Final Exam Review Chapter 2 Operating Leverage= contribution margin/ net income . It’s a measure of the extent to which fixed cost are being used. - Operating leverage: 2.23 times x (20% desired increased in net income) = 45% [i.e., $142,000 + ($142,000 × 0.45)]. Net income would increase to $205900 - Companies with high fixed cost structure will show higher net income. - When all costs are fixed, every additional sale in dollars contributes to one dollar of gross profit; Every small % change in revenue produces a large % change in profits. Fixed cost behavior: Total fixed cost does not change as activity increase or decrease (Ex. Monthly car payment). However, unit fixed cost is inversely related to activity, the per unit cost decreases when activity increases and vice versa. When activity: Increases Decreases Total fixed cost Remains constant Remains constant Per unit fixed cost decreases increases Variable cost behavior: Total variable cost increases/decreases in direct proportion to the number of items sold. However, per unit variable cost remains constant. - Risk may be reduced by converting fixed costs into variable costs, it would also risk the potential for profits. % change = (new- old)/ old Chapter 3 Contribution Margin = sales prices – variable costs Break-even point in units = fixed costs/ contribution margin per unit Contribution margin ratio= contribution margin/ sales prices per unit Break-even point in dollars= fixed costs/ CM ratio Break-even point in number of units= total sales/ sales prices per unit. Equation method= sales prices x units = variable cost x unit + fixed cost Determining sales volume for targeted profit : we add the desired profit under the equation to find out the missing amount = (Fixed costs + desired profit)/ contribution margin Margin of safety % = (budgeted sales – break-even sales)/ budgeted sales - The margin of safety is the cushion that exists between budgeted, or actual, sales and the break-even sales. - If managers are optimistic, risk aggressive then they should add the product with higher operating leverage although may have a risky margin of safety. - If managers are pessimistic, risk adverse they should add the product with the highest margin of safety although operating leverage may be low. Chapter 4: Allocation, cost object, cost driver. Chapter 5 Activity Based costing: improving product costing Overhead rates based on direct labor hours have been traditionally used in labor intensive processes. In these labor-intensive processes, overhead costs are relatively small, and the amounts allocated to products may be insignificant when compared with labor and material costs.
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