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Unformatted text preview: ) is squared, and all of the squared values are summed. Importantly, the defined
line is the one that minimizes the summed squared values! This line is deemed to be the best fit line,
hopefully giving the clearest indication of the fixed portion (the intercept) and the variable portion
(the slope) of the observed data.
One can always fit a line to data, but how reliable or accurate is that resulting line? The R-Square
value is a statistical calculation that characterizes how well a particular line fits a set of data. For the
illustration, note (in cell B21) an R2 of .798; meaning that almost 80% of the variation in cost can
be explained by volume fluctuations. As a general rule, the closer R2 is to 1.00 the better; as this
would represent a perfect fit where every point fell exactly on the resulting line. Download free ebooks at bookboon.com
18 Cost Behavior Analysis Cost Analysis The R-Square method is good in theory. But, how does one go about finding the line that results in a
minimization of the cumulative squared distances from the points to the line? One way is to utilize
built-in tools in spreadsheet programs, as illustrated above. Notice that the formula for cell B21 (as
noted at the top of spreadsheet) contains the function RSQ(C5:C16,B5:B16). This tells the
spreadsheet to calculate the R2 value for the data in the indicated ranges. Likewise, cell B20 is
based on the function SLOPE (C5:C16,B5:B16). Cell B19 is INTERCEPT(C5:C16,B5:B16). Most
spreadsheets provide intuitive pop-up windows with prompts for setting up these statistical
Spreadsheets have not always been available. You may be curious to know the underlying
mechanics for the least squares method. If so, you can check out the link on the website. 2.4 Recap
Before moving on, let’s review a few key points. A good manager must understand an
organization’s cost structure. This requires careful consideration of variable and fixed cost
components. However, it is sometimes difficult to discern the exact cost structure. As a result,
various methods can be employed to analyze cost behavior. Once an organization’s cost structure is
understood, it then becomes possible to perform important diagnostic calculations which are the
subject of the next sections of this chapter. your chance
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19 Break-Even and Target Income Cost Analysis 3. Break-Even and Target Income
CVP analysis is imperative for management. It is used to build an understanding of the relationship
between costs, business volume, and profitability. The analysis focuses on the interplay of pricing,
volume, variable and fixed costs, and product mix. This analysis will drive decisions about what
products to offer, how to price them, and how to manage an organization’s cost structure. CVP is at
the heart of techniques that are useful for calculating the break-even point, volume levels necessary
to achieve targeted income levels, and similar computations. The starting point for these
calculations is to consider the contribution margin. 3.1 Contribution Margin
The contribution margin is revenues minus variable expenses. Do not confuse the contribution
margin with gross profit as discussed in the previous chapter (revenues minus cost of sales). Gross
profit would be calculated after deducting all manufacturing costs associated with sold units,
whether fixed or variable. Instead, the contribution margin is a conceptual number reflecting the
amount available from each sale, after deducting all variable costs associated with the units sold.
Some of these variable costs are product costs, and some are selling and administrative in nature.
The contribution margin is generally a number calculated for internal use and analysis; it does not
ordinarily become a part of the externally reported data set. 3.2 Contribution Margin: Aggregated, per Unit, or Ratio?
When speaking of the contribution margin, one might be referring to aggregated data, per unit data,
or ratios. This point is illustrated below for Leyland Sports, a manufacturer of score board signs.
The production cost is $500 per sign, and Leyland pays its sales representatives $300 per sign sold.
Thus, variable costs are $800 per sign. Each sign sells for $2,000. Leyland’s contribution margin is
$1,200 ($2,000 - ($500 + $300)) per sign. In addition, assume that Leyland incurs $1,200,000 of
fixed costs, regardless of the level of activity. Below is a schedule with contribution margin
information, assuming 1,000 units are produced and sold:
Total $2,000 100% 8 00,000 8 00 40% $1,200,000 $1,200 60% Total * Ratio $2,000,000 P er Unit Ratio $4,000,000 $2,000 100% 1 ,600,000 8 00 40% $2,400,000 Sales (1,000 X $2,000) P er Unit $1,200 60% Variable costs (1...
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