Chapter 6: How is Cost-Volume-Profit Analysis Used for Decision Making?

Costing Methods

-Absorption/Full Costing -Variable/Direct/Marginal Costing

Absorption/Full Costing

-All variable and fixed manufacturing costs are included as inventoriable costs -Fixed costs are part of the cost of the product

Variable/Direct/Marginal Costing

-All variable manufacturing costs (direct or indirect) are included as inventoriable costs -Fixed costs are considered expenses of the period

Margin of Safety

-Difference between the current sales revenue and the sales revenue at the breakeven point -Margin of Safety ($) = Sales ($) - Sales at BEP ($) -Margin of Safety (U) = Sales (U) - Sales at BEP (U) Sales ($) - Sales at Breakeven Point ($) -Margin of Safety (%) = ------------------------------------ Sales ($)

Finished = Sold

-If all units finished are sold, all fixed costs go to the income statement in the cost of good sold of the period -Income from operations will be the same in absorption and variable costing -Inventories have no effect

Finished > Sold

-Some units finished are not sold and remain in the inventory (ending inventory) -In absorption costing that part of the fixed cost remains in the ending inventory -Inventories increase -In variable costing, all fixed cost will go to the income statement as the expense of the period -Therefore, Income from operations: Absorption > Variable

Finished < Sold

-The units sold were all units produced in this period plus units in the beginning inventory -In absorption costing, the CGS will include the fixed cost of the period plus the fixed cost of the units in the beginning inventory -Inventories decrease -In variable costing only fixed cost of the period will go to the income statement -Therefore, Income from operations: Absorption < Variable

Operating Leverage

-To measure the impact of changes in sales on income from operations -% change in OI = DOL x % change in sales

Sales Method

1.Accumulate sales, variable costs, and contribution margins of all the products 2.Use this information to calculate contribution margin ratio 3.Calculate BEP ($) 4.Calculate the percentage of sales for each product relative to the total sales 5.Allocate the BEP ($) using the respective percentages to calculate BEP ($) for each product

Ratio (Percentage) Contribution Margin

Contribution Margin Ratio = Contribution Margin/Sales or Revenue

Degree of Operating Leverage (DOL)

Contribution Margin/Income from Operations (OI)

Sales Mix

Is the relative combination in which company's products are sold

Absorption Costing Sales

Sales - Cost of goods sold/Gross profit - Operating expenses/Income from operations

Total Contribution Margin

Sales - Variable Cost

Variable Costing Income Statement

Sales - Variable cost of goods sold/Manufacturing margin - Variable operating expenses/Contribution margin - Fixed manufacturing costs - Fixed operating costs/ Income from operations

Unitary Contribution Margin

Selling Price - Unit Variable Cost

Multiproduct CVP Analysis

•Different products have different selling prices, cost structures, and contribution margins •For a company with more than one product, sales mix should be constant

Cost-Volume-Profit (CVP) Analysis

•Discusses the behavior and relationship among: Cost, Volume, and Profit •Identifies break-even points, profits, and losses •Focuses on how profits are affected by: Selling prices, Sales volume, Unit variable costs, Total fixed costs, and Mix of products sold

Contribution Margin

•How much of a company's revenues are available to cover fixed costs?

CVP Assumptions

•Revenue and costs are linear •Revenue and costs can be accurately divided into variable and fixed elements •Selling price, variable cost per unit, and total fixed costs remain constant within the relevant range. •Number of units produced = number of units sold •Selling prices and costs are assumed to be known with certainty Sales mix is constant (for multi-product company