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 CGS2100 2 Break Even in Unit Sales Unit Sales to Break Even Fixed Expenses Unit CM Break Even in Sales Dollars D ollar Sales to Break Even Fixed Expenses CM Ratio CVP Relationships in Equation Form Contribution Format Income Statement Profit Sales Variable Expenses Fixed Expenses Company with a Single Product Pro fit P Q V Q Fixed Expenses or Profit Unit CM Q Fixed Expenses CVP Relationships in Graphic Form The CVP graph illustrates the relationship among revenue cost profit and volume Unit volume is represented on the X axis Dollars are represented on the Y axis Preparing the CVP Graph 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 total expense fixed variable at the representing sales volume you have selected it back to intersects the dollar axis After the point has been plotted draw a line through the point where the fixed expense line CGS2100 representing have selected 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 total sales dollars at the activity level you Break even point 200 000 in sales 400 bikes or Step 3 Total Sales Step 2 Total Expenses 300 200 0 0 0 s r a l l o D 100 80 Step 1 Fixed Expenses Loss area 3 Total Sales Profit area 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 Fixed Expenses Effects of the CM Ratio The CM Ratio shows how the contribution margin will be affected by a given change in total sales CGS2100 4 Effect on Contribution Margin Increase in Contribution Margin Increase in 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 to Attain a Target Profit Target Profit Fixed Expense Unit CM Formula Method Dollar Sales Dollar Sales to Break Even Target Profit Fixed Expense CM Ratio Break Even Analysis Formula Method Unit Sales Unit Sales to Break Even Fixed Expense Unit CM Formula Method Dollar Sales Dollar Sales to Break Even Fixed Expense CM Ratio Margin of Safety Margin of Safety in Dollars Total Sales Breakeven Sales CGS2100 5 Margin of Safety Percentage Margin of Safety in 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 Fixed 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 2 3 4 Selling price is constant The price does not change as volume changes 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 CGS2100 6 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 Under absorption costing product costs include ALL manufacturing costs o Direct Materials o Direct Labor o Variable Manufacturing o Fixed Manufacturing Overhead 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 Variable costing is an alternative for internal management reports Under variable costing product costs include only the VARIABLE manufacturing costs o Direct Materials o Direct Labor unless o Variable Manufacturing fixed Overhead 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 Absorption Costing Variable Costing 10 10 Direct Materials Direct Labor and Variable Manufact Overhead CGS2100 7 Fixed Manufacturing Overhead Total Unit Product Cost 6 16 Comparative Income Effects 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