Accounting for Managers - Ch. 12 PP

Typical Fixed Costs:

- Property taxes - Insurance - Supervisory salaries - Depreciation expense - Advertising

Breakeven Point

The breakeven point is expressed as the amount of revenue that must be realized for the firm (or product or activity or group of products or activities) to have neither profit nor loss (i.e., operating income equal to zero). - The contribution margin model is used to determine the breakeven point by setting operating income equal to zero and solving the model for the revenue or physical sales volume that will cause that result.

Financial Accounting

has more of a scorekeeping, historical orientation that provides information to owners and others outside the organization.

The Traditional Format vs. Contribution Margin Format:

Both formats report the same operating income! - Use of the traditional income statement model can result in misleading and erroneous conclusions when changes in activity levels are being considered

Relationship of Total Cost to Volume of Activity

Describes the cost behavior pattern. ---> Costs will react to changes in the level of business activity. - Total variable costs change when the volume of activity changes. - Total fixed costs remain unchanged when the volume of activity changes.

Fixed Costs and the Relevant Range

Examining fixed costs and the relevant range indicates that total cost doesn't change for a wide range of activity, but then jumps to a new higher cost for the next higher range of activity.

Contribution Margin Ratio

It is the ratio of contribution margin to revenues. - This ratio can then be used to calculate directly the change in contribution margin given a change in revenues.

Margin of Safety Ratio =

Margin of Safety / Total Sales

Estimating Cost Behavior Patterns

One analytical technique involves using a scattergram to identify high and low cost-to-volume data relationships; then simple arithmetic is used to compute the variable cost per unit and total fixed cost which may then be combined into a cost formula

Cost Behavior Patterns: The Key

Recall the two simplifying assumptions that are made in connection with the determination of cost behavior patterns: ---> First, the behavior pattern is true only within a relevant range of activity; if activity moves out of the relevant range, the cost will change. ---> Second, the cost behavior pattern identified is assumed to be linear within the relevant range, not curvilinear.

The High-Low Method

- The High-Low Method of calculating the variable cost behavior pattern, or variable cost rate, relates the change in cost to the change in activity, using the highest and lowest relevant observations. Variable Rate = (High Cost - Low Cost) / (High Activity - Low Activity) - With the variable rate known, the fixed cost element can then be developed because total cost is equal to variable cost plus fixed cost.

The Management Process

Planning is a key part of the management process; and although there are many descriptions of that process, a generally acceptable definition would include reference to the process of planning, organizing, and controlling an entity's activities so that the organization can achieve its desired outcomes. - A general model suggests that control is achieved through feedback. ---> Actual results are compared to planned results; if a difference exists between the two, then either the plan or the actions, or perhaps both, are changed. ---> Management decision making occurs in each phase of the planning and control cycle using information provided by the accounting information system in an effort to continuously improve organizational performance.

Traditional Income Statement Format

The traditional income statement format is used for external reporting purposes. - It emphasizes expenses classified by function. - Based on the traditional format, cost of goods sold is subtracted from revenue to arrive at gross profit. - Operating expenses are subtracted from gross profit to arrive at operating income.

Margin of Safety =

Total Sales - Breakeven Sales

Break Even Point Analysis:

Volume in Units at Breakeven = Fixed Expenses / Contribution Margin Per Unit Total Revenues at Breakeven = Fixed Expenses / Contribution Margin Ratio Volume in Units at Breakeven = Total Revenues Required / Revenue Per Unit Volume in Units for Desired Level of Operating income = (Fixed Expenses + Desired Operating Income) / Contribution Margin Per Unit Total Revenues for Desired Level of Operating Income = (Fixed Expenses + Desired Operating Income) / Contribution Margin Ratio

Margin of Safety

a relative measure of risk that describes a company's current sales performance in relation to its breakeven sales.

Managerial Accounting

accounting supports the internal future-oriented planning decisions made by management.

Managerial Accounting versus Financial Accounting

- Managerial accounting is used internally by managers. ----> It concentrates on the present and the future for planning and control. ---> Its breadth of concern is micro, covering individual units of the organization. ---> Control reports are issued frequently and promptly in managerial accounting. ---> In this form of accounting, reasonable accurate and relevant data are required, and no reporting standards are imposed. - Financial accounting's service perspective is external in nature. ---> It concentrates on historical data. ---> Its breadth of concern is macro, covering the entire organization. ---> Financial accounting is reported monthly, a week or more after month-end. ---> In this form of accounting, reliability is very important, and high accuracy of data is desired. ---> The reporting standards for financial accounting are established by GAAP and the FASB.

Typical variable costs:

- Raw materials - Direct labor - Factory utilities - Sales commissions - Shipping costs

Multiple Products or Services and Sales Mix Considerations

- Sales mix refers to the relative proportion of total sales accounted for by different products or services. - Different products have different selling prices, costs, and contribution margins. - A change in the sales mix will result in a different total contribution margin ratio.

Contribution Margin Income Statement Format

The contribution margin format is used primarily by management. - It emphasizes expenses classified by cost behavior. - Based on the contribution format, variable expenses are subtracted from revenues to arrive at contribution margin. - Fixed expenses are subtracted from contribution margin to arrive at operating income. - The contribution margin format derives its name from the difference between revenues and variable expenses. - Contribution margin means that this amount is the contribution to fixed expenses and operating income from the sale of products or provision of services. ---> The key to this concept lies in understanding cost behavior patterns. ---> As revenues increase as a result of selling more products or providing more services, variable expenses will increase proportionately, and so will contribution margin. ---> However, fixed expenses will not increase because they are not a function of the level of revenue-generating activity.

Cost Formula:

Total Cost = Fixed Cost + Variable Cost Total Cost = Fixed Cost + (Variable Rate Per Unit of Activity x Number Units of Activity)

Cost Behavior Patterns

- The fixed or variable label refers to the behavior of total cost relative to a change in activity. - When referring to the behavior of unit costs, however, the labels may be confusing because variable costs are constant if expressed on a per unit basis, but fixed costs per unit will change as the level of activity changes. - Thus, it is necessary to understand the behavior pattern on both a total cost basis and a per unit basis as illustrated. ---> Variable costs change in total as activity changes but are constant on a per unit basis. ---> Fixed costs do not change in total as activity changes but will vary if expressed on a per unit of activity basis. - Some costs are partly fixed and partly variable. Sometimes costs with this mixed behavior pattern are called semivariable costs. ---> Analytical techniques can break this type of cost into its fixed and variable components, and a cost formula can be developed. - Great care must be taken with the use of fixed cost per unit data because any change in the volume of activity will change the per unit cost. ---> . As a general rule, do not unitize fixed expenses because they do not behave on a per unit basis! Sometimes fixed costs must be unitized, as in the development of a predetermined overhead application rate. It is also important to recognize that the relevant range is often quite wide, and significant increases in activity can be achieved without increasing fixed costs.

Operating Leverage

- When an entity's revenues change because the volume of activity changes, variable expenses and contribution margin will change proportionately. ---> But the presence of fixed expenses, which do not change as the volume of activity changes, means that operating income will change proportionately more than the change in revenues. - This magnification of the effect on operating income resulting from a change in revenue is called "operating leverage." - Operating leverage is a measure of how sensitive net income is to percentage changes in sales. ---> With high leverage, a small percentage increase in revenue can produce a much larger percentage increase in income.