Business 2: Profitability and Pricing Analysis Flashcards
Total Cost = ?
= FC + (VC per unit * Volume)
Margin of safety ($) = ?
= Total sales ($) - Breakeven sales ($)
Breakeven point ($) = ?
= Total fixed costs / CM Ratio
= Unit price * Breakeven point (in units)
CM Ratio = ?
= CM / Sales
Breakeven point (in units) = ?
= Total FC / CM per unit
How do you calculate units needed to achieve a given amount of after tax income?
= (Fixed cost + pretax profit) / CM per unit
How do you calculate pretax profit?
Pretax profit = after tax profit / (1 - tax rate)
When production is greater than sales, what is the difference b/w the absorption costing and variable costing methods?
Absorption costing income GREATER THAN variable costing income
How do you calculate the unit selling price to achieve a target profit?
= (FC + VC + Pretax profits) / # units sold
When using CVP analysis for decision making, what are five general assumptions we make?
1) All costs can be separated into VC or FC
2) Volume is only relevant factor affecting cost
3) All costs behave in linear fashion in relation to production volume over LT
4) Costs behaviors are anticipated to remain constant over the relevant range
5) Costs show greater variability over time
True or false.
The longer the time period, the smaller the percentage of VC.
False (greater the percentage of VC)
In its simplest form, CVP analysis assumes that the product mix remains what?
Constant (use of a single product)
When conducting CVP analysis, what costing approach is used?
Contribution approach (rather than GAAPq absorption approach )
Does the absorption approach segregate fixed and variable costs?
NO
Does the contribution approach segregate fixed and variable costs?
YES
What is the general equation for the absorption approach?
Revenue Less: COGS = Gross Margin Less: Operating expenses = Net income
Absorption approach. What are the components of COGS?
Product costs ( = DM + DL + O/H fixed and variable)
Absorption approach. What are the components of operating expenses?
Period costs ( = SG&A fixed and variable)
The contribution approach is extremely useful for what kind of decision making?
Internal decision making
What is the general equation used for the contribution approach?
Revenue Less: Variable costs = CM Less: Fixed costs = Net income
Contribution approach. What is included in variable costs?
= DM + DL + Variable O/H + Variable SG&A
Contribution approach. What is included in fixed costs?
= Fixed O/H + Fixed SG&A
How is the contribution ratio formula expressed?
CM ratio = CM / Revenue
What is the difference between the absorption approach and the contribution approach?
Treatment of fixed factory overhead
True or false.
SG&A expenses are period costs under both the absorption approach and contribution approach.
True
Under the absorption approach, how is fixed factory O/H treated?
- Product cost
- Included in inventory values
Under the contribution approach, how is fixed factory O/H treated?
- Period cost
- Expensed in period incurred
Define period cost
- Costs that are not the costs of producing the product manufactured and are thus not inventoriable
- Charged to the period in which they are incurred
True or false.
Under absorption costing, we use fixed O/H of units sold.
True
True or false.
Under variable (direct) costing, we used the fixed O/H of all units produced (even if not sold),
True
What is the difference between absorption costing operating income and variable costing operating income if all production is sold every period?
- Production = Sales
- No difference
What is the difference between absorption costing operating income and variable costing operating income if there is an increase in inventory?
Absorption net income > Variable net income
What is the difference between absorption costing operating income and variable costing operating income if there is a decrease in inventory (sales greater than production)?
Absorption net income < Variable net income
What are two limitations of absorption costing?
1) Level of inventory affects net income b/c fixed costs are a component of product cost
2) NI reported under this method less reliable b/c cost of product includes FC and therefore level of inventory affects net income
What is a key benefit of variable costing?
- NI reported under this method more reliable (especially for use in performance evaluations) b/c cost of product does not include FC and therefore level of inventory does not affect NI
What are two limitations of variable costing?
1) Not GAAP
2) IRS doesn’t allow the use of variable cost method for financial reporting
How can you predict performance based on volume?
- After breakeven has been achieved
- Each add. unit sold will increase NI by the amount of CM per unit
Define margin of safety
Excess of sales over breakeven sales (expressed as $ or %)
How is the margin of safety expressed in dollars calculated?
Total sales ($) - Breakeven sales ($) = Margin of safety ($)
How is the margin of safety expressed as a percent calculated?
Margin of safety ($) / Total sales
True or false.
Target costing is a technique used to establish the product cost allowed to ensure both profitability per unit and total sales volume.
True
How do you calculate the target cost of a product?
Market price - Required profit
What are three strategies to establish a transfer price?
1) Negotiated price
2) Market price
3) Cost
What does the arm’s length principle state?
- Transfer prices must approximate the prices for comparable transactions b/w unrelated parties who are acting on their own free will
In interpreting the arm’s length principle, what factors should be assessed to determine comparability?
- Nature of goods, services, property
- Contractual terms
- Economic conditions
- Functions performed
- Risks assumed
