Chapter 8: Cost-Volume-Profit Relationships

Question 1

Cost-volume-profit (CVP) analysis is one of the most powerful tools ____ have

Answer 1

managers

It helps them understand the interrelationships among cost, volume, and profit in an organization

Question 2

Characteristics of a contribution margin income statement

Answer 2

DIffers from the costing income statement

Ideal tool to explore how profits will change when different operating decisions are made

Question 3

Preparing a contribution margin income statement

Answer 3

Step 1: Calculate the product cost for each speaker
Step 2: Compute the variable cost of goods sold
Step 3: Compute the variable selling and administrative expense
Step 4: Determine the total fixed cost
STep 5: Putting it all together

Question 4

Step 1: Calculate the product cost for each speaker

Answer 4

Product cost must only include the variable cost of manufacturing (Direct materials, Direct labour, variable manufacturing overhead)

DOES NOT INCLUDE: Selling or administrative cost

Question 5

Step 2: Compute the variable cost of goods sold

Answer 5

Start by computing ending inventory

beg. inv) + (Production) - (Quantity Sold) = (Ending inv

Question 6

When the variable cost per unit is unchanged between periods or there are no inventories, then the variable cost of goods sold can be calculated directly as:

Answer 6

(Variable COGS) = (Variable product cost per unit) x (Units sold)

Question 7

Step 3: Compute the variable selling and administrative expense

Answer 7

Example from text: The variable selling and admin cost per speaker sold is $30.

The total cost for 400 speakers would be $30 x 400 = $12,000

Question 8

Step 4: Determine the total fixed cost

Answer 8

The total manufacturing fixed cost (FMOH) and the fixed selling and general and administrative cost (FSG&A) is:
FMOH + FSG&A = $25000 + $10000 = $35000

Question 9

cost–volume–profit analysis (Look at CVP analysis)

Answer 9

A tool that helps managers understand the interrelationships between cost, volume, and profit.

Question 10

CVP analysis

Answer 10

Short-form for cost–volume–profit analysis, a tool that helps managers understand the interrelationships between cost, volume, and profit.

Question 11

contribution margin

Answer 11

The amount available to cover fixed expenses and then provide profits for the period.

Difference between sales revenue and variable expenses

Question 12

Unit contribution margin

Answer 12

Expressed on a per-unit basis

Question 13

Contribution margin ratio (CM Ratio)

Answer 13

Expressed as a percentage of sales

Contribution margin / sales * 100

Question 14

Contribution margin is used ______ to cover fixed expenses, and then whatever remains goes towards ______

Answer 14

First

Profits

Question 15

If the contribution margin is not sufficient to cover the fixed expenses, then what?

Answer 15

A loss occurs for the period

Question 16

Break-even point (BEP)

break even point

Answer 16

The level of sales at which profit is zero.

Defined as the point where total sales equal total expenses (variable or fixed)

Or

The point where total contribution margin equals total fixed expenses.

Once BEP has been reached, NI will increase by the amount of the unit CM for each additional unit sold

If neither # units nor price/unit are available: BEP$ = FC / CMR

Question 17

Once the break-even point has been reached,

Answer 17

net income will increase by the amount of the unit contribution margin for each additional unit sold

Example: If 351 speakers are sold, we can assume net income for the month is $100

Question 18

contribution margin (CM) ratio

Answer 18

The contribution margin as a percentage of total sales.

Question 19

CM ratio =

equation

Answer 19

Contribution margin / sales

Example: $40,000 / $100,000 = 40%

Question 20

CM ratio (Single product company) = 
(equation)

Answer 20

Per unit contribution margin / per unit sales revenue

Example: $100 / $250 = 40%

Question 21

CM ratio explained

Answer 21

For each dollar increase in sales, total contribution margin will increase by 40 cents (= $1 sales x CM ratio of 40%)

Question 22

The impact on contribution margin of any given dollar change in total sales can be computed in seconds by simply applying the CM ratio to the dollar change

Answer 22

FOr example: If Auto Blast plans a $30,000 increase in sales during the coming month, management can expect the contribution margin to increase by $12,000
($30,000 increased sales x CM ratio of 40%)

Question 23

The contribution format income statement can be expressed in equation form as follows

Answer 23

Profit = (Sales - Variable Expenses) - Fixed expenses

Question 24

When a company has a single product

Answer 24

Sales = Selling price per unit x Quantity sold = P x Q

Variables expenses = Variable expenses per unit x Quantity sold = V x Q

Profit = (P x Q - V x Q) - fixed expenses

Question 25

CVP graph (aka break-even chart)

Answer 25

A graph that highlights cost–volume–profit relationships over wide ranges of activity

Question 26

Breakdown of CVP graph

Answer 26

Unit volume is on the horizontal 9X) axis) Dollars are on the vertical (y) axis

Question 27

How to draw a CVP graph

Answer 27

1) Draw a line parallel to the volume axis to represent total fixed expenses (in the example FC were $35,000) 2) Choose some volume of sales and plot the point representing total expenses (fixed and variable) at the activity level you have selected (in example, Robert chose a volume of 600 speakers) After the point has been plotted, draw a line through it back to the point where the fixed expenses line intersects the dollar axis 3) Again, choose a volume of sales and plot the point representing total sales dollars at the activity level you have selected (example: Robert chose a volume of 600 speakers, sales at that level is 150,000. Draw a line through this point back to the origin

Question 28

Break even on a CVP graph

Answer 28

When the two lines cross on the graph

Question 29

Assumptions of CVP analysis

Answer 29

1) Selling price is constant - the price of product / service will not change as volume changes 2) Costs are linear and can be accurately divided into variable and fixed elements - The variable element is constant per unit - The fixed element is constant in total over the entire relevant range 3) In multi-product companies, the sales mix is constant 4) In manufacturing companies, inventories do not change - the number of units produces = the number of units sold

Question 30

Management levers

Answer 30

Unit variable costs Fixed costs Selling price

Question 31

Example 1: Increase in fixed cost, leading to an increase in sales volume

Answer 31

Background: $10,00 increase in advertising will increase sales by 30%, making sales go from $100,000 to $130,000 Lever: fixed cost

Question 32

incremental analysis

Answer 32

An analytical approach that focuses only on those items of revenue, cost, and volume that will change as a result of a decision.

Question 33

Example 2: Increase in unit variable costs, leading to an increase in sales volume

Answer 33

Management want to use higher-quality parts, increasing VC from $150 to $160 (lowering contribution by $10 per speaker), they think doing this would increase sales by 20% Lever: Variable cost

Question 34

Example 3: Increase in fixed cost, decrease in selling price, leading to an increase in sales volume

Answer 34

Manager wants to cut selling price by $20 per speaker, making a speaker $230 and increase advertising by $15000 per month. Apparently sales will increase by 50% to 600 speakers per month Levers: Sales price and fixed cost

Question 35

Example 4: increase in variable cost per unit and decrease in fixed cost, leading to an increase in sales volume

Answer 35

Commission of $15 per speaker rather than salary. THis change will increase monthly sales by 15% to 460 speakers Lever: Variable cost and fixed cost

Question 36

Break-even point can be computed using 2 methods

Answer 36

1) Equation method | 2) Contribution margin method

Question 37

Equation method

Answer 37

A method of computing the break-even point that relies on the equation Sales = Variable expenses + Fixed expenses + Profits.

Question 38

Equation method equation

Answer 38

Sales = Variable expenses + Fixed expenses + Profits If breaking even profits always = 0!!!!!!!!!

Question 39

contribution margin method

Answer 39

A method of computing the break-even point in which the fixed expenses are divided by the contribution margin per unit

Question 40

contribution margin method equation

Answer 40

Break-even point in units sold = Fixed expenses / Unit contribution margin

Question 41

Variation of CM ratio, this finds the break-even in total sales dollars, rather in units sold

Answer 41

Break-even point in total sales dollars = FIxed expenses / CM ratio

Question 42

The contribution margin approach

Answer 42

Unit sales to attain target profit = (Fixed expenses + Target profit) / Unit contribution margin

Question 43

After tax income (ATI) = | equation

Answer 43

(1-t) x before-tax income (BTI)

Question 44

Before-tax income (BTI) =

Answer 44

ATI / (1-t)

Question 45

margin of safety

Answer 45

The excess of budgeted (or actual) sales over the break-even volume of sales.

Question 46

Margin of safety equation =

Answer 46

Total budgeted (or actual) sales - Break-even sales

Question 47

Margin of safety percentage = | %%%%

Answer 47

Margin of safety in dollars / Total budgeted or actual sales

Question 48

Cost structure

Answer 48

Refers to a relative proportion of fixed and variable costs in an organization

Question 49

Lever

Answer 49

A tool for multiplying force.

Question 50

operating leverage

Answer 50

A measure of how sensitive net income is to a given percentage change in sales. It is computed by dividing the contribution margin by net income.

Question 51

If operating leverage is high:

Answer 51

A small percentage increase in sales can produce a much larger percentage increase in net income

Question 52

degree of operating leverage (DOL)

Answer 52

A measure, at a given level of sales, of how a percentage change in sales volume will affect profits. The degree of operating leverage is computed by dividing contribution margin by net income.

Question 53

degree of operating leverage equation =

Answer 53

Contribution margin / net income

Question 54

The number from the degree of operating leverage equation says that net income grows x times faster as its sales

Answer 54

A operating leverage of 4 means the net income grows four times as fast as its sales

Question 55

Fundamental Mathematical Formula:

Answer 55

% Change = (New – Old) / Old percentage change

Question 56

Advantages of Variable Costing and the Contribution Approach

Answer 56

Variable costing combined with the contribution approach, creates many advantages for internal reports: Enabling CVP analysis Explaining changes in net operating income Supporting decision making

Question 57

Net Operating Income from the Contribution Margin (“Variable Costing”) approach will not necessarily equalNet Operating Income from the Gross Margin (“Absorption Costing”) approach

Answer 57

Because ... Costs will hit the Income Statement at different times

Question 58

Absorption Costing:

Answer 58

* all product costs (both fixed and variable) are assigned to products. * Both the COGM and COGS will consist of both fixed and variable costs of manufacturing

Question 59

Variable Costing:

Answer 59

* Only manufacturing costs that vary with output are treated as product costs (DM, DL & variable MOH) * Both the COGM and COGS will consist of only variable costs of manufacturing. * Fixed manufacturing costs are treated as period costs and expensed during the accounting period