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Definition: Breakeven Point
The point at which revenues equal total costs.

Formula: Contribution Approach
 Revenues
 Less: Variable Costs
 Equals: Contribution Margin
 Less: Fixed Costs
 Equals: Net Income

Formula: Unit Contribution Margin

Formula: Contribution Ratio
Represents Contribution Margin as a percentage of Revenue

Formula: Absorption Approach Formula
 Revenue
 Less: Product Costs (COGS)
 Equals: Gross Margin
 Less: Period Costs (Operating Expenses)
 Equals: Net Income

Treatment of Fixed Factory Overhead
Contribution Approach vs. Absorption Approach
 Fixed Factory Overhead
 1) Contribution Approach = Period Cost
 (Included in Fixed Costs)
 2) Absorption Approach = Product Cost
 (Included in Cost of Goods Sold)

Effect on Net Income:
Contribution vs. Absorption Approach
Production Greater than Sales
 Results in Greater Inventory:
 Net income Absorption > Net income Contribution
Reason: Under absorption costing, a portion of Fixed OH is included with each unit in ending inventory, while all FOH is expensed during the period under contribution approach

Effect on Net Income:
Contribution vs. Absorption Approach
Sales Greater than Production
Absorption Net Income < Variable Net Income

Formula: Breakeven Point in Units

Formula: Breakeven Point in Dollars
(Two Formulas)
Formula 1:
Formula 2:

Formula: Required Sales Volume for Target Profit (Sales Dollars)
Sales ($) = Variable Costs + Fixed Costs+ Net Income Before Taxes

Formula: Required Sales Volume for Target Profit (Sales Units)

Formula: Margin of Safety (Sales Dollars)
Total Sales ($)  Breakeven Sales ($)

Formula: Margin of Safety (%)
=

Formula: Target Cost
Target Cost = Market Price  Required Profit

Definition: Irrelevant Costs
 Costs that do not differ between alternatives
  Ignored from Marginal Cost analysis

Definition: Incremental Costs
(Aka: Differential Costs and OutOfPocket Costs)
The additional costs incurred to produce an additional amount of the unit over the present output
Relevant Cost

Definition: Sunk Costs
Costs that are unavoidable because they were incurred in the past and cannot be changed
NotRelevant

Definition: Opportunity Costs
The cost of foregoing the next best alternative when making a decision
 Relevant Cost

Definition: Controllable Costs
Costs that can be authorized at a specific level of management
 Relevant only if they will change as a result of selecting different alternatives

Definition: Uncontrollable Costs
Costs that are authorized at a different level
 Not relevant because they cannot be changed by the manager making the decision

Definition: Marginal Cost
The costs required for a oneunit increase in activity (includes all variable costs and any avoidable fixed costs associated with a decision)
 Relevant

Special Order Decision:
ACCEPT IF:
Effect on Fixed Cost:
 Accept if: Profitable
 Revenue > Relevant Costs
 Effect on Fixed Cost:
 Fixed costs are generally not relevant unless the special order will change total fixed costs

Special Order Decisions:
Presumed Excess Capacity
Accept if Selling Price per Unit is greater than Variable Cost per Unit
SP > Relevant Costs (VC)

Special Order Decision:
Presumed Full Capacity
Accept if Selling Price per Unit is greater than Variable Cost per Unit and any forgone Opportunity Costs
SP > VC + Opportunity Costs

Formula: Opportunity Cost per Unit

Make vs. Buy Decision:
Excess Capacity
Cost of Making product internally is the cost that will be avoided if the product is not made
Cost of making the product internally is the maximum outside purchase price

Make vs. Buy:
No Excess Capacity
The cost of making the product internally is the cost that will be avoided (saved) if the product is not made plus the opportunity cost associated with the decision

Sell or Process Further Decision
if Incremental revenue > Incremental Cost
= Process Further

Keep or Drop Segment
Keep if:
Drop if:
 Keep Segment if: Lost CM > Avoided FC
 Drop Segment if: Lost CM < Avoided FC
The fixed costs associated with the segment must be identified as either avoidable (relevant) or unavoidable even if the segment is discontinued

Sensitivity Analysis
Change in Total Costs/Change in Volume = VC per Unit

Regression Analysis
y = mx + b
TC = (VC/unit * Volume) + Total FC

Coefficient of Correlation (r)
Measures the strength of the linear relationship between the independent variable (x) and dependent variable (y)
Range = 1, 0, 1
 1 = Perfect Inverse Relationship
 0 = No relationship
 1 = Perfect Direct Relationship

Coefficient of Determination (R )
R is the proportion of the total variation in the dependent variable (x) explained by the independent variable (y)
Value between 0 and 1
The higher the value, the better the fit on the regression line

Formula: Flexible Budget Formula
Total Cost = Fixed Cost + (Variable cost per unit * # of units)

