Chapters 3 & 9: CVP Analysis, Variable & Absorption Costing

What happens to Fixed Costs in relation to volume?

Do not change with volume

What approach do we use for Fixed Costs in order to make decisions?

Contribution Margin Approach

What things does the Contribution Margin Approach show that income changes with?

• Changes in output levels

• Selling prices

• Variable costs

• Fixed costs

What metric do Fixed Costs provide?

A break-even metric

What is the formula for Breakeven Quantity?

Fixed Costs/Contribution Margin per Unit

What is the formula for Target Profit Analysis?

(Fixed Costs + Target Profit)/Contribution Margin per Unit

What is the formula for Pre-Tax Profit (Operating Income)?

After-Tax Profits / (1 - Tax Rate)

What is the formula for After-Tax Profit (Net Income)?

Pre-Tax Profits * (1 - Tax Rate)

What are the formulas for Required Revenue?

• Revenue per Unit * Target Quantity

• (Fixed Costs + Operating Income)/Contribution Margin Ratio

What is the formula for the Contribution Margin Ratio?

Contribution Margin/Revenue

What is Margin of Safety?

The excess of expected sales over breakeven sales

What is the formula for Margin of Safety?

Expected Sales - Breakeven Sales

What do you do if there’s more than one product or service?

A weighted average contribution margin must be calculated

What is the formula for Weighted Average CM per Unit?

(Product #1 CM/unit * Qty) + (Product #2 CM/unit Qty) + … / Total units Sold for All Products

What is the formula for Multi-Product Breakeven?

Fixed Costs/Weighted Average CM per Unit

What is Variable Costing?

Method of inventory costing in which only variable manufacturing costs (direct and indirect) are included in inventory

What approach does Variable Costing use?

Contribution Margin Approach

What happens to fixed manufacturing costs under variable costing?

• Excluded from inventoriable costs

• Treated as costs of the period in which they’re incurred (period costs)

What is Absorption Costing?

Method of inventory costing in which all variable and fixed manufacturing costs are included in inventory

What approach does Absorption Costing use?

Financing Accounting Income Statement

What’s the big difference between Variable and Absorption Costing?

How they treat fixed manufacturing costs

What are considered Product Costs under both Variable and Absorption Costing?

• Direct Materials

• Direct Labor

• Variable Overhead

What are considered Period Costs under both Variable and Absorption Costing?

• Selling Expenses

• Administrative Expenses

What cost is the only one that changes classifications between Variable and Absorption Costing methods?

Fixed Overhead

What distinction is central in Absorption Costing?

Between manufacturing and non-manufacturing costs

What distinction is central in Variable Costing?

Between variable costs and fixed costs

What type of income will differ between Variable and Absorption Costing?

Operating Income

What is the difference in Operating Income due to in variable and absorption costing?

Fixed Manufacturing costs because under Absorption Costing it is capitalized as inventory, and under Variable Costing it is expensed as period costs

If Production = Sales, how does Operating Income change across Variable and Absorption Costing?

It is equal

If Production > Sales, how does Operating Income change across Variable and Absorption Costing?

• Variable Costing: Lower

• Absorption Costing: Higher

If Production < Sales, how does Operating Income change across Variable and Absorption Costing?

• Variable Costing: Higher

• Absorption Costing: Lower

How may managers seek to manipulate income?

Producing too many units —> Higher FG inventory —> More fixed costs capitalized —> Less fixed costs expenses —> Increased profit

How can you prevent the unnecessary buildup of inventory for bonus purposes?

Base manager’s bonuses on profit calculated using Variable Costing

What is the drawback of taking the recommended approach to prevent the unnecessary buildup of inventory for bonus purposes?

Complicated system of producing two inventory figures (have to do both if you do variable costing)

Under absorption costing, what happens to fixed MOH if production > sales?

Some of the current period’s fixed MOH is still in inventory at the end of the period

Under absorption costing, what happens to fixed MOH if production < sales?

All the current period’s fixed MOH AND some of a prior period’s fixed MOH flow into COGS