Cost Accounting Chapter 6

Cost-volume-profit (CVP) analysis
focuses on how profits are affected by the following five factors: selling prices, sales volume, unit variable costs, total fixed costs, mix of products sold.

Break-even point
the level of sales at which the profit is zero

Cost-volume profit (CVP) graph
a graphical representation of the relationships between an organizations revenues, costs, and profits on the one hand and its sales volume on the other hand, graph is based on the following equation: Profit=Unit CM*Q-Fixed expenses

Incremental analysis
an analytical approach that focuses only on those costs and revenues that change as a result of a decision

Target profit analysis
estimating what sales volume is needed to achieve a specific target profit

The equation method
Profit=Unit CM*Q-Fixed expense

The formula method (short cut version of the equation method)
Unit sales to attain the target profit= (Target profit + Fixed Expenses)/Unit CM

Target Profit Analysis in terms of sales dollars
Dollar sales to attain a target profit= (Target profit + Fixed expenses)/ CM ratio

Break-even in unit sales
Unit sales to break even = Fixed expenses/Unit CM

Break-even in sales dollars
Dollar sales to break even= Fixed expenses/ CM ratio

The margin of safety
the excess of budgeted (actual) dollar sales over the break-even dollar sales

Margin of safety in dollars
total budgeted (or actual sales)-break-even sales

Margin of safety percentage
margin of safety in dollars/ total budgeted (or actual) sales in dollars

Operating leverage
a measure of how sensitive net operating income is to a given percentage change in dollar sales

The degree of operating leverage
a measure, at a given level of sales, of how a percentage change in sales will affect profits; DOL=contribution margin/net operating income

Sales mix
the relative proportion 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.

Assumptions of CVP analysis
selling price is constant, costs are linear and can be accurately divided into variable (constant per unit) and fixed (constant in total) elements, in multiproduct companies the sales mix is constant, in manufacturing companies inventories do not change (units produced=units sold)

Variable expense ratio
the ration of variable expenses to sales; total variable expense/sales OR variable expenses per unit/unit selling price

Contribution margin ratio (CM)
contribution margin/sales OR unit contribution margin/unit selling price; the relationship between profit and the CM ration can be expressed: Profit=CM ratio*sales-fixed expenses

CVP Equations
Profit= the contribution format income statement is expressed (sales-variable expenses)-fixed expenses; if a company sells only a single product, Sales = P*Q , Variable expenses: V*Q, Profit= (P*Q-V*Q)-fixed expenses

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