Ch4, Module 2 Flashcards
Cost volume profit analysis
used by managers to forecast profits at different levels of sales and production volume.
Synonymous with breakeven analysis
where revenue = total cost
absorption approach
required for GAAP
GAAP does not segregate fixed and variable costs
revenue -COGS =GM -operating expenses =net income
Contribution approach
uses variable costing (also called direct costing)
not GAAP but it is extremely useful for decision making purposes.
revenue - variable costs = contribution margin - fixed costs = net income
contribution margin ratio
= CM / revenue
treatment of fixed factory OH - absorption vs contribution approach
absorption - all fixed factory oh is treated as a product cost and is included in inventory values (hits the B/S)
contribution - all fixed factory oh is treated as a period expense and is expensed in the period incurred
treatment of selling, general and admin expenses
- absorption vs contribution approach
are period costs used in the determination of net income under both methods
under absorption costing identify the type costs for each of the following items (product or period)
- DM
- DL
- variable and fixed SGA exp.
- Variable MOH
- fixed MOH
DM, DL, variable and fixed MOH = product cost
variable and fixed SGA = period
under contribution (variable direct) costing, identify the type of costs for each of the following (product or period)
- DM
- DL
- variable and fixed SGA exp.
- Variable MOH
- fixed MOH
DM, DL, Variable MOH = product
fixed MOH and variable and fixed SGA exp = period
if the number of units produced exceeds the units sold, which costing system yields higher income?
if units produced > units sold then some fixed MOH is included with each unit in ending inventory for absorption costing (i.e. they’re added to ending inventory)
income is higher under absorption than contribution costing
if the number of units produced is less than the units sold, which costing system yields higher income?
fixed MOH from a previous period is charged to cost of sales effectively lowering income under absorption costing
income is higher under contirbution
What are the steps involved to calculate the difference between variable costing net income and absorption costing NI
- compute the fixed cost per unit (fixed MOH / units produced)
- compute the change in income (change in inventory units x fixed cost per unit)
- Determine the impact of the change in income
- no change in inv = same NI
- increase in inventory = absorption NI is higher
- decrease in inventory = contribution NI is higher
benefits and limitations of using absorption costing
benefits
- it’s GAAP!
- the IRS reqires the use of this method for financial reporting
limitations
- level of inventory affects NI because fixed costs are a component of product cost
- NI reporting under the absorption method is less reliable because the cost of the product includes fixed costs (as such inventory affects NI)
Benefits and limitations of Variable/Direct/Contribution costing
benefits
- variable and fixed costs are separated and can be easily traced to and controlled by mgt
- NI reported under the contribution income statement is more reliable because the cost of the product does not include fixed cost
- isolating contribution margins help aid decision making
limitations
- not GAAP
- IRS does not allow the use of the variable cost method
breakeven point in units
= total fixed costs / Contribution margin per unit
what you will need to sell in order to recover your variable and fixed costs
breakeven point in dollars
= unit price x breakeven point in units
OR
= total fixed cost / CM ratio
calculation to figure out how many units you have to sell in order to receive a specified target profit
sales (units) = (fixed cost + pretax profit you want to achieve) / contribution margin per unit
calculation to figure out how many sales dollars you have to generate in order to reach a specified target profit
sales dollars = variable costs + fixed cost + pretax profit you want to achieve
OR
sales dollars = (FC + Pretax profit you want to achieve) / contribution margin ratio
what is the calculation for setting a sales price based on an assumed level of volume
sales price per unit = (FC +VC +Pretax profit you’d like to achieve) / number of units sold
margin of safety
the excess of sales over breakeven sales (generally expressed as either dollars or percentage)
margin of safety (in dollars) = Total sales in dollars - breakeven in dollars
margin of safety % = margin of safety in dollars / total sales
target costing
a technique used to establish the product cost allowed to ensure both profitability per unit and total sales volume
target cost computation
target cost = market price - required profit
