Accounting 12 Midterm 2

The margin of safety

The margin of safety in dollars is the excess of budgeted (or actual) sales over the break-even volume of sales.

CVP graph

unit volume is represented on the horizontal (X) axis and dollars on the vertical (Y) axis.

A CVP graph can be prepared in three steps.

1. Draw a line parallel to the volume axis to represent total fixed expenses. 2. Choose some sales volume (e.g., 400 units) and plot the point representing total expenses (e.g., fixed and variable) at that sales volume. Draw a line through the data point back to where the fixed expenses line intersects the dollar axis. 3. Choose some sales volume (e.g., 400 units) and plot the point representing total sales dollars at the chosen activity level. Draw a line through the data point back to the origin.

Assumptions of CVP analysis

1. Selling price is constant 2. Costs are linear and can be accurately divided into variable and fixed components. 3.In multiproduct companies, the mix of products sold remains constant.

Interpreting the CVP graph.

1. The break-even point is where the total revenue and total expense lines intersect. 2. The profit or loss at any given sales level is measured by the vertical distance between the total revenue and the total expense lines.

CM ratio as it relates to variable expense ratio

CM ratio = 1 - Variable expense ratio.

Formula Method vs Equation method

Formula looks at how many units you need to sell and Equation looks at how much sales you need to generate

variable expense ratio

ariable expenses as a percentage of sales

CM ratio

calculated by dividing the contribution margin per unit by the selling price per unit. (per Unit) calculated by dividing the total contribution margin by total sales. (Total)

contribution margin

the amount remaining from sales revenue after variable expenses have been deducted.