Chapter 4 Terms, Important Equations, and Summary of Learning Objectives

LO 1. Determine the break-even point in number of units and in total sales dollars.

- At break even, total costs equal total sales revenue. - Break-even units equal total fixed costs divided by the contribution margin - Break-even revenue equals total fixed costs divided by the contribution margin ratio

LO 4. Apply cost-volume-profit analysis in a multiple-product setting.

- Multiple-product analysis requires the expected sales mix. - Break-even units for each product will change as the sales mix changes. - Increased sales of high contribution margin products decrease the break-even point. - Increased sales of low contribution margin products increase the break-even point.

Assumptions of Cost-Volume-Profit Analysis

- There are identifiable linear revenue and linear cost functions that remain constant over the relevant range - Selling prices and costs are known with certainty - Units produced are sold - there are no finished goods inventories - Sales mix is known with certainty for multiple-product break-even settings

LO 2. Determine the number of units that must be sold, and the amount of revenue required, to earn a targeted profit.

- To earn a target profit, total costs plus the amount of target profit must equal total sales revenue. - Units to earn target profit equal total fixed costs plus target profit divided by the contribution margin. - Sales revenue to earn target profit equals total fixed costs plus target profit divided by the contribution margin ratio.

LO 5. Explain the impact risk, uncertainty, and changing variables on cost-volume-profit analysis.

- Uncertainty regarding costs, prices, and sales mix affect the break-even point. - Sensitivity analysis allows managers to vary costs, prices, and sales mix to show various possible break-even points. - Margin of safety shows how far the company's actual sales and/or units above or below break-even point. - Operating leverage is the use of fixed costs to increase the percentage changes in profits as sales activity changes.

Percentage Change in Profits (eq.)

= Degree of Operating Leverage x Percent Change in Sales

Unit Contribution Margin (eq.)

= Price - Unit Variable Cost

Margin of Safety (eq.)

= Sales - Breakeven Sales

Total Contribution Margin (eq.)

= Sales - Total Variable Cost

Degree of Operating Leverage (DOL) (eq.)

= Total Contribution Margin / Operating Income

Break-Even Point in Units (eq.)

= Total Fixed Costs/ Unit Contribution Margin

Break-Even Point in Sales Dollars (eq.)

= Total Fixed Expenses/ Contribution Margin Ratio

Operating Income (eq.)

=Total Revenue - Total Expense

Contribution Margin Income Statement

Format that is based on the separation of costs into fixed and variable components Sales xxxx Total variable cost (xxxx) = Total Contribution Margin xxxx Total fixed cost (xxxx) = Operating Income (xxxx)

Contribution Margin Ratio (eq.)

The percentage of sales dollars remaining after variable costs are covered. = Total Contribution Margin/ Sales OR = Unit Contribution Margin/ Price per unit

Number of Units to Earn a Target Income (eq.)

Total Fixed Cost + Target Income / Contribution Margin per Unit

Cost Structure

a company's mix of fixed costs relative to variable costs

Cost-Volume-Profit Graph

depicts the relationships among cost, volume, and profits by plotting the total revenue line and total cost line on a graph.

Cost-Volume-Profit (CVP) Analysis

estimates how changes in costs, sales volume, and price affect a company's profit.

Contribution Margin

the difference between sales and variable expenses

Common Fixed Expenses

the fixed costs that are not traceable to the segments and would remain even if one of the segments was eliminated.

Break-even Point

the point where total revenue equals total cost

Variable Cost Ratio (eq.)

the proption of each sales dollar that must be used to cover variable costs = Total Variable Costs/ Sales OR = Unit Variable Cost/ Price per Unit

Indifference Point

the quantity at which two systems produce the same operating income

Sales Mix

the relative combination of products being sold by a firm.

Operating Leverage

the use of fixed costs to extract higher percentage changes in profits as sales activity changes.

Direct Fixed Expenses

those fixed costs that can be traced to each segment and would be avoided if the segment did not exist.

Profit-Volume Graph

visually portrays the relationship between profits and units sold.