Ch4, Module 2

Question 1

Cost volume profit analysis

Answer 1

used by managers to forecast profits at different levels of sales and production volume.

Synonymous with breakeven analysis

where revenue = total cost

Question 2

absorption approach

Answer 2

required for GAAP

GAAP does not segregate fixed and variable costs

revenue 
-COGS
=GM
-operating expenses
=net income

Question 3

Contribution approach

Answer 3

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

Question 4

contribution margin ratio

Answer 4

= CM / revenue

Question 5

treatment of fixed factory OH - absorption vs contribution approach

Answer 5

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

Question 6

treatment of selling, general and admin expenses

- absorption vs contribution approach

Answer 6

are period costs used in the determination of net income under both methods

Question 7

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

Answer 7

DM, DL, variable and fixed MOH = product cost

variable and fixed SGA = period

Question 8

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

Answer 8

DM, DL, Variable MOH = product

fixed MOH and variable and fixed SGA exp = period

Question 9

if the number of units produced exceeds the units sold, which costing system yields higher income?

Answer 9

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

Question 10

if the number of units produced is less than the units sold, which costing system yields higher income?

Answer 10

fixed MOH from a previous period is charged to cost of sales effectively lowering income under absorption costing

income is higher under contirbution

Question 11

What are the steps involved to calculate the difference between variable costing net income and absorption costing NI

Answer 11

1. compute the fixed cost per unit (fixed MOH / units produced)
2. compute the change in income (change in inventory units x fixed cost per unit)
3. 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

Question 12

benefits and limitations of using absorption costing

Answer 12

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)

Question 13

Benefits and limitations of Variable/Direct/Contribution costing

Answer 13

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

Question 14

breakeven point in units

Answer 14

= total fixed costs / Contribution margin per unit

what you will need to sell in order to recover your variable and fixed costs

Question 15

breakeven point in dollars

Answer 15

= unit price x breakeven point in units

OR

= total fixed cost / CM ratio

Question 16

calculation to figure out how many units you have to sell in order to receive a specified target profit

Answer 16

sales (units) = (fixed cost + pretax profit you want to achieve) / contribution margin per unit

Question 17

calculation to figure out how many sales dollars you have to generate in order to reach a specified target profit

Answer 17

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

Question 18

what is the calculation for setting a sales price based on an assumed level of volume

Answer 18

sales price per unit = (FC +VC +Pretax profit you’d like to achieve) / number of units sold

Question 19

margin of safety

Answer 19

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

Question 20

target costing

Answer 20

a technique used to establish the product cost allowed to ensure both profitability per unit and total sales volume

Question 21

target cost computation

Answer 21

target cost = market price - required profit