Topic 1: Cost Classification and Cost Volume Profit (CVP) Operating Leverage (OL): measures how sensitive NOI

Operating Leverage (OL): measures how sensitive NOI is to percentage changes in sales. It is a measure, at any given
Product or Period cost? If product, direct or indirect? level of sales, of how a percentage change in sales will affect percentage change in profits
Period Cost: non-product costs; expensed in period Operating Leverage = CM / NOI
incurred. Includes SG&A, marketing/ads, admin svcs High OL results in greater CM relative to NOI -> high FC -> more exposure to volatility in earnings -> will earn more as
Product Cost: traced or assigned to products sales increase but have potential to lose more if there is a decrease in sales.
- Direct Costs: traced to products/cost objects (DM/DL) OL * % Change in sales = Change in NOI
- Indirect costs: assigned to products/cost objects Sales Mix: relative proportion in which a company’s products are sold. Different products have different selling prices,
(indirect materials/labor, overhead) cost structures, and contribution margins.
Examples: If you find the BEP in $ for a multi-segment company, you can find the associated BEP for each division by multiplying
R&D for new iPhone - Period the total company BEP $ by the % of the company a given segment is responsible for.
Utilities for HQ - Period Mixed Cost: contains both variable and fixed elements. Ex: Utility costs include a fixed monthly cost plus usage cost
Cost of iPhone display - Direct Product To solve for the variable cost per unit given a data table, use the High-Low Method.
Advertising for new iPhone - Period 1. Select Highest and Lowest Activity levels.
Apple store hourly wages - Period 2. VC = (Highest – Lowest Cost) / (Highest – Lowest Units (x)).
Cost of glue to make phone - Indirect Product 3. Plug in the VC you found into one of the points to find TFC
Cost Classification on basis of Cost Behavior: 4. Total Fixed Cost = Total Cost – Total VC
Fixed Cost – unchanged as cost driver changes in relevant range 5. TFC = TC – (VC * Units(x))
Variable costs – change in direct proportion to cost driver 6. Cost Equation: Cost = TFC + VC*(x)
Mixed Costs – fixed cost and variable cost component Alternate Method: Use Linear Regression to find Cost Equation
Relevant range - range of activity over which total FC and per unit VC doesn’t change Topic 2: Differential Analysis
Difference in Product costs under Variable and Absorption Costing arises due to the way FMOH is expensed. Differential cost / revenue: a future cost / benefit that differs between any two alternatives
Absorption vs Variable Costing: Incremental / Avoidable Cost: increase or avoidable cost between two alternatives.
- Absorption: Fixed manufacturing costs must be assigned to products to properly match revenues and costs. Following should not be considered in decision making:
- Variable: Fixed manufacturing costs are capacity costs and will be incurred even if nothing is produced. Sunk Cost: cost that has already been incurred and cannot be changed
Effects on Net Operating Income (NOI): Future Cost and Benefits that do not differ between alternatives
- Absorption: Absorption costing income is influenced by changes in unit sales and units of production. Net operating Opportunity costs DO need to be considered.
income can be increased simply by producing more units even if those units are not sold. Adding/Dropping Segments: Only do it if profit will increase
- Variable: Variable costing income is only affected by changes in unit sales. It is not affected by the number of units CM Approach – Consider loss in CM and gain from reducing costs to calculate whether decision is profitable or not
produced. As a general rule, when sales go up, net operating income goes up, and vice versa. Fixed Cost Value should still be calculated to full capacity. Compare CM lost by dropping segment vs. fixed expenses
Calculate Net Operating Income (NOI) using Variable & Absorption Costing: saved by dropping the segment.
Variable Costing NOI Calculation Make or Buy Decision: Do not consider irrelevant costs such as depreciation or fixed overhead. Don’t consider SG&A.
(aka what we learned in previous ACCT classes): USE THIS TABLE for Avoidable fixed costs (full value) need to be added to the make section. Only do the AVOIDABLE ones though.
Revenue answering problems Relevant Cost of Buying = Variable Cost Saved + Additional Benefit
- Variable COGS and SG&A Expense about differences in Relevant Cost of Making = Costs for making (aka production costs) that can be avoided by buying instead
= Contribution Margin (CM) production/sales, Special Order Decisions: Only incremental costs and benefits are relevant. If existing FC don’t change, they are not
- FMOH (total) inventory, and NOI relevant. Incremental Revenue - Incremental Cost, if it’s positive, take the order.
- Fixed SG&A under variable vs If there are simultaneous increases/decreases, use the total number of customers to calculate variable cost.
= NOI absorption costing Minimum Selling Price for special order is = DM + DL + VMOH + V.Sales. Do NOT include FMOH.
Absorption Costing NOI Calculation Volume Trade-Offs: When there is a constrained resource like wood for chairs or tables, or time on a production
(new method from current ACCT class): machine, this resource restricts the company from meeting customer demand. You have to pick the most profitable
Revenue item to maximize volume and then “spend” the rest of the resource on the other thing your company produces.
- COGS (which is Units Sold x (normal Variable Cost/unit + (FMOH/Units Produced)) 7. Calculate how much of the constrained unit is required per product
= Gross Margin 8. Calculate CM per product
- SG&A Expenses (Fixed & Variable) 9. Calculate CM per unit of constrained resource (CM per product / constrained units per product)
= NOI 10. Determine which product makes more CM per product, then maximize how much volume you can produce
For problems where they give you some info about NOI, production level, per-unit costs, and/or a cost accounting 11. Calculate how much volume of the constrained resource is left to make the other product
method, look for what they gave you and what you need to find. Then reference the table above to determine which 12. If you’re asked how much you’re willing to pay for additional product, it’s CM per constrained unit from Step 3
of the 3 scenarios you’re in. Then remember that the only difference should be due to FMOH. Calculate accordingly. Sell or Process Further: Ignore joint costs, irrelevant. If Incremental Revenue > Incremental Cost, process further.
CVP Analysis – hinges on Contribution Margin and Break-Even Point (BEP) Analysis Topic 3: Master Budgeting – recommend pasting your favorite budget examples on the other side of this sheet
Contribution Margin (CM) is the amount remaining from revenue after variable expenses have been deducted – Order of Budget Development for analysis: Sales, Production/Inventory, Materials and Cash for Materials, Labor,
basically how much does this order/product/customer “contribute” to covering our fixed costs? MOH, S&A, Cash
CM Ratio or CM% = CM / Sales Revenue Sales Budget is typically provided in the question.
BEP Analysis: find where CM = Fixed Costs Production/Inventory: Required Production = Budgeted Sales + Desired Ending Inventory – Beginning Inventory
# units for BEP = FC / CM per unit Materials: Materials to purchase = Production*Materials per unit + Desired Ending Inventory – Beginning Inventory
Sales $ needed for BEP = FC/CM Ratio Direct Labor (DL): Units of Production*DL per unit = DL Hours Required * Hourly Wage Rate = DL Cost
Profits using CM & BEP = Units sold above BEP x CM per unit MOH: Total MOH Cost = Budgeted DL hours*Variable MOH rate + Fixed MOH (note MOH per hr for unit product cost)
For profit impact questions due to changes in costs/sales/price: make full income statement for before/after change Unit Product Cost = DM + DL + VMOH (all per unit). This is used to determine COGS on budgeted income statement
Target Profit Analysis (remember you can rearrange the terms in these equations to isolate the variable of interest): S&A: Budgeted Sales * Variable S&A + Fixed S&A – noncash expenses = Cash S&A Expenses
Profit = Unit CM x Quantity (x) – FC Cash: Beg Cash + Cash Collections – Cash Disbursements (from all the other budgets) + Financing = Ending Cash
Unit Sales to attain Target Profit = (Target Profit + FC) / CM per Unit Finished Goods: Opening Stock + Purchased/Produced = Closing Stock + Sales
$ Sales = (Target Profit + FC) / CM Ratio Raw Materials: Opening Stock + Purchases = Closing stock + Produced
Margin of Safety (MOS) is the amount by which sales can drop before losses are incurred.
MOS = Total Sales – Break Even Sales ; BEP sales = FC/CM per unit; CM per Unit = (Sales – VC) / Units Produced