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ACG 3331 EXAM 2 WITH COMPLETE SOLUTIONS
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fixed costs costs that don't change (in total) as we produce more units, increase activity level, or increase volume (ie. rent, insurance, salaries, etc.)
variable costs costs that do change (in total) as we produce more units, increase activity level, or increase volume (ie. materials, hourly workers' wages, etc.)
mixed (semi-variable) costs
- fixed costs + variable costs
- costs that do change (in total) as we produce more units, increase activity level, or increase volume
relevant range
- the "typical" range of activity
- if we are analyzing a volume that is outside this, we cannot nail down our cost behavior(s) and our cost estimates become unreliable
only fixed cost(s)
only variable cost(s)
semi-variable (mixed) cost(s)
in total increases; per unit stays the same If the activity level increases, what happens to variable costs?
in total stays the same; per unit decreases If the activity level increases, what happens to fixed costs?
in total increases; per unit decreases If the activity level increases, what happens to mixed (semi-variable) costs?
step costs costs that appear to be fixed over a range of values but then "jump"
tight; narrow Step variable costs are...
wide Step fixed costs are....
curvilinear costs costs that are curvy or bendy in different relevant ranges
scatter graph/plot (visual fit) we attempt to place the line where we think it goes after looking at the graph when estimating mixed costs
- this is a super subjective method
- different people will pick slightly different spots for their line
high-low method we connect a line between only two data points when estimating mixed costs
- we use the points with the highest and lowest activity level
- these two points might not be representative of all points (ie. outliers)
least squares regression analysis statistical software such as Excel uses all of the data points to fit a true line of best fit for estimating mixed costs
- this method also gives us a bonus statistic to measure the quality of the fit
- this statistic is called R^2 - bigger is better
account analysis (classification) an accountant looks at a cost and estimates its fixed and variable components
m = (y2 - y1) / (x2 - x1) = (change in cost) / (change in activity) How do you calculate slope?
multiple regression theoretically, we can use more than one independent variable (x) to estimate our total costs (ex. we can use x1 = # of units and x2 = # machine hours to predict y = total costs)
y = a + b1x1 + b2x What is the equation for multiple regression?
engineering method of cost estimation a new advanced way to estimate total cost which involves a highly technically trained individual micro-analyzes all costs down to the penny (ex. an engineer is hired to help a biotech firm estimate their cost to produce a new drug)
cost behavior changes even once a firm nails down their fixed and variable costs, these can change over time (ie. learning curve effect and experience curve)
learning curve effect as workers become more efficient and can pump out more units in the same amount of time, the variable cost per unit would decrease
experience curve
break-even analysis
- a firm's total revenue = total expenses (costs)
- a firm's income (profit) = $
CVP assumptions
- revenues are linear throughout the relevant range (per-unit selling price is constant)
- costs are linear throughout the relevant range (per-unit variable cost is constant)
- every cost can be classified as either fixed or variable
- inventory levels do not change (units produced = units sold)
- if we sell multiple items, our product mix remains constant
- operating income = sales revenue - variable costs - fixed costs
- operating income = sales price(x) - VC per unit(x) - fixed costs What are the two formulas for operating income?
units needed = (fixed cost + target operating income [profit]) / CM per unit
How do you solve for number of units needed?
sales revenue needed = (fixed cost + target operating income) / CM ratio How do you solve for sales revenue needed?
plug in $0 for target operating income What is an important factor to remember when solving for break-even?
after tax net income = operating income * (1 - tax rate) What is the formula to solve for after tax net income?
operating income = net income / (1 - tax rate) What is the formula to solve for operating income?
sales revenue
- COGS = gross margin
- operating expenses = operating income
- taxes = net income What is the traditional income statement?
sales revenue
- variable costs = contribution margin
decreases if the selling price increases, the break-even point ____________
increases if the selling price decreases, the break-even point ______________
decreases if the CM per unit increases, the break-even point ____________
increases if the CM per unit decreases, the break-even point ______________
if a firm sells several products (not just one) What are these steps in regards to?
- step #1: compute the firm's weighted average CM
- step #2: plug WACM into the # units needed formula
- step #3: distribute your answer in step #2 according to the sales mix
margin of safety when we compute the difference between a firm's current (or target) sales and their break-even sales
- this is the firm's "buffer"
- can be computed in number of units, revenues, or as a percent
margin of safety = target - breakeven
- MOS = target units - breakeven units
- MOS = target sales - breakeven sales What are the formulas for margin of safety?
cost structure how much fixed costs firms are willing to take on vs. how much variable costs they are willing to take on
high; risky; high if a company chooses to take on a lot of fixed costs relative to their variable costs, they have chosen a ________ operating leverage
- this is seen as a _______ cost structure (the highs are high but the lows are low)
- all else equal, these companies tend to have a _______ CM ratio
low; not risky; low if a company chooses to take on very little fixed costs relative to their variable costs, they have chosen a ________ operating leverage
- this is seen as a __________ cost structure (the highs aren't terribly high but the lows aren't terribly low either)
- all else constant, these companies tend to have a _________ CM ratio
- product costs = DM + DL + VOH + FOH
therefore, every time a product is made, it absorbs some of the fixed overhead
variable costing (CM method) this method (used only internally) states that product costs include the following:
- product costs = DM + DL + VOH
fixed overhead gets expensed in its entirety right away, as if it were a period cost (hence, no fixed overhead)
absorption costing Which form of costing uses the traditional income statement?
- categorizes cost by their function (not their behavior)
- costs are broken up into product (COGS) and period (operating expenses)
variable costing Which form of costing uses the CM income statement?
- categorizes costs by their behavior (not their function)
- costs are broken up into fixed and variable costs
constant if # produced = # sold --> income with full costing = income with variable costing
- in this case, inventory levels are _________
rising if # produced > # sold --> income with full costing > income with variable costing
- in this case, inventory levels are __________
falling if # produced < # sold --> income with full costing < income with variable costing
- in this case, inventory levels are ___________
difference in operating incomes = (FOH/unit produced) * (diff. in # units produced vs. sold) What is the difference in operating incomes formula?
once the operating budget is complete, firms are able to make a budgeted or pro-forma
what you need = what goes out + ending - beginning What is the formula for most of the math in the operating budget?
financial budget this budget lays out how much a firm plans to spend, borrow, etc. in actual physical cash (ie. cash budget & capital expenditures budget)
cash budget
- tracks physical cash from ongoing operations
- outlines a firm's cash inflows and outflows
- differs from the operating expenses budget for two reasons:
timing -- when firms make sales or purchases, they don't necessarily get or spend the cash right away
non-cash expenses -- firms may expense items that do not require cash
capital expenditures budget
tracks large (rare) purchases used for projects
balance sheet once the financial budget is complete, firms are able to make a budgeted or pro-forma
ending cash balance = total cash available - cash disbursements + financing What is the formula to find a firm's ending cash balance?
in this period; actual cash (no depreciation or bad debit) What are the two things to keep in mind when figuring out a firm's ending cash balance:
- make sure that the cash expenses are paid ______________
- make sure that the expense involves ________________
