Acc 202 Exam Two
high low method steps
1. Determine the high and low costs 2. High cost - low cost = Average cost 3. High quantity - low quantity = Average quantity 4. Average cost / Average quantity = Variable cost per unit (b) 5. Use high or low numbers and plug into formula (y (high cost) = a + bx (variable cost x high quantity) and solve for Fixed costs (a) 6. Use Fixed Costs (a) amount to solve for new costs
a master budget for a manufacturing company is designed to answer 10 key questions as follows:
1. How much sales will we earn? 2. How much cash will we collect from customers? 3. How much raw material will we need to purchase? 4. How much manufacturing cost (including direct materials, direct labor, and manufacturing overhead) will we incur? 5. How much cash will we pay to our suppliers and our direct laborers, and how much will we pay for manufacturing overhead resources? 6. What is the total cost that will be transferred from finished goods inventory to cost of goods sold? 7. How much selling and administrative expense will we incur and how much cash will we pay related to those expenses? 8. How much money will we borrow from or repay to lenders—including interest? 9. How much net operating income will we earn? 10. What will our balance sheet look like at the end of the budget period?
Self-imposed budgets have a number of advantages:
1. Individuals at all levels of the organization are recognized as members of the team whose views and judgments are valued by top management. 2. estimates prepared by front-line managers are often more accurate and reliable than estimates prepared by top managers who have less intimate knowledge of markets and day-to-day operations. 3. Motivation is generally higher when individuals participate in setting their own goals than when the goals are imposed from above. -create commitment. 4. manager who is not able to meet a budget that has been imposed from above can always say that the budget was unrealistic and impossible to meet. -With a self-imposed budget, this claim cannot be made.
CVP Assumptions
1. Selling price is constant. The price of a product or service will not change as volume changes. 2. Costs are linear and can be accurately divided into variable and fixed components. The variable costs are constant per unit and the fixed costs are constant in total over the entire relevant range. 3. In multiproduct companies, the mix of products sold remains constant. (greatest danger lies in relying on simple CVP analysis when a manager is contemplating a large change in sales volume that lies outside the relevant range.)
The cash budget is composed of four main sections:
1. The cash receipts section. -lists all of the cash inflows, except from financing, expected during the budget period. Generally, the major source of receipts is from sales. 2. The cash disbursements section. - summarizes all cash payments that are planned for the budget period. These payments include raw materials purchases, direct labor payments, manufacturing overhead costs, and so on, as contained in their respective budgets. In addition, other cash disbursements such as equipment purchases and dividends are listed. (six types) 3. The cash excess or deficiency section. 4. The financing section. -details the borrowings and principal and interest repayments projected to take place during the budget period. (details the borrowings and principal and interest repayments projected to take place during the budget period.)
Advantages of Budgeting
1. communicate management's plans throughout the organization. 2. force managers to think about and plan for the future. -In the absence of the necessity to prepare a budget, many managers would spend all of their time dealing with day-to-day emergencies. 3. process provides a means of allocating resources to those parts of the organization where they can be used most effectively. 4. process can uncover potential bottlenecks before they occur. 5. coordinate the activities of the entire organization by integrating the plans of its various parts. -helps to ensure that everyone in the organization is pulling in the same direction. 6. define goals and objectives that can serve as benchmarks for evaluating subsequent performance.
Self-imposed budgeting has two important limitations
1. lower-level managers may make suboptimal budgeting recommendations if they lack the broad strategic perspective possessed by top managers. 2. self-imposed budgeting may allow lower-level managers to create too much budgetary slack. -the manager who creates the budget will be held accountable for actual results that deviate from the budget, the manager will have a natural tendency to submit a budget that is easy to attain (i.e., the manager will build slack into the budget). -should be scrutinized by higher levels of management
quantifying the dollar sales needed to attain a target profit
1. solve for the unit sales needed to attain the target profit using the equation method or formula method and then simply multiply the result by the selling price. 2. use the equation method to compute the dollar sales needed to attain the target profit. 3. use the formula method to compute the dollar sales needed to attain the target profit as shown below: Dollar sales to attain the target profit= Target profit + Fixed expenses CM ratio
Scattergraph
A method of segregating the fixed and variable components of a mixed cost by plotting on total costs at several activity levels and drawing a regression line through the points. has a horizontal x-axis that represents production activity, a vertical y-axis that represents cost, data that are plotted as points on the graph, and a regression line that runs through the dots to represent the relationship between the variables.
least-squares regression method
A method of separating a mixed cost into its fixed and variable elements by fitting a regression line that minimizes the sum of the squared errors.
Changes in the sales mix can cause perplexing variations in a company's profits.
A shift in the sales mix from high-margin items to low-margin items can cause total profits to decrease even though total sales may increase. Conversely, a shift in the sales mix from low-margin items to high-margin items can cause the reverse effect—total profits may increase even though total sales decrease. It is one thing to achieve a particular sales volume; it is quite another to sell the most profitable mix of products.
cash excess or deficiency section is computed as follows:
Beginning cash balance XXX Add cash receipts XXX Total cash available XXX Less cash disbursements XXX Excess (deficiency) of cash available over disbursements XXX if a cash deficiency exists during any budget period or if there is a cash excess during any budget period that is less than the minimum required cash balance, the company will need to borrow money. Conversely, if there is a cash excess during any budget period that is greater than the minimum required cash balance, the company can invest the excess funds or repay principal and interest to lenders.
contribution margin ratio and the variable expense ratio can be mathematically related to one another:
CM ratio= Contribution margin/Sales CM ratio= Sales−Variable expenses/Sales CM ratio= 1−Variable expense ratio
company that has only one product, the CM ratio can also be computed on a per unit basis as follows:
CM ratio= Unit contribution margin/Unit selling price
effect of a change in sales on the contribution margin is expressed in equation form as:
Change in contribution margin= CM ratio × Change in sales the impact on net operating income of any given dollar change in total sales can be computed by applying the CM ratio to the dollar change.
master budget concludes with the preparation of a cash budget, income statement, and balance sheet.
Information from the sales budget, selling and administrative expense budget, and the manufacturing cost budgets all influence the preparation of the cash budget.
interest computed as follows:
Interest on the $130,000 borrowed at the beginning of the first quarter : $130,000 × 0.03 per quarter × 4 quarters* $ 15,600 Interest on the $70,000 borrowed at the beginning of the second quarter: $70,000 × 0.03 per quarter × 3 quarters* 6,300 Total interest accrued to the end of the fourth quarter $ 21,900
top managers often initiate the budgeting process by issuing profit targets
Lower-level managers are directed to prepare budgets that meet those targets. The difficulty is that the targets set by top managers may be unrealistically high or may allow too much slack. -If the targets are too high and employees know they are unrealistic, motivation will suffer. -If the targets allow too much slack, waste will occur. -Unfortunately, top managers often are not in a position to know whether the targets are appropriate.
Margin of Safety in dollars equation:
Margin of safety in dollars= Total budgeted (or actual) sales − Break‐even sales can be expressed in percentage form by dividing the margin of safety in dollars by total dollar sales: Margin of safety percentage= Margin of safety in dollars/Total budgeted (or actual) sales in dollars single-product company the margin of safety also can be expressed in terms of the number of units sold by dividing the margin of safety in dollars by the selling price per unit.
Chapter Eight
Master Budgeting
relation between the percentage change in sales and the percentage change in net operating income is given by the following formula:
Percentage change in net operating income= Degree of operating leverage × Percentage change in sales
Equation Method
Profit= Unit CM×Q−Fixed expense -relies on the basic profit equation Cost-volume-profit analysis technique that uses the algebraic relationship among sales, variable costs, fixed costs, and desired net income before taxes to solve for required sales volume
When a company has only a single product CI equation
Profit=(P×Q−V×Q)−Fixed expenses -Sales expenses==Selling price per unit×Quantity sold=P×Q -Variable expenses per unit×Quantity sold=V×Q
contribution format income statement equation form
Profit=(Sales−Variable expenses)−Fixed expenses
relation between profit and the CM ratio can also be expressed using the following equation:
Profit=CMratio×Sales−Fixed expenses in terms of changes: Change in profit= CM ratio × Change in sales − Change in fixed expenses
Profit graph equation
Profit=UnitCM×Q−Fixed expenses
Importance of Relevant Range
Relevant range is important because if you make the assumption that all of your costs will remain constant, whether they are fixed or variable, you may make errors on your projections. Also, if you ignore relevant range, you may hit capacity issues where you don't realize you physically cannot make all of the goods needed because you have hit your capacity for the time period.
the company's minimum required borrowings at the beginning of the first quarter would be computed as follows:
Required Borrowings at the Beginning of the First Quarter: Desired ending cash balance $ 30,000 Plus deficiency of cash available over disbursements 94,000 Minimum required borrowings $ 124,000
many of the schedules in a master budget hinge on a variety of estimates and assumptions that managers must make when preparing those schedules.
Sales budget: What are the budgeted unit sales? What is the budgeted selling price per unit? What percentage of accounts receivable will be collected in the current and subsequent periods? Production budget: What percentage of next period's unit sales needs to be maintained in ending finished goods inventory? Direct materials budget: How many units of raw material are needed to make one unit of finished goods? What is the budgeted cost for one unit of raw material? What percentage of next period's production needs should be maintained in ending raw materials inventory? What percentage of raw material purchases will be paid in the current and subsequent periods? Direct labor budget: How many direct labor-hours are required per unit of finished goods? What is the budgeted direct labor wage rate per hour? Manufacturing overhead budget: What is the budgeted variable overhead cost per unit of the allocation base? What is the total budgeted fixed overhead cost per period? What is the budgeted depreciation expense on factory assets per period? Selling and administrative expense budget: What is the budgeted variable selling and administrative expense per unit sold? What is the total budgeted fixed selling and administrative expense per period? What is the budgeted depreciation expense on non-factory assets per period? Cash budget: What is the budgeted minimum cash balance? What are our estimated expenditures for noncurrent asset purchases and dividends? What is the estimated interest rate on borrowed funds?
Schedule 4:
The direct labor budget shows the direct labor-hours required to satisfy the production budget. -By knowing in advance how much labor time will be needed throughout the budget year, the company can develop plans to adjust the labor force as the situation requires. -Companies that neglect the budgeting process run the risk of facing labor shortages or having to hire and lay off workers at awkward times. Erratic labor policies lead to insecurity, low morale, and inefficiency. many companies have employment policies or contracts that prevent them from laying off and rehiring workers as needed.
Relevant Range
The range of activity within which assumptions about variable and fixed cost behavior are valid. relevant range is the range of output or production in which our assumptions are true. If you move outside the relevant range, your cost assumptions are no longer valid.
Preparing the profit graph
To plot the line, compute the profit at two different sales volumes, plot the points, and then connect them with a straight line.
In a single product situation, the formula for computing the unit sales to break even is:
Unit sales to break even= Fixed expenses/Unit CM
break-even analysis, an assumption must be made concerning the sales mix
Usually the assumption is that it will not change. However, if the sales mix is expected to change, then this must be explicitly considered in any CVP computations.
company has only one product, the variable expense ratio can also be computed on a per unit basis as follows:
Variable expense ratio= Variable expense per unit/Unit selling price
Continuous or perpetual budgets
a 12-month budget that rolls forward one month (or quarter) as the current month (or quarter) is completed. In other words, one month (or quarter) is added to the end of the budget as each month (or quarter) comes to a close. This approach keeps managers focused at least one year ahead so that they do not become too narrowly focused on short-term results.
Schedule 6: ending finished goods inventory budget
a budget showing the dollar amount of unsold finished goods inventory that will appear on the ending balance sheet
A self-imposed budget or participative budget
a budget that is prepared with the full cooperation and participation of managers at all levels.
Budget
a detailed plan for the future that is usually expressed in formal quantitative terms. actual spending is compared to the budget to make sure the plan is being followed. Budgets are used for two distinct purposes—planning and control.
Cash Budget
a detailed plan showing how cash resources will be acquired and used.
responsibility accounting
a manager should be held responsible for those items—and only those items—that the manager can actually control to a significant extent. -Each line item (i.e., revenue or cost) in the budget is the responsibility of a manager who is held responsible for subsequent deviations between budgeted goals and actual results. -In effect, it personalizes accounting information by holding individuals responsible for revenues and costs. This concept is central to any effective planning and control system. -Someone must be held responsible for each cost or else no one will be responsible and the cost will inevitably grow out of control.
Operating Leverage
a measure of how sensitive net operating income is to a given percentage change in dollar sales. Operating leverage acts as a multiplier. -If operating leverage is high, a small percentage increase in sales can produce a much larger percentage increase in net operating income.
High-Low Method
a method of separating a mixed cost into its fixed and variable elements by analyzing the change in cost between the high and low activity levels
least-squares regression analysis
a statistical technique that analyzes the relationship between independent (causal) and dependent (effect) variables
Schedule 1: Sales Budget
all of its numbers are derived from cell references to the Budgeting Assumptions tab and formulas—none of the numbers appearing in the schedule were actually keyed into their respective cells. Furthermore, it bears emphasizing that all remaining schedules in the master budget are prepared in the same fashion—they rely almost exclusively on cell references and formulas.
success of a budget program
also depends on whether top management uses the budget to pressure or blame employees.
Appendix 5A
analyzing mixed costs
Blaming employees
breeds hostility, tension, and mistrust rather than cooperation and productivity.
Degree of Operating Leverage (DOL)
can be used to quickly estimate what impact various percentage changes in sales will have on profits, without the necessity of preparing detailed contribution format income statements. the effects of operating leverage can be dramatic. -If a company is near its break-even point, then even small percentage increases in sales can yield large percentage increases in profits. (explains why management will often work very hard for only a small increase in sales volume.) EX) If the degree of operating leverage is 5, then a 6% increase in sales would translate into a 30% increase in profits.
High-Low Method Formula
change in cost / change in activity
Structuring Sales Commissions
companies usually compensate salespeople by paying them a commission based on sales, a salary, or a combination of the two. Commissions based on sales dollars can lead to lower profits. -the higher selling price and hence the larger commission. -from the standpoint of the company, profits will be greater if salespeople steer customers toward the cheaper model because it has the higher contribution margin.
master budget
consists of a number of separate but interdependent budgets that formally lay out the company's sales, production, and financial goals. -10 schedules contained in a master budget The master budget culminates in a cash budget, a budgeted income statement, and a budgeted balance sheet.
After completing Schedules 1-5
data he needed to compute the absorption unit product cost for the units produced during the budget year. This computation was needed for two reasons: 1. to help determine cost of goods sold on the budgeted income statement; 2. to value ending inventories on the budgeted balance sheet. The cost of unsold units is computed on the ending finished goods inventory budget.
Schedule 9: budgeted income statement
data in the beginning balance sheet and the data developed in Schedules 1- 8 one of the key schedules in the budget process. It shows the company's planned profit and serves as a benchmark against which subsequent company performance can be measured.
direct materials budget
details the raw materials that must be purchased to fulfill the production budget and to provide for adequate inventories. The required purchases of raw materials are computed as follows: Required production in units of finished goods XXX + Units of raw materials needed per unit of finished goods XXX = Units of raw materials needed to meet production XXX Add desired units of ending raw materials inventory XXX = Total units of raw materials needed XXX Less units of beginning raw materials inventory XXX = Units of raw materials to be purchased XXX + Unit cost of raw materials XXX = Cost of raw materials to be purchased XXX
contribution income statement
emphasizes the behavior of costs and therefore is extremely helpful to managers in judging the impact on profits of changes in selling price, cost, or volume. (would not ordinarily be made available to those outside the company.)
CVP
estimate how profits are affected by the following five factors: Selling prices. Sales volume. Unit variable costs. Total fixed costs. Mix of products sold.
Target profit analysis
estimate what sales volume is needed to achieve a specific target profit. we can rely on the same two approaches, the equation method or the formula method.
The final schedule of the master budget is the balance sheet
estimates a company's assets, liabilities, and stockholders' equity at the end of a budget period.
Purpose of Scattergraph
estimating costs to anticipate operating costs at different activity levels. result of a scattergraph analysis is a formula with the total amount of fixed cost and the variable cost per unit of activity.
Cost-volume-profit (CVP) analysis
helps managers make many important decisions such as what products and services to offer, what prices to charge, what marketing strategy to use, and what cost structure to maintain.
formula method
in a single product situation, we can compute the sales volume required to attain a specific target profit using the following formula: Unit sales to attain the target profit=Target profit+Fixed expensesUnit CM
Control
involves gathering feedback to ensure that the plan is being properly executed or modified as circumstances change.
Schedule 2: Production Budget
ists the number of units that must be produced to satisfy sales needs and to provide for the desired ending finished goods inventory. Production needs can be determined as follows: Budgeted unit sales XXX Add desired units of ending finished goods inventory XXX = Total needs XXX Less units of beginning finished goods inventory XXX = Required production in units XXX production requirements are influenced by the desired level of the ending finished goods inventory
Schedule 5: manufacturing overhead budget
lists all costs of production other than direct materials and direct labor.
Schedule 7: selling and administrative expense budget
lists the budgeted expenses for areas other than manufacturing. In large organizations, this budget would be a compilation of many smaller, individual budgets submitted by department heads and other persons responsible for selling and administrative expenses.
anticipated profit or loss at any given level of sales on CVP
measured by the vertical distance between the total revenue line (sales) and the total expense line (variable expense plus fixed expense).
estimate the effect of a planned increase in sales on profits
multiply the increase in units sold by the unit contribution margin. The result will be the expected increase in profits.
estimate the profit at any sales volume above the break-even point
multiply the number of units sold in excess of the break-even point by the unit contribution margin The result represents the anticipated profits for the period.
Bonuses
often based on meeting and exceeding budgets. -Typically, no bonus is paid unless the budget is met. -The bonus often increases when the budget target is exceeded, but the bonus is usually capped out at some level.
Operating budgets
ordinarily cover a one-year period corresponding to the company's fiscal year. -Many companies divide their budget year into four quarters. (The first quarter is then subdivided into months, and monthly budgets are developed.) = This approach has the advantage of requiring periodic review and reappraisal of budget data throughout the year.
The budgeted income statement
provides an estimate of net income for the budget period and it relies on information from the sales budget, ending finished goods inventory budget, selling and administrative expense budget, and the cash budget.
Sales mix
refers to the relative proportions in which a company's products are sold. The idea is to achieve the combination, or mix, that will yield the greatest profits. Most companies have many products, and often these products are not equally profitable. -Hence, profits will depend to some extent on the company's sales mix. -Profits will be greater if high-margin rather than low-margin items make up a relatively large proportion of total sales.
A loss on CVP
represented by the vertical distance between the total expense and total revenue lines) gets bigger as sales decline
Formula Method
shortcut version of the equation method. -simply skips a few steps in the equation method. It centers on the idea that each unit sold provides a certain amount of contribution margin that goes toward covering fixed expenses.
merchandise purchases budget
showing the amount of goods to be purchased from suppliers during the period. prepares a production budget because it is a manufacturing company. If it were a merchandising company, instead it would prepare a merchandise purchases Budgeted cost of goods sold XXX Add desired ending merchandise inventory XXX = Total needs XXX Less beginning merchandise inventory XXX = Required purchases XXX usually accompanied by a schedule of expected cash disbursements for merchandise purchases.
profit graph
simpler form of the CVP graph a linear equation, it plots as a single straight line
two "big picture" of Master Budgets
that the budget is designed to answer 10 key questions and that it is based on various estimates and assumptions help to understand why and how a master budget is created.
Contribution margin
the amount remaining from sales revenue after variable expenses have been deducted. -Thus, it is the amount available to cover fixed expenses and then to provide profits for the period. -used first to cover the fixed expenses, and then whatever remains goes toward profits. -If the contribution margin is not sufficient to cover the fixed expenses, then a loss occurs for the period.
Pressuring employees
the budget is too often used as a pressure device and excessive emphasis is placed on "meeting the budget" under all circumstances. Rather than being used as a weapon, the budget should be used as a positive instrument to assist in establishing goals, measuring operating results, and isolating areas that need attention.
operating leverage.
the choice of a cost structure better structure depends on many factors: long-run trend in sales, year-to-year fluctuations in the level of sales, and the attitude of the owners toward risk, etc. -it is not obvious which cost structure is better. Both have advantages and disadvantages.
A gain on CVP
the company earns a profit and the size of the profit (represented by the vertical distance between the total revenue and total expense lines) increases as sales increase.
if sales are zero
the company's loss would equal its fixed expenses. Each unit that is sold reduces the loss by the amount of the unit contribution margin. Once the break-even point has been reached, each additional unit sold increases the company's profit by the amount of the unit contribution margin.
CM ratio is particularly valuable in situations where:
the dollar sales of one product must be traded off against the dollar sales of another product. In this situation, products that yield the greatest amount of contribution margin per dollar of sales should be emphasized.
margin of safety
the excess of budgeted or actual sales dollars over the break-even volume of sales dollars. It is the amount by which sales can drop before losses are incurred. The higher the margin of safety, the lower the risk of not breaking even and incurring a loss.
break even point
the level of sales at which profit is zero. will show neither profit nor loss but just cover all of its costs Once the break-even point has been reached, net operating income will increase by the amount of the unit contribution margin for each additional unit sold.
What happens if actual results do not measure up to the budgeted goals?
the manager should take the initiative to understand the sources of significant favorable or unfavorable discrepancies, should take steps to correct unfavorable discrepancies and to exploit and replicate favorable discrepancies, and should be prepared to explain discrepancies and the steps taken to correct or exploit them to higher management.
To eliminate such conflicts, commissions can be based on contribution margin rather than on selling price.
the salespersons will want to sell the mix of products that maximizes contribution margin. Providing that fixed costs remain constant, maximizing the contribution margin will also maximize the company's profit. by maximizing their own compensation, salespersons will also maximize the company's profit.
sales budget influences
the variable portion of the selling and administrative expense budget and it feeds into the production budget, which defines how many units need to be produced during the budget period.
The break-even on PG
the volume of sales at which profit is zero and is indicated by the dashed line on the graph. -the profit steadily increases to the right of the break-even point as the sales volume increases -the loss becomes steadily worse to the left of the break-even point as the sales volume decreases.
incremental analysis
they consider only the costs and revenues that will change if the new program is implemented. Although in each case a new income statement could have been prepared, the incremental approach is simpler and more direct and focuses attention on the specific changes that would occur as a result of the decision.
The production budget use
to determine the direct materials, direct labor, and manufacturing overhead budgets a company has prepared these three manufacturing cost budgets, it can prepare the ending finished goods inventory budget.
point of an effective responsibility accounting system
to make sure that nothing "falls through the cracks," that the organization reacts quickly and appropriately to deviations from its plans, and that the organization learns from the feedback it gets by comparing budgeted goals to actual results. The point is not to penalize individuals for missing targets.
Preparing the CVP Graph
unit volume is represented on the = horizontal (X) axis dollars on the = vertical (Y) axis 1. Draw a line parallel to the volume axis to represent total fixed expense. 2. Choose some volume of unit sales and plot the point representing total expense (fixed and variable) at the sales volume you have selected. -After the point has been plotted, draw a line through it back to the point where the fixed expense line intersects the dollars axis. 3.choose some sales volume and plot the point representing total sales dollars at the activity level you have selected. -Draw a line to the origin
managers who have such a bonus plan or whose performance is evaluated based on meeting budget targets:
usually prefer to be evaluated based on highly achievable budgets. -may help build a manager's confidence -generate greater commitment to the budget -also reducing the likelihood that a manager will engage in undesirable behavior at the end of budgetary periods to secure bonus compensation.
the variable expense ratio
variable expenses as a percentage of sales Variable expense ratio= Variable expenses/Sales
The break-even point on CVP
where the total revenue and total expense lines cross.
first step in the budgeting process is preparing a sales budget
which is a detailed schedule showing the expected sales for the budget period. -An accurate sales budget is the key to the entire budgeting process -all other parts of the master budget depend on the sales budget. -If the sales budget is inaccurate, the rest of the budget will be inaccurate -The sales budget is based on the company's sales forecast
with its lower fixed costs and higher variable costs
will enjoy greater profit stability and will be more protected from losses during bad years, but at the cost of lower net operating income in good years.
higher fixed costs and lower variable costs
will experience wider swings in net operating income as sales fluctuate, with greater profits in good years and greater losses in bad years.
Chapter Five
Cost-volume-profit (CVP) Relationships
Cost structure
refers to the relative proportion of fixed and variable costs in an organization. Managers often have some latitude in trading of between these two types of costs.
cost-volume-profit (CVP) graph
relationships among revenue, cost, profit, and volume are illustrated -highlights CVP relationships over wide ranges of activity (sometimes called a break-even chart)
break-even point in dollar sales using three methods
1. solve for the break-even point in unit sales using the equation method or formula method and then simply multiply the result by the selling price. 2. use the equation method to compute the break-even point in dollar sales. 3. use the formula method to compute the dollar sales needed to break even as shown below: Dollar sales to break even= Fixed expenses/CM ratio break-even point in dollar sales is the same under all three methods
degree of operating leverage at a given level of sales is computed by the following formula:
Degree of operating leverage= Contribution margin/Net operating income The degree of operating leverage is a measure, at a given level of sales, of how a percentage change in sales volume will affect profits. The degree of operating leverage is not a constant; it is greatest at sales levels near the break-even point and decreases as sales and profits rise.
simple profit equation in terms of the unit contribution margin (Unit CM)
Profit=UnitCM×Q−Fixed expenses -Unit CM Profit= Selling price per unit−Variable expenses per unit=P−V -Profit= (P×Q−V×Q)−Fixed expenses -Profit= (P−V)×Q−Fixed expenses
lever
a tool for multiplying force.
the contribution margin ratio (CM ratio)
contribution margin as a percentage of sales -hows how the contribution margin will be affected by a change in total sales. CM ratio =Contribution margin/Sales
Planning
involves developing goals and preparing various budgets to achieve those goals.
calculate the break-even point (in unit sales and dollar sales)
managers can use either of two approaches, the equation method or the formula method.
Equation Method
the only difference between this equation and the equation used for break-even calculation is the profit figure. In the break-even scenario, the profit is $0, whereas in the target profit scenario the profit is x (ex)$40,000.)
profit
to stand for net operating income in equations.