Financial Accounting Flashcards
Learning Objectives, glossary terms
Differentiate between variable cost, fixed cost, and mixed cost.
Variable costs change with production level, fixed costs remain constant regardless of production, and mixed costs contain both variable and fixed components.
Nature of variable costs (aggregate and per unit)
In aggregate, total variable costs increase with production volume. Per unit, variable costs remain constant regardless of production level.
Nature of fixed costs (Aggregate and per unit)
In aggregate, total fixed costs remain constant regardless of production volume. Per unit, fixed costs decrease as production volume increases.
Concept of Economies of Scale
Economies of scale occur when increasing production leads to lower per-unit costs due to spreading fixed costs over more units and operational efficiencies
Relevant Range
Relevant range refers to the production levels within which cost assumptions (fixed and variable) are valid. Costs may change outside this range
Specific types of fixed costs - Committed and Discretionary
Committed fixed costs are long-term and difficult to change (eg lease agreements). Discretionary fixed costs are easier to modify or eliminate (e.g, advertising budgets)
Nature of Step Costs and Business Strategy
Step costs remain fixed over a range of activity levels but jump to a higher amount once the range limit is exceeded. Strategies include careful capacity planning and cost management
Nature of a Mixed (semi variable) Cost
Mixed costs have both fixed and variable components. They increase with production but not in direct proportion
Using a scattergraph, method of least squares, and the high-low method to sort fixed/variable components of a mixed cost
1) Scattergraphs plot costs against activity levels to visualize the cost behavior
2)The method of least squares statistically determines the best-fitting line to separate fixed and variable components
3)The High-Low method uses the highest and lowest activity levels to estimate fixed and variable cost components
Applying the mechanics of the high-low method
1)Identify the highest and lowest activity levels
2)Calculate the variable costs per unit:(Cost at highest activity - cost at lowest activity)/(Highest activity units - Lowest activity units)
3)Determine fixed costs: Total cost at either activity level - (Variable cost per unit * Number of units at that level)
Define cost-volume-profit (CVP) analysis
CVP analysis studies how changes in costs and volume affect a company’s operating income and net-income
Prepare a “Break-Even” Graph
A break-even graph shows total costs and total revenue at different levels of activity, indicating the break even point where total revenue equals total costs
Define the contribution margin (Aggregate, per unit, ratio)
1)Contribution margin is a sales revenue minus variable costs.
2)Aggregate CM is the total CM for all units sold
3)Per Unit CM is CM per individual unit sold
4)CM ratio is CM divided by sales revenue, expressed as a percentage
Understand the break even point and target income
1)Break-even point is where total revenue equals total costs, resulting in zero-profit
2)Target income is the level of sales needed to achieve a specific profit
Perform break-even and target income computations
1)Break-Even Sales(Unit) = Fixed Costs/CM per unit
2)Break-Even Sales(Dollars) = Fixed Costs/CM ratio
3)Target income Sales (Unit) = (Fixed costs + target income)/CM per unit
4)Target Income Sales (Dollars) = (Fixed Costs + Target Income)/CM Ratio
Applications for CVP analysis
CVP analysis helps in pricing decisions, product mix decisions, determining the impact of changes in costs, and planning for profit levels
Understand the impact of operating changes on break-even and other CVP computations
Operating changes (like cost structures or sales volumes) alter break-even points and other CVP (cost-volume-profit) analyses by affecting total costs and revenue relationships
Be available to adjust CVP calculations for changes in fixed and variable costs
To adjust CVP calculations for changes in fixed and variable costs, recalculate the break even-point and contribution margin using the new cost figures
Understand the income impacts of per unit revenue shifts
Shifts in per unit revenue directly affect total income, impacting break-even points and profitability. Higher per unit revenue increases total income, while lower revenue decreases it
Be able to apply CVP analysis to firms with multiple products
Use a weighted-average contribution margin for multiple products to conduct CVP analysis, considering the sales mix proportions
Cite the assumptions of CVP modeling
1)Sales price per unit is constant
2)Variable costs per unit are constant
3)Total fixed costs are constant
4)All units produced are sold
5)For multiple products the sales is constant
Break-even Point
The level of activity where revenues equals total expenses, producing a net zero income, also the point where the contribution margin is said to cover fixed costs
Committed-Fixed Cost
Costs that arise from an organizations commitment to engage in operations, unavoidable elements like depreciation, rent, insurance, property taxes
Contribution margin
Revenues minus all variable expenses, whether related to production or selling and administration (not to be confused with gross profit)
Cost-Volume-Profit-Analysis
(CVP) Analysis focusing on the interplay of pricing, volume, variable and fixed costs, and product mix
Discretionary fixed costs
Fixed costs resulting from yearly spending decisions; proper planning can result in avoidance of these costs as necessary (eg advertising and training)
Economies of scale
Efficiencies associated with increases in volume
Fixed Cost
A total cost that remains the same regardless of volume; total cost is constant and per unit cost decreases with volume increases
High-Low Method
A simple means for separating costs into fixed and variable components, based upon the difference between costs at the highest and lowest observed levels of activity
Method of least squares
A complex means of separating costs into fixed and variable components, based upon minimizing the variances between all observations and the resulting assumed cost function
Mixed costs
A cost that has both fixed and variable components
Relevant range
The level of activity for which assumptions underlying CVP are expected to hold true
scattergraph
A simplistic mapping of observed data points, where a line is visually drawn to represent the estimated cost function
Step Cost
A cost function that is fixed over a range , and then increases by a measured step to a new level at the next higher increment of activity
Target income
A level of income that is to be obtained; CVP projects activity levels necessary to achieve this benchmark
Variable Cost
A per-unit cost that is the same regardless of volume; total variable cost increases with volume increases
