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# Exam 2 Study Guide Acct 2210- 001

AU

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This 5 page Study Guide was uploaded by Callisa Ruschmeyer on Thursday September 29, 2016. The Study Guide belongs to Acct 2210- 001 at Auburn University taught by Mr. Fetsch in Fall 2016. Since its upload, it has received 11 views. For similar materials see Managerial Accounting in Accounting at Auburn University.

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Date Created: 09/29/16

Exam #2 Study Guide Chapters 5 and 6 Chapter 5 Basics of Cost-Volume-Profit Analysis The contribution income statement is helpful to managers in judging the impact on profits of changes in selling price, cost, or volume o The emphasis is on cost behavior Contribution Margin (CM) is the amount remaining from sales revenue after variable expenses have been deducted CM is used first to cover fixed expenses --> any remaining CM contributes to net operating income The Contribution Approach Sales, variable expenses, and contribution margin can also be expressed on a per unit basis o CM basically finds the value that will generate more profit per extra unit sold of a product (see slide 9 for visual) We do not need to prepare an income statement to estimate profits at a particular sales volume o Breakeven = number of units sold above BE X contribution margin per unit Summary for ways to find Contribution Margin o CM = sales - variable costs o CM = unit CM X Q sold o CM = Sales X CM ratio CVP Relationships in Equation Form The contribution format income statement can be expressed in the equation o Profit = (Sales - Variable expenses) - fixed expenses Sales = quantity sold (Q) X selling price per unit (P) --> Q X P Variable expenses = quantity sold (Q) X variable expenses per unit (V) --> Q X V o SO, Profit = [(P*Q) - (V*Q)] - fixed expenses It is often useful to express the simple profit equation in terms of the unit contribution margin (Unit CM) o Unit CM = selling price per unit - variable expenses per unit --> P - V Profit = [(P*Q) - (V*Q)] - fixed expenses Profit = (P-V)*Q - fixed expenses Profit = Unit CM X Q - fixed expenses Variables o Q = quantity sold o P = selling price per unit o V = variable expenses per unit o Unit CM = P - V CVP Relationships in Graphic Form The relationships among revenue, cost, profit, and volume can be expressed graphically by preparing a CVP graph X axis is dollars; Y axis is units Breakeven point is where sales and total expenses intercept Exam #2 Study Guide Chapters 5 and 6 Profit area: Sales - Total expenses o The in-between spaces of these two lines, if the sales line is above the total expenses line Loss area: Total expenses - sales o The in-between spaces of these two lines, if the sales line is below the total expenses line There is another type of graph that compares profit (x axis) to number of units sold (y axis), but it is less known and harder to comprehend Contribution Margin Ratio (CM Ratio) The CM ratio is calculated by dividing the total contribution margin by total sales o CM Ratio = CM / Total Sales Total sales = quantity sold X selling price per unit Or! CM Ratio can be found by dividing the contribution margin per unit by the selling price per unit o CM Ratio = CM per unit / SP per unit CM per unit = unit SP - unit VC Operating income/profit = CM - fixed expenses o Or (CM ratio X sales) - fixed expenses Variable Expense Ratio Ratio = total variable expenses / total sales Ratio in a single product analysis = variable expense per unit by unit selling price Break-even Analysis Break-even in Unit Sales o Equation Method Profits of $0 = Unit CM x Q - fixed expenses Basically, solve for Q o Formula Method Unit sales to break even = fixed expenses / CM per unit Solving for units (Q) with division Break-even in Dollar Sales o Equation method Profits of $0 = CM ratio X sales - fixed expenses Solve for sales using CM ratio (which is a percent) o Formula Method Dollar sales to break even = fixed expenses / CM ratio Solving for sales with division Target Profit Analysis Target Profit using Units o Equation Method Profit = Unit CM X Q - fixed expenses Q = the number of units that need to be sold to reach the target profit Exam #2 Study Guide Chapters 5 and 6 o Formula Method Unit sales to attain the target profit = (target profit + fixed expenses) / CM per unit Target Profits using Sales o Equation Method Profit = CM ratio X Sales - fixed expenses o Formula Method Dollar sales to attain the target profit = (target profit + fixed expenses) / CM ratio The Concept of Sales Mix Sales mix is the relative proportion in which a company's products are sold Different products have different selling prices, cost structures, and contribution margins When a company sells more than one product, break-even analysis becomes more complex *** LO-7 and LO-8 can be ignored *** LO-7: Operating Leverage o Cost structure refers to the relative proportion of fixed and variable costs in an organization Managers often have some latitude in determining their organization's cost structure o There are advantages and disadvantages to high fixed cost (or low variable cost) and low fixed cost (or high variable cost) structures An advantage of a high fixed cost structure is that income will be higher in good years compared to companies with lower proportion of fixed costs A disadvantage of a high fixed cost structure is that income will be lower in bad years compared to companies with lower proportion of fixed costs LO-8: Computing operating leverage at a particular level of sales o Sales commission is also discussed with a few brief slides in the PowerPoint Chapter 6 Overview of Variable and Absorption Costing Variable Costing Absorption Costing Product Costs Direct Materials Direct Materials Direct Labor Direct Labor Variable MOH Variable MOH Fixed MOH Period Costs Fixed MOH Variable S and Adm. Variable S and Adm. Expenses Expenses Fixed S and Adm. Fixed S and Adm. Expenses Expenses Exam #2 Study Guide Chapters 5 and 6 Absorption Costing Absorption costing is the method that will produce the highest values for work in process and finished goods inventories Under absorption costing, all product costs variable and fixed, are included when determining unit product cost. Under variable costing, only the variable production costs are included in product costs Under the absorption costing, every unit produced absorbs some of the fixed MOH (product cost) o If some of the units produced are not sold in that period, some current costs are held in inventory rather than being expensed o If more units are sold than are produced, the deferred costs will finally be expensed Relation between production Effect on inventory Relation between variable and and sales absorption income Units produced = units sold No change in Absorption = Variable inventory Units produced > units sold Inventory Absorption > Variable increases Units produced < units sold Inventory Absorption < Variable decreases Enabling CVP Analysis Variable costing categorizes costs as fixed and variable, so it is much easier to use this income statement format for CVP analysis Because absorption costing assigns fixed manufacturing overhead costs to units produced, a portion of fixed manufacturing overhead resides in inventory when units remain unsold o The potential result is positive operating income when the number of units sold is less than the break-even point Explaining Changes in Net Operating Income Variable costing income is only affected by changes in unit sales. o It is not affected by the number of units produced o As a general rule, when sales go up, net operating income goes up, and vice versa Absorption costing income is influenced by changes in unit sales and units of production o Net operating income can be increased simply by producing more units even if those units are not sold Supporting Decision Making Variable costing correctly identifies the additional variable costs incurred to make one more unit. o It also emphasizes the impact of total fixed costs on profits If you only use absorption costing, production managers can manipulate operating income by overproducing or under producing Exam #2 Study Guide Chapters 5 and 6 Decentralization and Segment Reporting A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data Keys to segmented income statements 1. A contribution format should be used because it separates fixed from variable costs and it enables the calculation of a contribution margin 2. Traceable fixed costs should be separated from common fixed costs to enable the calculation of a segment margin Identifying Traceable Fixed Costs and Common Fixed Costs Traceable fixed costs arise because of the existence of a particular segment and would disappear over time if the segment itself disappeared o Example- no computer division = no computer division manager Common fixed costs arise because of the overall operation of the company and would not disappear if any particular segment were eliminated o Example- no computer division = still have a company president Realize that the traceable fixed costs of one segment may be a common fixed cost of another segment Segment Margin Computed by subtracting the traceable fixed costs of a segment from its contribution margin It is the best gauge of the long-run profitability of a segment On an income statement o Contribution margin is computed by taking sales minus variable costs o Segment margin is a division's contribution to profits o Break-even analysis- computed by dividing the sum of the company's traceable fixed costs and common fixed costs by the company's overall contribution margin ratio A business segment's break-even point is computed by dividing its traceable fixed costs by its contribution margin ratio Omission of Costs- costs assigned to a segment should include all costs attributable to that segment from the company's entire value chain Common Costs and Segments Common costs should not be arbitrarily allocated to segments based on the rationale that "someone has to cover the common costs" for two reasons 1. This practice may make a profitable business segment appear to be unprofitable 2. Allocating common fixed costs forces managers to be held accountable for costs they cannot control

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