finman3e testbank mod15

Module 15 Cost-Volume-Profit Analysis and Planning Learning Objectives – coverage by question True / False Multiple Choice Exercises Problems Essays LO1 – Identify the uses and limitations of traditional cost-volume-profit analysis. 1-4 1, 2, 37-43 1, 2 LO2 – Prepare and contrast contribution and functional income statements. 5, 6 3-12, 44-55, 69 1 5 3, 4 LO3 – Apply cost-volume-profit analysis to find a break-even point and for preliminary profit planning. 7, 8 13-28, 56-67, 70 2-4, 12, 13 1-6 LO4 – Analyze the profitability and sales mix of a multiple product firm. 9 29, 30, 68, 71-75 14 5-7 LO5 – Apply operating leverage ratio to assess opportunities for profit and the risks of loss. 10 31-36, 76-86 5-11, 15 Module 15: Cost-Volume-Profit Analysis and Planning True False Topic: Purpose of Cost-Volume-Profit Analysis LO: 1 1. Cost-volume-profit analysis is most useful for determining costs. Answer: False Rationale: Cost-volume-profit analysis is not intended for estimating cost, but to provide an analytical framework for profit planning, especially during the early stages of planning. Topic: Profitability Analysis LO: 1 2. Fixed costs, variable costs, and revenues are all included in profitability analysis? Answer: True Rationale: Profit is the difference between revenue and total costs, which includes both variable and fixed costs. Topic: Break Even Analysis LO: 1 3. Cost-Volume-Analysis is not typically used to determine the break-even point. Answer: False Rationale: Indeed, on of the key reasons for cost-volume-analysis is to determine the point of break even. Topic: Assumptions Underlying Cost-Volume-Analysis LO: 1 4. One of the basic assumptions underlying the cost-volume-analysis model is that the revenue curve is curvilinear, reflecting changing prices as volume changes. Answer: False Rationale: The revenue curve is assumed to be linear, not curvilinear. CVP analysis assumes selling price per unit is constant throughout the range of the model. Topic: Contribution Margin LO: 2 5. Contribution margin is the difference between total revenue and total variable costs. Answer: True Rationale: Contribution margin is the profit contribution available to cover fixed costs and provide a profit. Topic: Functional Format Income Statements LO: 2 6. Functional income statements that classify expenses based on business function (production, sales, administration), and are typically found in corporate annual reports. Answer: True Rationale: Corporate annual reports include income statements that follow the functional format. Topic: Cost-Volume-Profit Graph LO: 3 7. A cost-volume-profit graph includes lines for total revenues, total fixed cost, total variable cost, and total profit. Answer: False Rationale: Total profit is not show as a plotted line on a cost-volume-profit graph. It is the area between the lines for total revenues and total costs. Topic: Effects of Changes on CVP Graph LO: 3 8. If prices are assume to increase by 10%, the slope of the cost curve will increase (be steeper) by 10%, but there will be no changes in the cost curves. Answer: True Rationale: Changing sales prices affect the revenue curve but not the cost curves on a CVP graph. Topic: Sales Mix Analysis LO: 4 9. The break-even point for a company with multiple products cannot be determined using a unit contribution margin calculation since there are multiple products each of which has a different unit contribution margin. Answer: False Rationale: One method for calculating break-even point for a multi-product firm is to calculate a weighted average unit contribution margin, which is divided into total fixed costs to determine break-even point. Topic: Operating Leverage LO: 5 10. A company that has only fixed cost has no operating leverage. Answer: True Rationale: Operating leverage is best described as a measure of the extent to which an organization’s costs are fixed. Multiple Choice Topic: Assumptions of CVP Analysis LO: 1 1. A basic assumption of the cost-volume-profit model is that: All costs can be accurately classified as either fixed or variable Cost drivers can be organized into unit-level, batch level, product-level and facility-level factors Higher volumes of product require lower prices The mix of products changes over time Answer: A Rationale: The basic CVP model requires all cost to be treated as either fixed or variable. Topic: Assumptions of CVP Analysis LO: 1 2. All of the following are assumptions used in cost-volume-profit analysis, except: All costs are classified as fixed or variable The total cost function is linear The total revenue function is linear All of the above Answer: D Rationale: The CVP model assumes linearity of both the revenue and cost functions, and it assumes that all costs are either fixed or variable. Topic: Contribution Margin LO: 2 3. The contribution margin is: The difference between sales price and total variable cost The difference between total sales and total cost of goods sold The difference between total revenue and total variable cost Total sales minus total cost of goods sold Answer: C Rationale: Contribution margin is calculated as revenues minus variable costs. It can be calculated on either an aggregate or per-unit basis. Topic: Unit Contribution Margin LO: 2 4. A unit contribution margin measures: The difference between price and variable cost per unit The difference between sales and cost of goods sold on a unit basis The difference between unit sales and total costs per unit The percentage difference between sales and cost of goods sold Answer: A Rationale: Unit selling price minus unit variable cost is the definition of unit contribution margin. Topic: Contribution Margin Ratio LO: 2 5. The portion of each dollar that can be used to cover fixed costs and provide a profit is known as: Contribution margin ratio Gross margin percent Margin of safety Operating leverage Answer: A Rationale: Contribution margin ratio is the portion (or percent) of revenues available for covering fixed costs and providing a profit. It is calculated as contribution margin dollars divided by sales. Topic: Contribution Income Statement Format LO: 2 6. In a contribution income statement: All fixed costs are grouped together and subtracted from gross profit. Net income plus all fixed expenses equal the contribution margin. The contribution margin is computed as the difference between sales revenue and fixed costs. The gross margin is computed as the difference between sales revenue and the cost of goods sold. Answer: B Rationale: Contribution margin minus fixed costs equals net income; therefore net income plus fixed costs equals contribution margin. Topic: Income Statement Format LO: 2 7. Costs are classified according to behavior on a(n): Abrams-Ingram cost grid Contribution income statement Functional income statement Statement of financial position Answer: B Rationale: The definition of a contribution income statement is that it classifies costs by variable and fixed, and shows both contribution margin and net income. Topic: Contribution Margin Calculation LO: 2 8. Rozella’s income statement is as follows: Sales (10,000 units) $120,000 Less variable costs - 48,000 Contribution margin $72,000 Less fixed costs - 24,000 Net income $ 48,000 What is the unit contribution margin? $12.00 $ 7.20 $ 4.80 $ 2.40 Answer: B Rationale: Contribution margin of $72,000 divided by 10,000 units equals a unit contribution margin of $7.20 Topic: Contribution Margin Ratio LO: 2 9. Rozella’s income statement is as follows: Sales (10,000 units) $120,000 Less variable costs - 48,000 Contribution margin $72,000 Less fixed costs - 24,000 Net income $ 48,000 What is the contribution margin ratio? 167 percent 30 percent 40 percent 60 percent Answer: D Rationale: $72,000 divided by $120,000 equals 60 percent. Topic: Profitability Analysis LO: 2 10. Rozella’s income statement is as follows: Sales (10,000 units) $120,000 Less variable costs - 48,000 Contribution margin $72,000 Less fixed costs - 24,000 Net income $ 48,000 If sales increase by 1,000 units, profits will: Increase by $12,000 Increase by $7,200 Increase by $4,800 Increase by $8,000 Answer: B Rationale: The unit contribution margin is $72,000 Contribution Margin divided by 10,000 units, or $7.20 per unit. If sales increase by 1,000 units, total contribution margin and total profits will increase by 1,000 units times $7.20, or $7,200, because fixed costs will remain unchanged. Topic: Profitability Analysis LO: 2 11. Rozella’s income statement is as follows: Sales (10,000 units) $80,000 Less variable costs - 48,000 Contribution margin $32,000 Less fixed costs - 24,000 Net income $ 8,000 If sales increase by $15,000, profits will: Increase by $1,000 Increase by $4,000 Increase by $6,000 Increase by $15,000 Answer: C Rationale: Contribution margin will increase by $6,000, which is equal to $15,000 of increased sales times the 40% contribution margin percentage (calculated as contribution margin of $32,000 divided by $80,000 of sales). Since fixed costs will remain unchanged, net income also increases by $6,000. Topic: Contribution Margin Calculation LO: 2 12. Total contribution margin is calculated by subtracting: Cost of goods sold from total revenues Fixed costs from total revenues Total manufacturing costs from total revenues Total variable costs from total revenues Answer: D Rationale: Contribution margin is defined as total revenues minus total variable costs. Topic: Profit-Volume Graph LO: 3 13. A profit-volume graph: Is most useful in situations where there are multiple cost drivers Plots both revenue and total cost on the Y axis Plots contribution margin on the Y axis and volume on the X axis Plots total profit on the Y axis against total volume on the X axis Answer: B Rationale: A cost-volume-profit graph plots total activity volume on the X axis and total revenue and total cost on the Y axis. Topic: Profit-Volume Graph LO: 3 14. A profit-Volume graph differs from a Cost-Volume-Profit graph in that: A profit-volume graph ignores the effect of cost on profit The cost-volume-profit graph is not as practical because it can not be seen two-dimensionally The cost-volume-profit graph shows revenues and costs separately The profit-volume graph has only two lines: one for profit and one for volume Answer: C Rationale: The profit-volume graph shows total profit as a separate line; whereas, the cost-profit-volume graph shows profit only as the area represented by the distance between the total revenue line and the total cost line. Topic: Cost-Profit-Volume Graph LO: 3 15. In a cost-volume-profit graph: An increase in unit variable costs would decrease the slope of the total costs line An increase in the unit selling price would shift the break-even sales point to the left An increase in the unit selling price would shift the break-even sales point to the right The total revenues line crosses the horizontal axis at the break-even point Answer: B Rationale: An increase in selling price increases the slope of the total revenue line, thereby causing its intersection with the total cost line to shift to the left. Topic: Cost-Volume-Profit Analysis LO: 3 16. Using cost-volume-profit analysis, we can conclude that a 20 percent reduction in variable costs will: Not affect the break-even sales volume if there is an offsetting 20 percent increase in fixed costs Reduce the break-even sales volume by 20 percent Reduce total costs by 20 percent Reduce the slope of the total costs line by 20 percent Answer: D Rationale: The slope of the total cost line is equal to the variable cost per unit of activity; therefore, if the variable cost per unit is decreased by 20%, the slope of the total cost line will decrease by 20%. Topic: Cost-Volume-Profit Graph LO: 3 17. The point where the total costs and the total revenues lines intersect provides information about the: Budgeted income Center point in the relevant range Number of units that must be sold to break even Profit maximizing sales volume Answer: C Rationale: Break-even point is defined as the activity level where total revenue equals total cost. Topic: Break-Even LO: 3 18. The break-even point is: The volume of activity where all of the variable costs, but none of the fixed costs are recovered Where total fixed costs equal total variable costs Where total revenues equal total costs All of the above Answer: C Rationale: Break-even point is defined as the activity level where total revenue equals total cost. Topic: Cost-Volume-Profit Graph LO: 3 19. In a cost-volume profit graph: The slope of the total cost line is dependent on the variable cost per unit The slope of the total revenues line is the contribution margin per unit The total costs line normally begins at zero The total revenue line is plotted above the total cost line Answer: A Rationale: The slope of the total cost line is equal to the variable cost per unit of activity; therefore, the slope of the total cost line is dependent upon the variable cost per unit. Topic: Contribution Margin LO: 3 20. The total contribution margin at the break-even point: Equals total fixed costs Is zero Is greater than total variable costs Plus total fixed costs equal total revenues Answer: A Rationale: Contribution margin is define as total revenue minus total variable costs; therefore, at break-even point contribution margin is sufficient to cover fixed costs but provide no profit. Topic: Break-Even Point in Sales Dollars LO: 3 21. The break-even point in sales dollars may be computed as: Fixed costs divided by contribution margin per unit The difference between total contribution margin and operating profit divided by the contribution margin ratio Fixed costs divided by the difference in unit price and unit variable costs Total contribution margin divided by the unit contribution margin per unit Answer: B Rationale: The difference between contribution margin and operating profit is equal to fixed costs, and fixed costs divided by the contribution margin ratio (or percent) equals break-even point in sales dollars. Topic: Break-Even Calculation LO: 3 22. George Company sells one product at a price of $20 per unit. Variable expenses are 40 percent of sales, and fixed expenses are $20,000. The sales dollars level required to break even are: $ 2,500 $12,000 $33,333 $50,000 Answer: C Rationale: Break even in sales dollars = fixed costs divided by contribution margin percentage = $20,000 / (100% - 40%) = $33,333. Topic: Break-Even Calculation LO: 3 23. Determine the unit break-even point, assuming fixed costs are $60,000 per period, variable costs are $6.00 per unit, and the sales price is $10.00 per unit. 5,000 8,333 15,000 12,000 Answer: C Rationale: $60,000 / ($10 - $6) = 15,000 units at break-even Topic: Break-Even Calculation LO: 3 24. The following information pertains to Oliver’s 2011 operations: Selling price per unit $50 Variable costs per unit $20 Total fixed costs $100,000 Oliver’s break-even point in units is: 2,000 units 3,333 units 5,000 units 60,000 units Answer: B Rationale: $100,000 / ($50 - $20) = 3,333 units at break-even Topic: Profit Planning LO: 3 25. The following information pertains to Oliver’s 2011 operations: Selling price per unit $50 Variable costs per unit $20 Total fixed costs $100,000 The sales volume required to obtain a target pretax profit of $25,000 is: $125,000 $208,333 $250,000 $312,500 Answer: B Rationale: $100,000 + $25,000 / [($50 - $20) / $50] = $208,333 Sales Volume Topic: Break-Even in Sales Dollars Calculation LO: 3 26. The following information pertains to Palmer’s 2011 operations: Selling price per unit $100 Variable costs per unit $60 Total fixed costs $80,000 Tax rate 40% Palmer’s break-even point in sales dollars is: $133,333 $200,000 $500,000 $333,333 Answer: B Rationale: $80,000/[($100 - $60)/$100] = $80,000/0.40 = $200,000 Topic: Profit Planning Calculation LO: 3 27. The following information pertains to Manning, Inc: Selling price per unit $100 Variable costs per unit $70 Total fixed costs $420,000 Tax rate 40% The sales volume required to obtain a target after-tax profit of $108,000 is: 6,000 units 8,572 units 14,000 units 20,000 units Answer: D Rationale: Pre-tax profit = after-tax profit / (1- tax rate). $108,000 / 0.6 = $180,000. ($420,000 + $180,000) / ($100 - $70) = $600,000 / $30 = 20,000 units Topic: Break-Even in Sales Dollars Calculation LO: 3 28. The following information pertains to Manning, Inc: Selling price per unit $100 Variable costs per unit $70 Total fixed costs $420,000 Tax rate 40% The break-even point in sales dollars is: $ 700,000 $ 427,000 $ 600,000 $1,400,000 Answer: D Rationale: $420,000 / [($100 - $70) / $100] = $420,000 / 0.30 = $1,400,000 Topic: Sales Mix LO: 4 29. Sales mix refers to: The portion of unit variable costs that are consumed by each product The absolute portion of total variable costs consumed by each product The relative portion of unit or dollar sales that are derived from each product None of the above Answer: C Rationale: Sales mix is a term defined as the percentage of total sales generated by each product for a company that offers multiple products to customers. Topic: Sales Mix LO: 4 30. Which of the following statements regarding sales mix is true? A shift in the sales mix can have a significant impact on the bottom line. One of the limiting assumptions of the basic cost-volume-profit model is that the analysis is for a single product or the sales mix is constant. Sales mix analysis is important in multiple-product or service organizations. All of the above are true Answer: D Rationale: All of the above statements regarding sale mix are true. Topic: Operating Leverage LO: 5 31. Operating leverage is best described as: A measure of the extent to which an organization’s costs are fixed A measure of the extent to which an organization’s contribution margin is sensitive to levels of debt A measure of the extent to which an organization’s operations are financed by debt A measure of the extent to which an organization’s profits contribute to reductions in debt Answer: A Rationale: Operating leverage is created by the existence of fixed costs; therefore, it is a measure of the extent to which a company has fixed costs. Topic: Operating Leverage Calculation LO: 5 32. Operating leverage is computed as: Contribution margin divided by income before taxes Fixed costs divided by income before taxes Income before taxes divided by total debt Operating income divided by total debt Answer: A Rationale: Operating leverage is calculated by dividing the dollar amount of contribution margin for a given level of operations by the amount of operating profit or the profit before taxes. Topic: Effect of Operating Leverage LO: 5 33. All else being equal, this is true about a firm with high operating leverage relative to a firm with low operating leverage: A higher percentage of the high operating leverage firm’s costs are fixed The debt payments limit the high operating leverage firm’s opportunities to turn a big profit The high operating leverage firm has more debt The high operating leverage firm is exposed to less risk Answer: A Rationale: Increased leverage is created by having a higher portion of total costs consisting fixed costs. Topic: Reducing Operating Leverage LO: 5 34. The best way to reduce operating leverage is to: Substitute direct materials for direct labor Substitute direct labor for automated equipment Substitute equity for debt Substitute in-house direct labor with outsourced labor Answer: B Rationale: Operating leverage is reduced by reducing fixed costs; therefore, by replacing automated equipment (i.e., depreciation, etc.) which is a fixed cost, with direct labor which is a variable cost, the portion of fixed costs will be reduced and operating leverage will be reduced. Topic: Operating Leverage Calculation LO: 5 35. Widrick Corporation had the following income statement for 2011: Sales $40,000 Less variable costs - 28,000 Contribution margin $12,000 Less fixed costs - 6,000 Net income $ 6,000 Widrick’s 2011 operating leverage is: 0.333 2.0 3.0 2.333 Answer: B Rationale: $12,000 / $6,000 = 2.0 Topic: Operating Leverage Calculation LO: 5 36. The Scully Corporation has the following data for 2011: Selling price per unit $10 Variable costs per unit $6 Fixed costs $20,000 Units sold 10,000 Scully’s 2011 operating leverage is: 0.50 2.00 4.00 1.00 Answer: B Rationale: [10,000 × ($10 – $6)] = $40,000 contribution margin - $20,000 = $20,000 Profit. $40,000 / $20,000 = 2.00 Operating leverage Topic: Profitability Analysis LO: 1 37. Profitability analysis involves examining the relationships among all of the following except: Revenues Costs Profits Products Answer: D Topic: CVP Analysis Assumptions LO: 1 38. A basic assumption of the cost-volume-profit model is that: All costs are classified as mixed costs The total cost function is linear outside of the relevant range The sales mix of multiple products remains constant More than one cost driver is required Answer: C Topic: Variable Manufacturing Costs LO: 1 39. Which of the following would be classified as a variable manufacturing cost? Depreciation Sales commissions Property taxes Lubricants for machinery Answer: D Topic: Fixed Costs LO: 1 40. Which of the following would be classified as a fixed selling and administrative cost? Sales Commissions Depreciation on office equipment Depreciation on factory equipment Wages of production supervisor Answer: B Topic: Profit Formula LO: 1 41. The following costs relate to Boxwood Company for a relevant range of up to 10,000 units annually: Variable Costs: Direct materials $2.50 Direct labor 0.75 Manufacturing Overhead 1.25 Selling and administrative 1.00 Fixed Costs: Manufacturing overhead $10,000 Selling and Administrative 5,000 Boxwood sells each unit for $10.00. Which of the following equations best describes the equation to determine total profit for a sales volume of 8,000 units? Profit = $10.00X – ($15,000 + $5.50X) Profit = $15,000 + $5.50X Profit = $10.00X – ($10,000 – $4.50X) Profit = $10X Answer: A Topic: Profit Formula LO: 1 42. The following costs related to Simpson Company for a relevant range of up to 20,000 units annually: Variable Costs: Direct materials $5.00 Direct labor 1.50 Manufacturing Overhead 2.50 Selling and administrative 2.00 Fixed Costs: Manufacturing overhead $20,000 Selling and Administrative 10,000 The selling price per unit of product is $15.00. At a sales volume of 15,000 units, what is the total cost for Simpson Company? $155,000 $195,000 $200,000 $250,000 Answer: B Topic: Profit Formula LO: 1 43. The following costs related to Simpson Company for a relevant range of up to 20,000 units annually: Variable Costs: Direct materials $5.00 Direct labor 1.50 Manufacturing Overhead 2.50 Selling and administrative 2.00 Fixed Costs: Manufacturing overhead $20,000 Selling and Administrative 10,000 The selling price per unit of product is $15.00. At a sales volume of 15,000 units, what is the total profit for Simpson Company? $ 30,000 $ 70,000 $225,000 $300,000 Answer: A Topic: Contribution Income Statement LO: 2 44. The difference between total revenue and total variable cost is called: Gross Profit Gross Margin Contribution Margin Profit Answer: C Topic: Contribution Income Statement LO: 2 45. Costs are classified according to behavior on which of the following? Contribution Income Statement Functional Income Statement Cost of Goods Sold Cost of Goods Manufactured Answer: A Topic: Contribution Income Statement LO: 2 46. Contribution margin measures: The difference between total sales and total cost of goods sold The difference between total sales and total costs The difference between sales and variable manufacturing costs The difference between total sales and total variable costs Answer: D Topic: Contribution Margin Ratio LO: 2 47. The contribution margin ratio is: The difference between price and variable cost per unit The percentage difference between sales and cost of goods sold The portion (or percent) of revenues available for covering fixed costs and providing a profit The percentage difference between total revenues and total costs Answer: C Topic: Contribution Margin Ratio LO: 2 48. The following information is available for Brentwood Corporation for a sales volume of 500 stereo speakers for the past month: Total Per Unit Sales $125,000 $250 Less: variable expenses 75,000 150 Contribution margin $ 50,000 $100 Less: fixed expenses $ 35,000 Net operating income $ 15,000 What is the contribution margin ratio? 12.0% 30.0% 40.0% 60.0% Answer: C Topic: Analysis Using Contribution Margin Ratio LO: 2 49. The following information is available for Brentwood Corporation for a sales volume of 500 stereo speakers for the past month: Total Per Unit Sales $125,000 $250 Less: variable expenses 75,000 150 Contribution margin $ 50,000 $100 Less: fixed expenses $ 35,000 Net operating income $ 15,000 If sales increase by $50,000, net income will increase by what amount? $ 6,000 $ 8,000 $20,000 $30,000 Answer: C Topic: Contribution Margin LO: 2 50. Rockford Corporation reported the following on their contribution format income statement: Sales (10,000 units) $350,000 Less: variable expenses 200,000 Contribution margin $150,000 Less: fixed expenses 135,000 Net operating income $ 15,000 What is the unit contribution margin? $35.00 $20.00 $15.00 $13.50 Answer: C Topic: Contribution Margin Ratio LO: 2 51. Rockford Corporation reported the following on their contribution format income statement: Sales (10,000 units) $350,000 Less: variable expenses 200,000 Contribution margin $150,000 Less: fixed expenses 135,000 Net operating income $ 15,000 What is the contribution margin ratio? 38.57% 57.14% 42.86% 4.30% Answer: C Topic: Contribution Margin LO: 2 52. Rockford Corporation reported the following on their contribution format income statement: Sales (10,000 units) $350,000 Less: variable expenses 200,000 Contribution margin $150,000 Less: fixed expenses 135,000 Net operating income $ 15,000 For each additional unit of sales, net operating income will increase by: $35.00 $21.50 $15.00 $ 1.50 Answer: C Topic: Contribution Margin LO: 2 53. Rockford Corporation reported the following on their contribution format income statement: Sales (10,000 units) $350,000 Less: variable expenses 200,000 Contribution margin $150,000 Less: fixed expenses 135,000 Net operating income $ 15,000 If sales increase by 10%, net operating income will increase by what amount? $-0- $ 1,500 $15,000 $30,000 Answer: C Topic: Contribution Margin LO: 2 54. Contribution margin is calculated by subtracting: Total variable costs from total revenues Total manufacturing costs from total revenues Fixed costs from total revenues Cost of goods sold from total revenues Answer: A Topic: Gross Margin LO: 2 55. Gross margin is calculated by subtracting: Total variable costs from total revenues Total manufacturing costs from total revenues Fixed costs from total revenues Cost of goods sold from total revenues Answer: D Topic: Cost-Volume-Profit Graph LO: 3 56. A cost-volume-profit graph: Plots both revenue and total cost on the Y-axis Plots both revenue and total cost on the X-axis Plots contribution margin on the Y-axis and volume on the X-axis Plots contribution margin on the X-axis and volume on the Y-axis Answer: A Topic: Cost-Volume-Profit Graph LO: 3 57. 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: Shift downward and have a steeper slope Shift downward and have a flatter slope Shift upward and have a flatter slope Shift upward and have a steeper slope Answer: C Topic: Cost-Volume-Profit Graph LO: 3 58. Gardner 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 increases Contribution margin per unit decreases Breakeven-even in units increase Contribution margin decreases Answer: A Topic: Margin of Safety LO: 3 59. The margin of safety is: The excess of sales over variable expenses. The excess of sales over fixed expenses. The excess of sales over the break-even volume of sales. The excess of net operating income over actual net operating income. Answer: C Topic: Break-Even Point LO: 3 60. Smith Company sells a single product at a selling price of $30 per unit. Variable expenses are $12 per unit and fixed expenses are $41,400. Smith’s break-even point is: 1, 380 units 2,300 units 3,450 units 6,900 units Answer: B Topic: Break-Even Point LO: 3 61. The following information pertains to Simpson Company: Sales (25,000 units) $500,000 Manufacturing expenses: Variable 170,000 Fixed 35,000 Selling and general expenses: Variable 5,000 Fixed 30,000 Simpson’s break-even point in number of units is: 4,924 5,000 6,250 9,286 Answer: B Topic: Margin of Safety LO: 3 62. The following monthly data are available for the Wilson Company and its only product: Unit selling price $36 Unit variable expenses $28 Total fixed expenses $50,000 Actual sales for the month of March 7,000 units The margin of safety for the company during March was: $ 27,000 $ 56,000 $ 6,000 $106,000 Answer: A Topic: Break-Even Point LO: 3 63. Rex Company sells a single product. The product has a selling price of $40 per unit and variable expenses of $15 per unit. The company’s fixed expenses total $30,000 per year. The company’s break-even point in terms of total sales dollars is: $100,000 $ 80,000 $ 60,000 $ 48,000 Answer: D Topic: Profit Planning LO: 3 64. Monson Company sells its product for $6 a unit. Next year, fixed expenses are expected to be $200,000 and variable expenses are estimated at $4 per unit. How many units must Monson sell to generate net operating income of $40,000? 50,000 units 60,000 units 100,000 units 120,000 units Answer: D Topic: Profit Planning LO: 3 65. Last year, Fox Company reported a profit of $70,000 when sales totaled $520,000 and the contribution margin ratio was 40%. If fixed expenses increase by $10,000 next year, what will sales have to be for the company to earn a profit of $80,000? $562,500 $570,000 $600,000 $625,000 Answer: B Topic: Margin of Safety LO: 3 66. If sales volume increases and all other factors remain constant, then the: Contribution margin ratio will increase Break-even point will decrease Margin of safety will increase Net operating income will decrease Answer: C Topic: Contribution Margin LO: 3 67. All other things being the same, which of the following statements would be true of the contribution margin and variable expenses of a capital-intensive company with high fixed costs and low variable costs as compared to a labor-intensive company with low fixed costs and high variable costs? Higher contribution margin and higher variable costs Lower contribution margin and higher variable costs Higher contribution margin and lower variable costs Lower contribution margin and lower variable costs Answer: C Topic: Break-Even Point LO: 4 68. In calculating the break-even point for a multi-product company, which of the following assumptions are commonly made? Sales volume equals production volume Variable expenses are constant per unit. A given sales mix is maintained for all volume changes. 1 and 2 1 and 3 2 and 3 1, 2 and 3 Answer: D Topic: Contribution Income Statement LO: 2 69. Menlove Corporation has provided the following cost data for last year when 100,000 units were produced and sold: Raw materials $200,000 Direct labor 100,000 Manufacturing overhead 200,000 Selling and administrative expense 150,000 All costs are variable except for $100,000 of manufacturing overhead and $100,000 of selling and administrative expense. If the selling price is $10 per unit, the net operating income from producing and selling 110,000 units would be: $450,000 $385,000 $405,000 $605,000 Answer: C Topic: Break-Even Point LO: 3 70. Easton Company’s break-even point in sales is $900,000, and its variable expenses are 75% of sales. If the company lost $32,000 last year, sales must have amounted to: $628,000 $772,000 $804,000 $868,000 Answer: B Topic: Multiple-Product Cost-Volume-Profit Analysis LO: 4 71. Campbell Company sells two products, as follows: Selling Price per Unit Variable expense per Unit Product Y $150 $ 75 Product Z 300 200 Fixed expenses total $225,000 annually. The expected sales mix in units is 60% for product Y and 40% for product Z. How much is Campbell’s expected break-even sales in dollars? $300,000 $420,000 $475,000 $555,882 Answer: D Rationale: BEP in sales dollars = Fixed Costs / CM Ratio The weighted average CM ratio = ($75 x 0.60) + ($100 x 0.40) = $85 The weighted average Sales Price = ($150 x 0.60) + ($300 x 0.40) = $210 Weighted Average CM ratio = $85 / $210 = 0.404762 BEP in $ = $225,000 / 0.404762 = $555,882 (rounded) Topic: Sales Mix LO: 4 72. Sales mix refers to: The portion of unit variable costs that are consumed by each product The relative portion of unit or dollar sales that are derived from each product The portion of manufacturing costs allocated to each product The portion of selling and general administrative costs allocated to each product Answer: B Topic: Multiple-Product Cost-Volume-Profit Analysis LO: 4 73. Marlin Company sells three different products that are similar, but are differentiated by various product features. Budgeted sales by product and in total for the coming year are shown below: Product Standard Deluxe Premium Total Percentage of total sales 48% 20% 32% 100% Sales $240,000 $100,000 $160,000 $500,000 Less: variable costs 72,000 80,000 88,000 240,000 Contribution margin $168,000 $ 20,000 $ 72,000 $260,000 Less: fixed expenses $223,600 Net operating income $ 36,400 The break-even point in sales dollars for Martin Company is: $320,000 $430,000 $447,200 $500,000 Answer: B Topic: Multiple-Product Cost-Volume-Profit Analysis LO: 4 74. Marlin Company sells three different products that are similar, but are differentiated by various product features. Budgeted sales by product and in total for the coming year are shown below: Product Standard Deluxe Premium Total Percentage of total sales 48% 20% 32% 100% Sales $240,000 $100,000 $160,000 $500,000 Less: variable costs 72,000 80,000 88,000 240,000 Contribution margin $168,000 $ 20,000 $ 72,000 $260,000 Less: fixed expenses $223,600 Net operating income $ 36,400 If the actual percentage of sales for the year were Standard, 40%; Deluxe, 50%; and Premium, 10%, than: The overall contribution margin would increase and break-even sales would decrease. The overall contribution margin would decrease and break-even sales would decrease. The overall contribution margin would increase and break-even sales would increase. The overall contribution margin would decrease and break-even sales would increase. Answer: D Topic: Multiple-Product Cost-Volume-Profit Analysis LO: 4 75. Marlin Company sells three different products that are similar, but are differentiated by various product features. Budgeted sales by product and in total for the coming year are shown below: Product Standard Deluxe Premium Total Percentage of total sales 48% 20% 32% 100% Sales $240,000 $100,000 $160,000 $500,000 Less: variable costs 72,000 80,000 88,000 240,000 Contribution margin $168,000 $ 20,000 $ 72,000 $260,000 Less: fixed expenses $223,600 Net operating income $ 36,400 If customers are indifferent to which of the products to purchase from Marlin Company, which product line should sales personnel recommend to customers that would most improve overall operating income? Product line with the highest sales price Product line with the lowest variable cost Product line with the highest contribution margin ratio Product line with the highest percentage of total budgeted sales Answer: C Topic: Operating Leverage LO: 5 76. Operating leverage is best described as: A measure of the extent to which an organization’s costs are fixed A measure of the extent to which an organization’s contribution margin is affected by sales mix of products A measure of the extent to which an organization’s operations are financed by debt A measure of the extent to which an organization’s operations are financed by equity Answer: A Topic: Operating Leverage LO: 5 77. Operating leverage is computed as: Contribution margin divided by net income Contribution margin divided by before-tax profit Fixed costs divided by before-tax profit Operating income divided by total debt Answer: B Topic: Operating Leverage LO: 5 78. Herald Company has sales of 1,000 units at $60 per unit. Variable expenses are 30% of the selling price. If total fixed expenses are $30,000, the degree of operating leverage is: 1.50 1.67 3.50 5.00 Answer: C Topic: Operating Leverage LO: 5 79. Brown Company’s contribution margin ratio is 15%. If the degree of operating leverage is 12 at the $150,000 sales level, before-tax profit at the $150,000 sales level must equal: $1,500 $1,875 $2,160 $2,700 Answer: B Topic: Operating Leverage LO: 5 80. Patterson Company has sales of 2,000 units at $70 per unit. Variable expenses are 40% of the selling price. If total fixed expenses are $44,000, the degree of operating leverage is: 0.79 1.40 2.10 3.50 Answer: C Topic: Operating Leverage LO: 5 81. A firm can reduce is operating leverage by substituting: Direct materials for direct labor Direct labor for robotic equipment Equity for debt Debt for equity Answer: B Topic: Operating Leverage LO: 5 82. Patterson Company’s contribution margin ratio is 20%. If the degree of operating leverage is 15 at the $225,000 sales level, before-tax profit at the $225,000 sales level must equal: $2,250 $3,000 $5,063 $6,750 Answer: B Topic: Operating Leverage LO: 5 83. Rawlings Corporation’s variable expenses are 60% of sales. At a $400,000 sales level, the degree of operating leverage is 5. If sales increased by $40,000, the new degree of operating leverage will be (rounded): 2.86 3.67 5.00 5.25 Answer: B Topic: Operating Leverage LO: 5 84. Other things being equal, the higher the degree of operating leverage, the _________ profit opportunity with increased sales and __________ risk of loss with a decrease in sales. Higher; higher Higher; lower Lower; lower Lower; higher Answer: A Topic: Operating Leverage LO: 5 85. At its current level of sales, a company has a degree of operating leverage of 5. This means that a 10% increase in sales would result in a: 5% Increase in before-tax profit 10% Increase in before-tax profit 50% Increase in before-tax profit 50% Increase in contribution margin Answer: C Topic: Operating Leverage LO: 5 86. Company A has a degree of operating leverage of 10, whereas, Company B has a degree of operating leverage of 5. Each company has the same level of sales. Which of the following statements is true? If sales increase by 10%, Company B would have a higher increase in before-tax profit. If sales decrease by 10%, Company A would have a lower decrease in before-tax profit. Company A has a higher relative amount of fixed costs in its cost structure than does Company B. Company B has a higher relative amount of fixed costs in its cost structure than does Company A. Answer: C Exercises Topic: Contribution Income Statement LO: 2 1. Oak, Inc. had the following income statement for last period: Sales $40,000 Cost of Sales (manufacturing) 24,000 Selling and General Administrative 6,000 Net Income $10,000 If costs of sales was 75% variable and 25% fixed, and Selling and General Expense was 60% variable and 40% fixed, prepare a contribution format income statement and calculate its contribution margin percentage? Answer: Sales $ 40,000 Variable costs; Manufacturing $18,000 Selling and general administrative 3,600 (21,600) Contribution margin $ 18,400 Fixed costs: Manufacturing $ 6,000 Selling and general administrative 2,400 8,400 Net Income $ 10,000 Contribution margin ratio = Contribution Margin / Sales = $18,400 / $40,000 = 0.46 Topic: Break-Even Calculation LO: 3 2. Jimmer, Inc. had a contribution margin of $22,400 on sales of $40,000 and had fixed costs of $16,800. Calculate its break-even point in sales dollars. Answer: Contribution margin percent = $22,400 / $40,000 = 0.56 or 56.0% Break-even = $16,800 / .56 = $30,000 Proof: $30,000 X .56 = $16,800 - $16,800 = $0 Topic: Profit Planning LO: 3 3. Knudson Company has a variable cost percentage of 40% on a product that sells for $25 per unit. Fixed costs are $22,500. Knudson wants to know how many units must be sold (a) to break even and (b) to earn a profit of $18,000. Ignore income taxes. Answer: Contribution margin per unit = (1.00 - 0.40) X $25 = $15.00 per unit Break-even = $22,500 / $15.00 = 1,500 units To earn a profit of $18,000 = (22,500 + 18,000) / $15.00 = 2,700 units Topic: Break-Even Calculation LO: 3 4. Bountiful Company had the following functional income statement for the month of May, 2011: Bountiful Company Functional Income Statement For the Month Ending May 31, 2011 Sales (15,000 units) $300,000 Cost of goods sold: Direct materials $60,000 Direct labor 45,000 Variable manufacturing overhead 37,500 Fixed factory overhead 50,000 192,500 Gross profit $107,500 Selling and administrative expenses: Variable $ 7,500 Fixed 20,000 27,500 Net income $ 80,000 Calculate Bountiful’s break-even sales in units. Answer: Unit variable costs = $4 (materials) + $3 (labor) + $2.50 (overhead) + $0.50 (selling and admin) = $10.00 Contribution margin = $20 (Sales) - $10.00 (variable costs) = $10 Fixed costs = $50,000 (factory overhead) + $20,000 (S&A) = $70,000 Break-even = $70,000 (fixed costs) / $10 (contribution margin) = 7,000 units Topic: Operating Leverage LO: 5 5. Perry Corporation’s income statement is presented below. Sales $ 40,000 Less variable costs (28,000) Contribution margin $ 12,000 Less fixed costs (6,000) Net income $ 6,000 Calculate Perry’s operating leverage. Answer: $12,000 (contribution margin) / $6,000 (operating income) = 2.0 Topic: Operating Leverage LO: 5 6. The Joseph Corporation has the following current data: Selling price per unit $20 Variable costs per unit $12 Fixed costs $60,000 Units sold 20,000 Calculate Joseph Corporation’s current operating leverage. Answer: Contribution margin = ($20 - $12) × 20,000 = $160,000 Net income = contribution margin of $160,000 less fixed cost of $60,000 = $100,000 Operating leverage = $160,000 ÷ $100,000 = 1.60 Topic: Operating Leverage LO: 5 7. Cosgrove sells tiling grout and reports the following data: Kilograms produced and sold 620,000 kg Sales revenue $4,960,000 Variable manufacturing expense 2, 325,000 Fixed manufacturing expense 1,308,000 Variable selling and administrative expense 341,000 Fixed selling and administrative expense 412,000 Net operating income $ 574,000 Calculate the company’s degree of operating leverage. Answer: Contribution margin = $4,960,000 (sales) - $2,325,000 (variable manufacturing expense) - $341,000 (variable selling and administrative expense) = $2,294,000 Operating leverage = $2,294,000 (contribution margin) / $574,000 (net operating income) = 4.0 (rounded). Topic: Effect of Decrease in Sales on Operating Margin LO: 5 8. The Joseph Corporation has the following data for 2010: Selling price per unit $20 Variable costs per unit $12 Fixed costs $60,000 Units sold 20,000 Calculate Joseph’s operating leverage at the end of 2011, assuming that 2011 sales decrease to 15,000 units. Answer: Contribution margin = ($20 - $12) × 15,000 = $120,000 Net income = contribution margin of $120,000 less fixed cost of $60,000 = $60,000 Operating leverage = $120,000 / $60,000 = 2.00 Topic: Effects of Decrease in Sales on Operating Margin LO: 5 9. Cosgrove sells tiling grout and reports the following data: Kilograms produced and sold 620,000 kg Sales revenue $4,960,000 Variable manufacturing expense 2, 325,000 Fixed manufacturing expense 1,308,000 Variable selling and administrative expense 341,000 Fixed selling and administrative expense 412,000 Net operating income $ 574,000 Calculate the company’s operating leverage if sales decrease by 10%. Answer: Contribution margin = $4,960,000 (sales) - $2,325,000 (variable manufacturing expense) - $341,000 (variable selling and administrative expense) = $2,294,000 Decrease in contribution margin = $2,294,000 (1 - 0.10) = 2,064,600 Operating Income = $2,064,600 - $1,308,000 (fixed manufacturing overhead) - $412,000 (fixed selling and admin expense) = $344,600 New degree of operating leverage = $2,064,600 (contribution margin) / $344,600 (operating income) = 5.99 Topic: Change in Operating Leverage LO: 5 10. The Brady Corporation has the following data for 2010: Selling price per unit $15 Variable costs per unit $9 Fixed costs $45,000 Units sold 15,000 Calculate Brady’s current operating leverage at the end of 2010, and its operating leverage at the end of 2011, assuming 2011 unit sales are only 12,000 units. Answer: At the end of 2010: Contribution margin = ($15 - $9) x 15,000 = $90,000 Operating income = $90,000 - $45,000 (fixed costs) = $45,000 Operating leverage = $90,000 / $45,000 = 2.0 At the end of 2011: Contribution margin = $6 x 12,000 units = $72,000 Operating income = $72,000 (contribution margin) - $45,000 (fixed cost) = $27,000 Operating leverage = $72,000 / $27,000 = 2.67 Topic: Operating Leverage Effect on Net Income LO: 5 11. If before-tax profit is $25,000 and operating leverage is 1.50 at the end of the most recent period, a 20% increase in sale will increase net income by what percent and what dollar amount? Answer: Net income will increase by 30%, which is the increase in sales percent of 20% times the current operating leverage of 1.50. Therefore, net income will increase by 30% of $25,000, or $7,500 to $32,500. Topic: Cost Estimation and Cost-Volume-Profit Analysis LO: 3 12. Oregon Manufacturing had the following data for the past three months. January February March Sales in units 3000 3,750 4,500 Operating expenses $272,000 $296,000 $320,000 Using the high-low method, estimate Oregon’s total fixed costs, contribution margin ratio and break-even point in sales dollars for April. Oregon expects to sell 5,000 units for $50 per unit. Answer: a = ($320,000 – $272,000) / (4,500 – 3,000) = $32 variable cost per unit b = $320,000 – $32 (4,500 units) = $176,000 or $272, 000 - $32(3,000 units) = $176,000 Contribution Margin = $50 - $32 = $18 Contribution Margin Ratio = $18 / $50 = 0.36 or 36.0% Break-even point in sales = $176,000 / 0.36 = $488,889 (rounded) Topic: Cost Estimation and Cost-Volume-Profit Analysis LO: 3 13. Maple Manufacturing had the following data for 2010 and 2011: 2011 2010 Revenues $40,578 $37,182 Operating Expenses 34,720 32,678 Operating Income $ 5,858 $ 4,504 Using the high-low method, estimate Maple’s variable cost ratio, and calculate its contribution margin ratio, total fixed costs, and break-even point in sales dollars. Answer: Using revenues as the measure of activity volume, the difference in operating expenses between 2011 and 2010 divided by the difference in revenues equals the variable cost ratio: Variable cost ratio = ($34,720 – $32,678) / ($40,758 – $37,182) = 0.6013 Contribution margin ratio = 1 – 0.6013 = 0.3987 Fixed costs equal total contribution margin less net income: ($40,578 x 0.3987) – $5,858 = $10,320 Breakeven Sales = Fixed Costs divided by Contribution Margin Ratio $10,320 / 0.3987 = $25,884 Topic: Multi-Product Contribution Margin LO: 4 14. Assume the Mountain Furniture Company sells two kinds of picnic tables, pine and redwood. At a 2:1 unit sales mix in which Mountain sells two pine tables for every redwood table, the following revenue and cost information is available. Pine Table Redwood Table Unit selling price $400 $1,200 Unit variable costs $250 $ 300 Unit contribution margin $150 $ 600 Fixed costs per month: $18,000 Assuming a 2:1 sales mix, calculate Mountain Furniture’s current monthly average unit contribution margin, break-even sales volume, and number of units of Pine and Redwood tables at break-even point. Answer: Average unit contribution margin: ($150 x 2/3) + ($600 x 1/3) = $300 Break-even sales volume: $18,000 (fixed costs) / $300 (average contribution margin) = 60 With a 2:1 sales mix, at break-even, there will be 40 pine tables and 20 redwood tables. Topic: Operating Leverage LO: 5 15. During the most recent fiscal period, Karson Company had sales of $80,000. Variable costs are 40% of sales and fixed costs amounted to $16,000 for the year. Calculate the following: Contribution margin ratio Operating leverage Breakeven sales in dollars Operating profit if sales increase by 15% next year Answer: a. Contribution margin ratio = Contribution Margin / Sales Variable costs = $80,000 x 40% = $32,000 Contribution margin = $80,000 – $32,000 = $48,000 Contribution margin ratio = $48,000 / $80,000 = 0.60 or 60.0% b. Operating income = Contribution Margin – Fixed Costs = $48,000 - $16,000 = $32,000 Operating Leverage = Contribution Margin / Operating Income; $48,000 / $32,000 = 1.50 c. Breakeven sales = Fixed costs / Contribution margin ratio = $16,000 / 0.6 = $26,667 d. Increase in sales of 15% would increase operating income by 15% x 1.5 = 22.5% Operating income = $32,000 x 1.225 = $39,200. Sales ($80,000 x 1.15) = $92,000 Variable Costs = (92,000 x 40%) = $36,800 Contribution Margin = $92,000 – $36,800 = $55,200 Operating Profit = $55,200 – $16,000 = $39,200 Problems Topic: Break-Even Analysis and Profit Planning LO: 3 1. Ozark Outdoors is a manufacturer of outdoor items. The company is considering the possibility of offering a new sleeping bag that would sell for $125 each. Cost to manufacture these sleeping bags includes $35 in materials and $25 in direct labor for each sleeping bag. Variable marketing and selling costs would be $15 each. In order to manufacture these sleeping bags, the company would need to incur $120,000 in fixed costs for new equipment. Required: a. Compute the break-even point of the sleeping bag in units sold. b. What would be the total revenue at the break even point? c. How many units would Ozark need to sell to earn a profit of $21,000? d. If fixed costs in fact are $150,000 rather than $120,000, how many units would need to be sold in order to earn $21,000? Answer: a. The breakeven point is $120,000 / ($125-35-25-15) = 2,400 units b. Total revenue at the break-even point would be 2,400 units times $125 = $300,000 c. To earn $21,000, it would need to sell ($141,000 / $50) = 2,820 units d. To earn $21,000, it would need to sell ($171,000 / $50) = 3,420 units Topic: Break-Even Analysis and Profit Planning LO: 3 2. The Farm Fresh Food Market is a merchandiser of organic food items. The company is considering the possibility of selling pomegranates that would sell for $0.59 each. Pomegranates can be acquired in unlimited quantities for $0.43 each. There are no additional variable costs associated with acquiring and selling pomegranates since labor is on a salaried basis. However, in order to acquire pomegranates at this price, Farm Fresh must pay $4,000 per year for membership in an International co-op. Required: a. How many pomegranates would Farm Fresh need to sell annually to justify joining the co-op (break-even)? b. What would be the total revenue at the break even point? c. How many pomegranates would the company need to sell to earn a profit of $6,000? d. If pomegranates cost were $0.51 instead of $0.43, how many pomegranates would need to be sold in order to earn the same $6,000? Answer: a. The breakeven point is $4,000 / ($0.59 - $0.43) = 25,000 units b. Total revenue at the break-even point would be 25,000 units times $0.59 = $14,750 c. To earn $6,000, it would need to sell ($10,000 / $0.16) = 62,500 units d. To earn $6,000, it would need to sell ($10,000 / $0.08) = 125,000 units. Twice as many units! Topic: Cost-Volume-Profit Analysis LO: 3 3. Supply the missing data in each independent case. Case A Case B Case C Case D Case E Unit sales 700 300 ? ? ? Sales revenue $35,000 ? ? $90,000 $50,000 Variable cost per unit $45 $3 $15 ? ? Contribution Margin ? $600 ? ? $20,000 Fixed costs $7,500 ? $60,000 ? ? Operating income ? -$500 ? ? ? Unit contribution margin ? ? ? $2 $4 Break-even point (units) ? ? 5,000 15,000 ? Margin of Safety ? ? 2,000 15,000 2800 Answer: Case A Case B Case C Case D Case E Unit sales 700 300 7,000 30,000 5,000 Sales revenue $35,000 $1,500 $189,000 $90,000 $50,000 Variable cost per unit $45 $3 $15 $1 $6 Contribution Margin $3,500 $600 $84,000 $60,000 $20,000 Fixed costs $7,500 $1,100 $60,000 $30,000 $8,800 Operating income -$4,000 -$500 $24,000 $30,000 $11,200 Unit contribution margin $5 $2 $12 $2 $4 Break-even point (units) 1,500 550 5,000 15,000 2,200 Margin of Safety -800 -250 2,000 15,000 2,800 Case A: Case B: Price = $35,000 / 700 = $50 Revenue = $600 + (300) x ($3) = $1,500 Unit C. M. = $50 - $45 = $5 Fixed Costs = $500 + $600 = $1,100 Total C. M. = ($5) x (700) = $3,500 Unit C. M. = $600 / 300 = $2 Op. Inc. = $3,500 - $7,500 = -$4,000 B. E. point = $1,100 / $2 = 550 B. E. point = $7,500 / $5 = 1,500 Margin Safety = 300 - 550 = -250 Margin Safety = 700 – 1,500 = -800 Case C: Case D: Unit Sales = 5,000 + 2,000 = 7,000 Unit Sales = 15,000 +15,000 = 30,000 Price = ($84,000/7,000) + ($15) = $27 Fixed Costs = (15,000) x ($2) = $30,000 Revenue = ($27) x (7,000) = $189,000 Price = $90,000/30,000 = $3 C. M. = $189,000 - (7,000) x ($15) = $84,000 V. C. per unit = $3 - $2 = $1 Op. Inc. = $84,000 - $60,000 = 24,000 C. M. = ($2) x (30,000) = $60,000 Unit C. M. = $27 - $15 = $12 Op. Inc. = $60,000 - $30,000 = $30,000 Case E: Unit Sales = $20,000/$4 = 5,000 Price = $50,000 / 5,000 = $10 V. C. per unit = $10 - $4 = $6 B. E. point = 5,000 – 2,800 = 2,200 Fixed Costs = (2,200) x ($4) = $8,800 Op. Inc. = $20,000 - $8,800 = $11,200 Topic: Cost Estimation and Cost-Volume-Profit Analysis LO: 3 4. Presented below are condensed data from the 2010 and 2011 Urban Utility Corporation’s income statements (in millions): 2010 2011 Revenues $15,331 $12,121 Operating Expenses - 11,569 - 11,248 Operating Income $ 3,762 $ 873 Required: Analyze Urban Utility’s cost-volume-profit relationships by applying the high-low method of cost estimation to the above information and complete the following: a. Estimate the variable cost ratio. b. Estimate annual fixed costs. c. Compute the contribution margin ratio. d. Compute the annual break-even point in dollars. e. Applying these calculations, predict Urban Utility’s operating income if 2012 revenues are predicted as $15,000 million. f. What factors make the above analysis appropriateness for Urban Utility? What circumstances would make it inappropriate for Urban Utility? Answer: a. The variable cost ratio is the difference in total costs ($11,569 - $11,248) divided by the difference in revenues ($15,331 - $12,121). This equals ($321/$3,210) = 0.10 b. The estimated annual fixed cost: $11,569 - (0.10) ($15,331) = $10,036 million c. The contribution margin ratio: 1 - 0.10 = 0.90 d. Break-even point: $10,036/0.90 = $11,151 million e. Contribution margin $15,000 x (1.00 – 0.10) = $13,500 Fixed costs = - 10,036 Operating income = $ 3,464 million f. Assuming stable prices, costs, and technology, the analysis is appropriate for Urban Utility. If there were changes in prices, costs, or technology, the analysis might not be appropriate. Topic: Contribution Income Statements and CVP Analysis LO: 2, 3 5. The PC Supply manufactures memory cards that sell to wholesalers for $2.00 each. Variable and fixed costs are as follows: Variable Costs per card: Fixed Costs per Month: Manufacturing Direct materials $0.30 Direct labor 0.25 Factory overhead 0.25 0.80 Factory overhead $4,000 Selling and admin. 0.15 Selling and admin. 3,000 Total $0.95 Total $7,000 PC Supply produced and sold 10,000 cards during October 2010. There were no beginning or ending inventories. Required: a. Prepare a contribution income statement for the month of October. b. Determine PC Supply’s monthly break-even point in units. c. Determine the effect on monthly profit of a 500 unit increase in monthly sales. d. If PC Supply is subject to an income tax of 40 percent, determine the dollar sales volume is required to earn a monthly after-tax profit of $15,000. Answer: a. PC Supply Company Contribution Income Statement For the Month Ending October 31, 2010 Sales ($2 x 10,000) $20,000 Less variable costs: Direct materials ($0.30 x 10,000) $3,000 Direct labor ($0.25 x 10,000) 2,500 Variable factory overhead ($0.25 x 10,000) 2,500 Variable S & A exp. ($0.15 x 10,000) 1,500 -$ 9,500 Contribution margin $10,500 Less fixed costs: Factory overhead $4,000 Selling and administrative 3,000 - 7,000 Profit $ 3,500 b. Unit selling price $2.00 Less unit variable costs - 0.95 Unit contribution margin $1.05 Break-even point = $7,000 / $1.05 = 6,667 units c. Increase in unit sales 500 Unit contribution margin x $1.05 Increase in monthly profits $ 525 d. Desired before-tax profit = $15,000 / (1 - 0.40) = $25,000 Contribution margin percentage = $1.05 / $2.00= 52.5 percent Required sales volume = ($7,000 + $25,000) / 0.525 = $60,952 (rounded) Topic: Contribution Margin LO: 3 6. The Hall Company had the following functional income statement for the month of January 2011: Sales ($10 x 20,000 units) $200,000 Cost of goods sold: Direct materials $50,000 Direct labor 20,000 Variable factory overhead 60,000 Fixed factory overhead 26,000 - 156,000 Gross profit $ 44,000 Selling and administrative expenses: Variable $12,000 Fixed 24,000 - 36,000 Net income $ 8,000 There were no beginning and ending inventories. Required: a. Prepare a contribution income statement. b. Calculate the contribution margin per unit. c. Calculate the contribution margin ratio. Answer: a. Hall Company Contribution Income Statement For the Month Ending January 31, 2011 Sales $200,000 Less variable costs: Direct materials $50,000 Direct labor 20,000 Variable factory overhead 60,000 Variable S & A expenses _12,000 -142,000 Contribution margin $ 58,000 Less fixed costs: Factory overhead $26,000 Fixed S & A expenses 24,000 - 50,000 Net income $ 8,000 b. $58,000 / 20,000 units = $2.90 per unit c. $58,000 / $200,000 = 29 percent Essay Questions Topic: Cost-Volume-Profit Analysis Model LO: 1 1. Briefly describe the cost-volume-profit analysis model and discuss how it can be used. Answer: Cost-Volume-Profit analysis is a technique used to examine the relationships among the total volume of some cost driver (usually volume), total costs, total revenues, and consequently, profits during a defined period of time (typically a month, a quarter or a year). Cost-Volume-Profit analysis is widely used in service, manufacturing, merchandising, and even non-profit organizations. Cost-Volume-Profit analysis is most useful in the early stages of planning because it provides an easily understood framework for discussing planning issues and organizing relevant data. The analysis is used to address a variety of issues. These include (1) determining a breakeven point in sales units or sales dollars; (2), determining the amount of sales (units or dollars) necessary to earn a target profit; (3) determining sensitivity of profit to changes in price or costs. Topic: Assumptions of Cost-Volume-Profit Analysis LO: 1 2. Cost-Volume-Profit analysis is subject to a number of assumptions. List five assumptions that are necessary to make cost-volume-profit analysis tractable (feasible). Answer: The text discusses five assumptions that facilitate cost-volume-profit. These assumptions are: 1. All costs are classified as either fixed or variable (with respect to the cost driver analyzed). 2. The variable cost function (and consequently, the total cost function) are linear within the range relevant to analysis. 3. The total revenue function is linear within the range relevant to analysis. 4. The analysis is either for a single product (or service) or multiple products with a known constant sales mix. 5. The analysis considers only one cost driver (most commonly sales volume). Topic: Contribution versus Functional Income Statement LO: 2 3. Briefly compare and contrast a contribution income statement with a functional income statement. Answer: In a contribution income statement, costs are classified according to behavior as variable or fixed, and the contribution margin (the difference between total revenues and total variable costs) that goes toward covering fixed costs and providing a profit is emphasized. In a functional income statement, costs are classified according to function (rather than behavior), such as manufacturing, selling, and administrative. This is the type of income statement typically included in corporate annual reports. Topic: Contribution Margin LO: 2 4. Briefly explain the terms (1) contribution margin and (2) contribution margin ratio and why they are useful (two to three sentences each). Answer: (1) Contribution margin is defined as the difference between total revenues and total variable costs. Unit contribution margin is defined as the difference between the unit selling price and the unit variable costs. In either case, contribution margin identifie