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ACIS 2116--Chapter 5, Cost Volume-Profit Relationships

by: Shannon Cummins

ACIS 2116--Chapter 5, Cost Volume-Profit Relationships ACIS 2116

Marketplace > Virginia Polytechnic Institute and State University > Managerial Accounting > ACIS 2116 > ACIS 2116 Chapter 5 Cost Volume Profit Relationships
Shannon Cummins
Virginia Tech
GPA 3.34

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About this Document

These notes cover the numerous relationships between sales, variable expenses, and fixed expenses, and how to use these relationships to analyze a company's earnings. They highlight major formulas...
Principles of Accounting
Chris Sherman
Class Notes
ACIS, 2116, Accounting, Managerial, Chapter, 5, cost, Volume, profit, Relationships, fixed, variable, Expenses, sales, Revenue, Income, formulas, definitions, Concept, check, earnings
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This 6 page Class Notes was uploaded by Shannon Cummins on Monday October 3, 2016. The Class Notes belongs to ACIS 2116 at Virginia Polytechnic Institute and State University taught by Chris Sherman in Fall 2016. Since its upload, it has received 6 views. For similar materials see Principles of Accounting in Managerial Accounting at Virginia Polytechnic Institute and State University.

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Date Created: 10/03/16
Chapter 5—Cost Volume­Profit Relationships Primary purpose – to estimate how profits are affected by the following five factors: 1. Selling prices 2. Sales volume 3. Unit variable costs 4. Total fixed costs 5. Mix of products sold. However, to simplify calculations, three assumptions are held: 1. Selling price is constant.  The price of a product or service will not change as volume changes. 2. Costs are linear and can be accurately divided into variable and fixed elements.  The variable  element is constant per unit.  The fixed element is constant in total over the entire relevant range. 3. In multiproduct companies, the mix of products sold remains constant. Contribution margin – the amount remaining from sales revenue after variable expenses have been  deducted. Break­even point – the level of sales at which profit is zero. Concept Check: 1. Which of the following statements is a common assumption underlying cost­volume profit  analysis? a. The variable cost per unit remains constant. b. The selling price per unit remains constant. c. Total fixed costs are constant within the relevant range. d. The total variable costs remain constant as the level of sales fluctuates. 2. One a company hits its break­even point, net operating income will a. Increase by an amount equal to the selling price per unit multiplied by the number of  units sold above the break­even point. b. Increase by an amount equal to the contribution margin ratio multiplied by the number of  units sold above the break­even point. c. Increase by an amount equal to the contribution margin per unit multiplied by the number of units sold above the break­even point. d. Increase by an amount equal to the variable cost per unit multiplied by the number of  units sold above the break­even point. CVP Relationship: Profit = (Sales – variable expenses) – fixed expenses Profit = Unit Contribution margin x quantity sold – fixed expenses Contribution margin ratio – the contribution margin as a percentage of sales.  CM ratio = contribution margin / sales  In a company that has only one product, CM ratio = unit contribution margin / unit selling price Change in contribution margin = CM ratio x change in sales Profit = CM ratio x sales – fixed expenses Change in profit = CM ratio x change in sales – change in fixed expenses Concept check: 3. The contribution margin ratio always increases when a. Sales increase. b. Fixed costs decrease. c. Total variable costs decrease. d. Variable costs as a percent of sales decrease.  Variable expense ratio – the ratio of variable expenses to sales.  Variable expense ratio = variable expenses / sales Incremental analysis – an analytical approach that focuses only on those costs and revenues that change  as a result of a decision. Break­Even Analysis: Unit sales to break even = fixed expenses / unit CM Concept Check: 4. Assume the selling price per unit is $30, the contribution margin ratio is 40%, and the total fixed  cost is $60,000.  What is the break­even point in sales? a. 2,000 b. 3,000 c. 4,000 d. 5,000 Dollar sales to break even = fixed expenses / CM ratio Target Profit Analysis: Target profit analysis – estimating what sales volume is needed to achieve a specific target profit.  Unit sales to attain the target profit = (target profit + fixed expenses) / unit CM  Dollar sales to attain the target profit = (target profit + fixed expenses) / CM ratio Margin of safety – the excess of budgeted or actual dollar sales over the break­even dollar sales.  Margin of safety in dollar sales = total budgeted (or actual) sales – break­even sales  Margin of safety percentage = margin of safety in dollars / total budgeted (or actual) sales in  dollars. Concept Check: 5. Assume a company produces one product that sells for $55, has a variable cost per unit of $35,  and has fixed costs of $100,000.  How many units must the company sell to earn a target profit of  $50,000? a. 7,500 units b. 10,000 units c. 12,500 units d. 15,000 units 6. Given the same facts as in question 5 above, if the company exactly meets its target profit, what  will be its margin of safety in sales dollars? a. $110,000 b. $127,500 c. $137,500 d. $150,000 7. Which of the following statements is false with respect to the margin of safety? a. The total budgeted (or actual) sales minus sales at the break­even point equals the margin of safety in dollars. b. The margin of safety in dollars divided by the total budgeted (or actual) sales in dollars  equals the margin of safety percentage. c. In a single product company, the margin of safety in dollars divided by the variable cost  per unit equals the margin of safety in units. d. The margin of safety in dollars can be a negative number. Cost structure: Which cost structure is better—high variable costs and low fixed costs or the opposite?  No single answer to this question is possible; each approach has its advantages. The answer depends on many factors:  Long­run trend in sales  Year­to­year fluctuations in level of sales  Attitude of the owner towards risk Operating leverage – a measure of how sensitive net operating income is to a given percentage change in  dollar sales.  Degree of operating leverage = contribution margin / net operating income  Percentage change in net operating income = degree of operating leverage x percentage change in sales Sales mix – the relative proportions in which a company’s products are sold.  Sales mix is computed by  expressing the sales of each product as a percentage of total sales. Concept Check: 8. Which of the following statements is true? a. One minus the contribution margin ratio equals the variable expense ratio. b. Incremental analysis focuses only on the costs and revenues that change as a result of a  decision. c. Sales commissions based on sales dollars can lead to lower profits than commissions  based on contribution margin. d. If a company’s total sales remain constant, then its net operating income must remain  constant even if the sales mix fluctuates.


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