Projection and Forecasting Techniques: Part 2_ M2 Flashcards
What is the Projection and Forecasting Methods?
- The contribution margin is the difference between the sales price and total variable costs.
- Cost-volume-profit analysis examines the effect that volume changes have on variable and fixed costs and the resulting profit or loss.
- The breakeven point determines the sales (in dollars or units) required to have no profit or loss from operations.
- Gross operating profit is the difference between total sales and total operating expenses
What are the underlying assumptions of Cost-Volume-Profit?
- All costs can be divided into fixed and variable elements.
- Volume is the only relevant factor affecting cost.
- Selling prices are to be unchanged.
What is the difference between absorption GAAP Costing and Variable CM Costing approach?
The difference between variable costing and full absorption costing lies in the treatment of fixed manufacturing costs.
FULL ABSORPTION/FULL COST/GM/GAAP
- Full absorption costing treats fixed manufacturing costs as product costs, while variable costing expenses these as period costs.
- Selling costs, regardless if fixed or variable, are all considered period costs.
- Encourages mgmt to increase inventories as it absorbs FOH which included factory mgmt salaries.
VARIABLE/DIRECT/(CM)/Throughput COSTING
- Variable costing treats all fixed costs (fc expenses + FOH) as period costs, expensing the costs regardless of sales. Thus, the difference in net income would be the amount of fixed manufacturing costs inventoried under absorption costing:
How to calculate the difference between Full Absorption Costing GAAP and Direct Variable Costing?
Step: 1
FOH TC / Units Produced = $FOH per unit
Step: 2
$FOH per unit x Units Sold = Cost of Goods Sold
Step: 3
COGS - FOH TC = difference left on BS and is the difference in Variable costing amount.
How to calculate operating income using Absorption Costing?
Sales
<COGS> (FOH + VOH (DM+DL+VOH) + Beg Inv + purchases - sales - End Inv)
**=GM**
<Expenses> Period Cost
**= Operating Income**
</Expenses></COGS>
How to calculate Operating Income using Variable costing?
Sales
<COGS> (VC (DM+DL+VOH) + Beg Inv + purchases - sales - End Inv)
**=CM**
<FC> as Period Cost
<Expenses> Period Cost
**= Operating Income**
</Expenses></FC></COGS>
What is the effect on income for Absorption and Variable Costing methods?
Absorption vs. Variable
Production Greater than Sales
- If units produced is greater than units sold, income will be higher under absorption costing because production is not a COGS/expensed until it is sold.
- With Variable costing all VC will be a COGS/ expensed, whether it is sold or not there by decreasing operating income.
Sales Greater than Production
- If units sold exceed units produced, Absorption Method Operating System income will be less than Variable Costing method because the units sold will be a COGS FC and VC whereas with VC only the VC will be a COGS.
What are the benefits and limitations of Absorption Costing and Variable Costing?
Absorption (GAAP) Costing
BENEFITS
- GAAP
- IRS requires this method
LIMITATIONS
- Level of inventory affects net income because FC are a component of production cost
- Net Income reported under absorption costing is less reliable than under VC Method because COGS includes FC.
- With FC included in FOH, this would result in evaluating managers based on the actions of those in another function.
Variable (Direct) Costing
BENEFITS
- VC and FC are separated and VC can be easily traced to and controlled by management.
- NI reported under the CM to aid in decision making.
LIMITATIONS
- Variable Costing is not GAAP
- IRS does not allow this method
How is inventory account treated on the balance sheet of absorption costing?
- Requires all product costs to be included in inventory. No segregation is made between fixed and variable costs, and the costs are expensed when the product is sold.
- Production costs in addition to the prime costs (DM + DL + FOH applied) is included in inventory with absorption costing.
- Indirect and fixed costs related to production are included in the cost of the product under absorption costing.
How are SG&A treated in Absorption vs. Variable or CM Costing?
- Operating income is the bottom-line figure under both the absorption approach and the contribution approach. Both methods take SG&A (fixed and variable) into account, which means both will produce the same bottom-line figure.
- The gross margin (absorption) will remain the same, as SG&A expenses do not factor into the gross margin calculation. The contribution margin (Variable) will be lower (not higher) due to higher variable SG&A expenses.
- Inventory amounts will be the same under both methods, as
SG&A expenses are period costs and will not impact inventory calculations.
How to calculate FC?
FC can be derived by taking the CM ratio and multiplying it by breakeven sales in dollars.
- CM Ratio = CM/SP If the CM is $40, and VC are $10, the SP per unit must be $50. The CM ratio will therefore be $40/$50, or 80%.
- Breakeven sales of $150,000 × 80% is equal to FC of $120,000.
What is cost based-pricing?
- Price stability.
- Fixed-cost recovery.
- Price justification.
What is Target Costing?
- The objective of target costing is to set a target cost allowed to ensure both profitability per unit and total sales volume.
- This requires knowledge of the given selling price of the product so that allowable production costs can be determined.
How to calculate pre-tax profit from net income?
NI / (1-TR)
What is the CM or CM Ratio to use when deciding which product to sell?
CM Ratio is better than CM.
