-total variable costs change when activity changes.
-total fixed costs remain unchanged when activity changes
-some costs are partly fixed and partly variable. Called semi-variable or mixed costs.
Total variable cost
Example: raw materials, increased number of units produced results in an increased
total cost of raw materials.
total fixed costs
Example: Factory building depreciation
Will not change with level of production
General rule: do not utilise fixed expenses as they do not behave on a per unit basis.
cost behaviour patterns
,-typical variable costs:
-raw materials
-direct labor(wages)
-factory water, light, electricity
-sales commissions
-delivery costs
-typical fixed costs:
-land tax
-insurance
-supervisory salaries
-depreciation
-advertising
assumptions
two assumptions regarding cost behaviour:
-relevant range
-linearity
relevant range
-the relevant range is the level of activity over which a particular cost behaviour pattern
exists
-example: office space is available at a rental rate of $30,000 per year in increments of
1,000 space metres. As business grows, more space is rented, increasing the total cost.
Fixed costs and the relevant range
, total cost does not change for a wide range of activity, and then jumps to a new higher
cost for the next higher range of activity.
CVP analysis and contribution margin
-CVP stands for cost-volume-profit
-CVP analysis uses cost behaviour to make decisions
-when we separate costs into fixed and variable, we create a contribution margin (sales
less variable costs)
contribution margin format
-difference between sales revenue and variable expenses
-useful in the planning, control and evaluation processes applied to a firm's operations.
-the contribution to fixed costs and operating income from the sale of a product or
provision of a service.
The contribution margin format
emphasises cost behaviour. Contribution margin covers fixed costs and provides
income.
contribution margin represents the $value of sales available to cover fixed costs, once
variable costs have been met.
Portion of each sales dollar that remains after covering the variable costs and are
available to cover fixed costs or provide for profit.
sales less variable costs= contribution margin (CM)
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