CGS2100 1 Test 2 Study Guide Chapters 5 6 8 Chapter 5 Cost Volume Profit Relationships Cost Volume Profit CVP Analysis CVP analysis is concerned with the effects on net operating income of Selling Prices Sales Volume Unit Variable Costs Total Fixed Costs The Mix of Products Sold Contribution Margin The contribution margin is the amount remaining from sales revenue after variable expenses have been deducted It is the amount of sales that contributes toward covering fixed expenses and then toward profits The unit contribution margin remains constant so long as the selling price and the unit variable cost do not change Break Even Point The break even point is The point where total sales revenue equals total expenses variable and fixed The point where total contribution margins equals total fixed expenses Each additional unit sold increases net operating income by the amount of the unit contribution margin Type text Type text Type text 2 Break Even in Unit Sales Unit Sales Break Even Expenses Unit CM Break Even in Sales Dollars D o llar S ales Break Even Expenses C M Ratio CVP Relationships in Equation Form Contribution Format Income Statement Profit Sales Variable Expenses Expenses Company with a Single Product Pro fit P Q V Q Expense s or Profit Unit CM Q Expenses CVP Relationships in Graphic Form Unit volume is represented on the X axis Dollars are represented on the Y axis Preparing the CVP Graph The CVP graph illustrates the relationship among revenue cost profit and volume 1 Draw a line parallel to the volume axis to represent total fixed expenses 2 Choose some volume of unit sales and plot the point representing total expense fixed variable at the sales volume you have After the point has been plotted draw a line through it back to the point where the fixed expense line intersects the dollar selected axis CGS2100 0 0 0 s r a l l o D 300 250 230 200 100 80 3 Again choose some sales volume and plot the point representing total sales dollars at the activity level you have selected Step 3 Total Sales Step 2 Total Expenses Break even point 400 bikes or 200 000 in sales Step 1 Fixed Expenses o s s a r e a L 300 200 0 0 0 s r a l l o D 100 80 3 Total Sales P r o fit a r e a Total Expenses 200 400 Number of bikes 500 600 200 400 Number of bikes 600 Contribution Margin Ratio The contribution margin CM ratio is the ratio of contribution margin to total sales CM Ratio Contribution Margin Total Sales Company with a Single Product CM Ratio Unit Contribution Margin Unit Selling Price Relationship Between Profit and CM Ratio Profit CM Ratio Sales Expenses Effects of the CM Ratio The CM Ratio shows how the contribution margin will be affected by a given change in total sales Type text Type text Type text 4 Effect on Contribution Margin Increase Contribution Margin Increase Sales CM Ratio Effect on Net Operation Income If fixed expenses do not change the net operating income for the month will also increase by the same Increase in Contribution Margin Target Profit Analysis In Target Profit Analysis we estimate what sales we estimate what sales volume is needed to achieve a specific target profit Formula Method Unit Sales Unit Sales Attain a Target Profit Target Profit Expense Unit CM Formula Method Dollar Sales Dollar Sales Break Even Target Profit Expense CM Ratio Break Even Analysis Formula Method Unit Sales Unit Sales Break Even Expense Unit CM Formula Method Dollar Sales Dollar Sales Break Even Expense CM Ratio Margin of Safety CGS2100 5 Margin of Safety in Dollars Total Sales Breakeven Sales Margin of Safety Percentage Margin of Safety Dollars Total Sales Operating Leverage Operating leverage measures how a given percentage change in sales affects net operating income Degree of Operating Leverage Contribution Margin Net Operating Income The degree of operating leverage is not constant it changes with the level of sales Multiproduct Break Even Analysis When a company has multiple products the overall contribution margin CM ratio is used in break even analysis Overall CM Ratio Total Contribution Margin Total Sales Dollars Breakeven Sales Expenses Overall CM Ratio Sales Mix The relative proportions in which the products are sold is called the sales mix If the sales mix changes the overall contribution margin ratio will change Assumptions of CVP Analysis 1 Selling price is constant The price does not change as volume changes Type text Type text Type text 6 2 3 4 Costs are linear and can be accurately split into fixed and variable elements The total fixed cost is constant and the variable cost per unit is constant The sales mix is constant in multi product companies In manufacturing companies inventories do not change The number of units produced equals the number of units sold Chapter 6 Variable Costing and Segment Reporting Tools for Management Differences in Variable Costing and Absorption Costing Absorption Costing Variable Costing Absorption costing was used in earlier chapters and is generally considered to be required for external financial reports Variable costing is an alternative for internal management reports Under variable costing product costs Under absorption costing product costs include ALL manufacturing costs include only the VARIABLE manufacturing costs o Direct Materials o Direct Labor o Variable Manufacturing Overhead o Fixed Manufacturing Overhead o Direct Materials o Direct Labor unless fixed o Variable Manufacturing Overhead Under absorption costing the following costs are treated as period expenses and are excluded from products o Variable selling and Administrative Costs o Fixed Selling and Administrative Costs Under Variable Costing the following costs are treated as period expenses and are excluded from product costs o Fixed Manufacturing Overhead o Variable Selling and Administrative Costs o Fixed Selling and Administrative Costs Calculating Unit Product Costs for Each Direct Materials Absorption Costing 10 Variable Costing 10 CGS2100 7 Direct Labor and Variable Manufact Overhead Fixed Manufacturing Overhead Total Unit Product Cost Comparative Income Effects 6 16 0 10 Relation Between Production and Sales Units produced Unit sales No change in inventory Units produced Unit sales Inventory increases Units produced Unit sales Inventory decreases Relation Between Variable and Absorption Costing Net Operating Incomes Absorption costing NI Variable costing NI Absorption costing NI Variable costing NI Absorption costing NI Variable costing NI Segmented Income