Accounting 202: Chapter 20

Effect of margin of safety

(actual sales - break-even sales) / actual sales = margin of safety ratio

Determining sales mix with limited resources

- all companies have limited resources whether it be flour space, raw materials, direct labor hours, etc. - management must decide which products to sell to maximize net income 1. calculate the contribution margin per unit of limited resource 2. calculate to increase machine usage

Theory of constraints: sales mix with limited resources

- approach used to identify and manage constraints so as to achieve company goals - a company must continually: identify constraints and find ways to reduce or eliminate them, when appropriate

Decision Making concerns

- generally accepted accounting principles require that absorption be used for the costing of inventory for external reporting purposes - net income measured under GAAP (absorption costing) is often used internally to: evaluate performance, justify cost reductions, or evaluate new projects - companies have recognized that net income calculated using GAAP does not highlight differences between variable and fixed costs and may lead to poor business decisions

Basic Concepts

- management often wants the information reported in a special format income statement - CVP income statement is for internal use only 1. cost and expenses are classified as fixed or variable 2. reports contribution margin as a total amount and on a per unit basis (net income)

Potential Advantages of variable costing

- use of variable cost is consistent with CVP anaylsis - net income under variable costing is unaffected by changes in production level. Tied to changes in sales - presentation of fixed costs in the variable costing approach makes it easier to identify fixed cost and to evaluate their impact on the company's profitability

Break-even sales in dollars:

- works well if a company has many products - calculates breakeven point in terms of sales dollars for: division, product lines, not individual products

Steps for Break-even sales in units;

1. determine the weighted average contribution margin formula: (unit contribution margin x sales mix %) + (unit contribution margin x sales mix %) = weighted average contribution margin 2. use the weighted average unit contribution margin to compute the break-even points in units: formula: fixed costs / weighted average unit contribution margin = Break-even point in units

Steps for break-even sales in dollars:

1. determine the weighted-average contribution margin forumla: (unit contribution margin x sales mix %) + (unit contribution margin x sales mix %) = weighted average contribution margin 2. Calculate break-even point in dollars forumla: fixed costs / weighted-average unit contribution margin ratio = break-even point in sales dollars

Break-even analysis

1. fixed costs/unit contribution margin = Creak-even point in units 2. Fixed costs / contribution margion ratio = Break-even point in sales dollars

_____ margin will equal the ___ cost

Contribution; Fixed

Effects of contribution margin ratio

contribution margin / sales = contribution margin ratio

When sales revenue are ____, to much operating leverage can have devestating consequences

declining

With Break-even point in units you can:

determine how much of an item you have to sell

Absorb and variable costing:

differences: between absorption and variable costing 1. absorption from fixed MOH is a product cost variable from fixed MOH is a period cost Similarities: 2. under both costing methods, selling and administrative expenses are treated as period cost 3. companies financial reports because GAAP requires that fixed MOH be treated as a product cost

Operating Leverage

extent that net income reacts to a given change in sales - higher fixed cost relative to variable costs cause a company to have higher operating leverage

Calculate Break-even point

fixed costs/ contribution margin ratio = break-even point in sales dollars

1. Calculate the contribution margin per unit of limited resouces

formula: contribution margin per unit / machiene hours required = contribution maargin per unit of limited resource

When sales revenue are _____, high operating leverage means that profits will increase

increasing

2. Calculate to increase machine usage

machine hours x contribution margin per unit of limited resources = contribution margin

Target Net income

once the company achieves break-even sales a sales goal can be set that will result in a target net income 1. (fixed costs + target net income) / unit contribution margin = required sales in units 2. (fixed costs + target net income) / controbution margin ratio = reqired sales in sales dollars

Degree of operating leverage

provides a measure of a company's earnings volatility - computed by dividing total contribution margin by net income formula; contribution margin / net income = degree of operating leverage

Sales Mix

relative percentage in which a company sells its products - its important because different products often have very different contribution margins ex. 1. if a company's unit sales are 80% printers and 20% computers, its sale mix is 80% to 20%

Cost structure

relative proportion of fixed versus variable cost that a company incurs - may have a significant effect on profitability - company must carefully choose its cost structure

CVP Analysis

study of the effects of changes in cost and volume on a company's profit - important to profit planning - critical in management decisions such as: determining product mix, maximizing use of production facilities, setting selling price

Margin of Safety

tells us how far sales can drop before the company will operate a loss - can be expressed in units or dollars 1. actual (expected) sales - break-even sales = margin safety in sales dollars 2. margin in safety dollars - actual (expected) sales = margin safety in units

Under______ costing, product cost consist of: direct materials, direct labor, and variable manufactuing overhead

Variable

Companies can compute brea-even sales for a mix of two or more products by determining the ________ ______ _____ _____ of all the products ex. Total - 2,000 units 500 units go to TV 1,500 units go to camcorder tv: 500/2,000 = 25% camcorder: 1500/2000 = 75%

Weighted-average unit contribution margin