I don't understand cost volume profit analysis , topic in managerial accounting?

As well as, fixed cost and variable cost, absorption and variable costing.

it is a first subject I have in MBA and my previous study wasn't in business.

So I miss a lot of information related to income statement I guess.

Chapter 6: Absorption and variable costing Lecture notes Two general approaches are used for valuing inventories and cost of goods sold. One approach, called absorption costing, is generally used for external reporting purposes (it is the traditional income statement). The other approach, called variable costing, is preferred by some managers for internal decision making and must be used when an income statement is prepared in the contribution format. This chapter shows how these two methods differ from each other. I. Overview of variable and absorption costing: a. Variable costing treats only those costs of production that vary with output as product costs. This approach dovetails with the contribution approach income statement and supports CVP analysis because of its emphasis on separating variable and fixed costs. - The cost of a unit of product consists of direct materials, direct labor, and variable overhead. Fixed manufacturing overhead, and both variable and fixed selling and administrative expenses are treated as period costs and deducted from revenue as incurred. 1 b.Absorption costing treats all costs of production as product costs, regardless of whether they are variable or fixed. Since no distinction is made between variable and fixed costs, absorption costing is not well suited for CVP computations. ii. The cost of a unit of product consists of direct materials, direct labor, and both variable and fixed overhead. iii.Variable and fixed selling and administrative expenses are treated as period costs and are deducted from revenue as incurred. Important Note: 1. Absorption Costing is the Traditional Approach of Income Statement and it is used for external reporting and required by GAAP and IFRS. 2. Contribution Approach relies on Variable costing and is used for internal Management uses and not required by GAAP and IFRS. 2 Example: Harvey Company produces a single product with the following information available: Required: 1- What is the product cost per unit using the absorption costing method and the variable costing method? 2- Assuming that there were no beginning inventory in year 1 and unit selling price is $30, calculate the company's net income using the absorption costing method and the variable costing method under the following three alternatives: a. Sales volume in year 1 is 25,000 units b. Sales volume in year 2 is 20,000 units c. Sales volume in year 3 is 30,000 units 3- How much fixed manufacturing overhead cost is left in ending inventory at the end of year 2? 4- Why Net income figures are different in year 2 and year 3? Reconcile the difference. Solution: 1- Unit product cost is determined as follows: 3 2- a. year 1 sales volume = production volume = 25000 units Absorption costing method Sales (25000 * 30) Less: Cost of Goods Sold (25000*16) Gross Profit Less: Selling and Administraive Exp: Variable (3*25000) Fixed 750,000 400,000 350,000 75,000 100,000 Net Income Sales (25000*30) Less: Variable Costs: Cost of Goods Sold (25000*10) Selling and Administrative Contribution Margin Less: Fixed Expenses: Fixed Manufacturing overhead Fixed Selling and Admin. Net Income 175,000 Variable Costing Method 750,000 250,000 75,000 425,000 150,000 100,000 175,000 Conclusion (1): when sales volume = production volume then net income in both methods is equal. 4 b. Year 2 sales level (20000 units) production level (25000 units) Absorption costing method Sales (30000 * 30) Less: Cost of Goods Sold (30000*16) Gross Profit Less: Selling and Administraive Exp: Variable (3*30000) Fixed 900,000 480,000 420,000 90,000 100,000 Net Income Sales (30000*30) Less: Variable Costs: Cost of Goods Sold (30000*10) Selling and Administrative Contribution Margin Less: Fixed Expenses: Fixed Manufacturing overhead Fixed Selling and Admin. Net Income 230,000 Variable Costing Method 900,000 300,000 90,000 510,000 150,000 100,000 260,000 Conclusion (3): when sales volume is greater than production level then net income under absorption costing method is lower than net income under variable costing. Why? 3. At the end of the second year 5000 units are not sold, this means that the fixed Manufacturing costs related to these 5000 units are not recognized as cost of goods sold 6 as per absorption costing method and therefore $30,000 of fixed manufacturing costs are not recognized in the traditional income statement and hence postponed recognizing till they are sold later. 4. In year 2, Net income as per absorption costing is higher than the net income per variable costing method. This is due to the fact that level of production is higher than sales volume in that year. This resulted in having a balance of ending inventory equals to 5000 units which contain fixed manufacturing overhead not recognized as per absorption costing but however recognized by variable costing. Net Income as per Absorption costing Less: Fixed manufacturing overhead in ending Inventory (6*5000) $120,000 Net Income as per Variable Costing Method 90,000 7 (30,000) Change in fixed cost, sales volume and variable cost Chapter 5 page number (192 - 196) Name: Auf Abdulrahman Al Hammadi Name: Hamed AlKaabi Name: juma khasib juma 201410648 201410650 201420587 1 Introduction Main objective of presentation is to show the impact of changes in FC, USP, UVC on BEP analysis. Companies may choose cost structure, to invest more in FC or VC? 2 Break-even point FC The break-even point= USP UVC We have a numerator and the denominator so, if we want to decrease the BEP we must do two things 1. Decrease the numerator 2. Increased the denominator 3 Decrease the numerator Change in Fixed cost If fixed cost increased the BEP incensed but, If fixed cost decrease the BEP decrease 4 Increased the denominator We have two things in denominator USP and UVC If USP increased the CM increased the BEP decreased If USP decreased the CM decreased the BEP increased In other hand If UVC increased the CM decreased the BEP increased If UVC decreased the CM increased the BEP decreased 5 Conclusion If we want to decrease the BEP we must do a three things Fixed cost Unit sales price Unit variable cost we can't increase the unit price unless we check with the competitor's price. The FC will be high, so we can find a good shop with low price, but the issue is sales will be decrees because of the location . 6 TARGET PROFIT AND BREAK EVEN ANALYSIS TARGET PROFIT ANALYSIS Target profit analysis is used for CVP analysis primarily. Under Target profit analysis we calculate how much sales volume is needed to achieve a specified target profit. THE EQUATION METHOD By using a the Equation method we can find the required target profits by sales . For Acoustic Concept company has only one product so its easy to use contribution margin form of equation . THE FORMULA METHOD The formula method is the short term version of the Equitation method In Formula method we can skip a few steps used in the equitation method EXAMPLE Target profit : $ 40,000 Unit Contribution Margin: $100 Fixed Expense : $35,000 CALCULATING TARGET PROFIT We can calculate target profit by two methods The equation method The formula method EQUATION METHOD Profit = Unit CM X Q - Fixed Expenses $40000 = $100 X Q - $35000 $100 X Q = $ 40000 + $ 35000 Q = ( $40000+ $35000) / $ 100 Q = 750 FORMULA METHOD U S to attain the TP=TP + Fix Exp / Unit CM = $40000 + $35000 / $100 = 750 TARGET PROFIT ANALYSIS IN TERMS OF SALES DOLLARS To Know what dollars sales are needed to achieve target profit we can use several methods like Equation method or formula method Then multiply the result by selling price EXAMPLE Unit sale = 750 units Price per speaker = $250 Total sales = $187,500 TARGET PROFIT BY ACOUSTIC METHOD Profit = CM Ratio X Sales - Fixed Expenses $ 40,000 = 0.40 X Sales -$35,000 0.40 X Sales = $ 40,000 + $ 35,000 Sales = ( $ 40,000 + $ 35,000 / 0.40 Sales = $ 187,500 COMPUTING DOLLARS SALES Dollars Sale to get T P = T P + Fix Exp/ CM Ratio = $40,000 + $ 35,000/ 0.40 = $ 187,500 BREAK EVEN ANALYSIS Break Even point is a level of sales at which company profit is zero . Breakeven analysis examines the short run relationship between changes in volume and changes in total sales revenue, expenses and net profit Also known as C-V-P analysis (Cost Volume Profit Analysis) We can calculate break even point by Equation Method or Formula method both The target profit is zero in break even analysis BREAK EVEN UNIT SALES 1. 2. 3. U S to attain TP = T P + Fix Exp / Unit CM U S to break even = $0 + Fix Exp/ Unit CM U S to break Evan = Fixed Exp/ Unit CM = $35,000/ $ 100 = 350 BREAK EVEN IN SALES DOLLARS IN FORMULA METHOD Dollars sales to attain TP =TP+ Fix Exp/ CM Ratio Dollars Sales to BE = $0+ Fix Exp/CM Ratio BREAK EVEN POINT IN ACOUSTIC METHOD Dollers Sales to BE = Fix Exp/ CM Ratio = $ 35,000/ 0.40 = $ 87,500 I HOPE I HAVE BEEN ABLE TO PRESENT THE CONCEPT CLEARLY Thank you for watching