CHAPTER 5 COST - CHAPTER 5 COST-VOLUME-PROFIT...

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CHAPTER 5 COST-VOLUME-PROFIT RELATIONSHIPS (CVP) 1. CONTRIBUTION MARGIN(internal)—sales revenue – variable expenses a. Amount available to cover fixed expense then provide profits for period b. Increase in VE >> Decrease in CM c. (Sales- variable expenses=CM) – fixed expenses = net operating income d. CM RATIO = CM / SALES i. Each dollar increase, Total CM (and net operating income) will increase by (%) in cents/$ ii. Change in contribution margin (impact on net income) = CM ratio x change in sales 2. CVP ANALYSIS a. Help managers make decisions—what products/services to offer, what prices, what marketing strategy, what cost structure to maintain b. Estimate how profits are affected by: i. Selling prices ii. Sales volume iii. Unit variable costs iv. Total fixed costs v. Mix of products sold c. ASSUMPTIONS (simplify calculations)—may be violated in practice i. Selling price is constant (price will not change as volume changes) ii. Costs are linear and accurately divided into variable (constant per unit) and fixed (constant in total) iii. In multiproduct companies, mix of products sold constant d. Contribution format income statement i. Profit (net operating income) = (sales – variable expenses) – fixed expenses CM ii. (Selling price per unit x quanity sold) – (variable expense per unit x quantity sold) – fixed expenses e. VARIABLE EXPENSE RATIO = variable expense / sales f.
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