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What is the purpose of Cost-Volume-Profit (CVP) Analysis? What is another name for CVP?
- aka Breakeven Analysis
- To forecast profits at different levels of sales and/or production volume.
What are the assumptions necessary to use CVP analysis?
- (1) All costs can be separated into either variable or fixed costs
- (2) Volume is the only relevant factor affecting cost.
- (3) All costs behave in a linear fashion in relation to production volume.
- (4) Costs will remain constant over the relevant range of production (efficiency doesn't change)
- (5) Costs show greater variability over time. The longer the time period, the greater the percentage of variable costs; the shorter the time period, the greater the percentage of fixed costs.
- (6) Selling prices remain unchanged
What is the primary difference between the Absorption vs Contribution approaches to allocating costs? Which one is GAAP?
- Absorption is GAAP and allocates both variable and fixed costs to units produced (and units in inventory).
- Contribution is not GAAP and allocates only variable costs to units produced; fixed costs are period expense.
What is the equation for the Absorption approach to cost allocation?
- Gross Margin
- (Operating Expenses)
- Net Income
What is the equation for the Contribution approach to cost allocation?
- (Variable Costs)
- Contribution Margin
- (Fixed Costs)
- Net Income
When using the Contribution approach, which items are included in Production costs, and which are included when calculating the Contribution Margin?
- Production Costs: Direct Materials, Direct Labor, the variable portion of production overhead.
- Contribution Margin: all production costs + the variable portion of SG&A (such as shipping cost).
What is the formula for the contribution ratio? How is this used?
- Contribution Margin / Revenues
- Used to create the number of units needed for breakeven production
When production is greater than sales, how are net income and ending inventory affected using Absorption vs Contribution costing?
- Absorption Costing: allocates fixed factory overhead to production costs on a per-unit basis. If some units produced are not sold, this cost follows to inventory. Net income is higher, and inventory is higher.
- Contribution Costing: allocates fixed factory overhead as a period cost. If some units are not sold, the FOH doesn't follow inventory. Net income is lower, and inventory is lower.
When production is less than sales, how are net income and ending inventory affected using Absorption vs Contribution costing?
- Absorption Costing: Fixed OH that was allocated to inventory becomes part of COGS. Net income is lower, and ending inventory is lower.
- Contribution Costing: Fixed OH was previously charged as a period cost. Net income is higher, ending inventory remains lower (unit for unit).
Compare the effects of Absorption vs Contribution costing on net income in the following situations: (1) units produced = units sold, (2) units produced < units sold, (3) units produced > units sold
- (1) Absorption net income = Contribution net income
- (2) Absorption net income > Contribution net income
- (3) Absorption net income < Contribution net income
Which costing method is a more accurate for use in performance evaluations and why?
- The Contribution method is more accurate as the manager has control only over the variable costs.
- The Absorption method includes both fixed and variable costs, thus rating performance on items outside of the manager's control.
True / False: Variable (contribution) costing can be used for (1) tax reporting, (2) external reporting?
- (1) False. Absorption costing must be used.
- (2) False. Variable costing is not GAAP and cannot be used for external reporting.
What is the formula for the Breakeven Point in Units, and how is this used?
- Total fixed costs / Contribution Margin per unit = # units
- Determines the number of units that must be sold in order to pay for all costs (without profit).
What is the formula for the Breakeven Point in Dollars and how is this used?
- (1) Use the breakeven point in units x price per unit = Total Sales
- (Total fixed costs / contribution margin per unit) x price per unit OR
- (2) Total fixed costs / contribution margin ratio
What is the variation on the Breakeven Point in Units formula to ensure a certain amount of profit is made?
(fixed costs + pretax profit) / contribution margin per unit
What is the variation on the Breakeven Point in Dollars formula to ensure a certain amount of profit is made? What is an alternate formula?
- Sales Dollars = (fixed costs + pretax profit) / Contribution margin ratio OR
- Sales Dollars = total variable costs + fixed costs + pretax profit, where total variable costs = variable cost/unit x # units.
After breakeven has been achieved, each additional unit sold will increase net income by how much?
The Contribution Margin per unit.
What is the formula to set a selling price based on an assumed number of units sold?
- Sales price per unit = (fixed costs + total variable costs + pretax profit) / assumed number of units sold, where
- total variable cost = VCost per unit x assumed number of units sold.
Define Margin of Safety. What is the formula?
- The excess of sales over breakeven sales (aka the pretax profit or net operating income)
- Margin of safety (dollars) = total sales - breakeven dollars.
What is the formula for the margin of safety percentage
Margin of safety (dollars) / total sales
What is the purpose of target costing? What is the formula?
- Once a price has been determined, the target costs are the total production costs to maximize profit.
- Target cost = market price - required profit
- (Can use totals or per unit amounts)