2008:

Unit selling price of DVD playerUnit selling price of DVD player $500$500Unit variable costsUnit variable costs $300$300Total monthly fixed costsTotal monthly fixed costs $200,000$200,000Units soldUnits sold 1,6001,600

LO 5: Indicate what contribution margin is and how it can be exLO 5: Indicate what contribution margin is and how it can be expressed.pressed.

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Contribution Margin Per UnitContribution Margin Per UnitContribution Margin Per UnitContribution margin is availableContribution margin is available to cover fixed costs and to contribute to income

The formula for The formula for contribution margin per unit and the computation for and the computation for VargoVargoVideo are:Video are:

LO 5: Indicate what contribution margin is and how it can be exLO 5: Indicate what contribution margin is and how it can be expressed.pressed. 34

CVP Income Statement-CM effectCVP Income StatementCVP Income Statement--CM effectCM effect

LO 5: Indicate what contribution margin is and how it can be exLO 5: Indicate what contribution margin is and how it can be expressedpressed..

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Contribution Margin RatioContribution Margin RatioContribution Margin RatioShows the percentage of each sales dollar Shows the percentage of each sales dollar available to apply toward fixed costs and available to apply toward fixed costs and profitsprofits

The formula for The formula for contribution margin ratio and and the computation for the computation for VargoVargo Video are:Video are:

LO 5: Indicate what contribution margin is and how it can be exLO 5: Indicate what contribution margin is and how it can be expressed.pressed. 36

Contribution Margin RatioContribution Margin RatioContribution Margin RatioRatio helps to determine the effect of changes in sales on net income

LO 5: Indicate what contribution margin is and how it can be exLO 5: Indicate what contribution margin is and how it can be expressed.pressed.

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Contribution margin:Contribution margin:

a.a. Is revenue remaining after deducting variable Is revenue remaining after deducting variable costscosts.

b. May be expressed as contribution margin per unit.

c. Is selling price less cost of goods sold.

d. Both (a) and (b) above.

Let’s ReviewLetLet’’s Reviews Review

LO 5: Indicate what contribution margin is and how it can be expLO 5: Indicate what contribution margin is and how it can be expressed.ressed. 38

Break-Even AnalysisBreakBreak--Even AnalysisEven AnalysisProcess of finding the Process of finding the break-even point

level of activity at which level of activity at which total revenues equaltotal costs (both fixed and variable)(both fixed and variable)

Can be computed or derivedCan be computed or derivedfrom a mathematical equation,by using contribution margin, orfrom a cost-volume profit (CVP) graph

Expressed either in sales units or in sales dollars

LO 6: Identify the three ways to determine the breakLO 6: Identify the three ways to determine the break--even point.even point.

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Break-Even Analysis: Mathematical EquationBreakBreak--Even Analysis: Mathematical EquationEven Analysis: Mathematical EquationBreak-even occurs where total sales equal variable costs plus fixed costs; i.e., net income is zero. The formula for the The formula for the break-even point and the and the computation for computation for VargoVargo Video are:Video are:

To find To find sales dollarssales dollars required to breakrequired to break--even:even:1000 units X $500 = $500,000 (break1000 units X $500 = $500,000 (break--even dollars)even dollars)

LO 6: Identify the three ways to determine the breakLO 6: Identify the three ways to determine the break--even point.even point.40

Break-Even Analysis:Contribution Margin Technique

BreakBreak--Even Analysis:Even Analysis:Contribution Margin TechniqueContribution Margin Technique

At the break-even point, contribution margin must equal total fixed costs

(CM = total revenues – variable costs)

The break-even point can be computed using either contribution margin per unit or contribution margin ratio.

LO 6: Identify the three ways to determine the breakLO 6: Identify the three ways to determine the break--even point.even point.

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Contribution Margin TechniqueContribution Margin TechniqueContribution Margin Technique

When the BEP in units is desired, contribution margin per unit is used in the following formula which shows the computation for Vargo Video:

When the BEP in dollars is desired, contribution margin ratio is used in the following formula which shows the computation for Vargo Video:

LO 6: Identify the three ways to determine the breakLO 6: Identify the three ways to determine the break--even point.even point. 42

Break-Even Analysis: Graphic Presentation

BreakBreak--Even Analysis: Graphic Even Analysis: Graphic PresentationPresentationA cost-volume profit (CVP) graph shows costs,

volume and profits.Used to visually find the break-even pointTo construct a CVP graph:To construct a CVP graph:

Plot the total sales line starting at the zero activity level

Plot the total fixed cost using a horizontal linePlot the total cost line (starts at the fixed-cost

line at zero activityDetermine the break-even point from the

intersection of the total cost line and the total sales line

LO 6: Identify the three ways to determine the breakLO 6: Identify the three ways to determine the break--even point.even point.

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Break-Even Analysis: Graphic Presentation

BreakBreak--Even Analysis: Graphic Even Analysis: Graphic PresentationPresentation

LO 6: Identify the three ways to determine the breakLO 6: Identify the three ways to determine the break--even point.even point.44

GossenGossen Company is planning to sell 200,000 Company is planning to sell 200,000 pliers for $4 per unit. The contribution pliers for $4 per unit. The contribution margin ratio is 25%. If margin ratio is 25%. If GossenGossen will break will break even at this level of sales, what are the even at this level of sales, what are the fixed costs?fixed costs?

a.a. $100,000$100,000.

b. $160,000.

c. $200,000.

d. $300,000.

Let’s ReviewLetLet’’s Reviews Review

LO 6: Identify the three ways to determine the breakLO 6: Identify the three ways to determine the break--even point.even point.

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Break-Even Analysis: Target Net IncomeBreakBreak--Even Analysis: Target Net IncomeEven Analysis: Target Net Income

Level of sales necessary to achieve a specified income

Can be determined from each of the approaches Can be determined from each of the approaches used to determine breakused to determine break--even sales/units:even sales/units:

from a mathematical equation,by using contribution margin, orfrom a cost-volume profit (CVP) graph

Expressed either in sales units or in sales dollars

LO 7: Give the formulas for determining sales required LO 7: Give the formulas for determining sales required to earn target net income.to earn target net income.

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Break-Even Analysis: Target Net Income

BreakBreak--Even Analysis: Target Net Even Analysis: Target Net IncomeIncomeMathematical EquationMathematical Equation

Using the formula for the Using the formula for the break-even point, simply include the desired net income as a factor. The The computation for computation for VargoVargo Video is as follows:Video is as follows:

LO 7: Give the formulas for determining sales required to LO 7: Give the formulas for determining sales required to earn target net income.earn target net income.

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Break-Even Analysis: Target Net IncomeBreakBreak--Even Analysis: Target Net IncomeEven Analysis: Target Net Income

Contribution Margin TechniqueContribution Margin Technique

To determine the required sales in units for Vargo Video:

To determine the required sales in dollars for Vargo Video:

LO 7: Give the formulas for determining sales required to LO 7: Give the formulas for determining sales required to earn target net income.earn target net income.

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The mathematical equation for computing The mathematical equation for computing required sales to obtain target net income required sales to obtain target net income is:is:

Required sales =Required sales =a.a. Variable costs + Target net incomeVariable costs + Target net income.

b. Variable costs + Fixed costs + Target net income.

c. Fixed costs + Target net income.

d. No correct answer is given.

Let’s ReviewLetLet’’s Reviews Review

LO 7: Give the formulas for determining sales required to LO 7: Give the formulas for determining sales required to earn target net income.earn target net income.

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Operating LeverageOperating Leverage

•• Operating Leverage is a measure of how Operating Leverage is a measure of how sensitive net operating income is to sensitive net operating income is to percentages in sales. Operating leverage percentages in sales. Operating leverage acts as a multiplier. If operating leverage acts as a multiplier. If operating leverage is high, a small percentage increase in is high, a small percentage increase in sales can produce a much larger sales can produce a much larger percentage increase in net operating percentage increase in net operating income.income.

Degree of Operating Leverage = Contribution Margin/NOI

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Break-Even Analysis: Margin of Safety

BreakBreak--Even Analysis: Margin of Even Analysis: Margin of SafetySafety

Difference between actual or expected sales and sales at the break-even pointMeasures the “cushion” that management has if expected sales fail to materialize

May be expressed in dollars or as a ratioTo determine the margin of safety in dollars for Vargo Video assuming that actual/expected sales are $750,000:

LO 8: Define margin of safety, and give the formulas for computiLO 8: Define margin of safety, and give the formulas for computing it.ng it.

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Break-Even Analysis: Margin of Safety

BreakBreak--Even Analysis: Margin of Even Analysis: Margin of SafetySafety

Margin of Safety RatioMargin of Safety Ratio

Computed by dividing the margin of safety in dollars by the actual or expected sales

To determine the margin of safety ratio for VargoVideo assuming that actual/expected sales are $750,000:

The higher the dollars or the percentage, the The higher the dollars or the percentage, the greater the margin of safetygreater the margin of safety

LO 8: Define margin of safety, and give the formulas for computiLO 8: Define margin of safety, and give the formulas for computing it.ng it. 52

CVP Income Statement RevisitedCVP Income Statement RevisitedCVP Income Statement Revisited

LO 9: Describe the essential features of a costLO 9: Describe the essential features of a cost--volumevolume--profit income statement.profit income statement.

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Marshall Company had actual sales of Marshall Company had actual sales of $600,000 when break$600,000 when break--even sales were even sales were $420,000. What is the margin of safety $420,000. What is the margin of safety ratio?ratio?

a.a. 25%25%.

b. 30%.

c. 33 1/3%.

d. 45%.

Let’s ReviewLetLet’’s Reviews Review

LO 8: Define margin of safety, and give the formulas for LO 8: Define margin of safety, and give the formulas for computing it.computing it. 54

Chapter Review - Brief Exercise 22-4 Chapter Review Chapter Review -- Brief Exercise 22Brief Exercise 22--4 4

DeinesDeines Company accumulates the following data concerning Company accumulates the following data concerning a mixed cost, using miles as the activity level.a mixed cost, using miles as the activity level.

MilesMiles TotalTotal MilesMilesTotalTotal

DrivenDriven CostCost DrivenDriven CostCostJanuary 8,000 $14,150$14,150 MarchMarch 8,5008,500

$15,000$15,000February 7,500February 7,500 $13,600$13,600 AprilApril 8,2008,200

$14,490$14,490

Compute the variable and fixed cost elements using the high-low method.

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Chapter Review - Brief Exercise 22-4 Chapter Review Chapter Review -- Brief Exercise 22Brief Exercise 22--4 4 High Level of Activity:High Level of Activity: March $15,000 8,500 milesMarch $15,000 8,500 milesLow Level of Activity: Low Level of Activity: February 1February 13,600 3,600 7,500 miles7,500 miles

Difference $ 1,400 1,000 milesDifference $ 1,400 1,000 miles

Step 1Step 1: : Variable Cost per Unit = $1,400 Variable Cost per Unit = $1,400 ÷÷1,000 miles1,000 miles

= = $1.40 variable cost per mile$1.40 variable cost per mile

Step 2:Step 2: HighHigh LowLowTotal Cost:Total Cost: $15,000 $13,600$15,000 $13,600Variable Cost:Variable Cost:

8,500 X $1.408,500 X $1.40 11,900 11,900 7,500 X $1.407,500 X $1.40 10,500 10,500

Total Fixed CostsTotal Fixed Costs $ 3,100$ 3,100 $ 3,100$ 3,100