Ch. 3 Cost-Volume-Profit (CVP) Analysis

Question 1

Cost-Volume-Profit (CVP) Analysis

Answer 1

*Examines the behavior of total revenues, total costs, and operating income as changes occur in the units sold, the selling price, the variable cost per unit, or the fixed costs of a product.

Question 2

Contribution Margin

Answer 2

= Total revenues – Total variable costs
or
= CM per unit x Number of units sold
or
= CM% x Revenues
*Indicates why operating income changes as the number of units sold changes
*Increase in CM exactly equals the increase in operating income (or the decrease in operating loss)
*Indicates how much of a company’s revenues are available to cover fixed costs

Question 3

Contribution margin per unit

Answer 3

= Selling price – Variable cost per unit

*Recognizes the tight coupling of selling price and variable cost per unit

Question 4

Contribution margin percentage (contribution margin ratio)

Answer 4

= Contribution margin per unit / Selling price

• Useful for companies that sell multiple products
• Contribution margin per dollar of revenue
• ABC earns 40% for each dollar of revenue (40 cents) they take in.

Revenues
xCM%
=CM
--Fixed costs
=Operating income

Question 5

Contribution margin income statement

Answer 5

*Groups costs into variable costs and fixed costs to highlight contribution margin
Operating income = CM – Fixed costs
*Increase in CM exactly equals the increase in operating income (or the decrease in operating loss)

Revenues
--Variable costs
=CM
--Fixed costs
=Operating income

Question 6

Change in Contribution Margin

Answer 6

= CM% x Change in revenues
CM at revenue of $8,000, .40 x $8,000 = $3,200
CM at revenue of $5,000, .40 x $5,000 = $2,000
Change in CM when rev. increases by $3,000 = $1,200
(.40 x $3,000 = $1,200)

Question 7

3 Methods for expressing CVP Relationships

Answer 7

1. Equation method
2. Contribution margin method
3. Graph method
   * Different methods are useful for different decisions.
   * Equation method and CM method are most useful when managers want to determine operating income at a few specific sales levels (ie. 5, 15, 25, and 40 units sold)
   * The graph method helps managers visualize the relationship between units sold and operating income over a wide range of quantities.

Question 8

Equation Method

Answer 8

Revenues (selling price x #units sold)
–Variable costs (variable cost per unit x #units sold)
–Fixed costs
=Operating income

Question 9

Contribution Method

Answer 9

CM per unit (selling price x variable cost per unit)
x #units sold
–Fixed cots
=Operating income

Question 10

Graph method

Answer 10

• Helps managers visualize the relationships between total revenues and total costs. The graph shows each relationship as a line
• Assume total costs and total revenues behave in a linear way
  1. Total costs line: sum of fixed and variable costs
  2. Total revenues line

Question 11

Revenue Driver

Answer 11

• A variable, such as volume, that causally affects revenues

* The NUMBER OF UNITS SOLD is the only revenue driver and the only cost driver

Question 12

Note about classifying Fixed or Variable costs

Answer 12

• The SHORTER the time horizon, the higher percentage of total costs considered FIXED. (pg. 73)
• Always consider the relevant range, the length of the time horizon, and the specific decision situation when classifying costs as variable or fixed.

Question 13

Breakeven Point (BEP)

Answer 13

*Quantity of output sold at which total revenues equal total costs–that is, the quantity of output sold that results in $0 of operating income.
Q = Operating income (target) + Total fixed cost / Unit CM
Q = $0 + Total fixed cost / Unit CM
Q = Total fixed cost / Unit CM
*Although this breakeven point is expressed in units, it can also be expressed in revenues:
Breakeven revenues = Breakeven Q x Selling price
or
Breakeven revenues = Fixed costs / CM%

Question 14

Quantity formula (target profit of something other than $0)

Answer 14

Q = Operating income (target) + Total fixed cost /
Unit CM

Revenue = Operating income (target) + Total fixed cost / CM%

Question 15

PV graph (profit volume)

Answer 15

*Shows how changes in the quantity of units sold affect operating income.

Question 16

Net Income

Target net income and income taxes

Answer 16

*Net income is operating income + nonoperating revenues (such as interest revenue) – nonoperating costs (such as interest cost) – income taxes

Operating income
\+nonoperating revenues
--nonoperating costs
--income taxes
=Net income
*for simplicity: Net income = Operating income -- Income taxes

Question 17

Target Net Income formula

Answer 17

= (Target operating income) – (Target operating income x tax rate)
or
=(target operating income) x (1 – tax rate)

Target operating income $1,600
–Tax at 40% (.40x1,600) 640
=Target net income $960

Question 18

Target Operating Income formula

Answer 18

= Target net income / 1 – tax rate

Question 19

Target prices

Answer 19

Target operating income
\+Fixed costs
=Target CM
/by #of units sold
=Target CM per unit
\+Variable cost per unit
=Target selling price

Question 20

Sensitivity Analysis

Answer 20

• A “What-if” technique managers use to examine how an outcome will change if the original predicted data are not achieved or if an underlying assumption changes.
• Answers questions such as “What will operating income be if the quantity of units sold decreases by 5% from the original prediction?” and “What will operating income be if variable cost per unit increases by 10%?”

Question 21

Margin of Safety

Answer 21

• Gives managers a good feel for a decision’s risks.
• Answers the “What-if” question: If budgeted revenues are above the breakeven point and drop, how far can they fall below budget before the breakeven point is reached?
• A low margin of safety increases the risk of a loss
• Margin of safety = Budgeted (or actual) revenues – Breakeven revenues
• Margin of safety (in units) = Budgeted (or actual) sales quantity – Breakeven quantity
• Margin of safety % = Margin of safety in dollars / Budgeted (or actual) revenues
• The analysis implies that if revenues fall by more than x%, you would suffer a loss.

Question 22

Operating leverage

Answer 22

• The risk-teturn tradeoff across alternative cost structures
• Describes the effects that FIXED COSTS have on changes in operating income as changes occur in units sold and contribution margin
• Organizations with a high proportion of fixed costs in their cost structures, have high operating leverage
• Small increases in sales lead to large increases in operating income
• Small decreases in sales result in relatively large decreases in operating income

Question 23

Degree of operating leverage

Answer 23

= Contribution margin / Operating income

• In the presence of fixed costs, the degree of operating leverage is different at different levels of sales.
• In general, whenever there are fixed costs, the degree of operating leverage decreases as the level of sales increases beyond the breakeven point.
• If fixed costs are $0, CM equals operating income and the degree of operating leverage equals 1.00 at all levels.

Question 24

Sales Mix

Answer 24

• Quantities (or proportion) of various products (or services) that constitute a company’s total unit sales.
• Multiple different products

Question 25

Breakeven point in bundles

Answer 25

= Fixed costs / CM per bundle