Chapter 5 Flashcards
Why is CVP useful?
predict impact on profits of changes in prices of products, volume or level of activity, unit variable costs, total fixed costs, and the sales mix
Contribution margin definition
the amount remaining from sales revenue after variable expenses have been deducted. Covers FC and then towards profit; the amount of sales (net of variable expenses) that contributes toward covering fixed expenses and then profits
Unit contribution margin definition
used to predict changes in total contribution margin and in profits (assuming no change in FC) as result of changes in unit sales of product
Contribution Margin Ration (CM ratio) definition
ratio of contribution margin to total sales. Shows how the CM is affected by a given dollar change in total sales.
Why is CM ratio easier to work with than unit contribution margin?
when a company has multiple products because CM ratio demonated in sales dollars
Applications of CVP concepts
used to estimate the impact on profit of changes in selling price, VC per unit, sales volume, and total FC. also estimate effect on profit of a change in parameters
Break-even analysis
target profit analysis in which target profit is zero and also where total sales revenue equals total expenses or where total CM=total fixed expenses
Target profit analysis definition
estimate level of sales requried to attain specified target profit
Profits
Sales- Variable expenses - fixed expressions
Sales
Variable expenses + fixed expenses + profits
Unit sales
(fixed expenses + profits) / Unit contribution margin
Price x Unit sales
Unit vaariable cost x Unit sales + fixed expenses + profits
Sales
(Fixed expenses + profits) / Contribution margin ratio= price x unit sales
1-Variable expense ratio
Contribution margin ratio
What are the two ways to do break even point using the equation method
solve for break even unit sales or solve for break even sales in dollars
What are two ways to find break even using contribution margin ratio
solve for break even unit sales or solve for break even sales in dollars
Unit sales to attain target profits
(fixed expenses + target profits) / Unit contribution margin
Dollar sales to achieve target profits
(fixed expenses + target profits) / Contribution margin ratio
margin of safety definition
the excess of budgeted (or actual) sales over the break-even volume of sales. The amount by which sales can drop before losses begin to be incurred
Margin of safety in dollars equation
total sales- break even sales
margin of safety percentage
margin of safety in dollars / total sales
cost structure definition
the relative proportion of fixed and variable costs in an organization
operating leverage
a measure of how sensitive net opearting income is to a given percentage change in sales
degree of operating sales=
contribution margin / net operating income
degree of operating leverage x percentage change in sales=
Percentage change in net operating income
What does the degree of operating leverage tell us
the higher degree of operating leverage, the larger increase in net operating income
Is the degree of operating leverage constant?
No. the degree is infinite at break even point because denominator is zero
If companies have same profit, selling price, unit sales and total expenses, what can we infer?
company with higher operating leverage will have higher proportion of fixed costs in its cost structure
If they do not have same profit, sales, selling price, and total expenses, can we make assumptions about cost structure?
No!
sales mix definition
relative proportions in which a company’s products are sold. if change, overall contribution margin ratio will change
Overall CM ratio=
Total contribution margin / Total sales
CVP analysis assumption about sales mix (for firm with one product)
assume sales mix will not change. under constant sales mix assumption, break even lvl of sales dollars computed using overall CM ratio
CVP analysis assumption about sales mix (for firm with one product)
break-even sales = fixed expenses / overall CM ratio….Sales to achieve target profits = (fixed expenses + target profits) / Overall CM ratio
Assumptions in CVP Analysis
Selling price is constant, costs are linera and can be accurately divided into variable and fixed elements, sales mix is constant in multi-product companies, in manufacturing companies inventories do not change
variable expenses
unit variable cost x unit sales
Unit contribution margin
Price-unit variable cost
variable expense ratio=
1- variable expenses/sales
contribution margin=
Sales-variable expenses
What does the assumption that costs are linear and can be accurately divided into V and F elements mean?
implies operating conditions are stable and fixed costs are fixed even when volume changes dramatically
basic profit equation
(P-V)Q - FC
Target profit volume
Q=(profit+FC)/(P-V)
Target profit revenue
PxQ=(profit+FC)/(P-V)/P
Breakeven volume
Q(BE)=FC/(P-V)
Breakeven Revenue
PxQ=FC/(P-V)/P
After taxes Volume
Q=(profit/(1-t) + FC) / (P-V)
After taxes revenue
PxQ=(profit/(1-t) + FC) / (P-V) / P
revenue
PxQ
Variable cost
VC x Q
CM
Q x (P-VC)
Taxable income
Tx (Q x (P-VC) - FC)
Net Income
Q x (P-VC) - FC - T x [Q x (P-VC) -FC )
Static Breakeven Taxable income
=0
Static Breakeven volume
Q= FC / (P-VC)
Net Income Breakeven volume
((profit / (1-T)) + FC ) / (P - VC)
CVP is concerned witht he effects on net operating income of
selling prices, sales volume, unit variable costs, total fixed costs, the mix of products sold
Why is a contribution format income statement useful?
it highlights cost behavior
When does the unit contribution margin remain constant?
As long as the selling price and unit variable cost do not change
What happens if the contribution margin does not cover fixed expenses?
There is a loss
What happens when additional units are sold?
fixed expenses are whittled downuntil they have been covered
break even point definition
the points where total sales equals total expenses and where total contribution margin equals total fixed expenses
How much does each additional unit sold increases net operating income by?
the amount of the unit contribution margin
When does Profit = Q(P-V) - Fixed expense apply?
when a company has a single product
When does CM ratio = Unit contribution margin / Unit selling price?
when a company has only one product
Major assumptions of CVP Analysis
- selling price is constant. The price does not change as volume changes. 2. costs are linear and can be accurately split into fixed and variable elements. the total fixed cost is constant and the variable cost per unti is constant. the sales mix is constant in multi product ocmpanies. in manufacturing companies, inventories do not change. the number of units produced equals the number of units sold.
