CHAPTER 3 Question Solutions

CHAPTER 3 COST–VOLUME–PROFIT ANALYSIS

 NOTATI  NOTATION ON USED IN CHAPTER 3 SOLUTIONS SP: VCU: C!U: #C: TOI:

Selling price Variable Variable cost per nit Contribtion "argin "argin per nit #i$e% costs Target Target operating inco"e

Cost&'ol"e&pro(it )CVP* anal+sis e$a"ines t,e be,a'ior o( total re'enes- total costsan% operating inco"e as c,anges occr in t,e nits sol%- selling price- 'ariable cost per nit- or  (i$e% costs o( a pro%ct.

3-1

3-2

/. 0. 3.

. 3.3

T,e ass"ptions n%erl+ing t,e CVP anal+sis otline% in C,apter 3 are C,ang C,anges es in in t,e t,e le'el le'el o( re'e re'en nes es an% an% cos costs ts aris arisee onl+ onl+ bec becas asee o( c,ang c,anges es in in t,e t,e n"b n"ber  er  o( pro%ct )or ser'ice* nits sol%. Total tal cost costss can can be sepa separa rate te% % into into a (i$ (i$e% e% co" co"po ponen nentt t,at t,at %oes %oes not 'ar+ 'ar+ 1it, 1it, t,e t,e ni nits ts sol sol% % an% a 'ariable co"ponent t,at c,anges 1it, respect to t,e nits n its sol%. 2,en 2,en repr repres esen ente te% % grap, grap,ic ical all+ l+-- t,e t,e be,a'i be,a'ior orss o( tot total al re'e re'en nes es an% an% tota totall costs costs are are lin linear  ear  )represente% as a straig,t line* in relation to nits sol% 1it,in a rele'ant range an% ti"e  perio%. T,e T,e sell sellin ing g pric pricee- 'ar 'aria iabl blee cost cost per nitnit- an% (i$e (i$e% % cost costss are are 4no1 4no1n n an% an% cons consta tant nt..

Operating inco"e is total re'enes (ro" operations (or t,e acconting perio% "ins cost o( goo%s sol% an% operating costs )e$cl%ing inco"e ta$es*: Operating inco"e 5 Total re'enes (ro" operations 6  Net inco"e is operating inco"e pls nonoperating re'enes )sc, as interest re'ene* "ins "ins nonoper nonoperati ating ng costs costs )sc, )sc, as intere interest st cost* cost* "ins "ins inco"e inco"e ta$es. ta$es. C,apte C,apterr 3 ass"e ass"ess nonoperating re'enes an% nonoperating costs are 7ero. T,s- C,apter 3 co"ptes net inco"e as:  Net inco"e 5 Operating inco"e 6 Inco"e ta$es Contribtion "argin is t,e %i((erence bet1een total re'enes an% total 'ariable costs. Contribtion "argin per nit is t,e %i((erence bet1een selling price an% 'ariable cost per nit. Contribtion&"argin percentage is t,e contribtion "argin per nit %i'i%e% b+ selling price.

3-4

T,ree "et,o%s to e$press CVP relations,ips are t,e e8ation "et,o%- t,e contribtion "argin "et,o%- an% t,e grap, "et,o%. T,e (irst t1o "et,o%s are "ost se(l (or anal+7ing operating inco"e at a (e1 speci(ic le'els o( sales. T,e grap, "et,o% is se(l (or 'isali7ing t,e e((ect o( sales on operating inco"e o'er a 1i%e range o( 8antities sol%.

3-5

9rea4e'en anal+sis %enotes t,e st%+ o( t,e brea4e'en point- 1,ic, is o(ten onl+ an inci%ental part o( t,e relations,ip bet1een cost- 'ol"e- an% pro(it. Cost&'ol"e&pro(it relations,ip is a "ore co"pre,ensi'e ter" t,an brea4e'en anal+sis. 3-6

CVP certainl+ is si"ple- 1it, its ass"ption o( otpt as t,e onl+ re'ene an% cost %ri'er- an% linear re'ene an% cost relations,ips. 2,et,er t,ese ass"ptions "a4e it si"plistic %epen%s on t,e %ecision conte$t. In so"e cases- t,ese ass"ptions "a+ be s((icientl+ accrate (or CVP to pro'i%e se(l insig,ts. T,e e$a"ples in C,apter 3 )t,e so(t1are pac4age conte$t in t,e te$t an% t,e tra'el agenc+ e$a"ple in t,e Proble" (or Sel(&St%+* illstrate ,o1 CVP can  pro'i%e sc, insig,ts. In "ore co"ple$ cases- t,e basic i%eas o( si"ple CVP anal+sis can be e$pan%e%. 3-7

An increase in t,e inco"e ta$ rate %oes not a((ect t,e brea4e'en point. Operating inco"e at t,e brea4e'en point is 7ero- an% no inco"e ta$es are pai% at t,is point. 3-8

Sensiti'it+ anal+sis is a 1,at&i(; tec,ni8e t,at "anagers se to e$a"ine ,o1 an otco"e 1ill c,ange i( t,e original pre%icte% %ata are not ac,ie'e% or i( an n%erl+ing ass"ption c,anges. T,e a%'ent o( t,e electronic sprea%s,eet ,as greatl+ increase% t,e abilit+ to e$plore t,e e((ect o( alternati'e ass"ptions at "ini"al cost. CVP is one o( t,e "ost 1i%el+ se% so(t1are applications in t,e "anage"ent acconting area. 3-9

3-10

E$a"ples incl%e: !an(actring66sbstitting a robotic "ac,ine (or ,orl+ 1age 1or4ers !ar4eting66c,anging a sales (orce co"pensation plan (ro" a percent o( sales %ollars to a (i$e% salar+ Csto"er ser'ice66,iring a sbcontractor to %o csto"er repair 'isits on an annal retainer basis rat,er t,an a per&'isit basis

3-11

E$a"ples incl%e: !an(actring66sbcontracting a co"ponent to a spplier on a per&nit basis to a'oi%  prc,asing a "ac,ine 1it, a ,ig, (i$e% %epreciation cost !ar4eting66c,anging a sales co"pensation plan (ro" a (i$e% salar+ to percent o( sales %ollars basis Csto"er ser'ice66,iring a sbcontractor to %o csto"er ser'ice on a per&'isit basis rat,er t,an an annal retainer basis

Operating le'erage %escribes t,e e((ects t,at (i$e% costs ,a'e on c,anges in operating inco"e as c,anges occr in nits sol%- an% ,ence- in contribtion "argin.