Chapter 5 Managerial Accounting

TF: The Degree of operating leverage is not a constant, it is greatest at sales levels near the break even point and decreases as sales and profits rise

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Define incremental Analysis:

An analytical approach that focuses only on those costs and revenues that change as a result of a decision.

Give the equation for Target Profit in Units:

(Fix Cost+Target Profit)/CM per Unit

Give the equation Target Profit in Sales Dollars

(Fix Cost+Target Profit)/CM ratio

What is the equation to find profit?

(P x Q) - (V x Q) - fixed expenses

Define High-Low Method

- based on the rise-over run formula for the slope of a straight line (assuming the relationship between a cost and an activity can be represented by a straight line, then the slope equals the variable cost per unit) o Should only be used If a scatterplot indicates a linear relationship between cost and activity o Only uses 2 data points o Fixed cost is calculated after variable cost per unit is calculated using either the high or low level of activity o Variable cost per unit is calculated as: change in cost / change in units (of activity)

Give another way to find the Variable cost ratio%

1-CM Ratio%

5. Parker Company has provided the following data for the most recent year: net operating income, $30,000; fixed expense, $90,000; sales, $200,000; and CM ratio, 60%. The company's margin of safety in dollars is: a) $150,000; b) $30,000; c) $50,000; d) $80,000. 6. The margin of safety in percentage form is: a) 60%; b) 75%; c) 40%; d) 25%. 7. What is the company's total contribution margin? a) $110,000; b) $120,000; c) $170,000; d) $200,000. 8. What is the company's degree of operating leverage? a) 0.25; b) 0.60; c) 1.25; d) 4.00.

5. c) $50,000; Dollar sales to break even = Fixed expenses / CM ratio = $90,000 / 0.60 = $150,000 Margin of Safety = Sales - BE in $= $200,000-$150,000 = $50,000 6. d) 25%. MOS Ratio%= MOS in $/Sales 50k/200k=25% 7. b) $120,000; Use algebra by setting CM Ratio% = CM/Sales .6=CM/200k solve for CM CM=120,00 OR just multiply sales by .6 and get 200k 8. d) 4.00. DOOPL= CM/Net operating Income 120k/30k=4

A change in profits that occurs due to a change in sales and fixed expenses may be calculated as

CM ratio x Change in sales - change in fixed expenses

Define Cost-Volume Profit Analysis

CVP helps manager make important decisions such as: what products to offer what prices to charge what marketing strategies to use what cost structure to maintain.

Define the contribution margin ratio (CM Ratio):

Contribution Margin/Sales

Give the equation for % change in Net Income

Degree of Operating Leverage* %change in sales

describe the Break even point of a multi-product company

Different than one product Break even point = fixed expenses / overall CM ratio

TF, why: A shift in sales mix toward less profitable products will cause the overall break-even point to fall.

False, The reverse is true - the overall break-even will rise because the average CM ratio will be lower as a result of selling less profitable products.

Give the equation for Margin of Safety in dollars and percent:

MOS in $ = sales - break even point in $$ MOS % = MOS in $ / total budgeted(or actual) sales

Give the equation for MOS Ratio%

MOS in sales Dollars/Total sales dollars

Define Cost Structure

Refers to the relative proportions of fixed and variable costs in an organization

Give the equation for MOS in sales dollars

Total Sales dollars- BE sales dollars

Give the equation for MOS in Units

Total Unit Sales- BE Units

TF, If the sales mix changes, the break-even point may change.

True A change in sales mix often results in a change in the overall CM ratio. If the overall CM ratio changes, the break-even will also change

TF,Why For a given increase in sales dollars, a high CM ratio will result in a greater increase in profits than will a low CM ratio.

True The CM ratio measures how much of a sales dollar is translated into increased contribution margin

TF, why: When a company has more than one product, a key assumption in break-even analysis is that the sales mix will not change.

True This is a key assumption because a change in the sales mix will change the break-even

TF, why: Once the break-even point has been reached, net operating income will increase by the unit contribution margin for each additional unit sold.

True, At the break-even all fixed costs are covered. All contribution margin generated from that point forward increases net operating income

Define the Engineering Approach

a detailed analysis of cost behavior based on an industrial engineer's evaluation of the inputs that are required to carry out a particular activity and of the prices of those inputs

Define R^2

a measure of goodness of fit (statistic)

Define operating Leverage:

a measure of how sensitive net operating income is to a given percentage change in dollar sales

Define Degree of Operating Leverage

a measure, at a given level of sales, of how a percentage change in sales will affect profits

Define Account Analysis

a method for analyzing cost behavior in which an account is classified as either variable or fixed based on the analyst's prior knowledge of how the cost in the account behaves

Define Least-squares regression method

a method of separating a mixed cost into its fixed and variable elements by fitting a regression line that minimizes the sum of the squared errors o In the form of Y = a + bX o A = the intercept (total fixed cost) o B = slope (variable cost per unit)

What happens once the Break Even point has been reached?

net operating income will increase by the amount of the unit contribution margin for each additional unit sold

Define Sales Mix

refers to the relative proportions in which a company's products are sold The idea is to achieve the combination or mix that will yield the greatest profits

Describe the Equation Method:

relies on the basic profit equation Profit (0) = Unit CM x Q - fixed expenses Solve for q to find quantity needed to break even

Describe the Formula Method: Give the equation for Unit sales to break even: Give the equation for Dollar sales to Break Even:

shortcut version of the equation method Unit sales to break even = Fixed expenses / Unit CM Dollar sales to break even = Fixed expenses / CM ratio or Units Sales to break even*Selling Price

Define break-even point What can it be affected by?

the level of sales at which profit is 0 Can be affected by sales mix, contribution margin per unit, and total fixed costs

For special bulk orders that will not increase fixed costs the equation for selling price per unit =

variable cost per unit + desired profit per unit

Define Variable expense ratio

variable expenses/ sales.

1. Lester Company has a single product. The selling price is $50 and the variable cost is $30 per unit. The company's fixed expense is $200,000 per month. What is company's unit contribution margin? a) $50; b) $30; c) $20; d) $80. 2. What is the company's contribution margin ratio? a) 60%; b) 40%; c) 167%; d) 20%. 3.What is the company's break-even in sales dollars? a) $500,000; b) $33,333; c) $200,000; d) $400,000. 4. How many units would the company have to sell to attain target profits of $50,000? a) 10,000; b) 12,500; c) 15,000; d) 13,333.

1.C, 20 Unit selling price $50 Less: Unit variable expenses 30 = Unit contribution margin $20 2. B, 40% Unit contribution margin $20 Unit selling price $50 20/50=.4 so, Contribution margin ratio 40% 3. a) $500,000 Dollar sales to break even = Fixed expenses / CM ratio = $200,000 / .40 = $500,000 4. b) 12,500; Unit sales to attain target profit = Target profit + Fixed expense / Unit CM = $200,000 + $50,000 / $20 = 12,500

When a company produces and sells multiple products:

Each product most likely has a unique contribution margin A change in the sales mix will most likely change the break even point Each product most likely creates a unique total of fixed costs

Define target profit analysis

Estimating what sales volume is needed to achieve a specific target profit.

TF, why One way to compute the break-even point is to divide total sales by the CM ratio.

F, The break-even is computed by dividing total fixed expenses by the CM ratio

TF, Why If sales increase by 8%, and the degree of operating leverage is 4, then profits can be expected to increase by 12%.

False, Profits should increase by 32% = 4 X 8%

TF, explain why If product A has a higher unit contribution margin than product B, then product A will also have a higher CM ratio than product B.

False, The CM ratio is the unit contribution margin divided by the unit selling price. One product might have a higher unit contribution than another, but its selling price may be lower.

TF, Why The break-even point occurs where the total contribution margin is equal to total variable expenses.

False, The break-even occurs when profits are 0

TF, why If a company's cost structure shifts toward higher fixed costs and lower variable costs, the company's CM ratio will fall.

False, The reverse is true - one would expect the company's CM ratio to rise. Variable costs would be lower and hence the CM ratio would be higher

Define contribution margin

Sales Revenue- variable expenses (the amount to cover fixed expenses and then provide profits)

To simplify Cost-Volume Analysis, what 3 things are usually assumed?

Selling price is constant Costs are linear and can be divided into variable and fixed components In multi-product companies, the mix of products sold remains constant

TF: A company with a high ratio of fixed costs is more likely to experience a loss when sales are down than a company with mostly variable costs. They are also more likely to experience greater profit when sales are up than a company with mostly variable costs

T

TF, why: Incremental analysis focuses on the differences in costs and revenues between alternatives.

T, By definition, incremental analysis deals only with differences between alternatives

TF, why The break-even point can be expressed either in terms of units sold or in terms of total sales dollars.

True, The break-even can be computed in terms of units sold or sales dollars.

Define the Variable Expense ratio

Variable Expenses/ Sales

In March, Espresso Express had electrical costs of $225 when the total volume was 4,500 cups of coffee served. In April, electrical costs were $227.50 for 4,750 cups of coffee. Using high-low method, which is the estimated fixed cost of electricity per month? a) $200; b) $180; c) $225; d) $150

b) $180 High activity level $227.50 cost 4,750 cups Low Activity level $225.00 cost 4,500 cups Change $2.50 cost 250 cups Change in cost / change in activity = $2.50 / 250 cups = $0.01 per cup Total cost at the high activity = $227.50 Less: variable cost element = 47.50 (4,750 X $0.01 per cup) Fixed cost element = $180.00

Practice If sales increase from $400,000 to $450,000, and if the degree of operating leverage is 6, net operating income should increase by: a) 12.5%; b) 75%; c) 67%; d) 50%.

b) 75%; Percentage change in sales = $450,000 - $400,000 / $400,000 = 12.5% How to find Net operating Income when sales % changes= Degree of Operating leverage* Percentage change in dollar sales= 6*12.5%=75%

In multiple product companies, a shift in the sales mix from less profitable products to more profitable products will cause the company's break-even point to: Why? a) increase; b) decrease; c) there will be no change in the break-even points; d) none of these

b) decrease; A shift to more profitable products would result in an increase in the overall CM ratio. Thus, fewer sales would be needed to cover the fixed costs and the break-even would therefore decrease.

Herman Corp. has two products, A and B, with the following total sales and total variable costs: Product A Product B Sales $10,000 $30,000 Variable Expenses $ 4,000 $24,000 What is the overall contribution margin ratio? a) 70%; b) 50%; c) 30% d) 40%

c0 30% Add together and find CM Overall CM ratio%= Overall CM/Overall sales= 12k/40k= 30%

Give the equation for Degree of operating Leverage:

contribution margin / net operating income

Give the Equation for %change in net operating income

degree of operating leverage * %change in sales

The primary purpose of Cost-Volume Analysis is to ____________ What are the five factors?

estimate how profits are affected by 5 factors Selling Prices Selling Volume Unit Variable cost Total Fixed Costs Mix of products

Describe the Margin of Safety:

excess of budgeted or actual sales dollars over the break-even volume of sales dollars In other words, the amount by which sales can drop before losses are incurred o The higher the margin the lower risk of not breaking even and incurring losses

Define Linear cost Behavior

exists whenever a straight line is a reasonable approximation for the relation between cost and activity

TF, Why: The degree of operating leverage remains the same at all levels of sales.

false, The degree of operating leverage decreases as a company moves further and further from its break-even

Define Scatterplot method of cost analysis

• Total maintenance cost, Y, is plotted on the vertical axis - cost is the dependant variable because it depends on the activity level • The activity, X, is on the horizontal axis and is the independent variable because it causes variations in the cost