Ch 20-21 Reviews

On the CVP graph, where is the breakeven point shown? Why?

On the CVP graph the breakeven pint is illustrated by the intersection of the sales revenue line and the total cost line, because that is the point where revenues equal expenses and profit is $0.

What is operating leverage? What does it mean if a company has a degree of operating leverage of 3?

Operating leverage predicts the effects that fixed costs have on changes in operating income when sales volume changes. If a company has a degree of operating leverage of 3, then a percentage change in sales will have 3 times the percentage change in profits. For example, if sales increase by 10%, then profits will increase by 30% (3x10%).

Explain how sales mix can affect the profitability of a company.

Sales mix effects the profitability of a company because the different products in the sales mix have different contribution margins. Varying sales mixes produce differing profits for the company.

What is a company's cost structure? How can cost structure affect a company's profits?

The cost structure of a company is the proportion of fixed costs to variable costs. The relationship between fixed costs and variable costs can have a substantial impact on profits. Companies with higher fixed costs are at greater risk when sales decrease because of the reduced contribution margin, but they have greater opportunity for rewards when sales increase.

What is the relevant range?

The relevant range is the range of the volume of activity where total fixed costs remain constant and the variable cost per unit remains constant.

Explain how increasing production can increase gross profit when using absorption costing.

Increasing production spreads the total fixed costs over more units in absorption costing, which decreases total cost per unit. If the products are not sold and remain in ending Finished Goods Inventory, then the decrease in cost per unit will decrease Cost of Goods Sold and increase Gross Profit.

How can CVP analysis be used by companies with multiple products?

It can be used by companies with multiple products by using the same CVP formulas, but with a weighted-average contribution margin. The weighted-average contribution margin is determined by an evaluation of the sales mix.

A chain of convenience stores has one manager per store who is paid a monthly salary. Relative to Store #36 located in Atlanta, Georgia, is the manager's salary fixed or variable? Why?

The manager's salary is a fixed costs relative to store #36. The salary remains fixed regardless of the volume of activity at store #36. This meets the definition of a fixed cost.

What is the margin of safety? What are the three ways it can be expressed?

The margin of safety is the excess of expected sales over breakeven sales. The margin of safety can be expressed in units, in dollars, or as a ratio.

What is cost-volume-profit analysis?

CVP analysis is a planning tool that examines the relationship among costs and how they affect profits or losses. CVP analysis is also referred to as cost-volume-price analysis because changes in sales prices also affect profits or losses.

What is a business segment? Give some examples.

A business segment is an identifiable part of the company for which financial information is available. Businesses can be segmented by geography, customer types, products, or salespersons.

How does a contribution margin income statement differ from a traditional income statement?

A contribution margin income statement classifies cost by behavior; that is, cost are classified as either variable costs or fixed costs. A traditional income statement classifies costs by function; costs are classified as either product costs or period costs.

What are the three approaches to calculating the sales required to achieve the target profit?

A.) The equation approach. The equation is: Net sales revenue (sales price per unit x units sold)-VC (VC per unit x units sold)-FC=Target Profit B.) The contribution margin approach. The equation is: Fixed Costs + Target Profit / Contr. Margin per unit =Required Sales Units C.) The Contribution margin ratio approach. The equation is: Fixed costs + Target Profit /Contr. Margin Ratio =Required Sales in Dollars

How are absorption costing and variable costing the same? How are they different?

Absorption costing and variable costing are similar in that they both include direct materials, direct labor, and variable manufacturing overhead as product costs. They differ in that absorption costing includes fixed manufacturing overhead as a product cost and variable costing does not. An additional difference is that absorption costing is required by GAAP for external reporting, whereas variable costing is used for internal reporting purposes.

When should a company use absorption costing when setting sales prices? When should it use variable costing?

Absorption costing considers the full cost of the product over its entire life cycle; therefore, absorption costing should be used when determining sales prices for long-term planning. Variable costing should be used for short-term pricing decisions or other situations in which fixed costs are irrelevant. An example of this is when the company has excess capacity and an opportunity to accept a customer order at a discounted sales price.

What is absorption costing?

Absorption costing is a costing method that considers direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead as product costs. Absorption costing is required by GAAP for external reporting.

What effect does an increase in sales price have on contribution margin? An increase in fixed costs? An increase in variable costs?

An increase in selling price of a product will increase the contribution margin. An increase in fixed costs has no effect on the contribution margin. An increase in variable costs will reduce the contribution margin.

What is a fixed cost? Give an example.

Fixed costs are costs that do not change in total over wide ranges of volume. Fixed costs remain constant regardless of changes in the volume of activity. An example of a fixed cost is rent. The amount of rent does not change in direct proportion to increases or decreases in production, but remains fixed over a specified period.

What is sensitivity analysis? How do managers use this tool?

It is a "what if" technique that estimates profit or loss results if selling price, costs, volume, or underlying assumptions change. Managers use sensitivity analysis to examine how various business strategies will affect the profitability of the company. It provides managers with better information for decision making.

In the long run, all costs are controllable. Is this statement true? Why or why not?

It is true that all costs are controllable in the long run. The cost is controlled at the appropriate level of management from the production supervisor all the way up to upper management. Each level of management has costs it is responsible for controlling.

What is a mixed cost? Give an example.

Mixed costs are costs that contain both a fixed and variable component. An example of a mixed cost is cell phone service. Many cell phone plans offer a basic plan that includes a specified number of minutes with a per-minute charge for any use that exceeds the included plan minutes. The cost of the basic plan is the fixed cost component and the per-minute charge is the variable cost component.

How do service companies differ from manufacturing companies?

Service companies differ from manufacturing companies in that they provide services, rather than products, to their customers. Therefore, service companies do not have inventory or cost of goods sold.

How can variable costing be used in service companies?

Service companies have both fixed and variable costs, therefore variable costing can be used.

What is target profit?

Target profit is the operating income that results when sales revenue minus variable and fixed costs equals management's profit goal.

What are the CVP assumptions?

The CVP assumptions are: A.) The price per unit does not change as volume changes. B.) Managers can classify costs as variable, fixed, or mixed. C.) The only factor that affects total costs is change in volume, which increases or decreases variable and mixed costs. D.) Fixed costs do not change. E.) There are no changes in inventory levels.

What is 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 zero-the point at which total revenues equal total costs.

Why is the calculation to determine the breakeven point considered a variation of the target profit calculation?

The calculation to determine breakeven point is considered a variation of the target profit calculation because the equations and methodology are the same as calculating target profit equal to zero.

What is contribution margin?

The contribution margin is the difference between net sales revenue and variable costs. It is called the contribution margin because it is the amount that contributes to covering fixed costs and then provides operating income.

Of the three approaches to calculate sales required to achive target profit, which one(s) calculate the required sales in units and which one(s) calculate the required sales in dollars?

The equation approach and the contribution margin approach calculate the required sales in units, whereas the contribution margin ratio approach calculates the required sales in dollars.

What is the purpose of using the high-low method?

The purpose of the high-low method is to separate mixed costs into their variable and fixed components by identifying the highest and lowest levels of activity over a period of time.

Explain why the fixed manufacturing overhead cost per unit changes when there is a change in the number of units produced.

The reason fixed manufacturing overhead cost per unit changes when there is a change in the number of units produced is that the total fixed manufacturing cost is divided by the number of units produced to determine cost per unit. When production falls, the cost per unit increases because there are fewer units to absorb the fixed manufacturing costs. When production rises the opposite occurs.

A chain of convenience stores has one manager per store who is paid a monthly salary. Relative to the number of stores, is the manager's salary fixed or variable? Why?

The salary of the manager is a variable cost relative to the number of stores. The salary increases or decreases in direct proportion to the number of stores in the chain. This meets the definition of a variable cost.

Describe the three steps of the high-low method.

The three steps of the high-low method are: A. Identify the highest and lowest levels of activity and calculate the variable cost per unit. B. Calculate the total fixed cost. C. Create and use an equation to show the behavior of a mixed cost.

What are the three ways contribution margin can be expressed?

The three ways contribution margin can be expressed are: A.) Contribution margin as a total amount; net sales revenue minus variable costs B.) Unit contribution margin; net sales revenue per unit minus variable costs per unit. C.) Contribution margin ratio; the ratio of contribution margin to net sales revenue.

What are the two components that can affect contribution margin? Why is it important to investigate both?

The two components that affect contribution margin are the number of units sold and the price/cost per unit. The two components create a volume effect and a price/cost effect. It is important to investigate both because changes in either component can have dramatic effects on the contribution margin. Increases in price can decrease the volume of units sold and vice versa.

What is variable costing?

Variable costing is an alternative costing method that considers only variable manufacturing costs when determining product cost. Variable costing includes direct materials, direct labor, variable manufacturing overhead as product costs. Fixed manufacturing overhead is considered a period cost and is expensed in the period in which it is incurred because these costs are incurred whether or not the company manufactures any goods. Variable costing can not be used for external reporting, but is useful to managers for planning and controlling.

Why is it appropriate to use variable costing when planning production in the short term?

Variable costing is appropriate when planning production in the short term because fixed costs are irrelevant in this situation.

What is a variable cost? Give an example.

Variable costs are costs that increase or decrease in total in direct proportion to increases or decreases in the volume of activity. An example of a variable cost is the battery used in a notebook or tablet computer. As computer production increases or decreases, the number of the batteries used will increase or decrease in direct proportion. As the number of batteries used increases or decreases, so does the total cost of batteries.

When units produced equal units sold, how does operating income differ between variable costing and absorption costing?

When units produced equals units sold, there is no difference in operating income between absorption costing and variable costing. In this scenario, all fixed manufacturing costs are expensed, so no production costs are assigned to inventory accounts.

When units produced exceed units sold, how does operating income differ between variable costing and absorption costing? Why?

When units produced exceeds units sold, the operating income will be higher under absorption costing. IN this scenario, some of the fixed manufacturing overhead costs absorbed in the product cost are still in ending Finished Goods Inventory and are on the balance sheet.

When units produced are less than units sold, how does operating income differ between variable costing and absorption costing? Why?

When units sold exceeds units produced, the operating income will be higher under variable costing. In this scenario, the units sold under absorption costing have a higher cost per unit, which increases cost of goods sold and decreases operating income.