BEC 2 Planning Techniques Flashcards
Cost-volume-Profit (CVP) Analysis for decision making.
Breakeven analysis
- Used by mangers to forecast profits at different levels of sales and production volume.
- The point at which revenues equal total costs is termed the breakeven point.
- CVP analysis = breakeven analysis
Cost-volume-Profit (CVP) Analysis.
Assumptions
- General assumptions
- all costs can be separated into variable or fixed costs
- volume relevant factor affecting cost
- all costs behave in a linear fashion in relation to production volume
- cost behaviors are anticipated to remain constant over the relevant range of production volume because there is an assumption that the efficiency of production does not change
- costs show greater variability over time - Use of single product
- Contribution approach (direct costing) us used rather than absorption approach
- Selling prices remain unchanged
Contribution approach
Contribution approach - uses variable costing, useful in internal decision making a. Equation Revenue Less variable costs Contribution margin Less fixed costs Net income b. Presentation - total or per unit - unit contribution margin - unit sales price minus the unit variable cost - contribution margin ratio
Absorption approach
Absorption approach a. Equation Revenue Less COGS Gross margin Less: Operating expenses Net income
Contribution approach vs Absorption approach
Fixed factory overhead
- Treatment of fixed factory overhead
a. Absorption - Product cost
all fixed factory overhead is treated as a product cost and is included in inventory values. COGS includes both fixed and variable costs.
b.Contribution - Period cost
all fixed factory overhead is treated as a period cost and is expensed in the period incurred. Inventory values include only the variable manufacturing costs, so COGS includes only variable manufacturing costs.
Contribution approach vs Absorption approach
Selling, general and admin expenses
Treatment of selling, general, and administrative expenses- period costs for both methods
- Absorption - both variable and fixed selling, general, and admin exp are operating expenses
- Contribution - the variable selling, general and admin exp are part of the total variable costs
Absorption costing
Product costs: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Period costs: Variable and fixed selling, general, and admin exp
Absorption method
Sales Less: Cost of goods sold Gross margin Less: Fixed selling and variable admin exp Operating income
Variable costing
Product costs: Direct materials Direct labor Variable manufacturing overhead Period costs: Fixed manufacturing overhead Variable and fixed selling, general, and admin exp
Contribution margin
Sales Less: Variable COGS Less Variable selling and admin exp Contribution margin Less: Fixed exp Fixed manufacturing overhead Fixed selling and admin exp Operating income
Effect on income
- Production greater than sales.
If units produced exceed units sold, then some units are added to ending inventory and income is higher under absorption costing than under variable costing. - Sales greater than production.
If units sold exceed units produced, then ending inventory is less than beginning inventory and income is lower under absorption costing than under variable costing.
Benefits and limitations of
Absorption costing
Absorption GAAP Costing
a. Benefits
- it is GAAP
- the IRS requires it
b. Limitations
- the level of inventory affects net income because fixed costs are component of product cost.
- the net income reported under the absorption method is less reliable than under the variable method because the cost of the product includes fixed costs and the level of inventory affects net income
Benefits and limitations of variable costing
Variable costing
a. Benefits
- variable and fixed costs are separated and can be easily traced to and controlled by management
- NI reported under the contribution income statement is more reliable than under the absorption method because the cost of the product does not include fixed costs, and level of inventory does not affect net income
- variable costing isolates the contribution margins in financial statements to aid in decision making
b. Limitations
- not GAAP
- the IRS does not allow to use it for financial reporting
Breakeven computation
determines the sales required to achieve zero profit or loss from operations. After breakeven has been achieved, each additional unit sold will increase net income by the amount of the contribution margin per unit.
Total fixed costs / Contribution margin per unit = Breakeven point in units
Sales dollars
There are two approaches to computing breakeven in sales dollars
- Contribution margin per unit: Unit price x Breakeven point in units = Breakeven point in dollars
- Contribution margin ratio: Total fixed costs / Contribution margin ratio = Breakeven point in dollars
Required sales volume for Target Profit
Breakeven analysis can be extended to calculate the required sales dollars or unit sales required to produce a target profit.
Sales = Variable costs + (Fixed costs + Net income before taxes)
OR
Sales = (Fixed cost + Profit) / Contribution margin ratio
Tax considerations
- Target profit before tax:
Target profit before tax = Target profit after tax + Tax (or 1-tax rate)
2.The breakeven point in sales:
Sales = Variable costs + Fixed costs + Target profit before taxes
Contribution margin per unit
Selling price per unit - Variable costs per unit
Margin of safety concepts
The margin of safety is the excess of sales over breakeven sales and is expressed in $ or %
1. Sales $
Total sales $ - Breakeven sales $ = Margin of safety $
- Sales %
Margin of safety $ / Total sales = Margin of safety %
