Cost Accounting Chapter 3

Front 1

CVP stands for

Back 1

Cost Volume Profit

Front 2

Cost Volume Profit

Back 2

examines the behavior of total revenues, total costs, and operating income as changes occur in the units sold, the selling price, the variable cost per unit or the fixed costs of a product.

Front 3

Contribution margin

Back 3

The difference between total revenues and total variable costs is called contribution margin. This indicates why operating income changes as the number of units changes. When calculating contribution margin be sure to subtract all variable costs.

Front 4

Contribution margin per unit

Back 4

The difference between selling price and variable cost per unit. Recovnizes the tight coupling of selling price and variable cost per unit.

Front 5

Contribution margin equation

Back 5

Contribution margin = contribution margin per unit x number of units sold

Front 6

Contribution income statement

Back 6

Revenues
Variable costs
Contribution margin
fixes costs
net operating income

Front 7

Contribution margin percentage

Back 7

equals contribution margin per unit divided by selling price.

Front 8

Graph method

Back 8

Total costs line. The total costs line is the sum of fixed costs and variable costs. Total revenues line. One convenient starting point is $0 and 0 units sold. Select a second point by choosing any other convenient output and determining to corresponding revenue. Profit or loss at any sales level can be determined by the distance between the two lines at that level.

Front 9

Cost Volume Profit Assumptions

Back 9

1. changes in the levels of revenues and costs arise only because of changes in the number of product (or service) units sold.
2. Total costs can be separated into 2 components: a fixed component that does not vary with units sold and a variable component that changes with respect to COGS.
3. When represented graphically, the behaviors of total revenues and total costs are linear in relation to units sold within a relevant range.
4. Selling price, variable cost per unit, and total fixed costs are known and constant.

Front 10

The cost volume profit assumptions make clear:

Back 10

The difference between fixed and variable costs. The shorter the time horizon the higher percentage of total costs considered fixed.

Front 11

Breakeven point

Back 11

Quantity of output sold at which total revenues equal total costs-- that is the quantity of output sold that results in $0 of operating income. Managers are interested in this point because they wanna avoid losses.

Front 12

A PV graph shows what?

Back 12

shows how changes in the quantity of units sold affect operating income.

Front 13

How is a PV graph drawn?

Back 13

the PV line is drawn using 2 points. One convenient point is the operating loss at zero units sold, which is equal to the fixed costs. A second convenient point is the breakeven point.

Front 14

Net income

Back 14

operating income plus nonoperating revenues minus nonoperating costs minus income taxes. To make net income evaluations, CVP calculations for target income must be stated in terms of target net income instead of target operating income.

Front 15

Target operating income equation

Back 15

Target net income / 1 - tax rate

Front 16

Sensitivity analysis

Back 16

a what if technique that managers use to examine how an outcome will change if the original predicted data are not achieved or if an underlying assumption changes. In the context of CVP analysis, sensitivity analysis answers questions such as, what will operating income be if the quantity of units decreases by 5% from the original prediction? And what will operating income be if variable cost per unit increases by 10%? The sensitivity of operating income to various possible outcomes broadens managers perspectives about what might actually occur before they commit costs.

Front 17

Margin of safety

Back 17

The amount by which budgeted (or actual) revenues exceed breakeven revenues. Margin of safety is the sales quantity minus the breakeven quantity. Answers the what if question: if budgeted revenues are above breakeven and drop, how far can they fall below budget before the breakeven point is reached.

Front 18

Margin of safety regular equation

Back 18

Margin of safety = budgeted revenue - breakeven revenues

Front 19

Margin of safety (in units)

Back 19

Budgeted sales (units) - breakeven sales (units)

Front 20

margin of safety percentage

Back 20

Margin of safety in dollars / budgeted (or actual) revenues

Front 21

What type of safety margin do you want?

Back 21

A high one. A low margin of safety increases the risk of a loss.

Front 22

Operating leverage

Back 22

describes the effects that fixed costs have on changes in operating income as changes occur in units sold and contribution margin. Organizations with a high proportion of fixed costs in their cost structures have high operating leverage.

Front 23

Degree of operating leverage equation

Back 23

Contribution margin / operating income

Front 24

What does the degree of operating leverage help managers calculate?

Back 24

The effect of fluctuations in sales on operating income.

Front 25

What actions are managers taking to reduce fixed costs

Back 25

Many are moving their manufacturing facilities from the US to lower cost countries. To substitute high fixed costs with lower variable costs, companies are pushing products from lower cost suppliers instead of manufacturing products themselves.

Front 26

Sales mix

Back 26

The quantities (or proportions) of various products (or services) that constitute total unit sales of a company. The number of total units sold to break even in a multi product company depends on the sales mix.

Front 27

Gross Margin

Back 27

Measure of competitiveness--how much can a co. charge for its products over and above the cost of acquiring or producing them.

Front 28

Contribution margin indicates

Back 28

how much of a company's revenue are available to cover fixed costs. It helps in assessing risk of a loss. Risk of loss is low if, when sales are low, contribution margin exceeds fixed costs.