Accounting Exam 2

CVP graph

highlights CVP relationships over wide ranges of activity -sometimes called a break-even chart -unit volume: horizontal axis, dollars: vertical axis 1) draw a line parallel to the volume axis to represent fixed expenses 2) choose some volume of unit sales and plot the point representing total expense (fixed + variable) at the sales volume you selected, and draw a line through it back to the point where the fixed expense line intersects the dollar axis 3) choose some sales volume and plot the point representing total sales dollars at the activity level you have selected, and draw a line through this point back to the origin

profit graph

linear equation, straight line-to plot the line, compute the profit at two different sales volume, plot the points, and then connect them with a straight line

cost structure and profit stability

low variable costs and high fixed costs--> if sales increase, better cost structure, due to a higher contribution margin ratio, therefore profits will increase more rapidly as sales increase. high variable costs and low fixed costs--> BETTER PROFIT STABILITY. If sales drop, better cost structure, due to higher margin of safety, and lower contribution margin (won't lose contribution margin rapidly when sales decline), and lower break-even point. Less vulnerable to downturns. Provides more protection.

management by exception

managers focus on quantities and costs that exceed standards, a practice known as ________________

cost structure

refers to the relative proportion of fixed and variable cost in an organization

sales mix

refers to the relative proportions in which a company's products are sold -idea is to achieve the combination, or mix, that will yield the greatest profits -company's with multiple products that are not equally profitable--> profits will depend to some extent on the _____________ -profits greater if high-margin rather than low-margin items make up a relatively large proportion of total sales.

disadvantages of standard costs

-Emphasis on negative may impact morale. -Standard cost reports may not be timely. -Incentives to build inventories. -Favorable variances may be misinterpreted. -Continuous improvement may be more important than meeting standards. -Emphasizing standards may exclude other important objectives.

contribution margin ratio (CM ratio)

-contribution margin as a percentage of sales -used to compute changes in contribution margin and net operating income resulting from changes in sales volume -particularly valuable in situations where the dollar sales of one product must be traded off against the dollar sales of another product-- the products that yield the greatest amount of contribution margin per dollar of sales should be emphasized

sales mix and break-even analysis

-different products with different selling prices, different costs, and different contribution margins -the break-even point depends on the mix in which the various products are sold -If the sales mix changed, then the break-even point will also usually change. -usual assumption: sales mix will not change

Target Profit Analysis

-one of the key uses of CVP analysis -we estimate what sales volume is needed to achieve a specific profit -use either 1) the Equation Method of 2) the Formula Method-- same answers from both methods

assumptions that commonly underlie CVP analysis

1) selling price is constant 2) costs are linear and can be accurately divided into variable and fixed elements 3) in multi product companies, the sales mix is constant 4) in manufacturing companies, inventories do not change

Target Profit Analysis in Terms of Sales Dollars

1) use equation method or formula method to solve for unit sales and then multiply the result by the selling price. OR, 2) use the basic equation stated in terms of the contribution margin ratio: profit= CM ratio x Sales - Fixed expenses, and solve for sales. OR, 3)compute dollar sales to attain a target profit as follows: Dollar sales to attain a target profit= (Target profit + Fixed expenses)/ CM ratio -most useful for companies with multiple products

Profit

= (Sales- Variables expenses)- Fixed expenses = (PxQ - VxQ) - Fixed expenses =Unit CM x Q - Fixed expenses

Profit

= CM ratio x Sales - fixed expenses derived from: =contribution margin - fixed expenses = (contribution margin/sales) x Sales - fixed expenses

percentage change in net operating income

= Degree of operating leverage x Percentage change in sales

margin of safety percentage

= Margin of safety in dollars/ Total budgeted (or actual) sales in dollars

margin of safety in units sold

= Margin of safety in dollars/ selling price per unit

margin of safety in dollars

= Total budgeted (or actual) sales - Breakeven sales

degree of operating leverage

= contribution margin/ net operating income - a measure, at a given level of sales, of how a percentage change in sales volume will affect profits. -tells you that net operating income grows ____ times as fast as its sales. -not constant -greatest at sales levels near the break-even point and decreases as sales and profits rise

CM ratio

= contribution margin/sales -shows how the contribution margin will be affected by a change in total sales - a ratio of __% means that for each dollar increase in sales, total contribution margin will increase by __ cents ($1 x CM ratio of __%) -net operating income will also increase by __ cents, assuming that fixed costs are not affected by the increase in sales.

budget

A ___________ is set for total costs.

standard

A _____________ is a per unit cost. ___________ are often used when preparing budgets.

direct labor rate variance

AH(AR-SR)

materials price variance

AQ(AP-SP) Actual Quantity= Actual quantity purchased

relate CM ratio to the variable expense ratio

CM ratio= contribution margin/sales CM ratio= (sales - variable expenses)/sales CM ratio= 1 - variable expense ratio

price standards

Final, delivered cost of materials, net of discounts.

operating leverage

Higher proportion of fixed costs in cost structures= higher ___________________.

Fixed expenses

If sales are zero, the company's loss would equal its _________________.

Unfavorable Efficiency Variance

Poorly trained workers Insufficient demand Poor quality materials Poor supervision of workers Poorly maintained equipment

advantages of standard costs

Possible reductions in production costs Management by exception Improved cost control and performance evaluation Better Information for planning and decision making

Cost Volume Profit Analysis

Powerful tool that helps managers understand the relationships among cost, volume, and profit. _____ analysis focuses on how profits are affected by the following five factors: 1) selling prices, 2) sales volume, 3) unit variable costs, 4) total fixed costs, 5) mix of products sold. -helps managers understand how profits are affected by these key factors, it is a vital tool in many business decisions -these decisions include what products and services to offer, what prices to charge, what marketing strategy to use, and what cost structure to maintain.

Equation Method

Profit= Unit CM x Q - Fixed expenses -plug in the targeted profit and solve for quantity (Q)

materials quantity variance

SP(AQ-SQ) Actual Quantity= Actual quantity used

direct labor efficiency variance

SR(AH-SH)

break-even analysis

Special case of target profit analysis in which the target profit is 0. -use either the equation or formula method

activity standards (variable overhead standards)

The activity is the base used to calculate the predetermined overhead.

contribution margin

The amount remaining from sales revenue after variable expenses have been deducted. The amount available to cover fixed expenses and then to provide profits for next period. First cover fixed expenses, then remains go towards profits. If it is not sufficient to cover fixed expenses, then a loss occurs for the period. The ______________ per unit, is how much money will be left over to cover fixed expenses after the sale of a unit.

standard price

The amount that should have been paid for the resources acquired.

price variance

The difference between the actual price and the standard price.

quantity variance

The difference between the actual quantity and the standard quantity.

standard quantity

The quantity allowed for the actual good output.

rate standards (variable overhead standards)

The rate is the variable portion of the predetermined overhead rate.

quantity standards

Use product design specifications.

time/efficiency standards

Use time and motion studies for each labor operation.

rate standards

Use wage surveys and labor contracts.

Total Quality Management

_______________ and other initiatives have sought to eliminate all defects and waste. Ideal standards, that allow for no waste, have become more popular. The emphasis is on improvement over time, not attaining the ideal standards right now.

ideal standards

________________, based on perfection, are unattainable and discourage most employees.

practical standards

___________________ should be set at levels that are currently attainable with reasonable and efficient effort.

Production managers

____________________ who make work assignments are generally responsible for rate variances.

operating leverage

a measure of how sensitive net operating income is to a given percentage change in dollar sales -acts as a multiplier -If __________________ is high, a small percentage increase in sales can produce a much larger percentage increase in net operating income.

degree of operating leverage

can be used to quickly estimate what impact various percentage changes in sales will have on profits, without the necessity of preparing detailed income statements

incremental analysis

considering only the revenue, cost, and volume that will change if the new program is implemented -simpler and more direct approach- focuses on the specific changes that would occur as a result of the decision

break-even in dollar sales

dollar sales to attain target profit= Target profit + Fixed expenses/ CM ratio dollar sales to attain target profit= $0 + Fixes expenses/ CM ratio dollar sales to attain target profit= Fixed expenses/ CM ratio

contribution income statement

emphasizes behavior of costs and therefore is extremely helpful to manager in judging the impact on profits of changing selling price, cost, or volume.

dangers of relying on CVP analysis

greatest danger lies in relying on simple CVP analysis when a manager is contemplating a large change in volume that lies outside the relevant range

standard cost variance

the amount by which an actual cost differs from the standard cost -favorable/unfavorable

margin of safety

the excess of budgeted or actual sales dollars over the break even volume of sales dollars -it is the amount by which sales can drop before losses are incurred -The higher the ____________________, the lower the risk of not breaking even and incurring a loss.

break-even point

the level of sales at which profit is zero

variable expense ratio

the ratio of variable expenses to sales =variable expenses/sales -can be computed by dividing the total variable expenses by the total sales, or in a single product analysis, it can be computed by dividing the variable expenses per unit by the unit selling price.

structuring sales commissions

to eliminate conflicts, commissions can be based on contribution margin rather than on selling price -by maximizing their own compensation, salespersons will also maximize the company's profit

Formula Method

unit sales to attain target profit = (target profit + fixed expenses)/ Unit CM

break-even in unit sales

unit sales to break even= Target Profit + Fixed Expenses/ Unit CM unit sales to break even= $0 + Fixed expenses/ Unit CM unit sales to break even= Fixed expenses/ Unit CM