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CHAPTER REVIEWCost Behavior Analysis1.(L.O. 1) Cost behavior analysis is the study of how specific costs respond to changes in the level of business activity. A knowledge of cost behavior helps management plan operations and decide between alternative courses of action.2.The activity index identifies the activity that causes changes in the behavior of costs; examples include direct labor hours, sales dollars, and units of output. Once an appropriate activity index is chosen, costs can be classified as variable, fixed or mixed.Variable and Fixed Costs3.(L.O. 1) Variable costs are costs that vary in total directly and proportionately with changes in the activity level. Examples of variable costs include direct materials and direct labor, cost of goods sold, sales commissions, and freight-out. A variable cost may also be defined as a cost that remains the same per unit at every level of activity.4.Fixed costs are costs that remain the same in total regardless of changes in the activity level. Examples include property taxes, insurance, rent, supervisory salaries, and depreciation. Fixed costs per unit vary inversely with activity; as volume increases, unit cost declines and vice versa.Relevant Range5.The range over which a company expects to operate during the year is called the relevant range. Although a linear (straight-line) relationship for costs may not be realistic, the linear assumption produces useful data for CVP analysis as long as the level of activity remains within the relevant range.Mixed Costs6.(L.O. 2) Mixed costs are costs that contain both a variable element and a fixed element; they increase in total as the activity level increases, but not proportionately. For purposes of CVP analysis, mixed costs must be classified into their fixed and variable elements.7.The high-low method uses the total costs incurred at the high and low levels of activity. The difference in costs represents variable costs, since only the variable cost element can change as activity levels change.8.The steps in computing fixed and variable costs under the high-low method are:a.Determine variable cost per unit from the following formula:Change in÷High minus Low=Variable CostTotal CostsActivity Levelper Unitb.Determine the fixed cost by subtracting the total variable cost at either the high or the low activity level from the total cost at that activity level.Cost-Volume-Profit Analysis9.(L.O. 3) Cost-volume-profit (CVP) analysis is the study of the effects of changes in costs and volume on a company’s profits. It is a critical factor in such management decisions as profit planning, setting selling prices, determining product mix, and maximizing use of production facilities.10.CVP analysis considers the interrelationships among the following components: (a) volume or level of activity, (b) unit selling prices, (c) variable cost per unit, (d) total fixed costs, and (e) sales mix.Basic CVP Components11.The following assumptions underlie each CVP analysis:a.The behavior of both costs and revenues is linear throughout the relevant range of the activity index.b.Costs can be classified accurately as either variable or fixed.c.Changes in activity are the only factors that affect costs.d.All units produced are sold.e.When more than one type of product is sold, the sales mix will remain constant. That is, the percentage that each product represents of total sales will stay the same.Contribution Margin12.Contribution margin is the amount of revenue remaining after deducting variable costs. The formula for contribution margin per unit is:Unit Selling–Unit Variable=Unit ContributionPriceCostsMargin 13.Contribution margin per unit indicates the amount available to cover fixed costs and contribute to income. The formula for the contribution margin ratio is:Contribution÷Unit Selling=Unit ContributionMargin Per UnitPriceMarginThe ratio indicates the portion of each sales dollar that is available to apply to fixed costs and to contribute to income.Break-Even Analysis14.(L.O. 4) The break-even point is the level of activity at which total revenue equals total costs (both fixed and variable). Knowledge of the break-even point is useful to management when it decides whether to introduce new product lines, change sales prices on established products, or enter new market areas.15.A common equation used for CVP analysis is as follows:Sales - Variable Costs - Fixed Costs = Net Income16.Under the contribution margin technique, the break-even point can be computed by using either the unit contribution margin or the contribution margin ratio.17.The formula, using unit contribution margin, is:Fixed÷Unit Contribution=Break-evenCostsMargin Point in Units18.The formula using the contribution margin is:Fixed÷Contribution=Break-evenCostsMargin RatioPoint in Dollars19.A chart (or graph) can also be used as an effective means to determine and illustrate the break-even point. A cost-volume-profit (CVP) graph is as follows:Target Net Income20.(L.O. 5) Target net income is the income objective for individual product lines. The following equation is used to determine target net income sales:Required Sales - Variable Costs - Fixed Costs = Target Net Income21.Using the contribution margin technique, we can compute in either units or dollars the sales required to meet a target net income. To compute the sales required in units the following formula is used:(Fixed Costs + Target Net Income) ÷ Unit Contribution Margin = Required Sales in UnitsTo compute the sales required in dollars, the contribution margin ratio is used rather than the unit contribution margin, as follows:(Fixed Costs + Target Net Income) ÷ Contribution Margin Ratio = Required Sales in DollarsMargin of Safety22.Margin of safety is the difference between actual or expected sales and sales at the break-even point.a.The formula for stating the margin of safety in dollars is:Actual (Expected)–Break-even=Margin of SafetySalesSalesin Dollarsb.The formula for determining the margin of safety ratio is:Margin of Safety÷Actual (Expected)=Margin of in DollarsSalesSafety RatioThe higher the dollars or the percentage, the greater the margin of safety.BRIEF EXERCISE 5-1Indirect labor is a variable cost because it increases in total directly and proportionately with the change in the activity level.Supervisory salaries is a fixed cost because it remains the same in total regardless of changes in the activity level.Maintenance is a mixed cost because it increases in total but not proportionately with changes in the activity level.BRIEF EXERCISE 5-2VARIABLE COSTRelevant RangeFIXED COSTRelevant Range$10,000?$10,000?8,000?8,000?1778002540006,000?6,000?4,000?4,000?2,000?2,000?020406080100020406080100Activity LevelActivity LevelBRIEF EXERCISE 5-3$60,000COST-3175-1270000106045-177800098425190881000Total Cost Line?45,000?30,000Variable Cost Element?15,000Fixed Cost Element05001,0001,5002,0002,500Direct Labor HoursBRIEF EXERCISE 5-4HighLowDifference$15,000–$13,500=$1,500??8,500–??7,500=?1,000$1,500 ÷ 1,000 = $1.50—Variable cost per mile.HighLowTotal costLess: Variable costs8,500 X $1.507,500 X $1.50Total fixed costs$15,000?12,750?????????????$ 2,250 $13,500 11,250$ 2,250The mixed cost is $2,250 plus $1.50 per mile.BRIEF EXERCISE 5-5HighLowDifference$74,500–$36,000=$38,500?40,000–?18,000=?22,000$38,500 ÷ 22,000 = $1.75 per unit.Activity LevelHighLowTotal costLess: Variable costs40,000 X $1.7518,000 X $1.75Total fixed costs$74,500?70,000000,000$?4,500$36,000?31,500$?4,500BRIEF EXERCISE 5-61.(a)$288 = ($640 – $352)(b)45% ($288 ÷ $640)2.(c)$207 = ($300 – $93)(d)31% ($93 ÷ $300)3.(e)$1,300 = ($325 ÷ 25%)(f)$975 ($1,300 – $325)BRIEF EXERCISE 5-7RUSSELL INC.CVP Income StatementFor the Quarter Ended March 31, 2017Sales$2,200,000Variable costs ($920,000 + $70,000 + $86,000) 1,076,000Contribution margin1,124,000Fixed costs ($440,000 + $45,000 + $98,000) ?583,000Net income$? 541,000BRIEF EXERCISE 5-8(a)$520Q – $286Q – $163,800 = $0$234Q = $163,800Q = 700 units(b)Contribution margin per unit $234, or ($520 – $286)X = $163,800 ÷ $234X = 700 unitsBRIEF EXERCISE 5-9Contribution margin ratio= [($300,000 – $180,000) ÷ $300,000] = 40%Required sales in dollars= $110,000 ÷ 40% = $275,000BRIEF EXERCISE 5-10If variable costs are 70% of sales, the contribution margin ratio is ($1 – $0.70) ÷ $1 = .30. Required sales in dollars = ($195,000 + $75,000) ÷ .30 = $900,000BRIEF EXERCISE 5-11Margin of safety = $1,000,000 – $800,000 = $200,000Margin of safety ratio = $200,000 ÷ $1,000,000 = 20%BRIEF EXERCISE 5-12Contribution margin per unit $1.60 is ($6.00 – $4.40)Required sales in units= ($480,000 + $1,500,000) ÷ $1.60 = 1,237,500. ................
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