accounting exam chapter 21
fixed or variable costs
CVP analysis requires management to classify costs as either fixed or variable with respect to production or sales volume, within the relevant range of operations.
fixed cost
Fixed costs do not change when the volume of activity changes (within a relevant range). the total amount of fixed cost does not change as volume changes, fixed cost per unit of output decreases as volume increases
after tax income
Management then assesses whether this income is an adequate return on assets invested. Management will also consider whether sales and income can be increased by raising or lowering prices. CVP analysis is good for addressing these kinds of "what-if" questions.
the normal operating range for a business
The concept of relevant range is important to classifying costs for CVP analysis. The relevant range of operations
margin of safety
The excess of expected sales over the break-even sales level is called margin of safety , the amount that sales can drop before the company incurs a loss.
Operating Leverage
The extent, or relative size, of fixed costs in the total cost structure Companies having a higher proportion of fixed costs in their total cost structure are said to have higher operating leverage. An example of this is a company that chooses to automate its processes instead of using direct labor, increasing its fixed costs and lowering its variable costs.
variable cost
Variable costs change in proportion to changes in volume of activity
cvp relies on several assumptions
costs are variable or fixed ,all units produced are sold , costs are linear within relevant range
contribution margin per unit
is the amount by which a product's unit selling price exceeds its variable cost per unit. Exhibit 21.9 shows the formula for contribution margin per unit.
contribution margin ratio
is the percent of a unit's selling price that exceeds total unit variable cost. It is interpreted as the percent of each sales dollar that remains after deducting the unit variable cost
break-even point
is the sales level at which total sales equal total costs and a company neither earns a profit nor incurs a loss. A key concern when launching a project is whether it will break even—that is, whether sales will at least cover total costs.
cvp uses four inputs
number of units sold, sales price per unit , variable costs per unit , fixed costs
CVP analysis
used to predict how changes in cost and sales levels affect profit
contribution margin
which equals total sales minus total variable costs. Contribution margin contributes to covering fixed costs and generating profits