Questions and Answers
What is the break-even point?
The contribution per unit is calculated by adding the variable cost per unit to the sales price per unit.
False
What formula is used to determine the break-even point in units?
Break-even point = Total fixed costs / Contribution per unit
The contribution per unit for this scenario is calculated by subtracting the variable cost per unit from the ________ per unit.
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If the sales price per unit is $8 and the variable cost per unit is $5, what is the contribution per unit?
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Match the following terms with their definitions:
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The safety margin is the amount by which actual sales can exceed anticipated sales.
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What is the required contribution for Seven League Boots to achieve a profit of $70,000 with fixed costs of $119,000?
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The total contribution must remain constant for a price increase to maintain the same profit level.
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What is the unit contribution if the sales price is $20 and the variable cost is $12?
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The C/S ratio is calculated by dividing the contribution per unit by the ________.
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A decrease in sales price will always lead to an increase in total profit.
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To keep total profits constant, the minimum sales volume must also remain constant when the sales price increases.
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What does the contribution to sales (C/S) ratio measure?
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The breakeven point is reached when total contribution exceeds total fixed costs.
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Match the following financial terms with their definitions:
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The safety margin can indicate how much actual sales can decline before reaching the breakeven point.
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Match the following calculations with their concepts:
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If a company has a C/S ratio of 45%, then its variable cost to sales ratio is 55%.
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What is the safety margin for a company with budgeted sales of 8,000 units and a breakeven point of 7,000 units?
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If Betty Battle's selling price increases to $21 and the variable cost decreases to $9, what will be the new contribution margin per unit?
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A breakeven chart shows the relationship between sales volume and total costs only.
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The segmented area between the breakeven point and expected sales in units indicates the _____ margin.
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Match the following terms with their definitions:
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The total costs line on a breakeven chart starts at the origin.
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Match the following costs with their types:
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A profit/volume (P/V) chart only illustrates costs at various sales levels.
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The fixed costs on the breakeven chart are represented by a straight line parallel to the _____ axis.
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What does the gradient of the profit-volume (P/V) line represent?
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The profit-volume line starts at the origin (0,0) on the graph.
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The profit-volume chart helps in visualizing the relationship between ______ and profit.
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Match the following terms with their definitions:
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What happens to the breakeven point if the selling price is increased and demand decreases?
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The variable cost per unit is assumed to be constant at all levels of production in breakeven analysis.
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In terms of unit sales, to calculate the sales revenue at breakeven, one would use the formula ______ / contribution margin.
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Which of the following is NOT a limitation of breakeven analysis?
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Study Notes
Cost-Volume-Profit (CVP) Analysis and Break-Even
- Cost-volume-profit (CVP) analysis examines the relationship between costs, sales volume, and profit, focusing on budgeting and profit projections.
- Break-even point (BEP) is the sales level at which total revenue equals total costs, resulting in zero profit.
- Safety margin indicates how much actual sales can drop below anticipated sales before incurring a loss.
Break-Even Point Calculation
- Break-even formula:
[ \text{Break-even Point} = \frac{\text{Total Fixed Costs}}{\text{Contribution per Unit}} ] - Contribution per unit calculated as:
[ \text{Contribution per Unit} = \text{Sales Price per Unit} - \text{Variable Cost per Unit} ] - Example calculation:
- Expected sales: 10,000 units at 8eachtotals8 each totals 8eachtotals80,000.
- Variable cost: 5perunitleadstoacontributionof5 per unit leads to a contribution of 5perunitleadstoacontributionof3 per unit.
- Fixed costs: 21,000;thus,BEP=(21,0003=7,000)unitsor21,000; thus, BEP = (\frac{21,000}{3} = 7,000) units or 21,000;thus,BEP=(321,000=7,000)unitsor56,000 in revenue.
Contribution to Sales (C/S) Ratio
- C/S ratio reflects the contribution earned per dollar of sales; also termed the profit/volume ratio.
- C/S ratio formula for break-even in terms of sales revenue:
[ \text{Break-even Sales Revenue} = \frac{\text{Fixed Costs}}{\text{C/S Ratio}} ] - Example: A product with a C/S ratio of 37.5% indicates that 0.375contributionisearnedper0.375 contribution is earned per 0.375contributionisearnedper1 of sales.
Safety Margin
- Safety margin quantifies the buffer between budgeted sales and break-even sales volume, expressed in units or as a percentage.
- Example calculation: With budgeted sales of 8,000 units and a BEP of 7,000 units, the safety margin is 1,000 units or 12.5%.
Profit Targets
- To achieve target profit, sales revenue must cover total variable costs, total fixed costs, and desired profit.
- Target profit formula:
[ S = V + F + P ]
where ( S ) = sales revenue, ( V ) = total variable costs, ( F ) = total fixed costs, and ( P ) = target profit. - Example: If fixed costs are 68,000andrequiredprofitis68,000 and required profit is 68,000andrequiredprofitis16,000, then required contribution is $84,000.
Changes in Sales Price or Costs
- Adjusting sales price or costs requires recalculating sales volumes to maintain profit levels.
- Example: Increasing the selling price but losing sales volume necessitates calculating the new required sales volume to preserve profit.
Break-even and Profit/Volume Charts
- Break-even charts visually depict sales levels at which a company meets costs with various sales volumes.
- The intersection of the sales line and total costs line represents the break-even point.
- Profit/Volume (P/V) charts illustrate relationships among sales, profit, and safety margins, allowing assessment of price changes' effects on profitability.
Example of Breakeven Analysis with Charts
- Using a factory with fixed costs of 40,000andvariablecostsof40,000 and variable costs of 40,000andvariablecostsof0.50 per unit:
- Budgeted sales at 120,000 units yield a breakeven output point derivation leading to visual interpretation of profits/losses at different sales volumes.### Profit/Volume (P/V) Charts
- P/V charts illustrate the relationship between profit and sales volume, identifying breakeven points and profit/loss scenarios.
- Breakeven point is a critical metric indicating the volume at which total revenues equal total costs.
- Breakeven point 1 occurs at 80,000 units; breakeven point 2 drops to 71,429 units with a price increase, showing a lower sales revenue threshold for cover costs.
Budgeted Profits and Sales Volume
- With a budgeted price increase to 1.20anddemanddroppingto105,000units,contributionbecomes1.20 and demand dropping to 105,000 units, contribution becomes 1.20anddemanddroppingto105,000units,contributionbecomes73,500.
- Total profit under these conditions is 23,500afteraccountingforfixedcostsof23,500 after accounting for fixed costs of 23,500afteraccountingforfixedcostsof50,000.
- Sales above 50,000 units yield higher profits at the new price; below this threshold, losses are greater with the increased price.
Advantages of P/V Charts
- P/V charts convey changes in selling price, variable costs, fixed costs, and sales demand clearly compared to traditional breakeven charts.
- They can integrate variable cost changes, depicting profit/loss at varying levels of output.
- An increase in variable cost to 0.60over120,000unitsresultsinacontributionof0.60 over 120,000 units results in a contribution of 0.60over120,000unitsresultsinacontributionof52,000, leading to a total profit of $12,000 at 130,000 units.
Limitations of Cost Volume Profit (CVP) Analysis
- Breakeven analysis best applies to single products or products produced in a constant mix, limiting broader applicability.
- Time-intensive preparation may hinder effective use for rapid decision-making.
- Assumes fixed costs remain constant, which may not hold true in real-world scenarios.
- Variable costs per unit and sales prices are assumed stable at all output levels.
- Ignores inventory levels by equating production directly with sales.
- Lacks consideration for uncertainties in cost estimations, risking decision quality.
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Description
This quiz explores the fundamentals of cost-volume-profit (CVP) analysis and break-even analysis. It examines how these concepts help organizations understand the relationships between costs, volume, and profit at different activity levels. We'll also cover the significance of the break-even point in financial decision-making.
