ACCT 230 EXAM 3 ALLEN

Cost-volume-profit (CVP) analysis

the study of effects of changes in costs and volume on a companys profits

why is CVP important

- important profit planning tool

- useful in setting selling prices, determining product mix, and maximizing use of production facilities

assumption under CVP

cost and revenues are linear throughout the relevant range

assumption under CVP

costs can be classified as either variable or fixed with reasonable accuracy

assumption under CVP

all units produced are sold

assumption under CVP

sales mix percents will remind constant

breakeven point

level of sales where the company will realize no income and will suffer no loss

breakeven point

where revenues=expenses, profit =0

NO PROFIT

Target Net Income

profit objective for the company or an individual segment

Margin of safety

difference between actual or expected sales and breakeven sales

margin of safety

expected/actual sales - breakeven sales

margin of safety percent

margin of safety/expected sales

sensitivity analysis

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

CVP equation

Revenues - variable costs - fixed costs = desired profit

what does the CVP graph allow

the graph allows management to see what profit will be at various levels of sales (profit planning)

what does the contribution margin per unit say???

every unit sold contributes (the amount $X) towards covering fixed costs, after break even (the amount $X) goes towards profit

contribution margin

the money left over from sales after paying all variable expenses associated with producing a product.

what does the contribution margin ratio say????

(the percent X%) goes towards covering fixed costs. after break even, (the percent X%) of sales is profitable. the remaining percent 100-x= goes towards variable costs

Sales Mix

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

IMPORTANT BC SOME PRODUCTS ARE MORE PROFITABLE THAN OTHERS

Cost structure

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

Operating leverage

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

find increase in NI

degree of operating leverage X change in sales

find increase in NI

CM ratio X increase in sales

companies with high fixed costs relative to variable costs have high operating leverage

high earnings volatility

is it good that when a companys sales revenue is increasing, high operating leverage is good ???????

YES because that indicates the profits will increase rapidly

When sales are declining, too much operating leverage will cause...

PROFITS TO DECREASE RAPIDLY

decrease in variable cost

decrease in breakeven point

decrease in variable cost

increase in contribution margin ratio

fixed cost decrease

break even point decrease

fixed cost decrease

no change in contribution margin ratio

absorption (full) costing

accumulate all products costs w/ inventory

WIP---> FG----> COGS

Absorption costing

sales

(VARIABLE & FIXED)

gross margin

(VARIABLE & FIXED)

NI

Absorption costing

ALL MANUFACTORING COSTS ARE CHARGED/ABSORBED BY THE PRODUCT required for external reporting (GAAP and IFRS)

Absorption costing

required for external reporting (GAAP and IFRS)

- does not faciiitate CVP analysis and other management decision

Variable costing

same as contribution margin income statement

- accumulate only variable product costs with inventory

how is fixed OH treated in variable costing

expensed in full in the period incurred (treated as period costs)

IMPORTANT

must still assign product costs to inventory, however inventory valuation is limited to variable product costs

what is variable costing used for?

internal purposes only: facilitates planning (CVP analysis) evaluation of segments

variable costing income statement

sales

NO FIXED MANU OH

contribution margin

net income

Potential advantages of variable costing

- consistent with cost volume profit analysis and supports decision making

- net income computed under variable costing is unaffected by changes in production levels

- management may be tempted to overproduce in a given period in order to increase net income under absorption costing

segment

is any part or activity of an organization about which a manger seeks cost revenue

------> store, product line, department, geographic region

segment

GAAP and IFRS require certain segmented data be reported by publicly traded companies

- to facilitate performance evaluation and decision making, segmented income statements can be prepared at various levels

- sales and variable costs are generally traceable to a given segment but fixed costs may or may not be

direct fixed costs

exist bc the segment exists (are traceable)

--> store managers salary to c-stat store

common fixed costs (indirect)

exist bc of multiple departments, must be allocated but the allocations are not useful for evaluating segment segments

---> VP of production (salary) to the 4 product lines they oversee

segmented income statements

Sales

contribution margin

segment margin (best measure of performance evaluation)

(must be allocated)

division income

profit planning

the process of determining the actions needed to achieve the desired level of profits

budget

detailed plan for the future and is usually expressed in quantitative terms, the varIous budgets are collectively known as a MASTER BUDGET

Perpetual (continuous) budget

a 12 month budget in which one month or quarter is added to the budget as one month or quarter comes to a close

benefits of budgeting

-encourages managers to plan for the future

-communication of corporate goals

-coordination of activities of segments

-provides a means for allocating resources effectively

-helps uncover potential problems/bottlenecks (provides for before the fact control)

- provides benchmarks for evaluating performance (provides a basis for after the fact control)

responsibility accounting

- system of accountability in which managers are held responsible for economy factors over which they have significant control

- budget is part of this process

advantages of participative budgeting

- all managers are seen as part of a team (motivator)

- often more accurate since budget is prepared by manager with first hand knowledge

limitations of participative budgeting

- lower level mangers may lack strategic focus (wont see how your role impacts the whole organization )

- temptation for managers to introduce budgetary slack

- companies fail to recognize human factor

TIME CONSUMING

The Human Factor: Behavioral Considerations in Budgeting

- a budget may inspire a manager to higher levels of performance OR pull down the morale

- the effectiveness of a budget program is directly related to its acceptance

Budget Committee

Provides oversight over the budgeting process

- often includes the president vice presendes and controller

- responsible for resolving disputes and approving the final budget

master budget

summary of companys plan

- master budget is a set interdependent budgets resulting in a budgeted income statement and a budgeted balance sheet