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Cost-Volume-Profit Analysis
ANSWERS TO REVIEW QUESTIONS
8-1
fixed expenses
unit contribution margin
= 0
in units expense
in units expenses
sales price
The term unit contribution margin refers to the contribution that each unit of sales
makes toward covering fixed expenses and earning a profit. The unit contribution
margin is defined as the sales price minus the unit variable expense.
8-3
In addition to the break-even point, a CVP graph shows the impact on total expenses,
total revenue, and profit when sales volume changes. The graph shows the sales
volume required to earn a particular target net profit. The firm's profit and loss areas
are also indicated on a CVP graph.
8-4
The safety margin is the amount by which budgeted sales revenue exceeds breakeven sales revenue.
8-5
An increase in the fixed expenses of any enterprise will increase its break-even
point. In a travel agency, more clients must be served before the fixed expenses are
covered by the agency's service fees.
8-6
A decrease in the variable expense per pound of oysters results in an increase in the
contribution margin per pound. This will reduce the company's break-even sales
volume.
McGraw-Hill/Irwin
Managerial Accounting, 6/e
8-7
8-8
When the sales price and unit variable cost increase by the same amount, the unit
contribution margin remains unchanged. Therefore, the firm's break-even point
remains the same.
8-9
The fixed annual donation will offset some of the museum's fixed expenses. The
reduction in net fixed expenses will reduce the museum's break-even point.
8-10
A profit-volume graph shows the profit to be earned at each level of sales volume.
8-11
8-12
McGraw-Hill/Irwin
8-2
8-13
The gross margin is defined as sales revenue minus all variable and fixed
manufacturing expenses. The total contribution margin is defined as sales revenue
minus all variable expenses, including manufacturing, selling, and administrative
expenses.
8-14
East Company, which is highly automated, will have a cost structure dominated by
fixed costs. West Company's cost structure will include a larger proportion of
variable costs than East Company's cost structure.
A firm's operating leverage factor, at a particular sales volume, is defined as its
total contribution margin divided by its net income. Since East Company has
proportionately higher fixed costs, it will have a proportionately higher total
contribution margin. Therefore, East Company's operating leverage factor will be
higher.
8-15
When sales volume increases, Company X will have a higher percentage increase in
profit than Company Y. Company X's higher proportion of fixed costs gives the firm
a higher operating leverage factor. The company's percentage increase in profit can
be found by multiplying the percentage increase in sales volume by the firm's
operating leverage factor.
8-16
The sales mix of a multiproduct organization is the relative proportion of sales of its
products.
The weighted-average unit contribution margin is the average of the unit
contribution margins for a firm's several products, with each product's contribution
margin weighted by the relative proportion of that product's sales.
8-17
The car rental agency's sales mix is the relative proportion of its rental business
associated with each of the three types of automobiles: subcompact, compact, and
full-size. In a multi-product CVP analysis, the sales mix is assumed to be constant
over the relevant range of activity.
8-18
McGraw-Hill/Irwin
Managerial Accounting, 6/e
8-19
8-20
The low-price company must have a larger sales volume than the high-price
company. By spreading its fixed expense across a larger sales volume, the low-price
firm can afford to charge a lower price and still earn the same profit as the high-price
company. Suppose, for example, that companies A and B have the following
expenses, sales prices, sales volumes, and profits.
Company A
Sales revenue:
350 units at $10...............................................
100 units at $20...............................................
Variable expenses:
350 units at $6.................................................
100 units at $6.................................................
Contribution margin .............................................
Fixed expenses.....................................................
Profit ......................................................................
Company B
$3,500
$2,000
2,100
$1,400
1,000
$ 400
600
$1,400
1,000
$ 400
8-21
The statement makes three assertions, but only two of them are true. Thus the
statement is false. A company with an advanced manufacturing environment
typically will have a larger proportion of fixed costs in its cost structure. This will
result in a higher break-even point and greater operating leverage. However, the
firm's higher break-even point will result in a reduced safety margin.
8-22
McGraw-Hill/Irwin
8-4
SOLUTIONS TO EXERCISES
EXERCISE 8-23 (20 MINUTES)
1.
2.
3.
4.
fixed expenses
unit contribution margin
$54,000
= 13,500 pizzas
$10 $6
$10 $6
= .4
$10
Contribution-margin ratio
fixed expenses
contribution-margin ratio
$54,000
= $135,000
.4
Let X denote the sales volume of pizzas required to earn a target net profit of
$60,000.
$10X $6X $54,000 = $60,000
$4X = $114,000
X = 28,500 pizzas
McGraw-Hill/Irwin
Managerial Accounting, 6/e
1
2
3
4
Sales
Revenue
$360,000
55,000
320,000 c
160,000
Variable
Expenses
$120,000
11,000
80,000
130,000
Total
Contribution
Margin
$240,000
44,000
240,000
30,000
Fixed
Expenses
$90,000
25,000
60,000
30,000d
Net
Income
$150,000
19,000
180,000
-0-
Break-Even
Sales
Revenue
$135,000 a
31,250b
80,000
160,000
cBreak-even
$80,000
60,000
$20,000
McGraw-Hill/Irwin
8-6
Cost-volume-profit graph:
$600,000
Total expenses
Break-even point:
20,000 tickets
$500,000
Profit
area
Variable
expense
(at 30,000
tickets)
$400,000
$300,000
Loss area
$200,000
Annual
fixed
expenses
$100,000
5,000
McGraw-Hill/Irwin
Managerial Accounting, 6/e
10,000
15,000
20,000
25,000
Tickets
sold per
30,000 year
Stadium capacity.................................................
Attendance rate ...................................................
Attendance per game..........................................
6,000
2/3
4,000
McGraw-Hill/Irwin
8-8
Profit-volume graph:
$200,000
$100,000
Break-even point:
20,000 tickets
0
$(100,000)
5,000
10,000
15,000
Profit
area
20,000
25,000
Tickets sold
per year
Loss
area
$(200,000)
Annual fixed
expenses
$(300,000)
$(360,000)
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Safety margin:
Budgeted sales revenue
(10 games 6,000 seats .45 full $20) ................................................
Break-even sales revenue
(20,000 tickets $20).................................................................................
Safety margin ...................................................................................................
3.
$540,000
400,000
$140,000
Let P denote the break-even ticket price, assuming a 10-game season and 40 percent
attendance:
(10)(6,000)(.40)P (10)(6,000)(.40)($12) $360,000 = 0
24,000P = $408,000
P = $17 per ticket
McGraw-Hill/Irwin
8-10
fixed costs
unit contribution margin
2,000,000p
= 4,000 components
1,500p 1,000p
p denotes Argentinas peso, worth 1.003 U.S. dollars on the day this exercise was
written.
2.
(2,000,000p ) (1.05)
1,500p 1,000p
2,100,000 p
= 4,200 components
500p
3.
4.
10,500,000p
7,000,000p
3,500,000p
2,000,000p
1,500,000p
2,000,000p
1,400p 1,000p
= 5,000 components
5.
1,400p
11,200,000p
8,000,000p
3,200,000p
2,000,000p
1,200,000p
The price cut should not be made, since projected net income will decline by
300,000p.
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Sales ..........................................................................
Less: Cost of goods sold .........................................
Gross margin ................................................................
Less: Operating expenses:
Selling expenses ............................................
Administrative expenses ...............................
Net income ....................................................................
$1,000,000
750,000
$ 250,000
$75,000
75,000
150,000
$ 100,000
Sales ..........................................................................
Less: Variable expenses:
Variable manufacturing..................................
Variable selling ...............................................
Variable administrative ..................................
Contribution margin.....................................................
Less: Fixed expenses:
Fixed manufacturing ......................................
Fixed selling....................................................
Fixed administrative.......................................
Net income ....................................................................
2.
$1,000,000
$500,000
50,000
15,000
$ 250,000
25,000
60,000
565,000
$ 435,000
335,000
$ 100,000
contribution margin
net income
$435,000
=
= 4.35
$100,000
McGraw-Hill/Irwin
8-12
= 12% 4.35
= 52.2%
4.
Most operating managers prefer the contribution income statement for answering this
type of question. The contribution format highlights the contribution margin and
separates fixed and variable expenses.
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Sales
Price
$1,000
600
Unit
Variable Cost
$600 ($550 + $50)
300 ($270 + $30)
Unit
Contribution Margin
$400
300
Sales mix:
High-quality bicycles..........................................................................................
Medium-quality bicycles ....................................................................................
3.
Weighted-average unit
contribution margin
30%
70%
4.
fixed expenses
weighted - average unit contribution margin
$148,500
=
= 450 bicycles
$330
Bicycle Type
High-quality bicycles
Medium-quality bicycles
Total
5.
Break-Even
Sales Volume
135 (450 .30)
315 (450 .70)
Sales Price
$1,000
600
Sales
Revenue
$135,000
189,000
$324,000
This means that the shop will need to sell the following volume of each type of
bicycle to earn the target net income:
High-quality............................................................................
Medium-quality ......................................................................
McGraw-Hill/Irwin
8-14
Revenue..........................................................
Variable expenses .........................................
Contribution margin ......................................
Fixed expenses..............................................
Net income .....................................................
Amount
$1,500,000
900,000
$600,000
450,000
$ 150,000
Percent
100
60
40
30
10
2.
Decrease in
Revenue
$300,000*
Contribution Margin
Percentage
40%
Decrease in
Net Income
$120,000
= $600,000/$1,500,000
contribution margin
net income
$600,000
=
=4
$150,000
3.
4.
in revenue
factor
= 25% 4
= 100%
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Requirement (1)
$1,875,000
1,125,000
$ 750,000
675,000
$ 75,000
Requirement (2)
$1,500,000
1,800,000
$ (300,000)
350,000
$ (650,000)
1.
2.
3.
4.
A change in the tax rate will have no effect on the firm's break-even point. At the breakeven point, the firm has no profit and does not have to pay any income taxes.
McGraw-Hill/Irwin
8-16
SOLUTIONS TO PROBLEMS
PROBLEM 8-34 (30 MINUTES)
1.
2.
3.
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Let P denote the selling price that will yield the same contribution-margin ratio:
P $13.20 $6.00
$30.00 $12.00 $6.00
=
P
$30.00
P $19.20
.4 =
P
.4P = P $19.20
$19.20 = .6P
P = $19.20/.6
P = $32.00
McGraw-Hill/Irwin
8-18
1.
2.
3.
4.
fixed cost
contribution - margin ratio
$702,000
=
= $3,375,000
$25.00 $19.80
$25.00
fixed costs + target net profit
unit contribution margin
$702,000 + $390,000
=
= 210,000 units
$25.00 $19.80
=
Break-even point =
McGraw-Hill/Irwin
Managerial Accounting, 6/e
$25.00 $19.80
$25.00
= .208
Let P denote sales price required to maintain a contribution-margin ratio of .208. Then
P is determined as follows:
P $8.20 ($4.00)(1.10) $6.00 $1.60
= .208
P
P $20.20 = .208P
.792P = $20.20
P = $25.51 (rounded)
Check:
McGraw-Hill/Irwin
8-20
$1,800,000
$6
= 300,000 units
2.
3.
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Let P denote the selling price that will yield the same contribution-margin ratio:
P $19.50 $3
$24 $15 $3
=
P
$24
P $22.50
.25 =
P
.25P = P $22.50
$22.50 = .75P
P = $22.50/.75
P = $30
McGraw-Hill/Irwin
8-22
$32.00
9.60
$22.40
Model A is more profitable when sales and production average 184,000 units.
Model A
Model B
$5,888,000
$5,888,000
$ 294,400
$ 294,400
1,472,000
$1,766,400
$4,121,600
1,971,200
$2,150,400
1,177,600
$1,472,000
$4,416,000
2,227,200
$2,188,800
4.
McGraw-Hill/Irwin
Managerial Accounting, 6/e
2.
Promotional campaign:
Increase in contribution margin (10%)............................................................
Increase in monthly promotional expenses ($180,000/12)............................
Decrease in operating income .........................................................................
3.
$10,800
(15,000)
$(4,200)
Sales ....................................................................................
Less: variable expenses ....................................................
Contribution margin ...........................................................
Mall Store
Items Sold at
Their
Variable Cost Other Items
$180,000*
$180,000*
180,000
72,000
$
-0$108,000
$(21,600)
18,000
$ (3,600)
*$180,000 is one half of the Mall Store's dollar sales for November 20x4.
McGraw-Hill/Irwin
8-24
Sales mix refers to the relative proportion of each product sold when a company
sells more than one product.
2.
(a)
Yes. Plan A sales are expected to total 65,000 units (19,500 + 45,500), which
compares favorably against current sales of 60,000 units.
(b)
Yes. Sales personnel earn a commission based on gross dollar sales. As the
following figures show, Cold King sales will comprise a greater proportion of
total sales under Plan A. This is not surprising in light of the fact that Cold
King has a higher selling price than Mister Ice Cream ($43 vs. $37).
Current
Units
Mister Ice Cream..........
Cold King......................
Total ........................
(c)
21,000
39,000
60,000
Sales
Mix
35%
65%
100%
Plan A
Units
19,500
45,500
65,000
Sales
Mix
30%
70%
100%
McGraw-Hill/Irwin
Managerial Accounting, 6/e
$ 721,500
1,956,500
$2,678,000
No. The company would be less profitable under the new plan.
Sales revenue:
Mister Ice Cream: 21,000 units x $37; 19,500 units x $37..............
Cold King: 39,000 units x $43; 45,500 units x $43..........................
Total revenue ...............................................................................
Less variable cost:
Mister Ice Cream: 21,000 units x $20.50; 19,500 units x $20.50....
Cold King: 39,000 units x $32.50; 45,500 units x $32.50................
Sales commissions (10% of sales revenue) ...................................
Total variable cost .......................................................................
Contribution margin................................................................................
Less fixed cost (salaries)........................................................................
Net income ...............................................................................................
3.
(a)
Plan A
$ 777,000
1,677,000
$2,454,000
$ 721,500
1,956,500
$2,678,000
$ 430,500
1,267,500
$ 399,750
1,478,750
267,800
$2,146,300
$ 531,700
----___
$ 531,700
$1,698,000
$ 756,000
200,000
$ 556,000
The total units sold under both plans are the same; however, the sales mix
has shifted under Plan B in favor of the more profitable product as judged by
the contribution margin. Cold King has a contribution margin of $10.50
($43.00 - $32.50), and Mister Ice Cream has a contribution margin of $16.50
($37.00 - $20.50).
Plan A
Units
Mister Ice Cream..............
Cold King..........................
Total ............................
McGraw-Hill/Irwin
8-26
Current
19,500
45,500
65,000
Plan B
Sales
Mix
30%
70%
100%
Units
39,000
26,000
65,000
Sales
Mix
60%
40%
100%
Plan B is more attractive both to the sales force and to the company.
Salespeople earn more money under this arrangement ($274,950 vs.
$200,000), and the company is more profitable ($641,550 vs. $556,000).
Sales revenue:
Mister Ice Cream: 21,000 units x $37; 39,000 units x $37 .............
Cold King: 39,000 units x $43; 26,000 units x $43 .........................
Total revenue...............................................................................
Less variable cost:
Mister Ice Cream: 21,000 units x $20.50; 39,000 units x $20.50 ...
Cold King: 39,000 units x $32.50; 26,000 units x $32.50 ...............
Total variable cost ......................................................................
Contribution margin ...............................................................................
Less: Sales force compensation:
Flat salaries .......................................................................................
Commissions ($916,500 x 30%).......................................................
Net income...............................................................................................
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Current
Plan B
$ 777,000
1,677,000
$2,454,000
$1,443,000
1,118,000
$2,561,000
$ 430,500
1,267,500
$1,698,000
$ 756,000
$ 799,500
845,000
$1,644,500
$ 916,500
200,000
$ 556,000
274,950
$ 641,550
Current income:
Sales revenue...
Less: Variable costs $1,008,000
Fixed costs. 2,736,000
Net income.
$4,032,000
3,744,000
$ 288,000
If operations are shifted to Mexico, the new unit contribution margin will be $74.40
($96.00 - $21.60). Thus:
Break-even point = fixed costs unit contribution margin
= $2,380,800 $74.40
= 32,000 units
3.
(a)
CompTronics desires to have a 32,000-unit break-even point with a $72 unit
contribution margin. Fixed costs must therefore drop by $432,000 ($2,736,000 $2,304,000), as follows:
Let X = fixed costs
X $72 = 32,000 units
X = $2,304,000
(b)
McGraw-Hill/Irwin
8-28
(a)
Increase
(b)
No effect
(c)
Increase
(d)
No effect
(b)
(c)
Standard model:
Break - even volume =
$16,000
= 25,000 tubs
$3.50 $2.86
$22,000
= 27,500 tubs
$3.50 $2.70
$40,000
= 40,816 tubs (rounded)
$3.50 $2.52
Super model:
Giant model:
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Profit
$40
$20
Break-even point:
40,816 tubs
0
10
20
30
40
Profit
area
50
Tubs sold
per year
(in thousands)
Loss
Loss
area
($20)
($40)
McGraw-Hill/Irwin
8-30
The sales price per tub is the same regardless of the type of machine selected.
Therefore, the same profit (or loss) will be achieved with the Standard and Super
models at the sales volume, X, where the total costs are the same.
Model
Standard .....................................................
Super...........................................................
Variable Cost
per Tub
$2.86
2.70
Total
Fixed Cost
$16,000
22,000
This reasoning leads to the following equation: 16,000 + 2.86X = 22,000 + 2.70X
Rearranging terms yields the following:
Check: the total cost is the same with either model if 37,500 tubs are sold.
Standard
Variable cost:
Standard, 37,500 $2.86...........................
Super, 37,500 $2.70 ................................
Fixed cost:
Standard, $16,000 ......................................
Super, $22,000............................................
Total cost..........................................................
Super
$107,250
$101,250
16,000
$123,250
22,000
$123,250
Since the sales price for popcorn does not depend on the popper model, the sales
revenue will be the same under either alternative.
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Total revenue
Dollars per year
(in millions)
20
18
Profit
area
Break-even point:
80,000 units or
$8,000,000 of sales
16
14
Total expenses
12
10
8
6
4
Loss
area
Fixed expenses
2
50
McGraw-Hill/Irwin
8-32
100
150
200
Break-even point:
contribution margin $12,000,000
=
= .75
sales
$16,000,000
fixed expenses
$6,000,000
Break - even point =
=
contribution - margin ratio
.75
= $8,000,000
3.
4.
5.
6.
Cost structure:
Sales revenue........................................................
Variable expenses ................................................
Contribution margin .............................................
Fixed expenses .....................................................
Net income ............................................................
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Amount
$16,000,000
4,000,000
$12,000,000
6,000,000
$ 6,000,000
Percent
100.0
25.0
75.0
37.5
37.5
2.
Operating leverage refers to the use of fixed costs in an organizations overall cost
structure. An organization that has a relatively high proportion of fixed costs and
low proportion of variable costs has a high degree of operating leverage.
McGraw-Hill/Irwin
8-34
Plan A
Plan B
$720,000
$720,000
$450,000
72,000
$522,000
$198,000
33,000
$165,000
$450,000
----__
$450,000
$270,000
99,000
$171,000
Plan A has a higher percentage of variable costs to sales (72.5%) compared to Plan
B (62.5%). Plan Bs fixed costs are 13.75% of sales, compared to Plan As 4.58%.
Operating leverage factor = contribution margin net income
Plan A: $198,000 $165,000 = 1.2
Plan B: $270,000 $171,000 = 1.58 (rounded)
Plan B has the higher degree of operating leverage.
4 & 5. Calculation of profit at 5,000 units:
Sales revenue: 5,000 units x $120.
Less variable costs:
Cost of purchasing product:
5,000 units x $75..
Sales commissions: $600,000 x 10%...
Total variable cost..
Contribution margin
Fixed costs
Net income.
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Plan A
Plan B
$600,000
$600,000
$375,000
60,000
$435,000
$165,000
33,000
$132,000
$375,000
---- __
$375,000
$225,000
99,000
$126,000
McGraw-Hill/Irwin
8-36
fixed costs
unit contribution margin
LaborIntensive
Production
System
$45.00
$8.40
10.80
7.20
3.00
29.40
$15.60
ComputerAssisted
Manufacturing
System
$45.00
$7.50
9.00
4.50
3.00
24.00
$21.00
(b)
McGraw-Hill/Irwin
Managerial Accounting, 6/e
$24X + $4,410,000
$5.40X =
$1,680,000
X =
311,111 units*
*Rounded
3.
Operating leverage is the extent to which a firm's operations employ fixed operating
costs. The greater the proportion of fixed costs used to produce a product, the
greater the degree of operating leverage. Thus, the computer-assisted
manufacturing method utilizes a greater degree of operating leverage.
The greater the degree of operating leverage, the greater the change in
operating income (loss) relative to a small fluctuation in sales volume. Thus, there
is a higher degree of variability in operating income if operating leverage is high.
4.
5.
Zodiacs management should consider many other business factors other than
operating leverage before selecting a manufacturing method. Among these are:
McGraw-Hill/Irwin
8-38
In order to break even, during the first year of operations, 10,220 clients must visit the
law office being considered by Steven Clark and his colleagues, as the following
calculations show.
Fixed expenses:
Advertising................................................................................
$ 980,000
Rent (6,000 $56).....................................................................
336,000
Property insurance...................................................................
54,000
Utilities ......................................................................................
74,000
Malpractice insurance..............................................................
360,000
Depreciation ($120,000/4) ........................................................
30,000
Wages and fringe benefits:
Regular wages
($50 + $40 + $30 + $20) 16 hours 360 days ......... $806,400
Overtime wages
(200 $30 1.5) + (200 $20 1.5) ..........................
15,000
Total wages............................................................. $821,400
Fringe benefits at 40% ....................................................... 328,560 1,149,960
Total fixed expenses ......................................................................
$2,983,960
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Safety margin:
Safety margin = budgeted sales revenue break-even sales revenue
Budgeted (expected) number of clients = 50 360 = 18,000
Break-even number of clients = 10,220 (rounded)
Safety margin = [($60 18,000) + ($4,000 18,000 .20 .30)]
[($60 10,220) + ($4,000 10,220 .20 .30)]
= [$60 + ($4,000 .20 .30)] (18,000 10,220)
= $300 7,780
= $2,334,000
McGraw-Hill/Irwin
8-40
$1,250,000 $750,000
25,000 units
2.
3.
fixed costs
unit contribution margin
$300,000
= 15,000 units
$20
$300,000 + $280,000
= 29,000 units
$20
4.
McGraw-Hill/Irwin
Managerial Accounting, 6/e
5.
= .40
= .40P
= $34
= $56.67 (rounded)
in direct-material cost = $4
Check:
$56.67 $30 $4
$56.67
= .40 (rounded)
McGraw-Hill/Irwin
8-42
Memorandum
Date:
Today
To:
From:
Subject:
Activity-Based Costing
The $300,000 cost that has been characterized as fixed is fixed with respect to sales
volume. This cost will not increase with increases in sales volume. However, as the activitybased costing analysis demonstrates, these costs are not fixed with respect to other
important cost drivers. This is the difference between a traditional costing system and an
ABC system. The latter recognizes that costs vary with respect to a variety of cost drivers,
not just sales volume.
2.
$52
24
$28
$ 30,000
44,800
9,000
332,200
$416,000
60,000
$476,000
fixed costs
unit contribution margin
$476,000
$28
= 17,000 units
McGraw-Hill/Irwin
Managerial Accounting, 6/e
4.
Its break-even point will be higher (17,000 units instead of 15,000 units).
(b)
The number of sales units required to show a profit of $280,000 will be lower
(27,000 units instead of 29,000 units).
(c)
These results are typical of situations where firms adopt advanced manufacturing
equipment and practices. The break-even point increases because of the
increased fixed costs due to the large investment in equipment. However, at
higher levels of sales after fixed costs have been covered, the larger unit
contribution margin ($28 instead of $20) earns a profit at a faster rate. This results
in the firm needing to sell fewer units to reach a given target profit level.
McGraw-Hill/Irwin
8-44
The controller should include the break-even analysis in the report. The Board of
Directors needs a complete picture of the financial implications of the proposed
equipment acquisition. The break-even point is a relevant piece of information. The
controller should accompany the break-even analysis with an explanation as to
why the break-even point will increase. It would also be appropriate for the
controller to point out in the report that the advanced manufacturing equipment
would require fewer sales units at higher volumes in order to achieve a given
target profit, as in requirement (3) of this problem.
To withhold the break-even analysis from the controller's report would be a
violation of the following ethical standards:
(a)
(b)
(c)
McGraw-Hill/Irwin
Managerial Accounting, 6/e
$810,000
= $450 per ton
1,800
fixed costs
unit contribution margin
2.
$495,000
= 1,100 tons
$450
3.
$945,000
495,000
$450,000
Sales in tons......................................................................
Contribution margin per ton:
Foreign order ($900 $550) .......................................
Regular sales ($1,000 $550)....................................
Total contribution margin ................................................
Foreign
Order
1,500
$350
$525,000
McGraw-Hill/Irwin
8-46
Regular
Sales
1,500
$450
$675,000
$ 525,000
675,000
$1,200,000
495,000
$ 705,000
5.
$495,000 + $117,000
$450 + $50
$612,000
= 1,224 tons
$500
Break - even point in sales dollars = 1,224 tons $1,000 per ton
= $1,224,000
6.
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Hedge
Clippers
$84
$39
15
$54
$30
50,000
$1,500,000
Line
Trimmers
$108
$ 36
12
$ 48
$ 60
50,000
$3,000,000
Leaf Blowers
$144
$ 75
18
$ 93
$ 51
100,000
$5,100,000
Total
$9,600,000
$6,000,000
1,800,000
$7,800,000
$1,800,000
720,000
$1,080,000
2.
(a)
Unit
Contribution
Hedge Clippers ..........................................
$30
Line Trimmers............................................
60
51
Leaf Blowers ..............................................
Weighted-average unit
contribution margin.............................
(b)
Sales
Proportion
.25
.25
.50
(a) (b)
$ 7.50
15.00
25.50
$48.00
McGraw-Hill/Irwin
8-48
Sales
Proportion
.25
.25
.50
3.
(a)
(b)
Unit
Sales
Contribution Proportion
Hedge Clippers .................................................
$30
.20
Line Trimmers*..................................................
57
.20
36
.60
Leaf Blowers ....................................................
Weighted-average unit contribution margin..
(a) (b)
$ 6.00
11.40
21.60
$39.00
Sales proportions:
Sales
Proportions
Hedge Clippers................................................
.20
Line Trimmers .................................................
.20
.60
Leaf Blowers....................................................
Total..................................................................
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Total Unit
Sales
200,000
200,000
200,000
Product Line
Sales
40,000
40,000
120,000
200,000
(a)
fixed costs
unit contribution margin
$420,000
= 70,000 units
$6
(b)
=
Break - even point (in sales dollars) =
=
2.
contribution margin
sales revenue
$2,000,000 $1,400,000
= .3
$2,000,000
fixed costs
contribution - margin ratio
$420,000
= $1,400,000
.3
target after - tax net income
(1 t )
unit contribution margin
fixed costs +
=
$180,000
$720,000
(1 .4)
=
$6
$6
$420,000 +
=
= 120,000 units
3.
McGraw-Hill/Irwin
8-50
$420,000 + $63,000
= 80,500 units
$6
$1,000,000
$500,000
Break-even point:
70,000 units
Loss 25,000
area
50,000
75,000
Profit
area
100,000
Units sold
per year
$(500,000)
$(1,000,000)
$(1,500,000)
McGraw-Hill/Irwin
Managerial Accounting, 6/e
fixed costs +
=
$420,000 +
=
$180,000
(1 .5)
$6
$780,000
$6
= 130,000 units
McGraw-Hill/Irwin
8-52
2.
$120.00 $79.20
= .34
$120.00
target after - tax net income
(1 t)
unit contribution margin
fixed expenses +
$33,120
(1 .40) $530,400
X=
=
$120.00 $79.20
$40.80
$475,200 +
X = 13,000 units
3.
$554,400
= 10,500 units
$132.00 $79.20
Let Y denote the variable cost of the mountaineering model such that the break-even
point for the mountaineering model is 10,500 units.
Then we have:
$475,200
$120.00 Y
(10,500) ($120.00 Y ) = $475,200
10,500 =
Y = $74.74 (rounded)
Thus, the variable cost per unit would have to decrease by $4.46 ($79.20 $74.74).
McGraw-Hill/Irwin
Managerial Accounting, 6/e
4.
5.
Weighted-average unit
contribution margin
Break-even point
SUMMARY OF EXPENSES
Manufacturing ....................................................................
Selling and administrative.................................................
Interest ................................................................................
Costs from budgeted income statement.....................
If the company employs its own sales force:
Additional sales force costs .........................................
Reduced commissions [(.15 .10) $24,000] ............
Costs with own sales force...............................................
If the company sells through agents:
Deduct cost of sales force ............................................
Increased commissions [(.225 .10) $24,000].........
Costs with agents paid increased commissions............
McGraw-Hill/Irwin
8-54
$10,800
(3,600)
3,000
$ 16,200
$7,200
(a)
$14,400,000
$24,000,000
= 1 .60
= .40
$7,200,000
.40
= $18,000,000
(b)
2.
$13,200,000
$24,000,000
= 1 .55
= .45
$10,800,000
Break - even sales dollars =
.45
= $24,000,000
Contribution margin ratio = 1
$7,200,000 + $2,400,000
.325
$9,600,000
=
.325
= $29,538,462 (rounded)
McGraw-Hill/Irwin
Managerial Accounting, 6/e
The volume in sales dollars (X) that would result in equal net income is the volume
of sales dollars where total expenses are equal.
Total expenses with agents paid
increased commission
$16,200,000
$13,200,000
X + $7,200,000 =
X + $10,800,000
$24,000,000
$24,000,000
.675 X + $7,200,000 = .55 X + $10,800,000
.125 X = $3,600,000
X = $28,800,000
Therefore, at a sales volume of $28,800,000, the company will earn equal before-tax
income under either alternative. Since before-tax income is the same, so is after-tax
net income.
McGraw-Hill/Irwin
8-56
a. In order to break even, Columbus Canopy Company must sell 500 units. This
amount represents the point where revenue equals total costs.
Revenue = variable costs + fixed costs
$800X = $400X + $200,000
$400X = $200,000
X = 500 units
To achieve its annual after-tax profit objective, management should select the first
alternative, where the sales price is reduced by $80 and 2,700 units are sold during
the remainder of the year. This alternative results in the highest profit and is the
only alternative that equals or exceeds the companys profit objective. Calculations
for the three alternatives follow.
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Alternative (2):
Re venue = ($800)(350) + ($740)( 2,200)
= $1,908,000
Variable cost = ($400)(350) ($350)( 2,200)
= $910,000
Before - tax profit = $1,908,000 $910,000 $200,000
= $798,000
After - tax profit = $798,000 (1 .4)
= $478,800
Alternative (3):
Re venue = ($800)(350) + ($760)( 2,000)
= $1,800,000
Variable cost = $400 2,350
= $940,000
Before - tax profit = $1,800,000 $940,000 $180,000
= $680,000
After - tax profit = $680,000 (1 .4)
= $408,000
McGraw-Hill/Irwin
8-58
SOLUTIONS TO CASES
CASE 8-54 (50 MINUTES)
1.
$3,480,000
120,000
240,000
216,000
$4,056,000
$360
120
$240
Break-even point
in patient-days
McGraw-Hill/Irwin
Managerial Accounting, 6/e
Increase in revenue
(20 additional beds 90 days $360 charge per day) ....................................
$ 648,000
Increase in expenses:
Variable charges by medical center
(20 additional beds 90 days $120 per day) ............................................
$ 216,000
1,160,000
Salaries
(20,000 patient-days before additional 20 beds + 20 additional
beds 90 days = 21,800, which does not exceed 22,000 patient-days;
therefore, no additional personnel are required) .........................................
Total increase in expenses......................................................................................
Net change in earnings from rental of additional 20 beds ...................................
-0$1,376,000
$ (728,000)
McGraw-Hill/Irwin
8-60
2.
$
$
150,000
135,000
240,000
525,000
$15,000,000
9,000,000
$ 6,000,000
750,000
$ 5,250,000
$5,250,000
= .35
$15,000,000
fixed expenses
contribution - margin ratio
$525,000
=
= $1,500,000
.35
McGraw-Hill/Irwin
Managerial Accounting, 6/e
$15,000,000
9,000,000
$ 6,000,000
3,750,000
$ 2,250,000
$2,250,000
= .15
$15,000,000
target after - tax net income
(1 t )
contribution - margin ratio
fixed expenses +
=
$1,995,000
$3,000,000
(1 .3)
=
=
.15
.15
= $20,000,000
$150,000 +
Check:
Sales .....................................................................
Cost of goods sold (60% of sales).....................
Gross margin .......................................................
Selling and administrative expenses:
Commissions.................................................
All other expenses (fixed) ............................
Income before taxes............................................
Income tax expense (30%)..................................
Net income ...........................................................
McGraw-Hill/Irwin
8-62
$ 20,000,000
12,000,000
$ 8,000,000
$ 5,000,000
150,000
5,150,000
$ 2,850,000
855,000
$ 1,995,000
Thus, the company will have the same before-tax income under the two alternatives
if the sales volume is $1,875,000.
Check:
Sales ..............................................................................
Cost of goods sold (60% of sales)..............................
Gross margin ................................................................
Selling and administrative expenses:
Commissions............................................................
All other expenses (fixed)........................................
Income before taxes.....................................................
Income tax expense (30%)...........................................
Net income ....................................................................
Alternatives
Employ
Sales
Pay 25%
Personnel
Commission
$1,875,000
$1,875,000
1,125,000
1,125,000
$ 750,000
$ 750,000
93,750*
525,000
$ 131,250
39,375
$ 91,875
468,750
150,000
$ 131,250
39,375
$ 91,875
*$1,875,000 5% = $93,750
$1,875,000 25% = $468,750
McGraw-Hill/Irwin
Managerial Accounting, 6/e
ISSUE 8-58
ITS TIME TO CASH IN SOME CHIPS, BIG BLUE, BUSINESS WEEK, JUNE 3, 2002, P. 43,
SPENCER E. ANTE.
The cost structure is the relative proportion of fixed to variable costs. Because
semiconductor manufacturing requires capital-intensive, high-technology, equipment, it
is characterized by very high fixed costs. In organizations like these, profit is very
sensitive to changes in volume. For this reason, analysts are concerned that IBM
should be making significant efforts to reduce fixed costs (by shutting down
manufacturing lines) rather than making minor adjustments to labor levels.
ISSUE 8-59
"RELIANCE GROUP MAY SEE SHIELD FROM CREDITORS," THE WALL STREET JOURNAL,
AUGUST 15, 2000, DEVON SPURGON, GREGORY ZUCKERMAN, AND FRANCINE L. POPE.
Managers apply operating leverage to convert small changes in sales into large changes
in a firms profitability. Fixed costs are the lever that managers use to take a small
increase in sales and obtain a much larger increase in net income. Having a cost
structure with relatively high fixed costs provides rewards and risks to a firm. With a
high degree of operating leverage, each additional sale decreases the average cost per
unit. Each dollar of revenue becomes pure profit once the fixed costs are covered. This
is beneficial if sales are increasing; however, the reverse is true if sales are decreasing.
With decreasing sales, the fixed costs do not decrease, and profit declines significantly
more than revenue.
In the article, high operating leverage was not working to benefit Reliance Group
Holdings, Inc. Consequently, its stock rating was downgraded.
ISSUE 8-60
LEVI WILL CUT 20% OF WORK FORCE, SHUT SIX PLANTS IN RESTRUCTURING, THE
WALL STREET JOURNAL, APRIL 9, 2002, TERI AGINS.
The cost structure is the relative proportion of fixed to variable costs. Outsourcing can
lead to lower fixed costs, if it enables a company to divest of fixed assets (such as plant
and equipment) or eliminate salaried personnel (such as department supervisors). As
fixed costs are reduced, the company moves toward a cost structure with a larger
proportion of variable costs.
McGraw-Hill/Irwin
Managerial Accounting, 6/e