Chapter 5 & 6

How can absorption costing not be good?

It gives the impression that fixed manufacturing overhead is variable with respect to the number of units produced, but it is not. The result can be inapprpriate pricing decisions and product discontinuation decisions.

How does cost-volume profit analysis help managers?

It helps them make many important decisions such as what products and services to offer, what prices to charge, what marketing strategy to use, and what cost structure to maintain.

How do you calculate the margin of safety in dollars? Calculate the margin of safety percentage?

It is calculated by the total sales-break even sales. b) calculated by the margin of safety/total sales.

Can traceable costs become common costs?

It is important to realize that the traceable fixed costs of one segment may be a common fixed cost of another segment. A landing fee paid to land an airplane at an airport is traceable to a partciluar flight, but not to first-class, business-class, and economy-class passengers.

We can calculate the break-even in dollars sales in two ways

Profit= CM ratio x sales -fixed expenses. Or we can use the formula target profit + fixed expenses/cm ratio.

Variable Costing

Treats only those costs of production that vary with output as product costs. It contains direct materials, direct labor, and variable overhead. (fixed MO, variable and fixed selling and administrative expenses are served as period costs)

How do you calculate the net income change if you have the degree of operating leverage?

You multiply the increase in sales by the operating leverage to get the increase in profit.

Traceable fixed costs

a fixed cocst that is incurred because of the existence of the segment and would disappear over time if the segment itself diasppeared.

Segment

any part or activity of an organization about which a manager seeks cost, revenue, or profit data. Ex: sales terrotiories, individual stores, service centers, etc.

Segment margin

computed by subtracting the traceable fixed costs of a segment from its CM. It is used to assess the long-run profitability of a segment.

"Upstream" costs and "Downstream" costs

Include research and devlopment and product design costs. Include marketing, distribution, and customer service costs. Not including this will result in the undercosting of products.

Variable Expense Ratio

Is the ratio of variable expenses to sales. It can be computed by dividng the total variable expenses by the total sales

Sales Mix

Is the relative proportion in which a company's products are sold. Break-even analyses become more complex because of the relative mix of the products.

What is the cost-volume profit analysis's purpose?

It estimates how profits are affected by selling prices, sales volumes, unit variable costs, total fixed costs, and mix of products sold.

Contribution Margin Ratio

It is the CM as a percentage. It is calculated by CM/sales.

The Margin of Safety

it is 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.

Formula method

(shortcut version): fixed expenses+target profit/unit cm

What are the two keys to building segmented income statements?

1) a contribution format should be used because it separates fixed from variable costs and it enables the calculatino of a CM. 2)traceable fixed costs should be separated from common fixed costs to enable the caculation of a segment margin.

Why shouldn't common costs be allocated to segments?

Allocating common costs to segments reduces the value of the segment margin as a guide to long-run segment profitability. Therefore, common costs are not allocated to segments, because they would remain if one segment was eliminated.

Structuring Sales Commissions

Commissions based on sales dollars can lead to lower profits in a company.

What are the inapprpriate methods of allocating costs among segments?

Costs that can be traced directly to specific segments of a company should not be allocated to other segments. Some comapnies allocate costs to segments using arbitrary bases. Costs should be allocated to segments for internal decision making purposes only when the allocaiton base actually drives the cost being allocated.

Dollar sales to break even for multi-product can be calculated by

Fixed Expenses/CM ratio

Multi-Product Break-Even Analysis

For fixed expenses are only subtracted from the total contribution margin, and not for each product.

How is profit calcaulated?

Profit=(sales-variable expenses)-fixed expenses To calculate sales you multiply selling price per unit times quantity sold. TO find variable expenses you multiply variable expenses per unit times quantity sold. Or it can be calculated by unit cm X the quantity sold- fixed expenses.

Equation method

Profit=unit CM times quantity - fixed expenses

Where is the break even point on the graph located?

The break-even point is where the total revenue and the total expensee lines crosses?

BreakHow can the change in profit be calculated?

The change in profit can be calculated by cm ratio x change in sales - change in fixed expenses.

Break-Even Point

The level of sales at which profit is zero. Once the break even point is reached, net operating income will increase by the amount of the unit contribution margin for each additional unit sold.

During calculations, what is assumed about cost-volume profit?

The selling price is constant, costs are linear, and can be accurately divided into variable and fixed elements, and the mix of products sold remains constant.

Absorption Costing

Treats all costs of production as product costs. It consists of direct materials, direct labor, and both variable and fixed overhead. (only selling and administrtaive are applied to period expenses) This will result in higher inventory sale value.

How do you prepare a CVP Graph?

Usually the unit volume is usually represented on x-axis and dollars is represented on the y-axis.

Which is easier to use?

Variable costing categorzing costs as fixed and variable so it is much easier to use this income statement format for CVP analysis.

Explain the difference between variable costing and absorption costing income

Variable costing income is only affected by changes in unit sales. It is not affected by the number of sales produced. When sales go up, net operating income goes up. Absorption costing income is influenced by changes in unit sales and units of production. Net income can be increasesd by producing more units even if those units are not sold.

What occurs to the relation between production and sales?

When units produced equal units sold, the two methods report the same net operating income. When units produced are greater than units sold, absorption income is greater than variable costing. This is due because some of the fixed MP is deferred in inventories. When units produced is less than units sold, absoprtion costing income is less than variable costing. The fixed manufacturing overhead is released from inventories.

Common Fixed Costs

is a fixed cost that supports the operations of more than one segment, but is not traceable in whole.

Contribution margin

is the amount remaining from sales revenue after viarable expenses have been deducted. It is the amount available to cover fixed expenses and then the remaining goes to the net operating income.

Operating leverage

the measure of how sensitive net operating income is to a given percentage change in dollars sales. (how a percentage change in sales volume will affect profits)

How is the degree of operating leverage calculated?

the percentage of change in operating income/percentage of change in sales. Or it can be caulated by the contribution margin/net operating income (it will be single digits)