ACC 220 Exam 3 Valerie Simmons

Define fixed cost

-costs that remain the same in total regardless of changes in the activity level

-fixed costs per unit vary inversely with activity: As volume increases, unit cost declines, and vice versa

incremental

The amounts in the net income column for revenues or costs

Define opportunity cost

A potential benefit (lost income) that may be obtained from following an alternative course of action

Define mixed cost

-are costs that contain both a variable- and a fixed-cost element

-Mixed costs, therefore, change in total but not proportionately with changes in the activity level

CVP Income Statement Components

Sales

-Variable Costs

=Contribution Margin

-Fixed Costs

=Net Income

Formula for unit contribution margin

Unit selling price - Unit variable costs = Unit contribution margin

Mathematical equation to find break even point in DOLLARS

Fixed costs / Contribution margin ratio

Define cost volume profit graph

A graph showing the relationship between costs, volume, and profits.

Define target net income

Income objective set by management

Mathematical equation to find target net income DOLLARS

Required sales - variable costs - fixed costs = TNI

Define Margin of safety

-difference between actual or expected sales and sales at the break-even point

-It measures the "cushion" that a particular level of sales provides.

-It tells us how far sales could fall before the company begins operating at a loss.

Mathematical equation margin of safety in DOLLARS

Actual (expected) sales - break even sales

The higher the dollars or the percentage

the greater the margin of safety

Steps in decision making process

1) Identify problem and assign responsibility

2) Determine and evaluate possible courses of action

3) Make a decision

4) Review results

Formula for net income

Revenues - expenses

2 assumptions with accepting an order at a special price

1) Sales of products in other markets would not be affected (Usually customer is FOREIGN)

2) The company is NOT operating at full capacity

Buying from an outside source

outsourcing

Decision rule make or buy decision

Buy is the cost of buying is less than the cost to make

Decision rule sell or process further

Process further as long as the incremental revenue from such processing exceeds the incremental processing costs

Key for making sell or process further decision

ADD the cost to process further in the SELL Column

Define cost behavior analysis

the study of how specific costs respond to changes in the level of business activity

Define variable cost

-are costs that vary in total directly and proportionately with changes in the activity level

-remains the same per unit at every level of activity

-if level of activity doubles, variable cost doubles

Examples of variable costs

-direct materials

-direct labor

-COGS

-sales commissions

-freight out

-gasoline

Examples of fixed costs

-property taxes

-insurance

-rent

-supervisor salary

-depreciation

Example of mixed cost

The rental of a U-Haul truck is a good example of a mixed cost. Assume that local rental terms for a 17-foot truck, including insurance, are $50 per day plus 50 cents per mile. When determining the cost of a one-day rental, the per day charge is a fixed cost (with respect to miles driven), whereas the mileage charge is a variable cost.

Define relevant range

The range over which a company expects to operate during a year

Define Contribution Margin

the amount of revenue remaining after deducting variable costs.

Formula contribution margin ratio

Unit contribution margin / unit selling price = Contrition margin ratio

Define break even point

The level of activity where total revenues equal total costs (variable plus fixed)

What are the 3 ways that the break even point can be calculated?

1. Computed from a mathematical equation.

2. Computed by using contribution margin.

3. Derived from a cost-volume-profit (CVP) graph.

Mathematical equation to find break even point

net income set to 0

Required Sales - Variable Costs - Fixed Costs = Net Income of 0

Mathematical equation to find break even point in UNITS

Fixed costs / Unit contribution margin

What is recorded on horizontal axis of CVP graph?

Sales volume

-This axis should extend to the maximum level of expected sales

What is recorded on the vertical axis of CVP graph?

Both total revenues (sales) and total costs (fixed plus variable)

-Dollars

Mathematical equation to find target net income by UNITS

(Fixed costs + Target net income) / Unit contribution margin = Required sales in units

Mathematical equation margin of safety ratio

Margin of safety in dollars / Actual (expected) sales = ratio

Example: A margin of safety ratio of 33% means

that the company's sales could fall by 33% before it operates at a loss.

Define incremental analysis

Process used to identify the financial data that change under alternative courses of action

-helps management decision making process

-focus on the differences between two courses of action

Incremental analysis identifies the probable effects of decisions on

future earnings

-estimate

-costs & revenues may change

Define relevant cost

Costs (and revenues) that differ across alternatives

-eg: direct materials & direct labor change with how much of an item you produce

Define sunk cost

-Costs that have already been incurred and will not be changed or avoided by any present or future decisions.

-Sunk costs are NOT RELEVANT

-already have been paid

Common types of decisions involving incremental analysis

-accept order at special price

-make or buy components of parts or finished parts

-sell or process further

-repair, retain, or replace equipment

-eliminate an unprofitable business segment or product

Make or buy-how to report opportunity cost?

-ADDED to the make column

-It is considered an additional cost of making the product because we will only get this additional income if we can buy the component parts from the outside source

Retain or replace equipment-how to report trade-in of old equipment?

-The cost of old equipment is a SUNK COST and NOT RELEVANT to the decision and is not included in the analysis

-The SALE of old equipment is subtracted in the replace column and added to net income

Decision rule accept an order at a special price

Accept if the incremental revenue exceeds the incremental variable costs

Decision rule eliminating an unprofitable segment

Retain segment unless fixed costs eliminated EXCEED contribution margin lost

Problem where useful lives of two pieces of equipment are different

use the SHORTER useful life for BOTH assests