Accounting cheet Final

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Wilfrid Laurier University *

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BU393

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Accounting

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Feb 20, 2024

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Chapter 6: Question: LMS has a break-even point of 40,000 units. If the firm's sole product sells for $20 and fixed costs total $240,000, the variable cost per unit must be: Explanation: BEP = (FC+NI)/CM → CM = SP – VC → 40,000 = (240,000+0)/(20 - VC) → 40,000(20 - VC) = 240,000 → 800,000 - 240,000 = 40,000VC → 560,000/40,000 = VC → VC = $14 Question: Sanderson sells a single product for $50 that has a variable cost of $30. Fixed costs amount to $5 per unit when anticipated sales targets are met. If the company sells one unit in excess of its break-even volume, the bottom-line profit will be, explanation: If they were to sell one unit above their break-even point their profit would equal the CM per unit. At their breakeven point profit is 0 so, their breakeven point + 1sale is 0+CM →CM = $50-$30 = $20 Question: If the company desired to earn a target net profit of $820,000, it would have to sell: Explanation: CM per unit = (SP–VC)/units = (5,000,000 - 3,000,000)/5,000 = $400 BEP = (FC+NI)/CM = (800,000+820,000)/400 = 4050 units Question: Yellow, Inc., sells a single product. The variable costs ratio is 40%. and fixed costs total $120,000. What dollar sales level would Yellow have to achieve to earn a target net profit of $240,000? Explanation: CM = 1–VC ratio = 1 – 40% = 60% → BEP = (FC+NI)/CM =(120,000+240,000)/60% =$600,000 Question: Dana sells a single product at $20 per unit. The firm's most recent income statement revealed unit sales of 100,000, variable costs of $800,000, and fixed costs of $400,000. If a $4 drop in selling price will boost unit sales volume by 20%, the company will Experience: Explanation: Current state → Revenue = SP per unit * sales units = $20*100,000 = $2,000,000 → Net income = Sales–VC–FC = $2,000,000–800,000–400,000 = $800,000 → New State Revenue = SP per unit * sales units = (20–4) * (100,000*120%) = $16*120,000 =$1,920,000 → New Variable costs = $800,000*120% = $960,000 → Net Income = Sales–VC–FC = $1,920,000 – 960,000 – 400,000 = $560,000 → Change in profitability = New NI – Old NI = $560,000 - $800,000 = $(240,000) Question: If total fixed costs are $70,000, variable cost percentage 60%, and targeted net income is $18,000, then the target sales in dollars is: Explanation: CM = 1 – VC ratio = 1 – 60% = 40% → BEP = (FC+NI)/CM =(70,000+18,000)/40% =$220,000 Question: If Edco's sales revenues increase 15%, what will be the percentage increase in income? Explanation: NI increases = DOL*sales increase = 5*15% = 75% Question: At a volume of 20,000 units, Dries reported sales revenues of $1,000,000, variable costs of $300,000, and fixed costs of $260,000. The company's break-even point in units is: Explanation: BEP = (Fixed costs + Net Income)/CM →CM = (Sales – VC)/units = (1,000K – 300K)/20K = $35 → BEP = (260,000+0)/35 = 7,429 units Question: Grey, Inc. sells a single product for $20. Variable costs are $8 per unit and fixed costs total $120,000 at a volume level of 5,000 units. Assuming that fixed costs do not change, Green's break-even sales would be: Explanation: BEP units = (Fixed costs + Net Income)/CM =(120,000+0)/(20–8) =10,000 units → BEP sales = BEP units * SP per unit = 10,000 units * $20 = $200,000 Question: Strayer has a break-even point of 120,000 units. If the firm's sole product sells for $40 and fixed costs total $480,000, the variable cost per unit must be: Explanation: BEP = (Fixed costs + Net Income)/CM →120,000 = (480,000 + 0) / (40–VC) → 120,000*(40–VC) = 480,000 → 4,800,000 – 120,000VC = 480,000 VC = (4,800,000–480,000)/120,000 → VC = $36 Question: The Ship company is Planning to produce two products, Alt and Tude. Ship is planning to sell 100,000 units of Alt at $4.00 a unit and 200,000 units of Tude at $3.00 a unit. Variable costs are 70% of sales for Alt and 80% for Tude. In order to realize a net profit of $160,000, what must the total fixed costs be? Explanation: BEP = (Fixed costs + Net Income)/weighted average CM WACM = (SalesAlt/Total sales)*SP per unit *CM% + (SalesTude/Total sales)*SP per unit * CM% =(100,000/300,000)*$4*30% + (200,000/300,00 0)*$3*20% WACM=$.80 per unit → BEP = (Fixed costs + Net Income)/WACM 300,000 = (Fixed costs + 160,000)/.80 → 300,000*.80 = Fixed costs + 160,000 → 240,000–160,000 = Fixed Costs = $80,000 Question: T aylor, Inc., produces only two products, A and B . These account for 60% and 40% of the total sales dollars of Taylor, respectively. Variable costs (as a percentage of sales dollars) are 60% for A and 85 %for B . Total fixed costs are $150,000. What is Taytor's breakeven point in sales dollars? Explanation: BEP = (Fixed costs + Net Income)/WACM → WACM = Sales Mix A*CM B% + Sales Mix B * CM B% = 60%*40% + 40%*15% =30% → BEP = (Fixed costs + Net Income)/CM =$150,000/30% = $500,000 Question: Sunny Seattle Inc. began business on January 1, and by December 31 had sold all its production of 100,000 units. Fixed costs are $50,000 and variable costs are 75% of the unit sales price. What is the total cost assuming a profit of $80,000? Explanation: BEP = (Fixed costs + Net Income)/CM → BEP = (50,000+80,000)/25% = $520,000 → Selling price per unit = BEP Sale / BEP units = $520,000/100,000 units = $52 VC per unit = SP*VC% = $52*75% = $39 → Total VC = VC per unit * units sold = $39*100,000 units = $390,000 → Total costs = VC + FC = $390,000 + $50,000 = $440,000 Chapter 7: Question: Wagner Company sells product A at a selling price of $21 per unit. Wagner's cost per unit based on the full capacity of 200,000 units is as follows: A special order offering to buy 20,000 units was received from a foreign distributor. The only selling costs that would be incurred on this order would be $3 per unit per shipping. Wagner has sufficient existing capacity to manufacture the additional units. In negotiating a price for the special order, Wagner should consider that the minimum selling price per unit should be: For the new order following costs will be incurred: DM $ 4 DL $ 5 Variable FOH 6*1/3 = $ 2 Shipping $ 3 Thus, the total variable cost is 4+5+2+3 = $ 14 Question: The following are Sails Unlimited's unit costs of making and selling a jib at an output of 1,000 jibs per month (which represents the firm's capacity).Currently, Sails Unlimited is selling 800 jibs monthly in the United States. An order has been received from a retailer in Mexico for 100 jibs with a special America's Cup emblem. Although the order would not affect current sales in the United States, it would require the purchase of a specialized printing tool at $250 (salvage value of $50). Also, variable selling and administrative costs for this order would only be 50 % of normal. If Sails Unlimited accepts this special order and receives $5,200 for it, the effect on Sails Unlimited's net income would be: Variable Cost for additional order = DM + DL + VOH + 50% of VS&A$8 = $10 + $20 + $5 + $20*50% = $45 → Change in NI = Sales revenue – Variable Cost – Additional Cost = 5200 – 100 * 45 – (250 – 50) = $500 increase Question: You have an opportunity to purchase a new machine for $100,000. Your old machine's original cost was $150,000 and has a trade in value equal to its current salvage value of $10,000. Currently your annual operating costs are $40,000. The salesman who sells the machine estimates that you can save 30% on your operating costs. The estimated life of both machines is 10 years, at which time both machines will have zero salvage value. The effect of buying the new machine would be: The relevant costs between the decision to Buy and Not Buy are as follows: Buy: Cost of new machine, salvage value of old machine, reduction in operating costs over 10 years = -100,000 + 10,000 + 30% * 40,000 * 10 = 30,000 increase Chapter 2: (Raw materials added = purchases) Raw Materials BB + Purchases - EB - Ind M = DM Used WIP BB + DM + DL + MOH – EB = CGM Finished Goods BB + CGM - EB = CGS EB of RM = BB + Purchases - Ind M - DM used DL = TMC - DM - MOH CGM (EB) = BB + TMC - EB BB of FG = CGS - CGM - EB CGS = Sales Revenue - Gross Profit/margin or Total MOH = VMOH + FMOH Conversion Cost(CC) = MOH or FOH + DL Prime Cost = DL + DM Total Manufacturing Costs(TMC) = Prime Costs + MOH CGM = BWIP + Raw materials added + MOH + DL - EWIP Variable = Unit costs are the same → y=b(x) Fixed = Total cost is the same→ y= FC Mixed = Unit costs are different → Y= FC+ b(x) Total Cost = Fixed Cost + Variable Cost (Xunits) Unit Variable Cost = ????? ???𝑖???? ???? ?????? ?? ??𝑖?? Operating income = Sales - CGS - Expenses(selling or advertising) Variable cost per unit = Total variable cost / unit COGM = Ending FG + COGS - Beginning FG COGM = BWIP + DM + DL + MOH - EWIP EWIP = BWIP Inventory + Manufacturing Costs – COGM COGM = BWIP + Raw Materials added + MOH added + DL Added – EWIP Ending Raw Materials = Beginning Raw Material + Purchases – Raw Materials added OI = Sales Rev – COGS – Selling X – Admin X COGM = BWIP + Total Manufacturing Costs – EWIP Beginning FG = COGs + Ending FG – COGM Total Manufacturing Costs = DL + MOH + DM Material Purchased = Ending DM + DM Used – Beginning DM COGS = Beginning FG +COGM – Ending FG Total cost @ “” units = Units * (DM + DL + MOH) Cost = mx + b M = (y2 - y1)/(x2 – x1) VMOH = TMOH – FMOH VMOH per unit = VMOH / units High-Low Method Cost Function y = a + b (X) → a (fixed component), b (slope or variable cost rate), x (quantity), y (total costs) Step 1: Identify highest and lowest points in terms of Step 2: Find Variable Cost/unit (b/m) = or ????? ???? ?????𝑖???? ? ?𝑖?ℎ??? ????? ?? ???𝑖?𝑖?? − ????? ???? ?????𝑖???? ? ?????? ????? ?? ???𝑖?𝑖?? ( ) ?𝑖?ℎ??? ????? ?? ???𝑖?𝑖?? − ?????? ????? ?? ???𝑖?𝑖?? ?(?)−?(?) ?(?) −?(?) Step 3: Find fixed component(a) by plugging x and y in the equation Fixed Cost = Total Cost Associated w Lowest Level of Activity - Variable Cost per unit (Lowest Level of Activity) Diff in Net Income = |Variable Costing NI - Absorption Costing NI| Per Unit FFOH = Absorption Unit Product Cost - Variable Unit Product Cost Change In Quantity of Inventory = ?𝑖?? 𝑖? ??? ?????? ??? ??𝑖? ???? BB = EB + Change In Quantity of Inventory Chapter 6: Bottom-line profit (NI) = Gross sales - Total expenses OR Contribution Margin/unit = Unit Selling Price - Unit Variable Cost Total Variable Costs = Total Variable Manufacturing CGS + Total Variable S&A Total Fixed Costs = Total Fixed MOH + Total Fixed S&A Total Costs = FC + VC per unit Selling Price/unit = Sales Revenue/ Units Sold Total Contribution Margin = Total Sales Revenue - Total Variable Costs Total Contribution Margin = Total Fixed Cost + Operating Income *at BEP, FC = CM, NI=0, Sales - Variable = FC Operating income = CM - Fixed Costs Variable Cost/unit = Selling Price per unit x VC % Contribution Margin/unit = or or CM% x Selling Price CM per unit = (SP – VC)/units ?????𝑖???𝑖?? ????𝑖? ????? 𝑖? ??𝑖?? ??𝑖?? ??? ??𝑖? ??% Contribution Margin Ratio % = or or ????? ?????𝑖???𝑖?? ????𝑖? ????? ????? ??????? ?????𝑖???𝑖?? ????𝑖?/??𝑖? ????𝑖?? ??𝑖?? ??? ??𝑖? ?𝑖??? ????? (?? ???) ????? ??????? Variable Cost % = or ????? ???𝑖???? ????? ????? ????? ??????? ???𝑖???? ????/??𝑖? ????𝑖?? ??𝑖?? ??? ??𝑖? CM% + VC% = 100% or CM= 1- VC ratio% Net Income = Total Revenue - Total Variable Cost - Total Fixed Cost Net Income = Units(SP-VC) - Fixed Costs Sales = NI + VC + FC Equation 1 Required Sales Xunits = or or ?𝑖??? ????? (??) + ?????? ????𝑖? (??) ??𝑖? ?????𝑖???𝑖?? ????𝑖? (??/??𝑖?) ?? + ?? ??/??𝑖? ?? + ?? (??−??) Equation 2 Required Sales X($) = or If calculating Break-even, NI=0 ?𝑖??? ????? (??) + ?????? ????𝑖? (??) ?????𝑖???𝑖?? ????𝑖? % ?? + ?? ??% Break Even Point (units) = ?𝑖??? ????? ?????𝑖???𝑖?? ????𝑖? ??? ??𝑖? Incremental Operating Income = $ Increase in sales x CM% Margin of Safety = Actual(expected sales) - Break-even Sales Margin of Safety Ratio = *The higher the MOS, lower the risk of loss ????𝑖? ?? ?????? ?????? ????? Operating Leverage/DOL (Sensitivity of NI to % Sales) = (*Neg. OL →FC >CM) ∆ ?????𝑖???𝑖?? ????𝑖?(??) ??????𝑖?? 𝑖?????(??) Total Revenues (TR) = (Xunits* SP/unit) Total Costs (TC) = FC + (Xunits*VC/unit) Total cost = VC + FC If CM then INCOME SP BEP , Fixed costs then BEP ↑ ↑ ↓ ↓ ↑ ↑ Contribution Margin = Total sales revenue - Total variable costs Break-even point = (FC + NI)/CM Contribution Margin = Sales price - variable cost Revenue = SP per unit * sales units Net income = Sales – VC – FC Change in profitability = New NI - Old NI New variable costs = Old NI * sales unit Variable Costs = VC per unit * sales units Change in profitability = New State – Old State Contribution Margin = Sales - VC NI Increase = DOL * sales increase Sales price per unit = Sales / unit BEP in sales = BEP units * SP per unit Sales = Units * SP per unit Safety Margin = Revenue - BEP Selling Price = Cost Price + Profit Margin Break Even Point (units) = BEP in sales / SP per unit WACM = (SalesAlt/Total sales)*SP per unit *CM% + (SalesTude/Total sales)*SP per unit * CM% BEP = (Fixed costs + Net Income)/WACM BEP = (Fixed costs + Net Income)/weighted average CM WACM = Sales Mix A*CM B% + Sales Mix B * CM B% Selling price per unit = BEP sale / BEP units Total VC = VC per unit * Units sold Sales price = CM / CM% BEP = (Fixed costs + Net Income) / CM % Chapter 7: Decision Steps: Step 1→ Capacity Analysis, Step 2 → Identfy Relevant data, Step 3 → Making decision 4 Decisions: Special order, make or buy (outsourcing), keep or eliminate (unprofitable product), retain or replace equipment Opportunity Cost(OC) = ?? ??? ??𝑖? ?? ??????? ????? × (# ?? ??𝑖?? ??????? ?? ??????? ?????) ( if production capacity #units in special order → No OC) ≥ Minimum Selling Price = ????? 𝑖??????????? ????? ????𝑖??? ?? ????𝑖?? ????𝑖?? ????? # ?? ??𝑖?? ????????? ?? ????𝑖?? ????? False statements Any product, service, or organizational unit to which costs are assigned for some management purpose is a cost driver. Indirect costs are easily traceable to a cost object. Variable selling and administrative expenses are part of product costs under the variable costing approach. Under variable costing, fixed manufacturing overhead cost is treated as a product cost. Variable manufacturing overhead costs are treated as period costs under both absorption and variable costing. When 50,000 units are produced the fixed cost is $10 per unit. Therefore, when 100,000 units are produced fixed costs will remain fixed at $10 per unit. Net operating income is affected by changes in production under both the variable costing and absorption costing approaches. Direct material costs and indirect material costs are prime costs. Ch 7 Formulas Factory overhead (FOH) = Units sold * Factory overhead FOH = FFOH + VFOH or VFOH = FOH – FFOH Level activity = VFOH / Unit Cost per item = (DM+DL+VFOH+V) Change in Net income = Sales revenue – Variable Cost – Additional Cost Income = Sales – (Variable cost of Manuf + Special promotion cost) Relevant cost = DM + DL + VOH Maximum external price = DM + DL + VOH + Avoidable FOH Maximum price = DM + DL + VOH Relevant cost (Special Orders) = Sales - VC - Shipping cost Eliminate product line = Variable cost + Avoidable fixed cost Chapter 3: EB (WIP) = DM + DL + Applied FOH Applied FOH = EB (WIP) - (DM + DL) application rate = Applied FOH/ DL Bugeted MOH = (MOH + Applied overhead) Budgeted base = Budgeted MOH / Labour rate EB (WIP) = DM + DL + Applied FOH - CGM DM = EB – DL – Applied FOH Applied MOH = DL / rate % CGM (EB) = BB + DM + DL + Applied FOH - EB Budgeted Rate = Budgeted MOH / Budgeted Base Applied MOH = Application rate * Actual qty used of the base Per unit cost = WIP (CGM) / Units produced EB = BB + Purchases - DM DM = BB + Purchases - EB WIP (CGM) = DM + DL + FOH Total manuf. Cost = DM + DL + Applied FOH OR DL = Total manuf. Cost - DM - Applied FOH Application Rate = Budgeted MOH / Budgeted base Underapplied (overapplied) manufacturing overhead = Actual manufacturing overhead - Manufacturing overhead applied Manufacturing overhead applied = Actual manufacturing overhead - Underapplied Overhead applied = Predetermined overhead rate × Amount of the allocation base incurred Predetermined overhead rate = Overhead applied ÷ Amount of the allocation base incurred Predetermined overhead rate = Estimated total manufacturing overhead ÷ Estimated total amount of the allocation base Estimated total manufacturing overhead = Predetermined overhead rate × Estimated total Job-Order Costing 1. Allocation Rate or Actual Cost Driver Rate = / 2. Allocated to Job k = Allocation Rate x Actual Quantity (AQ) used of Base by Job k Normal Costing 1. Application Rate = / 2. Applied MOH to Job k = Application Rate x Actual Quantity used of the Base by Job k To Find BB (WIP), EB (WIP), OR TMC to get → CGM 1. DL Hours = / 2. MOH = DL Hours x Predetermined Overhead Rate or Application Rate 3. BB or EB or TMC = DM + DL Cost + MOH 4. CGM = BB + DM + DL + MOH - EB

Chapter 1 Notes Managerial accounting - field of accounting that provides economic and financial information for manager and other internal users. Similarities between managerial and financial accounting. Both fields deal with economic events of business. Require a companies economic events to be quantified and communicated to interested parties. Management Functions and Organizational Structures. 1. Planning . Requires management to look ahead and to establish objectives. Objectives are often diverse: maximizing short-term profits and market share, maintaining a commitment to environmental protection and contributing to social programs. Key objective: add VALUE to business under its control 2. Directing. Involves coordinating a company’s diverse activities and HR ro produce smoothly running operation. Relates to implementing planned objectives and providing necessary incentives to motivate employees. 3. Controlling. Process of keeping the company’s activities on track. Managers determine whether planned goals are being achieved. Small operation - smart manager can make personal observations and asking good questions. Large business - use formal system of evaluation (includes such features as budgets, responsibility centres, and performance evaluations reports Organization charts - show the interrelationships of activities and the delegation of authority and responsibility within the company. Activity-Based Costing (ABC): In order to obtain more accurate product costs, many companies now allocate overhead using ABC. Under ABC, overhead is allocated based on each products use of resources. Theory of Constraints: A specific approach used to identify and manage constraints in order to achieve the company’s goals. Involves identification of constraints within value chain that limit company’s profitability. Lean Manufacturing: A process increasingly used by firms to manage operations more efficiently and with more Control. Balanced Scorecard: Corrects for managements sometimes limited perspective. A performance-measurement approach that uses both financial and non-financial. Measures to evaluate all aspects of a company’s operations in an integrated way Chapter 2 Notes Manufacturing Costs consists of activities and processes that convert raw materials into finished goods. Costs are typically incurred at production facility. Direct Materials (54%): Raw materials are the basic materials and parts used in manufacturing process. Direct materials → raw materials that can be physically and directly associated with manufacturing the finished product. Indirect materials → raw materials that do not physically become part of the finished product or cannot be traced because their physical association with the finished product is insignificant. Direct Labour (13%): Direct labour → work of factory employees that can be physically and directly associated with converting raw materials into finished goods Indirect labour → work of factory employees that has no physical association with the final product, or for which it is impractical to trace the costs to the goods produced. Manufacturing Overhead (33%): Manufacturing overhead → consists of costs that are indirectly associated with the manufacture of the finished product. Prime Costs and Conversion Costs: Prime costs → sum of all direct materials cost and direct labour costs. All direct manufacturing costs. Conversion costs → sum of all direct labour costs and manufacturing overhead costs. Costs of converting raw materials into a final product. Product vs. Period Costs: Product costs → costs that are a necessary and integral part of producing the finished Product. Also called inventoriable costs. All manufacturing costs are product costs. Companies record them when incurred. Do not become expenses until product is sold. Period costs → costs that are matched with the revenue of a specific time period rather than included in inventory as part of the cost to produce a saleable product. Cost Behaviour Analysis → study of how specific costs respond to changes in the level of business activity. Starting point is measuring key business activities. Activity index → identifies the activity that causes changes in the behaviour of costs. Variable costs → costs that vary in total directly and proportionately with changes in the activity level. Also defined as a cost that remains the same per unit at every level of activity. Fixed costs → costs that remain the same in total within relevant range regardless of changes in the activity level. Fixed costs per unit vary inversely with activity (as volume increases, unit cost declines and vice versa). Relevant range → range that a company expects to operate in during a year (aka normal or practical range). Low levels of activity: may be impossible to be cost-efficient. High levels of activity: labour costs may increase sharply because of overtime pay. Relationship between behaviour of variable costs and changes in activity level is often Curvilinear. Mixed costs → costs that have both a variable cost and fixed cost. Sometimes called semi-variable costs. Mixed costs change in total but not proportionally with changes in activity level. The High-Low Method of Classifying Costs: Mixed costs must be classified into their fixed and variable components. High-low method → mathematical method to separate mixed costs into their variable and fixed components that uses the total costs incurred at the high and low levels of activity. Manufacturing Costs in Financial Statements: Principle differences between manufacturer and merchandiser financial statements. The current assets section of balance sheet. Cost of goods sold section in income statement Balance Sheet: Merchandising company - shows one category of inventory. Manufacturer company - shows 3 inventory accounts (raw materials, work in process, finished goods). Income Statement: Merchandisers calculate cost of goods sold by adding the beginning merchandise inventory to the cost of goods purchased and subtracting ending merchandise inventory. Manufacturers calculator cost of goods sold by adding beginning finished goods inventory to the cost of goods manufactured and subtracting ending finished goods inventory. Determining the Cost of Goods Manufactured: Total cost of work in process → cost of the beginning work in process plus the total manufacturing costs for the current period. Ending work in process inventory → units that were partially completed at the end of the accounting period Chapter 3 Notes A Job-order costing system is used by companies that produce heterogeneous products of goods or services, where each product is unique and is made according to the customer’s specifications. Examples of companies that use job order costing system include auto repair services, aircraft manufacturing, and custom-made furniture. Cost Assignments Under Job-Order System: To assign production costs to the individual jobs or orders placed by customers, the costing system must maintain two sets of integrated WIP T-accounts : (i) a WIP account for each job/order in the subsidiary ledger and (ii) an aggregate WIP account in the general ledger. (i) In the Subsidiary Ledger, the system maintains a separate WIP account for each job (order). In each individual WIP accounts, the system tracks, and records in the debit side the production costs of DM, DL and MOH consumed by each job. (ii) In the General Ledger, the system maintains an aggregate WIP Control, in which the total production costs of DM, DL and MOH consumed by all jobs are aggregated in the debit side. The predetermined overhead application rate is based on estimated data, the actual total MOH costs recorded in the debit side of the MOH are more likely to be different from the total amount applied (assigned) to all jobs in the credit side. This generate an either debit balance or credit balance in the MOH account. This balance must be closed to $0. The balance in the MOH account captures the amount of underapplied or over-applied MOH. a) When MOH account has a debit balance, overhead is said to be under-applied. Under-applied overhead means that the overhead assigned to WIP is less than the overhead incurred. b) When manufacturing overhead has a credit balance, overhead is over-applied. Over-applied overhead means that the overhead assigned to WIP is greater than the overhead incurred. The amount of over/underapplied overhead measure an error in calculating the CGM. This, in turn, causes errors in the measurement of EB of WIP , CGS , and EB of FG . To correct these errors, at the end of the period, any balance in MOH account should be eliminated through an adjusting entry. There are two alternative methods to correct for the over or underapplied MOH: (1) direct write-off method and (2) proration method. Chapter 6 Notes Cost-Volume-Profit Analysis, Income Statement, and Contribution Margin. Cost-volume-profit (CVP) analysis: study of effects that changes in costs and volume have on a company’s profits. Important in profit planning. Critical factor in such management decisions as setting selling prices, determining product mix, and maximizing the use of production facilities. Basic Components: 1. Behaviour of both costs and revenues is linear throughout the relevant range of the activity index 2. All costs can be classified with reasonable accuracy as either variable or fixed 3. Changes in activity are the only factors that affect costs 4. Inventory levels remain constant (all units produced are sold) 5. When more than one type of product is sold, the sales mix will remain constant % of total sales that each product represents will stay the same *when these 5 assumptions are not valid, results of CVP analysis may be inaccurate*. CVP income statement: classifies costs as variable or fixed and calculates a contribution Margin. Contribution margin (CM): amount of revenue that remains after variable costs have been deducted. Often stated both as total amount and on per-unit basis *assume that the term costs includes all costs and expenses related to production and sale of product (include manufacturing product and selling and administrative period expenses)*. GAAP income statement differentiates between product costs (included in COGS) and periodcosts (listed in operating expenses) whereas CVP statement differentiates between variable and fixed costs. GAAP income statement emphasizes gross profit (net amount available to cover companies operating expenses). Difference between amount received for goods sold and cost of producing/purchasing goods. CVP income statement highlights contribution margin (net amount available to cover fixed costs). Difference between amount received for goods sold and company’s variable costs. CVP graph: graph showing relationship between costs, volume and profits. Sales volume is recorded along horizontal axis. Axis should extend to maximum level of expected sales. Both total revenues (sales) and total costs are recorded on vertical axis. Targeting operating income: income objective for individual product lines. Graphic Presentation: In CVP graph, in the operating income area of the graph, the distance between sales line and total cost line at any point equals operating income. Company can find required sales amount by analyzing differences between 2 lines until it finds desired operating income. Margin of Safety: Difference between actual or expected sales and sales at the break even point. Measures the “cushion” that a particular level of sales provides about breakeven point. Can be expressed in dollars, units or a ration. Sales mix: relative proportion in which each product is sold when a company sells more than one product. Important to managers because different products have substantially different contribution margins. Break-Even Sales in Units: Companies can calculate break-even sales for a mix of 2+ products by determining the weighted-average unit contribution margin of all the products. Chapter 7 Notes Incremental analysis (differential analysis) - the process used to identify financial expenses that change under alternative courses of action. Some cases, both costs and revenues will vary (in other cases, only costs or revenues will vary). Incremental analysis always involves estimates and uncertainty. Data for incremental analyses can be gathered from market analysts, engineers, and Accountants. The accountant is expected to produce the most reliable information available at the time the decision must be mad. Relevant cost - those costs and revenues that differ across alternatives. Only factors considered are (1) the costs and revenues that are different for each alternative, (2) those costs and revenues that will occur in the future. Costs and revenues that do not differ across alternatives can be Ignored. Opportunity cost - the potential benefit that may be lost from following a given course of action. Ex. a machine is used to make one type of product, the benefit of making another type may be lost. Sunk cost - costs that cannot be changed by any present or future decision. Ex. already purchased a machines, and now a newer machine is available, the book value of the original is a sunk cost. Incremental analysis sometimes involves changes that might seem contrary: Sometimes variable costs DO NOT CHANGE under alternative courses of action. Ex. direct labour is normally a variable cost but not relevant in deciding between 2 new machines if they require same labour. Somes fixed costs DO CHANGE . Ex. rent expense is normally a fixed cost but is relevant cost in decision whether to continue occupancy of building or to purchase/lease new building The approaches to incremental analysis do not consider time value of money (amounts to be paid or received in future years are not discounted for cost of interest). Qualitative Factors: The potential effects of the make-or-buy decision or of the decision to eliminate a line of business on existing employees and the community in which the plant is located. The costs savings that may result from outsourcing or from eliminating a plant should be weighed against these qualitative factors. One factor would be cost of lost morale that may result. Relationship of Incremental Analysis and Activity-Based Costing: Many companies have shifted to activity-based costing to allocate overhead costs to products. Main reason is that it results in more accurate allocation of overhead. Activity based costing will result in better identification of relevant costs, and therefore, a better incremental analysis. Types of Incremental Analysis Decisions: 1. Accept an order at a special price 2. Make or buy component parts or finished products 3. Sell products or process them further 4. Retain or replace equipment 5. Eliminate or retain an unprofitable business segment 6. Allocate limited resources. Special Orders: Sometimes company will have opportunity to obtain additional business if willing to make major price concession to specific customer or make special accommodation. The basic decision rule is to accept the special order if incremental price exceeds the incremental costs to complete the order. 1. Assumed that sales of the product in other markets would not be affected by special order (if other sales lost, would have to consider lost sales). 2. If operating at full capacity, likely to reject (company would have to expand plant capacity and special). Make or Buy: When manufacturer assembles component parts to produce a finished product, management must decide if they want to make or buy the components. The decision is often called outsourcing. Decision is based on incremental analysis. Sell or Process Further: Many manufacturers have the option of selling products at a particular point in the production cycle or continuing to process the products in order to sell them later at a higher price. Multi-Product Case: Sell-or-process further decisions are especially relevant to production processes that produce multiple products simultaneously. In many industries, several end products are produced from a single raw material and a common product process. Commonly called Joint Products Eliminate an Unprofitable Segment or Product: Key is to focus on relevant costs - the data that change under the alternative courses of action (decision to discontinue segment solely based on bottom line - net loss- is inappropriate). Sales Mix: One factor that affects sales mix decision is how much of the available resources each product uses. Everyone's resources are limited. When company has limited resources, management must decide which products to make and sell in order to maximize net income. Theory of constraints: specific approach that a company uses to identify and manage.

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