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chap 3

8 Pages
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Department
Accounting
Course Code
ACC 406
Professor
George Gekas

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LECTURE 3:
Cost volume Profit relationships OVERVIEW
Dr. George Andrew Gekas
These notes are posted on blackboard to high light and complement certain aspects
of the topic, facilitate those students who may have missed my lecture, balance
traditional with internet based learning and overall enhance students learning.
The notes are not meant to suggest what may be in the exams, replace coming to
class, textbook studying and/or problem solving.
This chapter examines cost volume Profit relationships or the cost behaviour
impact on company profitability.
Cost Behaviour – How an organization’s activities affect its costs.
Cost Drivers - Output measures of resources and activities.
Organizations can have many cost drivers. In this chapter, volume-based
cost drivers are used in order to examine cost behaviour.
Cause and Effect Relationships: What may cause a student to
perform poorly/well on an examination? There may be multiple
causes.
Comparing Variable and Fixed Costs
Variable and fixed costs refer to how cost behaves with respect to changes in
a particular cost driver.
Variable Cost - a cost that changes in direct proportion to changes in the
cost driver (i.e., costs per unit do not change, total costs do change).
Examples include the costs of materials, merchandise, parts, supplies,
commissions, and many types of labour.
Fixed Cost - a cost that is not immediately affected by changes in the cost
driver (i.e., costs per unit do change, total costs do not change within the
relevant range). Examples include real estate taxes, real estate insurance,
many executive salaries, and space rentals.
Fixed Costs and Time Period - All costs become variable as the
time period is expanded.
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Difficulties in Classifying Costs may not act in a linear manner with
volume-based cost drivers. Examples: when learning affects the production
time, and therefore the labour cost of units of product; some costs may be
affected by more than one cost driver; and whether costs are variable or
fixed often depends on the decision situation.
Relevant Range - the limits (i.e., time period and/or activity) of cost-driver
activity within which a specific relationship between costs and the cost
driver is valid.
Cost-Volume-Profit and Breakeven Analysis
Cost-Volume-Profit (CVP) Analysis - the study of the effects of output
volume on revenue (sales), expenses (costs), and net income (net profit). The
major simplifying assumption is to classify costs as either variable or fixed
with respect to the volume of output activity. A CVP scenario follows.
The Contribution-Margin Approach: Contribution Margin (CM)
Per Unit - the sales price per unit minus the variable expenses per unit.
The BEP is reached when total contribution margin equals total fixed
costs. Dividing total fixed costs by the CM per unit gives the BEP in
number of units.
CM Percentage or Ratio - the portion of every sales dollar that
contributes to covering fixed costs and, hopefully, provides for profit
(divide total contribution margin by total sales). Dividing total fixed
costs by the CM percentage (total contribution margin / total sales)
yields the sales dollars needed to break even. The use of the CM
percentage is necessary when a firm produces more than one product.
Break-Even Point (BEP) - the level of sales at which revenues equals
expenses and net income is zero. One direct use of the BEP is to assess
possible risk. By comparing planned sales with the BEP, managers can
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determine a Margin of Safety - how far sales can fall below the planned
level
before losses occur.
Margin of Safety = planned unit sales - break-even unit sales
A. Changes in Fixed Expenses
Increases (decreases) in fixed expenses increase (decrease) the BEP.
B. Changes in Contribution Margin per Unit
Increases (decreases) in the CM per unit decrease (increase) the BEP.
The Income Statement Equation Approach: The basic income
statement equation used for CVP analysis is:
sales - variable expenses - fixed expenses = net income
unit sales price x number of units- unit variable cost x number of
units- fixed expenses=net income
At the BEP, net income is zero. Let N = the number of units to be
sold to break even, put in values for the unit sales price, unit
variable cost and fixed expenses, and solve for N.
To compute the sales dollars needed to break even using the
equation technique, the variable expenses must be expressed as a
proportion of sales, which is called the Variable-Cost Ratio or
Percentage. Then, letting S = the sales dollars to break even, solve
for S in the equation:
S - (variable-cost ratio x S) - fixed expenses = 0
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Description
LECTURE 3: Cost volume Profit relationships OVERVIEW Dr. George Andrew Gekas These notes are posted on blackboard to high light and complement certain aspects of the topic, facilitate those students who may have missed my lecture, balance traditional with internet based learning and overall enhance studentearning. The notes are not meant to suggest what may be in the exams, replace coming to class, textbook studying andor problem solving. This chapter examines cost volume Profit relationships or the cost behaviour impact on company profitability. Cost Behaviour How an organizations activities affect its costs. Cost Drivers - Output measures of resources and activities. Organizations can have many cost drivers. In this chapter, volume-based cost drivers are used in order to examine cost behaviour. Cause and Effect Relationships: What may cause a student to perform poorlywell on an examination? There may be multiple causes. Comparing Variable and Fixed Costs Variable and fixed costs refer to how cost behaves with respect to changes in a particular cost driver. Variable Cost - a cost that changes in direct proportion to changes in the cost driver (i.e., costs per unit do not change, total costs do change). Examples include the costs of materials, merchandise, parts, supplies, commissions, and many types of labour. Fixed Cost - a cost that is not immediately affected by changes in the cost driver (i.e., costs per unit do change, total costs do not change within the relevant range). Examples include real estate taxes, real estate insurance, many executive salaries, and space rentals. Fixed Costs and Time Period - All costs become variable as the time period is expanded. www.notesolution.com
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