Kinney 8e_SM Ch09

Kinney 8e_SM Ch09 - 1 Chapter 9 CHAPTER 9 Break-Even Point...

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1 Chapter 9 CHAPTER 9 Break-Even Point and Cost-Volume-Profit Analysis QUESTIONS 1. The variable costing income statement classifies costs by the way they behave. Variable costs are deducted from revenues to determine contribution margin and then fixed costs are deducted from contribution margin to determine operating profit. Break-even analysis involves a study of fixed costs, variable costs and revenues to determine the volume at which total costs equal total revenues. Hence, variable costing provides the variable and fixed cost classification needed to compute break- even. The absorption costing income statement uses a functional classification-- manufacturing and nonmanufacturing costs--to compute gross profit and then operating income respectively. A functional classification requires cost to be classified based on the reason it was incurred, i.e., selling, administrative, or production. This classification does not separate variable from fixed costs and is therefore not useful in computing breakeven. 2. The break-even point is the starting point for CVP analysis because before a company can earn profits, it must first cover all of its variable and fixed costs; the point at which all costs are just covered is the break-even point. The formula approach requires solving for the exact break-even using the following algebraic equation: R(X)– V(X) – FC = 0; where R is revenue per unit, X is volume, V is variable cost per unit, and FC is fixed cost. The graph approach provides a visual relationship between revenues and costs. The break-even point is where the total revenue line intersects the total cost line on the traditional or cost-volume-profit graph or where the profit line intersects the x-axis on the profit-volume graph. Unlike the formula approach, the graph approach does not provide a precise solution because exact points cannot be determined from a visual view of the graph. The income statement approach requires preparing an income statement to prove the accuracy of the computations of break-even. Only by trial- and-error can the exact breakeven be determined using the income statement approach. 3. The contribution margin ratio is contribution margin per unit divided by selling price per unit. It represents the proportion of revenue that remains after variable costs are covered. The contribution margin ratio can be used to calculate breakeven in sales dollars by dividing fixed costs by the contribution margin ratio. 4. The usefulness of CVP analysis is its ability to clearly forecast income expected to result from the short-run interplay of cost, volume, price, and quantity. It is often useful in analyzing current problems regarding product mix, make or buy, sell or process further, and pricing. In the long run, however, all of these factors and their relationships and the
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Kinney 8e_SM Ch09 - 1 Chapter 9 CHAPTER 9 Break-Even Point...

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