Principles of Managerial Accounting Chapter 6

Cost-Volume-Profit (CVP) Analysis CVP is used to predict the impact on profits with changes: Selling price Variable cost per unit Sales volume Total fixed costs.

Contribution Margin Contribution margin: Contribution margin ratio: Sales minus variable costs. (Contribution to fixed costs and profits.) Contribution margin ratio: Contribution margin/sales Break-even point – the point when sales equals Fixed plus Variable costs (zero profit)

Break-even point Break-even – equation method To determine quantity: Sales(selling price per unit) = Variable cost (per unit) + Fixed cost To determine break-even in Sales Dollars: Sales = Variable cost per unit + Fixed Costs

Break-even point—Contribution Margin method Break-even in units = Fixed expenses/Unit contribution margin in dollars Break-even in dollars = Fixed expenses/contribution margin ratio

Margin of Safety The amount by which sales can drop before losses begin to be incurred. In dollars Total budgeted or actual sales – Break-even sales in dollars In Percentage form: Margin of safety in dollars/Total budgeted or actual sales

Operating Leverage The measure of how sensitive net income is to a given percentage change in sales Degree of operating leverage = Contribution margin/net income The higher the degree of operating leverage, the larger the increase in net income.

Assumptions: Unit selling price is constant Costs are linear and can be accurately divided into variable and fixed elements Sales mix is constant in multi-product companies In manufacturing companies, inventories do not change