Accy 202 Test #3

Front 1

Chapter 18

Back 1

Cost-Volume Profit

Front 2

Cost Behavior Analysis

Back 2

Is the study of how specific costs respond to changes in the level of business activity.

Front 3

Activity Levels

Back 3

Example: Room occupancy (in a hotel).

Front 4

Activity Index

Back 4

The activity level selected is referred to as the Activity Index (or Volume Index).

The Activity Index identifies the activity that causes changes in the behavior of costs.

Front 5

Variable Costs

Back 5

Costs that vary in total directly and proportionally with changes in the activity level. (If the level increases 10% total variable costs will increase 10%; level of activity decreases 25% total variable costs will decrease 25%).

Examples: Gasoline for airlines and trucking companies; Direct materials and direct labor for a manufacturer; Costs of goods sold, sales commission, and freight out for a merchandiser.

A Variable Cost may also be defined as a cost that remains the same PER UNIT at every level of activity.

Companies that rely heavily on labor to manufacture a product (Nike/Reebok), or to provide a service (Hilton/Marriott), are likely to have many variable costs.

Companies that use a high proportion of machinery and equipment in producing revenue (AT&T or Duke Energy Co.), may have few variable costs.

Front 6

Fixed Costs

Back 6

Costs that remain the same in total regardless of changes in activity level.

Examples: Property taxes, insurance, rent, supervisory salaries, and depreciation on buildings and equipment.

Fixed costs PER UNIT vary inversely with activity: As volume increases, unit cost declines, and vice versa.

The trend for many manufactures is to have more fixed costs and fewer variable costs. This trend is the result of increased use of automation and less use of employee labor. As a result, depreciation and lease charges (fixed costs) increase, whereas direct labor costs (variable costs) decrease.

Front 7

Linear

Back 7

If a relationship is linear (straight-line on a graph that is diagonal), then changes in the activity index will result in a direct, proportional change in the variable cost. Example: If the activity level doubles, the cost doubles.

In most business situations, a straight-line relationship does NOT exist for variable costs throughout the entire range of possible activity.

Front 8

Curvilinear

Back 8

In the real world, the relationship between the behavior of a variable cost and changes in the activity level is often Curvilinear.

In the curved sections of the line, a change in the activity index will not result in a direct, proportional change in the variable cost.

Total fixed costs also do not have a straight-line relationship over the entire activity range.

Front 9

Relevant Range

Back 9

The range over which a company expects to operate during a year is called the relevant range of the activity index.

Companies often operate over a somewhat narrower range, such as 40-80% of capacity.

Within the relevant range, a straight-line relationship generally exists for both variable and fixed costs.

Although the linear (straight-line) relationship may not be completely realistic, the linear assumption produces useful data for CVP analysis as long as the level of activity remains within the relevant range.

Front 10

Mixed Costs

Back 10

Costs that contain both a variable element and a fixed element.

Mixed costs change in total but not proportionately with changes in the activity level.

Example: U-Haul truck rental; $50 per day (fixed), $.50 cents per mile (variable).

Front 11

High-Low Method

Back 11

Uses the total costs incurred at the high and low levels of activity to classify mixed costs into fixed and variable components.

The difference between the high and low levels represents variable costs, since only the variable cost element can change as activity levels change.

The high-low method usually generates a reasonable estimate for analysis. However, it does not produce a precise measurement of the fixed and variable elements in a mixed cost because it ignores other activity levels in the computation.

Front 12

Cost-Volume Profit (CVP) Analysis

Back 12

Is the study of the effects of changes in costs and volume on a company's profits.

Important in profit planning

Critical factor in such management decisions as setting selling prices, determining product mix, and maximizing use of production facilities.

Front 13

The 5 CVP Assumptions

Back 13

1. The behavior of both costs and revenues is linear throughout the relevant range of the activity index

2. Costs can be classified accurately as either variable or fixed.

3. Changes in activity are the only factors that effect costs.

4. All units produced are sold.

5. When more than one type od product is sold, the sales mix will remain constant. That is, the percentage that each product represents of total sales will stay the same.

Front 14

Contribution Margin

Back 14

Is the amount of revenue remaining after deducting variable costs.

It is often stated as a total amount and on a per unit basis.

Front 15

Chapter 19

Back 15

Chapter 19

Front 16

Absorption Costing

Back 16

In this costing approach, a job is assigned the costs of direct materials, direct labor, and BOTH variable and fixed manufacturing overhead.

Also known as Full (Costing?).

It is named Absorption Costing because all the manufacturing costs are charged to, or absorbed by, the product.

It is the approach used for external reporting under GAAP.

Under absorption costing, the allocation of fixed costs to inventory makes it difficult to evaluate the impact of fixed costs on the company's results.

Front 17

Variable Costing

Back 17

Under Variable Costing, only direct materials, direct labor, and variable manufacturing overhead costs are considered product costs.

Under Variable Costing, companies recognize fixed manufacturing overhead costs as period costs (expenses) when incurred.

Companies may not use variable costing for external reports because GAAP require that fixed manufacturing overhead be accounted for as product cost.

Under Variable Costing, net income is NOT affected by the number of units produced; Only number of units SOLD.

Front 18

Selling and Administrative Expenses under Absorption and Variable Costing.

Back 18

Selling and Administrative Expenses are period costs under both absorption and variable costing.

Front 19

Whenever units produced exceed units sold, what happens with absorption/variable costing? How about vice versa?

Back 19

Absorption costing will show a higher net income number than variable costing.

When units produced are less than units sold, absorption costing shows a lower net income number that Variable costing.

Front 20

Chapter 20

Back 20

Chapter 20

Front 21

Budget

Back 21

A budget is a formal written statement of management's plans for a specified future time period, expressed in financial terms.