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Ch03 - CHAPTER 3 COST-VOLUME-PROFIT ANALYSIS 3-1...

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CHAPTER 3 COST-VOLUME-PROFIT ANALYSIS 3-1 Cost-volume-profit (CVP) analysis examines the behavior of total revenues, total costs, and operating income as changes occur in the output level, selling price, variable costs per unit, and/or fixed costs of a product. 3-2 The assumptions underlying the CVP analysis outlined in Chapter 3 are: 1. Changes in the level of revenues and costs arise only because of changes in the number of product (or service) units produced and sold. 2. Total costs can be separated into a fixed component that does not vary with the output level and a component that is variable with respect to the output level. 3. When represented graphically, the behavior of total revenues and total costs are linear (represented as a straight line) in relation to output units within a per unit relevant range and time period. 4. The selling price, variable cost per unit, and fixed costs are known and constant. 5. The analysis either covers a single product or assumes that the sales mix, when multiple products are sold, will remain constant as the level of total units sold changes. 6. All revenues and costs can be added and compared without taking into account the time value of money. 3.3 Operating income is total revenues from operations for the accounting period minus cost of goods sold and operating costs (excluding income taxes): Operating income = Total revenues from operations – Net income is operating income plus nonoperating revenues (such as interest revenue) minus nonoperating costs (such as interest cost) minus income taxes. Chapter 3 assumes nonoperating revenues and nonoperating costs are zero. Thus, Chapter 3 computes net income as: Net income = Operating income – Income taxes 3-4 Contribution margin is the difference between total revenues and total variable costs. Contribution margin per unit is the difference between selling price and variable cost per unit. Contribution-margin percentage is the contribution margin per unit divided by selling price. 3-5 Three methods to express CVP relationships are the equation method, the contribution margin method, and the graph method. The first two methods are most useful for analyzing operating income at a few specific levels of sales. The graph method is useful for visualizing the effect of sales on operating income over a wide range of quantities sold. 3-6 Breakeven analysis denotes the study of the breakeven point, which is often only an incidental part of the relationship between cost, volume, and profit. Cost-volume-profit relationship is a more comprehensive term than breakeven analysis. 3-1

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3-7 CVP certainly is simple, with its assumption of output as the only revenue and cost driver, and linear revenue and cost relationships. Whether these assumptions make it simplistic depends on the decision context. In some cases, these assumptions may be sufficiently accurate for CVP to provide useful insights. The examples in Chapter 3 (the software package context in
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