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COST-VOLUME-PROFIT ANALYSIS
3-1 Cost-volume-profit (CVP) analysis examines the behavior of total revenues, total costs,
and operating income as changes occur in the output level, selling price, variable costs per unit,
and/or fixed costs of a product.
3-2 The assumptions underlying the CVP analysis outlined in Chapter 3 are:
1. Changes in the level of revenues and costs arise only because of changes in the number of
product (or service) units produced and sold.
2. Total costs can be separated into a fixed component that does not vary with the output level
and a component that is variable with respect to the output level.
3. When represented graphically, the behavior of total revenues and total costs are linear
(represented as a straight line) in relation to output units within a per unit relevant range
and time period.
4. The selling price, variable cost per unit, and fixed costs are known and constant.
5. The analysis either covers a single product or assumes that the sales mix, when multiple
products are sold, will remain constant as the level of total units sold changes.
6. All revenues and costs can be added and compared without taking into account the time
value of money.
3.3 Operating income is total revenues from operations for the accounting period minus cost
of goods sold and operating costs (excluding income taxes):
Net income is operating income plus nonoperating revenues (such as interest revenue)
minus nonoperating costs (such as interest cost) minus income taxes. Chapter 3 assumes
nonoperating revenues and nonoperating costs are zero. Thus, Chapter 3 computes net income
as:
Net income = Operating income – Income taxes
3-4 Contribution margin is the difference between total revenues and total variable costs.
Contribution margin per unit is the difference between selling price and variable cost per unit.
Contribution-margin percentage is the contribution margin per unit divided by selling price.
3-5 Three methods to calculate the breakeven point are the equation method, the
contribution margin method, and the graph method. In the first two methods, the breakeven units
are calculated by dividing total fixed costs by contribution margin per unit.
3-6 Breakeven analysis denotes the study of the breakeven point, which is often only an
incidental part of the relationship between cost, volume, and profit. Cost-volume-profit
relationship is a more comprehensive term than breakeven analysis.
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3-7 CVP certainly is simple, with its assumption of output as the only revenue and cost
driver, and linear revenue and cost relationships. Whether these assumptions make it simplistic
depends on the decision context. In some cases, these assumptions may be sufficiently accurate
for CVP to provide useful insights. The examples in Chapter 3 (the software package context in
the text and the travel agency example in the Problem for Self-Study) illustrate how CVP can
provide such insights. In more complex cases, the basic ideas of simple CVP analysis can be
expanded.
3-8 An increase in the income tax rate does not affect the breakeven point. Operating
income at the breakeven point is zero, and no income taxes are paid at this point.
3-9 Sensitivity analysis is a "what-if" technique that managers use to examine how a result
will change if the original predicted data are not achieved or if an underlying assumption
changes. The advent of the electronic spreadsheet has greatly increased the ability to explore the
effect of alternative assumptions at minimal cost. CVP is one of the most widely used software
applications in the management accounting area.
3-12 Operating leverage describes the effects that fixed costs have on changes in operating
income as changes occur in units sold, and hence, in contribution margin. Knowing the degree of
operating leverage at a given level of sales helps managers calculate the effect of fluctuations in
sales on operating incomes.
3-13 CVP analysis is always conducted for a specified time horizon. One extreme is a very
short-time horizon. For example, some vacation cruises offer deep price discounts for people
who offer to take any cruise on a day's notice. One day prior to a cruise, most costs are fixed.
The other extreme is several years. Here, a much higher percentage of total costs typically is
variable.
CVP itself is not made any less relevant when the time horizon lengthens. What
happens is that many items classified as fixed in the short run may become variable costs with a
longer time horizon.
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3-14 A company with multiple products can compute a breakeven point by assuming there is
a constant mix of products at different levels of total revenue.
3-15 Yes, gross margin calculations emphasize the distinction between manufacturing and
nonmanufacturing costs (gross margins are calculated after subtracting fixed manufacturing
costs). Contribution margin calculations emphasize the distinction between fixed and variable
costs. Hence, contribution margin is a more useful concept than gross margin in CVP analysis.
The management would consider other factors before making the final decision. It is likely
that product quality would improve as a result of using state of the art equipment. Due to
increased automation, probably many workers will have to be laid off. Patel’s management
will have to consider the impact of such an action on employee morale. In addition, the
proposal increases the company’s fixed costs dramatically. This will increase the
company’s operating leverage and risk.
33
3-18 (35-40 min.) CVP analysis, changing revenues and costs.
FC $22,000
Q = = $45 per ticket
CMU
$32,000
= $45 per ticket
FC $22,000
Q = = $51 per ticket
CMU
$32,000
= $51 per ticket
= 628 tickets (rounded up)
FC $22,000
Q = = $19 per ticket
CMU
3-18 (Cont’d.)
34
FC + TOI $22,000 + $10,000
3b. Q = = $19 per ticket
CMU
$32,000
= $19 per ticket
The reduced commission sizably increases the breakeven point and the number of tickets
required to yield a target operating income of $10,000:
8%
Commission Fixed
(Requirement 2) Commission of $48
Breakeven point 432 1,158
Attain OI of $10,000 628 1,685
4a. The $5 delivery fee can be treated as either an extra source of revenue (as done below) or
as a cost offset. Either approach increases UCM by $5:
FC $22,000
Q = = $24 per ticket
CMU
$32,000
= $24 per ticket
The $5 delivery fee results in a higher contribution margin which reduces both the breakeven
point and the tickets sold to attain operating income of $10,000.
3-19 (15 min.) Gross margin and contribution margin, making decisions.
Salaries and wages of $150,000 could be variable costs and fixed costs. The answer assumes
they are all fixed costs.
35
1. Revenues $500,000
Deduct variable costs:
Cost of goods sold $200,000
Sales commissions 50,000
Other operating costs 40,000 290,000
Contribution margin $210,000
$210,000
2. Contribution margin percentage = $500,000 = 42%
If Mr. Schmidt spends $10,000 more on advertising, the operating income will increase by
$32,000 converting an operating loss of $10,000 to an operating income of $22,000.
Proof (Optional):
Operating costs:
Salaries and wages $150,000
Sales commissions (10% of sales) 60,000
Depreciation of equipment and fixtures 12,000
Store rent 48,000
Advertising 10,000
Other operating costs:
$40,000
Variable ( $500,000 × $600,000) 48,000
36
3-20 (20 min.) CVP exercises.
Budgeted
Variable Contribution Fixed Operating
Revenues Costs Margin Costs Income
Orig. $10,000,000G $8,200,000G $1,800,000 $1,700,000G $100,000
1. 10,000,000 8,020,000 1,980,000a 1,700,000 280,000
2. 10,000,000 8,380,000 1,620,000b 1,700,000 (80,000)
3. 10,000,000 8,200,000 1,800,000 1,785,000c 15,000
4. 10,000,000 8,200,000 1,800,000 1,615,000d 185,000
5. 10,800,000e 8,856,000f 1,944,000 1,700,000 244,000
6. 9,200,000g 7,544,000h 1,656,000 1,700,000 (44,000)
7. 11,000,000i 9,020,000j 1,980,000 1,870,000k 110,000
8. 10,000,000 7,790,000l 2,210,000 1,785,000m 425,000
Gstands for given.
a$1,800,000 × 1.10; b$1,800,000 × 0.90; c$1,700,000 × 1.05; d$1,700,000 × 0.95; e$10,000,000
× 1.08; f$8,200,000 × 1.08; g$10,000,000 × 0.92; h$8,200,000 × 0.92; i$10,000,000 × 0.10;
j$8,200,000 × 1.10; k$1,700,000 × 1.10; l$8,200,000 × 0.95; m$1,700,000 × 1.05
37
3-22 (10–15 min.) CVP analysis, income taxes.
1. Operating income = Net income ÷ (1 – tax rate)
= $84,000 ÷ (1 – 0.40) = $140,000
2. Contribution margin – Fixed costs = Operating income
Contribution margin – $300,000 = $140,000
Contribution margin = $440,000
3. Revenues – Variable costs = Contribution margin
Revenues – 0.80 Revenues = Contribution margin
0.20 Revenues = $440,000
Revenues = $2,200,000
4. Breakeven revenues = Fixed costs ÷ Contribution margin percentage
Breakeven revenues = $300,000 ÷ 0.20 = $1,500,000
3-23 (20–25 min.) CVP analysis, income taxes.
38
3-23 (Cont’d.)
39
3-24 (Cont’d.)
EXHIBIT 3-24A
PV Graph for Media Publishers
$4,000 FC = $3,500,000
UCM = $13.85 per book sold
3,000
2,000
Operating income (000’s)
1,000
0 Units so ld
100,000 200,000 300,000 400,000 500,000
-1,000 252,708; $0
-2,000
-3,000
(0; $3.5 million)
-4,000
2a.
FC
=
CMU
$3,500,000
=
$13.85
FC +OI
2b. Target OI =
CMU
310
3-24 (Cont’d.)
$3,500,000 + $2,000,000
=
$13.85
$5,500,000
=
$13.85
= 397,112 copies sold (rounded up)
3a. Decreasing the normal bookstore margin to 20% of the listed bookstore price of $30 has the
following effects:
SP = $30.00 × (1 – 0.20)
= $30.00 × 0.80 = $24.00
VCU =$ 4.00 variable production and marketing cost
+ 3.60 variable author royalty cost (0.15 × $30.00 × 0.80)
$ 7.60
FC
=
CMU
$3,500,000
=
$16.40
= 213,415 copies sold (rounded)
The breakeven point decreases from 252,708 copies in requirement 2 to 213,415 copies.
3b. Increasing the listed bookstore price to $40 while keeping the bookstore margin at 30% has
the following effects:
SP = $40.00 × (1 – 0.30)
= $40.00 × 0.70 = $28.00
VCU = $ 4.00 variable production and marketing cost
+ 4.20 variable author royalty cost (0.15 × $40.00 × 0.70)
$ 8.20
CMU= $28.00 – $8.20 = $19.80 per copy
$3,500,000
=
$19.80
= 176,768 copies sold (rounded)
The breakeven point decreases from 252,708 copies in requirement 2 to 176,768 copies.
3c. The answer to requirements 3a and 3b decreases the breakeven point relative to
requirement 2 because in each case fixed costs remain the same at $3,500,000 while contribution
margin per unit increases.
311
3-25 (10 min.) CVP analysis, margin of safety.
Fixed costs
1. Breakeven point revenues = Contributi on margin percentage
$400,000
Contribution margin percentage = $1,000,000 = 0.40
Selling price − Variable cost per unit
2. Contribution margin percentage = Selling price
SP − $12
0.40 =
SP
0.40 SP = SP – $12
0.60 SP = $12
SP = $20
For Q = 100 carpets, operating income under both Option 1 and Option 2 = $10,000
3-26 (Cont’d.)
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3b. For Q < 100, say, 99 carpets,
Option 1 gives operating income = $150 × 99 − $5,000 = $9,850
Option 2 gives operating income = $100 × 99 = $9,900
So Color Rugs will prefer Option 2.
Contributi on margin
4. Degree of operating leverage = Operating income
$150 ×100
Under Option 1, degree of operating leverage = $10,000
= 1.5
$100 ×100
Under Option 2, degree of operating leverage = $10,000
= 1.0
5. The calculations in requirement 4 indicate that when sales are 100 units, a percentage
change in sales and contribution margin will result in 1.5 times that percentage change in
operating income for Option 1, but the same percentage change in operating income for Option
2. The degree of operating leverage at a given level of sales helps managers calculate the effect
of fluctuations in sales on operating incomes.
1.
Unit
Variable Variable Contrib. Breakeven
Manuf. Mark./Distr. Margin Point in
Annual Fixed Costs per Costs per (5)= Units
Costs Selling Price Sweater Sweater (2) – (3) – (6) = (1) ÷
(1) (2) (3) (4) (4) (5)
Singapore $ 6,500,000 $32 $ 8.00 $11.00 $13 500,000
Thailand 4,500,000 32 5.50 11.50 15 300,000
U.S. 12,000,000 32 13.00 9.00 10 1,200,000
(b)
(a) Breakeven point
Breakeven point in revenues
in units sold Col. (a) × $32
Singapore 500,000 $16,000,000
Thailand 300,000 9,600,000
U.S. 1,200,000 38,400,000
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3-27 (Cont’d.)
2. Revenues
$32 × Variable Fixed Operating
800,000 Costs Costs Income
Singapore $25,600,000 $15,200,0001 $6,500,000 $3,900,000
Thailand 25,600,000 13,600,0002 4,500,000 7,500,000
U.S. 25,600,000 17,600,0003 12,000,000 (4,000,000)
1
($8 + $11) × 800,000 2
($5.50 + $11.50) × 800,000 3
($13 + $9) × 800,000
Thailand has the lowest breakeven point––it has both the lowest fixed costs ($4,500,000) and the
lowest variable cost per unit ($17.00). Hence, for a given selling price, Thailand will always
have a higher operating income (or a lower operating loss) than Singapore or the U.S.
The U.S. breakeven point is 1,200,000 units. Hence, with sales of 800,000 units, it has an
operating loss of $4,000,000.
Check
Revenues ($210 × 80,770; $120 × 53,846) $23,423,220
Variable costs ($90 × 80,770; $40 × 53,846) 9,423,140
Contribution margin 14,000,080
Fixed costs 14,000,000
Operating income (subject to rounding) $ 0
314
3-28 (Cont’d.)
Check
Revenues ($210 × 70,000; $120 × 70,000) $23,100,000
Variable costs ($90 × 70,000; $40 × 70,000) 9,100,000
Contribution margin 14,000,000
Fixed costs 14,000,000
Operating income $ 0
Check
Revenues ($210 × 108,621; $120 × 12,069) $24,258,690
Variable costs ($90 × 108,621; $40 × 12,069) 10,258,650
Contribution margin 14,000,040
Fixed costs 4,000,000
Operating income (subject to rounding) $ 0
315
3-28 (Cont’d.)
3c. As Zapo increases its percentage of new customers, which have a higher contribution
margin per unit than upgrade customers, the number of units required to break even decreases:
316
Operating
1b. income = ($45 × 40,000) − ($30 × 40,000) − ($60 × 800) − $240,000 = $312,000
3-30 (Cont’d.)
The breakeven point is not unique because there are two cost drivers—quantity of picture
frames and number of shipments. Various combinations of the two cost drivers can yield zero
operating income.
Variable manufacturing costs per unit = $1,100,000 ÷ 200,000 = $5.50 per unit
Operating income =
Fixed marketing
Contribution margin × Sales − Fixed manufacturing − and distribution
per unit quantity costs
costs
= ($3.50 × 230,000) − $500,000 − $350,000
= −$45,000
Foreman has confused gross margin with contribution margin. He has interpreted gross
margin as if it was all variable, and interpreted marketing and distribution costs as all fixed. In
317
fact, the manufacturing costs, subtracted from sales to calculate gross margin, and marketing and
distribution costs contain both fixed and variable components.
3-31 (Cont’d.)
1. King pays Foreman $2 million plus $4 (25% of $16) for every home purchasing the pay-
per-view. The expected value of the variable component is:
The expected value of King's payment is $3,520,000 ($2,000,000 fixed fee + $1,520,000).
2. SP = $16
VCU = $ 6 ($4 payment to Foreman + $2 variable cost)
CMU= $10
FC = $2,000,000 + $1,000,000 = $3,000,000
FC
Q =
UCM
$3,000,000
=
$10
= 300,000 homes
318
Variable cost per package 3,600
Contribution margin per package $ 400
Breakeven (units) = Fixed costs ÷ Contribution margin per package
3-33 (Cont’d.)
$480,000
= $400 per package = 1,200 tour packages
Revenue to achieve target income = (Fixed costs + target OI) ÷ Contribution margin ratio
$480,000 + $100,000
= = $5,800,000, or
0.10
Number of tour packages to earn $100,000 operating income:
$480,000 + $100,000
= 1,450 tour packages
$400
Fixed costs
Breakeven (units) = Contributi on margin per unit
Fixed costs
Contribution margin per unit =
Breakeven (units)
$504,000
= 1,200 tour packages = $420 per tour package
Because the current variable cost per unit is $3,600, the unit variable cost will need to be reduced
by $20 to achieve the breakeven point calculated in requirement 1.
Alternate Method: If fixed cost increases by $24,000, then total variable costs must be reduced
by $24,000 to keep the breakeven point of 1,200 tour packages.
Therefore the variable cost per unit reduction = $24,000 ÷ 1,200 = $20 per tour package.
319
3.34 (30 min.) CVP, target income, service firm.
Fixed costs
Breakeven quantity = Contributi on margin per child
$5,600
= = 14 children
$400
$5,600 + $10,400
= = 40 children
$400
Therefore the fee per child will increase from $600 to $650.
Alternatively,
320
3-25 (Cont’d.)
2. Since Galaxy is operating above the breakeven point, any incremental contribution margin
will increase operating income dollar for dollar.
Alternatively,
Operating income = Revenues – Variable costs – Fixed costs
= $500,000 – $275,000 – $135,000 = $90,000
Income taxes = 0.40 × $90,000 = $36,000
Net income = Operating income – Income taxes
= $90,000 – $36,000 = $54,000
321
3-36 (Cont’d.)
4. Let Q = Number of units to break even with new fixed costs of $146,250
322
3-37 (Cont’d.)
Let the fixed marketing and distribution costs be F. We calculate F when operating income =
$600,000 and the selling price is $99.
Hence, the maximum increase in fixed marketing and distribution costs that will allow
Tocchet to reduce the selling price and maintain $600,000 in operating income is $200,000
($1,600,000 – $1,400,000).
Tocchet will consider adding the new features provided the selling price is at least $109.50
per unit.
Fixed costs
Breakeven point in units = Contributi on margin per unit
$250,000
= $40 per unit = 6,250 footballs
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Contributi on margin per unit $40
3. Contribution margin ratio = Selling price
= = 40%
$100
1. Contribution margin per pair = selling price – Variable costs per pair
= $30 – $21 = $9 a pair
$441 ,000
a. Breakeven point in units = = 42,000 pairs
$10 .50
324
3-39 (Cont’d.)
$360 ,000
a. Breakeven point in units = = 41,380 pairs (rounded up)
$8.70
325
3-39 (Cont’d.)
3-39 Excel Application
Cost-Volume-Profit Analysis
Walk Rite Shoe Company
Original Data
Unit Variable Data:
Selling price $30.00
Cost of shoes $19.50
Sales commissions 1.50
Total variable costs 21.00
Annual Fixed Costs:
Rent $60,000
Salaries 200,000
Advertising 80,000
Other fixed costs 20,000
Total fixed costs $360,000
Problem 1
Contribution margin per unit $9.00
a. Breakeven units 40,000
b. Breakeven revenues $1,200,000
Problem 2
Revenues $1,050,000
Cost of shoes 682,500
Sales commissions 52,500
Total variable costs 735,000
Contribution margin $315,000
Total fixed costs 360,000
Operating income (Loss) $(45,000)
Problem 3
Total fixed costs $441,000
Contribution margin per unit $10.50
a. Breakeven units 42,000
b. Breakeven revenues $1,260,000
Problem 4
Total variable cost per unit $21.30
Contribution margin per unit $8.70
a. Breakeven units 41,380
b. Breakeven revenues $1,241,409
Problem 5
Revenues $1,500,000
Cost of shoes 975,000
Sales commissions 75,000
Manager’s commission 3,000
Total variable costs 1,053,000
Contribution margin $447,000
Total fixed costs 360,000
Operating Income (Loss) $87,000
326
3-40 (20–25 min.) CVP analysis, shoe stores (continuation of 3-39).
1. Because the unit sales level at the point of indifference would be the same for each plan,
the revenue would be equal. Therefore, the unit sales level sought would be that which produces
the same total costs for each plan.
The decision regarding the plans will depend heavily on the unit sales level that is
generated by the fixed salary plan. For example, as part (1) shows, at identical unit sales levels
in excess of 54,000 units, the fixed salary plan will always provide a more profitable final result
than the commission plan.
The decision regarding the salary plan depends heavily on predictions of demand. For
instance, the salary plan offers the same operating income at 58,000 units as the commission plan
offers at 58,667 units.
327
3-41 (10-20 min.) Sensitivity and inflation (continuation of 3-40).
2. Optimal operating income, given perfect knowledge, would be the $432,000 [($30 – $19.50
– $1.50) × 48,000] contribution computed above, minus $360,000 fixed costs, or $72,000.
3. The point of indifference is where the operating incomes are equal. Let X = unit cost per
pair that would produce the identical operating income of $67,200. Then:
Therefore, any rise in purchase cost in excess of $19.60 per pair increases the operating
income benefit of signing the long-term contract.
In a shortcut solution, you could take the $4,800 difference between the "ideal" operating
income (of $72,000) at the current cost per pair and the operating income under the contract (of
$67,200) and divide it by 48,000 units to get 10 cents per pair difference.
328
3-42 (30 min.) CVP analysis, income taxes, sensitivity.
1a. In order to break even, Almo Company must sell 500 units. This amount represents the
point where revenues equal total costs.
2. To achieve its net income objective, Almo Company should select the first alternative
where the sales price is reduced by $40, and 2,700 units are sold during the remainder of the
year. This alternative results in the highest net income and is the only alternative that equals or
exceeds the company’s net income objective. Calculations for the three alternatives are shown
below.
Alternative 1
Revenues = ($400 × 350) + ($360a × 2,700) = $1,112,000
Variable costs = $200 × 3,050b = $610,000
Operating income = $1,112,000 − $610,000 − $100,000 = $402,000
Net income = $402,000 × (1 − 0.4) = $241,200
a$400 – $40; b350 units + 2,700 units.
Alternative 2
Revenues = ($400 × 350) + ($370c × 2,200) = $954,000
Variable costs = ($200 × 350) + ($190d × 2,200) = $488,000
Operating income = $954,000 − $488,000 − $100,000 = $366,000
Net income = $366,000 × (1 − 0.4) = $219,600
c$400 – $30; d$200 – $10.
329
3-42 (Cont’d.)
Alternative 3
Revenues = ($400 × 350) + ($380e× 2,000) = $900,000
Variable costs = $200 × 2,350f = $470,000
Operating income = $900,000 − $470,000 − $90,000g = $340,000
Net income = $340,000 × (1 − 0.4) = $204,000
e$400 – 0.05 × $400 = 400 – $20; f350 units + 2,000 units; g$100,000 – $10,000
2. With its own sales force, Marston’s fixed marketing costs would increase to $3,420,000 +
$2,080,000 = $5,500,000.
Variable cost of marketing = 10% of Revenues
330
3-43 (Cont’d.)
The calculations indicate that at sales of $26,000,000, a percentage change in sales and
contribution margin will result in 2.89 times that percentage change in operating income if
Marston continues to use sales agents and 3.51 times that percentage change in operating income
if Marston employs its own sales staff. The higher contribution margin per dollar of sales and
higher fixed costs gives Marston more operating leverage, that is greater benefits (increases in
operating income) if revenues increase but greater risks (decreases in operating income) if
revenues decrease.
331
3-44 (15–25 min.) Sales mix, three products.
1. Sales of A, B, and C are in ratio 20,000 : 100,000 : 80,000. So for every 1 unit of A, 5
(100,000 ÷ 20,000) units of B are sold, and 4 (80,000 ÷ 20,000) units of C are sold.
Let Q = Number of units of A to break even
5Q = Number of units of B to break even
4Q = Number of units of C to break even
3. Contribution margin
A: 20,000 × $3 $ 60,000
B: 80,000 × $2 160,000
C: 100,000 × $1 100,000
Contribution margin $320,000
Fixed costs 255,000
Operating income $ 65,000
Breakeven point increases because the new mix contains less of the higher contribution
margin per unit, product B, and more of the lower contribution margin per unit, product C.
332
3-45 (30 min.) Multiproduct breakeven, decision making.
Fixed costs $495,000
1. Breakeven point in 2003 (units) = Contributi on margin per unit = = 16,500 units
$50 − $20
Breakeven point in 2003 (in revenues) = 16,500 units × $50 = $825,000 in sales revenues
$30
= = 60%
$50
$110 $110
= = = 55%
(3 ×$50 ) + ( 2 ×$25 ) $200
The breakeven point in 2004 increases because fixed costs are the same in both years but the
contribution margin generated by each dollar of sales revenue at the given product mix decreases
in 2004 relative to 2003.
3-45 (Cont’d.)
333
4. Despite the breakeven sales revenue being higher, Evenkeel should accept Glaston’s offer.
The breakeven points are irrelevant because Evenkeel is already above the breakeven sales
volume in 2003. By accepting Glaston’s offer, Evenkeel has the ability to sell all the 30,000 units
of Plumar in 2004 and make more sales of Ridex to Glaston without incurring any more fixed
costs.
Operating income in 2004 with and without Ridex are expected to be as folows:
2004 2004
without Ridex with Ridex
Sales $1,500,0001 $2,000,0002
Variable costs 600,0003 900,0004
Contribution margin 900,000 1,100,000
Fixed costs 495,000 495,000
Operating income $ 405,000 $ 605,000
1
$50 × 30,000 units
2
($50 × 30,000 units) + ($25 × 20,000 units)
3
$20 × 30,000 units
4
($20 × 30,000 units) + ($15 × 20,000 units)
334
3-46 (20–25 min.) Sales mix, two products.
The breakeven point is 120,000 Standard units plus 40,000 Deluxe units, a total of 160,000
units.
2a. Unit contribution margins are: Standard: $20 – $14 = $6; Deluxe: $30 – $18 = $12
If only Standard carriers were sold, the breakeven point would be:
$1,200,000 ÷ $6 = 200,000 units.
2b. If only Deluxe carriers were sold, the breakeven point would be:
$1,200,000 ÷ $12 = 100,000 units
3. Operating income = Contribution margin of Standard + Contribution margin of Deluxe – Fixed costs
= 180,000($6) + 20,000($12) – $1,200,000
= $1,080,000 + $240,000 – $1,200,000
= $120,000
The breakeven point is 163,638 Standard + 18,182 Deluxe, a total of 181,820 units.
The major lesson of this problem is that changes in the sales mix change breakeven points
and operating incomes. In this example, the budgeted and actual total sales in number of units
were identical, but the proportion of the product having the higher contribution margin declined.
Operating income suffered, falling from $300,000 to $120,000. Moreover, the breakeven point
rose from 160,000 to 181,820 units.
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3-47 (15 min.) CVP analysis under uncertainty.
Unit contribution margin = Selling price per unit − Variable costs per unit
= $10 − $8 = $2
Fixed costs
Breakeven point = Unit contributi on margin
$400,000
=
$2
The Shocking Pink umbrellas should be chosen because they have the higher expected operating
income.
3. The expected operating income from the two products would be identical. If the choice
criterion is to maximize expected operating income, the company will be indifferent between
Emerald Green and Shocking Pink umbrellas. However, assume that management considers risk
factors. Emerald Green umbrellas, for example, have a 10% chance of selling only 100,000
units, which would result in a net operating loss of $200,000. Also, there is a 30% chance that
sales of Emerald Green will exceed 300,000 units. If this event happens, the operating income of
Emerald Green umbrellas will be higher than the operating income of Shocking Pink umbrellas.
If management is reluctant to take risks, it would prefer selling the 300,000 units of Shocking
pink.
3-47 (Cont’d.)
336
The expected values are important, but the dispersion of the probability distribution is also
important. Normally, the wider the dispersion, the greater the risk. Knowledge of the entire
probability distribution helps management assess the risk before reaching a decision.
2. If variable costs are 52% of revenues, contribution margin percentage equals 48% (100%
− 52%)
Fixed costs
Breakeven revenues = Contributi on margin percentage
$2,160,000
= = $4,500,000
0.48
3. Revenues $5,000,000
Variable costs (0.52 × $5,000,000) 2,600,000
Fixed costs 2,160,000
Operating income $ 240,000
Competence
Clear reports using relevant and reliable information should be prepared. Preparing reports on
the basis of incorrect environmental costs in order to make the company’s performance look
better than it is violates competence standards. It is unethical for Bush to not report
environmental costs in order to make the plant’s performance look good.
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3-48 (Cont’d.)
Integrity
The management accountant has a responsibility to avoid actual or apparent conflicts of interest
and advise all appropriate parties of any potential conflict. Bush may be tempted to report lower
environmental costs to please Lemond and Woodall and save the jobs of his colleagues. This
action, however, violates the responsibility for integrity. The Standards of Ethical Conduct
require the management accountant to communicate favorable as well as unfavorable
information.
Objectivity
The management accountant’s Standards of Ethical Conduct require that information should be
fairly and objectively communicated and that all relevant information should be disclosed. From
a management accountant’s standpoint, underreporting environmental costs to make
performance look good would violate the standard of objectivity.
Bush should indicate to Lemond that estimates of environmental costs and liabilities should
be included in the analysis. If Lemond still insists on modifying the numbers and reporting lower
environmental costs, Bush should raise the matter with one of Lemond’s superiors. If after
taking all these steps, there is continued pressure to understate environmental costs, Bush should
consider resigning from the company and not engage in unethical behavior.
1. The annual breakeven point in units at the Peoria plant is 73,500 units and at the Moline
plant is 47,200 units, calculated as follows.
Peoria Moline
Selling price $150.00 $150.00
Less variable costs:
Manufacturing 72.00 88.00
Marketing and distribution 14.00 14.00
Contribution margin per unit $ 64.00 $ 48.00
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3-49 (Cont’d.)
Breakeven calculation:
2. The operating income that would result from the division production manager’s plan to
produce 96,000 units at each plant is $3,628,800. The normal capacity at the Peoria plant is
96,000 units (400 × 240); however, the normal capacity at the Moline plant is 76,800 units (320
× 240). Therefore, 19,200 units (96,000 – 76,800) will be manufactured at Moline at a reduced
contribution margin of $40.00 per unit ($48 – $8).
3. The optimal production plan is to produce 120,000 units at the Peoria plant and 72,000
units at the Moline plant. The full capacity of the Peoria plant, 120,000 units (400 units ×
300 days), should be utilized as the contribution from these units is higher at all levels of
production than the contribution from units produced at the Moline plant.
The contribution margin is higher when 120,000 units are produced at the Peoria plant and
72,000 units at the Moline plant. As a result, operating income will also be higher in this case
since total fixed costs for the division remain unchanged regardless of the quantity produced at
each plant.
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Chapter 3 Internet Exercise
The Internet exercise is available to students only on the Prentice Hall Companion Website
www.prenhall.com/horngren. Students can click on Cost Accounting, 11th ed., and access the
Internet Exercise for the chapter, which links to the Web site of a company or organization. The
Internet Exercise on the Web will be updated periodically so that it is current with the latest
information available on the subject organization's Web site. A printout copy of the Internet
exercise for this chapter as of early 2002 appears below.
The solution to the Internet exercise, which will also be updated periodically, is available
to instructors from the Companion Website's faculty view. To access the solution, click on Cost
Accounting, 11th ed., Faculty link, and then register once to obtain your password through the
online form. After the initial registration, you will have a personal login ID and password to use
to log in. A printout of the solution to the Internet exercise for this chapter as of early 2002
follows. The exercise and solution provide instructors with an idea of the content of the Internet
exercise for this chapter.
Internet Exercise
Southwest Airlines is the nation's fifth largest domestic carrier. It serves 57 cities with a fleet of
352 Boeing 737s. Southwest just marked its twenty-eighth consecutive year of profitability, and
enjoys the distinction of having the lowest operating cost structure in the domestic airline
industry. In this exercise you will examine factors that contribute to Southwest's success.
Go to www.iflyswa.com/, and click on the "About SWA" link, followed by the "Investor
Relations" link. From here you can access Southwest's 2000 annual report in Adobe Acrobat
pdf format. Use Southwest's 2000 annual report to answer the following questions:
1. Skim Southwest Airline's annual report, pages 7-15, and explain how each of the following
factors contributes to its low operating cost structure:
a. Load factor.
b. Type of aircraft.
c. Choice of markets, flights, in-flight service, and aircraft boarding procedures.
d. Method of ticketing.
2a. Go to Southwest's income statement and examine Southwest's 2000 operating expenses.
Identify each expense as either a fixed, variable, or mixed cost (a combination of fixed and
variable costs).
2b. In the short run are Southwest's labor costs predominantly fixed or variable? Explain your
answer.
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Internet Exercise (Cont’d.)
3. Identify potential cost drivers for the following expenses: salaries, fuel and oil,
maintenance materials and repairs, agency commissions, aircraft rentals, landing fees, and
depreciation.
Operating Expense Potential Cost Drivers
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Internet Exercise (Cont’d.)
1d. Southwest reduces ticketing costs by selling over 70% of its seats through its Web site or
phone calls to reservation agents versus an industry average of 20% to 25%. In addition
to lowering commission costs, this results in a greater use of e-tickets (electronic tickets).
E-tickets speed check-in times and reduce paper and back-office processing costs.
2a.
2b. In the short run Southwest's labor costs are predominantly fixed. While pilots,
mechanics, flight attendants, and administrators may be compensated for overtime, base
salaries are generally fixed. In the long run labor costs are variable. Southwest can
layoff employees if business slows or hire additional employees to meet increased
demand.
3.
Operating Expense Potential Cost Drivers
Salaries, wages, and benefits Number of flights, passengers, flight miles
Fuel and Oil Flight miles
Maintenance materials and repairs Flight miles and time
Agency commissions # of tickets, passenger revenues
Aircraft rentals Number of flights, passengers, flight miles,
Number of breakdowns by aircraft
Landing fees Number of flights, passengers
Depreciation Flight miles, cost of planes*
* If the unit of production method of deprecation is used, the expense is a function of
aircraft cost and usage.
4.
Revenue per passenger mile $0.1295 ($5467,965,000 ÷ 42,215,162,000)
Variable cost per passenger mile $0.0702 [(0.90 × $3,291,000,000) ÷ 42,215,162,000]
Contribution margin per mile $0.0593
Breakeven miles = Fixed cost / Contribution margin per mile
Breakeven miles = ($1,337,415,000 + $329,100,000 / $0.0593 = 28,103, 119,000 miles
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Internet Exercise (Cont’d.)
5. The variable cost of flying an additional passenger is very low. (How much can it
possibly cost to prepare an airline meal?) Thus, airlines value the ability to price discriminate
and offer low-priced tickets on empty flights to travelers with flexible flight plans.
The video case can be discussed using only the case writeup in the chapter. Alternatively,
instructors can have students view the videotape of the company that is the subject of the case.
The videotape can be obtained by contacting your Prentice Hall representative. The case
questions challenge students to apply the concepts learned in the chapter to a specific business
situation.
1. Customers who might be attracted to money order services include those new to the
location who don’t have a bank checking account, or those who do not wish to establish a
relationship with a bank for financial services. In the Northeast, Store 24 operates in
neighborhoods with large immigrant populations, whose members have yet to open bank
checking accounts. These customers are also likely to buy Store 24’s other products once they
are in the store.
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Video Case (Cont’d.)
5. Since it takes three times as long for a clerk to complete a money order transaction versus
a typical product sale (90 seconds versus 30 seconds), customers who are not purchasing money
orders will have to wait while the money order transaction is being completed. Some customers
may choose not to wait, thereby costing the store those sales. It is impossible to calculate the
exact cost since the number of customers who might leave and the contribution margin for the
average $3.00 sale is not known. Students may try to calculate the cost using the gross margin
percentage of 30%, but this percentage does not consider variable operating costs such as the
labor of the store clerk.
344