Summary and Review

CVP ANALYSIS WITH ONE PRODUCT

Total Revenues (TR) NI = TR – TVC – TFC
– Total Variable Costs (TVC)
= p  q – v  q – TFC
– Total Fixed Costs (TFC) = (p – v)  q – TFC
Net Income (NI)
p: unit selling price;
q: units sold;
v: variable cost per unit.
CVP ANALYSIS WITH ONE PRODUCT
NI = TR – TVC – TFC
= p  q – v  q – TFC
= (p – v)  q – TFC
= Unit Contribution Margin  q – TFC

p: unit selling price;

q: units sold;
v: variable cost per unit;
Unit Contribution Margin: p – v
CVP APPLICATION – Breakeven Analysis
Break-even point – Level of sales at which a firm earns zero profit, i.e., total
revenues equal total costs

NI = 0, TR = Total Costs, TR = TVC + TFC

(p – v)  q = TFC

Break even point q*, is:

q* = TFC / (p-v), where (p-v) is the unit contribution margin

CONTRIBUTION MARGIN RATIO
CM RATIO helps us compute sales volume in dollars in order to achieve a target
profit.
Recall, we multiply below (p-v)q by p/p (=1)

NI = (p – v) q − TFC
p –v
= (p q ) − TFC
p p –v
CM Ratio =
p –v
= (Sales ) − TFC p
p

NI = (CM Ratio) (Sales) – TFC

OPERATING LEVERAGE
Measures how sensitive income is to changes in sales
(measured in %).
High operating leverage → small percentage change in
sales can cause a large percentage change in income.
Degree of Operating Leverage (DOL)
Contribution Margin
=
Operating Income

% Increase in OI = DOL  % Increase in Sales

 Calculation of the
Predetermined Overhead Rate

▪ Calculating the predetermined manufacturing overhead rate

Predetermined Manufacturing Estimated Overhead Cost
=
Overhead Rate Estimated Application Base

▪ Using the predetermine manufacturing overhead rate

Applied Manufacturing Overhead = Predetermined Rate x Actual Application Base

Basic Production Cost Flows
Product Cost Flows – Part 1
Raw material purchases made during the period are added to
beginning raw materials inventory. The ending raw materials inventory
is deducted to arrive at the raw materials used in production.

As items are removed from raw materials inventory and placed into
the production process, they are called direct materials.
Product Cost Flows – Part 2
Direct labor used in production and manufacturing
overhead applied to production are added to direct
materials to arrive at total manufacturing costs.
Product Cost Flows – Part 3
Total manufacturing costs are added to the
beginning work in process to arrive at total work in
process.
Product Cost Flows – Part 4
The ending work in process inventory is deducted
from the total work in process for the period to
arrive at the cost of goods manufactured.
Product Cost Flows – Part 5
The cost of goods manufactured is added to the beginning finished goods
inventory to arrive at cost of goods available for sale. The ending finished
goods inventory is deducted from this figure to arrive at cost of goods sold.
The Product Cost Report summarizes all the
steps in the total cost allocation process

• Summary of units in process

• Equivalent units in process
• Total costs to be accounted for and cost per
equivalent unit
• Accounting for total cost
 Overview of Variable and Absorption
Costing

Variable Absorption
Costing Costing
Direct Materials
Product
Direct Labor Product
Costs
Variable Manufacturing Overhead Costs
Fixed Manufacturing Overhead
Period Variable Selling and Administrative Expenses Period
Costs
Fixed Selling and Administrative Expenses Costs
Comparative Effects of Absorption
and Variable Costing

Variable costing Net Income +

increase (or minus decrease) in inventoried fixed manufacturing
overhead
=
Absorption Net Income
ABC Product Costing Model

Two–stage product cost model

1. Assign overhead resource costs to activity cost pools for key overhead activities

▪ Determine cost driver

▪ Calculate predetermined rate

▪ Predetermined rate = Cost pool / Cost driver activity level

2. Assign cost pools to cost objects

▪ Assigned cost = Predetermined rate x Quantity of cost driver used by the cost object
ABC Product Costing Model
Operationalizing the two-stage model requires the
following:
Most CRITICAL
1. Identifying activities Step
2. Assigning cost to activities
3. Determining the basis (activity cost driver) for
assigning the cost of activities to cost objectives.
4. Determining the cost per unit of activity
5. Reassigning costs from the activity to the cost
objective on the basis of the cost objective’s volume of
consumption of activities
 Determining Standard Costs
Development of standard cost per unit of product for all variable inputs requires
6 components:

1. Direct material standard price (SP)

2. Direct material standard quantity (SQ)
3. Direct labor standard rate (SR)
4. Direct labor standard time allowed (SH)
5. Standard variable overhead rate
6. Variable overhead standard capacity

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A General Model for Variance Analysis
(2)
(1) Standard Cost of Actual (3)
Actual Cost: Inputs: Flexible Budget Cost:
Actual Quantity Actual Quantity Standard Quantity
of Input, of Input, Allowed for Actual Output,
at Actual Price at Standard Price at Standard Price
(AQ × AP) (AQ × SP) (SQ × SP)

Price Variance Efficiency Variance

(2) – (1) (3) – (2)

Total flexible Budget Variance

(3) – (1)
Variance Analysis - summary

• Materials price variance = AQ*(AP – SP)

• Materials efficiency variance = SP*(AQ – SQ)
• Labor rate variance = AH*(AR – SR)
• Labor efficiency variance = SR*(AH – SH)
• Variable overhead spending variance = Actual costs – (SR x AH),
assuming labor hours are used as the standard for overhead
• Variable overhead efficiency variance = SR*(AH - SH), assuming
labor hours are used as the standard for overhead
Revenue Center Variances
Three variances for revenue centers:
Revenue Actual × Actual Budgeted Budgeted
–
Variance = volume price volume × price

Sales Price Variance

Broken Actual Budgeted Actual
= selling – selling × sales
into two price price volume
variances
Sales Volume Variance
Actual Budgeted Budgeted
= sales – sales × selling
volume volume price
 Net Sales Volume Variances

Indicates the impact for a change in sales volume on the contribution margin
given the budgeted selling price and the standard variable cost.

Budgeted
Actual Budgeted
= volume – volume × contribution
margin

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 Inventory Turnover
As applied to a specific item of raw materials or finished goods:

Annual demand in units

Inventory turnover =
Average inventory in units

Higher turnover is better.

 Inventory Turnover

▪ When stated in dollars

▪ Can be used as a measure of an organization’s overall success in reducing inventory
or in increasing sales in relation to inventories

Cost of goods sold

Inventory turnover =
Average inventory in dollars

Higher turnover is better.

Profitability analysis

Operating profit margin

Operating Income
Sales
Return on assets
Operating Income
ROA= X Asset turnover
Average assets
Sales
Average assets

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 ROI
Investment center income
ROI =
Investment center asset base

ROI = Investment turnover x Return-on-sales

Sales Investment center income

= x
Investment center asset base Sales
 Other measures of performance
Residual Income:

Division income – Minimum rate × Investment center

of return asset base

Division
EVA = income after – Cost of Current
capital x Assets – Liabilities
taxes