Purdue MGMT 201 Spring 2019 Exam 2 Flashcards
Absorption Vs. Variable Costing
Differ on how they treat fixed manufacturing overhead
Absorption Costing
- a cost accounting system in which both fixed and variable production costs are assigned to products
- Gross Margin: Sales Revenue - COGS
Variable Costing
- a cost accounting system in which only variable production costs are assigned to products
- Contribution margin: Sales revenue - Variable Expenses
Variable and Fixed administrative costs
Always treated as a period cost and deducted from sales revenue
Comparison of AC to VC: Produced = Sold
Inventory effect = None, Fixed MO: AC = VC, Profit: AC = VC
Comparison of AC to VC: Produced > Sold
Inventory effect = Increase, Fixed MO: AC < VC, Profit: AC > VC
Comparison of AC to VC: Produced < Sold
Inventory effect = decrease, Fixed MO: AC > VC, Profit: AC < VC
Advantages of AC
- Fixed manufacturing overhead is treated the same as the other product costs, direct material and direct labor
- Consistent with long-run pricing decisions that must cover full cost
- External reporting and income tax law require absorption costing
Advantages of VC
- Management finds it easy to understand
- Consistent with CVP analysis
- Emphasizes contribution in short-run pricing decisions
- Impact of fixed costs on profits emphasized
- Profit for period not affected by changes in fixed manufacturing overhead
Cost Volume Profit Analysis
CVP summarizes the effects of changes in an organization’s volume of activity on its costs, revenues, and profit
Key Assumptions of CVP Analysis
- The behavior of total revenue is linear (straight-line)
• Which implies that the price of the product or service
will not change as sales volume varies within the
relevant range - The behavior of total expenses is also linear, which implies the following more specific assumptions
• Expenses can be categorized as fixed, variable, or
semi-variable
• The efficiency and productivity of the production
process and workers remain constant - In multiproduct organizations, the sales mix does not change
- In manufacturing firms, the inventory levels at the beginning and end of the period are the same
• Which implies that the number of units produced
during the period equals the number of units sold
Break Even Point
The level of activity where total revenues = total expenses (variable + fixed)
Contribution Margin
Sales Revenue - Variable Expenses
• The amount of revenue available to cover fixed costs
Using CM PER UNIT to calculate Break Even Point
- (Sales Price - Variable Cost Per Unit) / # Units
- Sale Price - answer from 1 = CM per Unit
- Break Even Point = Fixed expenses / CM per unit
$ / $ = Units
Finds number of unit sales needed
Using CM Ratio to calculate Break Even Point
- CM per Unit / Sales Price per Unit = %
- Break Even Point = Fixed expenses/ CM Ratio
$ / % = $
Finds Dollar sales needed
Target Profit
amount company wants to earn
To find how much they need to reach TP just add target profit to fixed expenses in equations
Safety Margin
The amount by which sales can drop before a loss occurs
Budgeted Sales Revenue – Break-Even Sales Revenue
Sales Mix
The relative proportion of each type of product sold
Weighted-Average Unit Contribution Margin
The average of the several products’ unit contribution margins, weighted by the relative sales proportion of each product
Break Even Point for multiproducts
Fixed Expenses / Weighted-Average Unit Contribution Margin
$ / $ = COMBINED number of units
Variable Cost Graph
- positive slope starting at 0, slope is variable cost per unit of activity
- Recall, total variable costs increase in direct proportion to increases in activity (aka cost driver)
Fixed Cost Graph
- Flat line
* Total fixed costs remain the same across the relevant range of the activity (aka cost driver)
Step Variable Costs Graph
- Looks like a staircase
- Step-variable costs can be adjusted more quickly and the width of the activity steps is much wider for the step-fixed cost
Fixed step Graph
- lines with jumps in between
- Total cost doesn’t change for a wide range of activity, and then jumps to a new higher cost for the next higher range of activity
Semi-Variable Costs Graph
• Positive slope not starting from 0
Engineered Costs
Physical relationship with activity measure => Direct Materials
• cannot make more donuts without using more ingredients
Committed Costs
Long-term - Cannot be reduced in the short term => Depreciation on buildings
• Results from an organization’s ownership or use of facilities – would be a major decision to change having long-term implications
• facility costs are committed costs
Discretionary Costs
May be altered in the short term by current managerial decisions => Advertising and R&D
• Discretionary costs can be easily changed in the short run, so management has flexibility about spending discretionary costs
Cost Estimation
Is the process of determining how a particular cost behaves
Methods include: Account-Classification, Visual-Fit, High-Low
High Low method
(High Cost – Low Cost) / (High Activity – Low Activity) = VC per unit of activity
TC = FC + VC * A
Data Collection Issues
- Missing data – Misplaced source documents or failure to record a transaction can result in missing data
- Outlier data points – Should be eliminated from data set
- Mismatched time periods costs – Production activity may be recorded daily, but costs may be recorded monthly
- Trade-offs in choosing the time period – Lots of data vs. a little
- Inflation – Historical cost data may not reflect future cost behavior
