Accounting Business Reporting for Decision Making

CHAPTER 10 Cost–volume–profit analysis 423

Number of times advertisement is aired

Total televisionadvertising cost

Total cost

Fixed cost

9500

10000

11000

12000

$13 000

0 1 2 3 4 5 6

FIGURE 10.3 Mixed cost behaviour

Coconut Plantations Pty Ltd established an online shop to increase sales of its coconut-based pro-

ducts. Jo, the manager, is taking a conservative approach to online selling and is initially only offering

a single product, coconut candles. She is planning to analyse profitability of the online shop before

offering a wider range of products. The following information relating to internet activity and internet

charges was extracted from her accounts and the sales database.

3 months to

31 March 2017

3 months to

30 June 2017

Number of online sales orders

Total internet charges $

5 000

150 000 $

5 500

155 000

Before CVP analysis can be undertaken, we need to split the total costs into their fixed and variable

components. Given our discussion of cost behaviour earlier, we know that fixed costs stay the same

regardless of the level of activity and total variable costs increase in proportion to output. Therefore, the

variable cost behaviour can explain why the costs of Coconut Plantations have increased by $5000 for an

increased activity level of 500 online sales orders. To calculate the variable cost per order we divide the

difference in cost by the difference in activity level as follows.

Change in internet charges

Change in online orders

Variable cost per unit

$5 000

500 online orders

$10 per online order

We know that total costs are equal to total fixed costs plus total variable costs. Therefore, to calculate

the total fixed costs we have to deduct the total variable costs, which will be equal to the number of sales

orders times $10, from the total costs. From the calculations below we have calculated total fixed costs

to be $100 000.

For 5000 online orders = $150 000 − (5000 online sales × $10) = $100 000

For 5500 online orders = $155 000 − (5500 online sales × $10) = $100 000

Coconut Plantations Pty Ltd can now use this cost behaviour knowledge to determine total costs for

any level of online orders within the relevant range. The manager will know that costs will increase at

the rate of $10 per online order due to the variable cost behaviour, and that fixed costs will remain con-

stant at $100 000. For example, if the manager wanted to know the total cost at 5100 online orders, we

would determine the variable cost (5100 × $10) and then add the fixed cost ($100 000), which would

give a total cost of $151 000.