accounting exam chapter 21

fixed or variable costs

CVP analysis requires management to classify costs as either fixed or variable with respect to production or sales volume, within the relevant range of operations.

fixed cost

Fixed costs do not change when the volume of activity changes (within a relevant range). the total amount of fixed cost does not change as volume changes, fixed cost per unit of output decreases as volume increases

after tax income

Management then assesses whether this income is an adequate return on assets invested. Management will also consider whether sales and income can be increased by raising or lowering prices. CVP analysis is good for addressing these kinds of "what-if" questions.

the normal operating range for a business

The concept of relevant range is important to classifying costs for CVP analysis. The relevant range of operations

margin of safety

The excess of expected sales over the break-even sales level is called margin of safety , the amount that sales can drop before the company incurs a loss.

Operating Leverage

The extent, or relative size, of fixed costs in the total cost structure Companies having a higher proportion of fixed costs in their total cost structure are said to have higher operating leverage. An example of this is a company that chooses to automate its processes instead of using direct labor, increasing its fixed costs and lowering its variable costs.

variable cost

Variable costs change in proportion to changes in volume of activity

cvp relies on several assumptions

costs are variable or fixed ,all units produced are sold , costs are linear within relevant range

contribution margin per unit

is the amount by which a product's unit selling price exceeds its variable cost per unit. Exhibit 21.9 shows the formula for contribution margin per unit.

contribution margin ratio

is the percent of a unit's selling price that exceeds total unit variable cost. It is interpreted as the percent of each sales dollar that remains after deducting the unit variable cost

break-even point

is the sales level at which total sales equal total costs and a company neither earns a profit nor incurs a loss. A key concern when launching a project is whether it will break even—that is, whether sales will at least cover total costs.

cvp uses four inputs

number of units sold, sales price per unit , variable costs per unit , fixed costs

CVP analysis

used to predict how changes in cost and sales levels affect profit

contribution margin

which equals total sales minus total variable costs. Contribution margin contributes to covering fixed costs and generating profits