Accounting 410 Final: Chapter 18

The promoter for the Rolling Stones' tour guaranteed $1.2 million to the group. In addition, 20% of the gross goes to the stadium where the performance is staged and another $400,000 for other expenses such as ticket takers and advertising. What amount of sales dollars are required for the promoter to break even?

Fixed costs = $1,200,000 + $400,000 = $1,600,000 Contribution margin ratio = 80%. Break-even sales = $1,600,000 ÷ .80 = $2,000,000.

What are Fixed Costs?

Fixed costs are costs that remain the same in total regardless of changes in the activity level. Examples include property taxes, insurance, rent, supervisory salaries, and depreciation. Fixed costs per unit vary inversely with activity; as volume increases, unit cost declines and vice versa.

FlightServe, a chartered aircraft company, decided to match up executives with charter flights in small "private jets". The company noted that the average charter jet had eight seats, but it would break even at an average of 3.3 seats per flight. How did FlightServe determine that it would break even with 3.3 seats full per flight?

FlightServe determined its break-even point with the following formula: Fixed costs ÷ Contribution margin per seat occupied = Break-even point in seats.

What is the contribution margin per unit formula?

Unit Selling Price - Unit Variable Costs = Contribution margin per unit

what are variable costs?

Variable Costs are costs that vary in total directly and proportionately with changes in the activity level. Examples of variable costs include direct materials and direct labor, cost of goods sold, sales commissions, and freight-out. A variable cost may also be defined as a cost that remains the same per unit at every level of activity.

break even point in units formula:

fixed costs / contribution margin per unit = break-even point in units

break even point in dollars formula:

fixed costs / contribution margin ratio = break-even point in dollars

what is the target net income? what is the formula?

it is the income objective for individual product lines. target net income = required sales - variable costs - fixed costs

What is the Variable Cost per Unit Formula?

variable cost per unit = Change in total costs / high minus low activity level

The recession that started in 2008 produced a surprise for some manufacturers— the number of jobs lost was actually lower than in previous recessions. Between 2000 and 2008 many factories adopted lean manufacturing practices that relied less on large numbers of low skilled workers, and more on machines and a few highly skilled workers. Because the employees are highly skilled, employers are reluctant to lose them. Would you characterize labor costs as being a fixed cost, a variable cost, or something else in this situation?

Because these labor costs are essentially unchanged for most levels of production, they are primarily fixed. However, it could be described as being a "step function." If production gets too far outside the normal range, workers' hours will change. If production goes too low, hours are cut, and if it goes too high, overtime hours are needed.

As the population increases and farmable land becomes more scare, growing food hydroponically in skyscrapers has been studied as an alternative way to grow food without incurring some of the common costs associated with farming (transportation to cities, pesticides, etc.). But, even while some costs are reduced by farming hydroponically, other costs are likely to increase. What are some of the variable and fixed costs that are impacted by hydroponic farming?

Compared to traditional methods, hydroponic farming would reduce the use of pesticides, herbicides, fuel, and water. Soil erosion would be eliminated, and land requirements would drop. But, fixed costs related to constructing greenhouses, suitable vertical planters, as well as investments in artificial lighting could be high.

What is the contribution margin?

Contribution margin is the amount of revenue remaining after deducting variable costs, and indicates the amount available to cover fixed costs and contribute to income.

What is the contribution margin ratio?

Contribution margin per unit / unit selling price = contribution margin ratio ratio indicates the portion of each sales dollar that is available to apply to fixed costs and to contribute to income.

What is the cost-volume profit analysis?

Cost-volume-profit (CVP) analysis is the study of the effects of changes in costs and volume on a company's profits. It is a critical factor in such management decisions as profit planning, setting selling prices, determining product mix, and maximizing use of production facilities.

How do you determine fixed costs?

Determine the fixed cost by subtracting the total variable cost at either the high or the low activity level from the total cost at that activity level.

What is Cost Behavior Analysis? What does a knowledge of cost behavior help?

It is the study of how specific costs respond to changes in the level of business activity A knowledge of cost behavior helps management plan operations and decide between alternative courses of action

What is the formula for margin of safety in dollars? what is the formula for margin of safety ratio? what does the ratios mean?

Margin of safety in dollars = actual (expected) sales - break-even sales margin of safety ratio = margin of safety in dollars / actual (expected) sales the higher the dollars or the percentage, the greater the margin of safety

What is the margin of safety?

Margin of safety is the difference between actual or expected sales and sales at the break-even point.

What are mixed costs?

Mixed costs are costs that contain both a variable element and a fixed element; they increase in total as the activity level increases, but not proportionately. For purposes of CVP analysis, mixed costs must be classified into their fixed and variable elements.

What does activity index identify?

The activity index identifies the activity that causes changes in the behavior of costs; examples include direct labor hours, sales dollars, and units of output.

What is the break-even point?

The break-even point is the level of activity at which total revenue equals total costs (both fixed and variable). Knowledge of the break-even point is useful to management when it decides whether to introduce new product lines, change sales prices on established products, or enter new market areas.

What is the high-low method?

The high-low method uses the total costs incurred at the high and low levels of activity. The difference in costs represents variable costs, since only the variable cost element can change as activity levels change.

What is relevant range?

The range over which a company expects to operate during the year. Although a linear (straight-line) relationship for costs may not be realistic, the linear assumption produces useful data for CVP analysis as long as the level of activity remains within the relevant range.

What are the 5 assumptions that underlie each CVP analysis?

a. The behavior of both costs and revenues is linear throughout the relevant range of the activity index. b. All costs can be classified as either variable or fixed with reasonable accuracy. c. Changes in activity are the only factors that affect costs. d. All units produced are sold. e. When more than one type of product is sold, the sales mix will remain constant. That is, the percentage that each product represents of total sales will stay the same.

What happens when an appropriate activity index is chose?

costs can be classified as variable, fixed or mixed

How do we find required sales in units using the contribution margin technique?

required sales in units = (fixed costs + target net income) / contribution margin per unit

How do we fin the required sales in dollars using the contribution margin ratio?

required sales in units = (fixed costs + target net income) / contribution margin ratio

CVP analysis common equation:

sales - variable costs - fixed costs = net income