Managerial Accounting Quiz 4

TRUE or FALSE? Cost of Goods Sold for a manufacturing company (e.g., Caterpillar) consists strictly of variable costs.

False

True or False: If you performed CVP analysis correctly and were meticulous in your analysis of a company's costs, changes in the sales mix will not affect your CVP analysis?

False

Example of mixed costs

Phone bill: - fixed cost of $35 per year - $1 for every text sent

Visual fit method

create a scatter plot and identify a pattern

Target Profit Level (units) formula

(total fixed costs + target profit level)/ (unit CM)

If the DOL is 7.5, if we increased sales volume by 10%, how much would operating profit increase by?

75%

DOL formula

(𝐂𝐨𝐧𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐌𝐚𝐫𝐠𝐢𝐧)/(𝐎𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐏𝐫𝐨𝐟𝐢𝐭)

Look at costs of education discussion

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Example of Discretionary fixed costs: spending money on digital advertising

- Stanford's MBA program budgets $3 million for digital advertising, but Stanford can easily reduce the amount budgeted to $1 million

Contribution margin

- Tells you the amount of money that you have left to contribute to fixed costs - Sales revenue - all variable costs

Examples of fixed costs

- rent - property tax - property insurance - CEO salaries

Examples of variable costs for merchandise company

- some administrative costs - sales commissions - shipping costs - COGS

Formula for weighted average contribution margin

(Contribution margin #1) * (% of sales #1) + (Contribution margin #2) * (% of sales #2)

Break-even point (in units) formula

(Total fixed costs) / (unit CM)

Equation for high low method

(high cost - low cost) / (high activity level - low activity level)

Target Profit Level (sales) formula

(total fixed costs + target profit level)/ (CM ratio)

Examples of variable costs for manufacturing company

- some administrative costs - sales commissions - shipping costs - direct labor costs - some manufacturing costs (materials, power, etc.)

Profit margins in the grocery store industry

- very low profit margins - have to make sure to price correctly - fierce competition - need to sell a lot to cover fixed costs

In the regression model of Y = a+bx, what does each variable stand for?

- y = total cost is the dependent variable - a = the intercept is the estimate of fixed costs - b = variable cost per unit - x = activity

Example of Committed fixed costs: reducing taxes for your factory

- your factory is located in New Jersey, where it pays a substantial amount of real estate taxes - You could reduce these taxes, but you'd have to make a major change like shutting down your factory or relocating your factory

-------- Lesson 10: CVP Analysis --------------

-------- Lesson 10: CVP Analysis --------------

-------- Lesson 9: Cost Behavior --------------

-------- Lesson 9: Cost Behavior --------------

Types of fixed costs

1. Committed fixed costs 2. Discretionary fixed costs

Three types of costs

1. Fixed costs 2. Variable costs 3. Mixed costs

How can a firm reduce its break-even point?

1. Reduce total fixed costs by outsourcing 2. Increase the unit contribution margin by reducing variables cost per unit (ex: find cheaper labor)

Types of variable costs

1. True variable cost 2. Step-variable cost

All types of costs

1. True variable cost 2. Step-variable cost 3. Committed fixed cost 4. Discretionary fixed cost 5. Mixed cost

Assumptions of CVP analysis

1. selling price per unit is constant throughout the relevant range 2. costs are linear over the relevant range 3. for companies with multiple products, the sales mix is constant 4. For manufacturing companies, inventory doesn't change (units produced = units sold)

Three ways to analyze mixed costs

1. visual-fit method 2. high-low method 3. regression method

Fixed cost for a relevant range

A cost that is fixed for a certain band of activity levels and for a specific time span

What does Degree of Operating Leverage tell us?

A measure, at a given level of sales, of how a percentage change in sales volume will affect profits.

Mixed costs

A mixed cost contains both a variable and a fixed component

Example of Discretionary fixed costs

Advertising R&D

Semivariable costs

Another word for mixed costs

Linearity assumption

Aside from step-variable costs, we typically assume a linear relationship between variable cost and activity level

When is DOL greatest?

At a sales level that is near the break-even point

Why is sales mix important?

Because different products have different selling prices and different contribution margins

How is a Contribution Format income statement arranged?

By the way that costs behave - separates variable and fixed costs

Fixed cost per-unit

Changes as activity level changes

Example of variable cost for a builder that builders treehouses

Cost of lumber depends on number of treehouses built

Example of Committed fixed costs

Depreciation on buildings and equipment

Discretionary fixed costs

Fixed costs that can be reduced in the short term

Committed fixed costs

Fixed costs that cannot be reduced in the short term without making fundamental changes to the business

What does After-tax target profit tell you?

How much the company needs to sell to achieve a certain profit after tax

Cost behavior

How to cost will change if the activity level changes

Why is it important to understand how costs behave?

If we understand how costs behave, we can predict how costs will change under various scenarios (example: wanting to reduce manufacturing costs)

Is Labor Cost Fixed or Variable?

It depends

Margin of Safety % formula

Margin of Safety % = (𝐌𝐚𝐫𝐠𝐢𝐧 𝐨𝐟 𝐒𝐚𝐟𝐞𝐭𝐲 (𝐢𝐧 𝐝𝐨𝐥𝐥𝐚𝐫𝐬))/(𝐁𝐮𝐝𝐠𝐞𝐭𝐞𝐝 𝐒𝐚𝐥𝐞𝐬 (𝐢𝐧 𝐝𝐨𝐥𝐥𝐚𝐫𝐬))

Margin of Safety formula

Margin of Safety = Budget Sales $ - Break-even Sales $

If you were to reduce the number of units you manufacture, would the fixed component of manufacturing overhead costs decrease?

No

Is DOL constant?

No

Example of trend towards more fixed costs

Previously, firms hired more labor during tax season (labor was variable). The tax software is now purchased for a flat fee.

R squared

Squared tells you the percentage of variation in the dependent variable that is explained by the independent variables

What does Margin of Safety tell us?

Tells us the amount by which sales can drop before we start losing money

What does Margin of Safety % tell us?

Tells us the percent by which sales can drop before we start losing money

What does the contribution Margin ratio tell us?

Tells you for every dollar of sales, how much the company generates that can go toward the company's fixed costs

What is Target Profit Level?

The amount of profit you want to make

What does the break-even point (in sales dollars) tell you?

The amount of sales revenue we must generate to break even

What does Target profit level in sales tell you?

The amount of sales revenue you need to generate to make the target profit

What does the break-even point (in units) tell you?

The amount of units a company needs to sell to break even

What does Target profit level in units tell you?

The amount of units you need to sell to make a profit to make the target profit

What does "sales mix" refer to?

The combination of products sold by the company

What must we know to calculate the break-even point in terms of sales dollars?

The contribution margin ratio

True Variable Costs

The cost of resource varies in direct proportion to activity level

Regression analysis method

The most precise (and most difficult) method for analyzing mixed costs is to run a regression - uses ordinary least-squares

Step-variable costs

The resource is obtained in large chunks, so the total costs varies when the activity level reaches certain thresholds - costs remain constant within a narrow threshold and increases when a certain threshold is reached

What does the high-low method determine?

The variable cost/unit

Why does contribution margin matter?

This is very helpful, because it can tell us how many units we need to cover our total fixed costs and to break even

How to find fixed cost

Total cost - total variable cost = total cost - (variable cost per unit * activity level)

Formula for break-even point (in sales dollars)

Total fixed costs / CM ratio

T/F: Fixed costs account for an increasing percentage of firms' overall cost structures due to automation

True

TRUE or FALSE? Cost of Goods Sold for a merchandise company (e.g., a retailer like Walmart) consists strictly of variable costs.

True

TRUE or FALSE? When we talk about "cost behavior" we mean we would like to figure out how a cost will change when the activity level changes.

True

True or False: CVP analysis assumes linearity of variable costs.

True

True or False: CVP analysis assumes the selling price of a product is constant.

True

True or False: Firms can decrease fixed costs and lower their break-even point by outsourcing?

True

True or False: The Degree of Operating Leverage is highest near the break-even point.

True

True or False: The Degree of Operating Leverage is not constant, and varies based on the given level of sales revenue?

True

Contribution margin ratio formula

Unit Contribution Margin / Unit Selling Price

When causes DOL to decrease?

When sales and profits rise

Does variable cost per-unit remain constant?

Yes

If you were to reduce the number of units you manufacture, would the variable component of manufacturing overhead costs decrease?

Yes

Formula for after-tax target profit (sales)

[ (Total FC) * (Target Profit after tax / (1 - tax rate) ] / CM ratio

Formula for after-tax target profit (units)

[ (Total FC) * (Target Profit after tax / (1 - tax rate) ] / unit CM

Fixed cost

a cost that stays constant even when the activity level changes

Variable cost

a cost that varies with changes in activity level

High-low method

can calculate the variable cost per unit by finding the slope of the line

Unit contribution margin

selling price per unit - variable cost per unit OR (Sales revenues - variable costs)/ # of units