Acct ch 5

computing dollar sales to break-even

($0 + Fixed Expenses)/CM Ratio

computing unit sales to break-even

($0 + Fixed Expenses)/Unit CM

computing dollar sales to attain a target profit

(Target Profit + Fixed Expenses)/CM Ratio or Profit = CM Ratio x Sales - Fixed Espenses

preparing a CVP graph

1. Draw a line parallel to the volume axis to represent total fixed expense 2. Choose some volume of unit sales and plot the point representing total expense (fixed and variable) at the sales volume you have selected; draw a line through it back to the point where the fixed expense line intersects the dollars axis 3. Choose some sales volume and plot the point representing total sales dollars at the activity level you have selected

equation when a company has only a single product:

1. Sales = Selling price per unit × Quantity sold = P × Q 2. Variable expenses = Variable expenses per unit × Quantity sold = V × Q 3. Profit = (P × Q × V × Q) × Fixed expenses

assumptions commonly underlie CVP analysis:

1. Selling price is constant. The price of a product or 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, and the fixed element is constant in total over the entire relevant range. 3. In multiproduct companies, the sales mix is constant. 4. In manufacturing companies, inventories do not change. The number of units produced equals the number of units sold.

simple profit equation in terms of the unit contribution margin (Unit CM)

1. Unit CM = Selling price per unit - Variable expenses per unit = P - V 2. Profit = (P × Q - V × Q) - Fixed expenses 3. Profit = (P - V) × Q - Fixed expenses 4. Profit = Unit CM × Q - Fixed expenses

the effect of a change in sales on the contribution margin expressed in equation form:

Change in contribution margin = CM ratio × Change in sales

calculating degree of operating leverage

Contribution Margin/Net Operating Income

calculating percentage change in net operating income

Degree of operating leverage x Percentage change in sales

calculating margin of safety by percentage

Margin of Safety in Dollars/Total Budgeted (or actual) Sales in Dollars

contribution format income statement expressed in equation form:

Profit = (Sales - Variable expenses) - Fixed expenses

the relation between profit and the CM ratio expressed in equation form:

Profit = CM ratio × Sales - Fixed expenses

calculating margin of safety in dollars

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

operating leverage

a measure of how sensitive net operating income is to a given percentage change in dollar sales

degree of operating leverage

a measure, at a given level of sales, of how a percentage change in sales volume will affect profits

plotting lines on a profit graph

compute the profit at two different sales volumes, plot the points, and then connect them with a straight line

contribution margin ratio (CM ratio)

contribution margin as a percentage of sales

contribution income statement

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

target profit analysis

estimates what sales volume is needed to achieve a specific target profit

cost-volume-profit (CVP) 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.

incremental analysis

focuses only on those costs and revenues that change as a result of a decision

cost-volume-profit (CVP) graph (or break-even chart)

highlights CVP relationships among revenue, cost, profit, and volume over wide ranges of activity; unit volume is represented on the horizontal (X) axis and dollars on the vertical (Y) axis

to estimate the profit at any sales volume above the break-even point:

multiply the number of units sold in excess of the break-even point by the unit contribution margin (anticipated profit)

profit graph

simpler form of the CVP graph, based on the following equation: Profit = Unit CM × Q - Fixed expenses

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 the period; used first to cover the fixed expenses, and then whatever remains goes toward profits

margin of safety

the excess of budgeted/actual sales dollars over the break-even volume of sales dollars or the amount by which sales can drop before losses are incurred; the higher the margin of safety, 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

cost structure

the relative proportion of fixed and variable costs in an organization

sales mix

the relative proportions in which a company's products are sold

calculating contribution margin ratio (CM ratio)

total contribution margin/total sales

calculating variable expense ratio

total variable expenses/total sales

CM ratio for only one product (computing on a per unit basis)

unit contribution margin/unit selling price