Cost Volume Profit Analysis

Self Test

Introduction to Accounting

Self Test

Click the “Check Your Answer” box below each question to reveal the correct answer and explanation.

Do you understand the terms?

1. Break even is

a. the point where the sales is equal to variable costs
b. the point were the fixed costs is equal to variable costs
c. the point were the contribution margin is equal to fixed costs
d. the point where the contribution margin is equal to variable costs

Answer

C. Break even, or 0 profits, occurs when contribution margin is equal to fixed costs. Sales – variable costs = contribution margin – fixed costs = profits. When contribution margin is equal to fixed costs the profit will be 0, or break-even.

2. Contribution margin is

a. the amount from sales that is available to cover fixed costs
b. the amount from sales that is available to cover variable costs
c. sales less fixed costs
d. fixed costs less variable cost

Answer

A. By definition, contribution margin is the amount that is available to cover fixed costs. Remember the income statement format: Sales – VC = CM – FC = profit

3. The contribution margin ratio is

a. the percentage of fixed costs to variable costsa. the percentage of fixed costs to variable costs
b. the percentage of sales to fixed costs
c. the percentage that income will increase as sales increase
d. the percentage of every sales dollar that is available to cover fixed costs

Answer

D. By definition, the contribution margin is the percentage of every sales dollar that is used to cover fixed costs.  c. is related to operating leverage.  a. and b. are not meaningful percentages.

4. Margin of safety indicates to management

a. how far sales can decrease and the company will be profitable
b. how much sales will decrease as the sales price is increased
c. how much fixed costs need to decrease to obtain profitability
d. how much variable costs will increase as sales increase

Answer

A. By definition, the margin of safety indicates how far sales in units or dollars can decrease and the company will still be profitable. This formula compare current sales to break even sales which give 0 profit.

5. A company must monitor the sales mix when

a. one product accounts for 99% of sales
b. the company has only one product
c. the company has many products with different contribution margins
d. the company has many products with the same contribution margin

Answer

C. The company needs to be aware of how many of the unit sales are high contribution margin units and the low contribution margin units. When sales as a percentage of total sales decrease in the higher contribution margin products, total company profits will decrease. Sales mix is not relevant when there is substantially only one product or the contribution margins are similar on all products.

Do you understand the formulas?

1. At the break-even point, contribution margin equals

a. total fixed costs
b. total revenues
c. total variable costs
d. all costs

Answer

A. Break even means that profits are 0. Therefore, the contribution margin is just enough to equal the fixed costs leaving 0 profit. Contribution margin less fixed costs equal profits. 

2. To calculate the break even point in sales dollars you would use the formula

a. sales / total costs
b. fixed costs / sales price
c. fixed costs / contribution margin per unit
d. fixed costs / total contribution margin / sales

Answer

D. The formula for breakeven in sales is total fixed costs / contribution margin ratio. The contribution margin ratio is calculated by total contribution margin / sales. 

3. Contribution margin is calculated as

a. sales – variable costs
b. sales – total fixed costs – variable costs
c. total variable costs – total fixed costs
d. total fixed costs – total variable costs

Answer

A. Contribution margin is: sales – variable costs. This can be calculated on a total dollar basis or a per unit basis.

4. Operating leverage is calculated as

a. operating income / fixed costs
b. operating income / variable costs
c. contribution margin / income
d. income / contribution margin

Answer

C. The formula for operating leverage is contribution margin divided by income. As the contribution margin increases and fixed costs remain the same, income will increase much faster than sales.

5. To obtain a target profit the company must have

a. contribution margin higher than fixed costs by the same amount as the target profit
b. fixed costs greater than the contribution margin by the same amount as the target profit
c. sales greater than fixed costs by the same amount as the target profit
d. none of the above is correct

Answer

A. Profit = Sales – VC = CM – FC, therefore the profit will equal the amount that contribution margin is higher than the fixed costs. Fixed costs greater than the contribution margin will produce a loss and not a profit (b.). Variable costs are left out of the formula in (c).

Do you understand how to apply the formulas?

1. If the selling price per unit increases, units sold to achieve break-even will

a. increase
b. decrease
c. remain the same
d. not enough information to be able to tell

Answer

B. The number of units required to break even will be less because the contribution margin from each unit will be higher if the selling price is higher.

2. When the contribution margin ratio increases, the sales dollars required to achieve break even will

a. increase
b. decrease
c. remain the same
d. not enough information to be able to tell

Answer

B. An increasing contribution margin ratio means that there is more of every sales dollar available to pay for fixed costs and give a profit. If there is more of every dollar left for profit, than less sales dollars are required to break even.

3. When fixed cost increases

a. the number of units that must be sold to achieve a target profit increase
b. the amount of sales dollars that must be sold to achieve a target profit decreases
c. the contribution margin increases
d. the variable costs increase proportionately

Answer

A. Contribution margin less fixed costs = profit. When fixed costs increase, contribution margin must increase also to achieve the target profit. Contribution margin increases as units increase.

4. Which cost would not be subtracted from sales to determine contribution margin per unit?

a. direct materials, one required for each unit
b. sales commission based on sales dollars
c. rent on the manufacturing facility
d. labor hours worked are two hours required for each unit at $10 per hour

Answer

C. Contribution margin is calculated: Sales less all variable costs. C. is a fixed cost. All other answers are variable costs because more costs are incurred as one more product is made/sold.

5. The margin of safety would be negative when

a. fixed costs are less than contribution margin
b. the company is currently unprofitable
c. variable costs are less than fixed costs
d. operating leverage is higher than 1.0

Answer

B. A negative margin of safety means that the company is not selling enough units to break even and is unprofitable. When fixed costs are less than contribution margin the company is profitable (a.). Variable costs can be more or less than fixed costs and that is not an indication that the company is not profitable. An operating leverage of more than one indicates the company has earned some level of profit.