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What is the purpose of Cost-Volume-Profit (CVP) Analysis? What is another name for CVP?
- aka Breakeven Analysis
- To forecast profits at different levels of sales and/or production volume.
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What are the assumptions necessary to use CVP analysis?
- (1) All costs can be separated into either variable or fixed costs
- (2) Volume is the only relevant factor affecting cost.
- (3) All costs behave in a linear fashion in relation to production volume.
- (4) Costs will remain constant over the relevant range of production (efficiency doesn't change)
- (5) Costs show greater variability over time. The longer the time period, the greater the percentage of variable costs; the shorter the time period, the greater the percentage of fixed costs.
- (6) Selling prices remain unchanged
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What is the primary difference between the Absorption vs Contribution approaches to allocating costs? Which one is GAAP?
- Absorption is GAAP and allocates both variable and fixed costs to units produced (and units in inventory).
- Contribution is not GAAP and allocates only variable costs to units produced; fixed costs are period expense.
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What is the equation for the Absorption approach to cost allocation?
- Revenues
- (COGS)
- Gross Margin
- (Operating Expenses)
- Net Income
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What is the equation for the Contribution approach to cost allocation?
- Revenues
- (Variable Costs)
- Contribution Margin
- (Fixed Costs)
- Net Income
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When using the Contribution approach, which items are included in Production costs, and which are included when calculating the Contribution Margin?
- Production Costs: Direct Materials, Direct Labor, the variable portion of production overhead.
- Contribution Margin: all production costs + the variable portion of SG&A (such as shipping cost).
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What is the formula for the contribution ratio? How is this used?
- Contribution Margin / Revenues
- Used to create the number of units needed for breakeven production
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When production is greater than sales, how are net income and ending inventory affected using Absorption vs Contribution costing?
- Absorption Costing: allocates fixed factory overhead to production costs on a per-unit basis. If some units produced are not sold, this cost follows to inventory. Net income is higher, and inventory is higher.
- Contribution Costing: allocates fixed factory overhead as a period cost. If some units are not sold, the FOH doesn't follow inventory. Net income is lower, and inventory is lower.
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When production is less than sales, how are net income and ending inventory affected using Absorption vs Contribution costing?
- Absorption Costing: Fixed OH that was allocated to inventory becomes part of COGS. Net income is lower, and ending inventory is lower.
- Contribution Costing: Fixed OH was previously charged as a period cost. Net income is higher, ending inventory remains lower (unit for unit).
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Compare the effects of Absorption vs Contribution costing on net income in the following situations: (1) units produced = units sold, (2) units produced < units sold, (3) units produced > units sold
- (1) Absorption net income = Contribution net income
- (2) Absorption net income > Contribution net income
- (3) Absorption net income < Contribution net income
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Which costing method is a more accurate for use in performance evaluations and why?
- The Contribution method is more accurate as the manager has control only over the variable costs.
- The Absorption method includes both fixed and variable costs, thus rating performance on items outside of the manager's control.
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True / False: Variable (contribution) costing can be used for (1) tax reporting, (2) external reporting?
- (1) False. Absorption costing must be used.
- (2) False. Variable costing is not GAAP and cannot be used for external reporting.
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What is the formula for the Breakeven Point in Units, and how is this used?
- Total fixed costs / Contribution Margin per unit = # units
- Determines the number of units that must be sold in order to pay for all costs (without profit).
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What is the formula for the Breakeven Point in Dollars and how is this used?
- (1) Use the breakeven point in units x price per unit = Total Sales
- (Total fixed costs / contribution margin per unit) x price per unit OR
- (2) Total fixed costs / contribution margin ratio
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What is the variation on the Breakeven Point in Units formula to ensure a certain amount of profit is made?
(fixed costs + pretax profit) / contribution margin per unit
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What is the variation on the Breakeven Point in Dollars formula to ensure a certain amount of profit is made? What is an alternate formula?
- Sales Dollars = (fixed costs + pretax profit) / Contribution margin ratio OR
- Sales Dollars = total variable costs + fixed costs + pretax profit, where total variable costs = variable cost/unit x # units.
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After breakeven has been achieved, each additional unit sold will increase net income by how much?
The Contribution Margin per unit.
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What is the formula to set a selling price based on an assumed number of units sold?
- Sales price per unit = (fixed costs + total variable costs + pretax profit) / assumed number of units sold, where
- total variable cost = VCost per unit x assumed number of units sold.
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Define Margin of Safety. What is the formula?
- The excess of sales over breakeven sales (aka the pretax profit or net operating income)
- Margin of safety (dollars) = total sales - breakeven dollars.
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What is the formula for the margin of safety percentage
Margin of safety (dollars) / total sales
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What is the purpose of target costing? What is the formula?
- Once a price has been determined, the target costs are the total production costs to maximize profit.
- Target cost = market price - required profit
- (Can use totals or per unit amounts)
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