Managerial Accounting - Chapter 20

cost structure

the proportion of fixed costs to variable costs of a company

# of units sold

total contribution margin / per unit contribution margin ($)

•Step 2: Calculate the total fixed costs

total fixed cost = total mixed cost - total variable cost = total mixed coat - (variable cost per unit • # of units) = $1,960 - ($2 per tablet • 480 tablets) = $1,960 - $960 = $1,000

•Step 3: Create and use an equation to show the behavior of a mixed cost

total mixed cost = total manufacturing maintenance cost = (variable cost per unit • # of units) + total fixed cost = ($2 per tablet • # of tablets) + $1,000 Example: ($2 per tablet • 400 tablets) + $1,000 = $1,800

•Step 1: Identify the highest and lowest levels of activity and calculate the variable cost per unit

variable cost per unit = change in total cost / change in volume of activity = (highest cost - lowest cost) / (highest volume - lowest volume) = ($1,960 - $1,480) / (480 tablets - 240 tablets) = $480 / 240 tablets = $2 per tablet

Step 3: calculate the breakeven point in units for each product in the sales mix "package" and then multiply the "package" breakeven point in units by each product's proportion of the sales mix

breakeven sales of cat beds (1,000 units • 3/5) = 600 cat beds breakeven sales of scratching posts (1,000 units • 2/5) = 400 scratching posts •add operating income of $20,000: required sales in units = (fixed cost + target profit) / weighted-average contribution margin per unit ($40,000 + $20,000) / $40 per unit = 1,500 units breakeven sales of cat beds (1,500 units • 3/5) = 900 cat beds breakeven sales of scratching posts (1,500 units • 2/5) = 600 scratching posts

Contribution Margin Income Statement (Internal: Direct (Variable Costs))

net sales revenue - variable costs (DM, DL, V MOH, and VS; cost behavior: some product & period costs) = contribution margin - fixed costs (MOH S; cost behavior: some product & period costs) = operating income

Relevant Range and Relativity

relevant range is the range of volume where total fixed costs and variable costs per unit remain constant on a graph

operating income

target profit

target profit / (1 - tax rate)

taxes

cost stickiness

the asymmetrical change in costs when there is a decrease in the volume of activity (costs increase more when sales volume is increasing than costs decrease when sales volume is decreasing)

fixed costs

• (doesn't change in total) over wide ranges of volume of activity (remains the same) so its graph: cost per unit (y) decreases/increases as volume (x) increases/decreases •COSTS THAT DO NOT CHANGE IN TOTAL OVER WIDE RANGES OF VOLUME -total fixed costs (y) (constant) / # of units produced (x) = fixed costs per unit (constant) (changes inversely because of volume) •manager's salary •depreciation cost per unit •supervisor's salary

variable costs

• (remain constant per unit) (doesn't change) but change in total as volume changes so its graph: volume (x) increases/decreases as total cost (y) increases/decreases •COSTS THAT DO CHANGE IN TOTAL IN DIRECT PROPORTION TO CHANGES IN VOLUME -total variable costs (y) (changes proportionally because of volume) = # of units produced (x) • variable costs per unit (constant) •materials cost per unit •total COGS •wages of production workers •wood used to build tables

Contribution Margin Ratio

• Contribution Margin / Net Sales Revenue •Example: $45,000 / $100,000 = 45% OR • Unit Contribution Margin / Net Sales Revenue Per Unit •Example: $225 per tablet / $500 per tablet = 45%

What Is Contribution Margin, and How Is It Used to Compute Operating Income?

• Net Sales Revenue - Variable Costs; this amount contributes to covering fixed costs •Example: ($500 per tablet • 200 tablets) - ($275 per tablet • 200 tablets) = $100,000 - $55,000 = $45,000

Changes in Fixed Costs

• required sales in units = (fixed cost + target profit) / contribution margin per unit •If the fixed costs increases from $13,500 to $16,500, the units needed to break even increases from 60 to 74. •Example: ($16,500 + $0) / ($500 per unit - $275 per unit) = 74 units*

Changes in the Sales Price

• required sales in units = (fixed cost + target profit) / contribution margin per unit •If the sales price changes from $500 to $475, the units needed to break even increases from 60 to 68. •Example: ($13,500 + $0) / ($475 per unit - $275 per unit) = 68 units*

Changes in Variable Costs

• required sales in units = (fixed cost + target profit) / contribution margin per unit •If the variable costs increases from $275 to $285, the units needed to break even increases from 60 to 63. •Example: ($13,500 + $0) / ($500 per unit - $285 per unit) = 63 units*

Step 2: calculate the breakeven point in units for the "package" of products

• required sales in units = (fixed cost + target profit) / weighted-average contribution margin per unit •Example: ($40,000 + $0) / $40 per unit = 1,000 units

Step 1: calculate the weighted-average contribution margin per unit

• weighted-average contribution margin per unit = total contribution margin / total sales mix in units •Example: $200 per unit/5 units = $40

Effects of Changes in Sales Price, Variable Costs, and Fixed Costs

•As sales price per unit increases, the contribution margin per unit increases and the breakeven point decreases •As sales price per unit decreases, the contribution margin per unit decreases and the breakeven point increases •As variable cost per unit increases, the contribution margin per unit decreases and the breakeven point increases •As variable cost per unit decreases, the contribution margin per unit increases and the breakeven point decreases •As total fixed cost increases, there's no effect on the contribution margin per unit and the breakeven point increases •As total fixed cost decreases, there's no effect on the contribution margin per unit and the breakeven point decreases

What Are Some Other Ways CVP Analysis Can Be Used?

•CVP analysis can be used for estimating target profits and breakeven points, as well as sensitivity analysis. • 3 additional applications of CVP are: -Margin of safety -Operating leverage -Sales mix

Breakeven Point — 3 Approaches

•CVP analysis can be used to estimate the amount of sales needed to achieve the breakeven point. •The breakeven point is the sales level at which the company does not earn a profit or a loss but has an operating income of 0. • 3 methods of estimated sales required to break even: -Equation approach -Contribution margin approach -Contribution margin ratio approach

How Is Cost-Volume-Profit (CVP) Analysis Used?

•Managers use information about cost behavior to make business decisions. •CVP analysis is a planning tool that looks at the relationships among costs and volume and how they affect profits (or losses).

How Do Costs Behave When There Is a Change in Volume?

•Some costs change as the volume of sales increases or decreases. Other costs are not affected by changes in volume of sales. •Different types of costs are: -Variable costs -Fixed costs -Mixed costs

Unit Contribution Margin

•The contribution margin can be expressed as a unit amount. •The terms unit contribution margin and contribution margin per unit are used interchangeably. • net sales revenue per unit - variable costs per unit •Example: ($500 per tablet - $275 per tablet) = $225 per tablet

Assumptions made with CVP Analysis

•The price per unit does not change as volume changes. •Managers can classify each cost as variable, fixed, or mixed. •The only factor that affects total costs is change in volume, which increases or decreases variable and mixed costs. •Fixed costs do not change. •There are no changes in inventory levels.

contribution margin approach

•a shortcut method of computing the required sales in units • required sales in units = (fixed cost) / contribution margin per unit (cost) •Example: ($13,500) / $225 per unit = 60 units for required sales

equation approach

•can be used to estimate the number of units a company needs to sell to achieve target profit or total sales revenue • Net Sales Revenue - TOTAL COSTS (Variable Costs - Fixed Costs) = Operating Income (or Target Profit) OR Net Sales Revenue - Total Costs = Operating Income (or Target Profit) •Example: ($500 per unit • units sold) - ($275 per unit • units sold) - $13,500 = $0 [($500 per unit - $275 per unit) • units sold)] - $13,500 = $0 $225 per unit • units sold = $0 + $13,500 $225 per unit • units sold = $13,500 $13,500 / $225 per unit = 60 units sold ($500 per unit • 60 units sold) - ($275 per unit • 60 units sold) - $13,500 = $0 in operating income (or target profit)

contribution margin ratio approach

•computes required sales in terms of sales dollars rather than in units • contribution margin / net sales revenue •Example: ($225 per tablet / $500 per tablet) = 45% • required sales in dollars = (fixed costs) / contribution margin ratio •Example: ($13,500) / 45% = $30,000

mixed costs

•have both fixed and variable components so its graph: volume (x) increases/decreases as mixed costs (fixed remains constant & variable increases/decreases) (y) increases/decreases -total mixed cost (y) = total fixed cost + total variable cost •total phone cost •total utility cost •compensation for sales representatives paid on a salary (fixed) plus commission basis (variable)

How is CVP Analysis Used for Sensitivity Analysis?

•managers can use CVP relationships to conduct sensitivity analysis, which is a "what if" technique that estimates profit or loss results if sales price, cost, volume, or underlying assumptions change

High-Low Method

•method to separate mixed costs into variable and fixed components •Step 1: Identify the highest and lowest levels of activity and calculate the variable cost per unit •Step 2: Calculate the total fixed costs •Step 3: Create and use an equation to show the behavior of a mixed cost

sales mix (or product mix)

•most companies sell more than one product •sales price and variable costs differ for each product •the combination of products that make up total sales •Step 1: calculate the weighted-average contribution margin per unit •Step 2: calculate the breakeven point in units for the "package" of products •Step 3: calculate the breakeven point in units for each product in the sales mix "package" and then multiply the "package" breakeven point in units by each product's proportion of the sales mix

margin of safety

•the excess of expected sales over breakeven sales., used to evaluate the risk of current operations and their plans for the future (drop in sales a company can absorb without incurring an operating loss) • expected values - breakeven sales = margin of safety in units •Example: 100 tablets - 60 tablets = 40 tablets • margin of safety in units • sales price per units = margin of safety in dollars •Example: 40 tablets • $500 per tablet = $20,000 • margin of safety ratio = margin of safety in units / expected sales in units •Example: 40% = 40 tablets / 100