Acct 230- Chapter 6: Cost-Volume-Profit Relationships

The measure of how sensitive net operating income is to a given percentage change in volume sales is called _______. sensitivity leverage operating leverage risk leverage

operating leverage

Atlas Corporation sells 100 bicycles during a month. The contribution margin per bicycle is $200. The monthly fixed expenses are $8,000. What is the profit from the sale of 100 bicycles? $12,000 $10,000 $20,000 $8,000

$12,000 Net operating income = Contribution margin of $20,000 (or 100 units × Unit contribution margin of $200 per unit) − Fixed expenses of $8,000 = $12,000.

Atlas Corporation sells 100 bicycles during a month at a price of $500 per unit. The variable expenses amount to $300 per bicycle. How much does profit increase if it sells one more bicycle? $500 $300 $200 $20,200

$200 Unit Contribution Margin = Selling price per unit of $500 − Variable expenses per unit of $300 = $200.

Taylor Company has current sales of 1,000 units, at a selling price of $190 per unit, variable costs per unit of $76, and fixed expenses of $96,000. The company believes sales will increase by 300 units, if the company introduces sales commissions as an incentive for the sales staff. The change will decrease the selling price to $175 per unit, increase variable cost per unit to $100, and decrease fixed expenses by $20,000. What is the net operating income after the changes? $21,500 $30,000 $24,

$21,500

Future Corporation has a single product; the product selling price is $100 and variable costs are $60. The company's fixed expenses are $10,000. What is the company's break-even point in sales dollars? $25,000 $2,500 $250 $16,667

$25,000

Walton Corporation is currently selling 104 units of its product. The company is deciding the price that it should charge for a bulk order of 40 units. The variable cost per unit is $200. This order will not involve any additional fixed costs and the company's current sales will not be affected. The company targets a profit of $4,000 on the bulk order. What selling price per unit should the company quote for the bulk order?

$300

Percent change in Net Op. Income

% Change in Sales * Degree of Op. Leverage

Least-Squares/Regression Method

(Most accurate) - Use a mathematical model to minimize deviations to determine the variable and fixed component of a cost - Estimates fixed and variable elements of a mix cost

Contribution Margin Income Stmt

- Classifies as variable or fixed and computes contribution margin Rev/sales - Variable Costs = Contrib. Marg.

CVP analysis considers the inherent interrelationships among the following:

- Volume or level of activity - Unit selling prices - Variable cost per unit - Total fixed costs - Sales mix

Contrabution Margin

- the amount of sales remaining after variable expenses have been deducted ***the amt that remains to cover fixed costs and generate a profit*** - total amt, ratio, or a per unit amt

4 methods for analyzing cost behavior

1. Account Analysis 2. Scattergraph Method 3. High-Low Method 4. Least-Squares/Regression Method

Assumptions underlying CVP analysis

1. Costs and revenues are linear throughout the relevant range (i.e. our cost definitions hold true) 2. Costs can be classified as either variable or fixed with reasonable accuracy 3. All units produced are sold 4. Sales mix will remain constant

Frank Corporation has a single product. Its selling price is $80 and the variable costs are $30. The company's fixed expenses are $5,000. What is the company's break-even point in unit sales? 63 units 167 units 50 units 100 units

100 units

Winter Corporation's current sales are $500,000. The contribution margin is $300,000 and the net operating income is $100,000. What is the company's degree of operating leverage? 3.00 0.60 2.00 1.67

3.00

Cartier Corporation currently sells its products for $50 per unit. The company's variable costs are $20 per unit. Fixed expenses amount to a total of $5,000 per month. What is the company's variable cost ratio? 40% 60% 100% 20%

40%

Cartier Corporation currently sells its products for $50 per unit. The company's variable costs are $20 per unit. Fixed expenses amount to a total of $5,000 per month. What is the company's contribution margin ratio? 40% 60% Correct 100% 20%

60%

The current sales of Trent, Incorporated, are $400,000, with a contribution margin of $200,000. The company's degree of operating leverage is 2. If the company anticipates a 30% increase in sales, what is the percentage change in net operating income for Trent, Incorporated? 24% 30% 60% 25%

60%

When a company's sales revenue is increasing, high operating leverage is good because it means that profits will ....

increase Rapidly

Which of the following methods do managers use to estimate the fixed and variable components of mixed costs by analyzing past records of cost and activity data? scattergraph account analysis least-squares regression

least-squares regression

Which of the following methods do managers use to estimate the fixed and variable components of mixed costs by analyzing past records of cost and activity data? scattergraph account analysis least-squares regression

least-squares regression

Contribution margin equals ________. sales minus fixed cost fixed cost minus variable cost sales minus variable cost minus fixed cost sales minus variable cost

sales minus variable cost

Why is sales mix important to managers?

some products are more profitable than others

What makes up 100% of sales?

Contribution Margin Ratio + Variable Cost Ratio

Contribution Margin Ratio

Contribution margin per unit / sales **OR** Total Contribution Margin/ Total Sales $

Margin of Safety (formula)

Expected/Actual Sales - Breakeven Sales

Companies with high fixed costs relative to variable cost have...

High operating leverage/ high earnings volatility

Margin of Safety Ratio

Margin of Safety / Expected or Actual Sales

To determine required sales for EACH PRODUCT (in sales mix)

Multiply by % of sales contributed from each product Sales $ * Product Mix

Scattergraph Method

Plot historical observations for cost and activity; then fit a line to the point so as to minimize deviations y = cost & x = activity

CVP Analysis: Equation method

Rev - VC - FC = Desired Profit SP(x) - VC/unit (x) - Total FC = Desired Profit

Sales Mix in CVP calculations: Break-even

Sale $ = (Total FC + Desired Profit)/ Overall CM Ratio

Traditional Income stmt (product/period format)

Sales - COGS (product) = Gross Margin - Operating expenses (period) = Net op. Income

Contribution Margin Income Stmt (variable/fixed format)

Sales - Variable costs (product & period) = Cont. Marg. - Fixed exp (product & period) = Net op Income

CVP Analysis: Contribution Margin Ratio Approach

Sales $ = (Total FC + Desired Profit) / CM%

Cost-Volume-Profit Analysis

The study of effects of changes in costs and volume on a company's profits - important for short term profit planning - useful in setting policies, determining product mix, and maximizing use of production facilities

Degree of Operating Leverage

Total Contribution Margin/ Net Income

Equation for a cost line

Total Cost = Total VC + Total FC **OR** Total cost - (VC/unit of activity * activity) + Total FC

Total Contribution Margin

Total Sales - Total Variable Costs

Contribution Margin per Unit

Unit selling price - unit variable costs

Variable Cost Ratio

Variable Cost per unit / sales **OR** Total Variable Cost/ Total Sales $

Account Analysis

determine behavior based on the analyst's prior knowledge about how costs behave--- limited value

A shift in the sales mix from high-margin items to low-margin items can cause total profit to ________. decrease increase remain the same

decrease

However, when sales are declining, too much operating leverage will cause profits to....

decrease Rapidly

Break-even point is the level of sales at which ______. total profits equals total costs total profits exceed total costs total revenue equals total costs total sales equal total projections

total revenue equals total costs

Once the break-even point has been reached, net operating income will increase by the amount of the _____ for each additional unit sold. unit contribution margin unit selling price variable expense per unit fixed expense per unit

unit contribution margin

Analyzing cost behavior

Accountants usually assume that costs are strictly linear; however, economists point out that many costs are actually curvilinear. BUT within a narrow range of activity known as the relevant range, assumption is that a cost can be APPROXIMATED by a straight line.

Sensitivity Analysis

Analysis of the effect of a change in a variable on profit ("what if analysis)

Target Net Income

The profit objective for the company or an individual segment Units: (T prof. + F. exp)/Units CM Sales Dollar: (T. prof + F. exp)/ CM% - ex. 10% more profit than last year; 10% of sales

Operating Leverage

The degree to which a company's net income reacts to a change in sales; provides a measure of the company's earnings volatility

Margin of Safety

The difference between the actual or expected sales and breakeven sales

Breakeven Point

The level of sales where the company will realize no incoe and will suffer no loss (rev = expenses, profit = 0) Profit (0) = SP(x) - VC (x) - FC Unit: Fixed exp/ unit CM Sales dollar: Fixed exp/ CM%

Sales Mix

The relative proportion in which each product is sold (when company sells more than one product)

Cost structure

The relative proportion of fixed versus variable costs that a company incurs-- cost structure can have a significant effect on a company

High-Low Method

Uses formulas and historical or projected info to calculate the variable and fixed components of cost 1. Calculate the VC per unit of Activity (High cost - Low cost) / (High activity - Low Activity) 2. Use Total Cost formula to sole for Total FC Total cost = (VC/Unit * # Units) + Total FC

CVP Analysis: Contribution Margin (Formula) Method

X *units* = (Total FC + Desired Profit)/ CM per unit