ACCT 2020 1st Edition Lecture 5 Outline of Last Lecture I Formulas II Basics of Cost Volume Profit Analysis III CVP relationships in graphic form IV Variable expense Ratio V Determine Sales Levels to Meet Target Profit VI Determine the Breakeven Point Outline of Current Lecture I Rules Guidelines Exam Review II Margin of Safety III Cost structure and Profit Stability IV Structuring Sales Commissions V Compute Break even point sales mix Current Lecture I Rules Guidelines Exam Review Know student I D number bring pencil etc Calculator no graphing only simple Go over problems in the back of the chapters and extra problems on MHConnect These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute II Margin of Safety The difference between the break even point and the current sales level How much could our sales decrease and we would still break even o Margin of safety MOS total sales break even sales o Can also be expressed as a percentage MOS margin of safety Actual sales o Can also be expressed in terms of units sold The margin of safety unit selling price III Cost structure and Profit Stability Cost structure refers to the relative proportion of fixed costs in an organization Managers often have some latitude in determining their organization s cost structure o An advantage of heavy fixed costs structure is that in good income years these fixed costs don t change with the production like commission so operating income high this is also a negative If you do really well then your income goes high and vice versa o A company with a variable costs structure does not go up as much in good years as it would if they had a high cost structure Variable is pretty steady over time and doesn t change as much as a fixed costs structure Operating leverage is a measure of how sensitive net operating income is to percentage changes in sales Is a measure at any given level of sales of how a percentage in sales volume will affect profits o Degree of operating leverage contribution margin net operating income o We can multiply this degree of leverage by any change in percentage of sales to understand how much volume will affect operating income o 3129 756 2373 1300 1073 2373 1073 2 211 operating leverage o 2 21 x 20 44 2 change in net operating income IV Structuring Sales Commissions The salesperson will generally sell the most expensive item if paid on commission In the case of selling two products and the less expensive product produces has a higher contribution margin then the company would want to motivate employees by paying higher commission for the product with the higher contribution margin V Compute Break even point sales mix Sales mix is the percent of revenue that come from different products sold The breakeven analysis assumes that sales mix stays constant if we changed that then the analysis is wrong We compute the break even point with sales dollars by using the contribution margin ratio With many products we need to use the CM ratio as a whole If the sales mix were to change then we would also have to change the CM ratio o DOLLAR SALES TO BREAK EVEN FIXED EXPENSES CM RATIO o PROFIT CMRATIO X SALES DOLLARS FIXED EXPENSES Key assumptions of CVP analysis o Selling price constant o Costs are linear and can be accurately divided into variable and fixed elements o Sales mix is constant o In manufacturing companies inventories do not change