BEC Chapter 2 - Profitability and Pricing Analysis

Question 1

Cost Volume Profit Analysis

Answer 1

Used by managers to forecast profits at different levels of sales and production volume.

Question 2

Break Even Point

Answer 2

The point at which revenues = total costs

Question 3

General Assumptions (5 in total)

Answer 3

1. all costs can be separated into either variable or fixed costs, depending on the behavior of the costs
2. Volume is the only relevant factor affecting cost.
3. All costs behave in a linear fashion in relation to production volume
4. 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
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 % of fixed costs

Question 4

Absorption Approach vs. Contribution Approach

Answer 4

Absorption Approach: GAAP reporting 
Equation:
Revenue 
- COGS
=Gross Margin
-Operating Expenses
= Net Income
Contribution Approach:
Sales
-Variable Costs
=CM
-Fixed Costs
=NI

Question 5

Difference between absorption and contribution approach

Answer 5

Difference is fixed factory overhead. Absorption approach: treated as product cost (in COGS)
Contribution approach: period cost (fixed costs are separated from variable costs)

Question 6

Effect on net income

Answer 6

Inventory > Sales = inventory increase - higher under absorption method than

Sales > inventory = inventory decrease - move from B/S to I/S

Question 7

Breakeven formula

Answer 7

BEP in units: Total Fixed Costs/CM per unit

BEP in $: Unit price x breakeven points in $
OR
Total fixed costs / CM ratio

Question 8

CVP Analysis - Profit Performance

Answer 8

Required sales volume for Target Profit - BEFORE TAX
Sales units needed to obtain a desired profit: sales (units) = (Fixed cost + pretax profit) / CM per unit

Sales $ needed to obtain a desired profit:
sales dollars = variable costs + fixed costs + pretax profit
OR
sales = Fixed cost + pretax profit / CM ratio

Question 9

Margin of Safety Concepts

Answer 9

How much output / sales level can fall before reaching break even point

Question 10

Marginal Analysis

Answer 10

Used when analyzing business decisions such as the introduction of a new product or changes in output levels of existing products, acceptance or rejection of special orders. Focuses on the RELEVANT revenues and costs that are associated with a decision

Question 11

Relevant revenues and costs

Answer 11

Relevant costs include direct costs, prime costs, discretionary costs, incremental, and opportunity costs

opportunity cost - benefit, profit, or value of something that must be given up to acquire or achieve something else

Question 12

Special Order Decisions

Answer 12

Short term decisions
Presumed excess capacity: Price > VC/Unit
Presumed full capacity: Price

Question 13

Marginal Analysis

Answer 13

Operational decision used when analyzing business decisions such as the introduction of a new product or changes in output levels of existing products, acceptance or rejection of special orders, making or buying a product or service, selling or processing further, and adding/dropping a segment. Marginal Analysis focuses on the relevant revenues and costs that are associated with a decision.

Question 14

Relevant Costs

Answer 14

Direct Costs, Prime costs (DM + DL), and Discretionary Costs
*Historical costs NOT RELEVANT

Question 15

Irrelevant Costs

Answer 15

Sunk Costs, unavoidable costs