Chapter 3 Cost Accounting

contribution margin method

(contribution margin per unit x # of units sold)- fixed costs= operating income

contribution margin equation using contribution margin %

=contribution margin % x revenues (in dollars)

operating income equation

=contribution margin- fixed costs or contribution margin % x revenues-fixed costs

contribution margin percentage (or ratio)

=contribution margin/ revenues can be used to calculate the % earned for each dollar of revenue

operating leverage

describes the effects that fixed costs have on changes in operating income as changes occur in units sold and contribution margin. Organizations with a high proportion of fixed costs in their cost structures have high operating leverage

slope of the total revenues line on cost- volume graph

equals the selling price

slope of total costs line on cost- volume graph

equals the variable cost per unit

cost- volume- profit analysis (CVP)

examines the behavior of total revenues, total costs, and operating income as changes occur in the units sold, the selling price, the variable cost per unit, or the fixed costs of a product

breakeven revenues

fixed costs/ contribution margin %

breakeven revenues for the bundle

fixed costs/ contribution margin % for the bundle

breakeven point in bundles

fixed costs/ contribution margin per bundle

target operating income using contribution margin method formula

(contribution margin per unit x quantity of units sold) - fixed costs= operating income can be rearranged: quantity of units required to be sold= (fixed costs+ target operating income)/ contribution margin per unit

revenues needed to earn target operating income

(fixed costs + target operating income)/ contribution margin %

calculate quantity of units to be sold using contribution margin method and equation 4

(fixed costs + target operating income)/ contribution margin per unit

target net income

(target operating income)-(target operating income x tax rate) or (target operating income) x (1- tax rate)

CVP assumptions

1. changes in revenue and costs only arise because of changes in the number of product (or service) units sold. The number of units is the only revenue driver and only cost driver. 2. total costs can be separated into two components: a fixed component that does not vary with units sold and a variable unit that does 3. when represented graphically, the behaviors of total revenues and total costs are liner in relation to units sold within a relevant range (and time period) 4. selling price, variable cost per unit, and total fixed costs (within a relevant range and time period) are known and constant

methods to model CVP relationships

1. equation method 2. contribution margin method 3. graph method

series of steps managers take to make the most profitable decisions

1. identify the problem 2. obtain information 3. make predictions about the future 4. make decisions by choosing among alternatives 5. implement the decision, evaluate performance, and learn

What is the difference between contribution margin and gross margin?

Contribution margin is revenues minus all variable costs whereas gross margin is revenues minus cost of goods sold. Contribution margin measures the risk of a loss, whereas gross margin measures the competitiveness of a product

How can manager incorporate income taxes into CVP analysis?

Income taxes can be incorporated into CVP analysis by using the target net income to calculate the target operating income. The breakeven point is unaffected by income taxes because no income taxes are paid when operating income equals zero.

How can managers apply CVP analysis to a company producing multiple products?

Managers apply CVP analysis in a company producing multiple products by assuming the sales mix of products sold remains constant as the total quantity of units sold changes

How do managers use CVP analysis to make decisions?

Managers compare how revenues, costs, and contributions margins change across various alternatives. They then choose the alternative that maximizes operating income.

How do managers apply CVP analysis in service and not-for-profit organizations?

Managers define output measures such as passenger-miles in the case of airlines or patient-days in the context of hospitals and identify costs that are fixed and those that vary with these measure of output

equation method

[(selling price)x(# of units sold)-(variable cost per unit)x(# of units sold)]-fixed costs= operating income

sensitivity analysis

a "what if" technique managers use to examine how an income will change if the original predicted data are not achieved or if an underlying assumption changes. Helps to visualize possible outcomes that might occur before the company commits to funding a project

revenue driver

a variable, such as volume, that causally affects revenues

how can CVP analysis help managers?

assists managers in understanding the behavior of a product's or service's total costs, total revenues, and operating income as changes occur in the output level, selling price, variable costs, or fixed costs

How can managers determine the breakeven point or the output needed to achieve a target operating income?

breakeven point is the quantity of output at which total revenues equal total costs. The 3 methods for computing the breakeven point and the quantity of output to achieve target operating income are the equation method, contribution margin method, and graph method. Each method is merely a restatement of others. Managers often select the method they find easier to use i a specific decision situation.

number of bundles required to be sold to breakeven

breakeven revenues/ revenue per bundle

margin of safety

budgeted (or actual) revenues- breakeven revenues

margin of safety (in units)

budgeted (or actual) sales quantity- breakeven quantity

to decide to reduce selling price

calculate the change in contribution margin from lowering price by subtracting the contribution margin from maintaining price from the contribution margin from lowering price. If the result is negative, then the price should not be lowered

target operating income using equation method formula

can be used to find what quantity must be sold to generate that income level [(selling price x quantity of units sold)-(variable cost per unit x quantity of units sold)]- fixed costs=operating income solve for Q

How should managers choose among different variable-cost/ fixed- cost structures?

choosing the variable- cost/ fixed- cost structure is a strategic decision for companies. CVP analysis helps managers compare the risk of losses when revenues are low and the upside profits when revenues are high for different proportions of variable and fixed costs in a company's cost structure.

change in contribution margin

contribution margin % x change in revenues

contribution margin percentage for the bundle

contribution margin of the bundle/ revenue of the bundle

contribution margin % when there is only one product

contribution margin per unit/ selling price

degree of operating leverage

contribution margin/ operating income

contribution margin vs. gross margin

contribution margin= revenues - all variable costs gross margin= revenues- COGs gross margin measures how much a company can charge for its products over and above the cost of acquiring or producing them whereas contribution margin indicates how much a company's revenues are available to cover fixed costs

graph method

helps managers visualize the relationships between total revenues and total costs since total costs and total revenues behave linearly, we can use to points to plot the line representing them: 1. Total Costs Line- sum of fixed costs and variable costs 2. Total Revenues Line- can start at 0 for $0 revenue when 0 units are sold and then pick any other output level and corresponding revenue point

contribution income statement

income statement that groups costs into variable costs and fixed costs to highlight the contribution margin

margin of safety %

margin of safety in dollars/ budgeted (or actual) revenues

net income

operating income+ non-operating revenues (such as interest revenues) - non-operating costs (such as interest cost)-income taxes

contribution margin per unit

selling price- variable cost per unit can be used to calculate contribution margin and operating income: contribution margin= contribution margin per unit x number of units sold operating income= contribution margin- fixed costs

What can managers do to cope with uncertainty or changes in underlying assumptions?

sensitivity analysis is a "what if" technique that examines how an outcome will change if the original predicted data are not achieved or if an underlying assumption changes. When making decisions, managers use CVP analysis to compare margins and fixed costs under different assumptions. Managers also calculates the margin of safety equal to budgeted revenues minus breakeven revenues.

to calculate breakeven point by using equation method

set equation method formula equal to 0 (operating income) and solve for quantity (Q) [(selling price x quantity sold) - (variable cost per unit x quantity sold)]- fixed costs= 0 if less than Q units are sold, this will result in a loss Q is the breakeven point if more than Q units are sold, this will result in a profit

to calculate breakeven point using contribution margin method

set operating income equal to 0 so that: (contribution margin per unit x breakeven quantity of units)= fixed costs rearrange the equation to: breakeven number of units= fixed costs/ contribution margin per unit

PV graph

shows how changes in the quantity of units sold affect operating income

to determine target selling price

target operating income +fixed costs =target contribution margin divided by number of units sold =target contribution margin per unit +variable cost per unit =target selling price

breakeven point (BEP)

that quantity of output sold at which total revenues equal total costs; in other words, the quantity of output sold that results in $0 of operating income

gross margin percent

the gross margin/ revenues

uncertainty

the possibility that an actual amount will deviate from an expected amount. A more comprehensive approach to recognizing uncertainty is to compute expected values using probability distributions

sales mix

the quantities (or proportion) of various products (or services) that constitute a company's total unit sales

contribution margin

total revenues- total variable costs indicates why operating income changes as the number of units sold changes