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Chapter 20: Summary Handout for Students

1. Effect of changes in volume on three different types of costs:

o Variable Costs

Total costs change in direct proportion to changes in volume

Cost per unit remains constant with changes in volume

o Fixed Costs

Total costs remain constant with changes in volume

Cost per unit is inversely proportional to changes in volume

o Mixed costs

Step 1: Variable cost per unit = Change in total cost/Change in volume of activity

Step 2: Total fixed cost = Total mixed cost Total variable cost

Step 3: Total mixed cost = (Variable cost per unit * Number of units) + Total fixed costs

2. Relevant range

o Volume of activity where total fixed costs and variable cost per unit remain constant

3. Cost-Volume-Profit Analysis is used to calculate breakeven point

o The Equation Approach:

Sales Revenue Variable costs Fixed costs = Operating income ($0)

o The Contribution Margin and the Contribution Margin Ratio Approaches:

Sales revenue Variable costs = Contribution margin

Contribution margin Fixed costs = Operating income

Units sold = Fixed costs + Operating income/Contribution margin per unit

Contribution margin ratio = Contribution margin/Sales revenue

Breakeven sales in dollars = Fixed costs/Contribution margin ratio

4. CVP Analysis can be used to calculate the sales level needed to earn a target profit

o Target sales in dollars = Fixed costs + Target profit/Contribution margin ratio

o Target sales in units = Fixed costs + Target profit/Contribution margin per unit

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5. Sensitivity analysis

o What-if technique that uses CVP to predict how changes in sales price, variable and/or fixed costs will

affect breakeven and profits

6. Margin of safety is the excess of expected sales over breakeven sales.

o Margin of safety in units = Expected sales in units Breakeven sales in units

o Margin of safety in dollars = Margin of safety in units * Sales price

o Margin of safety ratio = Margin of safety in units/Expected sales in units

7. Operating leverage predicts the effects fixed costs have on changes in operating income when sales volume

changes.

o Degree of operating leverage = Contribution Margin/Operating Income

8. The breakeven point can be calculated for multiple product lines or services

o Step 1: Calculate the weighted-average contribution margin per unit

o Step 2: Calculate the breakeven point in units for the package of products

Breakeven sales in total units = Fixed costs + Target Profit

Weighted-average contribution margin per unit