3/31 Lecture Notes - MA Mod 4

What are fixed costs?

• Costs that in total don’t change regardless of change in volume (quantity of units, output)

What is true about total FC?

• remain constant at every level of activity 

What is true about per unit FC?

•  vary inversely with the level of activity

What are some examples of fixed costs?

•  rent, S-L depreciation, insurance, property taxes, executive salaries

What is true about total VC?

• vary directly in proportion to changes in activity level

What is true about per unit VC?

•  remain constant at every level of activity 

What are some examples of variable costs?

•  direct materials, direct labor, indirect materials 

How do you find total costs?

• Total FC + (VC per unit * #units)

How is a traditional income statement set up? What is it used for?

• order is: sales revenue, COGS, gross profit, selling general and admin expenses, and income/loss

• is used for external reporting purposes; organized by manufacturing vs. non-manufacturing costs 

How do you find total contribution margin (CM)?

• Total Revenues (Sales) - total variable costs

• represents amount available to cover the firm’s fixed costs

How do you find CM per unit?

• price (P) per unit - variable cost (VC) per unit

What does contribution margin per unit represent?

• for every additional unit you produce and sell, how much does that 1 unit contribute towards profit

• anyway of saying it: tells a manager how much each unit sold will add towards net income

How is contribution margin income statement set up? What is it used by?

• order is: sales revenue, all variable costs, contribution margin, all fixed costs, income/loss

• used internally only; organized by ‘cost behavior’ 

How do you find net operating income (net income)?

• contribution margin - all fixed costs

How do you find price per unit?

• sales/quantity

When solving for break-even point what variable do we know?

• net-income = 0

What is the cost profit analysis equation?

•  Income = Q* (P per unit - VC per unit) - FC

What is true about the units found using cost profit analysis?

• always round up

What to remember when you are doing the calculations?

• make sure to include all variable costs and all fixed costs

What are the key assumptions to know about CVP analysis?

• constant selling price, price per unit, costs easily divided into variable and fixed components, typical cost behavior, units produced=units sold, product mix remains constant

What ways can we use to estimate fixed and variable cost components?

• scatter diagram

• high-low method

• regression

What are the steps taken for the scatter diagram method?

• plot data points and add line of fit

• y-intercept = estimated FC component of TC

• calculate slope using any 2 data points, represents variable cost per unit which is multiped by # of units to get the total variable cost component of TC

What is the high-low method?

• identity highest level of activity and lowest level of activity

• use 2 data points to calculate slope of the estimated line of fit to find variable cost per unit

• then pick one of 2 data points to plug into cost equation to find FC

What is the regression method (that is used on excel)?

• creates a graph and then a summary output which includes intercept and x variable 1 (parts of the coefficient)

• The intercept will be the FC component

• The x variable 1 will be the VC component

How to make a scatter diagram on excel?

• highlight data points, inset, XY scatter chart

• add trendline: chart design on meny bar, add chart element, trendline, linear

• chart design, add chart element, trendline, more trendline options, display equation on chart

How to do regression analysis on excel?

• highlight data, menu-bar Data, Data Analysis, Regression, ok

• look at coefficients

• intercept: represents fixed costs in cost equation

• x variable 1: per unit variable cost, our slope

How do you find contribution margin ratio?

• contribution margin / revenues

• tells the manager what % of a firm’s sales the contribution margin is

• represents % that any given change in dollar sales will add to contribution margin, and thus net income

How do you find break-even point using a formula? - units

• BEP = FC/ cm per unit

How do you find break-even point using a formula? - sales

BEP = FC/ cm ratio

How do you find break-even point using a CVP graph?

• plot revenue line using sales data and plot total cost line using a total cost equation based on VC and FC

• intersection of 2 lines is break even point

How to your create a CVP chart in excel?

• highlight TC and TR columns, menu-bar insert, line chart

• make vertical category in chart to currency

• x-axis, select data, series 1, name (click on column name)

How do you do target profit analysis using a contribution margin income statement?

• use the formula sales-VC=CM-FC=net income

• focus specifically on CM-FC=net income part to find units to achieve target profit

What is the formula to find sales?

• quantity * price

What is another way to CM?

• quantity * CM per unit

What is another way to find VC?

• quantity * VC per unit

How do you use a formula to do target profit analysis? - units

• units to achieve target = (target + FC) / cm per unit

How do you use a formula to do target profit analysis? - dollar sales

• dollar sales to achieve target = (target + FC)/ cm ratio

What is the relationship between VC and CM?

• if VC goes down. CM goes up (by same amount)

How do we compare initial and new net income?

• formula: sales - VC = CM - FC = net income

• sales (Q * P)

• VC= (Q* VC per unit)

• CM = (Q* CM per unit)

What is sales mix?

• sales mix is the relative percentage of total sales of each product

• in CVP analysis, we assume that sales mix is known and is constant during the period

What do we do to find break even when there are multiple products?

• use the weighted average CM method (WACM)

What is the WACM formula or basic set up?

• WACM = (CM per unit, 1 sales mix 1) + (CM per unit, 2 sales mix 2) + …..

• do this however many units

How do you find break even point using WACM?

• FC / WACM per unit