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Accounting 210 Chapter 6 Notes

by: Kristin Koelewyn

Accounting 210 Chapter 6 Notes ACCT210

Marketplace > University of Arizona > Accounting > ACCT210 > Accounting 210 Chapter 6 Notes
Kristin Koelewyn
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Chapter 6 Notes
Managerial Accounting
Heather Altman
Class Notes
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This 9 page Class Notes was uploaded by Kristin Koelewyn on Wednesday February 24, 2016. The Class Notes belongs to ACCT210 at University of Arizona taught by Heather Altman in Spring 2016. Since its upload, it has received 38 views. For similar materials see Managerial Accounting in Accounting at University of Arizona.


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Date Created: 02/24/16
Accounting 210: Chapter 6 Notes Cost Volume Profit Analysis: Additional Issues - CVP Analysis is: o The study of the effects of changes in costs and volume on a company’s profit. o Important to profit planning. o Critical in management decisions such as: ▯ Determining product mix, ▯ Maximizing use of production facilities, ▯ Setting selling prices. - Basic Concepts: o Management often wants the information reported in a special format income statement. o CVP income statement is for internal use only: ▯ Costs and expenses classified as fixed or variable. ▯ Reports contribution margin as a total amount and on a per unit basis. - Break Even Analysis: o Illustration: Vargo Video’s CVP income statement (Ill. 6-2) shows that total contribution margin is $320,000, and the company’s contribution margin per unit is $200. Contribution margin can also be expressed in the form of the contribution margin ratio which in the case of Vargo is 40% ($200 ÷ $500). - Target Net Income: o Once a company achieves break-even sales, a sales goal can be set that will result in a target net income. Illustration: Assuming Vargo’s target net income is $250,000, required sales in units and dollars to achieve this are: o Illustration: The contribution margin ratio is used to compute required sales in dollars. - Margin of Safety: o Tells us how far sales can drop before the company will operate at a loss. o Can be expressed in dollars or as a ratio. Illustration: Assume Vargo’s sales are $800,000: - CVP and Changes in the Business Environment: o Case I: A competitor is offering a 10% discount on the selling price of its camcorders. Management must decide whether to offer a similar discount. o Question: What effect will a 10% discount on selling price ($500 x 10% = $50) have on the breakeven point? o Case II: Management invests in new robotic equipment that will lower the amount of direct labor required to make camcorders. Estimates are that total fixed costs will increase 30% and that variable cost per unit will decrease 30%. o Question: What effect will the new equipment have on the sales volume required to break even? o Case III: Vargo’s principal supplier of raw materials has just announced a price increase. The higher cost is expected to increase the variable cost of camcorders by $25 per unit. Management decides to hold the line on the selling price of the camcorders. It plans a cost-cutting program that will save $17,500 in fixed costs per month. Vargo is currently realizing monthly net income of $80,000 on sales of 1,400 camcorders. o Question: What increase in units sold will be needed to maintain the same level of net income? - Question: Croc Catchers calculates its contribution margin to be less than zero. Which statement is true? o A .Its fixed costs are less than the variable cost per unit. o B. Its profits are greater than its total costs. o C .The company should sell more units. o D. Its selling price is less than its variable costs. - Break Even Sales in Units: o Sales mix is the relative percentage in which a company sells its products. o If a company’s unit sales are 80% printers and 20% computers, its sales mix is 80% to 20%. o Sales mix is important because different products often have very different contribution margins. o Companies can compute break-even sales for a mix of two or more products by determining the weighted average unit contribution margin of all the products. ▯ Illustration: Vargo Video sells not only camcorders but TV sets as well. Vargo sells its two products in the following amounts: 1,500 camcorders and 500 TVs. The sales mix, expressed as a function of total units sold, is as follows. o With a break-even point of 1,000 units, Vargo must sell: ▯ 750 Camcorders (1,000 units x 75%) ▯ 250 TVs (1,000 units x 25%) o At this level, the total contribution margin will equal the fixed costs of $275,000. - Break Even Sales in Dollars: o Works well if the company has many products. o Calculates break-even point in terms of sales dollars for ▯ Divisions or ▯ Product lines, ▯ NOT individual products. o Example: First, determine the weighted-average contribution margin. o Second, calculate break-even point in dollars. o With break-even sales of $937,500 and a sales mix of 20% to 80%, Kale must sell: ▯ $187,500 from the Indoor Plant division ▯ $750,000 from the Outdoor Plant division o If the sales mix becomes 50% to 50%, the weighted average contribution margin ratio changes to 35%, resulting in a lower break-even point of $857,143. - Determining Sales Mix with Limited Resources: o All companies have limited resources whether it be floor space, raw materials, direct labor hours, etc. o Management must decide which products to sell to maximize net income. ▯ Illustration: Vargo makes camcorders and TVs. Machine capacity is limited to 3,600 hours per month. ▯ Calculate the contribution margin per unit of: ▯ Management should produce more camcorders if demand exists or else increase machine capacity. ▯ If Vargo is able to increase machine capacity from 3,600 hours to 4,200 hours, the additional 600 hours could be used to produce either the camcorders or TVs. ▯ To maximize net income, all 600 hours should be used to produce and sell camcorders. - Sales Mix with Limited Resources: o Theory of Constraints: ▯ Approach used to identify and manage constraints so as to achieve company goals. ▯ Company must continually • Identify its constraints and • Find ways to reduce or eliminate them, where appropriate. o Question: If the contribution margin per unit is $15 and it takes 3.0 machine hours to produce the unit, the contribution margin per unit of limited resource is: ▯ A. $25 ▯ B. $5 ▯ C. $4 ▯ D. No correct answer is given - Cost Structure: o Cost Structure is the relative proportion of fixed versus variable costs that a company incurs. o May have a significant effect on profitability. o Company must carefully choose its cost structure. o Illustration: Vargo Video and one of its competitors, New Wave Company, both make camcorders. Vargo Video uses a traditional, labor-intensive manufacturing process. New Wave Company has invested in a completely automated system. The factory employees are involved only in setting up, adjusting, and maintaining the machinery. o New Wave contributes 80 cents to net income for each dollar of increased sales while Vargo only contributes 40 cents. o New Wave’s cost structure, which relies on fixed costs, is more sensitive to changes in sales. o New Wave needs to generate $150,000 more in sales than Vargo to break-even. o Because of the greater break-even sales required, New Wave is a riskier company than Vargo. o The difference in ratios reflects the difference in risk between New Wave and Vargo. o Vargo can sustain a 38% decline in sales before operating at a loss versus only a 19% decline for New Wave. - Operating Leverage: o Extent that net income reacts to a given change in sales. o Higher fixed costs relative to variable costs cause a company to have higher operating leverage. o When sales revenues are increasing, high operating leverage means that profits will increase rapidly. o When sales revenues are declining, too much operating leverage can have devastating consequences. ▯ Degree of Operating Leverage: • Provides a measure of a company’s earnings volatility. • Computed by dividing total contribution margin by net income. ▯ New Wave’s earnings would go up (or down) by about two times (5.33 ÷ 2.67 = 1.99) as much as Vargo’s with an equal increase in sales. o Question: The degree of operating leverage: ▯ A. Can be computed by dividing total contribution margin by net income. ▯ B. Provides a measure of the company’s earnings volatility. ▯ C. Affects a company’s break-even point. ▯ D. All of the above. - Appendix 6A: o Under variable and absorption, product costs consist of: ▯ Direct Materials ▯ Direct Labor ▯ Variable Manufacturing Overhead o The difference between absorption and variable costing is: - Variable versus Absorption Costing: o The difference between absorption and variable costing: o Under both costing methods, selling and administrative expenses are treated as period costs. o Companies may not use variable costing for external financial reports because GAAP requires that fixed manufacturing overhead be treated as a product cost. - Comparing Absorption with Variable Costing: o Illustration: Premium Products Corporation manufactures a polyurethane sealant, called Fix-It, for car windshields. Relevant data for Fix-It in January 2017, the first month of production, are as follows. o The manufacturing cost per unit is $4 ($13 -$9) higher for absorption costing because fixed manufacturing costs are treated as product costs. o Absorption Costing Example: o Variable Costing Example: o Question: Fixed manufacturing overhead costs are recognized as: ▯ a. Period costs under absorption costing. ▯ b. Product costs under absorption costing. ▯ c. Product costs under variable costing. ▯ d. Part of ending inventory costs under both absorption and variable costing. - Decision Making Concerns: o Generally accepted accounting principles require that absorption costing be used for the costing of inventory for external reporting purposes. o Net income measured under GAAP (absorption costing) is often used internally to ▯ Evaluate performance, ▯ Justify cost reductions, or ▯ Evaluate new projects. o Some companies have recognized that net income calculated using GAAP does not highlight differences between variable and fixed costs and may lead to poor business decisions. o These companies use variable costing for internal reporting purposes. - Potential Advantages of Variable Costing: o The use of variable costing is consistent with cost–volume–profit analysis. o Net income under variable costing is unaffected by changes in production levels. Instead, it is closely tied to changes in sales. o The presentation of fixed costs in the variable costing approach makes it easier to identify fixed costs and to evaluate their impact on the company’s profitability.


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