Represents Contribution Margin as a percentage of Revenue
Formula: Absorption Approach Formula
Revenue
Less: Product Costs (COGS)
Equals: Gross Margin
Less: Period Costs (Operating Expenses)
Equals: Net Income
Treatment of Fixed Factory Overhead
Contribution Approach vs. Absorption Approach
Fixed Factory Overhead
1) Contribution Approach = Period Cost
(Included in Fixed Costs)
2) Absorption Approach = Product Cost
(Included in Cost of Goods Sold)
Effect on Net Income:
Contribution vs. Absorption Approach
Production Greater than Sales
Results in Greater Inventory:
Net income Absorption > Net income Contribution
Reason: Under absorption costing, a portion of Fixed OH is included with each unit in ending inventory, while all FOH is expensed during the period under contribution approach
Effect on Net Income:
Contribution vs. Absorption Approach
Sales Greater than Production
Absorption Net Income < Variable Net Income
Formula: Breakeven Point in Units
Formula: Breakeven Point in Dollars
(Two Formulas)
Formula 1:
Formula 2:
Formula: Required Sales Volume for Target Profit (Sales Dollars)
Sales ($) = Variable Costs + Fixed Costs+ Net Income Before Taxes
Formula: Required Sales Volume for Target Profit (Sales Units)
Formula: Margin of Safety (Sales Dollars)
Total Sales ($) - Breakeven Sales ($)
Formula: Margin of Safety (%)
=
Formula: Target Cost
Target Cost = Market Price - Required Profit
Definition: Irrelevant Costs
Costs that do not differ between alternatives
- Ignored from Marginal Cost analysis
Definition: Incremental Costs
(Aka: Differential Costs and Out-Of-Pocket Costs)
The additional costs incurred to produce an additional amount of the unit over the present output
Relevant Cost
Definition: Sunk Costs
Costs that are unavoidable because they were incurred in the past and cannot be changed
Not-Relevant
Definition: Opportunity Costs
The cost of foregoing the next best alternative when making a decision
- Relevant Cost
Definition: Controllable Costs
Costs that can be authorized at a specific level of management
- Relevant only if they will change as a result of selecting different alternatives
Definition: Uncontrollable Costs
Costs that are authorized at a different level
- Not relevant because they cannot be changed by the manager making the decision
Definition: Marginal Cost
The costs required for a one-unit increase in activity (includes all variable costs and any avoidable fixed costs associated with a decision)
- Relevant
Special Order Decision:
ACCEPT IF:
Effect on Fixed Cost:
Accept if: Profitable
Revenue > Relevant Costs
Effect on Fixed Cost:
Fixed costs are generally not relevant unless the special order will change total fixed costs
Special Order Decisions:
Presumed Excess Capacity
Accept if Selling Price per Unit is greater than Variable Cost per Unit
SP > Relevant Costs (VC)
Special Order Decision:
Presumed Full Capacity
Accept if Selling Price per Unit is greater than Variable Cost per Unit and any forgone Opportunity Costs
SP > VC + Opportunity Costs
Formula: Opportunity Cost per Unit
Make vs. Buy Decision:
Excess Capacity
Cost of Making product internally is the cost that will be avoided if the product is not made
Cost of making the product internally is the maximum outside purchase price
Make vs. Buy:
No Excess Capacity
The cost of making the product internally is the cost that will be avoided (saved) if the product is not made plus the opportunity cost associated with the decision
Sell or Process Further Decision
if Incremental revenue > Incremental Cost
= Process Further
Keep or Drop Segment
Keep if:
Drop if:
Keep Segment if: Lost CM > Avoided FC
Drop Segment if: Lost CM < Avoided FC
The fixed costs associated with the segment must be identified as either avoidable (relevant) or unavoidable even if the segment is discontinued
Sensitivity Analysis
Change in Total Costs/Change in Volume = VC per Unit
Regression Analysis
y = mx + b
TC = (VC/unit * Volume) + Total FC
Coefficient of Correlation (r)
Measures the strength of the linear relationship between the independent variable (x) and dependent variable (y)
Range = -1, 0, 1
-1 = Perfect Inverse Relationship
0 = No relationship
1 = Perfect Direct Relationship
Coefficient of Determination (R)
R is the proportion of the total variation in the dependent variable (x) explained by the independent variable (y)
Value between 0 and 1
The higher the value, the better the fit on the regression line
Formula: Flexible Budget Formula
Total Cost = Fixed Cost + (Variable cost per unit * # of units)