Chapter 9: Short-term profit-planning: Cost-Volume-Profit Analysis

Question 1

What is CVP Analysis?

Answer 1

short-term profit-planning model. It is a method for analyzing how various operating decisions and marketing decisions will affect short-term profit. Financing and nonrecurring costs are excluded

Question 2

What is the CVP model?

Answer 2

Operating profit = Sales – Total Costs (Variable Costs + Fixed Costs).

Question 3

What is the contribution margin?

Answer 3

Difference between selling price per unit (p) and variable cost per unit (v). It is a measure of the change in operating profit for each unit change in sales and is P – VC

Question 4

What is the total contribution margin?

Answer 4

contribution margin per unit (p-v), multiplied by the number of units sold, Q.

Question 5

What is the contribution margin ratio?

Answer 5

ratio of contribution margin per unit to the selling price per unit (p-v) / p. This shows how much profit increases with an increase in sales dollars.

Question 6

What is the contribution margin statement?

Answer 6

variable costs are subtracted form sales to get total contribution margin, from which fixed costs are subtracted to yield amount of operating profit over a period.

Question 7

Name 4 strategic questions addressed by CVP analysis?

Answer 7

1. What is expected profit from given change in sales volume for existing products, and is it sufficient to support strategic objectives?
2. Is decision to add new customer or product profitable, and is it consistent with the organization’s competitive strategy?
3. Given the organization’s strategy and future expectations for sales volume, is it best to manufacture certain parts in-house or purchase from suppliers?
4. Fiven strategy and future expectations for sales volume, should company invest in future expansion?

Question 8

What is the breakeven point?

Answer 8

point at which total revenues equal total costs so that operating profit = 0

Question 9

What is the breakeven point in units?

Answer 9

Fixed Costs / (Price – VC)

Question 10

What is the breakeven point in dollars?

Answer 10

Fixed costs / ( (Price – VC) / Price)

Question 11

What is profit planning?

Answer 11

determining revenue required to achieve a desired profit level (add desired profit to fixed costs in Breakeven formulae). When firms require a certain after-tax income, the after-tax income must be divided by (1-Tc) in order to get to adequate pre-tax operating income.

Question 12

What is the difference between volume-based costing and ACtivity-based costing CVP?

Answer 12

batch and product level activity costs are modeled as costs that can change in ABC CVP as opposed to VBC CVP (because they can change on a short-term planning horizon)

Question 13

What are the Activity-based CVP components?

Answer 13

1. Fixed costs = F(vb) + F(ab), where
    F(vb) = portion of short-term fixed costs not varying with activity cost driver
    F(ab) = portion of short-term fixed costs that does vary with the activity cost driver
2. :
   - F(ab) = cost per batch for activity-based cost driver
   - B = number of units in a batch
   - F(ab) – b = cost per unit of product for batch-related costs for batch size b
3. CVP model: Q = (F(vb) + profit) / (p – v – (F(ab) / b) )

Question 14

What is a sensitivity analysis?

Answer 14

examination of how an amount changes if factors involved in predicting that amount change

Question 15

What is a what-if analysis?

Answer 15

calculation of an amount given different levels of factors influencing that amount

Question 16

What is the margin of safety?

Answer 16

amount of planned (or actual) sales above the breakeven point. If 1500 units are sold and breakeven point is 900, then the MOS = 1500 – 900 = 600

Question 17

What is the margin of Safety ratio?

Answer 17

Margin of Safety Ratio = margin of safety divided by breakeven sales. So 600 / 1500 = ….

Question 18

What is operating leverage?

Answer 18

extent of fixed costs in an organization’s cost structure. Higher relative amount of fixed costs, the higher operating leverage. This means that operating income is more sensitive to volume changes.

Question 19

What is the degree of operating leverage?

Answer 19

measure of sensitivity of operating profit to changes in volume, defines as contribution margin / operating profit at any Q

Question 20

What is the sales mix?

Answer 20

relative proportion in which a company’s products are sold.

Question 21

What is the weighted average contribution margin per unit?

Answer 21

average per-unit contribution margin based on assumed sales mixed determined on the basis of physical units

Question 22

What is the weighted average contribution margin ratio?

Answer 22

average contribution margin for a given sales mix based on sales dollars

Question 23

Name the two main assumptions and limitations of a conventional CVP Analysis?

Answer 23

• CVP Calculations performed within context of a traditional CVP model should be inside relevant range of activity to be around linearity
• Step costs (additional fixed costs after a certain number of units produced, usually to lighten capacity constraints) require CVP calculations for each individual range