Page 831 - Accounting Principles (A Business Perspective)

21. Cost-volume-profit analysis

holder. How many people would have to buy tickets to justify renting the movie? (The answer is 360 ticket-buyers
as shown in the solution to Demonstration problem at the end of this chapter.)
Solving problems like this requires an understanding of the relationship between costs, revenue, and volume.

This chapter discusses the use of cost-volume-profit analysis for decision making and planning. (Although
accountants call this topic cost-volume-profit analysis, it could just as easily have been called cost-volume- revenue
analysis.) All of the analysis in this chapter is on a before-tax basis.
In this chapter we will focus on short-run decisions. The term short run describes a time frame during which a
company's management cannot change the effects of certain past decisions. The short run is one year or less for
practical purposes. For example, GM's decision to offer a special rebate starting January 5 and expiring on January
31 would be a short-run decision. In contrast, GM's decision to begin producing cars in China .

In the short run, we assume many costs are fixed and unchangeable, such as building rental expense. However,
all costs are subject to change in the long run. Although we identify particular costs as fixed in this chapter, you
should realize that costs fixed in the short run may change in the long run. Someday the building rental agreement
will change, so the building rental expense will change.
Cost behavior patterns

Exhibit 166 shows four basic cost behavior patterns: fixed, variable, mixed (semivariable), and step. As
discussed in earlier chapters, fixed costs remain constant (in total) over some relevant range of output. Often, we
describe them as time-related costs. Depreciation, insurance, property taxes, and administrative salaries are
examples of fixed costs. Recall that so-called fixed costs are fixed in the short run but not necessarily in the long
run.

For example, a local high-tech company did not lay off employees during a recent decrease in business volume
because the management did not want to hire and train new people when business picked up again. Management
treated direct labor as a fixed cost in this situation. Although volume decreased, direct labor costs remained fixed.

Exhibit 166: Four cost patterns

In contrast to fixed costs, variable costs vary (in total) directly with changes in volume of production or sales.
In particular, total variable costs change as total volume changes. If pizza production increases from 100 10-inch

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