To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER COST-VOLUME-PROFIT ANALYSIS NOTATION USED IN CHAPTER SOLUTIONS SP: VCU: CMU: FC: TOI: Selling price Variable cost per unit Contribution margin per unit Fixed costs Target operating income 3-1 Cost-volume-profit (CVP) analysis examines the behavior of total revenues, total costs, and operating income as changes occur in the output level, selling price, variable cost per unit, or fixed costs of a product 3-2 The assumptions underlying the CVP analysis outlined in Chapter are Changes in the level of revenues and costs arise only because of changes in the number of product (or service) units produced and sold Total costs can be separated into a fixed component that does not vary with the output level and a component that is variable with respect to the output level When represented graphically, the behavior of total revenues and total costs are linear (represented as a straight line) in relation to output level within a relevant range and time period The selling price, variable cost per unit, and fixed costs are known and constant The analysis either covers a single product or assumes that the sales mix, when multiple products are sold, will remain constant as the level of total units sold changes All revenues and costs can be added and compared without taking into account the time value of money 3-3 Operating income is total revenues from operations for the accounting period minus cost of goods sold and operating costs (excluding income taxes): Operating income = Total revenues Costs of goods sold and operating, costs (excluding income taxes) from operations – Net income is operating income plus nonoperating revenues (such as interest revenue) minus nonoperating costs (such as interest cost) minus income taxes Chapter assumes nonoperating revenues and nonoperating costs are zero Thus, Chapter computes net income as: Net income = Operating income – Income taxes 3-4 Contribution margin is the difference between total revenues and total variable costs Contribution margin per unit is the difference between selling price and variable cost per unit Contribution-margin percentage is the contribution margin per unit divided by selling price 3-1 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 3-5 Three methods to express CVP relationships are the equation method, the contribution margin method, and the graph method The first two methods are most useful for analyzing operating income at a few specific levels of sales The graph method is useful for visualizing the effect of sales on operating income over a wide range of quantities sold 3-6 Breakeven analysis denotes the study of the breakeven point, which is often only an incidental part of the relationship between cost, volume, and profit Cost-volume-profit relationship is a more comprehensive term than breakeven analysis 3-7 CVP certainly is simple, with its assumption of output as the only revenue and cost driver, and linear revenue and cost relationships Whether these assumptions make it simplistic depends on the decision context In some cases, these assumptions may be sufficiently accurate for CVP to provide useful insights The examples in Chapter (the software package context in the text and the travel agency example in the Problem for Self-Study) illustrate how CVP can provide such insights In more complex cases, the basic ideas of simple CVP analysis can be expanded 3-8 An increase in the income tax rate does not affect the breakeven point Operating income at the breakeven point is zero, and no income taxes are paid at this point 3-9 Sensitivity analysis is a ―what-if‖ technique that managers use to examine how a result will change if the original predicted data are not achieved or if an underlying assumption changes The advent of the electronic spreadsheet has greatly increased the ability to explore the effect of alternative assumptions at minimal cost CVP is one of the most widely used software applications in the management accounting area 3-10 Examples include: Manufacturing––substituting a robotic machine for hourly wage workers Marketing––changing a sales force compensation plan from a percent of sales dollars to a fixed salary Customer service––hiring a subcontractor to customer repair visits on an annual retainer basis rather than a per-visit basis 3-11 Examples include: Manufacturing––subcontracting a component to a supplier on a per-unit basis to avoid purchasing a machine with a high fixed depreciation cost Marketing––changing a sales compensation plan from a fixed salary to percent of sales dollars basis Customer service––hiring a subcontractor to customer service on a per-visit basis rather than an annual retainer basis 3-12 Operating leverage describes the effects that fixed costs have on changes in operating income as changes occur in units sold, and hence, in contribution margin Knowing the degree of operating leverage at a given level of sales helps managers calculate the effect of fluctuations in sales on operating incomes 3-2 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 3-13 CVP analysis is always conducted for a specified time horizon One extreme is a very short-time horizon For example, some vacation cruises offer deep price discounts for people who offer to take any cruise on a day’s notice One day prior to a cruise, most costs are fixed The other extreme is several years Here, a much higher percentage of total costs typically is variable CVP itself is not made any less relevant when the time horizon lengthens What happens is that many items classified as fixed in the short run may become variable costs with a longer time horizon 3-14 A company with multiple products can compute a breakeven point by assuming there is a constant sales mix of products at different levels of total revenue 3-15 Yes, gross margin calculations emphasize the distinction between manufacturing and nonmanufacturing costs (gross margins are calculated after subtracting fixed manufacturing costs) Contribution margin calculations emphasize the distinction between fixed and variable costs Hence, contribution margin is a more useful concept than gross margin in CVP analysis 3-16 a b c d (10 min.) CVP computations Revenues $2,000 2,000 1,000 1,500 Variable Costs $ 500 1,500 700 900 Fixed Costs $300 300 300 300 Total Operating Contribution Costs Income Margin $ 800 $1,200 $1,500 200 500 1,800 1,000 300 1,200 300 600 3-3 Contribution Margin % 75.0% 25.0% 30.0% 40.0% To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 3-17 (10–15 min.) CVP computations 1a Sales ($25 per unit × 180,000 units) Variable costs ($20 per unit × 180,000 units) Contribution margin $4,500,000 3,600,000 $ 900,000 1b Contribution margin (from above) Fixed costs Operating income $ 900,000 800,000 $ 100,000 2a Sales (from above) Variable costs ($10 per unit × 180,000 units) Contribution margin $4,500,000 1,800,000 $2,700,000 2b Contribution margin Fixed costs Operating income $2,700,000 2,500,000 $ 200,000 Operating income is expected to increase by $100,000 if Ms Schoenen’s proposal is accepted The management would consider other factors before making the final decision It is likely that product quality would improve as a result of using state of the art equipment Due to increased automation, probably many workers will have to be laid off Patel’s management will have to consider the impact of such an action on employee morale In addition, the proposal increases the company’s fixed costs dramatically This will increase the company’s operating leverage and risk 3-4 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 3-18 (35–40 min.) CVP analysis, changing revenues and costs 1a SP VCU CMU FC = 8% × $1,000 = $80 per ticket = $35 per ticket = $80 – $35 = $45 per ticket = $22,000 a month Q = $22,000 FC = $45 per ticket CMU = 489 tickets (rounded up) 1b Q = $22,000 $10,000 FC TOI = $45 per ticket CMU = $32,000 $45 per ticket = 712 tickets (rounded up) 2a SP VCU CMU FC = $80 per ticket = $29 per ticket = $80 – $29 = $51 per ticket = $22,000 a month Q = $22,000 FC = $51 per ticket CMU = 432 tickets (rounded up) 2b Q = $22,000 $10,000 FC TOI = $51 per ticket CMU $32,000 $51 per ticket = 628 tickets (rounded up) = 3a SP VCU CMU FC = $48 per ticket = $29 per ticket = $48 – $29 = $19 per ticket = $22,000 a month Q = $22,000 FC = $19 per ticket CMU = 1,158 tickets (rounded up) 3-5 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 3b Q = $22,000 $10,000 FC TOI = $19 per ticket CMU = $32,000 $19 per ticket = 1,685 tickets (rounded up) The reduced commission sizably increases the breakeven point and the number of tickets required to yield a target operating income of $10,000: Breakeven point Attain OI of $10,000 8% Commission (Requirement 2) 432 628 Fixed Commission of $48 1,158 1,685 4a The $5 delivery fee can be treated as either an extra source of revenue (as done below) or as a cost offset Either approach increases CMU $5: SP VCU CMU FC = $53 ($48 + $5) per ticket = $29 per ticket = $53 – $29 = $24 per ticket = $22,000 a month Q = $22,000 FC = $24 per ticket CMU = 917 tickets (rounded up) 4b Q = $22,000 $10,000 FC TOI = $24 per ticket CMU = $32,000 $24 per ticket = 1,334 tickets (rounded up) The $5 delivery fee results in a higher contribution margin which reduces both the breakeven point and the tickets sold to attain operating income of $10,000 3-6 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 3-19 (20 min.) CVP exercises Revenues $10,000,000G 10,000,000 10,000,000 10,000,000 10,000,000 10,800,000e 9,200,000g 11,000,000i 10,000,000 Orig Gstands Variable Costs Contribution Margin $8,200,000G 8,020,000 8,380,000 8,200,000 8,200,000 8,856,000f 7,544,000h 9,020,000j 7,790,000l $1,800,000 1,980,000a 1,620,000b 1,800,000 1,800,000 1,944,000 1,656,000 1,980,000 2,210,000 Budgeted Operating Income Fixed Costs $1,700,000G 1,700,000 1,700,000 1,785,000c 1,615,000d 1,700,000 1,700,000 1,870,000k 1,785,000m $100,000 280,000 (80,000) 15,000 185,000 244,000 (44,000) 110,000 425,000 for given a$1,800,000 × 1.10; b$1,800,000 × 0.90; c$1,700,000 × 1.05; d$1,700,000 × 0.95; e$10,000,000 × 1.08; f$8,200,000 × 1.08; g$10,000,000 × 0.92; h$8,200,000 × 0.92; i$10,000,000 × 1.10; j$8,200,000 × 1.10; k$1,700,000 × 1.10; l$8,200,000 × 0.95; m$1,700,000 × 1.05 3-20 (20 min.) CVP exercises 1a [Units sold (Selling price – Variable costs)] – Fixed costs = Operating income [5,000,000 ($0.50 – $0.30)] – $900,000 = $100,000 1b Fixed costs ÷ Contribution margin per unit = Breakeven units $900,000 ÷ [($0.50 – $0.30)] = 4,500,000 units Breakeven units × Selling price = Breakeven revenues 4,500,000 units × $0.50 per unit = $2,250,000 or, Selling price -Variable costs Contribution margin ratio = Selling price $0.50 - $0.30 = = 0.40 $0.50 Fixed costs ÷ Contribution margin ratio = Breakeven revenues $900,000 ÷ 0.40 = $2,250,000 5,000,000 ($0.50 – $0.34) – $900,000 = $ (100,000) [5,000,000 (1.1) ($0.50 – $0.30)] – [$900,000 (1.1)] = $ 110,000 [5,000,000 (1.4) ($0.40 – $0.27)] – [$900,000 (0.8)] = $ 190,000 $900,000 (1.1) ÷ ($0.50 – $0.30) = 4,950,000 units ($900,000 + $20,000) ÷ ($0.55 – $0.30) = 3,680,000 units 3-7 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 3-21 (10 min.) CVP analysis, income taxes Monthly fixed costs = $50,000 + $60,000 + $10,000 = Contribution margin per unit = $25,000 – $22,000 – $500 = Monthly fixed costs $120,000 Breakeven units per month = = = Contribution margin per unit $2,500 per car Tax rate Target net income $120,000 $ 2,500 48 cars 40% $54,000 Target net income $54, 000 $54, 000 $90,000 - tax rate (1 0.40) 0.60 Quantity of output units Fixed costs + Target operating income $12 0, 000 $90, 000 84 cars required to be sold = Contribution margin per unit $2,500 Target operating income = 3-22 (20–25 min.) CVP analysis, income taxes Variable cost percentage is $3.20 $8.00 = 40% Let R = Revenues needed to obtain target net income $105,000 R – 0.40R – $450,000 = 0.30 0.60R = $450,000 + $150,000 R = $600,000 0.60 R = $1,000,000 or, Target net income $105,000 $450,000 + Tax rate 0.30 = $1,000,000 Breakeven revenues = = Contribution margin percentage 0.60 Proof: 2.a b Revenues Variable costs (at 40%) Contribution margin Fixed costs Operating income Income taxes (at 30%) Net income $1,000,000 400,000 600,000 450,000 150,000 45,000 $ 105,000 Customers needed to earn net income of $105,000: Total revenues Sales check per customer $1,000,000 $8 = 125,000 customers Customers needed to break even: Contribution margin per customer = $8.00 – $3.20 = $4.80 Breakeven number of customers = Fixed costs Contribution margin per customer 3-8 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com = $450,000 $4.80 per customer = 93,750 customers Using the shortcut approach: Change in net income = (Change in,number of customers,) (Unit,contribution,margin) (1 – Tax rate) New net income = (150,000 – 125,000) $4.80 (1 – 0.30) = $120,000 0.7 = $84,000 = $84,000 + $105,000 = $189,000 The alternative approach is: Revenues, 150,000 $8.00 Variable costs at 40% Contribution margin Fixed costs Operating income Income tax at 30% Net income $1,200,000 480,000 720,000 450,000 270,000 81,000 $ 189,000 3-9 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 3-23 (30 min.) CVP analysis, sensitivity analysis SP = $30.00 (1 – 0.30 margin to bookstore) = $30.00 0.70 = $21.00 VCU = $ 4.00 variable production and marketing cost 3.15 variable author royalty cost (0.15 $21.00) $ 7.15 CMU = $21.00 – $7.15 = $13.85 per copy FC = $ 500,000 fixed production and marketing cost 3,000,000 up-front payment to Washington $3,500,000 Solution Exhibit 3-23A shows the PV graph SOLUTION EXHIBIT 3-23A PV Graph for Media Publishers $4,000 FC = $3,500,000 CMU = $13.85 per book sold 3,000 Operating income (000’s) 2,000 1,000 U n its so ld 10 0,0 00 20 0,0 00 -1,000 30 0,0 00 40 0,0 00 252,708 units -2,000 -3,000 $3.5 million -4,000 3-10 50 0,0 00 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 3-40 (20 min.) Alternative cost structures, sensitivity analysis Selling price Demand Cost per package Revenues = Demand SP Package costs = $120 Demand Booth variable costs = Revenues Contribution margin Booth fixed fee Operating income Requirement Fixed fee $2,000 Percent of Revenues 0% $ 200 $ 230 $ 275 42 30 20 $ 120 $ 120 $ 120 $8,400 $6,900 $5,500 5,040 3,600 2,400 Percent of revenues 0 3,300 3,300 3,100 2,000 2,000 2,000 $1,360 $1,300 $1,100 $ 300 15 $ 120 $4,500 1,800 2,700 2,000 $ 700 Requirement Fixed fee $800 Percent of Revenues 15% $ 200 $ 230 $ 275 42 30 20 $ 120 $ 120 $ 120 $8,400 $6,900 $5,500 5,040 3,600 2,400 1,260 1,035 825 2,100 2,265 2,275 800 800 800 $1,300 $1,465 $1,475 See section of table labeled Requirement above If Mary pays a fixed fee of $2,000 to rent the booth, she should sell the Do-All packages at $200 each in order to maximize operating income Contribution margin can also be calculated as contribution margin per unit demand For example, when selling price is $230, contribution margin per unit is $110 ($230 – $120) and contribution margin is $3,300 ($110 per unit 30 units) See section of table labeled Requirement above If Mary pays a fixed fee of $800 plus 15% of revenues to rent the booth, she should sell the Do-All packages at $275 each in order to maximize operating income Contribution margin can also be calculated as contribution margin per unit demand For example, when selling price is $230, contribution margin per unit is $75.50 ($230 – $120 – 15% $230) and contribution margin is $2,265 ($75.50 per unit 30 units) 3-31 $ 300 15 $ 120 $4,500 1,800 675 2,025 800 $1,225 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 3-41 (30 min.) Alternative fixed-cost/variable-cost structures Annual fixed costs (FC) Selling price Variable cost per unit Contribution margin per unit (CMU) Annual breakeven units = FC CMU = Manual Automated $20,000 $30,000 $ 20 $ 20 10 $ 10 $ 12 2,000 2,500 Manual Units 2,000 3,000 CMU $ 10 $ 10 Contribution margin $20,000 $30,000 Fixed costs 20,000 20,000 Operating income $ $10,000 4,000 $ 10 $40,000 20,000 $20,000 5,000 6,000 7,000 $ 10 $ 10 $ 10 $50,000 $60,000 $70,000 20,000 20,000 20,000 $30,000 $40,000 $50,000 Automated Units 2,000 3,000 CMU $ 12 $ 12 Contribution margin $20,000 $36,000 Fixed costs 30,000 30,000 Operating income $ (6,000) $ 6,000 4,000 $ 12 $48,000 30,000 $18,000 5,000 6,000 7,000 $ 12 $ 12 $ 12 $60,000 $72,000 $84,000 30,000 30,000 30,000 $30,000 $42,000 $54,000 3-32 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Cut-n-Sew Operating Income: Manual vs Automated Plant $55,000 Operating Income $45,000 $35,000 $25,000 Manual $15,000 Automated $5,000 $(5,000)2,000 3,000 4,000 5,000 6,000 7,000 $(15,000) Units As seen from the above tables and graph, the two types of plants will result in the same operating income of $30,000 at a sales volume of 5,000 jackets This can also be computed analytically: Let Q be the volume at which the operating incomes of both plants are equal Equating operating income = (CMU Units) – Fixed Costs for both plants, $10Q – $20,000 = $12Q – $30,000 $2Q = $10,000 Q = 5,000 units If Cut-n-Sew anticipates sales of 4,000 jackets per year, it will earn an operating income of $20,000 from the manual plant, versus an operating income of $18,000 from the automated plant So, it will choose the manual plant However, note that the 4,000 jacket volume is only 1,000 short of the volume at which the automated plant becomes more profitable If Cut-n-Sew anticipates a 25% or greater growth in sales volume in the near term, it should consider investing in the automated plant which will be more profitable at higher volumes Also, competitive issues may suggest that Cut-n-Sew invest in the automated plant to benefit from other new technologies that may be available in the future 3-33 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 3-42 (30 min.) CVP analysis, income taxes, sensitivity 1a To break even, Almo Company must sell 500 units This amount represents the point where revenues equal total costs Let Q denote the quantity of canopies sold Revenue = Variable costs + Fixed costs $400Q = $200Q + $100,000 $200Q = $100,000 Q = 500 units Breakeven can also be calculated using contribution margin per unit Contribution margin per unit = Selling price – Variable cost per unit = $400 – $200 = $200 Breakeven = Fixed Costs Contribution margin per unit = $100,000 $200 = 500 units 1b To achieve its net income objective, Almo Company must sell 2,500 units This amount represents the point where revenues equal total costs plus the corresponding operating income objective to achieve net income of $240,000 Revenue = Variable costs + Fixed costs + [Net income ÷ (1 – Tax rate)] $400Q = $200Q + $100,000 + [$240,000 (1 0.4)] $400 Q = $200Q + $100,000 + $400,000 Q = 2,500 units To achieve its net income objective, Almo Company 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 net income and is the only alternative that equals or exceeds the company’s net income objective Calculations for the three alternatives are shown below Alternative Revenues Variable costs Operating income Net income = = = = ($400 350) + ($360a 2,700) = $1,112,000 $200 3,050b = $610,000 $1,112,000 $610,000 $100,000 = $402,000 $402,000 (1 0.40) = $241,200 a$400 – $40; b350 units + 2,700 units Alternative Revenues Variable costs Operating income Net income = = = = ($400 350) + ($370c 2,200) = $954,000 ($200 350) + ($190d 2,200) = $488,000 $954,000 $488,000 $100,000 = $366,000 $366,000 (1 0.40) = $219,600 c$400 – $30; d$200 – $10 3-34 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Alternative Revenues Variable costs Operating income Net income e$400 – (0.05 3-43 = = = = ($400 350) + ($380e 2,000) = $900,000 $200 2,350f = $470,000 $900,000 $470,000 $90,000g = $340,000 $340,000 (1 0.40) = $204,000 $400) = $400 – $20; f350 units + 2,000 units; g$100,000 – $10,000 (30 min.) Choosing between compensation plans, operating leverage We can recast Marston’s income statement to emphasize contribution margin, and then use it to compute the required CVP parameters Marston Corporation Income Statement For the Year Ended December 31, 2005 Revenues Variable Costs Cost of goods sold—variable Marketing commissions Contribution margin Fixed Costs Cost of goods sold—fixed Marketing—fixed Operating income Using Sales Agents $26,000,000 $11,700,000 4,680,000 2,870,000 3,420,000 Contribution margin percentage ($9,620,000 26,000,000; $11,700,000 $26,000,000) Breakeven revenues ($6,290,000 0.37; $8,370,000 0.45) Degree of operating leverage ($9,620,000 $3,330,000; $11,700,000 $3,330,000) 16,380,000 $9,620,000 6,290,000 $3,330,000 Using Own Sales Force $26,000,000 $11,700,000 2,600,000 2,870,000 5,500,000 14,300,000 $11,700,000 8,370,000 $ 3,330,000 37% 45% $17,000,000 $18,600,000 2.89 3.51 The calculations indicate that at sales of $26,000,000, a percentage change in sales and contribution margin will result in 2.89 times that percentage change in operating income if Marston continues to use sales agents and 3.51 times that percentage change in operating income if Marston employs its own sales staff The higher contribution margin per dollar of sales and higher fixed costs gives Marston more operating leverage, that is, greater benefits (increases in operating income) if revenues increase but greater risks (decreases in operating income) if revenues decrease Marston also needs to consider the skill levels and incentives under the two alternatives Sales agents have more incentive compensation and hence may be more motivated to increase sales On the other hand, Marston’s own sales force may be more knowledgeable and skilled in selling the company’s products That is, the sales volume itself will be affected by who sells and by the nature of the compensation plan 3-35 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Variable costs of marketing Fixed marketing costs Operating income = Revenues = 15% of Revenues = $5,500,000 Variable manuf costs Fixed manuf costs Variable marketing costs Fixed marketing costs Denote the revenues required to earn $3,330,000 of operating income by R, then R 0.45R 3-44 $2,870,000 0.15R $5,500,000 = $3,330,000 R 0.45R 0.15R = $3,330,000 + $2,870,000 + $5,500,000 0.40R = $11,700,000 R = $11,700,000 0.40 = $29,250,000 (15–25 min.) Sales mix, three products Sales of A, B, and C are in ratio 20,000 : 100,000 : 80,000 So for every unit of A, (100,000 ÷ 20,000) units of B are sold, and (80,000 ÷ 20,000) units of C are sold Let Q = Number of units of A to break even 5Q = Number of units of B to break even 4Q = Number of units of C to break even Contribution margin – Fixed costs = Zero operating income $3Q + $2(5Q) + $1(4Q) – $255,000 $17Q Q 5Q 4Q Total Contribution margin: A: 20,000 $3 B: 100,000 $2 C: 80,000 $1 Contribution margin Fixed costs Operating income Contribution margin A: 20,000 $3 B: 80,000 $2 C: 100,000 $1 Contribution margin Fixed costs Operating income = = $255,000 = 15,000 ($255,000 ÷ $17) units of A = 75,000 units of B = 60,000 units of C = 150,000 units $ 60,000 200,000 80,000 $340,000 255,000 $ 85,000 $ 60,000 160,000 100,000 $320,000 255,000 $ 65,000 3-36 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Let Q = 4Q = 5Q = Number of units of A to break even Number of units of B to break even Number of units of C to break even Contribution margin – Fixed costs = Breakeven point $3Q + $2(4Q) + $1(5Q) – $255,000 $16Q Q 4Q 5Q Total = = $255,000 = 15,938 ($255,000 ÷ $16) units of A (rounded up) = 63,752 units of B = 79,690 units of C = 159,380 units Breakeven point increases because the new mix contains less of the higher contribution margin per unit, product B, and more of the lower contribution margin per unit, product C 3-45 (30 min.) Multiproduct breakeven, decision making Breakeven point in 2005 (units) = Fixed costs $495,000 = = 16,500 units Contributi on margin per unit $50 $20 Breakeven point in 2005 (in revenues) = 16,500 units × $50 = $825,000 in sales revenues Breakeven point in 2006 (in units) Evenkeel expects to sell units of Plumar for every units of Ridex in 2006, so consider a bundle consisting of units of Plumar and units of Ridex Unit contribution Margin from Plumar = $50 – $20 = $30 Unit contribution Margin from Ridex = $25 – $15 = $10 The contribution margin for the bundle is $30 × units of Plumar + $10 × units of Ridex = $110 So bundles to be sold to break even = $495,000 = 4,500 bundles $110 Breakeven point in 2006 (in units) Plumar, 4,500 × = 13,500 units Ridex, 4,500 × = 9,000 units Breakeven point in revenues: Plumar 13,500 units × $50 per unit = $675,000 Ridex 9,000 units × $25 per unit = 225,000 Total $900,000 3-37 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Contribution margin percentage in 2005 = = Contribution margin percentage in 2006 = = Contribution margin per unit in 2005 Selling price in 2005 $30 = 60% $50 Contribution margin of bundle in 2006 Selling price of bundle in 2006 $110 $110 = = 55% (3 $50 ) (2 $25) $200 The breakeven point in 2006 increases because fixed costs are the same in both years but the contribution margin generated by each dollar of sales revenue at the given product mix decreases in 2006 relative to 2005 Despite the breakeven sales revenue being higher, Evenkeel should accept Glaston’s offer The breakeven points are irrelevant because Evenkeel is already above the breakeven sales volume in 2005 By accepting Glaston’s offer, Evenkeel has the ability to sell all the 30,000 units of Plumar in 2006 and make more sales of Ridex to Glaston without incurring any more fixed costs Operating income in 2006 with and without Ridex are expected to be as follows: Sales Variable costs Contribution margin Fixed costs Operating income 2006 2006 without Ridex with Ridex $1,500,0001 $2,000,0002 600,0003 900,0004 900,000 1,100,000 495,000 495,000 $ 405,000 $ 605,000 $50 × 30,000 units ($50 × 30,000 units) + ($25 × 20,000 units) $20 × 30,000 units ($20 × 30,000 units) + ($15 × 20,000 units) 3-38 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 3-46 (20–25 min.) Sales mix, two products Let Q 3Q = Number of units of Deluxe carrier to break even = Number of units of Standard carrier to break even Revenues – Variable costs – Fixed costs = Zero operating income $20(3Q) + $30Q – $14(3Q) – $18Q – $1,200,000 = $60Q + $30Q – $42Q – $18Q = $30Q = Q = 3Q = $1,200,000 $1,200,000 40,000 units of Deluxe 120,000 units of Standard The breakeven point is 120,000 Standard units plus 40,000 Deluxe units, a total of 160,000 units 2a 2b Unit contribution margins are: Standard: $20 – $14 = $6; Deluxe: $30 – $18 = $12 If only Standard carriers were sold, the breakeven point would be: $1,200,000 $6 = 200,000 units If only Deluxe carriers were sold, the breakeven point would be: $1,200,000 $12 = 100,000 units Operating income = Contribution margin of Standard + Contribution margin of Deluxe – Fixed costs = 180,000($6) + 20,000($12) – $1,200,000 = $1,080,000 + $240,000 – $1,200,000 = $120,000 Let Q 9Q = = Number of units of Deluxe product to break even Number of units of Standard product to break even $20(9Q) + $30Q – $14(9Q) – $18Q – $1,200,000 $180Q + $30Q – $126Q – $18Q $66Q Q 9Q = = = = = $1,200,000 $1,200,000 18,182 units of Deluxe (rounded up) 163,638 units of Standard The breakeven point is 163,638 Standard + 18,182 Deluxe, a total of 181,820 units The major lesson of this problem is that changes in the sales mix change breakeven points and operating incomes In this example, the budgeted and actual total sales in number of units were identical, but the proportion of the product having the higher contribution margin declined Operating income suffered, falling from $300,000 to $120,000 Moreover, the breakeven point rose from 160,000 to 181,820 units 3-39 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 3-47 1a (20 min.) Gross margin and contribution margin Cost of goods sold Fixed manufacturing costs Variable manufacturing costs $1,600,000 500,000 $1,100,000 Variable manufacturing costs per unit = $1,100,000 1b Total marketing and distribution costs Variable marketing and distribution (200,000 Fixed marketing and distribution costs Selling price 200,000 = $5.50 per unit $1,150,000 800,000 $ 350,000 $4) 200,000 units = $13 per unit Variable Variable marketing Contributi on margin manufacturing – and distribution = Selling – price per unit costs per unit costs per unit = $13 $5.50 $4.00 = $3.50 Operating income = = $2,600,000 Contributi on margin per unit = ($3.50 230,000) = $45,000 Sales quantity $500,000 Fixed manufactur ing costs Fixed marketing and distributi on costs $350,000 Foreman has confused gross margin with contribution margin He has interpreted gross margin as if it were all variable, and interpreted marketing and distribution costs as all fixed In fact, both the manufacturing costs (subtracted from sales to calculate gross margin) and the marketing and distribution costs, contain fixed and variable components Breakeven point in units Breakeven point in revenues Fixed manufactur ing, marketing and distributi on costs Contributi on margin per unit $850,000 = = 242,858 units (rounded up) $3.50 = 242,858 $13 = $3,157,154 = 3-40 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 3-48 (30 min.) Ethics, CVP analysis Contribution margin percentage = = = Breakeven revenues = = If variable costs are 52% of revenues, contribution margin percentage equals 48% (100% 52%) Breakeven revenues = = Revenues Variable costs Revenues $5,000,000 $3,000,000 $5,000,000 $2,000,000 = 40% $5,000,000 Fixed costs Contributi on margin percentage $2,160,000 = $5,400,000 0.40 Revenues Variable costs (0.52 Fixed costs Operating income Fixed costs Contributi on margin percentage $2,160,000 = $4,500,000 0.48 $5,000,000 2,600,000 2,160,000 $ 240,000 $5,000,000) Incorrect reporting of environmental costs with the goal of continuing operations is unethical In assessing the situation, the specific ―Standards of Ethical Conduct for Management Accountants‖ (described in Exhibit 1-7) that the management accountant should consider are listed below Competence Clear reports using relevant and reliable information should be prepared Preparing reports on the basis of incorrect environmental costs to make the company’s performance look better than it is violates competence standards It is unethical for Bush not to report environmental costs to make the plant’s performance look good Integrity The management accountant has a responsibility to avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict Bush may be tempted to report lower environmental costs to please Lemond and Woodall and save the jobs of his colleagues This action, however, violates the responsibility for integrity The Standards of Ethical Conduct require the management accountant to communicate favorable as well as unfavorable information 3-41 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Objectivity The management accountant’s Standards of Ethical Conduct require that information should be fairly and objectively communicated and that all relevant information should be disclosed From a management accountant’s standpoint, underreporting environmental costs to make performance look good would violate the standard of objectivity Bush should indicate to Lemond that estimates of environmental costs and liabilities should be included in the analysis If Lemond still insists on modifying the numbers and reporting lower environmental costs, Bush should raise the matter with one of Lemond’s superiors If after taking all these steps, there is continued pressure to understate environmental costs, Bush should consider resigning from the company and not engage in unethical behavior 3-49 (35 min.) Deciding where to produce Peoria Selling price Variable cost per unit Manufacturing Marketing and distribution Contribution margin per unit (CMU) Fixed costs per unit Manufacturing Marketing and distribution Operating income per unit Moline $150.00 $72.00 14.00 30.00 19.00 86.00 64.00 49.00 $ 15.00 CMU of normal production (as shown above) CMU of overtime production ($64 – $3; $48 – $8) Annual fixed costs = Fixed cost per unit Daily production rate Normal annual capacity ($49 400 units 240 days; $29.50 320 units 240 days) Breakeven volume = FC CMU of normal production ($4,704,000 $64; $2,265,600 48) Units produced and sold Normal annual volume (units) Units over normal volume (needing overtime) CM from normal production units (normal annual volume CMU normal production) CM from overtime production units (0; 19,200 $40) Total contribution margin Total fixed costs Operating income Total operating income $150.00 $88.00 14.00 15.00 14.50 102.00 48.00 29.50 $ 18.50 $64 $48 61 40 $4,704,000 $2,265,600 73,500 units 47,200 Units 96,000 96,000 96,000 76,800 19,200 $6,144,000 $3,686,400 6,144,000 4,704,000 $1,440,000 768,000 4,454,400 2,265,600 $2,188,800 $3,628,800 3-42 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com The optimal production plan is to produce 120,000 units at the Peoria plant and 72,000 units at the Moline plant The full capacity of the Peoria plant, 120,000 units (400 units × 300 days), should be used because the contribution from these units is higher at all levels of production than is the contribution from units produced at the Moline plant Contribution margin per plant: Peoria, 96,000 × $64 Peoria 24,000 × $64 – $3 Moline, 72,000 × $48 Total contribution margin Deduct total fixed costs Operating income $ 6,144,000 1,464,000 3,456,000 $11,064,000 6,969,600 $ 4,094,400 The contribution margin is higher when 120,000 units are produced at the Peoria plant and 72,000 units at the Moline plant As a result, operating income will also be higher in this case since total fixed costs for the division remain unchanged regardless of the quantity produced at each plant 3-43 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter Video Case The video case can be discussed using only the case writeup in the chapter Alternatively, instructors can have students view the videotape of the company that is the subject of the case The videotape can be obtained by contacting your Prentice Hall representative The case questions challenge students to apply the concepts learned in the chapter to a specific business situation STORE 24: Cost-Volume-Profit Analysis Customers who might be attracted to money order services include those new to the location who don’t have a bank checking account, or those who not wish to establish a relationship with a bank for financial services In the Northeast, Store 24 operates in neighborhoods with large immigrant populations whose members have yet to open bank checking accounts These customers are also likely to buy Store 24’s other products once they are in the store Contribution margin per unit: Selling price: 79.0 cents Deduct: Direct labor 22.5 cents ($9.00 per hour/60 minutes) × 1.5 minutes Processing fee 6.0 cents Contribution margin 50.5 cents per unit Equation method formula: Revenues – Variable costs – Fixed costs (FC) = Operating income (OI) Where (Unit selling price × quantity (Q)) – (Unit variable costs × Q) – Fixed costs = OI (0.79Q) – ((0.225 +0.06)Q) – $30.00 = $0 0.505Q – $30.00 = $0 0.505Q = $30.00 Q = $30.00/0.505 = 59.41 money orders (approximately per day) Contribution margin method: $30.00/0.505 cents per unit = 59.41 units per month Revenues – Variable costs – Fixed costs (FC) = Operating income (OI) (0.79Q) – ((0.225 +.06)Q) – $30.00 = $140 0.505Q – $30.00 = $140 0.505Q = $140 + 30.00 = $170 Q = $170.00/0.505 = 336.6 money orders per month (approximately 11 per day) 3-44 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Since it takes three times as long for a clerk to complete a money order transaction versus a typical product sale (90 seconds versus 30 seconds), customers who are not purchasing money orders will have to wait three times longer while the money order transaction is being completed Some customers may choose not to wait, thereby costing the store those sales It is difficult to calculate the exact cost since the number of customers who might leave and the contribution margin for the average $3.00 sale is not known Students may try to calculate the cost using the gross margin percentage of 30%, and an estimate of the variable operating costs such as the labor of the store clerk In June 2004, the Canadian convenience store industry released a report conducted by Moneris Solutions Group (Toronto) that revealed 40% of Canadian shoppers walked out of a convenience store in 2003 due to long checkout lines They estimated this behavior cost the industry $1.7 billion that year Store 24 may want to track customers coming to the store each hour to determine peak traffic times that could be used to justify additional staffing to cover those busy hours 3-45 ... Athletic scholarships, CVP analysis Variable costs per scholarship offer: Scholarship amount Operating costs Total variable costs $20,000 2,000 $22,000 Let the number of scholarships be denoted by Q... costs 600,000 Variable costs for scholarships $3,300,000 If the total number of scholarships is to remain at 200: Variable cost per scholarship $3,300,000 ÷ 200 Variable operating cost per scholarship... costs Variable manufacturing costs Variable marketing costs Total variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed marketing & administration costs Total fixed costs