65.(И.Р.)Cost behavior and cvp analysis

Cost-Volume-profit(CVP), in managerial economics is a form of cost accounting. It is a simplified model, useful for elementary instruction and for short-run decisions.

Cost-volume-profit (CVP) analysis expands the use of information provided by breakeven analysis. A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs). At this breakeven point (BEP), a company will experience no income or loss. This BEP can be an initial examination that precedes more detailed CVP analysis.

Cost-volume-profit analysis employs the same basic assumptions as in breakeven analysis. The assumptions underlying CVP analysis are:

The behavior of both costs and revenues is linear throughout the relevant range of activity. (This assumption precludes the concept of volume discounts on either purchased materials or sales.) Costs can be classified accurately as either fixed or variable. Changes in activity are the only factors that affect costs. All units produced are sold (there is no ending finished goods inventory). When a company sells more than one type of product, the sales mix (the ratio of each product to total sales) will remain constant.

CVP simplifies the computation of breakeven in break even analysis, and more generally allows simple computation of Target Income Sales. It simplifies analysis of short run trade-offs in operational decisions.

Limitations - CVP is a short run, marginal analysis: it assumes that unit variable costs and unit revenues are constant, which is appropriate for small deviations from current production and sales, and assumes a neat division between fixed costs and variable costs, though in the long run all costs are variable.

Basic graph

Basic graph of CVP, demonstrating relation of Total Costs, Sales, and Profit and Loss.

The assumptions of the CVP model yield the following linear equations for total costs and total revenue (sales):

TC=FC+Unit Variable Cost*Number of Units; (TC=TFC+V*X)

Total Revenue=Sales Price*Number of Units (TR=P*X)

These are linear because of the assumptions of constant costs and prices, and there is no distinction between Units Produced and Units Sold, as these are assumed to be equal. Note that when such a chart is drawn, the linear CVP model is assumed, often implicitly.

Profit is computed as TR-TC; it is a profit if positive, a loss if negative.

66. Accounting Cycle, Generally Accepted Accounting Principles, and Financial Statements

Accounting cycle: the name given to the collective process of recording and processing the accounting events of a company. The series of steps begin when a transaction occurs and end with its inclusion in the financial statements. Steps: Collecting and analysis data from transactions and events; Putting transactions into the general journal; Posting entries to the general ledger; Preparing an unadjusted trial balance; Adjusting entries appropriately; Preparing an adjusting trial balance; Organizing the accounts into the financial statements; closing books; preparing a post-closing trial balance to check the accounts.

GAAP: The conventions, rules, and procedures necessary to define accepted accounting practice at a particular time; Developed to provide guidelines for financial accounting; Evolve as better methods emerge or as circumstances change

Four Major Financial Statements: Income Statement, Statement of Owner’s Equity, Balance Sheet, Statement of Cash Flows

Income Statement Summarizes revenues earned and expenses incurred over an accounting period; Dated “For the Month Ended …” or “For the Year Ended …”; Shows whether a company achieved its profitability goal; Often considered the most important financial report.

Statement of Owner’s Equity Shows changes in owner’s equity over an accounting period; Dated “For the Month Ended …” or “For the Year Ended…”; Uses net income figure from income statement; Owner’s Capital balance at the end of period used to prepare balance sheet.

Balance Sheet Shows the financial position of a business on a certain date; Often called the statement of financial position; Presents view of business as holder of assets that are equal to the claims against those assets; Claims consist of the company’s liabilities and the owner’s equity

Statement of Cash Flows Shows cash flows into and out of a business during an accounting period; Shows important investing and financing transactions of the period; Focuses on liquidity; Explains how the Cash account changed during the period

The Accounting Cycle is a series of steps which are repeated every reporting period. The process starts with making accounting entries for each transaction & goes through closing the books.