Managerial Accounting Exam 2

scatter diagrams

1. Are graphs of unit volume and cost (Exhibit 5-5a). 2. Units are plotted on horizontal axis, cost on the vertical axis. 3. Each point reflects the cost and number of units for a prior period. 4. Estimated line of cost behavior¾drawn with a line that best "fits" the points visually. a. Intersection point of line on cost axis is at fixed cost amount. b. The variable cost per unit of volume equals the slope of the line. i. Select any two levels of units produced. ii. Identify total costs at each of those production levels. iii. Compute the slope of the line as follows: Change in Costs = variable cost per unit Change in volume (units)

break-even point

1. Break-even point a. Sales level at which company neither earns a profit nor incurs a loss. b. Can be expressed either in units or dollars of sales. 2. Computation of break-even point a. Break-even units = Fixed costs CM per unit b. Break-even sales dollars = Fixed costs CM%

Contribution Margin

1. Computed as total sales minus total variable costs. 2. The amount by which a product's unit selling prices exceeds its total unit variable cost. This excess amount contributes to covering fixed costs and generating profits on a per unit basis. 3. Contribution margin per unit is computed as: CM per unit = Selling price per unit - variable cost per unit

contribution margin income statement

1. Differs from a conventional income statement in two ways: i.Classifies costs and expenses as variable and fixed

Margin of safety

1. Expected Unit Sales Expected Sales Dollars - Break-even Unit sales - Break-even Sales Dollars Margin of safety (units) Margin of Safety (dollars) 2. Margin of Safety Rate (%) = Margin of Safety Expected Sales

step-wise costs

1. Fixed within a relevant range of the current production volume. If production volume expands significantly, total costs go up by a lump-sum amount (stair-step cost). 2.Treated as either fixed or variable cost in CVP analysis; depends on width of range, and requires judgment.

cost volume profit chart

1. Horizontal axis¾number of units produced and sold (volume) 2. Vertical axis¾dollars of sales and costs. 3. Three steps: a. Plot fixed costs on vertical axis; draw horizontal line at this level to show that FC remains unchanged regardless of output volume. b. Draw line reflecting total costs (variable costs plus fixed costs) for a relevant range of volume levels. i. Line starts at fixed costs on vertical axis. ii.Slope equals variable cost per unit iii. Compute total costs for any volume level, and connect this point with the vertical axis intercept. iv. Stop line at productive capacity for the planning period. c. Draw sales line. i. Line starts at origin (zero units and zero dollars of sales). ii. Slope of line is equal to selling price per unit; compute total revenues for any volume level, and connect this point with the origin. iii.Stop line at productive capacity for the planning period

mixed costs

1. Include both fixed and variable cost components. 2. When volume and cost are graphed, the mixed cost is represented by a straight line with an upward (positive) slope. Start of line is at fixed cost point (or amount of total cost when volume is zero) on cost (vertical) axis. As the volume of activity increases, mixed cost line increases at an amount equal to the variable cost per unit. 3.Mixed costs are often separated into fixed and variable components when included in a CVP analysis.

curvilinear costs

1. Increase at a non-constant rate as volume increases. 2. When volume and costs are graphed, curvilinear costs appear as a curved line that starts at intersection point of cost axis and volume axis (total cost is zero when volume is zero) and increases at different rates. 3.Often treated as variable costs in CVP analysis within a relevant range.

computing income from sales and costs

1. Sales (# units sold x unit selling price) - Variable Costs (# units sold x unit variable cost) Contribution Margin - Fixed Costs Income (pretax)

high-low method

1. Step 1: Identify the highest and lowest volume levels. Note that these may not be the highest or lowest level of costs. 2. Step 2: Compute the slope (variable cost per unit) using the high low volume levels Variable cost = high volume costs - low volume costs per unit high volume units - low volumes units 3. Step #3: Compute the estimated fixed costs by first computing the total variable costs at either the high or low volume level and then subtracting that amount from the total costs at that volume level. Use the cost equation. Total costs = Fixed costs + variable cost per unit x #of units 4.Deficiency of high-low method¾ignores all data points except the highest and lowest resulting in less precision.

Contribution Margin Ratio

1. The percent of a unit's selling price that exceeds total unit variable cost. Interpreted as what proportion of each sales dollars remains after deducting total unit variable costs. 2. Contribution margin ratio is computed as: CM % = CM per unit sales price per unit.

Fixed Costs

1. Total fixed costs remain unchanged in amount when volume of activity varies from period to period within a relevant range. 2. The fixed cost per unit of output decreases as volume increases (and vice versa). 3. When production volume and cost are graphed, units of product are usually plotted on the horizontal axis and dollars of cost are plotted on the vertical axis. (Exhibit 5.2) The fixed cost is represented by a horizontal line with no slope (cost remains constant at all levels of volume within the relevant range). 4. Fixed costs per unit decrease as production increases. This drop is known as economies of scale.

variable costs

1. Variable costs change in proportion to changes in volume of activity. 2. Variable cost per unit remains constant but the total amount of variable cost changes with the level of production. 3. When production volume and cost are graphed, (Exhibit 5.2) a. Variable cost is represented by a straight line starting at the zero cost level. b.The straight line is upward (positive) sloping. The line rises as volume increases.

Identifying Cost Behavior--CVP analysis

A. Cost-volume-profit analysis is a tool to predict how changes in costs and sales levels affect profit 1. CVP uses four main components including: number of units sold; sales price per unit; variable costs per unit; and fixed costs in total. 2. The concept of relevant range is important when classifying costs for CVP analysis. The relevant range is the normal operating range for a business. It excludes extremely high or low operating levels. 3.Conventional CVP analysis requires that all costs must be classified as either fixed or variable with respect to production or sales volume before CVP analysis can be used.

decision analysis--degree of operating leverage

A. Useful tool in assessing the effect of changes in the level of sales on income is the degree of operating leverage computation. B.Operating leverage is the extent, or relative size, of fixed costs in the total cost structure.

measuring cost behavior

After establishing that cost data are reliable and useful in predicting future costs, three methods are commonly used to analyze past cost behavior. Goal is to develop a cost equation.

Variable costs examples

Direct materials Direct labor Shipping Packaging Indirect Materials

Mixed Costs examples

Electricity Water Sales Rep (salary plus commission) Natural gas Maintenance

break even point in composite units

Fixed Costs/CM per composite unit = Composite Units to break-even

Fixed costs examples

Rent Depreciation (other than units of production) Property taxes Supervisor salaries Office salaries

reports contribution margin

Revenues - Variable Costs Contribution Margin - Fixed Costs Net Income E.Margin of safety can be expressed in units, dollars, or as a percent of predicted level of sales. It is the excess of expected sales over break-even sale. It is the amount that sales can drop before the company incurs a loss.

DOL computed as:

Total Contribution margin (dollars)/ pretax income

cost equation

Total costs = Fixed costs + variable cost per unit x #of units

applying cost volume profit analysis

Useful in helping managers forecast future sales or income.

CVP analysis relies on several assumptions

a. Costs can be classified as variable or fixed. b. Costs are linear within the relevant range. c.All units produced are sold. sales mix is constant

On either side of break-even point, the area between sales line and total cost line at any specific sales volume reflects the profit or loss expected at that point.

a. Volume levels to left of break-even point¾area is amount of loss expected because the total costs line is above the total sales line. b.Volume levels to right of break-even point¾area is amount of profit expected because the total sales line is above the total costs line.

Variable Costing and Performance Reporting

contribution margin income statement also known as a variable costing income statement. A. Variable costing - only costs that change in total with changes in production levels are included in product costs. B. Includes direct materials, direct labor and variable overhead costs. C. Fixed overhead costs are excluded from product costs. D.GAAP (external reporting) requires absorption costs whereby product costs includes direct materials, direct labor and all overhead (fixed and variable).

sales (in units) required for target income equals

fixed costs + target pretax income/ CM

1. Sales (in dollars) required for target pretax income equals:

fixed costs + target pretax income/ CM%

Example of a curvilinear cost

total direct labor cost when workers are paid by the hour