Business 2: Profitability and Pricing Analysis

Question 1

Total Cost = ?

Answer 1

= FC + (VC per unit * Volume)

Question 2

Margin of safety ($) = ?

Answer 2

= Total sales ($) - Breakeven sales ($)

Question 3

Breakeven point ($) = ?

Answer 3

= Total fixed costs / CM Ratio

= Unit price * Breakeven point (in units)

Question 4

CM Ratio = ?

Answer 4

= CM / Sales

Question 5

Breakeven point (in units) = ?

Answer 5

= Total FC / CM per unit

Question 6

How do you calculate units needed to achieve a given amount of after tax income?

Answer 6

= (Fixed cost + pretax profit) / CM per unit

Question 7

How do you calculate pretax profit?

Answer 7

Pretax profit = after tax profit / (1 - tax rate)

Question 8

When production is greater than sales, what is the difference b/w the absorption costing and variable costing methods?

Answer 8

Absorption costing income GREATER THAN variable costing income

Question 9

How do you calculate the unit selling price to achieve a target profit?

Answer 9

= (FC + VC + Pretax profits) / # units sold

Question 10

When using CVP analysis for decision making, what are five general assumptions we make?

Answer 10

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

Question 11

True or false.

The longer the time period, the smaller the percentage of VC.

Answer 11

False (greater the percentage of VC)

Question 12

In its simplest form, CVP analysis assumes that the product mix remains what?

Answer 12

Constant (use of a single product)

Question 13

When conducting CVP analysis, what costing approach is used?

Answer 13

Contribution approach (rather than GAAPq absorption approach )

Question 14

Does the absorption approach segregate fixed and variable costs?

Answer 14

NO

Question 15

Does the contribution approach segregate fixed and variable costs?

Answer 15

YES

Question 16

What is the general equation for the absorption approach?

Answer 16

Revenue
Less: COGS
= Gross Margin
Less: Operating expenses
= Net income

Question 17

Absorption approach. What are the components of COGS?

Answer 17

Product costs ( = DM + DL + O/H fixed and variable)

Question 18

Absorption approach. What are the components of operating expenses?

Answer 18

Period costs ( = SG&A fixed and variable)

Question 19

The contribution approach is extremely useful for what kind of decision making?

Answer 19

Internal decision making

Question 20

What is the general equation used for the contribution approach?

Answer 20

Revenue
Less: Variable costs 
= CM
Less: Fixed costs
= Net income

Question 21

Contribution approach. What is included in variable costs?

Answer 21

= DM + DL + Variable O/H + Variable SG&A

Question 22

Contribution approach. What is included in fixed costs?

Answer 22

= Fixed O/H + Fixed SG&A

Question 23

How is the contribution ratio formula expressed?

Answer 23

CM ratio = CM / Revenue

Question 24

What is the difference between the absorption approach and the contribution approach?

Answer 24

Treatment of fixed factory overhead

Question 25

True or false. SG&A expenses are period costs under both the absorption approach and contribution approach.

Answer 25

True

Question 26

Under the absorption approach, how is fixed factory O/H treated?

Answer 26

- Product cost | - Included in inventory values

Question 27

Under the contribution approach, how is fixed factory O/H treated?

Answer 27

- Period cost | - Expensed in period incurred

Question 28

Define period cost

Answer 28

- 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

Question 29

True or false. Under absorption costing, we use fixed O/H of units sold.

Answer 29

True

Question 30

True or false. Under variable (direct) costing, we used the fixed O/H of all units produced (even if not sold),

Answer 30

True

Question 31

What is the difference between absorption costing operating income and variable costing operating income if all production is sold every period?

Answer 31

- Production = Sales | - No difference

Question 32

What is the difference between absorption costing operating income and variable costing operating income if there is an increase in inventory?

Answer 32

Absorption net income > Variable net income

Question 33

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)?

Answer 33

Absorption net income < Variable net income

Question 34

What are two limitations of absorption costing?

Answer 34

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

Question 35

What is a key benefit of variable costing?

Answer 35

- 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

Question 36

What are two limitations of variable costing?

Answer 36

1) Not GAAP | 2) IRS doesn't allow the use of variable cost method for financial reporting

Question 37

How can you predict performance based on volume?

Answer 37

- After breakeven has been achieved | - Each add. unit sold will increase NI by the amount of CM per unit

Question 38

Define margin of safety

Answer 38

Excess of sales over breakeven sales (expressed as $ or %)

Question 39

How is the margin of safety expressed in dollars calculated?

Answer 39

Total sales ($) - Breakeven sales ($) = Margin of safety ($)

Question 40

How is the margin of safety expressed as a percent calculated?

Answer 40

Margin of safety ($) / Total sales

Question 41

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.

Answer 41

True

Question 42

How do you calculate the target cost of a product?

Answer 42

Market price - Required profit

Question 43

What are three strategies to establish a transfer price?

Answer 43

1) Negotiated price 2) Market price 3) Cost

Question 44

What does the arm's length principle state?

Answer 44

- Transfer prices must approximate the prices for comparable transactions b/w unrelated parties who are acting on their own free will

Question 45

In interpreting the arm's length principle, what factors should be assessed to determine comparability?

Answer 45

- Nature of goods, services, property - Contractual terms - Economic conditions - Functions performed - Risks assumed