Exam 2 Powerpoint Notes
Exam 2 Powerpoint Notes ACC 202
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This 11 page Study Guide was uploaded by Sharon Liang on Sunday February 14, 2016. The Study Guide belongs to ACC 202 at University of Kentucky taught by Dr. Stephen Weissmueller in Spring 2016. Since its upload, it has received 32 views. For similar materials see Managerial Accounting in Accounting at University of Kentucky.
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Date Created: 02/14/16
ACC 202 Exam 2 Chapter 4 Break-Even Point in Units and Sales Dollars Companies use Cost Value Profit (CVP) analysis to help them reach important benchmarks such as break even points Break even points occur when total revenue and total cost equal The level of sales at which contribution margin just covers fixed costs and when operating income is zero Since new companies typically experience losses (negative operating income), their first breakeven point is a milestone to them Using Operating Income in CVP analysis For CVP analysis, it’s useful to organize costs into fixed and variable components Below is the income statement format that’s based on separation of costs into fixed and variable components called contribution margin income statement Variable components include direct labor, direct materials, variable overhead, and variable selling and administrative costs Fixed overhead and fixed selling and administrative costs Contribution margin is the difference between sales and variable expense The amount of sales revenue left over after all the variable expenses are covered that can be used to contribute to fixed expense and operating income Break Even Point in Units Operating income = sales (price x # of units sold) – total variable expenses (variable cost per unit x # of units sold) – total fixed expenses Break even units = (total fixed cost)/(price – variable cost per unit) Break Even Point in Sales Dollars Sales revenue = unit selling price x units sold Variable Cost Ratio and Contribution Margin Ratio 1) Variable Cost Ratio Price – variable cost per unit Variable cost x units sold (variable cost per unit)/price 2) Contribution Margin Ratio (total contribution margin)/(total sales) (contribution margin per unit)/(price) Fixed Cost’s Relationship with Variable Cost Contribution and Margin Ratios Since the total contribution margin is the revenue remaining after total variable costs are covered, it must be the revenue available to cover fixed costs and contribute to profit The relationship of fixed cost to contribution margin affect operating income in 3 possibilities: 1) Fixed costs equals contribution margin; operating income equals zero; company breaks even 2) Fixed costs is less than contribution margin; operating income is greater than zero (positive); company makes profit 3) Fixed costs is more than contribution margin; operating income is less than zero; company makes loss Units to be Sold to Achieve Target Income While the break-even point is useful information and an important benchmark for relatively young companies, most companies would like to earn an operating income greater than 0. CVP allows us to do so by adding the target income amount to the fixed cost Sales Revenue to Achieve Target Income Impact of Change in Revenue on Change in Profit Assuming that fixed costs doesn’t change, the contribution margin ratio can find the profit impact of a change in sales revenue Change in profits = contribution margin ratio x change in sales Graphs of CVP Relationship: The Profit-Volume Graph A profit-volume graph visually portrays the relationship between profits (operating income) and units sold The profit-volume graph is the graph of the operating income equation: operating income: sales (price x units) – total variable costs (unit variable cost x units) – total fixed costs The operating income is the dependent variable while the number of units is the independent. The Cost Value Profit Graph Depicts relationship among costs, values, and profits (operating income) CVP Analysis Assumptions 1) Linear revenue and cost functions remain constant over relevant range 2) Selling costs and prices are known w/certainty 3) All units produced are sold; no finished goods inventories remain 4) Sales mix is known for multiple-product break-even settings Multiple Product Analysis CVP analysis is simple in the single-product settings. However, most firms produce and sell a number of products and services One important distinction is to separate direct and common fixed expenses Direct fixed expenses: can be traced to fix each segment and would be avoided if segment didn’t exist Common fixed expenses: not traceable segments and would remain even if one of the segments was eliminated Break Even Calculations for Multiple Products When multiple products are produced and sold, managers must estimate the sales mix and calculate a package contribution margin Sales mix is the relative combination of products being sold by a firm Break-even packages = (fixed costs)/(package contribution margin) CVP Analysis and Uncertainty Managers must be aware of many factors in our dynamic world. CVP analysis is a tool managers use to handle risk and uncertainty. Methods to Deal with Risk and Uncertainty 1) Managers must realize the uncertain nature of future prices, costs, and quantities 2) Management must assume a breakeven “band” rather than a breakeven point 3) Managers should use sensitivity such as “what if” analyses Margin of Safety Units sold or revenue earned above the break-even volume Margin of safety = selling units – breakeven units If expressed in percentage, it’s (margin of safety/revenues) x 100 Operating Leverage Use of fixed costs to extract higher percentage change in profits as sales activity changes Measure of the proportion of fixed costs in a company’s cost structure Used as an indicator of how sensitive profit is to changes in sales volume The degree of operating leverage (DOL) can be measured for a given level of sales by taking the ratio of contribution margin to operating income: (contribution margin)/(operating income) Sensitivity Analysis Chapter 8 Variable and Absorption Income Statements Many companies consist of separate business units called profit centers It’s important for these companies to determine both the overall performance of the business and the performance of the individual profit centers Therefore, it’s important to develop a segmented income statement for each profit center 2 methods of computing income has been developed: 1) Based on variable costing 2) Based on full or absorption costing Absorption Costing Assigns all manufacturing costs to the product Direct materials, direct labor, variable overhead, and fixed overhead define the cost of a product Under this method, fixed overhead is assigned to the product through the use of a predetermined fixed overhead rate and isn’t expensed until product is sold Fixed overhead is an inventoriable cost Variable Costing Stresses the difference between fixed and variable manufacturing costs Variable costing assigns only variable manufacturing costs to the product; these costs include direct materials, direct labor, and variable overhead Fixed overhead is treated as a period expense and is excluded from the product cost Under variable costing, fixed overhead of a period is seen as expiring that period and is charged in total against the revenues of the period Comparison of Absorption and Variable Costing Generally accepted accounting principles (GAAP) require absorption costing for external reporting The Financial Accounting Standards Board (FASB) and the Internal Revenue Service (IRS), and other regulatory bodies don’t accept variable costing as a product costing method for external reporting The only difference is the treatment of the fixed factory overhead The unit product cost under absorption costing is always greater than the unit product cost under variable costing Production, Sales, and Income Relationships The relationship between variable costing income and absorption costing income changes as the relationship between products and sales changes Segmented Income Statements Using Variable Costing Variable costing is useful in preparing segmented income statements because it gives useful information on variable and fixed expenses A segment is a subunit of a company of sufficient importance to warrant the production of performance reports Segments can be divisions, departments, product lines, customer classes, etc. In segmented income statements, fixed expenses are broken down into two categories: direct and common Direct Fixed Expenses Directly traceable to a segment These are sometimes referred to as avoidable fixed expenses because they vanish if the segment is eliminated For example, if the segments were sales regions, a direct fixed expense for each region would be the rent for the sales office Common Fixed Expenses Jointly caused by 2 or more segments These expenses persist even if one of the segments to which they’re common is eliminated - Example: Depreciation on the corporate headquarters building or the salary of the CEO would be a common fixed expense for most large companies Decision Making for Inventory Management Inventory can definitely affect operating income Besides the product cost of inventory, there are other types that relate to inventories of raw materials, WIP, and finished goods Internally Related Costs If the inventory is a material or good purchased from an outside source, then these inventory related costs are known as ordering costs or carrying costs If the material or good is produced internally, then the costs are called setup costs and carrying costs - Ordering costs are the costs of placing and receiving an order - Carrying costs are the costs of keeping and storing inventory - Stockout costs are the costs of not having a product available when demanded by a customer or the cost of not having a raw material available when needed for production Economic Order Quality: Traditional Method Once a company decides to carry inventory, 2 questions must be addressed: 1) How much should be ordered? 2) When should the order be placed? In choosing the order quantity, managers need to be concerned only with ordering and carrying costs Economic Order Quality Maintaining an order quality equal to the average inventory may not be the best choice. Some other order quality may produce a lower total cost. The goal is to find the order quantity that minimizes the total cost The number of units in the optimal size order quantity is called the economic order quality (EOQ) Reorder Point Knowing when to place an order (or setup production) is also an essential part of any inventory policy. The reorder point is the point in time when a new order should be placed (or setup started) It’s the function of the EOQ, lead time, and the rate at which inventory is used - Lead time is the time required to receive the EOQ once an order is placed or setup is started reorder point = rate of usage x lead time Safety Stock extra inventory carried to serve as an insurance against changes in demand (max daily usage – average daily usage) x lead time Just in Time Approach to Inventory Management Maintains that goods should be pulled through the system by present demand rather than being pushed through a fixed schedule based on anticipated demand The material or subassembly arrives just in time for production to occur so that demand can be met Fast food restaurants use this type of pull system Limits of Just in Time Approach It’s often referred to as a program of simplification, yet it doesn’t imply that JIT is easy to implement It requires time for building sound relationships with suppliers Insisting on immediate changes in delivery times and quality may not be realistic and may cause difficult confrontations between a company and its suppliers Reductions in inventory buffers may cause a regimented workflow and high stress levels among production workers Requires careful and thorough planning and preparation
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