Cost Volume Profit (CVP) Analysis: Understanding Contribution Margin and Break-Even Point, Study notes of Cost Accounting

Download Cost Volume Profit (CVP) Analysis: Understanding Contribution Margin and Break-Even Point and more Study notes Cost Accounting in PDF only on Docsity! Revised Summer 2016 Exam Review Page 1 of 17 COST VOLUME PROFIT Key Topics to Know • CVP analysis is based on the interactions among the following five elements: o Price or revenue of products o Volume or level of activity o Per units variable costs o Total fixed costs. o Mix of products sold (CVP analysis requires an assumption about sales mix) • Contribution Margin o Difference between gross margin and contribution margin o Understand the relationship among: Revenue, variable cost and contribution margin per unit Why fixed costs and operating income per unit are never used. Total revenue, variable cost, contribution margin and fixed costs Level of activity versus number of units sold o Contribution Margin is the remaining amount of sales dollars available to cover fixed expenses and profit. o Contribution Margin in Dollars = Sales Revenue - Variable Expenses. o Contribution Margin per unit = Selling Price per unit – Variable Expense per unit or total contribution margin / units sold o Contribution Margin Ratio (%) = Contribution Margin / Sales o Break-Even Point • At the Break-even Point: o Profit or operating income equals 0. o Total revenue equals total costs. o Total contribution margin equals fixed expenses. • The break-even point is measured in sales dollars and/or units sold. • Break-even sales and units sold are related by the unit selling price. • The break-even point may be calculated using either the Equation Method or the Contribution Margin Method: Revised Summer 2016 Exam Review Page 2 of 17 Equation Method: In Units Sold: sales $ per unit X units sold = variable expense $ per unit X units sold + fixed expenses + profit of 0 In Sales Dollars: sales as a % of sales = variable expenses as a % of sales + fixed expenses + profit of 0 Contribution Margin Method: In Units Sold: (Fixed Expenses + Profit of 0) Contribution Margin per unit In Sales Dollars: Fixed expenses + Profit of 0) Contribution Margin ratio • Calculate the break-even point in total sales dollars and total units sold for both single-product and multi-product companies. Sales mix, the relative combination in which a company's products are sold, is assumed to be constant for these companies. • Breakeven point for multi-product companies is calculated based on total company sales, variable costs and fixed costs. • Sales mix, the proportion of units sold for each product to the total units sold is assumed to remain constant. • Changes in sales volume are assumed to increase or decrease according to the sales mix. That is, the change in total units sold is made up of changes in units sold for the individual products in proportion to the sales mix. • Calculate the sales dollars and units sold necessary to achieve a target profit using the break-even formulas above and substituting the target profit for the break- even profit of 0. • Understand how the revenue function, variable, fixed and total cost functions and the break-even point shift on the CVP graph when revenue and/or cost assumptions are changed • Calculate the margin of safety. Margin of Safety is the excess of budgeted or actual sales over the break-even volume of sales. o Margin of safety in dollars = Total sales - Break-even sales o Margin of safety percentage = Margin of safety in dollars / Total sales • Calculate the degree of leverage (leverage factor) o Operating Leverage is a way to measure, at a given level of sales, how a percentage change in sales volume will affect profits. Revised Summer 2016 Exam Review Page 5 of 17 Problem #2 U Company’s first quarter income statement is presented below: Sales $800,000 Cost of Goods Sold 560,000 Gross Margin 240,000 Less: Operating Expenses: Selling Expenses $100,000 Administrative Expenses 110,000 210,000 Net Income $ 30,000 On average, a book sells for $40.00. Variable selling expenses are $3.00 per book; the remaining selling expenses are fixed. The variable administrative expenses are 5% of sales; the remainder of the administrative expenses is fixed. Required: a) Prepare a contribution format income statement for the first quarter. b) Prepare a breakeven income statement for the first quarter. c) If 24,000 books are sold during the second quarter, calculate the company’s expected contribution margin and net income. d) If 22,000 books are sold during the second quarter, how much fixed expenses could increase if the company wanted to maintain a net income of $35,000? Calculate the company’s expected contribution margin. Revised Summer 2016 Exam Review Page 6 of 17 Problem #3 P Company’s income statement for last year appears below: Sales $2,000,000 Cost of goods sold: Direct materials $500,000 Direct labor (variable) 150,000 Variable manufacturing overhead 50,000 Fixed manufacturing overhead 600,000 1,300,000 Gross Profit 700,000 Selling and administrative expenses Variable 100,000 Fixed 200,000 300,000 Operating Income 400,000 Required: a) Calculate the breakeven point. b) Calculate the degree of operating leverage. c) If units sold double next year, calculate the degree of leverage. Problem #4 H Company produces and sells storage sheds. Its current sales are $500,000. The company's accountant provided the following information: Selling price per unit $40.00 Manufacturing costs $100,000 + 40% sales Selling costs $30,000 + 10% sales Administrative costs $45,000 + 10% sales Required: a) Compute the product's contribution margin ratio. b) Compute the company's current net income. c) Compute the product's break-even point in dollars and units. d) Compute the amount of revenue necessary to earn $60,000 in profit. e) Compute the unit contribution margin. f) Compute the company's current margin of safety ratio. g) Should the company accept a proposal that increases sales by 20% and total fixed costs by 25%? Revised Summer 2016 Exam Review Page 7 of 17 Problem #5 In 2013, G Company sold 160,000 units of its product at a selling price of $40. The variable cost per unit was $30. G Company reported net income for the year of $220,000. Required: What was the amount of fixed costs for the year? Problem #6 The P Company makes and sells two models of blenders, as follows: Smoothie Pro Blendmaster Selling price per unit $50 $80 Variable cost per unit $25 $45 The P Company expects to incur annual fixed costs of $151,250. The relative sales mix of the products is 3 units of Smoothie Pro for every one unit of Blendmaster. Required: a) Determine the total number of blenders (Smoothie Pro and Blendmaster combined) that Parsons must sell to break even. b) What is the number of units of Smoothie Pro and of Blendmaster that Parsons would expect to sell at the break-even point? Revised Summer 2016 Exam Review Page 10 of 17 12. If a company decreases the variable expense per unit while increasing the total fixed expenses, the total expense line relative to its previous position will: a) shift downward and have a steeper slope. b) shift downward and have a flatter slope c) shift upward and have a flatter slope. d) shift upward and have a steeper slope 13. J Company’s fixed monthly expenses are $21,000 and its contribution margin ratio is 61%. Assuming that the fixed monthly expenses do not change, what is net operating income in a month when sales are $74,000? a) $7,860 b) $45,140 c) $24,140 d) $53,000 14. C Company’s operating leverage is 5.9. If the company's sales increase by 19%, its net operating income should increase by about: a) 5.9% b) 31.1% c) 19.0% d) 112.1% 15. G Company sells a single product. If the selling price per unit and the variable expense per unit both increase by 10% and fixed expenses do not change, then: Contribution margin per unit Contribution margin ratio Break-even in units A. Increases Increases Decreases B. No change No change No change C. No change Increases No change D. Increases No change Decreases a) A b) B c) C d) D Revised Summer 2016 Exam Review Page 11 of 17 16. Data concerning H Company’s two products for the most recent month is: Product V06Z Product U85C Sales $18,000 $17,000 Variable expenses $8,820 $1,330 The fixed expenses were $24,010. The break-even point for the company is: a) $33,817 b) $10,990 c) $34,160 d) $24,010 17. U Company produces and sells a single product. Data concerning that product appear below: Selling price per unit $100.00 Variable expense per unit $34.00 Fixed expense per month $312,180 Assume the company's target profit is $12,000. The unit sales to attain that target profit is closest to: a) 3,242 b) 4,912 c) 9,535 d) 5,896 18. D Company’s current sales are 25,400 units at $120 per unit. Break-even sales are 18,542 units. What is the margin of safety in dollars? a) $822,960 b) $2,032,000 c) $3,048,000 d) $2,225,040 19. E Company’s product has a selling price of $120.00 per unit and variable expense of $37.20 per unit. Monthly fixed expense is $356,040. What are the sales necessary to reach a target profit of $15,000? a) $371,040 b) $537,739 c) $701,894 d) $1,196,903 Revised Summer 2016 Exam Review Page 12 of 17 20. F Company produces and sells two products. Data concerning those products for the most recent month appear below: Product M06M Product Q20I Sales $11,000 $38,000 Variable expenses $2,420 $16,690 Fixed expenses for the entire company were $26,570. The break-even point for the entire company is closest to: a) $43,557 b) $26,570 c) $22,430 d) $45,680 Revised Summer 2016 Exam Review Page 15 of 17 Problem #3 Sales $2,000,000 Direct materials $500,000 Direct labor (variable) 150,000 Variable manufacturing overhead 50,000 Variable selling and administrative 100,000 800,000 Contribution margin 1,200,000 a) CM ratio = 1,200,000 / 2,000,000 = 60% Breakeven point = 300,000 / 60% = $500,000 b) Degree of leverage = 1,200,000 / 400,000 = 3 c) Degree of leverage = (1,200,000 + 1,200,000) / (400,000 + 1,200,000) = 1.5 Problem #4 a) Contribution margin ratio 100%-40%-10%-10% 40% b) Net income Contribution margin $500,000 x 40% = $200,000 Fixed expenses 175,000 $25,000 c) Breakeven sales $175,000 / 40% = $437,500 Breakeven units $437,500 / $40 = 10,938 d) Sales for $60,000 income ($175,000 + $60,000) / 40% = $587,500 e) Unit contribution margin $40 - $24 = $16 f) Margin of safety ratio ($500,000 - $437,500) $500,000 12.5% g) No; a sales increase of $100,000 will generate an additional $40,000 in contribution margin but total fixed costs will increase by $43,750. Therefore, income will be reduced by $3,750. Problem #5 Contribution margin per unit $40 - $30 = $10 Total contribution margin $10 × 160,000 = $1,600,000 Net income 220,000 Fixed expenses $1,380,000 Revised Summer 2016 Exam Review Page 16 of 17 Problem #6 a) Weighted average contribution margin (3x$25)+(1x$35) 4 units $27.50 Breakeven units $151,250 $27.50 5,500 units b) Units of Blendmaster 1 4 X 5,500 = 1,375 units Revised Summer 2016 Exam Review Page 17 of 17 Solutions to Multiple Choice Questions 1. C 2. B 3. A 4. D 5. B 6. C 7. C 8. B 9. C 10. B 11. C 12. A 13. C 14. C 15. D 16. D 17. C 18. A 19. C 20. B 21. A 22. B 23. A