Managerial Accounting Test 2 Study Guide PDF

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Managerial Accounting Exam 2 Study Guide. Includes Chapters 5, 6, and 6 Appendix A. Has chapter summaries, class notes, and examples. Will help you pass!...

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MANAGERIAL ACCOUNTING TEST 2 STUDY GUIDE CHAPTER 5 – COST-VOLUME-PROFIT RELATIONSHIPS: Applications of CVP analysis:  To examine the trade-offs between:  Selling Price  Sales Volume  Unit Variable Costs  Total Fixed Costs o To find the most profitable combination of these components Basics of CVP analysis:  CVP Assumptions: o Revenue is linear in relevant range (SP per unit is constant) o Costs are linear in relevant range and can be accurately divided into VC and FC elements o VC varies in total, but is constant per unit o FC is constant in total, but as activity increases, the FC/unit decreases o For multiproduct companies, sales mix is constant o Inventory levels do not change (#produced = #sold) 

Contribution Margin: amount available to cover fixed expenses and provide profit o As seen On the Contribution Format Income Statement: Sales -VE CM -FE NOI

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Total $450,000 180,000 270,000 216,000 54,000

Per Unit $30 12 $18

% 100% 40% 60%

= Constant Contribution Margin Ratio: CM expressed as a percent of sales = CM/Sales Break-Even Point: o Sales level (in units or dollars) at which net income equals zero  When sales = total expenses  When contribution margin = fixed expenses o BE point in units = FE CM per unit o BE point in sales $ = FE CM ratio o Once the BE point has been reached, net operating income will increase by the amount of the unit CM for each additional unit sold o At BE point, CM would exactly cover costs, NOI = 0

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This chapter is heavy on examples/application --- really look over some

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CVP Graph:

o  Blue line = total expense Target Profit Analysis:  This answers the question at what sales level (in units or dollars) will the company attain a certain profit level?  Target Profit sales level in unit sales = (FE + target profit) CM per unit  Target Profit sales level in $ sales = (FE + target profit) CM ratio Margin of Safety:    

The amount by which sales can drop before losses are incurred Computed at a particular activity level MoS = Actual (or budgeted) Sales – BE Sales MoS expressed as a percentage o MoS % = MoS in dollars/ Actual (or budgeted) sales in dollars o This makes our calculation more relative to where we are. 20% tells us more about our MoS from an overall perspective than $90,000

Degree of Operating Leverage:  How much impact do our fixed costs have? Our fixed cost is our shovel to move the boulder.  Cost structure is the proportion of variable and fixed costs present in a company  DOL measures extent to which fixed costs are being used by a company  Higher the fixed costs, higher the DOL (greater risk, greater potential return)  It is a multiplier that explains, “if sales increase X %, net income will increase (DOL * X)% o To get the % change in NOI, you multiply the DOL times percent change in sales  

Measured at a particular sales level Is greatest near the BE point and decreases as sales increase o FE has less of an effect

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To calculate: o DOL = Contribution Margin Net Operating Income

Sales Mix:  Proportion of total sales coming from each product (Relative combination of products sold)  What mix of products should be sold to maximize profit?  Higher CM products will contribute more to profit than low CM products  For a multiproduct company, sales mix is assumed to be constant  Best shown with an example:  Contribution Income Statement: Claimjumper % Makeover % Total % Sales $30,000 100% $70,000 100% $100,000 100% -VE 20,000 66.7% 50,000 71.4% 70,000 70% CM $10,000 33.3% $20,000 28.6% 30,000 30%  Overall CM Ratio -FE 24,000 NOI $6,000 o Sales Mix = 30/70 (Claimjumper/Makeover) 

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= Constant data  30,000/100,000 = 30  70,000/100,000 = 70 BE analysis with sales mix: o Using info above, BE point = FE/overall CMR = $24,000/30% = $80,000 

Of the $80,000, $24,000 (80,000 x 30%) is in regard to Claimjumper and $56,000 (80,000 x 70%) for Makeover

o If sales mix changes, the BE point is not the same. Sales mix must stay constant. A change in the sales mix will result in a loss of the sales mix shifted toward the less profitable product and vice versa. CHAPTER 6 - VARIABLE COSTING AND SEGMENT REPORTING: TOOLS FOR MANAGEMENT: Overview of Variable and Absorption Costing:  Variable Costing: o Classifies costs by behavior o Not GAAP or IRS approved o Uses the Contribution Income Statement o Sometimes referred to as direct costing or marginal costing o Cost Categories:      

DM – Product Cost DL – Product Cost VMOH – Product Cost FMOH – Period Cost VS&A – Period Cost FS&A – Period Cost

o To get the unit PRODUCT cost: 

DM + DL + VMOH  Unit product cost will always be less in variable costing than in absorption costing. This difference is due to FMOH. o To get the VC:  (Unit Product cost (COGS) + VS&A) * Units sold o To get the FC:  FMOH + FS&A o What costs make up the ending inventory? 

 The DM, DL, and VMOH for each product in ending inventory Absorption Costing: o Classifies costs by function o GAAP and IRS approved o Uses the Traditional Income Statement o Sometimes referred to as the full cost method o Cost Categories:  DM – Product Cost  DL – Product Cost  VMOH – Product Cost  FMOH – Product Cost  VS&A – Period Cost  FS&A – Period Cost o In this Costing Method, FMOH attaches to the Product, you see part of it in COGS and the rest in Ending Inventory o To get the unit PRODUCT cost: 

DM + DL + VMOH + FMOH  FMOH = total MOH/units produced

o COGS:  Unit Product cost * unit produced o S&A Expense:  (VS&A * units sold) + FS&A o What costs make up the ending inventory? 

 DM, DL, VMOH, and the FMOH assigned to each unit Comparing Variable and Absorption Costing: o When production = sales, inventory doesn’t change, absorption NI = variable NI o When production > sales, inventory increases, absorption NI > variable NI o When production < sales, inventory decreases, absorption NI < variable NI

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Reconciliation of Variable Costing with Absorption Costing

Variable NOI … Add/deduct FMOH deferred in/released from inventory under absorption costing … Absorption NOI o What you add or deduct: change in units of inventory * FMOH/unit

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 If inventory increases, you add the deferred inventory  If inventory decreases, you subtract (deduct) the deferred inventory Variable Costing and the Contribution Approach: o An advantage – it enables CVP Analysis o When production increases AND sales remain constant, unit product cost does NOT change, and net income does NOT change  All other things the same, when sales go up, NOI goes up o Variable costing correctly identifies the additional variable costs that will be incurred to

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make one more unit. Absorption Costing and the Traditional Income Statement o We attach a certain amount of FMOH to each product o When production increases AND sales remain constant, unit product cost decreases and net income increases  Unit product cost goes down, FMOH is spread across more products  FMOH per unit changes if you change FMOH or number of units produced  GM and NI increase because COGS is less. A lot of FMOH is in ending inventory  In the in-class example (pg. 3 of packet), we sold the same amount but nearly doubled profit  This is what outsiders see o By attaching FMOH to units, unit product cost is not constant. A change in production results in a change in unit product costs o Window dressing = producing more to manipulate income  Investors can see this because ending inventory would be unusually large o BE point is only true if inventory levels don’t change

Look through exercises for examples APPENDIX A – PRICING PRODUCTS AND SERVICES  Cost plus pricing: charge cost + extra o Price = cost base + extra 

 Extra = Mark Up % x cost Economists Approach to Cost Plus Pricing: o Works off the premise that if there is an increase (or decrease) in price, there will be a decrease (or increase) in volume o How sensitive is the change in volume to a change in price?

o Cost base = DM + DL + VMOH + VS&A o Step 1: Elasticity of Demand will be given; you do not need to calculate 

The products we are looking at have inverse price volume relationships. This means that the Elasticity of Demand will be negative. (price up = volume down; price down = volume up)  The higher the number (absolute value; ignore negative), the higher elasticity of demand  A higher elasticity of demand = more sensitive customers are to change in price  If demand is inelastic, price can be changes with little change in volume  If demand is elastic, change in price will result in significant change in volume. o Step 2: determine the profit maximizing price 

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Profit maximizing price = VC/u + [MU% x VC/u]  MU % = -1 . 1 + Ed  [MU % + VC/U] = Dollar Mark Up Absorption Costing Approach to Cost Plus Pricing: o Step 1: Calculate absorption unit cost  

Absorption costing uses a different cost base To calculate unit product cost = DM + DL + VMOH + FMOH  FMOH = total FMOH/units produced o Step 2: Determine the Markup % 

Markup % = (required ROI x investment) + S&A exp Unit product cost x unit sales  Can also be seen as $MU/Unit Product Cost If: then: MU $ MU Target SP % req ROI Increases Incr. Incr. Incr. Investment increases Incr. Incr. Incr. SGA Exp increases Incr. Incr. Incr. Unit sales increases Decr. Decr. Decr. Unit cost increases Decr. No change Incr.

o Step 3: Determine Price(determine target selling price(this isn’t profit maximizing price))  

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This price is the price to give you the profit I desire Target S.P. = unit product cost + (MU% x unit product cost)  MU% x unit product cost = Dollar Marginal Utility Target Costing Approach:

o Works on premise that price is known and must manufacture a product that will have a cost low enough to provide necessary profit. o What is the maximum cost to have necessary profit? Sales -Expenses Desired Profit o Expenses = total expenses; this is the target cost to produce AND sell the product, which means it’s all production and manufacturing costs. (all 6 cost categories) o Sales = selling price per unit * # of units expected to be sold. o Desired profit = minimum ROI * Investment  You want to get at least this much of your investment back annually o Target Cost = total cost to produce and sell the product o Target manufacturing cost = total cost to PRODUCE the product o Example: Sales -Costs NI    

Total 4,500,000 3,900,000

unit 15 13

$600,000 2 Start with putting in the total NI and unit cost Then for how many units you are producing and selling, see what you need the unit NI to be Then you can calculate the total target cost per unit and the total target cost in total If you’re given the S&A cost, you can subtract for the target manufacturing cost...