Chapter 2 Flashcards
What is the formula for the contribution approach?
Revenue
LESS: Variable costs
CONTRIBUTION MARGIN
LESS: Fixed costs
Net Income
What is the contribution margin ratio formula?
Contribution margin ratio = Contribution margin/Revenue
What is the absorption formula?
Revenue
LESS: Cost of goods sold
GROSS MARGIN
LESS: Operating expenses
Net Income
Explain the difference between the contribution approach and the absorption approach
The difference is the treatment of fixed overhead.
Under the absorption approach, fixed overhead is a product of cost.
Under the contribution approach, fixed overhead is a period cost
Explain the difference between absorption costing net income and variable costing net income
The difference depends on the change in inventory level during the period:
No change in inventory: absorption income = variable income
Increase in inventory: absorption income > variable income
Decrease in inventory: absorption income < variable income
What is the formula for breakeven point in units?
Total fixed costs/Contribution margin per unit = Breakeven point in units
What is the formula for breakeven point in dollars?
Total fixed costs/Contribution margin ratio = Breakeven point in dollars
What is the formula for required sales volume for target profit?
Sales (units) = (Fixed cost + Pretax profit)/Contribution margin per unit
What is the formula for setting selling prices based on assumed volume?
Sales price per unit = (Fixed costs + Variable costs + Pretax profit) / (Number of units sold)
What is the margin of safety formula?
Total sales (in dollars) - Breakeven sales (in dollars) = Margin of safety (in dollars)
Describe transfer pricing (from a non-global perspective) and list the strategies that may be used to establish transfer prices
A transfer price is the price charged for the sale/purchase of a product internally (between two or more divisions within the same company)
The following strategies may be used to establish transfer prices:
- Negotiated price
- Market Price
- Cost
Describe transfer pricing from a global perspective
Transfer pricing is a methodology for allocating profits and losses among related entities within the same legal group or corporation in different tax jurisdictions
Transfer prices must approximate the prices for comparable transactions between independent parties
Define opportunity costs evaluated in considering an opportunity when the firm is operating at capacity
Opportunity cost at full capacity is defined as the net benefit given up from the best alternative use of the capacity
How should management approach a special order decision?
Special orders require a firm to decide if a specially priced order should be accepted or rejected
When there is excess capacity, a special order should be accepted if the setting price per unit is greater than the variable cost per unit
If the company is operating at full capacity, the opportunity cost of producing the special order should be included in the analysis
How should management approach a make or buy decision?
The decision to make or buy a component (also referred to as insourcing vs. outsourcing) is similar to the special order decision.
Managers should consider only relevant costs and select the lowest-cost alternative
How should management approach a sell or process further decision?
A sell or process further decision is made by comparing the incremental cost and the incremental revenue generated after the split-off point…
If the incremental revenue exceeds the incremental cost, the organization should process further
If the incremental revenue exceeds the incremental revenue, the organization should sell at the split-off point