Accounting: Exam 2
Two Criteria for a Relevant Cost
1. Occurs in the future 2. Differs between decision alternatives
Special-Order Irrelevant Information
1. Old selling price 2. Fixed costs - from the company's normal course of business
Plymouth Corp. sells units for $100 each. Variable costs are $75 per unit, and fixed costs are $200,000. If Plymouth leases a new machine, fixed costs will increase by $60,000 a year, but production will be more efficient, saving $5 per unit. At what level of production will Plymouth be indifferent between leasing and not leasing the new machine?
12,000 Units Explanation: ($100-75)Q - $200,000 = ($100-70)Q - $260,000 $25Q - $200,000 = $30Q - $260,000 $60,000 = $5Q Q = 12,000 units
Indifference point formula
BEFORE = AFTER [(Selling Price X Q) - (Var. cost/unit X Q) - FC] = [(Selling Price X Q) - (Var. cost/unit X Q) - FC]
Contribution Margin Ratio formula
Contribution Margin (CM/ Sales
With respect to variable costs per unit, which of the following statements is true? A) They will decrease as production increases within the relevant range. B) They will increase as production decreases within the relevant range. C) They will decrease as production decreases within the relevant range. D) They will remain the same as production levels change within the relevant range.
D
Keep-or-Drop Decisions
Deciding whether to eliminate a particular division or segment of the business
Absorption Costing formula
Sales (revenues) - CGS (product costs (DM+DL+VOH+FOH)) = Gross Margin/Gross Profit - Operating Expenses (period costs) = Operating Income
Variable costing formula
Sales (revenues) - Variable costs (product and period) = Contribution Margin (CM) - Fixed costs (product and period) = Operating income
Operating income equation
Sales (selling price per unit * number of units) - Total Variable Costs (Var. cost per unit * # of units) - Total Fixed Costs = Operating Income
Target Profit in units
Target Units = (FC + Target profit) / CMu
Target Profit
The amount of net income that a business sets as a goal
Total cost formula
Total Cost = Total Fixed Cost + (Variable Cost per unit*Activity) (y=a+b(x))
Idle capacity
Additional work may be added without sacrificing existing work
Full capacity and Opportunity costs
At full capacity, adding additional work requires giving up a portion of the existing work. Hence, the benefit of the work given up was the opportunity cost.
What is the simplest form of CVP analysis?
Break-even analysis
Make or Buy Decision Process
Calculate all cost of making: 1. +all variable costs 2. +all fixed costs = avoidable + unavoidable Calculate net relevant revenue and costs of buying 1. +purchase cost 2. +any unavoidable/common fixed costs 3. -opportunities for the free capacity or new money coming in
Operating Leverage formula
Operating Leverage (OL) = Contribution Margin (CM) / Net Operating Income OL = CM / Op. Income (Formula given on exam)
Make or Buy Decisions
Produce a component or purchase it from an outside supplier?
Step-variable Costs
Rise in multiple steps across the relevant range.
Steps for determining keep-or-drop decisions
Step 1: Calculate Contribution Margin (CM) Step 2: Put fixed costs into categories - avoidable and unavoidable Step 3: Calculate Segment margin: CM - Avoidable fixed costs = Segment margin (Discontinue if it has a negative segment margin)
You decide you can make money selling water by the stadium on game days. You think you can sell each bottle for $2. You can buy the water bottles in bulk and each one costs you $.25. You will have fixed costs of $175. You think you can sell 200 units. Find Husker Water's breakeven point in SALES $.
$200 Explanation: BE$ = FC / CM% BE$ = $175 / [($2-$0.25)/$2] = $200
Assumptions of CVP
-All costs classified as either variable or fixed -Total sales and total costs can be graphed in a linear manner -Ignores items like discounts or bulk purchasing -Ignores finished goods inventory, CVP assumes everything we produce will be sold
High-low method Step 2 & 3
-Find fixed costs -Create the cost equation Total Cost = Total fixed costs + (Variable cost/unit* activity)
High-low method Step 1
-Find variable cost per unit of cost line Variable cost per unit = Difference in Total Cost (y1-y2)/Difference in Activity (x1-x2)
Variable Costing characteristics
-For INTERNAL management decisions ONLY -Separates variable and fixed costs -Uses the Contribution Margin income statement
Full Absorption Costing characteristics
-Required by GAAP for EXTERNAL reporting -Separates product and period costs -Uses the Traditional Income statement
Fixed Costs
-Total fixed costs remain constant as activity increases -Fixed cost per unit decrease as activity increases
Variable Costs
-Total variable costs increase as activity increases -Costs per unit are constant as activity increases
What happens to variable and fixed costs within the relevant range?
-Variable costs increase with increased activity -Fixed costs remain unchanged
Special-Order Relevant Information
1. +Special order selling price and quantity 2. -All variable costs 3. -New fixed costs and/or New var. costs
Two Criteria for a Irrelevant Cost
1. Costs that have been incurred in the past (sunk costs) 2. Costs that are the same regardless of the alternative
5 Steps in the Decision-Making Process
1. Identify the decision problem 2. Determine the decision alternatives 3. Identify the costs and benefits of the alternatives 4. Make the decision 5. Review the results of the decision
Rules of Sell-or-Process-Further Decisions
1. Only process further if revenues exceed costs 2. The manufacturing costs up to the sell-or-process decision point are sunk or irrelevant
You decide you can make money selling water by the stadium on game days. You think you can sell each bottle for $2. You can buy the water bottles in bulk and each one costs you $.25. You will have fixed costs of $175. You think you can sell 200 units. Find Husker Water's breakeven point in UNITS.
100 Bottles Explanation: BEu = FC / CMu BEu = $175 / ($2 - $0.25) = 100 bottles
A company has the following: -Selling price is $20 per unit -Variable costs are $7.20 per unit -Fixed costs $790 What is the operating income if 500 units are produced and sold?
5,610
Absorption costing would produce a lower operating income than variable costing: a.only when sales volume is greater than production volume b.only when sales volume is less than production volume c.only when sales volume is equal to production volume d.always
A
What is a scattergraph?
A graph with total cost plotted on the y-axis and some measure of activity on the x-axis.
What is a constrained resource?
A limited resource that restricts a company's ability to satisfy demand
Special-Order Decisions
A one-time order that is outside the scope of normal sales, often ordered at reduced sales for a large quantity.
All of the following are considerations for discontinuing a product or product line, except: A) whether the product has a positive or negative segment margin. B) not having any free capacity. C) determining if direct fixed costs could be avoided if the product or product line is discontinued.
B.
What is a constrained resource referred to as?
Bottleneck
Break-even in units analysis
Break-even Units (BEu) = Total Fixed Costs (FC)/Unit Contribution Margin (CMu) BEu = FC / CMu CMu = Selling price/unit - Var. Cost/unit
Break-even in dollars analysis
Break-even in dollars (BE$) = Total Fixed Costs (FC) / Contribution Margin % (CM%) BE$ = FC / CM%
The relevant range of a company is: A)at unusual peak times where more products are made and sold than usual B)when all costs are variable C)the range of the company's normal course of business (where cost behaviors are predictable) D)when all costs are fixed
C
When the extra revenue from processing further is less than the extra cost of processing further, the best decision would be to: A) process further. B) develop a new product. C) not process further. D) start over.
C
Mixed Costs
Contain a fixed portion that is incurred even when the facility is unused, and a variable portion that increases with usage. Ex: Utility costs
Contribution margin formula
Contribution Margin (CM) = Sales - Variable Costs
What is break-even analysis?
Determines the level of sales needed to break even or earn zero profit.
Which product to emphasize in regards to a contraint?
Emphasize the product with the highest CM per unit of the constraint
Cost-Volume-Profit Analysis (CVP)
Expresses the relationship among costs, volume, and the company's profit
Step-fixed Costs
Fixed over a wider range of activites.
Step Costs
Fixed over some range of activity, then increases.
Sell-or-Process-Further Formula
Fully processed revenue - Further-processing cost = Net of further-processing (Compare the "as is" revenue to Net of further-processing)
Relevant Costs
Have the potential to influence a decision
Margin of Safety formula
Margin of Safety = Actual Sales - Break-even Sales MOS = Sales - BE$ (Formula given on exam)
Margin of Safety Percentage formula
Margin of Safety as a Percentage = Margin of Safety / Sales MOS% = MOS / Sales (Formula given on exam)
What is operating leverage?
Measures the extent to which fixed costs are used to operate the business. (High fixed costs indicate a company is highly leveraged)
Calculating Operating Income after Discontinuing product
Step 1: Calculate Segment Margin (SM = CM - Avoidable FC) Step 2: + Op. Income of operations that will continue - Common fixed costs of discontinued product + New income from other opportunities from freed capacity = New Operating Income
How to find contribution margin per unit of the constraint?
Step 1: Find CM for each product Step 2: Multiply or divide to find CM/Constraint Step 3: Apply sales demand to product with the HIGHEST CM per the constraint
3 Steps of High-low method
Step 1: Find variable cost per unit of cost line Step 2: Find the fixed costs Step 3: Create the cost equation
Target Profit in dollars
Target Profit = (FC + Target Profit) / CM%
Sell-or-Process-Further Decision
The decision to sell a product as is or add additional features to sell it for a higher price
What is contribution margin?
The difference between sales revenue and variable costs
What is Margin of Safety?
The excess of budgeted (or actual) sales over the break-even volume of sales
Opportunity cost
The foregone benefit from choosing the other alternative
What is indifference point?
The level of volume at which total costs, and profits, are the same between two different alternatives.
What is relevant range?
The range of activity within which our assumptions about cost behavior hold true.
Irrelevant Costs
Those that will not influence a decision
