Business Explain: February 2017

Archive for February 2017

Which of the general-purpose financial statements provides information about the enterprise at a specific designated date?

The balance sheet provides information about the enterprise at a particular point in time.

How does earning revenue affect the accounting equation?

Revenue increases the asset side of the accounting equation and also increases the retained earnings account in the stockholders' equity section of the equation.

Distinguish between elements of financial statements and accounts?

Items reported on the financial statements are organized into classes or categories called elements. Accounts are specific items of subclassifications of the elements. Ex cash, land, and common stock.

What are the U.S. rules of accounting information measurement called?

The U.S. rules of accounting information measurement are called generally accepted accounting principles (GAAP).

How do financial and managerial accounting differ?

Fin accounting: provide information that is useful to external resource providers, Manag accounting: provides information that is useful to managers in operating an organization.

In CVP analysis, gross margin is a less-useful concept than contribution margin. Do you agree? Explain briefly.

Yes, gross margin calculations emphasize the distinction between manufacturing and nonmanufacturing costs (gross margins are calculated after subtracting variable and fixed manufacturing costs). Contribution margin calculations emphasize the distinction between fixed and variable costs. Hence, contribution margin is a more useful concept than gross margin in CVP analysis.

How can a company with multiple products compute its breakeven point?

A company with multiple products can compute a breakeven point by assuming there is a constant sales mix of products at different levels of total revenue.

"There is no such thing as a fixed cost. All costs can be unfixed given sufficient time." Do you agree? What is the implication of your answer for CVP analysis?

CVP analysis is always conducted for a specified time horizon. One extreme is a very short-time horizon. For example, some vacation cruises offer deep price discounts for people who offer to take any cruise on a day's notice. One day prior to a cruise, most costs are fixed. The other extreme is several years. Here, a much higher percentage of total costs typically is variable. CVP itself is not made any less relevant when the time horizon lengthens. What happens is that many items classified as fixed in the short run may become variable costs with a longer time horizon.

What is operating leverage? How is knowing the degree of operating leverage helpful to managers?

Operating leverage describes the effects that fixed costs have on changes in operating income as changes occur in units sold, and hence, in contribution margin.

Knowing the degree of operating leverage at a given level of sales helps managers calculate the effect of fluctuations in sales on operating incomes.

Give an example of how a manager can increase variable costs while decreasing fixed costs.

Manufacturing--subcontracting a component to a supplier on a per-unit basis to avoid purchasing a machine with a high fixed depreciation cost.

Marketing--changing a sales compensation plan from a fixed salary to percent of sales dollars basis
Customer service--hiring a subcontractor to do customer service on a per-visit basis rather than an annual retainer basis.

See: Give an example of how a manager can decrease variable costs while increasing fixed costs.

Give an example of how a manager can decrease variable costs while increasing fixed costs.

Manufacturing--substituting a robotic machine for hourly wage workers.

Marketing--changing a sales force compensation plan from a percent of sales dollars to a fixed salary.

Customer service--hiring a subcontractor to do customer repair visits on an annual retainer basis rather than a per-visit basis.

See: Give an example of how a manager can increase variable costs while decreasing fixed costs.

Describe sensitivity analysis. How has the advent of the electronic spreadsheet affect the use of sensitivity analysis. How has the advent of the electronic spreadsheet affected the use of sensitivity analysis?

Sensitivity analysis is a "what-if" technique that managers use to examine how an outcome will change if the original predicted data are not achieved or if an underlying assumption changes. The advent of the electronic spreadsheet has greatly increased the ability to explore the effect of alternative assumptions at minimal cost. CVP is one of the most widely used software applications in the management accounting area.

How does an increase in the income tax rate affect the breakeven point?

An increase in the income tax rate does not affect the breakeven point. Operating income at the breakeven point is zero, and no income taxes are paid at this point.

CVP analysis is both simple and simplistic. If you want realistic analysis to underpin your decisions, look beyond CVP analysis. Do you agree? Explain.

CVP certainly is simple, with its assumption of output as the only revenue and cost driver, and linear revenue and cost relationships. Whether these assumptions make it simplistic depends on the decision context. In some cases, these assumptions may be sufficiently accurate for CVP to provide useful insights. The examples in Chapter 3 (the software package context in the text and the travel agency example in the Problem for Self-Study) illustrate how CVP can provide such insights. In more complex cases, the basic ideas of simple CVP analysis can be expanded.

More: What is Cost-Volume-Profit (CVP) Analysis?

Why is it more accurate to describe the subject matter of this chapter as CVP analysis rather than as breakeven analyses?

Breakeven analysis denotes the study of the breakeven point, which is often only an incidental part of the relationship between cost, volume, and profit. Cost-volume-profit relationship is a more comprehensive term than breakeven analysis.

Describe three methods that managers can use to express CVP relationships ?

Three methods to express CVP relationships are

The equation method,
The contribution margin method, and
The graph method.

The first two methods are most useful for analyzing operating income at a few specific levels of sales. The graph method is useful for visualizing the effect of sales on operating income over a wide range of quantities sold.

Define contribution margin, contribution margin per unit, and contribution margin percentage.

Contribution margin is the difference between total revenues and total variable costs. Contribution margin per unit is the difference between selling price and variable cost per unit. Contribution-margin percentage is the contribution margin per unit divided by selling price.

Distinguish between operating income and net income ?

Operating income is total revenues from operations for the accounting period minus cost of goods sold and operating costs (excluding income taxes):

Operating income = Total revenues from operations - Costs of goods sold and operating costs (excluding income taxes)

Net income is operating income plus nonoperating revenues (such as interest revenue) minus non operating costs (such as interest cost) minus income taxes.

Net income = Operating income - Income taxes

Describe the assumptions underlying CVP analysis ?

1. Changes in the level of revenues and costs arise only because of changes in the number of product (or service) units sold.
2. Total costs can be separated into a fixed component that does not vary with the units sold and a variable component that changes with respect to the units sold.
3. When represented graphically, the behaviors of total revenues and total costs are linear (represented as a straight line) in relation to units sold within a relevant range and time period.
4. The selling price, variable cost per unit, and fixed costs are known and constant.

Define cost-volume-profit analysis ?

Cost-volume-profit (CVP) analysis examines the behavior of total revenues, total costs, and operating income as changes occur in the units sold, selling price, variable cost per unit, or fixed costs of a product.

Limitations of Break-Even Analysis:

1. The assumption that all costs and revenues are represented by straight lines in unrealistic.
2. Not all costs can be conveniently classified into fixed and variable costs. The introduction of semi-variable costs will make the technique more complicated.
3. There is no allowance made for stock levels on the break-even chart. It is assumed that all units produced are sold. This is unlikely to always be the case in practice.
4. It is also unlikely that fixed costs will remain unchanged at different output levels up to a maximum capacity.

Benefits of Break-Even Analysis:

1. Charts are relatively easy to construct and interpret.
2. It provides useful guidelines to management on break-even points, safety margins and profit/loss levels at different rates of output.
3. Comparisons can be made between different options by constructing new charts to show changed circumstances.
4. The equation produces a precise break-even result.
5. Break-even analysis can be used to assist managers when taking important decisions, such as location decisions, whether to buy new equipment and which project to invest in.