Chapter 2: Cost-Volume-Profit

Profit Equation

(Price × Units) - (Unit variable cost × Units) - Fixed cost

The Degree of Operating Leverage: (3)

1. Is not a constant 2. Is greatest at sales levels near the break-even point 3. Decreases as sales and profits rise

Cost Structure and Profit Stability Cost Structure depends on many factors such as: (3)

1. The long-run trend in sales 2. Year-to-year fluctuations in the level of sales 3. The attitude of the owners toward risk

Break-Even Percentage

= Fixed Expenses / Total CM x 100

Profit graph

A graph that shows how profits vary with changes in volume depending in sales

CVP graph

A graphical representation of the relationships between an organization's revenues, costs, and profits on the one hand and its sales volume on the other hand.

Degree of Operating Leverage

A measure, at a given level of sales, of how a percentage change in sales will affect profits. The _________ of _________ ____________ is computed by dividing contribution margin by net operating income.

Equation Method

A method of computing break-even sales using the contribution margin form to break-even calculations

Formula method

A method of setting claim reserves by using a mathematical formula using CM ratio as a divisor

CM Ratio

A ratio computed by dividing contribution margin by dollar sales

Margin of safety

Actual/Budgeted Sales - Break-even sales the units sold or expected to be sold or the revenue earned or expected to be earned above the break-even volume. excess of budgeted or actual dollar sales over the break-even dollar sales

From Income Statement Total Sales Less: Total Variable Costs = Contribution Margin Less: Total Fixed Costs = Operating Income

Basic Formula Selling price/unit x number of units - Variable cost/unit x number of units = CM/ unit x number of units - Fixed costs = Operating income SQ - VQ = CmQ - F = Oi

Break-Even Point in Units for the Multiple-Product Setting

Break-even sales = Fixed Costs/Weighted Average Contribution Margin Ratio

1. Selling prices 2. Sales Volume 3. Unit variable costs 4. Total Fixed Costs 5. Mix of Products sold

Factors in which profits are affected (5):

Break-even point in sales revenue

Fixed cost/Contribution margin ratio

The company with the higher fixed costs in its cost structure will have __________ operating leverage.

Higher

The mix of products

Is offered to the consumer by the retailer; also called the product assortment or merchandise mix

Margin of Safety percentage

Margin of safety in units/ Actual or estimated units Margin of safety in $/ Actual or estimated sales $

Sales revenue

Price × Units sold

Contribution margin

Ratio of the total contribution margin to total sales to estimate change in total sales would have on net operating income.

Contribution Margin Equation

Selling Price per unit - Variable Cost per unit

Units to breakeven

TFC/CM

21-4. Which of the following would not be an element of factory overhead? a. salary of a marketing manager b. amortization on the maintenance equipment c. salary of the plant supervisor d. property taxes on the plant buildings

The correct answer is "a". The marketing function is not directly related to the manufacturing function; all of the other costs are elements of factory overhead.

21-13. Which of the following is a period cost? a. direct materials b. indirect materials c. factory utilities d. administrative expenses

The correct answer is "d". Administrative costs are not directly related to the manufacturing function.

- The variable portion of mixed cost - Varies

The cost incurred for actual consumption of the service, thus it ________ in proportion to the amount of service actually consumed.

Break-even point

The level of sales at which profit is zero

The Fixed portion of mixed cost

The minimum cost of having a service ready and available for use.

Break-even point in units

Total Fixed cost/ Contribution Margin (Price - Unit variable cost)

Operating leverage

a measure of how sensitive net operating income is to a given percentage change in dollar sales. --> The higher degree the greater impact on company's profit

break-even analysis

a method of determining what sales volume must be reached before total revenue equals total costs unit sales to break even estimated by dividing the fixed expense by the unit contribution margin

Variable expense ratio

a ratio computed by dividing variable expenses by dollar sales

Margin of Safety in $

actual or estimated sales $ - BEP in sales $

Margin of Safety in units

actual or estimated units of activity - BEP in units

Total Fixed Costs

all the expenses that remain the same no matter how many products are made or sold

Incremental analysis

an analytical approach that focuses only on those costs and revenues that change as a result of a decision

Target profit analysis

estimating what sales volume is needed to achieve a specific target profit. total target profit + fixed expense divided by unit contribution margin

Direct fixed expenses

fixed costs that can be traced to each segment and would be avoided if the segment did not exist

Measure of risk

margin of safety

contribution margin (per unit)

price - variable cost Used extensively in CVP analysis. The amount of revenue remaining after deducting all variable costs (including variable production, selling & administrative costs) The amount left to cover fixed costs & "contribute" to net income.

Sales mix

relative combination of products being sold by a firm by expressing the sales of each product as a percentage of total sales Defining a particular sales mix allows us to convert a multiple-product problem to a single-product CVP format

Margin of Safety

the excess of budgeted or actual sales over the break-even sales

sales mix

the relative percentage in which a company sells its multiple products. It's changes can affect the break-even point, margin of safety, and the other critical factors.

Target profit break-even sales in units

total fixed cost + Target Profit/contribution margin

sales revenue for target profit

total fixed cost + target profit/contribution margin ratio

variable cost per unit

total variable costs/units

Unit variable costs

variable cost expressed on a per unit basis for a product, Variable Costs/Total Volume

The sales mix should be stated as a proportion of total revenues

when performing CVP calculations in sales $.