chapter 5 managerial accounting

activity index

identifies the activity that causes changes in the behavior of costs. with this, companies can classify the behavior of costs in response to changes in activity levels into three categories: variable, fixed, or mixed.

curvilinear

in the curved sections of the line, a change in activity index will not result in a direct, proportional change in the variable cost. (curvilinear is often what goes on in the real world, and is more realistic)

for purposes of CVP analysis, how must mixed costs be classified?

mixed costs must be classified into their fixed and variable elements.

what is the trend for many manufacturers in relation to fixed costs and variable costs?

the trend for many manufacturers is to have more fixed costs and fewer variable costs. this trend is the result of increased use of automation and less use of employee labor, which results in an increase in fixed costs and a decrease in variable costs.

breakeven point

total costs (variable plus fixed) exactly equal total revenue. the break even point can be expressed either in sales units or sales dollars. the process of finding the break even point is called break even analysis.

although the linear relationship may not be realistic, the linear assumption produces useful data for CVP analysis as long as __________

the level of activity remains within the relevant range

fixed costs

-costs that remain the same in total regardless of changes in activity level. -fixed costs per unit vary inversely with activity: as volume increases, unit cost declines, and vice versa. -examples: property taxes, insurance, rent, supervisory salaries, depreciation on buildings and equip, etc.

what are the 5 components of the CVP analysis

1) volume or level of activity 2)unit selling prices 3)variable costs per unit 4)total fixed costs 5)sales mix

contribution margin

amount of revenue remaining after deduction of variable costs. its often stated both as a total amount and on a per unit basis.

target net income

an income objective set by management. it indicates the sales necessary to achieve a specified level of income. companies determine the sales necessary to achieve target net income by using one of the three approaches

for an activity level to be useful in cost behavior analysis, changes in the level or volume of activity should be correlated to _____

changes in costs

CVP income statement

classifies costs as variable or fixed and computes a contribution margin. -this is often the format that management wants the CVP information reported

mixed costs

costs that contain a variable element and a fixed element. they therefore change in total but not proportionately with changes in the activity level. (ex: rental of a U-Haul truck. the per day charge is a fixed cost but the mileage charge is a variable cost) (examples of mixed costs are: maintenance and utilities)

variable costs

costs that vary IN TOTAL directly and proportionately with changes in the activity level. they can also be defined as a cost that remains the same per unit at every level of activity. examples: direct materials and direct labor for a manufacturer, cost of goods sold, sales commisions, etc

linear

if a relationship is linear (that is straight line), then the activity index will result in a direct, proportional change in the variable cost. (for example: if the activity level doubles the cost doubles) (linear relationships are not really realistic in the real world)

cost-volume profit graph

shoes costs, volume, and profits. this is an effective way to find the break even point. its useful bc the effects of a change in any element in the cvp analysis can be quickly seen, and so can the effects on total costs of wage increases.

the activity level selected is referred to as ___

the activity (or volume) index

margin of safety

the difference b/t actual or expected sales and sales at the break even point. -it measures the "cushion" that a particular level of sales provides. it tells us how far sales could fall before the company begins operating at a loss. -the margin of safety is expressed in dollars or as a ratio. -the higher the margin or percentage, the greater the margin of safety.

relevant range

the range over which a company expects to operate during a year is called the relevant range of the activity index. -within the relevant range, a straight line relationship generally exists for both variable and fixed costs.

cost behavior analysis

the study of how specific costs respond to changes in the level of business activity. a knowledge of cost behavior helps management plan operations and decide between alternative courses of action. cost behavior analysis applies to all types of entities.

cost-volume profit analysis (CVP)

the study of the effects of changes in costs and volume on a companys profits. CVP is important in profit panning. its also a critical factor in such management decisions as setting selling prices, determining product mix, and maximizing use of production facitilities.

high-low method

uses the total costs incurred at the high and low levels of activity to classify mixed costs into fixed and variable components. the difference in costs between the high and low levels represents variable costs since only the variable cost element can change as activity levels change.