Solution Manual08

CHAPTER 1

CHAPTER 8

Cost-Volume-Profit Analysis

Answers to Review Questions

8-1 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.

8-2In 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.

8-3a.In the contribution-margin approach, the break-even point in units is calculated using the following formula:

b. In the equation approach, the following profit equation is used:

fixed expenses

This equation is solved for the sales volume in units.

c.In the graphical approach, sales revenue and total expenses are graphed. The break-even point occurs at the intersection of the total revenue and total expense lines.

8-4The safety margin is the amount by which budgeted sales revenue exceeds break-even sales revenue.

8-5An 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.

8-6A 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.

8-7The president is correct. A price increase results in a higher unit contribution margin. An increase in the unit contribution margin causes the break-even point to decline.

The financial vice president's reasoning is flawed. Even though the break-even point will be lower, the price increase will not necessarily reduce the likelihood of a loss. Customers will probably be less likely to buy the product at a higher price. Thus, the firm may be less likely to meet the lower break-even point (at a high price) than the higher break-even point (at a low price).

8-8When 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.

8-9The 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.

8-10A profit-volume graph shows the profit to be earned at each level of sales volume.

8-11The most important assumptions of a cost-volume-profit analysis are as follows:

(a)The behavior of total revenue is linear (straight line) over the relevant range. This behavior implies that the price of the product or service will not change as sales volume varies within the relevant range.

(b)The behavior of total expenses is linear (straight line) over the relevant range. This behavior implies the following more specific assumptions:

(1)Expenses can be categorized as fixed, variable, or semivariable.

(2)Efficiency and productivity are constant.

(c)In multiproduct organizations, the sales mix remains constant over the relevant range.

(d)In manufacturing firms, the inventory levels at the beginning and end of the period are the same.

8-12Operating managers frequently prefer the contribution income statement because it separates fixed and variable costs. This format makes cost-volume-profit relationships more readily discernible.

8-13The 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.

8-14East 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.

8-15When 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.

8-16The 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.

8-17The 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.

8-18Cost-volume-profit analysis shows the effect on profit of changes in expenses, sales prices, and sales mix. A change in the hotel's room rate (price) will change the hotel's unit contribution margin. This contribution-margin change will alter the relationship between volume and profit.

8-19Budgeting begins with a sales forecast. Cost-volume-profit analysis can be used to determine the profit that will be achieved at the budgeted sales volume. A CVP analysis also shows how profit will change if the sales volume deviates from budgeted sales.

Cost-volume-profit analysis can be used to show the effect on profit when variable or fixed expenses change. The effect on profit of changes in variable or fixed advertising expenses is one factor that management would consider in making a decision about advertising.

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 ACompany B

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

$3,500

2,100

$1,400

1,000

$ 400

$2,000

600

$1,400

1,000

$ 400

8-21The 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.

8-22Activity-based costing (ABC) results in a richer description of an organization's cost behavior and CVP relationships. Costs that are fixed with respect to sales volume may not be fixed with respect to other important cost drivers. An ABC system recognizes these nonvolume cost drivers, whereas a traditional costing system does not.

Solutions to exercises

Exercise 8-23 (25 minutes)

Sales Revenue

Variable ExpensesTotal Contribution Margin

Fixed Expenses

Net IncomeBreak-even Sales Revenue

1$160,000a$40,000$120,000$30,000$90,000$40,000

2 80,000 65,000 15,000 15,000b -0- 80,000

3 120,000 40,000 80,000 30,000 50,000 45,000c

4 110,000 22,000 88,000 50,000 38,000 62,500d

Explanatory notes for selected items:

aBreak-even sales revenue

$40,000

Fixed expenses

30,000

Variable expenses

$10,000

Therefore, variable expenses are 25 percent of sales revenue.

When variable expenses amount to $40,000, sales revenue is $160,000.

b$80,000 is the break-even sales revenue, so fixed expenses must be equal to the contribution margin of $15,000 and profit must be zero.

c$45,000 = $30,000 ( (2/3), where 2/3 is the contribution-margin ratio.

d$62,500 = $50,000/.80, where .80 is the contribution-margin ratio.


1.Break-even point (in units)=

= = 8,000 pizzas

2.Contribution-margin ratio=

= = .5

Exercise 8-24 (continued)

3.Break-even point (in sales dollars)=

= = $80,000

4.Let X denote the sales volume of pizzas required to earn a target net profit of $65,000.

$10X $5X $40,000= $65,000

$5X= $105,000

X= 21,000 pizzas

Exercise 8-25 (25 minutes) 1.Break-even point (in units)=

= = 4,000 components

p denotes Argentinas peso, worth 1.004 U.S. dollars on the day this exercise was written.

2.New break-even point (in units)=

== 4,400 components

3.Sales revenue (5,000 ( 3,000p)

15,000,000pVariable costs (5,000 ( 2,000p)

10,000,000pContribution margin

5,000,000pFixed costs

4,000,000pNet income

1,000,000pexercise 8-25 (continued)

4. New break-even point (in units) =

= 8,000 components

5.Analysis of price change decision:

Price

3,000p2,500p

Sales revenue:(5,000 ( 3,000p)

(6,200 ( 2,500p)

Variable costs:(5,000 ( 2,000p)

(6,200 ( 2,000p)

Contribution margin

Fixed expenses

Net income (loss)

15,000,000p

10,000,000p

5,000,000p

4,000,000p

1,000,000p

15,500,000p

12,400,000p 3,100,000p 4,000,000p (900,000p)

The price cut should not be made, since projected net income will decline.


1.Cost-volume-profit graph:

exercise 8-26 (continued)

2.Stadium capacity

10,000

Attendance rate

( 50%Attendance per game

5,000

The team must play 4 games to break even.


1. Profit-volume graph:

Exercise 8-27 (Continued)

2.Safety margin:

Budgeted sales revenue

(12 games ( 10,000 seats ( .30 full ( $10)

$360,000

Break-even sales revenue

(20,000 tickets ( $10)

200,000

Safety margin

$160,000

3.Let P denote the break-even ticket price, assuming a 12-game season and 50 percent attendance:

(12)(10,000)(.50)P (12)(10,000)(.50)($1) $180,000=0

60,000P =$240,000

P =$4 per ticket


1.(a)Traditional income statement:

Europa Publications, Inc.Income StatementFor the Year Ended December 31, 20xx

Sales

$2,000,000

Less:Cost of goods sold

1,500,000

Gross margin

$ 500,000

Less:Operating expenses:

Selling expenses

$150,000

Administrative expenses

150,000 300,000

Net income

$ 200,000(b)Contribution income statement:

Europa Publications, Inc.Income StatementFor the Year Ended December 31, 20sxx

Sales

$2,000,000

Less:Variable expenses:

Variable manufacturing

$1,000,000

Variable selling

100,000

Variable administrative

30,000 1,130,000

Contribution margin

$ 870,000

Less:Fixed expenses:

Fixed manufacturing

$ 500,000

Fixed selling

50,000

Fixed administrative

120,000 670,000

Net income

$ 200,0002.

exercise 8-28 (continued)

3.

= 10% ( 4.35

= 43.5%

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.


1.

Bicycle TypeSales PriceUnit Variable CostUnit Contribution Margin

High-quality$500

$300 ($275 + $25)$200

Medium-quality300

150 ($135 + $15)150

2.Sales mix:

High-quality bicycles

25%

Medium-quality bicycles

75%

3.Weighted-average unit contribution margin= ($200 ( 25%) + ($150 ( 75%)

= $162.50

4.

Bicycle TypeBreak-Even Sales VolumeSales PriceSales Revenue

High-quality bicycles100 (400 ( .25)$500

$ 50,000

Medium-quality bicycles300 (400 ( .75)300

90,000

Total

$140,000


5.Target net income:

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

175 (700 ( .25)

Medium-quality

525 (700 ( .75)

EXERCISE 8-30 (30 MINUTES)

Answers will vary on this question, depending on the airline selected as well as the year of the inquiry. In a typical year, most airlines report a breakeven load factor of around 65 percent.Exercise 8-31 (25 minutes)

1.The following income statement, often called a common-size income statement, provides a convenient way to show the cost structure.

AmountPercent

Revenue

$500,000

100

Variable expenses

300,000

60

Contribution margin

$200,000

40

Fixed expenses

150,000

30

Net income

$ 50,000

10

2.

Decrease in Revenue

Contribution Margin Percentage

Decrease inNet Income

$75,000*(40%=$30,000

*$75,000 = $500,000 ( 15%

40% = $200,000/$500,000

Exercise 8-31 (Continued)

3.

4.


Requirement (1)Requirement (2)

Revenue

$600,000

$500,000

Less:Variable expenses

360,000

600,000

Contribution margin

$240,000

$(100,000)

Less:Fixed expenses

210,000

125,000

Net Income (loss)

$30,000

$(225,000)


1.

2.


3.Service revenue required to earn target after-tax income of $48,000

4.A change in the tax rate will have no effect on the firm's break-even point. At the break-even point, the firm has no profit and does not have to pay any income taxes.

solutions to Problems

Problem 8-34 (30 minutes)

1.Break-even point in units, using the equation approach:

$16X ($10 + $2)X $600,000=0

$4X=$600,000

X=

=150,000 units

2.New projected sales volume=200,000 ( 110%

=220,000 units

Net income=(220,000)($16 $12) $600,000

=(220,000)($4) $600,000

=$880,000 $600,000 = $280,000

3.Target net income = $200,000 (from original problem data)

New disk purchase price = $10 ( 130% = $13

Volume of sales dollars required:

Volume of sales dollars required

Problem 8-34 (Continued)

4.Let P denote the selling price that will yield the same contribution-margin ratio:

Check: New contribution-margin ratio is:


1.Break-even point in sales dollars, using the contribution-margin ratio:

2.Target net income, using contribution-margin approach:

Problem 8-35 (continued)

3.New unit variable manufacturing cost= $8 ( 110%

= $8.80

Break-even point in sales dollars:

4.Let P denote the selling price that will yield the same contribution-margin ratio:

Check: New contribution-margin ratio is:

PROBLEM 8-36 (30 MINUTES)1. Unit contribution margin:

Sales price

$64.00

Less variable costs:

Sales commissions ($64 x 5%)$ 3.20

System variable costs 16.00 19.20

Unit contribution margin..

$44.80

Break-even point = fixed costs unit contribution margin

= $985,600 $44.80

= 22,000 units

2. Model no. 4399 is more profitable when sales and production average 46,000 units.

ModelModel

No. 6754No. 4399

Sales revenue (46,000 units x $64.00)...$2,944,000$2,944,000


Sales commissions ($2,944,000 x 5%)$ 147,200$ 147,200

System variable costs:

46,000 units x $16.00. 736,000

46,000 units x $12.80.

588,800

Total variable costs..$ 883,200$ 736,000

Contribution margin...$2,060,800$2,208,000

Less: Annual fixed costs.. 985,600 1,113,600

Net income$1,075,200$1,094,400

3. Annual fixed costs will increase by $90,000 ($450,000 5 years) because of straight-line depreciation associated with the new equipment, to $1,203,600 ($1,113,600 + $90,000). The unit contribution margin is $48 ($2,208,000 46,000 units). Thus:

Required sales = (fixed costs + target net profit) unit contribution margin

= ($1,203,600 + $956,400) $48

= 45,000 units

4. Let X = volume level at which annual total costs are equal

$16.00X + $985,600 = $12.80X + $1,113,600

$3.20X = $128,000

X = 40,000 units

PROBLEM 8-37 (35 MINUTES)

1. Current income:

Sales revenue...

$3,360,000

Less: Variable costs$ 840,000

Fixed costs. 2,280,000 3,120,000

Net income.

$ 240,000

Advanced Electronics has a contribution margin of $60 [($3,360,000 - $840,000) 42,000 sets] and desires to increase income to $480,000 ($240,000 x 2). In addition, the current selling price is $80 ($3,360,000 42,000 sets). Thus:

Required sales = (fixed costs + target net profit) unit contribution margin

= ($2,280,000 + $480,000) $60

= 46,000 sets, or $3,680,000 (46,000 sets x $80)

2. If operations are shifted to Mexico, the new unit contribution margin will be $62 ($80 - $18). Thus:

Break-even point = fixed costs unit contribution margin

= $1,984,000 $62

= 32,000 units

3.(a)Advanced Electronics desires to have a 32,000-unit break-even point with a $60 unit contribution margin. Fixed cost must therefore drop by $360,000 ($2,280,000 - $1,920,000), as follows:

Let X = fixed costs

X $60 = 32,000 units

X = $1,920,000

(b)As the following calculations show, Advanced Electronics will have to generate a contribution margin of $71.25 to produce a 32,000-unit break-even point. Based on an $80.00 selling price, this means that the company can incur variable costs of only $8.75 per unit. Given the current variable cost of $20.00 ($80.00 - $60.00), a decrease of $11.25 per unit ($20.00 - $8.75) is needed.

Let X = unit contribution margin

$2,280,000 X = 32,000 units

X = $71.25

PROBLEM 8-37 (CONTINUED

4.(a)Increase

(b) No effect

(c) Increase

(d) No effect


1. 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 (45,500 + 19,500), 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, Deluxe sales will comprise a greater proportion of total sales under Plan A. This is not surprising in light of the fact that Deluxe has a higher selling price than Basic ($86 vs. $74).

CurrentPlan A

UnitsSales MixUnitsSales Mix

Deluxe...39,000 65%45,500 70%

Basic.21,000 35%19,500 30%

Total60,000100%65,000100%

(c) Yes. Commissions will total $535,600 ($5,356,000 x 10%), which compares favorably against the current flat salaries of $400,000.

Deluxe sales: 45,500 units x $86$3,913,000

Basic sales: 19,500 units x $74.. 1,443,000

Total.$5,356,000

PROBLEM 8-38 (CONTINUED)

(d) No. The company would be less profitable under the new plan.

CurrentPlan A

Sales revenue:

Deluxe: 39,000 units x $86; 45,500 units x $86$3,354,000$3,913,000

Basic: 21,000 units x $74; 19,500 units x $74.. 1,554,000 1,443,000

Total revenue.$4,908,000$5,356,000

Less variable cost:


Basic: 21,000 units x $41; 19,500 units x $41.. 861,000 799,500

Sales commissions (10% of sales revenue).

535,600

Total variable cost$3,396,000$4,292,600

Contribution margin..$1,512,000$1,063,400

Less fixed cost (salaries). 400,000 ----

Net income...$1,112,000$1,063,400

3.(a)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. Deluxe has a contribution margin of $21 ($86 - $65), and Basic has a contribution margin of $33 ($74 - $41).

Plan APlan B

UnitsSales MixUnitsSales Mix

Deluxe...45,500 70%26,000 40%

Basic.19,500 30%39,000 60%

Total65,000100%65,000100%


(b)Plan B is more attractive both to the sales force and to the company. Salespeople earn more money under this arrangement ($549,900 vs. $400,000) and the company is more profitable ($1,283,100 vs. $1,112,000).

CurrentPlan B

Sales revenue:


Basic: 21,000 units x $74; 39,000 units x $74.. 1,554,000 2,886,000

Total revenue.$4,908,000$5,122,000

Less variable cost:


Basic: 21,000 units x $41; 39,000 units x $41.. 861,000 1,599,000

Total variable cost$3,396,000$3,289,000

Contribution margin..$1,512,000$1,833,000

Less: Sales force compensation:

Flat salaries... 400,000

Commissions ($1,833,000 x 30%)

549,900

Net income ..$1,112,000$1,283,100


1.Plan A break-even point = fixed costs unit contribution margin

= $22,000 $22*

= 1,000 units

Plan B break-even point = fixed costs unit contribution margin

= $66,000 $30**

= 2,200 units

* $80 - [($80 x 10%) + $50]

** $80 - $50

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.


3. Calculation of contribution margin and profit at 6,000 units of sales:

Plan APlan B

Sales revenue: 6,000 units x $80.$480,000$480,000


Cost of purchasing product:

6,000 units x $50.$300,000$300,000

Sales commissions: $480,000 x 10%... 48,000 ----

Total variable cost..$348,000$300,000

Contribution margin$132,000$180,000

Fixed costs. 22,000 66,000

Net income.$110,000$114,000

Operating leverage factor = contribution margin net income

Plan A: $132,000 $110,000 = 1.2

Plan B: $180,000 $114,000 = 1.58 (rounded)

Plan B has the higher degree of operating leverage.

4 & 5.Calculation of profit at 5,000 units:

Plan APlan B

Sales revenue: 5,000 units x $80.$400,000$400,000


Cost of purchasing product:

5,000 units x $50..$250,000$250,000

Sales commissions: $400,000 x 10%... 40,000 ----

Total variable cost..$290,000$250,000

Contribution margin$110,000$150,000

Fixed costs 22,000 66,000

Net income.$ 88,000$ 84,000

Plan A profitability decrease:

$110,000 - $88,000 = $22,000; $22,000 $110,000 = 20%

Plan B profitability decrease:

$114,000 - $84,000 = $30,000; $30,000 $114,000 = 26.3% (rounded)


Consolidated would experience a larger percentage decrease in income if it adopts Plan B. This situation arises because Plan B has a higher degree of operating leverage. Stated differently, Plan Bs cost structure produces a greater percentage decline in profitability from the drop-off in sales revenue.

Note: The percentage decreases in profitability can be computed by multiplying the percentage decrease in sales revenue by the operating leverage factor. Sales dropped from 6,000 units to 5,000 units, or 16.67%. Thus:

Plan A: 16.67% x 1.2 = 20.0%

Plan B: 16.67% x 1.58 = 26.3% (rounded)

6.Heavily automated manufacturers have sizable investments in plant and equipment, along with a high percentage of fixed costs in their cost structures. As a result, there is a high degree of operating leverage.

In a severe economic downturn, these firms typically suffer a significant decrease in profitability. Such firms would be a more risky investment when compared with firms that have a low degree of operating leverage. Of course, when times are good, increases in sales would tend to have a very favorable effect on earnings in a company with high operating leverage.


1.

2.

3.Number of sales units required to earn target net profit

4.Margin of safety= budgeted sales revenue break-even sales revenue

= (120,000)($25) $2,250,000 = $750,000

5.Break-even point if direct-labor costs increase by 8 percent:

New unit contribution margin = $25.00 $10.50 ($5.00)(1.08) $3.00 $1.30

= $4.80

Break-even point

problem 8-40 (continued)

6.Contribution margin ratio

Old contribution-margin ratio

Let P denote sales price required to maintain a contribution-margin ratio of .208. Then P is determined as follows:

Check:New contribution-margin ratio


1. CVP graph:


2.Break-even point:

3.Margin of safety=budgeted sales revenue break-even sales revenue

=$8,000,000 $4,000,000 = $4,000,000

4.Operating leverage factor (at budgeted sales)

5.Dollar sales required to earn target net profit

6.Cost structure:

AmountPercent

Sales revenue

$8,000,000100.0

Variable expenses

2,000,000 25.0

Contribution margin

$6,000,00075.0

Fixed expenses

3,000,000 37.5

Net income

$3,000,000 37.5


1.(a)

(b)

2.

Number of units of sales required to earn target after-tax net income

3.

If fixed costs increase by $31,500:




5.Number of units of sales required to earn target after-tax net income


1. In order to break even, during the first year of operations, 10,220 clients must visit the law office being considered by Terry Smith and his colleagues, as the following calculations show.

Fixed expenses:

Advertising

$ 490,000

Rent (6,000 ( $28)

168,000

Property insurance

27,000

Utilities

37,000

Malpractice insurance

180,000

Depreciation ($60,000/4)

15,000

Wages and fringe benefits:

Regular wages

($25 + $20 + $15 + $10) ( 16 hours ( 360 days

$403,200

Overtime wages

(200 ( $15 ( 1.5) + (200 ( $10 ( 1.5)

7,500

Total wages

$410,700

Fringe benefits at 40%

164,280 574,980Total fixed expenses

$1,491,980Problem 8-43 (conTinued)

Break-even point:

0 = revenue variable cost fixed cost

0 = $30X + ($2,000 ( .2X ( .3)* $4X $1,491,980

0 = $30X + $120X $4X $1,491,980

$146X = $1,491,980

X = 10,220 clients (rounded)

*Revenue calculation:

$30X represents the $30 consultation fee per client. ($2,000 ( .2X ( .30) represents the predicted average settlement of $2,000, multiplied by the 20% of the clients whose judgments are expected to be favorable, multiplied by the 30% of the judgment that goes to the firm.

2.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 = [($30 ( 18,000) + ($2,000 ( 18,000 ( .20 ( .30)]

[($30 ( 10,220) + ($2,000 ( 10,220 ( .20 ( .30)]

= [$30 + ($2,000 ( .20 ( .30)] ( (18,000 10,220)

= $150 ( 7,780

= $1,167,000


1.Break-even point in units:

Calculation of contribution margins:

Computer-Assisted Manufacturing SystemLabor-Intensive Production System

Selling price

$30.00

$30.00

Variable costs:

Direct material

$5.00

$5.60

Direct labor

6.00

7.20

Variable overhead

3.00

4.80

Variable selling cost

2.00

16.00

2.00

19.60

Contribution margin per unit

$14.00

$10.40

(a)Computer-assisted manufacturing system:

(b)Labor-intensive production system:


2.

Celestial Products, Inc. would be indifferent between the two manufacturing methods at the volume (X) where total costs are equal.

$16X + $2,940,000=$19.60X + $1,820,000

$3.60X=$1,120,000

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.

Management should employ the computer-assisted manufacturing method if annual sales are expected to exceed 311,111 units and the labor-intensive manufacturing method if annual sales are not expected to exceed 311,111 units.

5.

Celestial Products management should consider many other business factors other than operating leverage before selecting a manufacturing method. Among these are:

Variability or uncertainty with respect to demand quantity and selling price.

The ability to produce and market the new product quickly.

The ability to discontinue production and marketing of the new product while incurring the least amount of loss.


1.Break-even sales volume for each model:

(a)Economy model:

(b)Regular model:

(c)Super model:




3.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 Economy and Regular models at the sales volume, X, where the total costs are the same.

ModelVariable Cost per TubTotalFixed Cost

Economy

$1.43

$ 8,000

Regular

1.35

11,000

This reasoning leads to the following equation: 8,000 + 1.43X = 11,000 + 1.35X

Rearranging terms yields the following: (1.43 1.35)X = 11,000 8,000

.08X = 3,000

X = 3,000/.08

X = 37,500

Or, stated slightly differently:

Volume at which both machines produce the same profit

Check: the total cost is the same with either model if 37,500 tubs are sold.

EconomyRegular

Variable cost:

Economy, 37,500 ( $1.43

$53,625

Regular, 37,500 ( $1.35

$50,625

Fixed cost:

Economy, $8,000

8,000

Regular, $11,000

11,000

Total cost

$61,625

$61,625

Since the sales price for popcorn does not depend on the popper model, the sales revenue will be the same under either alternative.


1.

2.Number of sales units required to earn target net profit

3.

*Annual straight-line depreciation on new machine

$2.00 = $4.50 $2.50 increase in the unit cost of the new part

4.Number of sales units required

to earn target net profit, givenmanufacturing changes

*Last year's profit: ($25)(25,000) $525,000 = $100,000


5.

*Sales price = $25 = $625,000 ( 25,000 units.

Let P denote the price required to cover increased direct-material cost and maintain the same contribution margin ratio:

*Old unit variable cost = $15 = $375,000 ( 25,000 units

Increase in direct-material cost = $2

Check:


1.Memorandum

Date:Today

To:

Vice President for Manufacturing, Jupiter Game Company

From:I.M. Student, Controller

Subject:Activity-Based Costing

The $150,000 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 activity-based 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. New break-even point if automated manufacturing equipment is installed:

Sales price

$26

Costs that are variable (with respect to sales volume):

Unit variable cost (.8 ( $375,000 ( 25,000)

12

Unit contribution margin

$14

Costs that are fixed (with respect to sales volume):

Setup (300 setups at $50 per setup)

$ 15,000

Engineering (800 hours at $28 per hour)

22,400

Inspection (100 inspections at $45 per inspection)

4,500

General factory overhead

166,100

Total

$208,000

Fixed selling and administrative costs

30,000

Total costs that are fixed (with respect to sales volume)

$238,000


3.Sales (in units) required to show a profit of $140,000:

Number of sales units required to earn target net profit

4.If management adopts the new manufacturing technology:

(a)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 $140,000 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 ($14 instead of $10) earns a profit at a faster rate. This results in the firm needing to sell fewer units to reach a given target profit level.

problem 8-47 (continued)5.

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)Competence: Prepare complete and clear reports and recommendations after appropriate analysis of relevant and reliable information.

(b)Integrity: Communicate unfavorable as well as favorable information and professional judgments or opinions.

(c)Objectivity: Communicate information fairly and objectively. Disclose fully all relevant information that could reasonably be expected to influence an intended user's understanding of the reports, comments, and recommendations presented.


1. Closing of downtown store:

Loss of contribution margin at Downtown Store

$(36,000)

Savings of fixed cost at Downtown Store (75%)

30,000

Loss of contribution margin at Mall Store (10%)

(4,800)

Total decrease in operating income

$(10,800)

2. Promotional campaign:

Increase in contribution margin (10%)

$ 3,600

Increase in monthly promotional expenses ($60,000/12)

(5,000)

Decrease in operating income

$(1,400)

3.Elimination of items sold at their variable cost:

We can restate the November 20x1 data for the Downtown Store as follows:

Downtown Store

Items Sold at Their Variable Cost

Other Items

Sales

$60,000*

$60,000*

Less: variable expenses

60,000

24,000Contribution margin

$-0-$36,000If the items sold at their variable cost are eliminated, we have:

Decrease in contribution margin on other items (20%)

$(7,200)

Decrease in fixed expenses (15%)

6,000Decrease in operating income

$(1,200)

*$60,000 is one half of the Downtown Store's dollar sales for November 20x1.


1.

Cincinnati Tool CompanyBudgeted Income StatementFor the Year Ended December 31, 20x2

WeedersHedge ClippersLeaf BlowersTotal

Unit selling price

$28

$36

$48

Variable manufacturing cost

$13

$12

$25

Variable selling cost

5

4

6

Total variable cost

$18

$16

$31

Contribution margin per unit

$10

$20

$17

Unit sales

( 50,000

( 50,000

( 100,000

Total contribution margin

$500,000

$1,000,000

$1,700,000

$3,200,000

Fixed manufacturing overhead

$2,000,000

Fixed selling and administrative costs

600,000

Total fixed costs

$2,600,000

Income before taxes

$600,000

Income taxes (40%)

240,000

Budgeted net income

$ 360,000

2.

(a) Unit Contribution(b) Sales Proportion

(a) ( (b)

Weeders

$10

.25

$ 2.50

Hedge Clippers

20

.25

5.00

Leaf Blowers

17

.50

8.50

Weighted-average unit

contribution margin

$16.00


Sales proportions:

Sales ProportionTotal Unit SalesProduct Line Sales

Weeders

.25162,500

40,625

Hedge Clippers

.25162,500

40,625

Leaf Blowers

.50162,500

81,250

Total

162,500

3.

(a) Unit Contribution(b) Sales Proportion

(a) ( (b)

Weeders

$10.20

$ 2.00

Hedge Clippers*

19.20

3.80

Leaf Blowers

12.60

7.20

Weighted-average unit contribution margin

$13.00

*Variable selling cost increases. Thus, the unit contribution decreases to $19 [$36 ($12 + $4 + $1)].

The variable manufacturing cost increases 20 percent. Thus, the unit contribution decreases to $12 [$48 (1.2 ( $25) $6].

Sales proportions:

Sales ProportionsTotal Unit SalesProduct Line Sales

Weeders

.20200,00040,000

Hedge Clippers

.20200,00040,000

Leaf Blowers

.60200,000120,000

Total

200,000


1.

2.Projected net income for sales of 2,100 tons:

Projected contribution margin (2,100 ( $225)

$472,500

Projected fixed costs

247,500

Projected net income

$225,000

3.Projected net income including foreign order:

Variable cost per ton = $495,000/1,800 = $275 per ton

Sales price per ton for regular orders = $900,000/1,800 = $500 per ton

Foreign OrderRegular Sales

Sales in tons

1,500

1,500

Contribution margin per ton:

Foreign order ($450 $275)

($175

Regular sales ($500 $275)

($225

Total contribution margin

$262,500

$337,500

Contribution margin on foreign order

$262,500

Contribution margin on regular sales

337,500Total contribution margin

$600,000

Fixed costs

247,500Net income

$352,500problem 8-50 (continued)

4.New sales territory:

To maintain its current net income, Ohio Limestone Company just needs to break even on sales in the new territory.

5.Automated production process:

6.Changes in selling price and unit variable cost:


1.

2.Number of units of sales required to earn target after-tax income

3.Break-even point (in units) for the mountaineering model

Let Y denote the variable cost of the touring model such that the break-even point for the touring model is 10,500 units.

Then we have:

Thus, the variable cost per unit would have to decrease by $2.97 ($52.80 $49.83).


4.

5.Weighted-average unit

contribution margin

Break-even point


1. Summary of Expenses

Expenses per Year (in thousands)

VariableFixed

Manufacturing

$7,200

$2,340

Selling and administrative

2,400

1,920

Interest

540

Costs from budgeted income statement

$9,600

$4,800

If the company employs its own sales force:

Additional sales force costs

2,400

Reduced commissions [(.15 .10) ( $16,000]

(800)

Costs with own sales force

$8,800

$7,200

If the company sells through agents:

Deduct cost of sales force

(2,400)

Increased commissions [(.225 .10) ( $16,000]

2,000

Costs with agents paid increased commissions

$10,800

$4,800


(a)

(b)

2.


3.

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=total expenses with own sales force

Therefore, at a sales volume of $19,200,000, the company will earn equal before-tax income under either alternative. Since before-tax income is the same, so is after-tax net income.

solutions to cases

Case 8-53 (50 minutes)

1.The break-even point is 16,900 patient-days calculated as follows:

Computation of Break-Even PointIn Patient-Days: PediatricsFor the Year Ended June 30, 20x2

Total fixed costs:

Medical center charges

$2,900,000

Supervising nurses($25,000 ( 4)

100,000

Nurses($20,000 ( 10)

200,000

Aids($9,000 ( 20)

180,000Total fixed costs

$3,380,000Contribution margin per patient-day:

Revenue per patient-day

$300

Variable cost per patient-day:

($6,000,000 $300 = 20,000 patient-days)

($2,000,000 20,000 patient-days)

100Contribution margin per patient-day

$200

Break-even point in patient-days

Case 8-53 (Continued)

2. Net earnings would decrease by $606,660, calculated as follows:

Computation of Loss from Rentalof Additional 20 Beds: PediatricsFor the Year Ended June 30, 20x2

Increase in revenue

(20 additional beds ( 90 days ( $300 charge per day)

$540,000Increase in expenses:

Variable charges by medical center

(20 additional beds ( 90 days ( $100 per day)

$180,000

Fixed charges by medical center

($2,900,000 ( 60 beds = $48,333 per bed, rounded)

($48,333 ( 20 beds)

966,660

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)

-0-

Total increase in expenses

$1,146,660Net change in earnings from rental of additional 20 beds

$(606,660)

CASE 8-54 (45 minutes)

1.a.In order to break even, Oakley must sell 500 units. This amount represents the point where revenue equals total costs.

b.In order to achieve its after-tax profit objective, Oakley must sell 2,500 units. This amount represents the point where revenue equals total costs plus the before-tax profit objective.

2.To achieve its annual after-tax profit objective, Oakley should select the first alternative, where the sales price is reduced by $40 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.

CASE 8-54 (CONTINUED)

Alternative (1):

Alternative (2):

Alternative (3):

Case 8-55 (50 minutes)

1.Break-even point for 20x2, based on current budget:

2.Break-even point given employment of sales personnel:

New fixed expenses:

Previous fixed expenses

$100,000

Sales personnel salaries

90,000

Sales manager's salary

160,000Total

$350,000New contribution-margin ratio:

Sales

$10,000,000

Cost of goods sold

6,000,000Gross margin

$4,000,000

Commissions (at 5%)

500,000Contribution margin

$3,500,000

Case 8-55 (continued)

3. Assuming a 25% sales commission:

New contribution-margin ratio:

Sales

$10,000,000

Cost of goods sold

6,000,000Gross margin

$4,000,000

Commissions (at 25%)

2,500,000Contribution margin

$1,500,000

Sales volume in dollars required to earn after-tax net income

Check (all figures rounded to the nearest dollar):

Sales

$ 13,333,333

Cost of goods sold (60% of sales)

8,000,000

Gross margin

$5,333,333

Selling and administrative expenses:

Commissions

$ 3,333,333

All other expenses (fixed)

100,000

3,433,333

Income before taxes

$1,900,000

Income tax expense (30%)

570,000

Net income

$1,330,000

case 8-55 (continued)

4. Sales dollar volume at which Niagra Falls Sporting Goods Company is indifferent:

Let X denote the desired volume of sales.

Since the tax rate is the same regardless of which approach management chooses, we can find X so that the companys before-tax income is the same under the two alternatives. (In the following equations, the contribution-margin ratios of .35 and .15, respectively, were computed in the preceding two requirements.)

.

.35X $350,000=.15X $100,000

.20X=$250,000

X=$250,000/.20

X=$1,250,000

Thus, the company will have the same before-tax income under the two alternatives if the sales volume is $1,250,000.

Check:

Alternatives

Employ Sales Personnel

Pay 25% Commission

Sales

$1,250,000

$1,250,000

Cost of goods sold (60% of sales)

750,000

750,000

Gross margin

$500,000

$500,000

Selling and administrative expenses:

Commissions

62,500*

312,500

All other expenses (fixed)

350,000

100,000

Income before taxes

$87,500

$87,500

Income tax expense (30%)

26,250

26,250

Net income

$61,250

$61,250

*$1,250,000 ( 5% = $62,500

$1,250,000 ( 25% = $312,500

current issues in Managerial accounting

ISSUE 8-56

"RELIANCE GROUP MAY SEE SHIELD FROM CREDITORS," THE WALL STREET JOURNAL, AUGUST 15, 2000, DEVON SPURGON, GREGORY ZUCKERMAN, AND FRANCINE L. POPE.

1. 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.

2. In the article, high operating leverage was not working to benefit Reliance Group Holdings, Inc. Consequently, its stock rating was downgraded.

ISSUE 8-57

"E-COMMERCE -- DEBATE -- TALKING TO THE PLAYERS: WILL THE INTERNET TAKE OVER COMMERCE? WE ASKED THREE PEOPLE WHO ASK THEMSELVES THAT QUESTION ALL THE TIME," THE WALL STREET JOURNAL, JULY 12, 1999, THOMAS E. WEBER.

According to Ken Seiff, Amazon is capturing such a huge amount of market share that it will eventually be able to build the most cost efficient distribution system, not only in the e-commerce field, but also in the traditional retail world. Once Amazon has developed this system and cemented its place as the online retailer of choice, price wars will not be as costly for Amazon as for its competitors.

ISSUE 8-58

"HAPPY SHOPPER," MANAGEMENT ACCOUNTING, JULY/AUGUST 2000, TONY BRABAZON.

The cost of losing a customer will vary across the customer life cycle. The loss can be estimated using discounted customer contribution margin, where the discounted customer contribution margin is calculated as the gross profit per customer less customer-related costs such as administration, distribution and financing.

ISSUE 8-59

"POSTAL SERVICE COULD FACE LOSS," THE ASSOCIATED PRESS, AUGUST 31, 2000, RANDOLPH E. SCHMID.

1. It is important for the U.S. Postal Service to forecast the volume and cost variables discussed in the article so its management can determine the revenue required to cover costs and determine cost of postage.

2. Unexpected costs will increase the break-even point in cost-volume-profit analysis. A decline in the volume of first-class mail will decrease the weighted-average contribution margin and increase the break-even point. An increase in advertising mail will increase revenue and decrease the breakeven point.

ISSUE 8-60

"START YOUR OWN FIRM," JOURNAL OF ACCOUNTANCY, MAY 2000, ROBERT B. SCOTT, JR.

1. The contribution margin is defined as sales revenue less all variable costs.

2. For a CPA firm, as described in the article, the contribution margin would be calculated as a clients total fees less all direct-service costs, such as staff time. According to the article, a client who generates total fees that are one and one half times the cost to service the engagement, especially a large client, may be worth keeping and developing. If the CPA is unable to recover at least one and one half times the direct-service cost, the CPA should consider ending the relationship.

ISSUE 8-61

"CHAIN REACTION," CMA MANAGEMENT, MARCH 1999, ANDREA SIGURDSON.

1. Cost-volume-profit analysis is a study of the relationships between sales volume, expenses, revenue, and profit. 2. CVP analysis can be applied to determine the effectiveness of an investment, for example, in seasonal price discounting or price specials. In price-sensitive categories, managers can use detailed studies of consumer price elasticity to better understand the ongoing relationship between pricing, volume and category profits. The principles of activity-based management applied to product categories can help management understand the actual costs of distribution and warehousing at the individual item level. A true picture of category and subcategory profitability can then be determined. Real estate and occupancy costs are also charged back to product categories within the store to develop a comprehensive picture of total profit or loss for each category. Using this information, retailers can assign strategic roles to each product category. High profile ones, although not always strong profit contributors, can help build overall customer traffic. Assigning clear category roles aids in the decision making process when allocating investment resources or scarce retail space among competing product categories.

Break-even point:

20,000 tickets

Total revenue

Total expenses

Variable expense

(at 30,000 tickets)

Annual fixed expenses

Tickets sold per year

5,000

10,000

15,000

20,000

25,000

30,000

Dollars per year

$300,000

$250,000

$200,000

$150,000

$100,000

$50,000

Profit

area

Loss area

(

EMBED Equation.3

(

25,000

20,000

15,000

10,000

5,000

Loss area

Break-even point:

20,000 tickets

Tickets sold

per year

Annual fixed expenses

$(180,000)

$(150,000)

$(100,000)

$(50,000)

0

$50,000

$100,000

$150,000

Dollars per year

Profit area

10

9

8

7

6

5

4

3

2

1

Dollars per year

(in millions)

200

150

100

50

Loss area

Units sold per year (in thousands)

Fixed expenses

Total revenue

Profit area

Break-even point:

80,000 units or

$4,000,000 of sales

Total expenses

Dollars per year

Profit

area

Units sold per year

$750,000

$500,000

Break-even point:

70,000 units

$250,000

(

0

75,000

50,000

25,000

100,000

Loss area

$(250,000)

$(500,000)

$(750,000)

Loss

Profit

Loss area

Fixed rental cost: $20,000 per year

Break-even point:

40,816 tubs

Units sold

per year

(in thousands)

50

40

30

20

10

($20)

($10)

0

Dollars per year (in thousands)

$20

$10

Profit area

(

McGraw-Hill/Irwin

( 2002 The McGraw-Hill Companies, Inc.

8-56 Solutions ManualMcGraw-Hill/Irwin

( 2002 The McGraw-Hill Companies, Inc.

Managerial Accounting, 5/e 8-57

_958158753.unknown

_958334894.unknown

_959940342.unknown

_960532924.unknown

_1049714072.unknown

_1049714340.unknown

_1049714513.unknown

_1049714710.unknown

_1049714265.unknown

_960535190.unknown

_1045980964.unknown

_1045980967.unknown

_1045980968.unknown

_1045980965.unknown

_962522078.unknown

_960532969.unknown

_960465696.unknown

_960465921.unknown

_960532855.unknown

_960465778.unknown

_959960541.unknown

_960463270.unknown

_960464400.unknown

_960463919.unknown

_959961961.unknown

_960463231.unknown

_959961658.unknown

_959940435.unknown

_958387957.unknown

_958448447.unknown

_958448638.unknown

_958448837.unknown

_958447687.unknown

_958388043.unknown

_958335325.unknown

_958340020.unknown

_958340260.unknown

_958387884.unknown

_958340327.unknown

_958340191.unknown

_958339795.unknown

_958339874.unknown

_958338626.unknown

_958335090.unknown

_958335273.unknown

_958334906.unknown

_958161300.unknown

_958333982.unknown

_958334607.unknown

_958334882.unknown

_958334792.unknown

_958334494.unknown

_958162648.unknown

_958163192.unknown

_958163426.unknown

_958332337.unknown

_958163209.unknown

_958163116.unknown

_958162100.unknown

_958162268.unknown

_958162011.unknown

_958160023.unknown

_958160514.unknown

_958160595.unknown

_958160155.unknown

_958159768.unknown

_958159929.unknown

_958159526.unknown

_951486019.unknown

_955882130.unknown

_955908542.unknown

_958127237.unknown

_958157952.unknown

_958158709.unknown

_958127684.unknown

_955908946.unknown

_955909550.unknown

_955908583.unknown

_955885638.unknown

_955908411.unknown

_951486198.unknown

_951487507.unknown

_951500167.unknown

_951502059.unknown

_951499909.unknown

_951486486.unknown

_951486069.unknown

_951478210.unknown

_951478408.unknown

_951485023.unknown

_951478314.unknown

_951478098.unknown

_951478161.unknown

_951478055.unknown

Date post:	28-Oct-2015
Category:	Documents
Upload:	yellowberries
View:	277 times
Download:	1 times

Solution Manual08

Documents