Ch20: pricing and product mix decisions

Question 1

What is CVP analysis?

Answer 1

used to assess impact on profitability of short term changes.

creates a baseline of desired performance, or information about what is needed to achieve desired targets.

Question 2

What is break even?

Answer 2

When costs are equal to revenues - at this level of sales there is no profit or loss.

Question 3

What is contribution margin?

Answer 3

the difference between sales price per unit and variable cost per unit.

Question 4

What is contribution margin ratio?

Answer 4

• unit contribution margin divided by unit sales price

- this is the proportion of each sales dollar available to cover fixed costs and create a profit.

Question 5

Calculate BE in units

Answer 5

fixed costs / CM per unit

Question 6

Calculate BE in $

Answer 6

fixed costs / (CM/unit sales price)

Question 7

Multiple product BE analysis

Answer 7

fixed costs / Weighted average CM

Question 8

Calculate Target net profit sales volume units

Answer 8

= (fixed costs + target profit) / CM

Question 9

Calculate Target net profit sales volume $

Answer 9

= (fixed costs + target profit) / (CM/sales price)

Question 10

Calculate Target profit before tax

Answer 10

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

Question 11

Calculate Sales volume to earn target profit after tax

Answer 11

= (fixed costs + target profit before tax) / CM

Question 12

What is the safety margin?

Answer 12

budgeted sales revenue - break even revenue

Question 13

What is the ABC approach to CVP analysis?

Answer 13

ABC categorises activities as unit, batch, product sustaining and facility. Batch, product sustaining and facility are non volume related activity costs.

BE = total batch, product, facility costs / (selling price per unit - costs per unit)

Question 14

What are the assumptions of CVP?

Answer 14

• behaviour of total revenue is linear - assume price is static as volume increases
• behaviour of total costs is linear - assumes stable costs
• assumes volume is cost driver for variable and fixed costs
• sales mix remains constant
• assumes inventory stays the same, units produced and sold for period are equal

Question 15

What happens when assumptions of CVP are not met?

Answer 15

Accuracy is compromised when these assumptions are not met. It is a simplistic model so use with caution.

Question 16

What are the assumptions of CVP using ABC?

Answer 16

• batch level costs are dependent on batch size
• management may change batch size and this will impact break even volume
• needs increased complexity when there are multiple products

Question 17

Is there long term usefulness to CVP analysis?

Answer 17

Short term or tactical decision tool.

• long term options factor time value of money
• assumptions of CVP are likely to be incorrect over long term ie. costs change, non linear etc.

Question 18

How does the economic pricing model work?

Answer 18

Involves setting a price that takes into account the costs of ownership to the customer, as well as customer value.