# braun_ma4_sm_10

July 6, 2017 | Author: nobleverma | Category: Revenue, Financial Accounting, Business Economics, Management Accounting, Business

#### Short Description

Cost volume behavior analysis...

#### Description

Chapter 7

Cost-Volume-Profit Analysis

Chapter 7 Cost-Volume-Profit Analysis Quick Check Answers: QC-1. d QC-2. c

QC-3. b QC-4. c

QC-5. a QC-6. c

QC-7. b QC-8. b

QC-9. c QC-10. d

Short Exercises (5-10 min.) S7-1 a.

Sales price per passenger……………………. Less: Variable cost per passenger………….. Contribution margin per passenger…………

\$ 50 20 \$ 30

b.

Contribution margin per passenger………… Divided by sales price per passenger………. Contribution margin ratio……………………..

\$30 ÷ 50 60%

c.

Total contribution margin (11,000 × \$30)…... Less: Fixed expenses………………………….. Operating income……………………………….

\$330,000 210,000 \$120,000

d.

Total contribution margin (\$490,000 × 60%) ………………………….. Less: Fixed expenses………………………….. Operating income……………………………….

\$294,000 210,000 \$84,000

(5 min.) S7-2 The unit contribution margin tells managers how much income is earned on each unit of sales before considering fixed costs. Each sale contributes its unit contribution margin towards covering fixed costs and generating a profit. Therefore, if the number of dinner cruises sold increases by 600 and each sale generates \$30 of contribution margin, operating income will increase (or operating loss will decrease) by \$18,000 (= 600 passengers × \$30 per passenger).

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Managerial Accounting 4e Solutions Manual

(5-10 min.) S7-3 Units sold (to break even)

Fixed expenses + Operating income Contribution margin per unit (passenger)

=

\$210,000 + 0 \$30*

= =

7,000 passengers

*Contribution margin per passenger

=

\$50 sales price

\$20 variable expense per passenger

Number of passengers to break even*……………. Sales price per passenger…………………………... Sales revenue to break even………………………..

7,000 × \$50 \$350,000

* from earlier calculation

(5 min.) S7-4 Sales in units

= = =

Fixed expenses + Operating income Contribution margin per unit \$210,000 + \$45,000 \$30 8,500 dinner cruise tickets

Or, using the equation approach: Sales revenue

Variable expenses

Fixed expenses

=

Operating income

Sale price Units per unit × sold

Variable cost Units per unit × sold

Fixed expenses

=

Operating income

[(\$50 × Units sold)

(\$20 × Units sold)] [(\$50 − \$20) × Units sold]

− \$210,000 − \$210,000 Units sold

= \$45,000 = \$45,000 = 8,500 tickets

To earn target income of \$45,000, the cruiseline must sell 8,500 dinner cruise tickets.

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Chapter 7

Cost-Volume-Profit Analysis

(5-10 min.) S7-5

(5 min.) S7-6 a. b. c. d. e. f. g. h. i. j.

Fixed expense line Total expense line Sales revenue line Dollars (vertical axis) Units (horizontal axis) Operating loss area Operating income area Breakeven point 150 \$300

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Managerial Accounting 4e Solutions Manual

(10 min.) S7-7

Req. 1 If the sales price declines to \$40, then the new unit contribution margin is \$20 (\$40 − \$20). The new breakeven point in units is: Fixed expenses + Operating income = Sales in units Contribution margin per unit \$210,000 + \$0 \$20

= =

10,500 dinner cruise passengers

To achieve breakeven, sales revenue needs to be \$420,000 (10,500 passengers × \$40 sales price per passenger). Also can be calculated as: Fixed expenses + Operating income = Sales in \$ Contribution margin ratio \$210,000 + \$0 0.50*

= =

\$420,000 dinner cruise revenue *CM ratio = \$20/\$40 = 0.50

Or, using the equation approach: Sales revenue

Sale price Units per unit × sold

Variable expenses Variable cost per unit ×

(\$40 × Units sold) − [(\$40 − \$20) × Units sold]

Units sold

(\$20 × Units sold)

Fixed expenses

=

Operating income

Fixed expenses

=

Operating income

− \$210,000 − \$210,000 Units sold

10,500 passengers × \$40 = \$420,000 Alternatively, Contribution margin ratio

= Sales in dollars

Contribution margin per unit Sale price per unit

= =

\$40 − \$20 \$20 0.50 Fixed expenses + Operating income Contribution margin ratio

= = =

= \$0 = \$0 = 10,500 passengers

\$210,000 + \$0 0.50 \$420,000

All else being constant, a decrease in sales price will decrease the contribution margin per unit and the contribution margin ratio. The breakeven point will therefore increase. Increases in sales price will have the opposite effect. 7-4

Chapter 7

Cost-Volume-Profit Analysis

(continued) S7-7 Req. 2 If the variable cost decreases to \$10, then the new unit contribution margin is \$40 (\$50 − \$10). The new breakeven point in units is: Fixed expenses + Operating income = Sales in units Contribution margin per unit \$210,000 + \$0 \$40

= =

5,250 dinner cruise passengers

To achieve breakeven, sales revenue needs to be \$262,500 (5,250 passengers × \$50 sales price per ticket). Or, using the equation approach: Sales revenue

Variable expenses

Fixed expenses

=

Operating income

Sale price Units per unit × sold

Variable cost Units per unit × sold

Fixed expenses

=

Operating income

(\$50 × Units sold) − [(\$50 − \$10) × Units sold]

(\$10 × Units sold)

− \$210,000 − \$210,000 Units sold

= \$0 = \$0 = 5,250 passengers

5,250 passengers × \$50 = \$262,500 Alternatively, Contribution margin ratio

= = Sales in dollars

Contribution margin per unit Sale price per unit

=

\$50 − 10 \$50 0.80 Fixed expenses + Operating income Contribution margin ratio

= = =

\$210,000 + \$0 0.80 \$262,500

All else being equal, a decrease in variable costs will increase the contribution margin per unit and the contribution margin ratio. The breakeven point will therefore decrease. An increase in variable costs will have the opposite effect.

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Managerial Accounting 4e Solutions Manual

(5-10 min.) S7-8 Req. 1 The decline in fixed costs does not affect the \$30 unit contribution margin calculated in S7-1. The new breakeven point in units is: Fixed expenses + Operating income = Sales in units Contribution margin per unit \$180,000 + \$0 \$30

= =

6,000 dinner cruise passengers

Or, using the equation approach: Sales revenue

Sale price Units per unit × sold

Variable expenses Variable cost per unit ×

(\$50 × Units sold) − [(\$50 − \$20) × Units sold]

Units sold

(\$20 × Units sold)

Fixed expenses

=

Operating income

Fixed expenses

=

Operating income

− \$180,000 − \$180,000 \$30 × Units sold Units sold

6,000 passengers × \$50 = \$300,000 Alternatively, Contribution margin ratio

= = Sales in dollars

\$50 − 20 \$50 0.60 Fixed expenses + Operating income Contribution margin ratio

= = =

7-6

Contribution margin per unit Sale price per unit

=

\$180,000 + \$0 0.60 \$300,000

= = = =

\$0 \$0 \$180,000 6,000 passengers

Chapter 7

Cost-Volume-Profit Analysis

(continued) S7-8

Req. 2 The breakeven point is lower than in S7-3. By cutting fixed costs, the cruiseline was able to decrease its breakeven point by 1,000 passengers (7,000 - 6,000). All else being equal, a decrease in fixed costs will decrease the breakeven point, while an increase in fixed costs will increase the breakeven point.

(5-10 min.) S7-9 Weighted-Average Contribution Margin per Unit Regular Executive Cruise Cruise Sale price per ticket \$ 50 \$130 Less: Variable expense per ticket 20 40 Contribution margin per ticket \$ 30 \$ 90 Sales mix in units × 4 × 1 Contribution margin \$120 \$ 90 Weighted-average contribution margin per unit (\$210 / 5)

Total

5 \$210 \$ 42.00

A simple average contribution margin would be \$60 [(30 + 90) / 2]. The weighted-average is less than the simple average because the cruiseline sells more regular cruises (with the lower contribution margin) than executive cruises. The weighted average contribution margin (\$42.00) is higher than the contribution margin of regular cruises (\$30) because the cruiseline sells some executive cruises, and executive cruises have a higher contribution margin (\$90) than regular cruises. Because the new sales mix creates a higher weighted average contribution margin, the cruiseline will need to sell fewer cruises, in total, to breakeven than when it just sold regular cruises.

(5-10 min.) S7-10 a. Sales in total tickets

= =

Fixed expenses + Operating income Weighted-average contribution margin per unit \$210,000 + \$0 \$42.00*

= 5,000 passengers *Weighted-average contribution margin per unit from S7-9. b. Breakeven sales of regular cruises (5,000 × 4/5)……… Breakeven sales of executive cruises (5,000 × 1/5)...... Total cruise passengers.................................………..

4,000 1,000 5,000

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Managerial Accounting 4e Solutions Manual

(5-10 min.) S7-11 a.

Margin of safety in units

Expected sales in units

= =

8,750 – 7,000*

=

1,750 passengers

Breakeven sales in units

*(from S7-3) b.

Margin of safety in dollars

Target level sales dollars

= =

\$437,500a - \$350,000b

=

\$87,500 a

-

Breakeven sales dollars

8,750 x \$50 = \$437,500 7,000 x \$50 = \$350,000

b

c.

Margin of safety as a percentage of expected sales

Margin of safety in dollars Expected sales in dollars

=

\$87,500 \$437,500

= =

20%

(5-10 min.) S7-12 a.

Contribution margin (8,750 × \$30 / cruise passenger)…………………………………...... Less: Fixed expenses…………………………. Operating income……………………………….. Operating Leverage Factor

\$262,500 210,000 \$52,500 =

Contribution margin Operating income

=

\$262,500 \$52,500

=

5.0

b.

If volume increases 10%, operating income will increase 50% (operating leverage factor of 5.0 multiplied by 10%).

c.

If volume decreases by 5%, operating income will decrease by 25% (operating leverage factor of 5.0 multiplied by 5%).

(5-10 min.) S7-13 a. 7-8

Margin of safety

=

Expected sales

Breakeven sales

Chapter 7 in units

Cost-Volume-Profit Analysis

in units =

1,500 – 750*

=

750 posters

in units

*Breakeven in units = \$15,000/(\$45-\$25) = 750 units b.

Margin of safety in dollars

Target level sales dollars

= =

\$67,500** - \$33,750***

=

\$33,750

-

Breakeven sales dollars

** Expected sales in dollars = 1,500 x \$45 = \$67,500 *** Breakeven in dollars = 750 x \$45 = \$33,750 c.

Margin of safety as a percentage of expected sales

Margin of safety in dollars Expected sales in dollars

=

= =

33,750 67,500 50%

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Managerial Accounting 4e Solutions Manual

(5-10 min.) S7-14 Contribution margin (1,500 × \$20 / poster)……. Less: Fixed expenses…………………………. Operating income……………………………….. Operating Leverage Factor

\$30,000 15,000 \$15,000

=

Contribution margin Operating income

=

\$30,000 \$15,000

= 2.0 If volume increases 20%, operating income will increase 40% (operating leverage factor of 2.0 multiplied by 20%). Proof: Original volume (posters) ………………………….. Add: Increase in volume (20% × 1,500) ……… New volume (posters) …………………………….... Multiplied by: Unit contribution margin…………. New total contribution margin…………………….. Less: Fixed expenses……………………………... New operating income……………………………… Less: Operating income before change in

1,500 300 1,800 × \$20 \$36,000 (15,000 ) \$21,000

volume (from above)……………………….....

(15,000 )

Increase in operating income……………………...

\$6,000

Percentage change (\$6,000 / \$15,000) ……………..

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40%

Chapter 7

Cost-Volume-Profit Analysis

(5-10 min.) S7-15

Req. 1 Product: Cupcakes Selling price per unit Less: Variable cost per unit CM

\$ \$ \$

6.00 4.00 2.00

To find the indifference point, you need to set the costs of Option 1 equal to the costs of Option 2: \$2,600 = \$1,700 + [(\$6 x .05) x CUPCAKES] Then solve for CUPCAKES: CUPCAKES = 3,000 Proof: Lease costs under Option 1: Fixed costs Variable costs (none) Total costs under Option 1

\$ 2,600 0 \$ 2,600

Lease costs under Option 2: Fixed costs Variable costs per unit (\$6 x .05) Times # of units at pt of indifference (3,000)

\$

0.30

\$ 1,700

3,000

Total variable costs Total costs under Option 2

900 \$2,600

Since the number of units is 2,200 and is less than the 3,000 point of indifference, option 2 would be the lowest cost option. Option 1 costs = \$2,600 Option 2 costs = \$1,700 + (\$6 x 0.05) x 2,200) = \$2,360 Req. 2 Option 1 is the better option for 4,500 units Option 1 costs = \$2,600 Option 2 costs = \$1,700 + ((\$6 x 0.05) x 4,500) = \$3,050

(5-10 min.) S7-16 1. Integrity - Mitigate actual conflicts of interest, regularly communicate with business associates to avoid apparent conflicts of interest. Advise all parties of any potential conflicts. 2. Competence - Maintain an appropriate level of professional expertise by continually developing knowledge and skills. 3. Competence - Perform professional duties in accordance with relevant laws, regulations, and technical standards. 4. Confidentiality - Keep information confidential except when disclosure is authorized or legally required. 5. Credibility - Disclose all relevant information that could reasonably be expected to influence an intended user's understanding of the reports, analyses, or recommendations.

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Managerial Accounting 4e Solutions Manual

Exercises (Group A) (15 min.) E7-17A Req. 1 Global Travel Contribution Margin Income Statements Sales revenue Less: Variable expenses (30% of sales revenue*) Contribution margin (70% of sales revenue**) Fixed expenses Operating income (loss) __________ *\$120,000 / \$400,000 = 0.30 **\$280,000 / \$400,000 = 0.70 (CM ratio)

\$270,000 81,000 189,000 170,800 \$ 18,200

\$410,000 123,000 287,000 170,800 \$ 116,200

Req. 2 Breakeven sales

=

\$170,800 + \$0 1 − 0.30

=

\$170,800 + \$0 0.70

= \$244,000

(10-15 min.) E7-18A This problem involves working backwards through the shortcut contribution margin formula and then working backwards through the contribution margin income statement to find the missing data. First, fill in the given data in the short cut contribution margin formula, and solve for the contribution margin ratio: Sales needed to breakeven \$48,000 Contribution margin ratio Contribution margin ratio

=

Fixed expenses Contribution margin ratio

=

\$24,000 Contribution margin ratio

=

\$24,000 \$48,000

= .50

Next, fill in the given data in the contribution margin income statement: Sales…………………………. Less: Variable expenses…. Contribution margin………. Less: Fixed expenses…….. Operating income…………..

7-12

\$ ? 42,000 ? 24,000 \$ ?

Chapter 7

Cost-Volume-Profit Analysis

(continued) E7-18A Because the contribution margin ratio 50% of sales revenue. Therefore: Variable expenses \$ 42,000 \$ 84,000 Or alternatively: Sales − \$42,000 Sales − 50% Sales 50% Sales Sales Sales

is 50% of sales revenue, the variable expenses must be = = =

50% × Sales revenue 50% × Sales revenue Sales revenue

= = = =

50% Sales \$42,000 \$42,000 \$42,000 50% \$84,000

=

Once sales revenue is found, the rest of the income statement follows: Sales………………………………. \$ 84,000 Less: Variable expenses………. 42,000 Contribution margin……………. \$ 42,000 Less: Fixed expenses………….. 24,000 Operating income………………. \$ 18,000 Therefore, at the current level of operations, the company’s sales revenue is \$84,000 and its operating income is \$18,000.

(15 min.) E7-19A Req. 1 Contribution margin per unit: Sale price....................................………….. Less: Variable expenses.................................…. Contribution margin per unit.................... Contribution margin ratio: Contribution margin per unit Sale price per unit

\$1.80 0.90 \$0.90

=

\$0.90 \$1.80

=

0.50

Req. 2 Breakeven sales in units

= =

Fixed expenses + Operating income Contribution margin per unit \$90,000 + \$0 \$0.90

= 100,000 packages

Breakeven sales in dollars

= =

Fixed expenses + Operating income Contribution margin ratio \$90,000 + \$0 0.50

= \$180,000

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Managerial Accounting 4e Solutions Manual

(continued) E7-19A Req. 3 Sales in units

= =

Fixed expenses + Operating income Contribution margin per unit \$90,000 + \$18,000 \$0.90

= 120,000 packages

(5-10 min.) E7-20A New contribution margin per unit: Sales price....................................………….. Less: Variable expenses.................................…. Contribution margin per unit.................... Sales in units

= =

\$1.80 0.80 \$1.00

Fixed expenses + Operating income Contribution margin per unit \$105,000 + \$18,000 \$1.00

= 123,000 packages The company would have to sell 3,000 more packages of socks (123,000 − 120,000 from E719A) to earn \$18,000 of operating income. The increase in fixed costs was not completely offset by the decrease in variable costs at the prior target profit volume of sales. Therefore, the company will need to sell more units in order to achieve its target profit level.

7-14

Chapter 7 Req. 1 Contribution margin ratio

(10-15 min.) E7-21A Contribution margin per unit Sales price per unit

= = =

Breakeven sales in dollars

Cost-Volume-Profit Analysis

\$5.25 − \$2.10 \$5.25 0.60 Fixed expenses + Operating income Contribution margin ratio

= = =

\$7,500 + \$0 0.60 \$12,500

Req. 2 If franchisees require a monthly operating income of \$7,500 Target sales Fixed expenses + Operating income = in dollars Contribution margin ratio = =

\$7,500 + \$7,050 0.60 \$24,250

Yes, the franchising concept is a good idea. Most locations are expected to sell more (\$25,000) than the sales required to earn the target profit (\$24,250).

(10- 15 min.) E7-22A Req. 1 Prior to changes, the average restaurant location had the following operating income: Contribution margin per unit (\$5.25 - \$2.10) \$ 3.15 Average sales volume units………………… × 6,500 Contribution margin………………………….. \$20,475 Less: Fixed expenses………………………. (7,500) Operating income……………………………... \$12,975 Req. 2 After the price cut and advertising fees, the average restaurant location will have the following operating income: New contribution margin per unit (\$4.75 sales price – \$2.10 variable cost……………………………………. \$ 2.65 New sales volume (units)…………. × 7,000 Contribution margin………………... \$18,550 Less: New fixed expenses (\$7,500 + \$600 advertising fee)…… (8,100) New operating income…………….. \$ 10,450 Assuming volume increases according to plan, cutting the sales price and advertising will allow the franchise owners to continue to reach their target profits of \$7,050 per month. However, their operating income will not be as high as before the changes.

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Managerial Accounting 4e Solutions Manual

(10-15 min.) E7-23A Req. 1 Breakeven sales in dollars

Fixed expenses + Operating income Contribution margin ratio

= = =

\$630,000 + \$0 0.70 \$900,000

Req. 2 Grover’s Steel Parts Operating Income Projections at Different Sales Levels Sales revenue \$ 520,000 × Contribution margin ratio 0.70 Contribution margin 364,000 Less: Fixed expenses 630,000 Operating income (loss) \$(266,000)

\$1,010,000 0.70 707,000 630,000 \$ 77,000

Req. 3 Yes, the income projections at the two different sales levels make sense given the breakeven sales level (\$900,000) computed in Req. 1. Req. 2 shows that if the company’s revenue is only \$520,000 (short of the revenue required to breakeven) the company incurs a loss. On the other hand, if revenue is \$1,010,000 (higher than the revenue required to breakeven), the company earns a profit.

(15 min.) E7-24A Req. 1 Target sales in dollars

= = =

Fixed expenses + Operating income Contribution margin ratio \$630,000 + \$77,000 0.40 \$1,767,500

Req. 2 Fixed expenses + Operating income Contribution margin ratio

Sales in dollars

=

\$1,010,000

=

\$404,000

=

Fixed expenses + \$77,000

\$327,000

=

Fixed expenses

Fixed expenses + \$77,000 0.40

Fixed expenses can only be \$327,000 to maintain the prior profit level of \$77,000 per month. Therefore, Grover will have to save at least \$303,000 per month in fixed costs (\$630,000 − \$327,000) by moving operations overseas if he plans to maintain his prior profit level.

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Chapter 7

Cost-Volume-Profit Analysis

(15-20 min.) E7-25A

Req. 1 (Fixed expenses + Operating income) / CM per unit = Breakeven in units (\$240,000 + \$0) / (\$2,400 - \$1,000 - \$200) = 200 units

(Fixed expenses + Operating income) / CM ratio = Breakeven in sales dollars CM ratio = (\$2,400 - \$1,000 - \$200) / \$2,400 = .50 (\$240,000 + \$0) / .50 = \$480,000 Req. 2 Total CM (\$2,400 - \$1,000 - \$200) x 410 = \$492,000 Projected operating income = \$492,000 - \$240,000 = \$252,000 Req. 3 New fixed expenses = \$240,000 + \$120,000 = \$360,000 New CM = \$2,400 – (\$1,000 - \$240) - \$200 = \$1,440 (Fixed expenses + Operating income) / CM per unit = Breakeven in units (\$360,000 + \$0) / (\$2,400 – (\$1,000 - \$240) - \$200) = 250 units (Fixed expenses + Operating income) / CM ratio = Breakeven in sales dollars CM ratio = (\$2,400 – (\$1,000 - \$240) - \$200) / \$2,400 = .60 (\$360,000 + \$0) / .60 = \$600,000 Req. 4 Total CM (\$2,400 – (\$1,000 - \$240) - \$200) x 410 = \$590,400 Projected operating income = \$590,400 - \$360,000 = \$230,400 Req. 5 Based purely on the financial analysis presented above (operating income for Req. 1 is more than the operating income for Req. 4), the company should not implement the software control system. However, the new control system would reduce waste and contribute to the company’s sustainability objectives. The company should take into account not only the financial measures such as operating income, breakeven point, and operating leverage, but also the sustainability impact of the decision. Student answers may vary for Req. 5.

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Managerial Accounting 4e Solutions Manual

(5-10 min.) E7-26A Use the short cut contribution margin formula to determine the company’s current level of fixed expenses: Fixed expenses Sales needed to breakeven = Contribution margin ratio Fixed expenses .20

\$350,000

=

\$350,000 × .20

=

Fixed expenses

\$70,000

=

Fixed expenses

After buying the equipment, the company’s fixed expenses will be \$125,000 (\$70,000 + \$55,000 increase). Calculate breakeven (in sales) at the new level of fixed expenses: Fixed expenses Sales needed to breakeven = Contribution margin ratio = =

\$125,000 .20 \$625,000

The company will now have to generate \$625,000 of sales revenue to breakeven.

(5-10 min.) E7-27A Sales price per unit……………….. Contribution margin ratio………... Contribution margin per unit…….

\$24.00 × .625 \$15.00

Find the number of scarves needed to breakeven on (or pay for) the extra entrance fee cost of \$120 (= \$1,200 × 10% increase): Fixed expenses Breakeven in units = Contribution margin per unit

Alternatively: Breakeven in sales revenue

=

\$120 \$15.00

=

8 scarves Fixed expenses Contribution margin ratio

= =

\$120 .625

= \$192 in sales revenue Dividing \$192 in sales revenue by the price per scarf (\$24) yields 8 scarves. The owner will have to sell an additional 8 scarves next year to cover the increase in entrance fees.

(15-20 min.) E7-28A 7-18

Chapter 7

Cost-Volume-Profit Analysis

Weighted-Average Contribution Margin per Unit Twig Sale price per unit \$15.00 Less: Variable cost per unit 2.50 Contribution margin per unit \$12.50 Multiply by: Sales mix in units × 4 Contribution margin \$50.00

Oak \$35.00 10.00 \$25.00 × 1 \$25.00

Weighted-average contribution margin per unit (\$75 / 5 units) Sales in total units: = =

Total

5 \$75.00 \$15.00

Fixed expenses + Operating income Weighted-average contribution margin per unit

\$300 + \$0 \$15

= 20 units Breakeven sales of twig stands (20 × 4/5)……………… Breakeven sales of oak stands (20 × 1/5).………………

16 units 4 units

By charging her husband part of the craft fair entrance fees, the wife’s fixed costs will decrease. Therefore, the wife will need to sell fewer scarves to breakeven than before her husband decided to share her craft booths.

(15-20 min.) E7-29A Weighted-Average Contribution Margin per Unit Standard Chrome Sales price per unit \$60 \$75 Less: Variable cost per unit 45 55 Contribution margin per unit \$15 \$20 Multiply by: Sales mix in units × 3 × 2 Contribution margin \$45 \$40 Weighted-average contribution margin per unit (\$110 / 5 units)

Total

5 \$ 85 \$ 17

Sales in total units: Fixed expenses + Operating income Weighted-average contribution margin per unit

= =

\$18,700 + \$0 \$17

= 1,100 units Breakeven sales of standard scooters (1,100 × 3/5)……………… Breakeven sales of chrome scooters (1,100 × 2/5).………………..

660 units 440 units

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Managerial Accounting 4e Solutions Manual

(continued) E7-29A

Sales in total units:

Fixed expenses + Operating income Weighted-average contribution margin per unit

=

\$18,700 + \$13,600 \$17

=

= 1,900 units Target sales of standard scooters (1,900 × 3/5)........……………… Target sales of chrome scooters (1,900 × 2/5)............…................

1,140 units 760 units

(20-30 min.) E7-30A This is a challenging exercise that requires students to work backwards. Use the weightedaverage contribution margin per unit chart, in conjunction with the shortcut formula, to work backwards to find the contribution margin of the Classic. Sales price per unit................……….. Less: Variable expense per unit. (\$125 + \$35) Contribution margin per unit..…….. Multiply by: Sales mix in units..........…………….. Contribution margin..........…………. Weighted-average contribution margin per unit..........…………….. a

Classic 215 × 3 645

Sales in total units

=

Fixed expenses + Operating income Weighted-average contribution margin per unit

2,100

=

\$195,000 + \$36,000 Weighted-average contribution margin per unit

Weighted-average contribution margin per unit

= =

7-20

Digital \$225 160 65 x7 \$455

\$231,000 2,100 \$110 / unit

Total

10 1,100 \$ 110

Chapter 7

Cost-Volume-Profit Analysis

(continued) E7-30A b

c

Weighted-average contribution margin per unit

Contribution margin per Classic watch

Total sales mix contribution margin Total sales mix units

=

\$455 + X 10

\$110

=

\$1,100

=

\$455 + X

X

=

\$645

3

=

\$645

=

\$215

×

Contribution margin per Classic watch

(15 min.) E7-31A Req. 1 The company’s operating income can be computed as follows: Sales revenue……………………………………. Less: Variable expenses……………………… Contribution margin……………………………. Less: Fixed expenses……(\$2,600,000 - \$1,088,000) Operating income……………………………….. Req. 2 Contribution margin ratio

5,712,000 6,800,000

= =

\$6,800,000 1,088,000 5,712,000 1,512,000 \$4,200,000

84%

Req. 3 Breakeven in sales dollars

1,512,000 84%

= =

\$1,800,000

Req. 4 If the company embarks on this advertising campaign, sales revenue and variable costs will rise by 14%, which will cause the contribution margin to increase by 14%. Fixed costs will rise by only \$250,000 due to the advertising campaign. Overall operating income will increase by \$549,680 See the computations to follow. The change in operating income can be computed as follows: Current contribution margin Percentage increase Increase in contribution margin Less: Increase in fixed costs of advertising campaign Increase in operating income

\$5,712,000 × 14% 799,680 250,000 \$549,680

7-21

Managerial Accounting 4e Solutions Manual Req. 1 Contribution margin ratio

Breakeven sales in dollars

=

1.00 – 0.60

=

0.40

= = Target sales in dollars

Margin of safety

Req. 2 Margin of safety as a percentage of target sales

Fixed expenses + Operating income Contribution margin ratio

=

\$12,000 + \$0 0.40 \$30,000 Fixed expenses + Operating income Contribution margin ratio

= =

\$12,000 + \$20,000 0.40

=

\$32,000 0.40

=

\$80,000

=

\$80,000 − \$30,000

=

\$50,000

=

\$50,000 \$80,000

= 0.625 or 62.5% of target sales Req. 3 Target sales……………………... Contribution margin ratio…….. Contribution margin…………… Less: Fixed expenses……….. Operating income………………. Operating Leverage Factor

\$80,000 × .40 \$32,000 12,000 \$20,000 =

Contribution margin Operating income

=

\$32,000 \$20,000

=

1.60

Req. 4 If volume decreases 12%, operating income will decrease 19.20% (operating leverage factor of 1.60 multiplied by 12%).

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Chapter 7

Cost-Volume-Profit Analysis

(10 min.) E7-33A First, find the company’s contribution margin: Sales……………………………… Contribution margin ratio…….. Contribution margin……………

\$60,000 × .35 \$21,000

Then, work backwards to find the company’s operating income: Contribution margin Operating leverage factor = Operating income =

\$21,000 Operating income

Operating income

=

\$21,000 1.40

Operating income

= \$15,000

1.40

Finally, finish the income statement to find the fixed expenses: Contribution margin…….. \$21,000 Less: Fixed expenses…. Unknown Operating income……….. \$15,000 Therefore, fixed expenses must be \$6,000.

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Managerial Accounting 4e Solutions Manual

(10-15 min.) E7-34A Req. 1 Selling price \$30 Less: Variable costs (\$6 + \$3 + \$3) 12 CM per unit \$18 Lease costs under Option A: Fixed costs Variable costs (none) Total costs under Option A

\$ 3,000 0 \$ 3,000

Lease costs under Option B: Fixed costs Total variable costs (10% x \$30 x 250) Total costs under Option B

\$ 1,650 750 \$ 2,400

The more attractive lease option is Option B because it results in the lowest total lease costs. Req. 2 To solve the question, you need to set the costs of Option A equal to the costs of Option B: \$3,000 = \$1,650 + (10% x \$30 x CANDLES) Then solve for CANDLES: CANDLES = 450 Req. 3 The lease option that is more attractive for the company if the company plans to sell 600 candles a month is option A, the fixed lease payment because the sales volume is more than the indifference point.

7-24

Chapter 7

(20-25 min.) E7-35A

Req. 1 Breakeven in units

Fixed expenses Contribution margin per unit

= = =

*

Req. 2 2a.

2b.

Cost-Volume-Profit Analysis

Selling price Less: variable cost per unit CM per unit

Sales in units to reach desired profit

Sales in dollars to reach desired profit

\$600 \$30* 20 grooming kits

\$62 \$32 \$30

Fixed expenses + Operating Income Contribution margin per unit

= =

\$600 + \$900 \$30

=

\$1,500 \$30

=

50 grooming kits

=

breakeven units x selling price per unit

=

50 units x \$62/each

=

\$3,100

2c. Condensed Income Statement Sales Less: variable expenses (50 x \$32)

\$3,100

Contribution margin

\$1,500

Less: fixed expenses

\$600

Operating income

\$900

\$1,600

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Managerial Accounting 4e Solutions Manual

(continued) E7-35A Req. 3 Margin of safety in dollars: Sales at target level: Sales at B/E level: Margin of safety in dollars Margin of safety in units: Sales at target level: Sales at B/E level: Margin of safety in units Margin of safety in %: Margin of safety in dollars: Sales at target level: \$1,860/\$3,100 =

\$3,100 \$1,240* \$1,860

50 20 30

\$1,860 \$3,100 60.00%

*Sales at B/E level: 20 kits x \$62 = \$1,240

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Chapter 7

Cost-Volume-Profit Analysis

(20-25 min.) E7-36A Req. 1 Total Sales

Per Unit

%

\$81,250

\$25

100%

48,750

15

60%

Contribution Margin

\$32,500

\$10

40%

Less: Fixed expenses

13,000

Less: Variable expenses

Operating income

\$19,500

1a) Total contribution margin is \$32,500. 1b) Per unit contribution margin is \$10. 1c) Operating income is \$19,500. 1d) Units sold = Total sales / sales price = \$81,250 / \$25 = 3,250 units Req. 2 2a. Breakeven in units

= =

\$13,000 \$10

=

1,300 units

2b. Breakeven sales in dollars

Fixed expenses Contribution margin per unit

= = =

Fixed expenses + Operating income Contribution margin ratio \$13,000 + 0 0.40 (from req. 1) \$32,500

Req. 3 3a. Sales in units to reach desired profit

=

Fixed expenses + Operating Income Contribution margin per unit

=

\$13,000 + \$53,000 \$10

=

\$66,000 \$10

=

6,600 units

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Managerial Accounting 4e Solutions Manual

(continued) E7-36A 3b. Budgeted Sales Units

3,250

Less: Breakeven Sales Units

1,300

Margin of Safety in Units

1,950

3c. Budgeted Sales

\$81,250

Less: Breakeven Sales Volume

\$32,500

Margin of Safety in Dollars 3d.

\$48,750

Margin of Safety in Dollars

\$48,750

Divided by: Budgeted Sales Dollars

\$81,250

Margin of Safety %

60.0%

(20-25 min.) E7-37A 1.

Sales price per unit............................................. Less: Variable cost per unit (7.30+6+2.60+2.10)......................................... Contribution margin per unit .............................

\$25.00 \$18.00 \$ 7.00

Contribution margin ratio

=

\$7.00 \$25.00

Sales revenue (140,000 × \$25.00)……………… Less: Variable expenses (140,000 × \$18.00)… Contribution margin……………………………..

=

.28

=

28%

\$ 3,500,000 (2,520,000) \$ 980,000

2.

Sales volume (units)……………………………… Unit contribution margin………………………… Contribution margin……………………………… Less: Fixed expenses………(\$292,000 + \$447,200) Operating income………………………………….

170,000 x \$7.00 \$1,190,000 (739,200) \$450,800

3.

Sales revenue……………………………………… Contribution margin ratio……………………….. Contribution margin……………………………… Less: fixed expenses……………………………. Operating income………………………………….

\$4,500,000 x 28% \$1,260,000 (739,200) \$ 520,800

4.

7-28

B/E sales in units

=

\$739,200 \$7.00

=

B/E sales in dollars

=

\$739,200 28%

=

105,600 units \$2,640,000

Chapter 7

Cost-Volume-Profit Analysis

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Managerial Accounting 4e Solutions Manual

(continued) E7-37A 5. 6.

\$739,200 + \$269,500 \$7.00

=

Original contribution margin per unit.................. Less: Increase in direct labor cost per unit (\$6.00 x 10%).......................................................... New contribution margin per unit………………...

\$0.60 \$6.40 \$739,200 24,000

New fixed expenses…………………………………

\$763,200 \$763,200 \$6.40

=

8.

Increase in volume…………………….. × Operating leverage factor………….. New fixed expenses……………………

9.

Margin of safety

\$ 240,800

Sales − Sales at breakeven \$3,500,000 − \$2,640,000 (from part 1) (from part 4) \$860,000

= Margin of safety as a percentage =

\$860,000 \$3,500,000

16 GB \$25 18 \$ 7 × 6 \$42

=

=

.25 (rounded )

32 GB

Total

\$50 22 \$28 ×1 \$28

7 \$70

Weighted-average contribution margin per unit Sales in units

4.07 = (rounde d)

\$980,000

8% 4.07 32.6% (rounded)

=

Sales price…………….. Less: Variable cost………….. Contribution margin…. Sales mix………………. Multiply by: Contribution margin….

119,250 Units

\$980,000 (739,200) \$ 240,800 =

=

\$739,200 + \$269,500 \$10

Smaller 16 GB: 100,870 × 6/7………………….. Larger 32 GB: 100,870 × 1/7….………………….

7-30

=

Contribution margin (from part 1)………………... Less: Fixed expenses……………………………... Operating income…………………………………… Operating Leverage factor

10.

\$7.00

Original fixed expenses……………………………. Plus: Increase in fixed expenses………………..

New breakeven in units 7.

144,100 units

25% = (rounded )

\$10.00

=

100,870 units

86,460 units (rounded) 14,410 units (rounded)

Chapter 7

Cost-Volume-Profit Analysis

The target profit volume is lower than before (Req. 5) because now the company is selling a product with a much higher unit contribution margin.

Exercises (Group B) (15 min.) E7-38B Req. 1 Contribution Margin Income Statements Sales revenue Less: Variable expenses (35% of sales revenue*) Contribution margin (65% of sales revenue**) Fixed expenses Operating income (loss) __________ *\$192,500 / \$550,000 = 0.35 **\$357,500 / \$550,000 = 0.65 (CM ratio)

\$190,000 66,500 123,500 176,800 \$ (53,300)

\$420,000 147,000 273,000 176,800 \$ 96,200

Req. 2 Breakeven sales

=

\$176,800 + \$0 1 − 0.35

=

\$176,800 + \$0 0.65

= \$272,000

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Managerial Accounting 4e Solutions Manual

(10-15 min.) E7-39B This problem involves working backwards through the shortcut contribution margin formula and then working backwards through the contribution margin income statement to find the missing data. First, fill in the given data in the short cut contribution margin formula, and solve for the contribution margin ratio: Sales needed to breakeven \$40,000 Contribution margin ratio

=

Fixed expenses Contribution margin ratio

=

\$30,000 Contribution margin ratio

=

\$30,000 \$40,000

Contribution margin ratio

= .75

Next, fill in the given data in the contribution margin income statement: Sales…………………………. Less: Variable expenses…. Contribution margin………. Less: Fixed expenses…….. Operating income…………..

\$ ? 45,000 ? 30,000 \$ ?

Because the contribution margin ratio is 75% of sales revenue, the variable expenses must be 25% of sales revenue. Therefore: Variable expenses \$ 45,000 \$180,000

= = =

25% × Sales revenue 25% × Sales revenue Sales revenue

Sales − \$45,000 Sales − 75% Sales 25% Sales Sales

= = = =

Sales

=

75% Sales \$45,000 \$45,000 \$45,000 25% \$180,000

Or alternatively:

Once sales revenue is found, the rest of the income statement follows: Sales………………………………. Less: Variable expenses………. Contribution margin……………. Less: Fixed expenses………….. Operating income……………….

\$180,000 45,000 \$135,000 30,000 \$ 105,000

Therefore, at the current level of operations, the company’s sales revenue is \$180,000, and its operating income is \$105,000.

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Chapter 7

Cost-Volume-Profit Analysis

(15 min.) E7-40B

Req. 1 Contribution margin per unit: Sale price....................................………….. Less: Variable expenses.................................…. Contribution margin per unit.................... Contribution margin ratio: Contribution margin per unit Sale price per unit

\$1.60 0.80 \$0.80

=

\$0.80 \$1.60

=

0.50

Req. 2 Breakeven sales in units

= =

Fixed expenses + Operating income Contribution margin per unit \$80,000 + \$0 \$0.80

= 100,000 packages

Breakeven sales in dollars

= =

Fixed expenses + Operating income Contribution margin ratio \$80,000 + \$0 0.50

= \$160,000 Req. 3 Sales in units

= =

Fixed expenses + Operating income Contribution margin per unit \$80,000 + \$25,000 \$0.80

= 131,250 packages

(5-10 min.) E7-41B New contribution margin per unit: Sale price....................................………….. Less: Variable expenses.................................…. Contribution margin per unit.................... Sales in units

= =

\$1.60 0.60 \$1.00

Fixed expenses + Operating income Contribution margin per unit \$95,000 + \$25,000 \$1.00

= 120,000 packages

(continued) E7-41B

7-33

Managerial Accounting 4e Solutions Manual The company would have to sell 11,250 fewer packages of socks (120,000 − 131,250 from E740B) to earn \$25,000 of operating income.

(10-15 min.) E7-42B Req. 1 Contribution margin ratio

= = Breakeven sales in dollars

Contribution margin per unit Sales price per unit

=

\$6.25 − \$2.50 \$6.25 0.60 Fixed expenses + Operating income Contribution margin ratio

= = =

\$8,250 + \$0 0.60 \$13,750

Req. 2 If franchisees require a monthly operating income of \$6,600 Target sales Fixed expenses + Operating income = in dollars Contribution margin ratio = =

\$8,250 + \$6,600 0.60 \$24,750

No, the franchising concept is not a good idea. The sales required to earn the target profit (\$24,750) are more than the expected sales generated (\$24,000).

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Chapter 7

Cost-Volume-Profit Analysis

(10- 15 min.) E7-43B

Req. 1 Prior to changes, the average restaurant location had the following operating income: Contribution margin per unit (from E7-42B) \$ 3.75 Average sales volume units………………… × 5,500 Contribution margin………………………….. \$20,625 Less: Fixed expenses………………………. (8,250) Operating income……………………………... \$12,375

Req. 2 After the price cut and advertising fees, the average restaurant location will have the following operating income: New contribution margin per unit (\$5.75 sales price – \$2.50 variable cost……………………………………. New sales volume (units)…………. Contribution margin………………... Less: New fixed expenses (\$8,250 + \$500 advertising fee)…… New operating income……………..

\$ 3.25 × 6,000 \$19,500 (8,750) \$ 10,750

Assuming volume increases according to plan, cutting the sales price and advertising will allow the franchise owners to reach their target profits of \$6,600 per month.

(10-15 min.) E7-44B Req. 1 Breakeven sales in dollars

= = =

Fixed expenses + Operating income Contribution margin ratio \$620,000 + \$0 0.80 \$775,000

Req. 2

Sales revenue × Contribution margin ratio Contribution margin Less: Fixed expenses Operating income (loss)

Operating Income Projections at Different Sales Levels \$ 520,000 0.80 416,000 620,000 \$(204,000)

\$1,020,000 0.80 816,000 620,000 \$ 196,000

Req. 3 Yes, the income projections at the two different sales levels make sense given the breakeven sales level (\$775,000) computed in Req. 1. Req. 2 shows that if the company’s revenue is only \$520,000 (short of the revenue required to breakeven) the company incurs a loss. On the other hand, if revenue is \$1,020,000 (higher than the revenue required to breakeven), the company earns a profit.

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Managerial Accounting 4e Solutions Manual

(15 min.) E7-45B Req. 1 Sales in dollars

= = =

Req. 2

Fixed expenses + Operating income Contribution margin ratio \$620,000 + \$196,000 0.50 \$1,632,000

Fixed expenses + Operating income Contribution margin ratio

Sales in dollars

=

\$1,020,000

=

\$510,000

=

Fixed expenses + \$196,000

\$314,000

=

Fixed expenses

Fixed expenses + \$196,000 0.50

Fixed expenses can only be \$314,000 to maintain the prior profit level of \$196,000 per month. Therefore, the company will have to save at least \$306,000 per month in fixed costs (\$620,000 − \$314,000) by moving operations overseas if it plans to maintain its prior profit level.

(15-20 min.) E7-46B Req. 1 (Fixed expenses + Operating income) / CM per unit = Breakeven in units (\$294,000 + \$0) / (\$2,100 - \$520 - \$110) = 200 units (Fixed expenses + Operating income) / CM ratio = Breakeven in sales dollars CM ratio = (\$2,100 - \$520 - \$110) / \$2,100 = .700 (\$294,000 + \$0) / .700 = \$420,000 Req. 2 Total CM = (\$2,100 - \$520 - \$110 ) x 290 = \$426,300 Projected operating income = \$426,300 - \$294,000 = \$132,300 Req. 3 New fixed expenses = \$294,000 + \$126,000 = \$420,000 New CM = (\$2,100 – ( \$520 - \$210) - \$110) = \$1,680 (Fixed expenses + Operating income) / CM per unit = Breakeven in units (\$420,000 + \$0) / \$1,680) = 250 units (Fixed expenses + Operating income) / CM ratio = Breakeven in sales dollars CM ratio = \$1,680 / \$2,100 = .800 (\$420,000 + \$0) / .800 = \$525,000 Req. 4 Total CM (\$2,100 – (\$520- \$210) - \$110) x 290 = \$487,200 Projected operating income = \$487,200 - \$420,000 = \$67,200

(continued) E7-46B 7-36

Chapter 7

Cost-Volume-Profit Analysis

Req. 5 However, the new control system would reduce waste and contribute to the company’s sustainability objective. The company should take into account not only the financial measures such as operating income, breakeven point, and operating leverage, but also the sustainability impact of the decision. Student answers may vary.

(5-10 min.) E7-47B Use the short cut contribution margin formula to determine the company’s current level of fixed expenses: Fixed expenses Contribution margin ratio

Sales needed to breakeven

=

\$500,000

=

\$500,000 × .50

=

Fixed expenses

\$250,000

=

Fixed expenses

Fixed expenses .50

After buying the equipment, the company’s fixed expenses will be \$300,000 (\$250,000 + \$50,000 increase). Calculate breakeven (in sales) at the new level of fixed expenses: Sales needed to breakeven

Fixed expenses Contribution margin ratio

= = =

\$300,000 .50 \$600,000

The company will now have to generate \$600,000 of sales revenue to breakeven.

(5-10 min.) E7-48B Sales price per unit……………….. Contribution margin ratio………... Contribution margin per unit…….

\$14.00 × .625 \$8.75

Find the number of scarves needed to breakeven on (or pay for) the extra entrance fee cost of \$350 (= \$1,400 × 25% increase): Fixed expenses Breakeven in units = Contribution margin per unit = =

\$350 \$8.75 40 scarves

7-37

Managerial Accounting 4e Solutions Manual Alternatively: Breakeven in sales revenue

(continued) E7-48B Fixed expenses Contribution margin ratio

= =

\$350 .625

= \$560 in sales revenue Dividing \$560 in sales revenue by the price per scarf (\$14) yields 40 scarves. The owner will have to sell an additional 40 scarves next year to cover the increase in entrance fees.

(15-20 min.) E7-49B Weighted-Average Contribution Margin per Unit Twig Sales price per unit \$18.00 Less Variable cost per unit 3.00 Contribution margin per unit \$15.00 Multiply by: Sales mix in units × 4 Contribution margin \$60.00 Weighted-average contribution margin per unit (\$90 / 5 units)

Oak \$38.00 8.00 \$30.00 × 1 \$30.00

Total

5 \$90.00 \$18.00

Sales in total units: Fixed expenses + Operating income Weighted-average contribution margin per unit

= =

\$360 + \$0 \$18

= 20 units Breakeven sales of twig stands (20 × 4/5)……………… Breakeven sales of oak stands (20 × 1/5).………………

16 units 4 units

By charging her husband part of the craft fair entrance fees, the wife’s fixed costs will decrease. Therefore, the wife will need to sell fewer scarves to breakeven than before her husband decided to share her craft booths.

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Chapter 7

Cost-Volume-Profit Analysis

(15-20 min.) E7-50B Weighted-Average Contribution Margin per Unit Standard Chrome Sales price per unit \$65 \$85 Less: Variable cost per unit 55 65 Contribution margin per unit \$10 \$20 Multiply by: Sales mix in units × 3 × 2 Contribution margin \$30 \$40 Weighted-average contribution margin

Total

5 \$70 \$ 14

Sales in total units to breakeven: Fixed expenses + Operating income = Weighted-average contribution margin per unit =

\$9,800 + \$0 \$14

= 700 units Breakeven sales of standard scooters (700 × 3/5)……………… Breakeven sales of chrome scooters (700 × 2/5).………………..

420 units 280 units

Sales in total units to achieve target operating income: Fixed expenses + Operating income = Weighted-average contribution margin per unit =

\$9,800 + 8,400 \$14

= 1,300 units Target sales of standard scooters (1,300 × 3/5)........…………… Target sales of chrome scooters (1,300 × 2/5)............….............

780 units 520 units

7-39

Managerial Accounting 4e Solutions Manual

(20-30 min.) E7-51B This is a challenging exercise that requires students to work backwards. Use the weightedaverage contribution margin per unit chart, in conjunction with the shortcut formula, to work backwards to find the contribution margin of the Classic. Digital \$250 170 80 × 8 \$640

Sales price per unit................……….. Less: Variable expense per unit. (\$120 + \$50) Contribution margin per unit..…….. Multiply by: Sales mix in units..........…………….. Contribution margin..........…………. Weighted-average contribution margin per unit..........…………….. a

2,200

=

\$200,000 + \$75,000 Weighted-average contribution margin per unit \$275,000 2,200

=

Weighted-average contribution margin per unit

Contribution margin per Classic watch

\$125 / unit Total sales mix contribution margin Total sales mix units

=

\$640 + X 10

\$125

=

\$1,250

=

\$640 + X

X

=

\$610

2

=

\$610

=

\$305

×

10 1,250 \$ 125

Fixed expenses + Operating income Weighted-average contribution margin per unit

Contribution margin per Classic watch

7-40

c

=

=

c

305 × 2 610

Total

Sales in total units

Weighted-average contribution margin per unit

b

Classic

Chapter 7

Cost-Volume-Profit Analysis

(15 min.) E7-52B Req. 1 The company’s operating income can be computed as follows: Sales revenue……………………………………. Less: Variable expenses……………………… Contribution margin……………………………. Less: Fixed expenses………(\$2,590,000 - \$1,342,000) Operating income………………………………..

\$6,100,000 1,342,000 4,758,000 1,248,000 \$3,510,000

Req. 2 Contribution margin ratio

= Req. 3 Breakeven in sales dollars

\$4,758,000 \$6,100,000

=

=

78%

\$1,248,000 78%

= \$1,600,000 The company will have to generate \$1,600,000 in sales in order to break even. Req. 4 If the company embarks on this advertising campaign, sales revenue and variable costs will rise by 16%, which will cause the contribution margin to increase by 16%. However, fixed costs will rise by \$260,000 dollars due to the advertising campaign. The change in operating income can be computed as follows: Current contribution margin Percentage increase Increase in contribution margin Less: Increase in fixed costs of advertising campaign Increase in operating income

\$4,758,000 × 16% 761,280 260,000 \$501,280

7-41

Managerial Accounting 4e Solutions Manual Req. 1 Contribution margin ratio

Breakeven sales in dollars

(15 min.) E7-53B =

1.00 − 0.40

=

0.60

= = Target sales in dollars

Req. 2 Margin of safety as a percentage of target sales

\$7,500 + \$0 0.60 \$12,500

=

Fixed expenses + Operating income Contribution margin ratio

=

\$7,500 + \$30,000 0.60

=

Margin of safety

Fixed expenses + Operating income Contribution margin ratio

=

\$37,500 0.60

=

\$62,500

=

\$62,500 − \$12,500

=

\$50,000

=

\$50,000 \$62,500

= 0.80 or 80% of target sales Req. 3 Target sales……………………... Contribution margin ratio…….. Contribution margin…………… Less: Fixed expenses……….. Operating income………………. Operating Leverage Factor

\$62,500 × .60 \$37,500 7,500 \$30,000 =

Contribution margin Operating income

=

\$37,500 \$30,000

=

1.25

Req. 4 If volume decreases 12%, operating income will decrease 15.0% (operating leverage factor of 1.25 multiplied by 12%).

(10 min.) E7-54B First, find the contribution margin: 7-42

Chapter 7 Sales……………………………… Contribution margin ratio…….. Contribution margin……………

Cost-Volume-Profit Analysis

\$45,000 × .20 \$ 9,000

Then, work backwards to find operating income: Contribution margin Operating leverage factor = Operating income =

\$9,000 Operating income

Operating income

=

\$9,000 1.60

Operating income

= \$5,625

1.60

Finally, finish the income statement to find the fixed expenses: Contribution margin…….. \$9,000 Less: Fixed expenses…. Unknown Operating income……….. \$ 5,625 Therefore, fixed expenses must be \$3,375.

(10-15 min.) E7-55B Req. 1 Selling price \$45 Less: Variable costs (\$10 + \$4 + \$2) CM per unit \$29

16

Lease costs under Option A: Fixed costs Variable costs (none) Total costs under Option A

\$ 3,600 0 \$ 3,600

Lease costs under Option B: Fixed costs Total variable costs (20% x \$45 x 190) Total costs under Option B

\$ 990 1,710 \$2,700

The more attractive lease option is Option B because it results in the lowest total lease costs. Req. 2 To solve the question, you need to set the costs of Option A equal to the costs of Option B: \$3,600 = \$990 + (20% x \$45 x CANDLES) Then solve for CANDLES: CANDLES = 290 Req. 3 The lease option that is more attractive for the company if the company plans to sell 490 candles a month is option A, the fixed lease payment because the sales volume is more than the indifference point. Lease costs under option A: #3,600 Lease costs under option B: \$990 + (20% x \$45 x 490) = \$5,400

(20-25 min.) E7-56B Req. 1 Breakeven in units

=

Fixed expenses Contribution margin per unit

7-43

Managerial Accounting 4e Solutions Manual = = *

Req. 2 2a.

2b.

Selling price Less: variable cost per unit CM per unit

Sales in units to reach desired profit

Sales in dollars to reach desired profit

\$720 \$40* 18 grooming kits

\$73 \$33 \$40 Fixed expenses + Operating Income Contribution margin per unit

= =

\$720 + \$1,080 \$40

=

\$1,386 \$40

=

45 grooming kits

=

target units x selling price per unit

=

45 units x \$73/each

=

\$3,285

2c. Condensed Income Statement Sales (45 x \$73) Less: variable expenses (45 x \$33)

\$3,285

Contribution margin

\$1,800

Less: fixed expenses Operating income

7-44

\$1,485 \$720 \$1,080

Chapter 7

Cost-Volume-Profit Analysis

(continued) E7-56B

Req. 3 Margin of safety in dollars: Sales at target level Sales at B/E level: (\$720 / 40) x \$73 Margin of safety in dollars

\$3,285 \$1,314 \$1,971

Margin of safety in units: Sales at target level: Sales at B/E level: (\$720 / 40) Margin of safety in units

45 18 27

Margin of safety in %: Margin of safety in dollars: Sales at target level: \$1,971/ \$3,285

\$1,971 \$3,285 60.0%

(20-25 min.) E7-57B Req. 1 Total Sales

Per Unit

%

\$115,000

\$50

100%

57,500

25

50%

Contribution Margin

\$57,500

\$25

50%

Less: Fixed expenses

11,500

Less: Variable expenses

Operating income

\$46,000

1a) Total contribution margin is \$57,500. 1b) Per unit contribution margin is \$25. 1c) Operating income is \$46,000. 1d) Units sold = Total sales / sales price = \$115,000 / \$50 = 2,300 units

7-45

Managerial Accounting 4e Solutions Manual

(continued) E7-57B

Req. 2 2a. Breakeven in units

=

Fixed expenses Contribution margin per unit

=

\$11,500 \$25

=

460 units

2b. Breakeven sales in dollars

= = =

Req. 3 3a.

Sales in units to reach desired profit

Fixed expenses + Operating income Contribution margin ratio \$11,500 + 0 0.50 (from req. 1) \$23,000

Fixed expenses + Operating Income Contribution margin per unit

= =

\$11,500 + \$58,000 \$25

=

\$69,500 \$25

=

2,780 units

3b. Budgeted Sales Units

2,300

Less: Breakeven Sales Units Margin of Safety in Units

460 1,840

3c. Budgeted Sales

\$115,000

Less: Breakeven Sales

\$23,000

Margin of Safety in Dollars

\$92,000

3d. Margin of Safety in Dollars Divided by Budgeted Sales Dollars Margin of Safety %

7-46

\$92,000 \$115,000 80.0%

Chapter 7

Cost-Volume-Profit Analysis

(20-25 min.) E7-58B 1.

Sales price per unit....................................... Less: Variable cost per unit (\$8.40+\$8+\$3.70+ \$1.90)................................... Contribution margin per unit.............................

\$25.00 \$22.00 \$ 3.00

Contribution margin ratio

=

\$3.00 \$25.00

=

.12

=

12%

Sales Revenue (100,000 × \$25.00)………… Less: Variable exp. (100,000 × \$22.00) Contribution margin……………….………..

\$ 2,500,000 (2,200,000) \$ 300,000

2.

Sales volume (units)………………………… Unit contribution margin…………………… Contribution margin………………………… Less: Fixed expenses (\$121,800+\$167,100)……………………… Operating income……………………………

130,000 x \$25.00 \$390,000 (288,900) \$101,100

3.

Sales revenue………………………………… Contribution margin ratio………………….. Contribution margin………………………… Less: Fixed expenses (\$121,800+\$167,100)……………………… Operating income……………………………

\$4,000,000 x 12% \$480,000 (288,900) \$ 191,100

4.

5.

B/E sales in units

=

\$288,900 \$3.00

B/E sales in dollars

=

\$288,900 12%

\$288,900 + \$260,100 \$3.00

=

= =

96,300 units \$2,407,500 183,000 units

7-47

Managerial Accounting 4e Solutions Manual

(continued) E7-58B 6.

Original contribution margin per unit.................. Less: Increase in Direct labor cost per unit (\$8.00 x 10%).......................................................... New contribution margin per unit………………...

\$3.00 \$0.80 \$2.20

Original fixed expenses……………………………. Plus: Increase in fixed expenses………………. New fixed expenses………………………………… New breakeven in units 7.

\$288,900 23,500 \$312,400 \$312,400 \$2.20

=

=

Contribution margin (from part 1)………………... Less: Fixed expenses…………………………….. Operating income…………………………………… Operating leverage factor

8.

Increase in volume…………………….. × Operating leverage factor………….. New fixed expenses……………………

9.

Margin of safety

\$300,000

=

\$11,100

=

Sales − Sales at breakeven \$2,500,000 − \$2,407,500 (from part 1) (from part 4) \$92,500

Margin of safety as a percentage = 16 GB \$25 22 \$ 3 × 9 \$27

92,500 2,500,000

=

.037

32 GB \$50 27 \$23 ×1 \$23

=

\$121,800 + \$167,100 + \$260,100 \$5.00

Smaller 16 GB: 109,800 × 9/10………………… Larger 32 GB: 109,800 × 1/10….………………

=

3.7%

Total

10 \$50

Weighted-average contribution margin per unit Sales in units

27.03 (rounded)

3% 27.03 81.1% (rounded)

=

Sales price…………….. Less: Variable cost………….. Contribution margin…. Multiply by: Sales mix………………. Contribution margin….

\$300,000 (288,900) \$11,100 =

=

10.

142,000 Units

\$5.00 109,800 units =

98,820 units 10,980 units

The target profit volume is lower than before (Req. 5) because now the company is selling a product with a much higher unit contribution margin.

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Chapter 7

Cost-Volume-Profit Analysis

Problems (Group A) (30-45 min.) P7-59A Req. 1 Cost-Volume-Profit Analysis Companies Q, R, S, T

Target sales Less: Variable expenses Less: Fixed expenses Operating income Units sold Contribution per unit

margin

Q \$625,000 125,000 370,000 \$130,000 80,000 \$

COMPANY R \$445,000 178,000 159,000 \$ 108,000 106,800

6.25

Contribution margin 0.80 ratio Computations (top to bottom for each company) Q:

\$

2.50

S \$236,000 118,000 94,000 \$ 24,000 12,500 \$

0.60

9.44 0.50

T \$780,000 156,000 493,000 \$131,000 16,000 \$

39.00 0.80

Sales − Variable expenses − Operating income = Fixed expenses \$625,000 − \$125,000 − \$370,000 = \$130,000 Sales − Variable expenses = Contribution margin; Contribution margin / Unit contribution margin = Units sold \$625,000 − \$125,000 = \$500,000; \$500,000 / \$6.25 = 2,048 units Contribution margin / Sales = Contribution margin ratio \$500,000 / \$625,000 = 0.80

R:

Sales × Contribution margin ratio = Contribution margin; Sales − Contribution margin = Variable expenses (\$445,000 × 0.60) = \$267,000; \$445,000 − \$267,000 = \$178,000 Sales − Variable expenses − Fixed expenses = Operating income \$445,000 − \$178,000 − \$159,000 = \$108,000 Contribution margin / Units sold = Contribution margin per unit \$267,000 / 106,800 = \$2.50

S:

Units sold × Unit contribution margin = Contribution margin; Sales − Contribution margin = Variable expenses 12,500 × \$9.44 = \$118,000; \$236,000 − \$118,000 = \$118,000 Sales − Variable expenses − Fixed expenses = Operating income \$236,000 − \$118,000 − \$94,000 = \$24,000 Contribution margin / Sales = Contribution margin ratio \$118,000 / \$236,000 = 0.50

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Managerial Accounting 4e Solutions Manual

(continued) P7-59A T:

Units sold × Unit contribution margin = Contribution margin; Contribution margin + Variable expenses = Sales 16,000 × \$39 = \$624,000; \$624,000 + \$156,000 = \$780,000 Sales − Variable expenses − Operating income = Fixed expenses \$780,000 − \$156,000 − \$131,000 = \$493,000 Contribution margin / Sales = Contribution margin ratio \$624,000 / \$780,000 = 0.80

Req. 2 Breakeven Sales: Q

B/E

=

\$370,000 0.80

=

\$462,500

R:

B/E

=

\$159,000 0.60

=

\$265,000

S:

B/E

=

\$94,000 0.50

=

\$188,000 Lowest breakeven point

T:

B/E

=

\$493,000 0.80

=

\$616,250

Company S’s low breakeven point is primarily due to its low fixed expenses.

(30-45 min.) P7-60A Req. 1 Revenue per show: 1,200 tickets × \$55 / ticket........................……………

\$66,000

Variable expenses per show: Programs: 1,200 guests × \$9 / guest....................… Cast: 60 cast members × \$320 / cast member......... Total variable expenses per show.......................…..

\$ 10,800 19,200 \$30,000

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Chapter 7

Cost-Volume-Profit Analysis

(continued) P7-60 Sales revenue

Variable expenses

− Fixed expenses

=

Operating income

=

Operating income

=

\$0

Revenue per show

×

Number of shows

Variable Number exp. per × of − Fixed expenses show shows

\$66,000

×

Number of shows

\$30,000 ×

Number of − \$969,000 shows

(\$66,000 – \$30,000) × Number of shows \$36,000 × Number of shows Number of shows Breakeven number of shows Req. 3 Contribution margin

= \$1,224,000 = = =

\$1,224,000 \$1,224,000 \$36,000 34 shows

= \$66,000 − \$30,000 = \$36,000 Fixed expenses + Target operating income Contribution margin per unit

Target number of shows

=

Target number of shows

=

\$1,224,000 + \$3,888,000 \$36,000

Target number of shows

=

\$5,112,000 \$36,000

Target number of shows

= 142 shows

This profit goal is unrealistic since the show currently performs 115 times a year. Req. 4 Fiddler on the Roof Contribution Margin Income Statement For the Year Ended December 31 Sales revenue (115 × \$66,000) Less: Variable expenses (115 × \$30,000) Contribution margin Less: Fixed expenses Operating income

\$7,590,000 3,450,000 4,140,000 1,224,000 \$2,916,000

7-51

Managerial Accounting 4e Solutions Manual Req. 1 Sales Revenue Sale price × Units sold per unit

(30-45 min.) P7-61A −

Variable expenses Variable cost × per unit

Units sold

− Fixed expenses

= Operating income

− Fixed expenses

= Operating income

(\$16.50 × Units sold) − (\$6.50 × Units sold) − \$1,095,000 (\$13.50 − \$3.50) × Units sold \$10.00 × Units sold Units sold Breakeven sales in units Req. 2

= \$0 = \$1,095,000 = \$1,095,000 =

\$1,095,000 \$10.00

= 109,500 cartons

Contribution margin = \$16.50 − \$6.50 = \$10.00 Contribution margin ratio = \$10.00 / \$16.50 = 0.61 (rounded) Target sales in dollars = Target sales in dollars = =

Fixed expenses + Target operating income Contribution margin ratio \$1,095,000 + \$308,000 0.61 \$1,403,000 0.61

= \$2,300,000 Req. 3 Team Spirit Calendars Contribution Margin Income Statement Month Ended June 30 Sales revenue (450,000 × \$16.50) Less Variable expenses: Cost of goods sold (450,000 × \$6.50 × 0.68) \$1,989,250 Operating expenses (450,000 × \$3.50 × 0.32) 936,000 Contribution margin Less: Fixed expenses Operating income

7-52

\$7,425,000 2,925,000 4,500,000 1,095,000 \$3,405,000

Chapter 7 Req. 4 Margin of Margin of Margin of Margin of

Cost-Volume-Profit Analysis

(continued) P7-61A safety safety safety safety

Operating leverage factor Operating leverage factor Operating leverage factor

= = = =

Sales − Sales at breakeven \$7,425,000 − (109,500 cartons × \$16.50 per carton) \$7,425,000 − \$1,806,750 \$5,618,250 Contribution margin Operating income \$4,500,000 = \$3,405,000 = 1.322 (rounded) =

Req. 5 If volume increases 16%, then operating income will increase 21.15% (operating leverage factor of 1.322 multiplied by 16%). Proof: Original volume (cartons)…..…………………... 450,000 Add: Increase in volume (16% × 450,000)… 72,000 New volume (cartons)………………………... 522,000 Multiplied by: Unit contribution margin……… \$10.00 New total contribution margin……………… \$5,220,000 Less: Fixed expenses………………………. (1,095,000) New operating income………………………. \$4,125,000 vs. Operating income before change in volume…………………………………….. 3,405,000 Increase in operating income………………. \$ 720,000 Percentage change (\$720,000 / \$3,405,000)

21.15% (rounded)

(30-45 min.) P7-62A Req. 1 Contribution margin ratio

= 0.75 (computed as 1.00 − 0.12 − 0.04 − 0.06)

0.03 −

Monthly fixed expenses = \$9,000 (computed as \$2,700 + \$280 + \$250 + \$600 + \$650 + \$4,520) Fixed expenses + Operating income Contribution margin ratio

Breakeven sales in dollars = =

\$9,000 + \$0 0.75

= \$12,000 Breakeven sales in units = (trades)

\$12,000 \$500

7-53

Managerial Accounting 4e Solutions Manual Sales revenue − Variable expenses − Fixed expenses

=

Target operating income

Sales revenue − 0.25 Sales revenue − \$9,000 = \$5,250 0.75 Sales revenue = \$14,250 Sales revenue =

\$14,250 0.75

Sales revenue = \$19,000 Req. 3

Req. 4 Breakeven sales in dollars (from Req. 1)

=

\$12,000

=

\$12,000 \$300

=

The decrease in the average trade revenue increases the breakeven point from 24 to 40 trades.

(25-35 min.) P7-63A Req. 1 Westlake Coffee Weighted-Average Contribution Margin per Unit Small Large 7-54

Total

Chapter 7 Sales price per unit Less: Variable expense per unit Contribution margin per unit Multiply by: Sales mix in units Contribution margin per unit

Cost-Volume-Profit Analysis

\$3.00 1.50 \$1.50 × 3 \$4.50

\$5.00 2.50 \$2.50 × 1 \$2.50

Weighted-average contribution margin per unit (\$7.00 / 4 units) Breakeven sales in total units: Fixed expenses + Operating income Weighted-average contribution margin per unit

=

4 \$7.00 \$1.75

\$28,000 + \$0 \$1.75

Breakeven sales of small coffees (16,000 × ¾)........ Breakeven sales of large coffees (16,000 × ¼)........

=

16,000 units

12,000 units 4,000 units

Proof: Westlake Coffee Contribution Margin Income Statement Month Ended February 29 Sales revenue [(12,000 × \$3) + (4,000 × \$5)] Less: Variable expenses [(12,000 × \$1.50) + (4,000 × \$2.50)]

\$56,000 28,000 28,000 28,000 \$ 0

Contribution margin Less: Fixed expenses Operating income Req. 2 Margin of safety

=

Actual sales − Breakeven sales

Margin of safety

=

\$126,000 − \$56,000*

= \$70,000 *Breakeven sales from proof in Req. 1.

7-55

Managerial Accounting 4e Solutions Manual Req. 3 Operating leverage factor

(continued) P7-63A = Contribution Margin Operating income = \$63,000 \$35,000 = 1.80

A 15% increase in volume will lead to 27% increase in operating income (15% multiplied by the operating leverage factor of 1.80). Therefore, the new operating income will be \$44,450 (\$35,000 old operating income × 1.27). Proof: Westlake Coffee Effect on Operating Income of 15% Increase in Sales Volume Increase in sales revenue (\$126,000 × 0.15) \$18,900 Increase in variable expenses (\$63,000 × 0.15)

Increase in contribution margin Change in fixed expenses Operating income before sales increase Operating income after sales increase

9,450 9,450 0 35,000 \$44,450

Alternatively, Westlake Coffee Effect on Operating Income of 15% Increase in Sales Volume Sales revenue (\$126,000 × 1.15) \$144,900 Variable expenses (\$63,000 × 1.15)

72,450

Contribution margin

72,450

Fixed expenses

28,000

Operating income

7-56

\$ 44,450

Chapter 7

Cost-Volume-Profit Analysis

Problems (Group B) (30-45 min.) P7-64B Req. 1 Cost-Volume-Profit Analysis Companies Q, R, S, T

Q \$757,500 242,400 340,000 \$ 175,100 85,000

Target sales Less: Variable expenses Less: Fixed expenses Operating income Units sold Contribution per unit

margin

Contribution ratio

margin

\$

COMPANY R \$445,000 178,000 159,000 \$ 108,000 106,800

6.06 0.68

\$

2.50

S \$162,500 32,500 81,000 \$ 49,000 15,625 \$

0.60

8.32 0.80

T \$1,000,000 360,000 488,000 \$152,000 20,000 \$

32.00 0.64

Computations (top to bottom for each company) Q:

Sales − Variable expenses − Operating income = Fixed expenses \$757,500 − \$242,400 − \$175,100 = \$340,000 Sales − Variable expenses = Contribution margin; Contribution margin / Unit contribution margin = Units sold \$757,500 − \$242,400 = \$515,100; \$515,100 / \$6.06 =85,000 units Contribution margin / Sales = Contribution margin ratio \$515,500 / \$757,500 = 0.68

R:

Sales × Contribution margin ratio = Contribution margin; Sales − Contribution margin = Variable expenses (\$445,000 × 0.60) = \$267,000; \$445,000 − \$267,000 = \$178,000 Sales − Variable expenses − Fixed expenses = Operating income \$445,000 − \$178,000 − \$159,000 = \$108,000 Contribution margin / Units sold = Contribution margin per unit \$267,000 / 106,800 = \$2.50

S:

Units sold × Unit contribution margin = Contribution margin; Sales − Contribution margin = Variable expenses 15,625 × \$8.32 = \$130,000; \$162,500 − \$130,000 = \$32,500 Sales − Variable expenses − Fixed expenses = Operating income \$162,500 − \$32,500 − \$81,000 = \$49,000 Contribution margin / Sales = Contribution margin ratio \$130,000 / \$162,500 = 0.80

7-57

Managerial Accounting 4e Solutions Manual

(continued) P7-64B T:

Units sold × Unit contribution margin = Contribution margin; Contribution margin + Variable expenses = Sales 20,000 × \$32.00 = \$640,000; \$640,000 + \$360,000 = \$1,000,000 Sales − Variable expenses − Operating income = Fixed expenses \$1,000,000 − \$640,000 − \$152,000 = \$208,000 Contribution margin / Sales = Contribution margin ratio \$640,000 / \$1,000,000 = 0.64

Req. 2 Breakeven Sales: Q:

B/E

=

\$340,000 0.72

=

\$500,000

R:

B/E

=

\$159,000 0.60

=

\$265,000

S:

B/E

=

\$81,000 0.80

=

\$101,250

\$488,000 0.64

=

T:

B/E

=

Lowest breakeven point

\$762,500

Company S’s low breakeven point is primarily due to its low fixed expenses.

(30-45 min.) P7-65B Req. 1 Revenue per show: 1,400 tickets × \$65 / ticket........................…………

\$91,000

Variable expenses per show: Programs: 1,400 guests × \$6 / guest....................… Cast: 65 cast members × \$320 / cast member......... Total variable expenses per show.......................…..

\$ 8,400 20,800 \$29,200

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Chapter 7

Cost-Volume-Profit Analysis

(continued) P7-65B

Req. 2 Sales revenue −

Variable expenses

− Fixed expenses

=

Operating income

=

Operating income

=

\$0

Revenue Number per × of show shows

Variable Number exp. per × of − Fixed expenses show shows

Number of shows

\$29,200 ×

\$91,000 ×

Number of − \$2,163,000 shows

(\$91,000 – \$29,200) × Number of shows \$61,800 × Number of shows Number of shows Breakeven number of shows Req. 3 Contribution margin

=

\$2,163,000

=

\$2,163,500

= =

\$2,163,500 \$61,800 35 shows

= \$91,000 − \$29,200 = \$61,800 Fixed expenses + Target operating income Contribution margin per unit

Target number of shows

=

Target number of shows

=

\$2,163,000 + \$3,708,000 \$61,800

Target number of shows

=

\$5,871,000 \$61,800

Target number of shows

= 95 shows

This profit goal is realistic. The show already performs 100 times a year. Req. 4 Wicked Contribution Margin Income Statement For the Year Ended December 31 Sales (100 x \$91,000) Less: Variable expenses (100 × \$29,200) Contribution margin Less: Fixed expenses Operating income

\$9,100,000 2,920,000 6,180,000 2,163,000 \$4,017,000

7-59

Managerial Accounting 4e Solutions Manual

(30-45 min.) P7-66B Req. 1

Sales Revenue −

Sale price × Units sold per unit

Variable expenses Variable cost × per unit

Units sold

− Fixed expenses

= Operating income

− Fixed expenses

= Operating income

(\$19.50 × Units sold) − (\$4.50 × Units sold) − \$1,125,000 (\$19.50 − \$4.50) × Units sold \$15.00 × Units sold Units sold Breakeven sales in units

= \$0 = \$1,125,000 = \$1,115,000 =

\$1,125,000 \$15.00

= 75,000 cartons

Req. 2 Contribution margin = \$19.50 − \$4.50 = \$15.00 Contribution margin ratio = \$15.00 / \$19.50 = 0.77 (rounded) Target sales in dollars = Target sales in dollars = =

Fixed expenses + Target operating income Contribution margin ratio \$1,125,000 + \$338,000 0.77 \$1,463,000 0.77

= \$1,900,000 Req. 3 Dudley Calendars Contribution Margin Income Statement Month Ended June 30 Sales revenue (475,000 × \$19.50) Less variable expenses: Cost of goods sold (475,000 × \$4.50 × 0.74) \$1,581,750 Operating expenses (475,000 × \$4.50 × 0.26) 555,750 Contribution margin Less: fixed expenses Operating income

7-60

\$9,262,500 2,137,500 7,125,000 1,125,000 \$6,000,000

Chapter 7 Req. 4 Margin of Margin of Margin of Margin of

Cost-Volume-Profit Analysis

(continued) P7-66B safety safety safety safety

Operating leverage factor Operating leverage factor Operating leverage factor

= = = =

Sales − Sales at breakeven \$9,262,500− (75,000 cartons × \$19.50 per carton) \$9,262,500− \$1,462,500 \$7,800,000 Contribution margin Operating income = \$7,125,000 / \$6,000,000 = 1.188 (rounded) =

Req. 5 If volume increases 13%, then operating income will increase 15.44% (operating leverage factor of 1.188 multiplied by 13%). Proof: Original volume (cartons)…..……………… Add: Increase in volume (13% × 475,000) New volume (cartons)……………………… Multiplied by: Unit contribution margin… New total contribution margin……………… Less: Fixed expenses……………………… New operating income……………………… vs. Operating income before change in volume……………………………………. Increase in operating income……………… Percentage change (\$926,250 / \$6,000,000)

475,000 61,750 536,750 \$15.00 \$8,051,250 (1,125,000) \$6,926,250 6,000,000 \$ 926,250 15.43% (rounded)

7-61

Managerial Accounting 4e Solutions Manual

(30-45 min.) P7-67B Req. 1

Contribution margin ratio

= 0.60 (computed as 1.00 − 0.10 − 0.05 − 0.23)

0.02 −

Monthly fixed expenses = \$6,000 (computed as \$2,500 + \$260 + \$250 + \$600 + \$640 + \$1,750) Fixed expenses + Operating income Contribution margin ratio

Breakeven sales in dollars = =

\$6,000 + \$0 0.60

= \$10,000 Breakeven sales in units = (trades)

\$10,000 \$500

= 20 trades Req. 2 Sales revenue − Variable expenses − Fixed expenses

=

Target operating income

Sales revenue − 0.40 Sales revenue − \$6,000 = \$5,400 0.60 Sales revenue = \$11,400 Sales revenue =

\$11,400 0.60

Sales revenue = \$19,000

7-62

Chapter 7

Cost-Volume-Profit Analysis

(continued) P7-67B Req. 3

Req. 4

Breakeven sales in dollars (from Req. 1)

=

\$10,000

=

\$10,000 \$400

=

The decrease in the average trade revenue increases the breakeven point from 20 to 25 trades.

7-63

Managerial Accounting 4e Solutions Manual

(25-35 min.) P7-68B

Req. 1

Margot Coffee Weighted-Average Contribution Margin per Unit Small Large Sale price per unit \$3.00 \$5.00 Less: Variable expense per unit 1.50 2.50 Contribution margin per unit \$1.00 \$2.50 Multiply by: Sales mix in units × 3 × 1 Contribution margin per unit \$4.50 \$2.50 Weighted-average contribution margin per unit (\$5.00 / 4 units) Breakeven sales in total units: Fixed expenses + Operating income Weighted-average contribution margin per unit

=

Total

4 \$7.00 \$1.75

\$42,000 + \$0 \$1.75

Breakeven sales of small coffees (24,000 × ¾)........ Breakeven sales of large coffees (24,000 × ¼)........

=

24,000 units

18,000 units 6,000 units

Proof: Margot Coffee Contribution Margin Income Statement Month Ended February 29 Sales revenue [(18,000 × \$3) + (6,000 × \$5)] Less: Variable expenses [(18,000 × \$1.50) + (6,000 × \$2.50)] Contribution margin Less: Fixed expenses Operating income Req. 2 Margin of safety

=

Actual sales − Breakeven sales

Margin of safety

=

\$154,000 − \$84,000*

\$84,000 42,000 42,000 42,000 \$ 0

= \$70,000 *Breakeven sales from proof in Req. 1. Req. 3 Operating leverage factor: = Contribution margin Operating income = \$77,000 \$35,000 = 2.2 A 15% increase in volume will lead to 33% increase in operating income (15% multiplied by the operating leverage factor of 2.2). Therefore, the new operating income will be \$46,550 (\$35,000 old operating income × 1.33).

7-64

Chapter 7

Cost-Volume-Profit Analysis

(continued) P7-68B

Proof:

Margot Coffee Effect on Operating Income of 15% Increase in Sales Volume Increase in sales revenue (\$154,000 × 0.15) \$23,100 Increase in variable expenses (\$77,000 × 0.15)

Increase in contribution margin Change in fixed expenses Operating income before sales increase Operating income after sales increase

11,550 11,550 0 35,000 \$46,550

Alternatively, Hemingway Coffee Effect on Operating Income of 15% Increase in Sales Volume Sales revenue (\$154,000 × 1.15) \$177,100 Variable expenses (\$77,000 × 1.15)

88,550

Contribution margin

88,550

Fixed expenses

42,000

Operating income

\$ 46,550

7-65

Managerial Accounting 4e Solutions Manual

Discussion & Analysis Questions A7-69 1. Define breakeven point. Why is the breakeven point important to managers? The breakeven point is the sales level at which operating income is zero; total revenues equal total expenses. The breakeven point is important to managers because they know the volume that needs to be sold in order to cover costs. Anything below that point results in a loss; anything above the point results in a profit. 2. Describe four different ways cost-volume-profit analysis could be useful to management. C-V-P is useful to managers because it helps them determine: 1. 2. 3. 4.

the breakeven point the volume needed to reach target profit how changes in costs, sales price, and volume affect the company’s profit and the firm’s risk level.

3. The purchasing manager for Rockwell Fashion Bags has been able to purchase the material for its signature handbags for \$2 less per bag. Keeping everything else the same, what effect would this reduction in material cost have on the breakeven point for Rockwell Fashion Bags? Now assume that the sales manager decides to reduce the selling price of each handbag by \$2. What would the net effect of both of these changes be on the breakeven point in units for Rockwell Fashion Bags? A decrease in the material costs, and keeping everything else the same, would lower the variable expenses for each handbag, which would increase the contribution margin per bag. This would, in turn, lower the breakeven point. If the manager reduces the selling price by \$2 along with the \$2 decrease in variable costs, the contribution margin would stay the same and so would the breakeven point. 4. Describe three ways that cost-volume-profit concepts could be used by a service organization. C-V-P can be used by a service organization to help them determine: 1. the breakeven point 2. the volume needed to reach target profit and 3. how changes in costs, sales price, and volume affect the company’s profit. 5. “Breakeven analysis isn’t very useful to a company because companies need to do more than break even to survive in the long run.” Explain why you agree or disagree with this statement. It’s true that companies need to do more than break even to survive in the long run, but breakeven analysis allows the manager to see the level that must be reached to cover costs. This becomes the starting point for determining target profits and analyzing how changes in selling prices, costs, and volume will affect profits. 6. What conditions must be met for cost-volume-profit analysis to be accurate? The following conditions must be met for C-V-P analysis to be accurate:     7-66

A change in volume is the only factor that affects costs. Managers can classify each cost (or the components of mixed costs) as either variable or fixed. These costs are linear throughout the relevant range of volume. Revenues are linear throughout the relevant range of volume. Inventory levels will not change. Copyright © 2015 Pearson Education, Inc.

Chapter 7 

Cost-Volume-Profit Analysis

The sales mix of products will not change. Sales mix is the combination of products that make up total sales. If profits differ across products, changes in sales mix will affect CVP analysis.

7-67

Managerial Accounting 4e Solutions Manual 12.

How can CVP techniques be used in supporting a company’s sustainability efforts? Conversely, how might CVP be a barrier to sustainability efforts? CVP analysis is often used by managers to determine how sustainability initiatives will impact the company’s operating income. Sustainability initiatives often result in both cost savings and additional costs. These costs and cost savings may be fixed or variable in nature. Managers use CVP analysis to determine how these initiatives will impact the volume needed to achieve the company’s operating income goals. CVP techniques can be used to quantify the environmental savings of a sustainable initiative. However, as mentioned above, CVP analysis will also uncover the costs associated with sustainable initiatives. These added costs may overshadow the environmental savings.

7-68

Chapter 7

Cost-Volume-Profit Analysis

Application & Analysis A7-70 Select one product that you could make yourself. Examples of possible products could be cookies, birdhouses, jewelry, or custom t-shirts. Assume that you have decided to start a small business producing and selling this product. You will be applying the concepts of cost-volumeprofit analysis to this potential venture. Note: This is a sample solution. Student answers will vary. CVP for a Product Basic Discussion Questions 1.

Describe your product. What market are you targeting this product for? What price will you sell your product for? Make projections of your sales in units over each of the upcoming five years. I make beaded necklaces for women who are interested in unique, yet affordable accessories to their wardrobes. The necklaces will sell for an average of \$100 each. Sales Projections 2012 150

2.

2013 175

2014 200

1 25 10 30 inches 1

\$15 \$6 \$3 \$2 \$1 \$27

Make a list of all of the equipment you will need to make your product. Estimate the cost of each piece of equipment that you will need. Equipment Tools Storage boxes for materials Beading boards Miscellaneous supplies TOTAL

4.

2016 250

Make a detailed list of all of the materials needed to make your product. Include quantities needed of each material. Also include the cost of the material on a per-unit basis. Materials per Necklace Pendants Beads Silver findings Wire Clasp TOTAL

3.

2015 225

\$100 \$75 \$50 \$50 \$275

Make a list of all other expenses that would be needed to create your product. Examples of other expenses would be rent, utilities, and insurance. Estimate the cost of each of these expenses per year. Rent Utilities Insurance TOTAL

7-69

Managerial Accounting 4e Solutions Manual 5. Now classify all of the expenses you have listed as being either fixed or variable. For mixed expenses, separate the expense into the fixed component and the variable component. Rent Utilities Insurance

Fixed Fixed Fixed

6. Calculate how many units of your product you will need to sell to breakeven in each of the five years you have projected. Fixed expenses / Unit contribution margin = Unit breakeven point \$1,850 / (\$100 - \$27) = 26 necklaces 7.

Calculate the margin of safety in units for each of the five years in your projection. Margin of Safety = Projected Sales – Breakeven Sales 2012 2013 2014 150-26=124 175-26=149 200-26=174 \$15,000\$17,500 \$20,000 \$2,600 \$2,600 \$2,600 \$12,400 \$14,900 \$17,400

8.

2015 225-26=199 \$22,500 \$2,600 \$19,900

2016 250-26=224 \$25,000 \$2,600 \$22,400

Now decide how much you would like to make in before-tax operating income (target profit) in each of the upcoming five years. Calculate how many units you would need to sell in each of the upcoming years to meet these target profit levels. Fixed expenses + Target profit / Unit CM = Yearly sales volume \$1,850 + \$12,000 / (\$100 - \$27) = 190 necklaces

9.

How realistic is your potential venture? Do you think you would be able to break even in each of the projected five years? How risky is your venture (use the margin of safety to help answer this question). Do you think your target profits are achievable? The venture looks realistic. The breakeven point is only 26 necklaces, which means I would need to sell on average less than three necklaces a month. The margin of safety is promising as long as the projected sales can be made. The target profits appear achievable, but will require implementing a solid marketing plan. Student answers will vary.

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Chapter 7

Cost-Volume-Profit Analysis

(30 min.) A7-71 Ethics Mini-Case 1.

a. The ethical issues in this situation are: Competence: “Provide decision support information and recommendations that are accurate, clear, concise, and timely.” In his initial report, Greg Michaels’ had an inaccuracy. It was a mistake, but ignoring the mistake is a breach of this principle. Confidentiality: “Keep information confidential except when disclosure is authorized or legally required.” Greg Michaels’ disclosure of the internal report to Beth Sparrow, an employee of a competing company, is neither authorized nor legally required. As a result, this is a clear ethical violation. Integrity: “Abstain from engaging in or supporting any activity that might discredit the profession.” Ignoring errors in reports which affect real business decisions could discredit the profession. Credibility: “Disclose all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, analyses, or recommendations.” It is reasonable to expect that the undisclosed error, if disclosed, would affect the understanding of the report. Thus, by not reporting this inaccuracy, Greg Michaels is violating this ethical principle. b. Greg Michaels’ responsibilities as a management accountant are to be honest, fair, objective, and responsible. He should seek to correct the mistake he had made by reporting it to his immediate supervisor. He is also responsible for maintaining confidential information, so he should not disclose confidential information to his friend, however much he may trust her. c. John Hammond is responsible for reviewing the reports which are given to him before signing off on them, especially in the case of interns or junior employees. It is not sufficient that a report looks professional, but he has a duty to also verify that it is accurate. d. Beth Sparrows is responsible for making ethical decisions. Since she is employed by a competing company, she should not look at Greg Michaels’ report, as it could result in unethical behavior. She should encourage Greg to take his concerns to his supervisor. She may give him general advice but should not examine anything which is confidential. 2. By omitting the fixed monthly sales staff salaries from the report, breakeven sales are reported as lower than they actually are. This error would certainly influence the decision about proceeding with the new proposal, since it would make the proposal look favorable and more profitable than it actually is. 3. First, Greg should report the mistake with his immediate supervisor. If he has concerns about his employment with the firm after this mistake, he should take these concerns to the HR department to get an objective third party which is not involved in this incident.

(20-25 min.) A7-72 Real-life Mini Case 1. Is the cost of down a fixed cost or a variable cost for a jacket manufacturer such as Lands’ End? Down is a variable cost to jacket manufacturers because more down is required for each additional unit (jacket) produced. 2. If the cost of down increases, what happens to the breakeven point for a downfilled jacket product line at Land’s End? If the cost of down increases, the breakeven point will also increase because the contribution margin will decrease.

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Managerial Accounting 4e Solutions Manual 3. What is the percentage increase in the cost of down per pound from 2010 to 2012 at Land’s End? Would you expect the breakeven units to change by this same percentage? Why or why not? The price of down increased by about 77% [(\$23 - \$13)/\$13]. The breakeven units will not change by this same percentage because down is only one material that goes into the cost of the jacket. If we assume that the other costs are assumed to have stayed the same, the actual total cost of making the jacket will increase by a smaller total percentage. Therefore, the breakeven in units will increase by a smaller amount than 77%. 4. If down increases by a certain percentage, will the selling price of a down-filled jacket need to change by that same percentage to maintain the same profit margin? Explain. No. Again, down is only one component of the jacket. The other materials in the jacket will help to lessen the impact of the percentage increase in the cost of down (assuming those other materials remain at a constant cost.) Therefore, the selling price will not have to be increased by 77 percent to cope with the 77 percent increase in the cost of down. 5. Assume that a Land’s End down jacket selling for \$100 uses 12 ounces of down. Further assume that Lands’ End has \$250,000 of fixed costs related to the down jacket line and its other variable manufacturing costs total \$60 per jacket. As stated in the story, the cost per pound of down was \$13 and \$23 in October 2010 and October 2012, respectively. Calculate the breakeven number of jackets both in (a) October 2010; and (b) October 2012. Do these breakeven numbers agree with your answers to the prior questions? October 2010 breakeven: \$250,000 / (\$100 – (\$60 + (\$13 x 12/16))) = 8,264 jackets (rounded) October 2012 breakeven: \$250,000 / (\$100 – (\$60 + (\$23 x 12/16))) = 10,989 jackets (rounded) Yes, these numbers agree to answers to the prior questions. 6. Assume now the same set of facts as in Question 5 but that Lands’ End raises the selling price of each jacket by \$10 in October 2013. Does the contribution margin percentage remain the same? No, the contribution margin would increase, this is because Lands’ End only uses 12 ounces of down in each jacket and the price per pound of down went up \$10. Therefore, the \$10 increase in price will overcompensate for the variable cost per unit increase of the jacket. October 2010 contribution margin: \$100 – (\$60 + (\$13 x 12/16)) = \$69.75 October 2010 contribution margin ratio: \$69.75 / \$100 = 69.75% October 2012 contribution margin: \$110 – (\$60 + (\$23 x 12/16)) = \$87.25 October 2012 contribution margin ratio: \$87.25 / \$110 = 79.32%

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