MAT 201 Module 6 Cost Behavior Example

Variable, Fixed and Sticky: Cost Behavior and Break-Even for a Creamery's Yogurt Line

Student Name

Business Administration Program, Aspen University

MAT 201: Principles of Accounting II

Instructor Name

Month Day, Year

Variable, Fixed and Sticky: Cost Behavior and Break-Even for a Creamery's Yogurt Line

Module 5 gave Cedar Valley Creamery's managers new internal reports. The first decision those reports must support concerns the yogurt line. A regional grocery chain has offered to buy 60,000 cases a year if the creamery cuts its price 6%. To decide, the plant manager needs to know which of the line's costs move with output and how many cases must be sold before the line stops losing money. This paper classifies the costs, finds the break-even point and tests the offer.

Classifying the Costs

Variable costs change in total with volume; each additional case adds the same amount. Fixed costs stay the same in total within a range of volume. Mixed costs have both parts.

Separating Utilities

Utility costs rise with production but are never zero. The high-low method compares just two months, the busiest and the quietest. In the highest month, the line produced 92,000 cases and used $61,400 of utilities; in the lowest, 64,000 cases and $47,400. The variable rate is the change in cost divided by the change in volume: $14,000 divided by 28,000 cases, or $0.50 per case. The fixed part is $61,400 minus $0.50 times 92,000, or $15,400 a month, $184,800 a year. The method is simple but uses only two months, which may be unusual, so the creamery's cost accountant will check it against a regression on all twelve months.

Contribution Margin and Break-Even

Variable cost per case is $8.40 plus $1.80 plus $1.60 plus $0.30 plus $0.50, or $12.60. With a price of $18, each case contributes $5.40 toward fixed costs and profit. Annual fixed costs total $540,000 plus $420,000 plus $475,200 plus $184,800, or $1,620,000. Break-even is $1,620,000 divided by $5.40, or 300,000 cases. Last year the line sold 342,000 cases, earning about $226,800 above break-even. The same figures give a target volume for any profit goal: to earn $400,000 from the line, the creamery would need to sell ($1,620,000 plus $400,000) divided by $5.40, or about 374,100 cases. The plant manager can use that figure to set sales targets with the sales director rather than guessing.

Testing the Grocery Chain's Offer

A 6% discount lowers the price to $16.92, and contribution falls to $4.32 per case. On 60,000 cases, the offer adds $259,200 of contribution, provided the plant has room. The line ran at about 81% of its 420,000-case capacity last year, so 60,000 more cases would fit. If accepting meant overtime or a new shift, fixed costs would rise and the answer would change. A second shift for the yogurt line would add about $310,000 a year in supervision and maintenance, which would turn the offer from a gain into a loss unless the chain bought far more than 60,000 cases. The plant manager should also consider whether existing customers would demand the same discount. If a third of current volume, about 114,000 cases, were repriced at the discount, the creamery would give up $191,520 of contribution, nearly erasing the gain. The offer is attractive only if the discounted price can be limited to the new volume, for example through a private-label cup sold only to that chain.

Margin of Safety and Profit Sensitivity

Last year's sales of 342,000 cases exceeded break-even by 42,000 cases, a margin of safety of about 12%. If sales fell by more than that, the line would lose money. Because fixed costs make up a large share of the line's costs, profit swings much more than sales: a 10% rise in volume from 342,000 cases would add $184,680 of contribution, raising the line's profit from $226,800 to about $411,500, an 81% increase. The same amplification works in reverse, which is why the plant manager watches volume closely.

What a Rise in Milk Prices Does

Milk is the largest variable cost, and its price is set each month by federal order formulas and the cooperative, not by the creamery. If milk prices rose 10%, variable cost per case would rise by $0.84 to $13.44, contribution would fall to $4.56 and break-even would rise to about 355,300 cases, above last year's sales. The creamery would need to raise prices, cut fixed costs or sell more just to avoid a loss. This sensitivity is one reason the plant cost report from Module 5 tracks milk cost per case weekly.

Costs That Do Not Fall Back

The straight-line model assumes costs move symmetrically with volume. Anderson et al. (2003) tested this for selling, general and administrative costs across many firms and found that a 1% sales gain lifted overhead by about 0.55%, whereas a 1% sales decline trimmed it by roughly 0.35% only. Managers appear to keep resources when sales fall, perhaps expecting recovery or wanting to avoid the cost of cutting and later rehiring.

Banker and Byzalov (2014) reviewed research on asymmetric cost behavior and explained it through managers' deliberate decisions about resources, shaped by expectations of future demand and by adjustment costs such as severance and hiring. Stickiness was common but varied with circumstances, and some costs showed the opposite pattern.

Balakrishnan et al. (2004) found that how strongly costs respond to a change in activity depends on how fully a firm's capacity is being used at the time. For Cedar Valley, this means that if the grocery chain's volume later disappears, fixed costs added to serve it may not leave as easily as they came.

Conclusion

The yogurt line breaks even at 300,000 cases and the grocery chain's offer adds contribution while capacity is available. Anderson, Banker and Janakiraman, Banker and Byzalov and Balakrishnan, Petersen and Soderstrom show why the analysis should allow for costs that rise easily and fall slowly.

References

Anderson, M. C., Banker, R. D., & Janakiraman, S. N. (2003). Are selling, general, and administrative costs "sticky"? Journal of Accounting Research, 41(1), 47-63. https://doi.org/10.1111/1475-679X.00095

Balakrishnan, R., Petersen, M. J., & Soderstrom, N. S. (2004). Does capacity utilization affect the "stickiness" of cost? Journal of Accounting, Auditing & Finance, 19(3), 283-300. https://doi.org/10.1177/0148558X0401900303

Banker, R. D., & Byzalov, D. (2014). Asymmetric cost behavior. Journal of Management Accounting Research, 26(2), 43-79. https://doi.org/10.2308/jmar-50846