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Lecture 3

ACC 406 Lecture 3: ACC 406 Lecture 3 notes Nicholas Bordignon

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ACC 406
Nicholas Bordignon

ACC 406 Lecture 3 Chapter 4: Cost-Volume-Profit Analysis: A Managerial Planning Tool Cost-Volume Profit Analysis - This powerful tool for planning and decision making can be used to calculate: o The number of units that must be sold to break even o The impact of a given reduction in fixed costs on the break-even point o The impact of an increase in price on profit Break-Even Point - Break-Even Point (BEP) is where profits are zero Using Operating Income in Cost-Volume-Profit Analysis - The income statement format that is based on the separation of costs into fixed and variable components is called the contribution margin income statement. - Contribution margin is used to cover fixed costs and operating income. - Divides costs based on behaviour. - Costs are divided into variable and fixed components. - Important subtotal is contribution margin = Sales revenue minus variable expenses. - The focus is on the firm as a whole. - Therefore, the costs refer to all costs of the company—production, selling, and administration. - So variable costs are all costs that increase as more units are sold, including: ACC 406 o direct materials o direct labour o variable factory overhead o variable selling and administrative costs - Similarly, fixed costs include: o fixed factory overhead o fixed selling and administrative expenses - Overhead related to the product but not directly Break-Even Point in Units Break-Even Point in Dollars Managers may prefer to use sales revenue as the measure of sales activity instead of units sold. This is especially useful in a multi-product environment Calculate: Units to Be Sold to Achieve a Target Income - CVP analysis gives us a way to determine how many units must be sold, or how much sales revenue must be generated, to earn a particular amount of target income. - Let’s look first at the number of units that must be sold to earn a target operating income. - Remember that at the break-even point, operating income is $0. - Add the target income amount to the fixed cost to determine the number of units ACC 406 Units to Be Sold to Achieve a Target Income - There are two ways to accomplish this: o 1. Using operating income equation o 2. Using the basic break-even equation Profit-Volume Graph - Visually portrays the relationship between profits and units sold - Operating income is the dependent variable. - Units sold is the independent variable. - The profit-volume graph is the graph of the operating income equation. Cost-Volume Profit Graph - Depicts relationship among cost, volume, and profit - Graphs two separate lines: ACC 406 o Total revenue o Total cost - Vertical axis is measured in dollars. - Horizontal axis is measured in units sold Assumptions of Cost-Volume-Profit Analysis - Revenue and cost functions are linear. - Price, total fixed costs, and unit variable costs can be identified and remain constant over relevant range. - All units produced
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