COSTRAM   that can be used to contribute to fixed

expense and operating income

CHAPTER 7: CVP Analysis
Unit Contribution Margin = Price - Unit
- Estimates how changes in costs
Variable Cost
(variable and fixed), sales volume, and
price affect a company’s profit.
Total Contribution Margin = Sales - Total
- Powerful tool for planning and
Variable Cost
decision making.
- Most versatile and widely used tool
Break Even Point in Units
used by managerial accountants to
- At the break even point, operating
help managers make better decisions
income equals $0.
- Used by companies to reach important
- More than the break-even units are
benchmarks, such as their
sold, the company begins to earn
- break-even point.
profit.
- Helps managers to pinpoint problems
and find solutions
Operating Income = (Price x Number of Units
Sold) - (Variable Cost per unit x Number of
Break - even point
Units Sold) - Total Fixed Cost
- Point where total revenue equals total
cost
Break even Units = Total Fixed Cost / (Price -
Variable costs - ​costs that increase as more
Variable cost per unit)
units are sold:
or
> Direct Materials, Direct Labor,
Break even Units = ​Total Fixed Cost
Variable Overhead, Variable Selling
Unit Contribution Margin
Expenses
Fixed Costs
Break- Even Point in Sales Dollar
> Fixed Overhead
- To calculate break-even point in sales
> Fixed Selling & Admininstrative
dollars, total variable costs are defined
Expenses
as percentage of sales rather than as
an amount per unit sold.
Contribution Margin Income Statement
- Makes it easy for managers to see
- Income statement that is based on
instantly how close they are to
the separation of costs into fixed and
breaking even using only sales
variable components
revenue data.
Sales xx
Total variable Cost xx
● Variable Cost Ratio
Total Contribution Margin xx
- The proportion of each sales dollar
Total fixed cost xx
that must be used to cover variable
Operating Income xx
costs.
Variable Cost Ratio = Total Variable Cost /
Contribution margin
Sales
- Difference between sales and variable
or
expense
Variable Cost Ratio = Unit variable Cost/ Price
- Amount of sales revenue left over all
the variable expenses are covered
 ● Contribution Margin Ratio
- The percentage of sales dollars
remaining after variable costs are
covered.
- The proportion of each sales dollar
available to cover fixed costs and
provide for profit
Contribution margin = Total Contribution
Margin / Sales
or
Contribution margin = Unit Variable Cost /
Price
How does the relationship of fixed cost to
contribution margin affect operating
income?
1. Fixed cost = Contribution Margin
* Operating Income is 0; the company is break
even
2. Fixed Cost < Contribution Margin
*Operating income is greater than 0; the
company makes profit
3. FIxed Cost > Contribution Margin
*Operating Income is less than 0; the
company incurs a loss
Break - Even Sales = Total Fixed Expenses /
Contribution Margin ratio
UNITS AND SALES DOLLARS NEEDED TO
ACHIEVE A TARGET INCOME
Units to be Sold to Achieve a Target
Income
- Add the target income amount to fixed
costs
- The operating income equation can be
used to find the number of units to sell
to earn a target income.
Number of Units to Earn Target Income =
Total Fixed Cost + Target Income /
Contribution Margin per Unit
Units for Income = (Target Income /Unit
Contribution Margin) +Break-even volume
Impact on a firm’s income resulting from a
change in the number of units sold can be
assessed by multiplying the unit contribution
margin by the change in units sold:
Change in operating income = Unit
contribution margin x Change in units sold
SALES REVENUE TO ACHIEVE A TARGET
INCOME
- Calculate the sales that x company
must make to earn an operating
income of 123:
Sales Dollar to Earn Target Income = (Total
Fixed Cost + Target Income) / Contribution
Margin ratio
Change in Profits = Contribution Margin Ratio
X Change in Sales
Cost - volume - profit graph
- Depicts the relationship among cost,
volume, and profits (operating income)
by plotting the total revenue line and
the total cost line on a graph.
- Vertical axis: measured in dollars
(price)
- Horizontal axis: measured in units sold
- Total revenue line: begins at origin
and rises with a slope equal to the
selling price per unit
- Total cost line: intercepts the vertical
axis at a point equal to total fixed
costs and rises with a slope equal to
the variable cost per unit
- When the total revenue line lies below
the total cost line: a loss region is
defined.
- When total revenue line lies above the
total cost line: profit region is defined.
 - The point where the total revenue and
total
total cost line intersect is the
break-even point.
Break - Even Packages = Total Fixed Cost /
ASSUMPTIONS OF CVP ANALYSIS Package Contribution Margin
❖ There are identifiable linear revenue
and linear cost functions that remain = $96,250 / $625
constant over the relevant range. = 154 packages
❖ Selling prices and costs are known A Break-even units = 154 x 3 = 462
with certainty. B Break-even units = 154 x 2= 308
❖ Units produced are sold - there are no
finished goods inventories. Income Statement
❖ Sales mix is known with certainty for
multiple- product break-even settings
A B Total
MULTIPLE PRODUCT ANALYSIS
Sales $184,80 $ 264, $ 431,
Direct Fixed expenses 0 400 200
- Fixed costs that can be traced to each
Total 150, 150 184,800 334,950
segment and would be avoided if the Variable
segment did not exist. Cost
Common fixed expenses
- Fixed costs that are not traceable to $34, 650 $ 61,600 $96,250
the segments and would remain even Contribut
if one of the segments was eliminated. ion
Margin
BREAK- EVEN POINT IN UNITS
Sales Mix Total 96, 250
- The relative combination of products Fixed
being sold by a firm. Cost
- Measured in units sold

Operatin $0
g Income
Prod Pr Unit Unit Sales Package
uct ic Varia Contrib Mix Contribut
e ble ution ion
Cost Margin Margin BREAK EVEN POINT IN SALES DOLLARS
- Uses the assumed sales mix but
avoids the requirement of building
Mulc $4 $325 $75 3 $225 package contribution margin
hing 00 - No knowledge of individual product
data is needed
Ridin 80 600 200 2 $400
g 0 * ​Fixed costs increases, sales mix remain the
same​ > higher break even packages
Pack $625 * ​Shift in sales mix but break even packages
age remain the same​ > loss

Contribution Margin Ratio = Contribution
Margin (sum of both products) / Total revenue
(both products)
Break Even Sales = Fixed Cost / Contribution
Margin Ratio
Income Statement
Sales xx
Total Variable Cost xx
Contribution Margin xx
Total Fixed Cost xx
Operating Income xx
Measures of risk
Margin of Safety
- The units sold or the revenue earned
above the break-even volume
- Crude measure of risk
- The risk of suffering losses is less if a
firm’s expected margin of safety is
large than if the margin of safety is
small
Margin of Safety = Sales - Break even sales
Operating Leverage
- The use of fixed costs to extract
higher percentage change in profits as
sales activity changes.
- Firms with a higher operating leverage
will experience greater reductions in
profits as sales decrease.
Degree of operating leverage (DOL)
- Can be measured for a given level of
sales by taking the ratio of contribution
margin to operating income
- Can be used directly to calculate the
change in operating income that would
result from a given percentage change
in sales.
Degree of Operating Leverage = Total
Contribution Margin / Operating Income
* If fixed costs are used to lower variable costs
such that contribution margin increases and
operating income decreases, then the degree
of operating leverage increases - (an increase
in risk).
* the greater the degree of operating leverage,
the more that changes in sales will affect
operating income.
Cost structure
- A company’s mix of fixed costs
relative to variable costs
Percentage Change in Profits = Degree of
Operating Leverage x Percent Change in
Sales
Sensitivity Analysis
- A “what-if” technique that examines
the impact of changes in underlying
assumptions on an answer.
KEY TERMS:
Contribution margin income statement
- The cost behavior-based income
statement. Costs are separated into
fixed and variable categories.
Degree of operating leverage (DOL)
- Shows the degree to which fixed costs
are used to obtain a higher percent
change in profits as sales change.
Indifference point
- The point at which two different
operating systems produce the same
income
CHAPTER 8: TACTICAL DECISION
MAKING AND RELEVANT ANALYSIS
Short run decision making
- Consist of choosing among
alternatives with an immediate or
limited end in view.
- Sometimes referred to as tactical or
relevant, decisions because they
involve choosing between alternatives
with an immediate or limited time
frame in mind.
Strategic decisions
- Usually are long term in nature
because they involve choosing
between different strategies that
attempt to provide competitive
advantage over a long time frame.
Decision Model
- A specific set of procedures that
produces a decision.
- Can be used to structure the decision
maker’s thinking and to organize the
information.
1. Recognize and define the
problem.
2. Identify alternatives as
possible solutions to the
problem. Eliminate alternatives
that clearly are not feasible.
3. Identify the costs and benefits
associated with each feasible
alternative. Classify costs and
benefits as relevant or
irrelevant, and eliminate
irrelevant ones from
consideration.
4. Estimate the relevant costs
and benefits for each feasible
alternative.
5. Assess qualitative factors
6. Make the decision by selecting
the alternative with the
greatest overall net benefit.
Differential cost
- The difference between the summed
costs of two alternatives in a decision.
Qualitative factors
- Factors that are hard to quantify in
financial terms, including things like
political pressure and product safety
Relevant costs
- 1) future items
- 2) differ across alternatives
Opportunity Costs
- The benefit sacrificed or forgone when
one alternative is chosen over another
- Relevant; because it is both future and
one that differs across alternatives
- Not an accounting cost but an
important consideration in relevant
decision making
Sunk cost
- Cost that cannot be affected by any
future action
- Depreciation
- Irrelevant
Make or buy decisions
- Those decisions involving a choice
between internal and external
production
- The alternative with the lower relevant
costs represents the best decision for
the company
Special Order Decisions
- Focus on whether a specially priced
order should be accepted or rejected
- Occurs when a company uses its
excess capacity to produce a “one
time” order for another company
Keep or Drop Decisions
- Requires that managers identify and
consider only the relevant information
of the business segment in question.
● Segment
- Subunit of a company of
sufficient importance to
warrant the production of
performance reports
 - Can be: divisions,
departments, product lines,
customer clauses, and so on.
Segmented Income Statements
- Allow managers to see the profitability
of individual segments of the
company, which is helpful when
making keep or drop decisions
Segment margin
- Profit contribution each segment
makes toward covering a firm’s
common fixed costs
*​negative segment - ​drags down the firm’s
total profit, making it time to consider
dropping the product.
Joint products
- Have common processes and costs
of production up to a split off point
Split off point
- Point of separation
*​joint costs
- Irrelevant costs
Sell or process-further decision
- An important relevant decision that a
manager must take
*​Processing costs
- Relevant
Product Mix
- Refers to the relative amount of each
product manufactured (or service
provided) by a company
● A manager should choose the
alternative that maximizes total profits
Constraints
- Limited resources and limited
demands
- Mathematical expressions that
express resource limitations
Markup
- A percentage applied to the base cost
Markup = Cost per unit + (Cost per unit x
Markup Percentage)
Target Costing
- Method of determining the cost of a
new product or service based on the
price (target price) that consumers are
willing to pay
Target Cost
- The difference between the sales
price needed to achieve a projected
market share and the desired per-unit
profit.
Target Cost = Target Price - Desire
Profit
Desired Profit = x% x Target Price
CHAPTER 9; PROFIT PLANNING AND
CONTROL
Planning
- Looking ahead to see what actions
should be taken to realize particular
goals
Control
- Looking backward, determining what
actually happened and comparing it
with the previously planned outcomes
Budgets
- Financial plans for the future and are a
key component of planning
Strategic plan
- Plots a direction for an organization’s
future activities and operations
- Generally covers at least 5 years
Advantages of Budgeting
1. Planning
2. Information for Decision Making
 3. Standards for Performance Evaluation
4. Improved Communication and
Coordination
Master Budget
- The comprehensive financial plan for
the organization as a whole
- Typically for 1 year period
Continuous Budget
- A moving 12-month budget
- As a month expires in the budget, an
additional month in the future is added
so that the company always has a 12
month plan on hand
Budget committee
- Reviews the budget, provides policy
guidelines and budgetary goals,
resolves differences that arise as the
budget is prepared, approves the final
budget, ang monitors the actual
performance of the organization as the
year unfolds
Budget director
- The controller
- Person responsible for directing and
coordinating the organization’s overall
budgeting process
Major Components of the Master Budget
1. Operating budgets - ​income
generating activities of a firm; sales,
production and finished goods
inventories; ultimate outcome is the
pro forma or budgeted income
statement.
2. Financial budgets - ​detail the inflows
and outflows of cash and the overall
financial position; expected financial
position at the end of the budget
period is shown in a budgeted, pro
forma balance​ sheet.
Sales budget
- approved by the budget committee
and describes expected sales in units
and dollars
- Basis for all the other operating
budgets and most of the financial
budgets
- ​Bottom up approach- ​requires
individual salespeople to submit sales
predictions
Production Budget
- Tells how many units must be
produced to meet sales and to satisfy
ending inventory requirements
Units to be produced = Expected Unit Sales +
Units in Desired Ending Inventory - Units in
Beginning Inventory
Direct Materials Purchases Budget
- Tells the amount and cost of raw
materials to be purchased in each
time period
Purchases = DM Needed for Production + DM
in Desired Ending Inventory - DM in Beginning
Inventory
Direct Labor Budget
- Shows the total labor hours and the
direct labor costs needed for the
number of units in the production
budget
Overhead Budget
- Shows the expected cost of all
production costs other than direct
materials and direct labor.
Ending finished goods Inventory Budget
- Supplieds information needed for the
balance sheet and also serves as an
important input for the preparation of
cost of goods sold budget
approved by the budget committee and
describes expected sales in units and dollars
Cost of Good Sold Budget
- Reveals the expected cost of the
goods to be sold
Selling and Administrative Expenses
Budget
- Outlines the planned expenditures for
nonmanufacturing activities.

****
Budgeting
- Creation of plan of action expressed in
financial terms
- Plays a key role in planning, control
and decision making
Operating Budget
- The budgeted income statement and
all supporting budgets
Financial Budget
- Includes the cash budget, capital
expenditures budget and budgeted
balance sheet
Cas Budget
- The beginning cash balance in the
cash account plus anticipated
receipts, minus anticipated
disbursements, plus or minus any
necessary borrowing
Budgeted (pro forma) balance sheet
- Gives the anticipated ending balances
of the asset, liability, and equity
accounts if budgeted plans hold