Cost-Volume-Profit Relationships: Solutions To Questions

Download as docx, pdf, or txt
Download as docx, pdf, or txt
You are on page 1of 90

Chapter 5

Cost-Volume-Profit Relationships
Solutions to Questions

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

193

5-1
The contribution margin (CM) ratio
is the ratio of the total contribution margin
to total sales revenue. It is used in target
profit and break-even analysis and can be
used to quickly estimate the effect on
profits of a change in sales revenue.
5-2
Incremental analysis focuses on the
changes in revenues and costs that will
result from a particular action.
5-3
All other things equal, Company B,
with its higher fixed costs and lower
variable costs, will have a higher
contribution margin ratio than Company A.
Therefore, it will tend to realize a larger
increase in contribution margin and in
profits when sales increase.
5-4
Operating leverage measures the
impact on net operating income of a given
percentage change in sales. The degree of
operating leverage at a given level of
sales is computed by dividing the
contribution margin at that level of sales
by the net operating income at that level
of sales.
5-5
The break-even point is the level of
sales at which profits are zero.
5-6
(a) If the selling price decreased,
then the total revenue line would rise less
steeply, and the break-even point would
occur at a higher unit volume. (b) If the
fixed cost increased, then both the fixed

cost line and the total cost line would shift


upward and the break-even point would
occur at a higher unit volume. (c) If the
variable cost increased, then the total cost
line would rise more steeply and the
break-even point would occur at a higher
unit volume.
5-7
The margin of safety is the excess
of budgeted (or actual) sales over the
break-even volume of sales. It is the
amount by which sales can drop before
losses begin to be incurred.
5-8
The sales mix is the relative
proportions in which a companys products
are sold. The usual assumption in costvolume-profit analysis is that the sales mix
will not change.
5-9
A higher break-even point and a
lower net operating income could result if
the sales mix shifted from high
contribution margin products to low
contribution margin products. Such a shift
would cause the average contribution
margin ratio in the company to decline,
resulting in less total contribution margin
for a given amount of sales. Thus, net
operating income would decline. With a
lower contribution margin ratio, the breakeven point would be higher because more
sales would be required to cover the same
amount of fixed costs.

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


194

Managerial Accounting, 14th Edition

Exercise 5-1 (20 minutes)


1. The new income statement would be:
Total
Per Unit
Sales (8,050 units). . $209,300
$26.00
Variable expenses...
144,900
18.00
Contribution margin
64,400
$ 8.00
Fixed expenses.......
56,000
Net operating
$ 8,400
income.................
You can get the same net operating income using the following
approach.
Original net operating
income............................. $8,000
Change in contribution
margin
(50 units $8.00 per
unit)..................................
400
New net operating income. . $8,400
2. The new income statement would be:

Sales (7,950 units)........


Variable expenses.........
Contribution margin......
Fixed expenses.............
Net operating income. . .

Per
Total
Unit
$206,70 $26.00
0
143,100
18.00
63,600 $ 8.00
56,000
$ 7,600

You can get the same net operating income using the following
approach.
Original net operating income.......
Change in contribution margin
(-50 units $8.00 per unit)........
New net operating income............

$8,000
(400)
$7,600

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

195

Exercise 5-1 (continued)


3. The new income statement would be:
Sales (7,000 units)....
Variable expenses.....
Contribution margin. .
Fixed expenses.........
Net operating
income...................

Total Per Unit


$182,000 $26.00
126,000
18.00
56,000 $ 8.00
56,000
$

Note: This is the company's break-even point.

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


196

Managerial Accounting, 14th Edition

Exercise 5-2 (30 minutes)


1. The CVP graph can be plotted using the three steps outlined in
the text. The graph appears on the next page.
Step 1. Draw a line parallel to the volume axis to represent the
total fixed expense. For this company, the total fixed expense is
$12,000.
Step 2. Choose some volume of sales and plot the point
representing total expenses (fixed and variable) at the activity
level you have selected. Well use the sales level of 2,000 units.
Fixed expenses.............................................
Variable expenses (2,000 units $24 per
unit)............................................................
Total expense................................................

$12,000
48,000
$60,000

Step 3. Choose some volume of sales and plot the point


representing total sales dollars at the activity level you have
selected. Well use the sales level of 2,000 units again.
Total sales revenue (2,000 units $36 per
unit)............................................................

$72,000

2. The break-even point is the point where the total sales revenue
and the total expense lines intersect. This occurs at sales of
1,000 units. This can be verified as follows:
Profit =
=
=
=
=

Unit CM Q Fixed expenses


($36 $24) 1,000 $12,000
$12 1,000 $12,000
$12,000 $12,000
$0

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

197

Exer
cise 5-2 (continued)

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


198

Managerial Accounting, 14th Edition

Exercise 5-3 (15 minutes)


1. The profit graph is based on the following simple equation:
Profit = Unit CM Q Fixed expenses
Profit = ($19 $15) Q $12,000
Profit = $4 Q $12,000
To plot the graph, select two different levels of sales such as
Q=0 and Q=4,000. The profit at these two levels of sales are $12,000 (= $4 0 $12,000) and $4,000 (= $4 4,000
$12,000).

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

199

Exercise 5-3 (continued)


2. Looking at the graph, the break-even point appears to be 3,000
units. This can be verified as follows:
Profit =
=
=
=

Unit CM Q Fixed expenses


$4 Q $12,000
$4 3,000 $12,000
$12,000 $12,000 = $0

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


200

Managerial Accounting, 14th Edition

Exercise 5-4 (10 minutes)


1. The companys contribution margin (CM) ratio is:
Total sales......................... $300,000
Total variable expenses..... 240,000
= Total contribution
margin............................ $ 60,000
Total sales..................... $300,000
= CM ratio.........................
20%
2. The change in net operating income from an increase in total
sales of $1,500 can be estimated by using the CM ratio as
follows:
Change in total sales................ $1,500
CM ratio.................................
20%
= Estimated change in net
operating income................... $ 300
This computation can be verified as follows:
Total sales.................
Total units sold......
= Selling price per
unit.........................
Increase in total
sales.......................
Selling price per
unit.........................
= Increase in unit
sales.......................
Original total unit
sales.......................
New total unit sales. .

$300,00
0
40,000 units
per
$7.50
unit
$1,500

per
$7.50
unit
200 units

40,000 units
40,200 units

Original
New
Total unit sales..........
40,000 40,200
$300,00 $301,50
Sales.........................
0
0
The McGraw-Hill Companies, Inc., 2012. All rights reserved.
Solutions Manual, Chapter 5

201

Variable expenses..... 240,000 241,200


Contribution margin. .
60,000 60,300
Fixed expenses.........
45,000 45,000
Net operating
income................... $ 15,000 $ 15,300

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


202

Managerial Accounting, 14th Edition

Exercise 5-5 (20 minutes)


1. The following table shows the effect of the proposed change in
monthly advertising budget:
Sales
With
Additional
Advertisin
Current
g
Differenc
Sales
Budget
e
$225,00
Sales.........................
0 $240,000 $15,000
135,00
Variable expenses.....
0 144,000
9,000
Contribution margin. . 90,000
96,000
6,000
Fixed expenses......... 75,000
83,000
8,000
Net operating
$ 15,00
income...................
0 $ 13,000 $(2,000)
Assuming that there are no other important factors to be
considered, the increase in the advertising budget should not
be approved because it would lead to a decrease in net
operating income of $2,000.
Alternative Solution 1
Expected total contribution margin:
$240,000 40% CM ratio.............
Present total contribution margin:
$225,000 40% CM ratio.............
Incremental contribution margin.....
Change in fixed expenses:
Less incremental advertising
expense........................................
Change in net operating income.....

$96,000
90,000
6,000
8,000
$(2,000)

Alternative Solution 2
Incremental contribution margin:
$15,000 40% CM ratio.............

$6,000

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

203

Less incremental advertising


expense........................................
Change in net operating income.....

8,000
$(2,000)

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


204

Managerial Accounting, 14th Edition

Exercise 5-5 (continued)


2. The $3 increase in variable expenses will cause the unit
contribution margin to decrease from $30 to $27 with the
following impact on net operating income:
Expected total contribution margin with
the higher-quality components:
3,450 units $27 per unit........................ $93,150
Present total contribution margin:
3,000 units $30 per unit........................
90,000
Change in total contribution margin............ $ 3,150
Assuming no change in fixed expenses and all other factors
remain the same, the higher-quality components should be
used.

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

205

Exercise 5-6 (10 minutes)


1. The equation method yields the required unit sales, Q, as
follows:
Profit =
$6,000 =
$6,000 =
$80
Q=
Q=
Q=

Unit CM Q Fixed expenses


($140 $60) Q $40,000
($80) Q $40,000
$6,000 + $40,000
$46,000 $80
575 units

2. The formula approach yields the required unit sales as follows:


Units sold to attain = Target profit + Fixed expenses
the target profit
Unit contribution margin
=

$8,000 + $40,000
$80 per unit

$48,000
$80 per unit

= 600 units

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


206

Managerial Accounting, 14th Edition

Exercise 5-7 (20 minutes)


1. The equation method yields the break-even point in unit sales,
Q, as follows:
Profit =
$0 =
$0 =
$2Q =
Q=
Q=

Unit CM Q Fixed expenses


($8 $6) Q $5,500
($2) Q $5,500
$5,500
$5,500 $2
2,750 baskets

2. The equation method can be used to compute the break-even


point in sales dollars as follows:

CM ratio =
=

Unit contribution margin


Unit selling price
$2
= 0.25
$8

Profit =
$0 =
0.25 Sales =
Sales =
Sales =

CM ratio Sales Fixed expenses


0.25 Sales $5,500
$5,500
$5,500 0.25
$22,000

3. The formula method gives an answer that is identical to the


equation method for the break-even point in unit sales:
Unit sales to break even =
=

Fixed expenses
Unit CM
$5,500
= 2,750 baskets
$2 per basket

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

207

Exercise 5-7 (continued)


4. The formula method also gives an answer that is identical to
the equation method for the break-even point in dollar sales:
Dollar sales to break even =
=

Fixed expenses
CM ratio
$5,500
= $22,000
0.25

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


208

Managerial Accounting, 14th Edition

Exercise 5-8 (10 minutes)


1. To compute the margin of safety, we must first compute the
break-even unit sales.
Profi
t=
$0 =
$0 =
$10
Q=
Q=
Q=

Unit CM Q Fixed expenses


($25 $15) Q $8,500
($10) Q $8,500
$8,500
$8,500 $10
850 units

Sales (at the budgeted volume of 1,000


$25,00
units)......................................................
0
Break-even sales (at 850 units)................ 21,250
Margin of safety (in dollars)...................... $ 3,750
2. The margin of safety as a percentage of sales is as follows:
Margin of safety (in dollars)................
Sales...............................................
Margin of safety percentage...............

$3,750
$25,00
0
15%

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

209

Exercise 5-9 (20 minutes)


1. The companys degree of operating leverage would be
computed as follows:
$36,00
Contribution margin..........
0
$12,00
Net operating income....
0
Degree of operating
leverage.........................
3.0
2. A 10% increase in sales should result in a 30% increase in net
operating income, computed as follows:
Degree of operating leverage...........................
Percent increase in sales...............................
Estimated percent increase in net operating
income...........................................................

3.0
10%
30%

3. The new income statement reflecting the change in sales is:

Sales.........................
Variable expenses.....
Contribution margin. .
Fixed expenses.........
Net operating
income...................

Percent
Amount of Sales
$132,00
0 100%
92,400
70%
39,600
30%
24,000
$ 15,600

Net operating income reflecting change in


$15,60
sales.............................................................
0
Original net operating income (a)................... 12,000
Change in net operating income (b)................ $ 3,600
Percent change in net operating income (b
a)..................................................................
30%

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


210

Managerial Accounting, 14th Edition

Exercise 5-10 (20 minutes)


1. The overall contribution margin ratio can be computed as
follows:
Overall CM ratio =
=

Total contribution margin


Total sales
$120,000
= 80%
$150,000

2. The overall break-even point in sales dollars can be computed


as follows:
Overall break-even =

Total fixed expenses


Overall CM ratio

$90,000
= $112,500
80%

3. To construct the required income statement, we must first


determine the relative sales mix for the two products:

Original dollar sales. .


Percent of total.........
Sales at break-even. .

Sales.........................
Variable expenses*. . .
Contribution margin. .
Fixed expenses.........
Net operating
income...................

Predator
Runway
Total
$100,000 $50,000 $150,00
0
67%
33%
100%
$75,000 $37,500 $112,50
0
Predator
Runway
Total
$75,000 $37,500 $112,50
0
18,750
3,750 22,500
$56,250 $33,750 90,000
90,000
$
0

*Predator variable expenses: ($75,000/$100,000) $25,000 =


$18,750
Runway variable expenses: ($37,500/$50,000) $5,000 =
The McGraw-Hill Companies, Inc., 2012. All rights reserved.
Solutions Manual, Chapter 5

211

$3,750

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


212

Managerial Accounting, 14th Edition

Exercise 5-11 (30 minutes)


1. Profit
$0
$0
$12Q
Q

= Unit CM Q Fixed expenses


= ($40 $28) Q $150,000
= ($12) Q $150,000
= $150,000
= $150,000 $12 per unit
12,500 units, or at $40 per unit,
Q = $500,000

Alternatively:

Fixed expenses
Unit sales =
to break even Unit contribution margin
=

$150,000
=12,500 units
$12 per unit

or, at $40 per unit, $500,000.


2. The contribution margin at the break-even point is $150,000
because at that point it must equal the fixed expenses.
3.

Units sold to attain= Target profit + Fixed expenses


target profit
Unit contribution margin
=

$18,000 + $150,000
=14,000 units
$12 per unit

Sales (14,000 units $40 per unit).......


Variable expenses
(14,000 units $28 per unit)..............
Contribution margin
(14,000 units $12 per unit)..............
Fixed expenses......................................
Net operating income............................

Total
Unit
$560,000 $40
392,000

28

168,000
150,000
$18,000

$12

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

213

Exercise 5-11 (continued)


4. Margin of safety in dollar terms:
Margin of safety = Total sales - Break-even sales
in dollars
= $600,000 - $500,000 = $100,000

Margin of safety in percentage terms:


Margin of safety = Margin of safety in dollars
percentage
Total sales
=

$100,000
= 16.7% (rounded)
$600,000

5. The CM ratio is 30%.


Expected total contribution margin: $680,000
30%................................................................... $204,000
Present total contribution margin: $600,000
30%................................................................... 180,000
Increased contribution margin.............................. $24,000
Alternative solution:
$80,000 incremental sales 30% CM ratio = $24,000
Given that the companys fixed expenses will not change,
monthly net operating income will increase by the amount of
the increased contribution margin, $24,000.

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


214

Managerial Accounting, 14th Edition

Exercise 5-12 (30 minutes)


1. Profit
$0
$0
$27Q
Q

= Unit CM Q Fixed expenses


= ($90 $63) Q $135,000
= ($27) Q $135,000
= $135,000
= $135,000 $27 per lantern
5,000 lanterns, or at $90 per lantern, $450,000 in
Q = sales

Alternative solution:

Fixed expenses
Unit sales =
to break even
Unit contribution margin
=

$135,000
= 5,000 lanterns,
$27 per lantern

or at $90 per lantern, $450,000 in sales


2. An increase in variable expenses as a percentage of the selling
price would result in a higher break-even point. If variable
expenses increase as a percentage of sales, then the
contribution margin will decrease as a percentage of sales.
With a lower CM ratio, more lanterns would have to be sold to
generate enough contribution margin to cover the fixed costs.
Present:
8,000 Lanterns
Per
Total
Unit

3.

Sales........................... $720,000

$90

Variable expenses.......
Contribution margin....

504,000
216,000

63
$27

Fixed expenses...........

135,000

Net operating income.

$81,000

Proposed:
10,000 Lanterns*
Total
Per Unit
$810,00
0 $81 **
630,00
0
63
180,000 $18
135,00
0
$
45,000

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

215

* 8,000 lanterns 1.25 = 10,000 lanterns


** $90 per lantern 0.9 = $81 per lantern
As shown above, a 25% increase in volume is not enough to
offset a 10% reduction in the selling price; thus, net operating
income decreases.

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


216

Managerial Accounting, 14th Edition

Exercise 5-12 (continued)


4.

Profit
$72,00
0
$72,00
0
$18Q
Q
Q

= Unit CM Q Fixed expenses


= ($81 $63) Q $135,000
= ($18) Q $135,000
= $207,000
= $207,000 $18 per lantern
= 11,500 lanterns

Alternative solution:

Unit sales to attain = Target profit + Fixed expenses


target profit
Unit contribution margin
=

$72,000 + $135,000
= 11,500 lanterns
$18 per lantern

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

217

Exercise 5-13 (30 minutes)


1. The contribution margin per person would be:
Price per ticket............................................
Variable expenses:
Dinner.......................................................
Favors and program..................................
Contribution margin per person...................

$30
$7
3 10
$20

The fixed expenses of the Extravaganza total $8,000; therefore,


the break-even point would be computed as follows:
Profit =
$0 =
$0 =
$20Q =
Q=
Q=

Unit CM Q Fixed expenses


($30 $10) Q $8,000
($20) Q $8,000
$8,000
$8,000 $20
400 persons; or, at $30 per person, $12,000

Alternative solution:

Fixed expenses
Unit sales =
to break even
Unit contribution margin
=

$8,000
= 400 persons
$20 per person

or, at $30 per person, $12,000.


2. Variable cost per person ($7 + $3)............... $10
Fixed cost per person ($8,000 250
persons)..................................................... 32
Ticket price per person to break even........... $42

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


218

Managerial Accounting, 14th Edition

Exercise 5-13 (continued)


3. Cost-volume-profit graph:

Total Sales
Break-even point: 400
persons, or $12,000 in sales

Total
Expenses
Fixed
Expenses

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

219

Exercise 5-14 (30 minutes)


Model A100
Amount %
$700,00
Sales.............
0 100
Variable
expenses.... 280,000 40
Contribution $420,00
margin........
0 60
Fixed
expenses....
Net
operating
income.......

1.

Model B900
Amount %
$300,00
0 100

Total Company
Amount
%
$1,000,00
0 100

90,000 30
$210,00
0 70

370,000 37
630,000 63 *
598,500
$

31,500

*630,000 $1,000,000 = 63%.


2. The break-even point for the company as a whole is:
Break-even point in = Fixed expenses
total dollar sales
Overall CM ratio
=

$598,500
= $950,000 in sales
0.63

3. The additional contribution margin from the additional sales is


computed as follows:
$50,000 63% CM ratio = $31,500
Assuming no change in fixed expenses, all of this additional
contribution margin should drop to the bottom line as increased
net operating income.
This answer assumes no change in selling prices, variable
costs per unit, fixed expenses, or sales mix.

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


220

Managerial Accounting, 14th Edition

Exercise 5-15 (15 minutes)


1. Sales (30,000 doors)....... $1,800,000
Variable expenses........... 1,260,000
Contribution margin........
540,000
Fixed expenses...............
450,000
Net operating income..... $ 90,000

$60
42
$18

Degree of operating = Contribution margin


leverage
Net operating income
=

$540,000
=6
$90,000

2. a. Sales of 37,500 doors represent an increase of 7,500 doors,


or 25%, over present sales of 30,000 doors. Because the
degree of operating leverage is 6, net operating income
should increase by 6 times as much, or by 150% (6 25%).
b. Expected total dollar net operating income for the next year
is:
Present net operating income...................... $90,000
Expected increase in net operating income
next year (150% $90,000)..................... 135,000
Total expected net operating income........... $225,000

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

221

Exercise 5-16 (30 minutes)


1. Variable expenses: $60 (100% 40%) = $36.
2.
a.

Selling price...................... $60 100%


Variable expenses............. 36 60%
Contribution margin.......... $24 40%
Let Q = Break-even point in units.
Profit
$0
$0
$24Q
Q
Q

=
=
=
=
=
=

Unit CM Q Fixed expenses


($60 $36) Q $360,000
($24) Q $360,000
$360,000
$360,000 $24 per unit
15,000 units

In sales dollars: 15,000 units $60 per unit = $900,000


Alternative solution:
CM ratio Sales Fixed
Profit = expenses
$0 = 0.40 Sales $360,000
0.40
Sales = $360,000
Sales = $360,000 0.40
Sales = $900,000
In units: $900,000 $60 per unit = 15,000 units
b.

Unit CM Q Fixed
Profit = expenses
$90,00
($60 $36) Q
0 = $360,000
$90,00
0 = ($24) Q $360,000
$24Q = $450,000
Q = $450,000 $24 per unit
Q = 18,750 units
In sales dollars: 18,750 units $60 per unit = $1,125,000

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


222

Managerial Accounting, 14th Edition

Exercise 5-16 (continued)


Alternative solution:
CM ratio Sales Fixed
Profit = expenses
$90,000 = 0.40 Sales $360,000
0.40
Sales = $450,000
Sales = $450,000 0.40
Sales = $1,125,000
In units: $1,125,000 $60 per unit = 18,750 units
c. The companys new cost/revenue relationships will be:
Selling price..................................
Variable expenses ($36 $3)........
Contribution margin......................
Profit
$0
$0
$27Q
Q
Q

$60 100%
33 55%
$27 45%

= Unit CM Q Fixed expenses


= ($60 $33) Q $360,000
= $27Q $360,000
= $360,000
= $360,000 $27 per unit
= 13,333 units (rounded).

In sales dollars: 13,333 units $60 per unit = $800,000


(rounded)
Alternative solution:
CM ratio Sales Fixed
Profit = expenses
$0 = 0.45 Sales $360,000
0.45
Sales = $360,000
Sales = $360,000 0.45
Sales = $800,000
In units: $800,000 $60 per unit = 13,333 units (rounded)

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

223

Exercise 5-16 (continued)


3. a
Fixed expenses
Unit sales =
. to break even
Unit contribution margin

= $360,000 $24 per unit = 15,000 units


In sales dollars: 15,000 units $60 per unit = $900,000
Alternative solution:

Dollar sales = Fixed expenses


to break even
CM ratio
= $360,000 0.40 = $900,000
In units: $900,000 $60 per unit = 15,000 units
b. Unit sales to attain Target profit + Fixed expenses
=
target profit
Unit contribution margin
= ($90,000 +$360,000) $24 per unit
= 18,750 units

In sales dollars: 18,750 units $60 per unit = $1,125,000


Alternative solution:
Dollar sales to attain= Target profit + Fixed expenses
target profit
CM ratio
= ($90,000 + $360,000) 0.40
= $1,125,000

In units: $1,125,000 $60 per unit = 18,750 units

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


224

Managerial Accounting, 14th Edition

Exercise 5-16 (continued)


c.

Fixed expenses
Unit sales =
to break even Unit contribution margin
= $360,000 $27 per unit
= 13,333 units (rounded)

In sales dollars: 13,333 units $60 per unit = $800,000


(rounded)
Alternative solution:

Break-even point = Fixed expenses


in sales dollars
CM ratio
= $360,000 0.45 = $800,000
In units: $800,000 $60 per unit = 13,333 (rounded)

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

225

Exercise 5-17 (20 minutes)


Total

Sales (30,000 units 1.15 = 34,500


1. units).................................................. $172,500
Variable expenses................................. 103,500
Contribution margin..............................
69,000
Fixed expenses.....................................
50,000
Net operating income........................... $19,000
Sales (30,000 units 1.20 = 36,000
2. units).................................................. $162,000
Variable expenses................................. 108,000
Contribution margin..............................
54,000
Fixed expenses.....................................
50,000
Net operating income........................... $4,000
Sales (30,000 units 0.95 = 28,500
3. units).................................................. $156,750
Variable expenses.................................
85,500
Contribution margin..............................
71,250
Fixed expenses ($50,000 + $10,000)....
60,000
Net operating income........................... $11,250
Sales (30,000 units 0.90 = 27,000
4. units).................................................. $151,200
Variable expenses.................................
86,400
Contribution margin..............................
64,800
Fixed expenses.....................................
50,000
Net operating income........................... $14,800

Per Unit
$5.00
3.00
$2.00

$4.50
3.00
$1.50

$5.50
3.00
$2.50

$5.60
3.20
$2.40

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


226

Managerial Accounting, 14th Edition

Exercise 5-18 (20 minutes)


Case #1
9,000 *
$270,000 * $30
162,000 * 18
108,000
$12
90,000 *

a.

Number of units sold.


Sales.........................
Variable expenses.....
Contribution margin. .
Fixed expenses.........
Net operating
income................... $18,000

Case #2
14,000
$350,000 * $25
140,000
10
210,000
$15 *
170,000 *
$40,000 *

Case #3
Case #4
20,000 *
5,000 *
$400,000
$20
$160,000 * $32
280,000 * 14
90,000
18
120,000
$6 *
70,000
$14
85,000
82,000 *

Number of units sold.


Sales.........................
Variable expenses...
Contribution margin. .
Fixed expenses.........
Net operating
income................... $35,000 *
b.
Sales.........................
Variable expenses.....
Contribution margin. .
Fixed expenses.........
Net operating
income...................

Sales.........................
Variable expenses.....
Contribution margin. .
Fixed expenses.........

$(12,000) *

Case #1
Case #2
$450,00
$200,00
0 * 100%
0 * 100 %
270,00
0
60
130,000 * 65
180,000
40%* 70,000
35 %
115,00
0
60,000 *
$
$
65,000 *
10,000
Case #3
Case #4
$700,00
$300,00
0 100%
0 * 100 %
140,00
0
20
90,000 * 30
560,000
80%* 210,000
70 %
470,00
225,00
0 *
0

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

227

Net operating
income...................

$
90,000 *

$(15,000
)*

*Given

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


228

Managerial Accounting, 14th Edition

Problem 5-19 (60 minutes)


1. Profit
$0
$0
$15Q
Q
Q

= Unit CM Q Fixed expenses


= ($40 $25) Q $300,000
= ($15) Q $300,000
= $300,000
= $300,000 $15 per shirt
= 20,000 shirts

20,000 shirts $40 per shirt = $800,000


Alternative solution:
Fixed expenses
Unit sales =
to break even
Unit contribution margin
=

$300,000
= 20,000 shirts
$15 per shirt

Dollar sales = Fixed expenses


to break even
CM ratio
=

$300,000
= $800,000 in sales
0.375

2. See the graph on the following page.


3. The simplest approach is:
Break-even sales.............
Actual sales.....................
Sales short of break-even

20,000
shirts
19,000
shirts
1,000
shirts

1,000 shirts $15 contribution margin per shirt = $15,000


loss
Alternative solution:
Sales (19,000 shirts $40 per shirt).................

$760,000

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

229

Variable expenses (19,000 shirts $25 per


shirt)...............................................................
Contribution margin..........................................
Fixed expenses..................................................
Net operating loss.............................................

475,000
285,000
300,000
$(15,000)

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


230

Managerial Accounting, 14th Edition

Problem 5-19 (continued)


2. Cost-volume-profit graph:

Total Sales
Break-even point: 20,000
shirts, or $800,000 in sales
Total
Expenses

Fixed
Expenses

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

231

Problem 5-19 (continued)


4. The variable expenses will now be $28 ($25 + $3) per shirt,
and the contribution margin will be $12 ($40 $28) per shirt.
Profit
$0
$0
$12Q
Q
Q

= Unit CM Q Fixed expenses


= ($40 $28) Q $300,000
= ($12) Q $300,000
= $300,000
= $300,000 $12 per shirt
= 25,000 shirts

25,000 shirts $40 per shirt = $1,000,000 in sales


Alternative solution:
Fixed expenses
Unit sales =
to break even
Unit contribution margin
=

$300,000
= 25,000 shirts
$12 per shirt

Dollar sales = Fixed expenses


to break even
CM ratio
=

$300,000
= $1,000,000 in sales
0.30

5. The simplest approach is:


Actual sales.............................
Break-even sales.....................
Excess over break-even sales..

23,500
shirts
20,000
shirts
3,500
shirts

3,500 shirts $12 per shirt* = $42,000 profit


*$15 present contribution margin $3 commission = $12 per
shirt
The McGraw-Hill Companies, Inc., 2012. All rights reserved.
232

Managerial Accounting, 14th Edition

Problem 5-19 (continued)


Alternative solution:
Sales (23,500 shirts $40 per shirt)............. $940,000
Variable expenses [(20,000 shirts $25 per
shirt) + (3,500 shirts $28 per shirt)]........ 598,000
Contribution margin...................................... 342,000
Fixed expenses.............................................. 300,000
Net operating income.................................... $ 42,000
6. a. The new variable expense will be $18 per shirt (the invoice
price).
Profit
$0
$0
$22Q
Q
Q

= Unit CM Q Fixed expenses


= ($40 $18) Q $407,000
= ($22) Q $407,000
= $407,000
= $407,000 $22 per shirt
= 18,500 shirts

18,500 shirts $40 shirt = $740,000 in sales


b. Although the change will lower the break-even point from
20,000 shirts to 18,500 shirts, the company must consider
whether this reduction in the break-even point is more than
offset by the possible loss in sales arising from having the
sales staff on a salaried basis. Under a salary arrangement,
the sales staff may have far less incentive to sell than under
the present commission arrangement, resulting in a loss of
sales and a reduction in profits. Although it generally is
desirable to lower the break-even point, management must
consider the other effects of a change in the cost structure.
The break-even point could be reduced dramatically by
doubling the selling price per shirt, but it does not
necessarily follow that this would increase the companys
profit.

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

233

Problem 5-20 (60 minutes)


1. The CM ratio is 30%.
Total
Sales (13,500 units). . . . $270,000
Variable expenses....... 189,000
Contribution margin... . $81,000

Per
Unit
$20
14
$6

Percentag
e
100%
70%
30%

The break-even point is:


Profit
$0
$0
$6Q
Q
Q

= Unit CM Q Fixed expenses


= ($20 $14) Q $90,000
= ($6) Q $90,000
= $90,000
= $90,000 $6 per unit
= 15,000 units

15,000 units $20 per unit = $300,000 in sales


Alternative solution:
Fixed expenses
Unit sales =
to break even
Unit contribution margin
=

$90,000
= 15,000 units
$6 per unit

Dollar sales = Fixed expenses


to break even
CM ratio
=

$90,000
= $300,000 in sales
0.30

2. Incremental contribution margin:


$70,000 increased sales 30% CM ratio. . . $21,000
Less increased fixed costs:
Increased advertising cost..........................
8,000
Increase in monthly net operating income.... $13,000
Since the company presently has a loss of $9,000 per month, if
the changes are adopted, the loss will turn into a profit of
The McGraw-Hill Companies, Inc., 2012. All rights reserved.
234

Managerial Accounting, 14th Edition

$4,000 per month.

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

235

Problem 5-20 (continued)


3. Sales (27,000 units $18 per unit*).......
Variable expenses
(27,000 units $14 per unit)...............
Contribution margin................................
Fixed expenses ($90,000 + $35,000)......
Net operating loss...................................

$486,000
378,000
108,000
125,000
$(17,000)

*$20 ($20 0.10) = $18


4.

Profit
$4,500
$4,500
$5.40
Q
Q
Q

= Unit CM Q Fixed expenses


= ($20.00 $14.60*) Q $90,000
= ($5.40) Q $90,000
= $94,500
= $94,500 $5.40 per unit
= 17,500 units

*$14.00 + $0.60 = $14.60.


Alternative solution:
Unit sales to attain = Target profit + Fixed expenses
target profit
CM per unit
=

$4,500 + $90,000
$5.40 per unit**

= 17,500 units
**$6.00 $0.60 = $5.40.
5. a. The new CM ratio would be:

Sales.......................................
Variable expenses...................
Contribution margin................

Per
Unit
$20
7
$13

Percentag
e
100%
35%
65%

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


236

Managerial Accounting, 14th Edition

Problem 5-20 (continued)


The new break-even point would be:
Fixed expenses
Unit sales =
to break even
Unit contribution margin
=

$208,000
= 16,000 units
$13 per unit

Dollar sales = Fixed expenses


to break even
CM ratio
=

$208,000
= $320,000 in sales
0.65

b. Comparative income statements follow:


Not Automated
Per
Total
Unit
%
Sales (20,000 units) $400,000
Variable expenses. . .
280,000
Contribution margin
120,000
Fixed expenses........
90,000
Net operating
income.................. $30,000

$20
14
$6

Automated
Per
Total
Unit
%
$400,00
100
0 $20 100
70 140,000
7
35
30 260,000 $13
65
208,000
$
52,000

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

237

Problem 5-20 (continued)


c. Whether or not one would recommend that the company
automate its operations depends on how much risk he or she
is willing to take, and depends heavily on prospects for future
sales. The proposed changes would increase the companys
fixed costs and its break-even point. However, the changes
would also increase the companys CM ratio (from 30% to
65%). The higher CM ratio means that once the break-even
point is reached, profits will increase more rapidly than at
present. If 20,000 units are sold next month, for example,
the higher CM ratio will generate $22,000 more in profits
than if no changes are made.
The greatest risk of automating is that future sales may drop
back down to present levels (only 13,500 units per month),
and as a result, losses will be even larger than at present due
to the companys greater fixed costs. (Note the problem
states that sales are erratic from month to month.) In sum,
the proposed changes will help the company if sales continue
to trend upward in future months; the changes will hurt the
company if sales drop back down to or near present levels.
Note to the Instructor: Although it is not asked for in the
problem, if time permits you may want to compute the point
of indifference between the two alternatives in terms of units
sold; i.e., the point where profits will be the same under
either alternative. At this point, total revenue will be the
same; hence, we include only costs in our equation:
Point of indifference in units
Let Q = sold
$14Q +
$90,000 = $7Q + $208,000
$7Q = $118,000
Q = $118,000 $7 per unit
Q = 16,857 units (rounded)
If more than 16,857 units are sold, the proposed
plan will yield the greatest profit; if less than 16,857 units are
sold, the present plan will yield the greatest profit (or the least
loss).
The McGraw-Hill Companies, Inc., 2012. All rights reserved.
238

Managerial Accounting, 14th Edition

Problem 5-21 (60 minutes)


1. The CM ratio is 60%:
Selling price...................
Variable expenses.........
Contribution margin......

$15 100%
6 40%
$ 9 60%

2.
Break-even point in=Fixed expenses
total sales dollars
CM ratio
=

$180,000
=$300,000 sales
0.60

3. $45,000 increased sales 60% CM ratio = $27,000 increase in


contribution margin. Since fixed costs will not change, net
operating income should also increase by $27,000.
4. a.

Degree of operating leverage =


=

Contribution margin
Net operating income
$216,000
=6
$36,000

b. 6 15% = 90% increase in net operating income. In dollars,


this increase would be 90% $36,000 = $32,400.

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

239

Problem 5-21 (continued)


5.

Last Year:
28,000 units
Per
Total
Unit
Sales......................... $420,000 $15.00
Variable expenses.....
Contribution margin. .

168,000
6.00
252,000 $9.00

Fixed expenses......... 180,000


Net operating
income................... $72,000

Proposed:
42,000 units*
Total
Per Unit
$567,00
0 $13.50**
252,00
0
6.00
315,000 $ 7.50
250,00
0
$
65,000

* 28,000 units 1.5 = 42,000 units


** $15 per unit 0.90 = $13.50 per unit
No, the changes should not be made.
6. Expected total contribution margin:
28,000 units 200% $7 per unit*........... $392,000
Present total contribution margin:
28,000 units $9 per unit..........................
252,000
Incremental contribution margin, and the
amount by which advertising can be
increased with net operating income
remaining unchanged................................. $140,000
*$15 ($6 + $2) = $7

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


240

Managerial Accounting, 14th Edition

Problem 5-22 (30 minutes)


Product
Mirrors

Vanities

40%
$200,00
0 100%

28%
$140,00
0 100%

1.
Sinks
Percentage of total
sales.......................

32%
$160,00
Sales.........................
0 100%
48,00
Variable expenses.....
0 30%
$112,00
Contribution margin. .
0 70%
Fixed expenses..........
Net operating
income (loss)..........

100%
$500,00
0 100%

160,000

80%

77,000

55%

285,000

57%

$ 40,000

20%

$ 63,000

45%

215,000
223,600

43%*

$ (8,600)

*$215,000 $500,000 = 43%.

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

Total

241

Problem 5-22 (continued)


2. Break-even sales:
Dollar sales = Fixed expenses
to break even
CM ratio
=

$223,600
= $520,000 in sales
0.43

3. Memo to the president:


Although the company met its sales budget of $500,000 for the
month, the mix of products sold changed substantially from
that budgeted. This is the reason the budgeted net operating
income was not met, and the reason the break-even sales were
greater than budgeted. The companys sales mix was planned
at 48% Sinks, 20% Mirrors, and 32% Vanities. The actual sales
mix was 32% Sinks, 40% Mirrors, and 28% Vanities.
As shown by these data, sales shifted away from Sinks, which
provides our greatest contribution per dollar of sales, and
shifted strongly toward Mirrors, which provides our least
contribution per dollar of sales. Consequently, although the
company met its budgeted level of sales, these sales provided
considerably less contribution margin than we had planned,
with a resulting decrease in net operating income. Notice from
the attached statements that the companys overall CM ratio
was only 43%, as compared to a planned CM ratio of 52%. This
also explains why the break-even point was higher than
planned. With less average contribution margin per dollar of
sales, a greater level of sales had to be achieved to provide
sufficient contribution margin to cover fixed costs.

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

242

Problem 5-23 (45 minutes)


1.
a.
Sales.......................
Variable expenses
Contribution margin
Fixed expenses........
Net operating
income..................

Alvaro

Bazan

%
800 100
480 60
320 40

%
480 100
96 20
384 80

Total
%
1,280 100
576 45
704 55
660

44

b.

Dollar sales to = Fixed expenses = 660 = 1,200


break even
CM ratio
0.55
Margin of safety = Actual sales - Break-even sales
= 1,280 - 1,200 = 80
Margin of safety = Margin of safety in euros
percentage
Actual sales
=

80
= 6.25%
1,280

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

243

Problem 5-23 (continued)


2.
a.
Sales...........................
Variable expenses.......
Contribution margin....
Fixed expenses............
Net operating income..

Alvaro
%
800 100
480 60
320 40

Bazan
%
480 100
96 20
384 80

Cano

%
%
320 100 1,600 100
240 75
816 51
80 25
784 49
660
124

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

Total

244

Problem 5-23 (continued)


b.Euro sales to
Fixed expenses
660
=
=
= 1,347(rounded)
break even
CM ratio
0.49
Margin of safety = Actual sales - Break-even sales
= 1,600 - 1,347 = 253
Margin of safety = Margin of safety in euros
percentage
Actual sales
253
=
= 15.81%
1,600

3. The reason for the increase in the break-even point can be


traced to the decrease in the companys average contribution
margin ratio when the third product is added. Note from the
income statements above that this ratio drops from 55% to
49% with the addition of the third product. This product, called
Cano, has a CM ratio of only 25%, which causes the average
contribution margin ratio to fall.
This problem shows the somewhat tenuous nature of breakeven analysis when more than one product is involved. The
manager must be very careful of his or her assumptions
regarding sales mix when making decisions such as adding or
deleting products.
It should be pointed out to the president that even though the
break-even point is higher with the addition of the third
product, the companys margin of safety is also greater. Notice
that the margin of safety increases from 80 to 253 or from
6.25% to 15.81%. Thus, the addition of the new product shifts
the company much further from its break-even point, even
though the break-even point is higher.

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

245

Problem 5-24 (60 minutes)


1. April's Income Statement:

Sales.........................
Variable expenses:
Production..............
Selling.....................
Total variable
expenses................
Contribution margin. .
Fixed expenses:
Production...............
Advertising..............
Administrative.........
Total fixed expenses. .

Standard
Deluxe
Pro
Amoun
t
% Amount % Amount %
$80,00
$450,00
0 100 $60,000 100
0 100

Amount
$590,00
0

44,000 55
4,000
5

27,000 45 157,500 35
3,000
5
22,500
5

228,500 38.7
29,500 5.0

48,000 60 30,000 50 180,000 40


$32,00
$270,00
0 40 $30,000 50
0 60

258,000 43.7

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


246

%
100

332,000 56.3
120,000
100,000
50,000
270,000
$
62,000

Net operating income

Solutions Manual, Chapter 5

Total

Problem 5-24 (continued)


May's Income Statement:
Standard
Deluxe
Amoun
t
% Amount %
$320,00
Sales........................
0 100 $60,000 100
Variable expenses:
Production.............. 176,000 55
27,000 45
16,00
Selling....................
0
5
3,000
5
Total variable
192,00
expenses................
0 60
30,000 50
$128,00
Contribution margin.
0 40 $30,000 50
Fixed expenses:
Production..............
Advertising.............
Administrative........
Total fixed expenses.
Net operating
income...................

Pro

Total

Amount %
$270,00
0 100

Amount %
$650,00 100.
0
0

94,500 35

297,500 45.8

13,500

108,000 40
$162,00
0 60

32,500

247

5.0

330,000 50.8
320,000 49.2
120,000
100,000
50,000
270,000
$
50,000

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


Solutions Manual, Chapter 5

Problem 5-24 (continued)


2. The sales mix has shifted over the last month from a greater
concentration of Pro rackets to a greater concentration of
Standard rackets. This shift has caused a decrease in the
companys overall CM ratio from 56.3% in April to only 49.2% in
May. For this reason, even though total sales (both in units and
in dollars) is greater, net operating income is lower than last
month in the division.
3. The break-even in dollar sales can be computed as follows:

Dollar sales to = Fixed expenses = $270,000 = $479,574 (rounded)


break even
CM ratio
0.563
4. Mays break-even point has gone up. The reason is that the
divisions overall CM ratio has declined for May as stated in (2)
above. Unchanged fixed expenses divided by a lower overall
CM ratio would yield a higher break-even point in sales dollars.
Standar
d
Pro
5.
Increase in sales............................. $20,000 $20,000
Multiply by the CM ratio..................
40% 60%
Increase in net operating income*. . $8,000 $12,000
*Assuming that fixed costs do not change.

The McGraw-Hill Companies, Inc., 2012. All rights reserved.


248

Managerial Accounting, 14th Edition

Problem 5-25 (45 minutes)


1. Sales (25,000 units SFr 90 per unit)........... SFr 2,250,000
Variable expenses
(25,000 units SFr 60 per unit).................
1,500,000
Contribution margin......................................
750,000
Fixed expenses.............................................
840,000
Net operating loss......................................... SFr (90,000)
2. Unit sales
Fixed expenses
=
to break even
Unit contribution margin

SFr 840,000
= 28,000 units
SFr 30 per unit

28,000 units SFr 90 per unit = SFr 2,520,000 to break even.


3. See the next page.
4. At a selling price of SFr 80 per unit, the contribution margin is
SFr 20 per unit. Therefore:
Fixed expenses
Unit sales =
to break even Unit contribution margin
=

SFr 840,000
SFr 20 per unit

= 42,000 units

42,000 units SFr 80 per unit = SFr 3,360,000 to break even.


This break-even point is different from the break-even point in
(2) because of the change in selling price. With the change in
selling price, the unit contribution margin drops from SFr 30 to
SFr 20, resulting in an increase in the break-even point.

Problem 5-25 (continued)


3.

Unit
Sellin
Unit
gPric Variable
e
Expense
(SFrs
)
(SFrs)
90
60
88
60
86
60
84
60
82
60
80
60
78
60

Unit
Contributio
n Margin
(SFrs)
30
28
26
24
22
20
18

Total
Net
Volum Contributio
Fixed
Operatin
e
n Margin Expenses g Income
(Units)
25,000
30,000
35,000
40,000
45,000
50,000
55,000

(SFrs)
750,000
840,000
910,000
960,000
990,000
1,000,000
990,000

(SFrs)
840,000
840,000
840,000
840,000
840,000
840,000
840,000

(SFrs)
(90,000)
0
70,000
120,000
150,000
160,000
150,000

The maximum profit is SFr 160,000. This level of profit can be earned by selling 50,000
units at a selling price of SFr 80 per unit.

Problem 5-26 (60 minutes)


1. The income statements would be:

Sales...........................
Variable expenses.......
Contribution margin....
Fixed expenses............
Net operating income..

Sales...........................
Variable expenses*......
Contribution margin....
Fixed expenses............
Net operating income..

Present
Per
Amount
Unit
$800,00
0
$20
560,000
14
240,000
$6
192,000
$
48,000
Proposed
Per
Amount
Unit
$800,00
0
$20
320,000
8
480,000
$12
432,000
$
48,000

%
100%
70%
30%

%
100%
40%
60%

*$14 $6 = $8
2. a. Degree of operating leverage:
Present:

Contribution margin
Degree of
=
operating leverage
Net operating income
=
Proposed:

$240,000
=5
$48,000

Contribution margin
Degree of
=
operating leverage
Net operating income
=

$480,000
= 10
$48,000

Problem 5-26 (continued)


b. Dollar sales to break even:
Present:
Dollar sales to = Fixed expenses
break even
CM ratio
=

$192,000
= $640,000
0.30

Proposed:
Dollar sales to = Fixed expenses
break even
CM ratio
=

$432,000
= $720,000
0.60

c. Margin of safety:
Present:
Margin of safety = Actual sales - Break-even sales
= $800,000 - $640,000 = $160,000
Margin of safety = Margin of safety in dollars
percentage
Actual sales
=

$160,000
= 20%
$800,000

Proposed:
Margin of safety = Actual sales - Break-even sales
= $800,000 - $720,000 = $80,000
Margin of safety = Margin of safety in dollars
percentage
Actual sales
=

$80,000
= 10%
$800,000

Problem 5-26 (continued)


3. The major factor would be the sensitivity of the companys
operations to cyclical movements in the economy. Because the
new equipment will increase the CM ratio, in years of strong
economic activity, the company will be better off with the new
equipment. However, the company will be worse off with the
new equipment in years in which sales drop. The fixed costs of
the new equipment will result in losses being incurred more
quickly and they will be deeper. Thus, management must
decide whether the potential for greater profits in good years is
worth the risk of deeper losses in bad years.
4. No information is given in the problem concerning the new
variable expenses or the new contribution margin ratio. Both of
these items must be determined before the new break-even
point can be computed. The computations are:
New variable expenses:
= (Sales Variable expenses) Fixed
Profit expenses
= ($1,200,000* Variable expenses)
$60,000** $240,000
Variable
expenses = $1,200,000 $240,000 $60,000
= $900,000
* New level of sales: $800,000 1.5 = $1,200,000
New level of net operating income: $48,000 1.25 =
** $60,000
New CM ratio:
$1,200,00
Sales.................................
0 100%
900,00
Variable expenses.............
0 75%
$ 300,00
Contribution margin..........
0 25%
With the above data, the new break-even point can be
computed:

Dollar sales =Fixed expenses = $240,000 =$960,000


to break even
CM ratio
0.25

Problem 5-26 (continued)


The greatest risk is that the increases in sales and net
operating income predicted by the marketing manager will not
happen and that sales will remain at their present level. Note
that the present level of sales is $800,000, which is well below
the break-even level of sales under the new marketing strategy.
It would be a good idea to compare the new marketing strategy
to the current situation more directly. What level of sales would
be needed under the new method to generate at least the
$48,000 in profits the company is currently earning each
month? The computations are:

Dollar sales to attain= Target profit + Fixed expenses


target profit
CM ratio
=

$48,000 + $240,000
0.25

= $1,152,000 in sales each month


Thus, sales would have to increase by at least 44% ($1,152,000
is 44% higher than $800,000) in order to make the company
better off with the new marketing strategy than with the
current approach. This appears to be extremely risky.

Problem 5-27 (30 minutes)


1. The numbered components are as follows:
(1) Dollars of revenue and costs.
(2) Volume of output, expressed in units, % of capacity,
sales, or some other measure of activity.
(3) Total expense line.
(4) Variable expense area.
(5) Fixed expense area.
(6) Break-even point.
(7) Loss area.
(8) Profit area.
(9) Revenue line.

Problem 5-27 (continued)


2.
a.

b.

c.

d.

e.

g.

h.

Line 3:
Line 9:
Break-even
point:

Remain unchanged.
Have a flatter slope.

Line 3:
Line 9:
Break-even
point:

Have a steeper slope.


Remain unchanged.

Line 3:
Line 9:
Break-even
point:

Shift downward.
Remain unchanged.

Line 3:
Line 9:
Break-even
point:

Remain unchanged.
Remain unchanged.

Line 3:
Line 9:
Break-even
point:

Shift upward and have a flatter slope.


Remain unchanged.
Probably change, but the direction is
uncertain.

Line 3:
Line 9:
Break-even
point:

Have a flatter slope.


Have a flatter slope.
Remain unchanged in terms of units;
decrease in terms of total dollars of
sales.

Line 3:
Line 9:
Break-even
point:

Shift upward.
Remain unchanged.

Line 3:

Shift downward and have a steeper


slope.
Remain unchanged.
Probably change, but the direction is
uncertain.

Line 9:
Break-even
point:

Increase.

Increase.

Decrease.

Remain unchanged.

Increase.

Problem 5-28 (60 minutes)


1.

Profit =
$0 =
$0 =
$1.20Q =
Q=
Q=

Unit CM Q Fixed expenses


($2.00 $0.80) Q $60,000
($1.20) Q $60,000
$60,000
$60,000 $1.20 per pair
50,000 pairs

50,000 pairs $2 per pair = $100,000 in sales.


Alternative solution:
Unit sales =Fixed expenses = $60,000 =50,000 pairs
to break even
CM per unit
$1.20 per pair

Dollar sales =Fixed expenses = $60,000 =$100,000 in sales


to break even
CM ratio
0.60
2. See the graph on the following page.
3.

Profit =
$9,000 =
$1.20Q =
Q=
Q=

Unit CM Q Fixed expenses


$1.20 Q $60,000
$9,000 + $60,000
$69,000 $1.20 per pair
57,500 pairs

Alternative solution:
Unit sales to attain = Target profit + Fixed expenses
target profit
CM per unit
=

$9,000 + $60,000
$1.20 per pair

= 57,500 pairs

Problem 5-28 (continued)


2. Cost-volume-profit graph:

Total Sales
Break-even point: 50,000
pairs, or $100,000 in sales

Total
Expenses
Fixed
Expenses

Problem 5-28 (continued)


Profit graph:

Break-even
point: 50,000
pairs of
stockings

Problem 5-28 (continued)


4. Incremental contribution margin:
$20,000 increased sales 60% CM ratio..... $12,000
Less incremental fixed salary cost................
8,000
Increased net operating income.................... $ 4,000
Yes, the position should be converted to a full-time basis.
5.
a.

Contribution margin
$75,000
Degree of
=
=
=5
operating leverage
Net operating income
$15,000

b. 5 20% sales increase = 100% increase in net operating


income. Thus, net operating income would double next year,
going from $15,000 to $30,000.

Problem 5-29 (75 minutes)


1. a. Selling price................. $37.50 100%
Variable expenses........
22.50 60%
Contribution margin..... $15.00 40%
Profit =
$0 =
$15Q =
Q=
Q=

Unit CM Q Fixed expenses


$15 Q $480,000
$480,000
$480,000 $15 per skateboard
32,000 skateboards

Alternative solution:
Unit sales = Fixed expenses
to break even
Unit CM
=

$480,000
$15 per skateboard

= 32,000 skateboards

b. The degree of operating leverage would be:


Degree of operating leverage =
=

Contribution margin
Net operating income
$600,000
= 5.0
$120,000

2. The new CM ratio will be:


Selling price.......................
Variable expenses.............
Contribution margin..........

$37.50 100%
25.50
68%
$12.00
32%

Problem 5-29 (continued)


The new break-even point will be:
Profit =
$0 =
$12Q =
Q=
Q=

Unit CM Q Fixed expenses


$12 Q $480,000
$480,000
$480,000 $12 per skateboard
40,000 skateboards

Alternative solution:
Unit sales = Fixed expenses
to break even
Unit CM
=

$480,000
$12 per skateboard

= 40,000 skateboards

3.

Profit =
$120,000 =
$12Q =
Q=
Q=

Unit CM Q Fixed expenses


$12 Q $480,000
$120,000 + $480,000
$600,000 $12 per skateboard
50,000 skateboards

Alternative solution:
Unit sales to attain = Target profit + Fixed expenses
target profit
Unit CM
=

$120,000 + $480,000
$12 per skateboard

= 50,000 skateboards

Problem 5-29 (continued)


Thus, sales will have to increase by 10,000 skateboards
(50,000 skateboards, less 40,000 skateboards currently being
sold) to earn the same amount of net operating income as
earned last year. The computations above and in part (2) show
the dramatic effect that increases in variable costs can have on
an organization. These effects from a $3 per unit increase in
labor costs for Tyrene Company are summarized below:

Break-even point (in skateboards).....


Sales (in skateboards) needed to
earn net operating income of
$120,000........................................

Expecte
Present
d
32,000 40,000
40,000

50,000

Note that if variable costs do increase next year, then the


company will just break even if it sells the same number of
skateboards (40,000) as it did last year.
4. The contribution margin ratio last year was 40%. If we let P
equal the new selling price, then:
P
0.60P
P
P

= $25.50 + 0.40P
= $25.50
= $25.50 0.60
= $42.50

To verify: Selling price........................ $42.50 100%


Variable expenses...............
25.50 60%
Contribution margin............ $17.00 40%
Therefore, to maintain a 40% CM ratio, a $3 increase in variable
costs would require a $5 increase in the selling price.

Problem 5-29 (continued)


5. The new CM ratio would be:
Selling price..................... $37.50
100%
Variable expenses........... 13.50 * 36%
Contribution margin........ $24.00
64%
*$22.50 ($22.50 40%) = $13.50
The new break-even point would be:
Profit =
$0 =
$24Q =
Q=
Q=

Unit CM Q Fixed expenses


$24 Q $912,000*
$912,000
$912,000 $24 per skateboard
38,000 skateboards

*$480,000 1.9 = $912,000


Alternative solution:
Unit sales = Fixed expenses
to break even
Unit CM
=

$912,000
$24 per skateboard

= 38,000 skateboards

Although this break-even figure is greater than the companys


present break-even figure of 32,000 skateboards [see part (1)
above], it is less than the break-even point will be if the
company does not automate and variable labor costs rise next
year [see part (2) above].

Problem 5-29 (continued)


6.

a.

Profit =
$120,000 =
$24Q =
Q=
Q=

Unit CM Q Fixed expenses


$24 Q $912,000*
$120,000 + $912,000
$1,032,000 $24.00 per skateboard
43,000 skateboards

*480,000 1.9 = $912,000


Alternative solution:
Unit sales to attain = Target profit + Fixed expenses
target profit
Unit CM
=

$120,000 + $912,000
$24 per skateboard

= 43,000 skateboards

Thus, the company will have to sell 3,000 more skateboards


(43,000 40,000 = 3,000) than now being sold to earn a
profit of $120,000 each year. However, this is still less than
the 50,000 skateboards that would have to be sold to earn a
$120,000 profit if the plant is not automated and variable
labor costs rise next year [see part (3) above].

Problem 5-29 (continued)


b. The contribution income statement would be:
Sales
(40,000 skateboards $37.50 per
skateboard)................................................
Variable expenses
(40,000 skateboards $13.50 per
skateboard)................................................
Contribution margin......................................
Fixed expenses.............................................
Net operating income...................................

$1,500,000
540,000
960,000
912,000
$ 48,000

Degree of operating = Contribution margin


leverage
Net operating income
=

$960,000
= 20
$48,000

c. This problem shows the difficulty faced by some companies.


When variable labor costs increase, it is often difficult to pass
these cost increases along to customers in the form of higher
prices. Thus, companies are forced to automate, resulting in
higher operating leverage, often a higher break-even point,
and greater risk for the company.
There is no clear answer as to whether one should have been
in favor of constructing the new plant.

Problem 5-30 (30 minutes)


1. The contribution margin per stein would be:
Selling price..................................................
$30
Variable expenses:
Purchase cost of the steins........................... $15
Commissions to the student salespersons....
6 21
Contribution margin......................................
$9
Since there are no fixed costs, the number of unit sales needed
to yield the desired $7,200 in profits can be obtained by
dividing the target profit by the unit contribution margin:

Target profit
$7,200
=
= 800 steins
Unit CM
$9 per stein
800 steins $30 per stein = $24,000 in total sales
2. Since an order has been placed, there is now a fixed cost
associated with the purchase price of the steins (i.e., the steins
cant be returned). For example, an order of 200 steins requires
a fixed cost (investment) of $3,000 (= 200 steins $15 per
stein). The variable costs drop to only $6 per stein, and the new
contribution margin per stein becomes:
Selling price...........................................
Variable expenses (commissions only). .
Contribution margin..............................

$30
6
$24

Since the fixed cost of $3,000 must be recovered before


Marbury shows any profit, the break-even computation would
be:
Unit sales =Fixed expenses = $3,000
=125 steins
to break even
Unit CM
$24 per stein

125 steins $30 per stein =$3,750 in total sales


If a quantity other than 200 steins were ordered, the answer
would change accordingly.

Problem 5-31 (45 minutes)


1. The contribution margin per unit on the first 30,000 units is:
Per Unit
Selling price....................... $2.50
Variable expenses.............
1.60
Contribution margin.......... $0.90
The contribution margin per unit on anything over 30,000 units
is:
Per Unit
Selling price....................... $2.50
Variable expenses.............
1.75
Contribution margin.......... $0.75
Thus, for the first 30,000 units sold, the total amount of
contribution margin generated would be:
30,000 units $0.90 per unit = $27,000.
Since the fixed costs on the first 30,000 units total $40,000, the
$27,000 contribution margin above is not enough to permit the
company to break even. Therefore, in order to break even,
more than 30,000 units will have to be sold. The fixed costs
that will have to be covered by the additional sales are:
Fixed costs on the first 30,000 units..................$40,000
Less contribution margin from the first 30,000
units................................................................ 27,000
Remaining unrecovered fixed costs................... 13,000
Add monthly rental cost of the additional
space needed to produce more than 30,000
units................................................................ 2,000
Total fixed costs to be covered by remaining
sales............................................................... $15,000

Problem 5-31 (continued)


The additional sales of units required to cover these fixed costs
would be:

Total remaining fixed costs


$15,000
=
Unit contribution margin on added units $0.75 per unit
=20,000 units
Therefore, a total of 50,000 units (30,000 + 20,000) must be
sold for the company to break even. This number of units would
equal total sales of:
50,000 units $2.50 per unit = $125,000 in total sales.
2.
Target profit
$9,000
=
=12,000 units
Unit contribution margin $0.75 per unit
Thus, the company must sell 12,000 units above the breakeven point to earn a profit of $9,000 each month. These units,
added to the 50,000 units required to break even, equal total
sales of 62,000 units each month to reach the target profit.
3. If a bonus of $0.15 per unit is paid for each unit sold in excess
of the break-even point, then the contribution margin on these
units would drop from $0.75 to only $0.60 per unit.
The desired monthly profit would be:
25% ($40,000 + $2,000) = $10,500
Thus,

Target profit
$10,500
=
=17,500 units
Unit contribution margin $0.60 per unit
Therefore, the company must sell 17,500 units above the
break-even point to earn a profit of $10,500 each month. These
units, added to the 50,000 units required to break even, would
equal total sales of 67,500 units each month.

Case 5-32 (75 minutes)


1. The contribution format income statements (in thousands of dollars) for the three
alternatives are:

Sales.............................................
Variable expenses:
Variable cost of goods sold.........
Commissions..............................
Total variable expense...................
Contribution margin......................
Fixed expenses:
Fixed cost of goods sold..............
Fixed advertising expense..........
Fixed marketing staff expense....
Fixed administrative expense.....
Total fixed expenses......................
Net operating income....................

18%
20%
Commission
Commission
Own Sales Force
$30,00
$30,00
0 100% $30,000 100%
0
100%
17,400
5,400
22,800
7,200

76%
24%

17,400
6,000
23,400
6,600

2,800
800

2,800
800

3,200
6,800

3,200
6,800

$ 400

* $800,000 + $500,000 = $1,300,000


** $700,000 + $400,000 + $200,000 = $1,300,000

$ (200)

17,400
3,000
78% 20,400
22% 9,600
2,800
1,300 *
1,300 **
3,200
8,600
$
1,000

68%
32%

Case 5-32 (continued)


2. Given the data above, the break-even points can be
determined using total fixed expenses and the CM ratios as
follows:
a.Dollar sales
Fixed expenses
$6,800,000
=
=
= $28,333,333
to break even
CM ratio
0.24
b.Dollar sales
Fixed expenses
$6,800,000
=
=
= $30,909,091
to break even
CM ratio
0.22
c.Dollar sales
Fixed expenses
$8,600,000
=
=
= $26,875,000
to break even
CM ratio
0.32
3.Dollar sales to attain Target profit + Fixed expenses
=
target profit
CM ratio

-$200,000 + $8,600,000
0.32

= $26,250,000
4.

X = Total sales revenue


Net operating income = 0.32X - $8,600,000
with company sales force

Net operating income


= 0.22X - $6,800,000
with the 20% commissions

The two net operating incomes are equal when:


0.32X
$8,600,000
0.10X
X
X

0.22X
= $6,800,000
= $1,800,000
= $1,800,000 0.10
= $18,000,000

Case 5-32 (continued)


Thus, at a sales level of $18,000,000 either plan will yield the
same net operating income. This is verified below (in thousands
of dollars):
20%
Commission
$ 18,00
0 100%

Sales........................
Total variable
expense.................
14,040
Contribution margin.
3,960
Total fixed expenses.
6,800
Net operating
income................... $ (2,840)

78%
22%

Own Sales
Force
$ 18,000 100%
12,240
5,760
8,600
$ (2,840)

5. A graph showing both alternatives appears below:

68%
32%

Case 5-32 (continued)


6.
To: President of Marston Corporation
Fm: Students name
Assuming that a competent sales force can be quickly hired
and trained and the new sales force is as effective as the sales
agents, this is the better alternative. Using the data provided
by the controller, unless sales fall below $18,000,000 net
operating income is higher when the company has its own
sales force. At that level of sales and below, the company
would be losing money, so it is unlikely that this would be the
normal situation.
The major concern I have with this recommendation is the
assumption that the new sales force will be as effective as the
sales agents. The sales agents have been selling our product
for a number of years, so they are likely to have more field
experience than any sales force we hire. And, our own sales
force would be selling just our product instead of a variety of
products. On the one hand, that will result in a more focused
selling effort. On the other hand, that may make it more
difficult for a salesperson to get the attention of a hospitals
purchasing agent.
The purchasing agents may prefer to deal through a small
number of salespersons, each of whom sells many products,
rather than a large number of salespersons each of whom sells
only a single product. Even so, we can afford some decrease in
sales because of the lower cost of maintaining our own sales
force. For example, assuming that the sales agents make the
budgeted sales of $30,000,000, we would have a net operating
loss of $200,000 for the year. We would do better than this with
our own sales force as long as sales are greater than
$26,250,000. In other words, we could afford a fall-off in sales
of $3,750,000, or 12.5%, and still be better off with our own
sales force. If we are confident that our own sales force could
do at least this well relative to the sales agents, then we should
certainly switch to using our own sales force.

CASE 5-33 (60 minutes)


Note: This is a problem that will challenge the very best students
conceptual and analytical skills. However, working through this
case will yield substantial dividends in terms of a much deeper
understanding of critical management accounting concepts.
1. The overall break-even sales can be determined using the CM
ratio.
Frog
Minnow
Worm
Total
$200,00
Sales.......................
0 $280,000 $240,000 $720,000
Variable expenses... 120,000 160,000 150,000 430,000
Contribution
margin.................. $ 80,000 $120,000 $ 90,000 290,000
Fixed expenses.......
282,000
Net operating
income.................
$ 8,000

CM ratio=

Contribution margin $290,000


=
=0.4028
Sales
$720,000

Dollar sales = Fixed expenses = $282,000 =$700,100 (rounded)


to break even
CM ratio
0.4028
2. The issue is what to do with the common fixed costs when
computing the break-evens for the individual products. The
correct approach is to ignore the common fixed costs. If the
common fixed costs are included in the computations, the
break-even points will be overstated for individual products and
managers may drop products that in fact are profitable.
a. The break-even points for each product can be computed
using the contribution margin approach as follows:
Unit selling price............
Variable cost per unit.....
Unit contribution margin
(a)................................

Frog Minnow Worm


$2.00
$1.40
$0.80
1.20
0.80
0.50
$0.80

$0.60

$0.30

Product fixed expenses


(b)............................... $18,000 $96,000 $60,000
Unit sales to break even
(b) (a)...................... 22,500 160,000 200,000

Case 5-33 (continued)


b. If the company were to sell exactly the break-even quantities
computed above, the company would lose $108,000the
amount of the common fixed cost. This occurs because the
common fixed costs have been ignored in the calculations of
the break-evens.
The fact that the company loses $108,000 if it operates at
the level of sales indicated by the break-evens for the
individual products can be verified as follows:
Frog
Minnow
Worm
Total
Unit sales.............. 22,500 160,000 200,000
$160,00 $ 429,00
Sales..................... $45,000 $224,000
0
0
Variable expenses.
27,000 128,000 100,000 255,000
Contribution
margin................ $18,000 $ 96,000 $ 60,000 174,000
Fixed expenses.....
282,000
$(108,000
Net operating loss.
)
At this point, many students conclude that something is
wrong with their answer to part (a) because the company
loses money operating at the break-evens for the individual
products. They also worry that managers may be lulled into a
false sense of security if they are given the break-evens
computed in part (a). Total sales at the individual product
break-evens is only $429,000 whereas the total sales at the
overall break-even computed in part (1) is $700,100.
Many students (and managers, for that matter) attempt to
resolve this apparent paradox by allocating the common
fixed costs among the products prior to computing the breakevens for individual products. Any of a number of allocation
bases could be used for this purposesales, variable
expenses, product-specific fixed expenses, contribution
margins, etc. (We usually take a tally of how many students
allocated the common fixed costs using each possible
allocation base before proceeding.) For example, the

common fixed costs are allocated on the next page based on


sales.

Case 5-33 (continued)


Allocation of common fixed expenses on the basis of sales
revenue:
Frog
Minnow
$200,00
Sales.........................
0 $280,000
Percentage of total
sales....................... 27.8%
38.9%
Allocated common
fixed expense* ....... $30,000 $ 42,000
Product fixed
expenses................ 18,000
96,000
Allocated common
and product fixed
expenses (a)........... $48,000 $138,000
Unit contribution
margin (b)..............
$0.80
$0.60
Break-even point
in units sold
(a)(b).................... 60,000 230,000

Worm
Total
$240,00
0 $720,000
33.3%

100.0%

$36,000 $108,000
60,000

174,000

$96,000 $282,000
$0.30
320,000

*Total common fixed expense Percentage of total sales


If the company sells 60,000 units of the Frog lure product,
230,000 units of the Minnow lure product, and 320,000 units
of the Worm lure product, the company will indeed break
even overall. However, the apparent break-evens for two of
the products are above their normal annual sales.
Frog

Minnow

Worm

Normal annual unit sales


volume....................................100,000 200,000 300,000
Break-even unit annual sales
(see above)............................. 60,000 230,000 320,000
Strategic decision................... retain
drop
drop

Case 5-33 (continued)


It would be natural to interpret a break-even for a product as
the level of sales below which the company would be
financially better off dropping the product. Therefore, we
should not be surprised if managers, based on the erroneous
break-even calculation on the previous page, would decide to
drop the Minnow and Worm lures and concentrate on the
companys core competency, which appears to be the Frog
lure. However, if they were to do that, the company would
face a loss of $46,000:
Frog
Minnow
Worm
Total
Sales....................... $200,000 dropped dropped $200,000
Variable expenses... 120,000
120,000
Contribution
margin.................. $ 80,000
80,000
Fixed expenses*......
126,000
Net operating loss...
$(46,000)
*By dropping the two products, the company reduces its
fixed expenses by only $156,000 (= $96,000 + $60,000).
Therefore, the total fixed expenses would be $126,000 (=
$282,000 $156,000).
By dropping the two products, the company would have a
loss of $46,000 rather than a profit of $8,000. The reason is
that the two products dropped were contributing $54,000
toward covering common fixed expenses and toward profits.
This can be verified by looking at a segmented income
statement like the one that will be introduced in a later
chapter.
Frog
$200,00
Sales...........................
0
Variable expenses....... 120,000
Contribution margin.... 80,000
Product fixed
expenses.................. 18,000
Product segment
margin...................... $ 62,000

Minnow Worm
Total
$280,00 $240,00 $720,00
0
0
0
160,000 150,000 430,000
120,000 90,000 290,000
96,000

60,000 174,000

$ 24,000 $ 30,000 116,000

Common fixed
expenses..................
Net operating income.

108,000
$ 8,000
$54,000

You might also like