381. Note that the profit steadily increases to the right of the break-even point as the sales volume increases and that the loss becomes steadily worse to the left of the break-even point as the sales volume decreases.382. Target profit analysis is one of the key uses of CVP analysis. In target profit analysis, we estimate what sales volume is needed to achieve a specific target profit.383. AAA, with its higher fixed costs and lower variable costs, will experience wider swings in net operating income as sales fluctuate, with greater profits in good years and greater losses in bad years.384. The degree of operating leverage is a measure, at a given level of sales, of how a percentage change in sales volume will affect profits.385. If two companies have the same total revenue and same total expense but different cost structures, then the company with the higher proportion of fixed costs in its cost structure will have higher operating leverage.386. The degree of operating leverage is not a constant; it is greatest at sales levels near the break-even point and decreases as sales and profits rise.387. This explains why management will often work very hard for only a small increase in sales volume.388. If the degree of operating leverage is 5, then a 6% increase in sales would translate into a 30% increase in profits.389. Providing that fixed costs remain constant, maximizing the contribution margin will also maximize the company’s profit.390. Conversely, a shift in the sales mix from low-margin items to high-margin items can cause the reverse effect—total profits may increase even though total sales decrease.391. The degree of operating leverage allows quick estimation of what impact a given percentage change in sales would have on the company’s net operating income.392. Note that the R2 is approximately 0.90, which is quite good and indicates that 90% of the variation in maintenance cost is explained by the variation in patient-days.393. Rather, fixed manufacturing overhead is treated as a period cost and, like selling and administrative expenses, it is reported as an expense on the income statement in its entirety each period.394. The cost of a unit of product under the absorption costing method consists of direct materials, direct labor, and both variable and fixed manufacturing overhead.395. Thus, absorption costing allocates a portion of fixed manufacturing overhead cost to each unit of product, along with the variable manufacturing costs.396. Thus, under absorption and variable costing, variable and fixed selling and administrative expenses are always treated as period costs and are reported as expenses on the income statement as incurred.397. In variable costing, fixed manufacturing overhead costs are considered to be period costs—just like selling and administrative costs—and are taken immediately to the income statement as period expenses.398. This occurs because one aircraft was sold in each month and, as previously mentioned, the selling price per aircraft, variable costs per aircraft, and total monthly fixed expenses remain constant.399. In variable costing, fixed manufacturing overhead is not included in product costs and instead is treated as a period expense just like selling and administrative expenses.400. An absorption costing income statement categorizes costs by function—manufacturing versus selling and administrative.
