BEC 2 Planning Techniques

Question 1

Cost-volume-Profit (CVP) Analysis for decision making.

Breakeven analysis

Answer 1

• Used by mangers to forecast profits at different levels of sales and production volume.
• The point at which revenues equal total costs is termed the breakeven point.
• CVP analysis = breakeven analysis

Question 2

Cost-volume-Profit (CVP) Analysis.

Assumptions

Answer 2

1. General assumptions
   - all costs can be separated into variable or fixed costs
   - volume relevant factor affecting cost
   - all costs behave in a linear fashion in relation to production volume
   - cost behaviors are anticipated to remain constant over the relevant range of production volume because there is an assumption that the efficiency of production does not change
   - costs show greater variability over time
2. Use of single product
3. Contribution approach (direct costing) us used rather than absorption approach
4. Selling prices remain unchanged

Question 3

Contribution approach

Answer 3

Contribution approach - uses variable costing, useful in internal decision making
a. Equation 
Revenue 
Less variable costs
Contribution margin
Less fixed costs
Net income
b. Presentation 
- total or per unit
- unit contribution margin  - unit sales price minus the unit variable cost 
- contribution margin ratio

Question 4

Absorption approach

Answer 4

Absorption approach
a. Equation
Revenue
Less COGS
Gross margin
Less: Operating expenses
Net income

Question 5

Contribution approach vs Absorption approach

Fixed factory overhead

Answer 5

1. Treatment of fixed factory overhead
   a. Absorption - Product cost
   all fixed factory overhead is treated as a product cost and is included in inventory values. COGS includes both fixed and variable costs.
   b.Contribution - Period cost
   all fixed factory overhead is treated as a period cost and is expensed in the period incurred. Inventory values include only the variable manufacturing costs, so COGS includes only variable manufacturing costs.

Question 6

Contribution approach vs Absorption approach

Selling, general and admin expenses

Answer 6

Treatment of selling, general, and administrative expenses- period costs for both methods

1. Absorption - both variable and fixed selling, general, and admin exp are operating expenses
2. Contribution - the variable selling, general and admin exp are part of the total variable costs

Question 7

Absorption costing

Answer 7

Product costs:
Direct materials
Direct labor
Variable manufacturing overhead
Fixed manufacturing overhead
Period costs:
Variable and fixed selling, general, and admin exp

Question 8

Absorption method

Answer 8

Sales
Less: Cost of goods sold
Gross margin
Less: Fixed selling and variable admin exp
Operating income

Question 9

Variable costing

Answer 9

Product costs:
Direct materials
Direct labor
Variable manufacturing overhead
Period costs:
Fixed manufacturing overhead
Variable and fixed selling, general, and admin exp

Question 10

Contribution margin

Answer 10

Sales
Less: Variable COGS
Less Variable selling and admin exp
Contribution margin 
Less: Fixed exp
Fixed manufacturing overhead
Fixed selling and admin exp
Operating income

Question 11

Effect on income

Answer 11

1. Production greater than sales.
   If units produced exceed units sold, then some units are added to ending inventory and income is higher under absorption costing than under variable costing.
2. Sales greater than production.
   If units sold exceed units produced, then ending inventory is less than beginning inventory and income is lower under absorption costing than under variable costing.

Question 12

Benefits and limitations of

Absorption costing

Answer 12

Absorption GAAP Costing

a. Benefits
- it is GAAP
- the IRS requires it
b. Limitations
- the level of inventory affects net income because fixed costs are component of product cost.
- the net income reported under the absorption method is less reliable than under the variable method because the cost of the product includes fixed costs and the level of inventory affects net income

Question 13

Benefits and limitations of variable costing

Answer 13

Variable costing

a. Benefits
- variable and fixed costs are separated and can be easily traced to and controlled by management
- NI reported under the contribution income statement is more reliable than under the absorption method because the cost of the product does not include fixed costs, and level of inventory does not affect net income
- variable costing isolates the contribution margins in financial statements to aid in decision making
b. Limitations
- not GAAP
- the IRS does not allow to use it for financial reporting

Question 14

Breakeven computation

Answer 14

determines the sales required to achieve zero profit or loss from operations. After breakeven has been achieved, each additional unit sold will increase net income by the amount of the contribution margin per unit.
Total fixed costs / Contribution margin per unit = Breakeven point in units

Question 15

Sales dollars

Answer 15

There are two approaches to computing breakeven in sales dollars

1. Contribution margin per unit: Unit price x Breakeven point in units = Breakeven point in dollars
2. Contribution margin ratio: Total fixed costs / Contribution margin ratio = Breakeven point in dollars

Question 16

Required sales volume for Target Profit

Answer 16

Breakeven analysis can be extended to calculate the required sales dollars or unit sales required to produce a target profit.
Sales = Variable costs + (Fixed costs + Net income before taxes)
OR
Sales = (Fixed cost + Profit) / Contribution margin ratio

Question 17

Tax considerations

Answer 17

1. Target profit before tax:
   Target profit before tax = Target profit after tax + Tax (or 1-tax rate)

2.The breakeven point in sales:
Sales = Variable costs + Fixed costs + Target profit before taxes

Question 18

Contribution margin per unit

Answer 18

Selling price per unit - Variable costs per unit

Question 19

Margin of safety concepts

Answer 19

The margin of safety is the excess of sales over breakeven sales and is expressed in $ or %
1. Sales $
Total sales $ - Breakeven sales $ = Margin of safety $

2. Sales %
   Margin of safety $ / Total sales = Margin of safety %

Question 20

Target costing

Answer 20

It is a technique used to establish the product cost allowed to ensure both profitability per unit and total sales volume.
1. Cost determination - the concept of target costing requires the selling price of the product to determine the production costs to be allowed.
a. Market circumstances creating target costing - as competition sets prices, any change in price could easily cause a customer defection.
b. Target cost computation
Target cost = Market price - Required profit

Question 21

Implications of Target Costing

Answer 21

If management commits to a target cost, serious measures must be employed to reduce costs.

1. Compromised quality
2. Increased marketing and downstream costs
3. Increased complexity in cost measurement
4. Product redesign

Question 22

Operational Decision Analysis

Answer 22

Marginal analysis is used when analyzing business decisions. Focuses on the relevant revenues and costs that are associated with a decision.

1. Relevant revenues and costs
2. irrelevant costs
3. Incremental costs
4. Sunk costs
5. Opportunity costs
6. Controllable costs
7. marginal costs

Question 23

Special order decisions

Answer 23

Opportunities that require a firm to decide if a specially priced order should be accepted or rejected.
1. Capacity issues
a. Excess Capacity
Selling price > Variable cost per unit
b. Presumed Full Capacity
Selling Price > Variable cost per unit + Opportunity cost

Question 24

Special order decisions - Strategic Factors

Answer 24

1. The effect on regular priced sales and other long term pricing issues.
2. The possibility of future sales to this customer
3. The possibility of exceeding plant capacity or the complexities of the order itself.
4. The pricing of the special order
5. The impact of income taxes
6. The effect on machinery and/or the scheduled machine maintenance program.

Question 25

Make vs Buy

Answer 25

A. Determining relevant costs and other make or buy issues 1. Capacity issues a. Excess capacity b. No excess capacity (full)

Question 26

Make vs Buy | Strategic Factors

Answer 26

1. The quality of the product purchased compared to the quality of the product manufactured. 2. The reliability of the purchased product 3. The value of service contracts or other warranties. 4. The risks associated with outsourcing or buying outside the organization 5. The most efficient use of the entity's resources.

Question 27

Sell or process further

Answer 27

1. Joint costs - the costs of a single process that yields multiple products. Sunk costs not relevant to decisions of whether to sell or process further. 2. Separable costs - incurred after the split off point and traced to the individual product, relevant cost. 3. Deciding factors to sell or process further - comparing the incremental cost and the incremental revenue generated after the split off point.

Question 28

Keep or drop a segment (product line)

Answer 28

1. Classification of costs - the fixed costs associated with the segment must be identified as either avoidable (relevant) or unavoidable even if the segment is discontinued. 2. Decision factors - a firm should compare the fixed costs that can be avoided if the segment is dropped to the contribution margin that will be lost if the segment is dropped. 1. Keep the segment if the lost contribution margin exceeds avoidable fixed costs. 2. Drop the segment if the lost contribution margin is less than avoided fixed costs.

Question 29

Keep or drop a segment (product line)

Answer 29

1. Classification of costs - the fixed costs associated with the segment must be identified as either avoidable (relevant) or unavoidable even if the segment is discontinued. 2. Decision factors - a firm should compare the fixed costs that can be avoided if the segment is dropped to the contribution margin that will be lost if the segment is dropped. 1. Keep the segment if the lost contribution margin exceeds avoidable fixed costs. 2. Drop the segment if the lost contribution margin is less than avoided fixed costs.

Question 30

Keep or drop a segment | Strategic factors

Answer 30

1. The complementary character of products and their relationship to the sales of other products. Manufactures might produce and price certain products as loss leaders to promote sales of more profitable products. 2. The impact of product addition or deletion on employee morale. 3. The growth potential of each product regardless of individual profitability 4. opportunity costs associated with available capacity

Question 31

Regresson analysis

Answer 31

A method for studying the relationship between two or more variables. One use of linear regression is to predict the value of a dependent variable corresponding to given values of the independent variables.

Question 32

Simple linear regression model

Answer 32

- Explains variation in a dependent variable as a linear function of one or more independent variables. - Simple regression involves only one independent variable - multiple regressions involve more than one independent variable

Question 33

Components of the simple linear regression model

Answer 33

``` y = A + Bx y - dependent variable x - independent variable A - y-intercept B - the slope of the regression line ```

Question 34

The coefficient of correlation (r)

Answer 34

the coefficient of correlation measures the strength of the linear relationship between the independent variable (x) and the dependent variable (y). In standard notation, the coefficient of correlation is "r" - 1.0 perfect inverse relationship 0 no relationship +1.0 perfect direct relationship

Question 35

The coefficient of determination R2

Answer 35

The coefficient of determination R2 is the proportion of the total variation in the dependent variable (y) explained by the independent variable (x). Its value lies between 0 and 1. The higher the R2, the greater the proportion of the total variation in y that is explained by the variation in x. That is, the higher the R2, the better the fit of the regression line.

Question 36

High low method

Answer 36

a simple technique used to estimate the fixed and variable portions of cost 1. Gather data 2. Analyze data 3. Formulate results

Question 37

High low method | Flexible budget formula

Answer 37

The result of the high low method is called: - a total cost formula and - a flexible budget formula 1. Flexible budget - a series of budgets that are prepared for a range of activity levels rather than a single activity 2. Formula - defines costs as equal to the fixed costs plus the variable costs per unit times the units. Total cost = Fixed cost + (Variable cost per unit + Number of units)

Question 38

Relevant costs for decision making

Answer 38

1. Incremental cost 2. Avoidable cost 3. Opportunity cost

Question 39

The relevance of a particular cost to a decision is NOT determined by:

Answer 39

1. Riskiness of the decision 2. Number of decision variables 3. Accuracy of the cost

Question 40

The margin of safety

Answer 40

the difference between current sales and breakeven sales. Breakeven sales = Fixed cost/Contribution margin ratio The margin of safety = Sales - Breakeven sales

Question 41

Variable and absorption costing - current ratio

Answer 41

Variable costing - fixed manufacturing overhead is treated as a period cost and expensed. Absorption costing - a product cost and is inventoried. Much higher inventory, current ratio higher

Question 42

Variable vs absorption costing | Absorption produces greater income than variable costing as inventory levels increase

Answer 42

The difference between variable and absorption costing is the manner in which fixed manufacturing costs are treated. Variable costing - only variable costs are included in inventory, fixed costs expensed Absorption costing - fixed costs included

Question 43

Breakeven calculation Variable cost 25% of sales Fixed cost $30,000

Answer 43

``` Sales = Fixed cost / Contribution Margin Ratio Sales = $30,000 / (1-.25) Sales = $40,000 ```

Question 44

Absorption vs variable costing Production exceeds sales OR Sales exceed production

Answer 44

When production exceeds sales, inventory increases and net income under absorption costing benefits from fixed man overhead that is recorded in inventory instead of recognition in COGS. Variable costing bears the full cost of all fixed costs and is less when inventory increases. When sales exceeds production, inventory fall, net income under absorption costing is reduced by COGS that includes fixed man overhead from prior periods that had been recorded in inventory.

Question 45

Regression analysis

Answer 45

- Can be used to separate costs into fixed and variable components by means of least squares. - a regression equation is a statistical model that estimates the dependent variables based on changes in the independent variable

Question 46

Learning curve analysis

Answer 46

used to determine increases in efficiency or production as experience is gained. Both products have long production runs, making learning curve analysis the nest method for estimating the cost of the competitive bid.

Question 47

Learning curve

Answer 47

Operating efficiency and/or production increases in repetitive tasks as experience is gained. The rate of improvement, measured by the learning curve, has a regular pattern, that can be stated: As cumulative quantities double, average cost per unit decreases by a specified percent of the previous cost. Cumulative units # 1 - ave time per unit 50h Cumulative units # 2 - ave time per unit 40h Cumulative units # 4 - ave time per unit 32h

Question 48

The regression analysis Formula y=90x+45 Production 100 units

Answer 48

``` The total cost formula is the formula for a line where total cost, the dependent variable (y) is equal to volume times the independent variable, variable costs (x) plus a constant (fixed costs) y= total cost x = volume y =(90x100)+45 y=9045 ```