ACC Ch. 18&19

Identify the three ways to determine the break-even point

The break-even point can be (a) computed from a mathematical equation, (b) computed by using a contribution margin technique, and (c) derived from a CVP graph.

Contribution margin (CM)

The amount of revenue remaining after deducting variable costs.

Contribution margin per unit

The amount of revenue remaining per unit after deducting variable costs; calculated as unit selling price minus unit variable cost.

Absorption costing

A costing approach in which all manufacturing costs are charged to the product.

Variable costing

A costing approach in which only variable manufacturing costs are product costs, and fixed manufacturing costs are period costs (expenses).

Cost-volume-profit (CVP) graph

A graph showing the relationship between costs, volume, and profits.

High-low method

A mathematical method that uses the total costs incurred at the high and low levels of activity to classify mixed costs into fixed and variable components.

Degree of operating leverage

A measure of the extent to which a company's net income reacts to a change in sales. It is calculated by dividing contribution margin by net income.

Theory of constraints

A specific approach used to identify and manage constraints in order to achieve the company's goals.

Cost-volume-profit (CVP) income statement

A statement for internal use that classifies costs as fixed or variable and reports contribution margin in the body of the statement.

Apply basic CVP concepts

Contribution margin is the amount of revenue remaining after deducting variable costs. It can be expressed as a per unit amount or as a ratio. The break-even point in units is fixed costs divided by contribution margin per unit. The break-even point in dollars is fixed costs divided by the contribution margin ratio. These formulas can also be used to determine units or sales dollars needed to achieve target net income, simply by adding target net income to fixed costs before dividing by the contribution margin. Margin of safety indicates how much sales can decline before the company is operating at a loss. It can be expressed in dollar terms or as a percentage.

Indicate what contribution margin is and how it can be expressed

Contribution margin is the amount of revenue remaining after deducting variable costs. It is identified in a CVP income statement, which classifies costs as variable or fixed. It can be expressed as a total amount, as a per unit amount, or as a ratio.

Mixed costs

Costs that contain both a variable- and a fixed-cost element and change in total but not proportionately with changes in the activity level.

Fixed costs

Costs that remain the same in total regardless of changes in the activity level.

Variable costs

Costs that vary in total directly and proportionately with changes in the activity level.

Explain the concept of mixed costs

Mixed costs increase in total but not proportionately with changes in the activity level. For purposes of CVP analysis, mixed costs must be classified into their fixed and variable elements. One method that management may use to classify these costs is the high-low method.

Understand how operating leverage affects profitability

Operating leverage refers to the degree to which a company's net income reacts to a change in sales. Operating leverage is determined by a company's relative use of fixed versus variable costs. Companies with high fixed costs relative to variable costs have high operating leverage. A company with high operating leverage will experience a sharp increase (decrease) in net income with a given increase (decrease) in sales. The degree of operating leverage can be measured by dividing contribution margin by net income.

Explain the term sales mix and its effects on break-even sales

Sales mix is the relative proportion in which each product is sold when a company sells more than one product. For a company with a small number of products, break-even sales in units is determined by using the weighted-average unit contribution margin of all the products. If the company sells many different products, then calculating the break-even point using unit information is not practical. Instead, in a company with many products, break-even sales in dollars is calculated using the weighted-average contribution margin ratio.

Describe the essential features of a cost-volume-profit income statement

The CVP income statement classifies costs and expenses as variable or fixed and reports contribution margin in the body of the statement.

Activity index

The activity that causes changes in the behavior of costs.

Margin of safety

The difference between actual or expected sales and sales at the break-even point.

Operating leverage

The extent to which a company's net income reacts to a change in sales. Operating leverage is determined by a company's relative use of fixed versus variable costs.

List the five components of cost-volume-profit analysis

The five components of CVP analysis are (a) volume or level of activity, (b) unit selling prices, (c) variable costs per unit, (d) total fixed costs, and (e) sales mix.

Target net income

The income objective set by management.

Break-even point

The level of activity at which total revenues equal total costs.

Contribution margin ratio

The percentage of each dollar of sales that is available to apply to fixed costs and contribute to net income; calculated as contribution margin per unit divided by unit selling price.

Relevant range

The range of the activity index over which the company expects to operate during the year.

Sales mix

The relative percentage in which a company sells its multiple products.

Cost structure

The relative proportion of fixed versus variable costs that a company incurs.

Explain the significance of the relevant range

The relevant range is the range of activity in which a company expects to operate during a year. It is important in CVP analysis because the behavior of costs is assumed to be linear throughout the relevant range.

Cost behavior analysis

The study of how specific costs respond to changes in the level of business activity.

Cost-volume-profit (CVP) analysis

The study of the effects of changes in costs and volume on a company's profits.

Distinguish between variable and fixed costs

Variable costs are costs that vary in total directly and proportionately with changes in the activity index. Fixed costs are costs that remain the same in total regardless of changes in the activity index.

Determine sales mix when a company has limited resources

When a company has limited resources, it is necessary to find the contribution margin per unit of limited resource. This amount is then multiplied by the units of limited resource to determine which product maximizes net income.