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# Accounting 210 Chapter 5 Notes ACCT210

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This 9 page Class Notes was uploaded by Kristin Koelewyn on Thursday February 11, 2016. The Class Notes belongs to ACCT210 at University of Arizona taught by Heather Altman in Spring 2016. Since its upload, it has received 49 views. For similar materials see Managerial Accounting in Accounting at University of Arizona.

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Date Created: 02/11/16

Accounting 210 Chapter 5 Notes: Cost-Volume-Profit - Cost Behavior Analysis is the study of how specific costs respond to changes in the level of business activity. o Some costs change; others remain the same. o Helps management plan operations and decide between alternative courses of action. o Applies to all types of businesses and entities. o Starting point is measuring key business activities. o Activity levels may be expressed in terms of: ▯ Sales dollars (in a retail company) ▯ Miles driven (in a trucking company) ▯ Room occupancy (in a hotel) ▯ Dance classes taught (by a dance studio) o Many companies use more than one measurement base. o Changes in the level or volume of activity should be correlated with changes in costs. o Activity level selected is called activity or volume index. ▯ Identifies the activity that causes changes in the behavior of costs. ▯ Allows costs to be classified as variable, fixed, or mixed. - Variable Costs: o Costs that vary in total directly and proportionately with changes in the activity level. ▯ Example: If the activity level increases 10 percent, total variable costs increase 10 percent. ▯ Example: If the activity level decreases by 25 percent, total variable costs decrease by 25 percent. o Variable costs remain the same per unit at every level of activity. o Illustration: Damon Company manufactures tablet computers that contain a $10 camera. The activity index is the number of tablets produced. As Damon manufactures each tablet, the total cost of the cameras used increases by $10. As part (b) of Illustration 5-1 shows, the unit cost of $10 for the camera is the same whether Damon produces 2,000 or 10,000 tablets. - Fixed Costs: o Costs that remain the same in total regardless of changes in the activity level within a relevant range. o Fixed cost per unit varies inversely with activity: As volume increases, unit cost declines, and vice versa o Examples: ▯ Property taxes ▯ Insurance ▯ Rent ▯ Depreciation on buildings and equipment o Illustration: Damon Company leases its productive facilities at a cost of $10,000 per month. Total fixed costs of the facilities will remain constant at every level of activity, as part (a) of Illustration 5- 2 shows. - Relevant Range: o Throughout the range of possible levels of activity, a straight- line relationship usually does not exist for either variable costs or fixed costs. o Relationship between variable costs and changes in activity level is often curvilinear. o For fixed costs, the relationship is also nonlinear – some fixed costs will not change over the entire range of activities, while other fixed costs may change. ▯ Range of activity over which a company expects to operate during a year. - Mixed Costs: o Costs that have both a variable element and a fixed element. o Change in total but not proportionately with changes in activity level. - High Low Method: o High-Low Method uses the total costs incurred at the high and the low levels of activity to classify mixed costs into fixed and variable components. o The difference in costs between the high and low levels represents variable costs, since only variable-cost element can change as activity levels change. ▯ Step 1: Determine variable cost per unit. • (Change in Costs)/ (High minus Low) = (variable cost per unit) • $63,000-$30,000/50,000-20,000= $33,000/30,000= $1.10 per mile ▯ STEP 2: Determine the fixed cost by subtracting the total variable cost at either the high or the low activity level from the total cost at that activity level. ▯ Maintenance costs are therefore $8,000 per month of fixed costs plus $1.10 per mile of variable costs. This is represented by the following formula: • Maintenance costs = $8,000 + ($1.10 x Miles driven) • Example: At 45,000 miles, estimated maintenance costs would be: o DO IT! High Low Method: Byrnes Company accumulates the following data concerning a mixed cost, using units produced as the activity level. ▯ (a) Compute the variable- and fixed-cost elements using the high-low method. • Variable: $14,740-$11,100/9,000-7,000= $3,640/2,800= $1.30 per unit • Fixed: $11,100-($1.30 x 7,000)= %11,100-9,100= $2,000 ▯ (b) Estimate the total cost if the company produces 8,000 units. • $2,000+$1.30 x 8,000)= $2,000+$10,400= $12,400 - Cost Volume Profit (CVP) Analysis: o The study of the effects of changes in costs and volume on a company’s profits. o Important in profit planning. o Critical factor in management decisions as ▯ Setting selling prices, ▯ Determining product mix, and ▯ Maximizing use of production facilities. o Basic Components: ▯ Behavior of both costs and revenues is linear throughout the relevant range of the activity index. ▯ Costs can be classified accurately as either variable or fixed. ▯ Changes in activity are the only factors that affect costs. ▯ All units produced are sold. ▯ When more than one type of product is sold, the sales mix will remain constant. o CVP Income Statement: ▯ A statement for internal use. ▯ Classifies costs and expenses as fixed or variable. ▯ Reports contribution margin in the body of the statement. • Contribution margin – amount of revenue remaining after deducting variable costs. ▯ Reports the same net income as a traditional income statement. o Unit Contribution Margin: ▯ Contribution margin is available to cover fixed costs and to contribute to income. ▯ Formula for contribution margin per unit and the computation for Vargo Video are: ▯ Vargo’s CVP income statement assuming a zero net income. ▯ Assume that Vargo sold one more camcorder, for a total of 1,001 camcorders sold. o Contribution Margin Ratio: ▯ Shows the percentage of each sales dollar available to apply toward fixed costs and profits. ▯ Formula for contribution margin ratio and the computation for Vargo Video are: ▯ Assume Vargo Video’s current sales are $500,000 and it wants to know the effect of a $100,000 (200-unit) increase in sales. o DO IT! Ampco Industries produces and sells a cell phone-operated thermostat. Information regarding the costs and sales of thermostats during September 2017 are provided below. Unit selling price of thermostat $85 Unit variable costs $32 Total monthly fixed costs $190,000 Units sold 4,000 Prepare a CVP income statement for Ampco Industries for the month of September. Provide per unit values and total values: - Break-Even Analysis: o Process of finding the break-even point level of activity at which total revenues equal total costs (both fixed and variable). o Can be computed or derived ▯ From a mathematical equation, ▯ By using contribution margin, or ▯ From a cost-volume profit (CVP) graph. o Expressed either in sales units or in sales dollars. o Mathematical Equation: Break-even occurs where total sales equal variable costs plus fixed costs; i.e., net income is zero. o Contribution Margin Technique: ▯ At the break-even point, contribution margin must equal total fixed costs (CM = total revenues – variable costs) ▯ Break-even point can be computed using either contribution margin per unit or contribution margin ratio. o Contribution Margin in Units: ▯ When the break-even-point in units is desired, contribution margin per unit is used in the following formula which shows the computation for Vargo Video: o Contribution Margin Ratio: ▯ When the break-even-point in dollars is desired, contribution margin ratio is used in the following formula which shows the computation for Vargo Video: ▯ o DO IT! Lombardi Company has a unit-selling price of $400, variable costs per unit of $240, and fixed costs of $180,000. Compute the break-even point in units using (a) a mathematical equation and (b) contribution margin per unit. ▯ (a) ▯ (b) - Target New Income: o Level of sales necessary to achieve a specified income. o Can be determined from each of the approaches used to determine break-even sales/units: ▯ ►from a mathematical equation, ▯ ►by using contribution margin technique, or ▯ ►from a cost-volume profit (CVP) graph. o Expressed either in sales units or in sales dollars. o Mathematical Equation: ▯ Using the formula for the break-even point, simply include the desired net income as a factor. o Contribution Margin Technique: ▯ To determine the required sales in units for Vargo Video: ▯ To determine the required sales in dollars for Vargo Video: - Margin of Safety: o Difference between actual or expected sales and sales at the breakeven point. o Measures the “cushion” that a particular level of sales provides. o May be expressed in dollars or as a percentage of sales. o Assuming actual/expected sales are $750,000: o Computed by dividing the margin of safety in dollars by the actual (or expected) sales. o Assuming actual/expected sales are $750,000: o The higher the dollars or percentage, the greater the margin of safety. o DO IT! Zootsuit Inc. makes travel bags that sell for $56 each. For the coming year, management expects fixed costs to total $320,000 and variable costs to be $42 per unit. Compute the following: ▯ (a.) Compute break-even point in dollars using the contribution margin (CM) ratio: ▯ (b.) Compute the margin of safety and margin of safety ratio assuming actual sales are $1,382,400: ▯ (c.) Compute the sales dollars required to earn net income of $410,000: Required sales in dollars=

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