DQ 1

For what is cost-volume-profit (CVP) analysis used? What are some main underlying assumptions that make CVP
analysis useful for decision makers? Why might decision makers use CVP analysis?

"Cost-Volume-Profit Analysis is the study of the effects of changes of costs and volume on a company's
profits" (Weygandt, Kimmel, & Kieso, 2010, pp 212). This is a critical factor in management decisions
and is important in profit planning. It is used to make decisions on setting selling prices, determining
product mix, and maximizing use of production facilities
The basic components are: Volume or level of activity, unite selling prices, variable cost per unit, total
fixed costs, and sales mix.
Underlying Assumptions:
Behavior of both costs an revenues is linear throughout the relevant range of the activity index
All costs can be classified as either variable or fixed with reasonable accuracy
Changes in activity are the only factors that affect costs
All units produced are sold
When more than one type of product is sold, the sales mix will remain constant.
CVP Analysis can provide management with a contribution margin for their products. A contribution
margin is the revenue remaining after deducting variable cost. Another key point in CVP analysis is the
level of activity at which total revenues equal total costs. This is call the break-even point, "which is
useful to management when it decides whether to introduce new product lines, change sales prices or
enter into a new market area" (Weygandt, et al, 2010, pp 215).
Reference
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2010). Managerial Accounting Tools for Business
Decision Making (5th ed.). Hoboken, NJ: John Wiley & Sons, Inc..

Sheila and class,

Good response. What do you think about this being used for break-even analysis?

On the CVP analysis, Chapter 6 objective 2, gives some great examples of how the
break-even analysis is used. By using the company's CVP income statement, you

can use the fixed costs and divide it by the contribution margin per unit to find out
what the break-even point is per unit. You can also use the fixed costs divided by
the contribution margin ratio and find out what the break-even point in dollars.
This can be very useful to new companies. Also you can use the break-even point
in dollars to help you calculate the margin of safety ratio. Which would allow
companies to know the impact that change in sales would be on two companies.

Good breakdown of the assumptions. This is a decent tool to give you an analysis but it really only works
within a certain volume "window". In reality, what cost structure will really change when you take volume too
high?

If the cost structure of the total fixed expenses were to increase or decrease it
would only effect the net income. See Example 1 below, this is the income
statement for a company. In Example 2, it shows where the fixed expenses change
from $200,000 to 175,000 and it also shows the change of the variable expense
change from 480,000 to 345,000. You can see how the cost structure of each the
variable and the fixed cost effects each part.

As you are looking at the CVP analysis I was wondering what your thoughts were about using this tool on a
make vs buy decision? Does this tool give you enough information to make that decision?

The decision to make or buy components should be made on the basis of incremental analysis. An
incremental analysis is "the process used to identify the financial data that change under alternative
courses of action" (Weygandt, Kimmel, & Kieso, 2010, pp 299). There are many types of incremental
analysis and the one that would be used for this situation is the make or buy component parts or finished
products.
During the incremental analysis a company must consider the direct material, direct labor, variable
manufacturing costs, fixed manufacturing costs, along with the purchasing price. Looking at the
illustration in the text book, illustrations 7-5 and 7-6, page 303. It discusses about at first glance it
appears that management should purchase the ignition switches, but after the analysis it is clear that in
would be more cost efficient to make the switches. What they found was that all of the variable cost
would be eliminated, however only $10,000 of the fixed cost would be eliminated. Therefore, the
making of the switches would be cost less.
Furthermore, it is important for management to take into account the social impact of its choice when
using the make-or-buy decision.
Reference

Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2010). Managerial Accounting Tools for Business
Decision Making (5th ed.). Hoboken, NJ: John Wiley & Sons, Inc..

DQ 2
What are the differences between variable and absorption costing? Why is variable costing not allowed for
GAAP reporting? Which method is more useful for internal decision making? Why? As a manager, which
would you prefer? Why?

Absorption costing is the cost that are charged to or absorbed by the product. "Variable costing is an
alternative approach, which only direct materials, direct labor, and variable manufacturing overhead cost
are considered product cost" (Weygandt, Kimmel, & Kieso, 2010. pp 263). The fixed cost are considered
period costs, expenses, and are allocated to the expense accounts as they are incurred. So the difference
is the fixed manufacturing overhead cost. "Under variable costing, companies charge the fixed
manufacturing overhead as an expense in the current period. Fixed manufacturing overhead costs of the
current period, therefore, are not deferred to future periods through the ending inventory" (Weygandt, et
al, 2010, pp 265).
"Generally accepted accounting principles require that absorption costing be used for the costing of
inventory for external reporting purposes" (Weygandt, et al, 2010, pp 270). The GAAP requires that the
fixed manufacturing overhead be accounted for as a product cost and not as an expense. Illustration 6A3 gives a good example of the difference. Net income measured under GAAP (absorption costing) is
often used internally to evaluate performance, justify cost reductions, or evaluate new projects. Some
companies, however, have recognized that net income calculated using GAAP does not highlight
differences between variable and fixed costs and may lead to poor business decisions. Consequently,
these companies use variable costing for internal reporting purposes.

I would prefer to use the variable costing, so I would have a better understanding of the current period
production, without it having the fixed cost to possibly cause the net income to go up or down. This
depends on the fixed income is allocated to the product. It may have been expenses for the prior month
and will give me a false view of if I need to produce more or less of the product in making decisions on

sales. Also the presentation of fixed costs in the variable costing approach makes it easier to identify
fixed costs and to evaluate their impact on the company's profitability.
Reference
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2010). Managerial Accounting Tools for Business
Decision Making (5th ed.). Hoboken, NJ: John Wiley & Sons, Inc..
DQ 3

Reference
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2010). Managerial Accounting Tools for Business
Decision Making (5th ed.). Hoboken, NJ: John Wiley & Sons, Inc..
(Weygandt, Kimmel, & Kieso, 2010).
(Weygandt, et al, 2010).
DQ 4

Reference
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2010). Managerial Accounting Tools for Business
Decision Making (5th ed.). Hoboken, NJ: John Wiley & Sons, Inc..
(Weygandt, Kimmel, & Kieso, 2010, pp 163).
(Weygandt, et al, 2010, pp 164).

Target net income

Mathematical equation
Required sales

Variable costs

$500Q

$300Q

+
+

Fixed Costs

$200,000

Target net income

$120,000

200Q

320,000

1,600

sales volume

$500

selling price

$300

variable costs per unit

$200,000

total fixed costs

$120,000

target net income