Accounting 230 Exam 3

analyzing cost behavior

Accountants usually assume that costs are strictly linear; however, economists point out that many costs are actually curvilinear. BUT within a narrow range of activity known as the relevant range, assumption is that a cost can be approximated by a straight line.

With regards to interpreation, what are the important areas that appear on a CVP graph?

Break-even point, loss area, and profit area

cost structure

The relative proportion of fixed versus variable costs that a company incurs--cost structure can have a significant effect on company profitability

The profit graph is based on the following linear equation:

Profit = Unit CM x Q - Fixed Expenses.

High Roller Incorporated is trying to decide whether to buy a private jet or to lease one. The finder's fee is incurred only if the private jet is bought. The finder's fee is what type of cost for this decision?

Relevant cost

remember

gaap and ifrs require certain segmented data be reported by publicly traded companies

common mistake with direct and common fixed costs

inappropriate allocation base used and or arbitrarily divide common costs among segments

Comparison of absorption and variable costing if production>sales volume

income will be higher under absorption costing

operating leverage

is the degree to which a company's net income reacts to a change in sales; provides a measure of the company's earnings volatility

Cost-volume-profit (CVP) analysis

is the study of the effects of changes in costs and volume on a company's profits -it is an important short run profit planning tool -useful in setting selling prices, determining product mix, and maximizing use of production facilities

When the number of units produced is greater than the number of units sold, variable costing net operating income will be ________.

less than absorption costing net operating income

what does the graph allow

management to see what profit will be at various levels of sales

Comparison of absorption and variable costing if production=sales volume

ni will be equal under the two costing approaches

Break even analysis assumes that

the average variable expense per unit is constant

Split-off point

the point in the manufacturing process at which the joint products can be recognized as separate products

Target Net Income

the profit objective for the company or an individual segment

Multiple Products sales mix

the relative proportion in which each product is sold (when a company sells more than one product)

at the break even point

total revenue is equal to total fixed costs plus total variable costs

Total Contribution Margin=

total sales - total variable costs

contribution margin per unit=

unit selling price - unit variable costs

What is represented on the X axis of a cost-volume-profit (CVP) graph?

unit volume

high-low method

uses the following formulas and historical or projected information to calculate the variable and fixed components of a cost aka the two part method

Which of the following costing approaches is best suited for cost-volume-profit analysis?

variable

Absorption costing income statements ignore ________.

variable and fixed cost distinctions

two methods for income determination

variable costing vs absorption costing

cost behavior types

variable costs (direct labor, direct material, overhead, selling/admin), fixed costs(fixed overhead, fixed selling/admin), mixed costs(combination of both)

the contribution margin income statement classifies costs as

variable or fixed and computes a contribution margin

When a company does not have enough capacity to produce all of the products and sales volume demanded by their customers, this leads to ________.

volume trade-off decisions

remember to always assume

we are in relevant range

if resources are limited

emphasize products with the greatest contribution margin per unit of scarce resource

Joint products

end products from a single raw material

common fixed costs

exist because of multiple departments; must be allocated, but the allocations are not useful for evaluating segments

direct fixed costs

exist because the segment exists (are traceable)

variable costing how is fixed oh treated

expensed in full in the period incurred (i.e. treat as a period cost)

if production>sales volume

expensed more fixed oh than incurred under absorption costing

remember

fixed costs that are traceable to a segment may become common if the segment is divided into smaller units

What is usually plotted as a horizontal line on the CVP graph?

fixed expense

The difference between absorption costing net operating income and variable costing net operating income can be explained by the way these two methods account for ________.

fixed overhead costs

Why use the Incremental Analysis Approach?

saves time; focus is on what's relevant

Period Costs

selling expenses and administrative expenses

If resources are not limited

simply rank product lines according to the contribution margin/unit and contribution margin ratio

Further processing of joint product cost

some companies make a number of end products from a single raw material

Multiple Products why is sales mix important to managers

some products are more profitable than others

Costs that have been incurred and cannot be eliminated regardless of the alternative chosen are ________.

sunk costs

remember

the choice of cost structure must be carefully considered by companies since there are many ways that they can influence their cost structure

segmented income statements are useful in evaluating

the effect dropping a segment will have on a company wide profit as well as identifying the breakeven point for each product based on the direct fixed costs related to the product line

the margin of safety shows

the excess of budgeted (or actual) sales over the break-even sales

the further away you are from the relevant range,

the less accurate your answer is

breakeven point

the level of sales where the company will realize no income and will suffer no loss;(where revenues=expenses,profit=0)

variable costing fixed costs

fixed manufacturing oh and fixed selling/admin expense

Assign the following costs to inventory

dm used, dl, variable overhead, fixed overhead

absorption cogs

dm, dl, variable oh, fixed oh

Margin of Safety Percentage=

margin of safety/expected or actual sales

percentage change in net operating income

% change in sales * degree of operating leverage

Contribution Margin Ratio=

(contribution margin/unit)/(sales prices/unit) or (variable cost/unit)/(total sales $)

make or buy non-financial factors

-employee welfare -product quality

For CVP Analysis for two or more products, must consider sales mix in CVP calculations:

1. break even in sales dollars for a multiple product firm is calculated as: sales $= (total fixed costs+desired profit)/(overall cm ratio) 2. to determine required sales for each product, multiply by percentage of sales contributed from each product sales $ required*product mix

high-low method calculations

1. calculate the VC per unit of Activity (high cost-low cost)/(high activity-low activity) 2.use the total cost equation to solve for total fixed costs total cost=(vc/unit x # units)= total fc *use high cost and high activity or low cost and low activity, not intermediate observations

decide how each cost is treated on an income statement prepared using the variable costing approach. period cost or product cost.

1. direct labor-product cost 2.fixed manufacturing overhead-period cost 3.variable manufacturing overhead-product 4.fixed selling and admin-period 5.variable selling and admin-period cost

To make a decision using incremental analysis

1. eliminate costs and benefits that do not differ, in total, between alternatives 2. base the decision on the remaining costs and benefits

cvp can answer these questions

1.how many units must we sell to just break even 2.how many unites should we sell if wed have a desired profit in mind 3.if we increase advertising, sales will increase, is the extra cost worth the extra sales?

Cost definitions and concepts

1.incremental revenue/costs 2.Relevant costs 3. Avoidable Costs 4.Sunk cost 5. Opportunity Cost

Managing constraints

1.work overtime 2.hire subcontractors 3.shift more workers to processes that are bottlenecks 4.invest in additional equipment 5.process improvements

if production<sales volume

Expensed more fixed oh than incurred under absorption costing

If production=sales volume

Fixed oh expensed is equal under both methods

What of the following forms the basis for a financial advantage when making a business decision?

Whether the dfferential benefits exceed the differential costs

CVP Analysis contribution margin formula method

X = (total FC + desired income before tax) / contribution margin per unit gives sales in UNITS

make or buy decisions

a company must decide whether to make a component part or buy it from and external supplier -be sure to consider opportunity cost -if part is made vc will generally change, fc may or may not

CVP Analysis for multiple products

a. sales mix b. why is sales mix important to managers c. for cvp analysis for two or more products, must consider sales mix in CVP calculation

CVP analysis considers the inherent interrelationships among the following:

a.volume or level of activity b.unit selling prices c.variable cost per unit d.total fixed costs e.sales mix

traditional is another word for

absorption or sales -cogs =gross profit -expenses (s&a) =net income

remember

absorption costing is required under gaap and ifrs for external reporting

when units produced < units sold

absorption net income<variable net income

when units sold=units produced

absorption net income=variable net income

when units produced > units sold

absorption net income>variable net income

Absorption (full) costing

accumulate all products with inventory WIP->FG->CGS

variable costing (contribution margin income stmt)

accumulate only variable product costs with inventory

Margin of Safety=

actual or expected sales - break even sales

CVP analysis assumes

all fixed costs are assumed to be period costs (that is, all FC will be expensed immediately)

remember

all manufacturing costs are charged to, or absorbed by, the product

Sensitivity Analysis

analysis of the effect of a change in a variable on profit (what if analysis)

segment

any part or activity of an organization about which managers seek cost, revenue, or profit data

contribution margin emphasizes

cost behavior

Joint Cost

costs that are incurred up to the split-off point in a process that produces joint products

A shift in the sales mix from high-margin items to low-margin items can cause total profit to ________.

decrease

Account Analysis

determine behavior based on the analyst's prior knowledge about how costs behave--limited in value

fixed overhead costs makes net incom

differ between the two income statements

Margin of Safety

difference between your actual or expected profitability and the break even point

Decide how each cost is treated on an income statement prepared using the variable costing approach.

direct labor-product fixed oh-period variable oh-product fixed s&a-period variable s&a-period

product costs

direct materials, direct labor, manufacturing overhead

Special Orders

occur when a customer orders a product that differs from standard output or offers a price lower than usual sales price 1.special order accepted if incremental revenues exceed incremental costs 2.typically, revenues and vs will increase; fc may or may not depend on if idle capacity exists

The measure of how sensitive net operating income is to a given percentage change in volume sales is called _______.

operating leverage

The potential benefit that is given up when one alternative is selected over another is called ________.

opportunity cost

All selling and administrative costs are

period costs under both absorption and variable costing

Scattergraph Method

plot historical observations for cost and activity; then fit a line to the points so as to minimize deviations

contribution margin=

revenue - variable costs

income statement product vs period format

sales <cogs> gross margin <operating expenses> *required for external reporting (GAAP and IFRS) *does not facilitate CVP analysis and other management decisions

remember

sales and variable costs are generally traceable to a given segment but fixed costs may or may not be

Variable cost ratio=

(total variable cost/total sales $) or (variable cost/unit)/(sales price/unit)

Add or Drop a segment

-Focus on RELEVANT Info. If any segment is eliminated: Total Revenues will decrease by amount of that division's revenues, Total variable costs will be reduced by that division's VC, but only avoidable Fixed Costs can be eliminated -beware of common fixed costs (may or may not change) -decision rule: retain the segment unless fixed costs eliminated exceed the contribution margin lost -also consider effect on related product lines

The following statements about segment margin are trure

-In preparing a segmented income statement, the variable expenses are deducted from sales to yield the contribution margin for each segment. -The segment margin represents the margin available after a segment has covered all of its own costs. -The segment margin is the best gauge of the long-run profitability of a segment because it includes only those costs that are caused by the segment.

When a company cannot fully satisfy demand because of a constraint, which of the following describes an action that should be taken?

-Investing to improve the capacity of the bottleneck -Reducing the number of defective units produced through the bottleneck -Relaxing the constraint

Which of the following statements about using different approaches to analyze alternatives is true?

-Mixing irrelevant costs with relevant costs may cause confusion and distract attention from the information that is critical. -Costs and revenues that do not differ between alternatives are irrelevant to decision making. -Differential analysis focuses on the future costs and benefits that differ between any two alternatives.

Incremental (or differential) Analysis Approach

-The process in which managers identify data that change under alternative actions to allow managers to choose among alternatives -Must identify which revenues and costs are relevant to the decision. -Every decision involves choosing from among at least two alternatives.

Avoidable costs

-a cost that can be eliminated (in whole or in part) by choosing one alternative over another (avoidable costs are relevant) -ex. if you don't go to college you don't have to spend money on tuition, fees, and books

Sunk costs

-a cost that has already been incurred (cannot be changed, thus not relevant) -ex. you will eat regardless if you go to college or not

Opportunity Cost

-benefits foregone (i.e.,income) by choosing the best alternative -ex. going to college vs getting a full time job

Assumptions underlying CVP analysis

-costs and revenues are linear throughout the relevant range -costs can be classified as either variable or fixed with reasonable accuracy -all units produced are sold -sales mix will remain constant

Retaining or dropping a segment non financial factors

-employees welfare -ex grocery store has eggs in the back of the store, you pick up other stuff while going back which increases other sales even if eggs don't create a-lot of profit because it cause people to buy other things too

Relevant Costs

-future costs that differ among the alternatives (also applies to revenues) -ex. if you go to college you have to pay for tuition, fees, and books

utilization of a constrained resource: product mix decisions

-management must decide which products to make and sell to maximize net income

Utilization of a Constrained Resource non financial factors

-may want a variety to choose from

accept or reject a special order non-financial factors

-one time offer with the hop of future regular price business -others find out -employees welfare-if they are overworked maybe reject, if the want to get paid more accept

All of the following are relevant to the sell or process further decision

-revenues beyond the split-off point -revenues at the split-off point -costs incurred beyond the split-off point

the contribution margin is the amount of

-sales remaining after variable expenses have been deducted -also it is the amount that remains to cover fixed costs and generate a profit

Incremental Revenues/Costs

-total difference in revenues/costs among two alternatives -extra revenues extra costs

when activity increases

-total variable cost increases -total fixed costs stay the same -variable costs per unit stays the same -fixed costs per unit decrease

the least-squares/regression method (most accurate)

-use a mathematical model to minimize deviations to determine the variable and fixed component of a cost - you are not responsible for the calculations in this class

remember

-variable costing approach is useful in cvp analysis -only the absorption approach can be used for financial reporting

4 methods for analyzing cost behavior

1. Account Analysis 2. Scattergraph Method 3. High-Low Method 4. Least-Squares/Regression Method

CVP analysis equation methods

1. Revenues-vc-fc=desired profit 2.SP(X)-VC per unit (X)-total fc=desired profit

potential advantages of variable costing

1. Variable costing is consistent with cost-volume-profit analysis and supports decision making 2. Net income computed under variable costing is unaffected by changes in production levels - Management may be tempted to overproduce in a given period in order to increase net income under absorption costing

Contribution Margin (variable/fixed format)

Sales -Variable Costs (Product & Period) =Contribution Margin -Fixed Costs (Product & Period) =Net operating Income

CVP Analysis contribution margin ratio approach

Sales $ = (total FC + desired income before tax) / contribution margin ratio provides answer in SALES DOLLARS

Traditional Income Statement (product period format)

Sales Revenue -cogs (product) = Gross Margin - operating expenses (period) = Income

Which of the following types of decisions involves deciding whether to accept or reject an order that is outside the scope of normal sales?

Special order

Which of the following is a common mistake made by companies when assigning costs to segments?

They assign the costs of the corporate headquarters buildings to segments because the segments must cover those costs.

Degree of Operating Leverage

Total Contribution Margin / Net Operating Income

equation for a cost line

Total Cost = Total VC + Total FC OR Total Cost = ((VC/Unit of activity) * Activity) + Total FC -therefore mixed costs must be separated into the variable and fixed components

variable costing assign the following costs to inventory

dm used, dl, variable overhead

companies with high fixed costs relative to variable costs have

high operating leverage

variable costing must sill assign product costs to inventory;

however, inventory valuation is limited to variable product costs

Another benefit of variable costing

if income is not what you want you can produce more units causing the variable cost for fixed overhead to decrease which will decrease cogs which will increase under absorption costing, variable costing helps prevent this manipulation

further processing of joint product costs

if incremental revenues>incremental costs

Comparison of absorption and variable costing if production<sales volume

income will be higher under variable costing

When a company's sales revenue is increasing, high operating leverage is good because it means that profits will ________________. However, when sales are declining, too much operating leverage will cause profits to ____________________

increase rapidly, decrease rapidly

When the units produced are equal to the units sold, the net operating income computed using the variable costing method is ______ the net operating income using the absorption costing method.

is equal to

When the units produced are less than the units sold, the net operating income computed using the variable costing method is ______ the net operating income using the absorption costing method.

is greater than

When the units produced exceed the units sold, the net operating income computed using the variable costing method is ______ the net operating income using the absorption costing method.

is less than

Which of the following methods do managers use to estimate the fixed and variable components of mixed costs by analyzing past records of cost and activity data?

least-squares regression

inventory values calculated using variable costing as opposed to absorption costing will generally be

less

Management's decision-making process

managers must make decisions regarding which products to offer, whether to make or buy a part, what prices to charge, etc.

segmented income statements

managers need more than a single, company-wide income statement; they need statements that focus on the various segments of a company

the amount by which a company's sales can decline before losses are incurred is called the

margin of safety

if two companies have the same total sales and total expenses and make the same product, which statement is true with respect to the volatility of net operating income when changes in sales occur

the volatility of net operating income will tend to be greater in the company with a higher proportion of fixed expenses in its cost structure

remember

to facilitate performance evaluation and decision-making, segmented income statements can be prepared at various levels

Contribution margin can be stated as a

total amount, a per unit amount or as a ratio

Once the break-even point has been reached, net operating income will increase by the amount of the _____ for each additional unit sold.

unit contribution margin

absorption operating expenses

variable and fixed selling and admin

variable costing variable costs

variable cogs (dm, dl, variable oh)variable selling/admin

The involvement by a company in more than one of the activities in the entire value chain from development through production, distribution, sales, and after-sales service is called ________.

vertical integration

remember

with variable costing fixed oh does not get deferred to a future period, nothing left, all expensed out