Planning Techniques

Question 0

What are the limitation of absorption costing?

Answer 0

1. The level of inventory affects net income because fixed costs are a component of product cost.
2. The net income reported under the absorption method is less reliable (especially for use in performance evaluations) than under the variable method because the cost of the product includes fixed costs and, therefore, the level of inventory affects net income.

Question 1

What are the benefits if absorption costing?

Answer 1

1. Absorption costing is GAAP.

2. The IRS requires the use of the absorption method for financial reporting

Question 2

What are the benefits of variable (direct) costing?

Answer 2

1. Variable and fixed costs are separated and can be easily traced to and controlled by management.
2. The net income reported under the contribution income statement is more reliable (especially for use in performance evaluations) than under the absorption method because the cost of the product does not include fixed costs and, therefore, the level of inventory does not affect net income.
3. Variable costing isolates the contribution margins in financial statements to aid in decision making (the contribution margin is defined as sales price less all variable costs, including variable sales and administrative costs, and breakeven analysis is often based on contribution margins).

Question 3

What are the limitations of variable costing?

Answer 3

1. Variable costing is not GAAP.

2. The IRS does not allow the use of the variable cost method for financial reporting.

Question 4

What is the formula for breakeven point in units?

Answer 4

Total fixed costs / contribution margin per unit

Question 5

What are the two methods for computing breakeven in sales dollars?

Answer 5

1. Contribution margin per unit
   Multiply breakeven in units by selling price per unit
2. Contribution margin ratio
   Total fixed costs / contribution margin ratio

Question 6

What is the formula for required sales volume for target market

Answer 6

1. Sales = variable costs + (fixed costs + net income before taxes)
2. Sales = fixed cost + profit / contribution margin ratio

Question 7

What is the formula for target profit before tax?

Answer 7

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

Question 8

What are the two ways of expressing margin of safety?

Answer 8

1. Sales dollars
Total sales (in dollars) - breakeven sales (in dollars)

2. Percent
   Margin of safety (in dollars) / total sales

Question 9

How do you calculate target cost?

Answer 9

Target cost = market price - required profit

Question 10

What are the costs considered in operational decision analysis?

Answer 10

1. Relevant revenues and costs
   Only relevant if they change as a result of selecting different alternatives
2. Irrelevant costs
   Do not differ between alternatives and should be ignored
3. Incremental costs
   The afflictions costs incurred to produce an additional amount of the unit over the present output.
4. Sunk costs
   Unavoidable so are not relevant costs
5. Opportunity costs
   The cost of foregoing the next best alternative when making a decision
6. Controllable costs
   Costs that can be authorized at a specific level of management
7. Marginal costs
   Include all variable costs AND any avoidable fixed costs