Managerial Accounting Chpt. 7

What if variable cost change?

CM changes Breakeven point changes

What if sales price changes?

CM will change Breakeven point will change

What are the 3 ways to compute the breakeven in terms of sales revenue?

-Income statement approach, -Shortcut approach using the unit contribution margin, -Shortcut approach using the contribution margin ratio.

Sensitivity Analysis

-Managers need to be prepared for increasing costs, pricing pressure from competitors, and other changing business conditions. -Managers use CVP analysis to conduct sensitivity analysis.  -Conducts "What if" analysis What if the sales price changes? What if costs change? What if the sales mix changes?

5 CVP assumptions

-No volume discounts, -Costs are linear throughout relevant range, -Revenues are linear in relevant range, -Inventory levels will not change, -Sales mix will not change

Components of CVP Analysis

5 Sales price per unit, Volume sold, Variable costs per unit, Fixed costs, Profit or loss.

Higher variable costs have the same effect a lower selling prices-- they both reduce the products unit contribution margin.

As a result more units need to be sold to breakeven or achieve target profits.

High Operating leverage

Higher levels of fixed costs and lower levels of variable costs, Higher contribution margin ratios, Higher risk, Higher potential for reward.

Dividing fixed costs by the unit contribution margin provides breakeven in sales unit.

Dividing fixed costs by the contribution margin ratio provides breakeven in sales dollars (sales revenue).

Margin of safety

Excess of actual or expected sales over breakeven sales. - The higher the margin of safety the greater cushion against loss and the less risky the business plan.

Cost volume profit analysis

Expresses the relationships among costs, volume, and the company's profit. Determines how much the company sell to cover costs or break even. Helps determine sales volume needed to earn a target profit.

Examples of High Operating Leverage

Golf courses, Airlines, Hotels, Car rentals, theme parks, Cruise lines

Low Operating Leverage Ex. Merchandising company

Have higher levels of variable costs and lower levels of fixed costs, Lower contribution margin ratios. For LOW operating leverage companies, changes in sales volume do not have as significant an effect on operating income, so they face: Lower risk, Lower potential for reward.

Sales Mix

Is the combination of products that make up total sales.

Contribution Margin ratio

Is the percentage of each sales dollar that is available for covering fixed expenses and generating a profit.

Breakeven Point

Is the sales level at which operating income is zero. Sales above breakeven, then profit. Sales below breakeven, then loss.

Why do managers prefer CVP?

It provides them with information in a ready to use format.

The operating leverage factor at a given level of sales, indicates the percentage change in operating income that will occur 1% change in volume.

It tells us how responsive a company's operating income is to changes in volume.

Do changes in fixed costs affect the contribution margin?

No

Sustainability And CVP

Reducing costs and helping the environment. Decreasing variable costs makes it easier to reach a target profit.

When faced with a choice between cost structures, choose what?

The lower operating leverage option when sales volume is expected to be lower than the indifference point. Choose the Higher operating leverage option when sale volume is expected to be higher than the indifference point.

Operating Leverage

The relative amount of fixed and variable costs that make up a company's total costs.

What if fixed costs changes?

Will not affect contribution margin, Will change breakeven point

When finding the breakeven point always use "0" as the operating income in the formula.

zero "0"