Deck 16: Cost-Volume-Profit Analysis

Question 1

Break-Even Units and Sales Revenue: Margin of Safety
Dupli-Pro Copy Shop provides photocopying service. Next year, Dupli-Pro estimates it will copy 2,800,000 pages at a price of $0.08 each in the coming year. Product costs include:

There is no variable selling expense; fixed selling and administrative expenses total $46,000.
Required:
1. Calculate the break-even point in units.
2. Calculate the break-even point in sales revenue.
3. Calculate the margin of safety in units for the coming year.
4. Calculate the margin of safety in sales revenue for the coming year.
5. What if the total selling and administrative expenses are reduced to $38,800? Recalculate:
a. Break-even point in units
b. Break-even point in sales revenue
c. Margin of safety in units for the coming year
d. Margin of safety in sales revenue for the coming year

Answer 1

1. The breakeven point is a point where there is no profit or loss, hence it shall be calculated by using following formula:
Hence, applying the above formula we get:
Note : Variable cost is calculated by adding Direct Material, Direct Labor and Variable Overhead, while fixed cost is calculated by adding Fixed Selling Expenses in total fixed overhead.
2. The Break Even Point in sales revenue shall be calculated by multiplying BEP units with the Sales price hence it shall be done in following manner:
3. The Margin of safety is a difference between actual sales and Break Even Point sales, hence it is calculated using formula:
4. The Margin of safety in terms of revenue shall be calculated by multiplying the sales price with Margin of Safety Sales, hence it shall be done in following manner:
5. If the total selling and administrative costs are reduced to 38,800 then the calculations shall be made in following manner:
a. Break Even Points in units:
b. Break Even Points in Sales Revenue: It shall be calculated by multiplying BEP units with the Sales price hence it shall be done in following manner:
c. Margin of Safety in Units:
d. Margin of Safety in terms of revenue:
The Margin of safety in terms of revenue shall be calculated by multiplying the sales price with Margin of Safety Sales; hence it shall be done in following manner:

Question 2

Define the term margin of safety. Explain what is meant by the term operating leverage. What impact does an increase in the margin of safety have on risk? What impact does an increase in leverage have on risk?

Answer 2

Margin of safety:
Margin of safety is the amount or percentage extent by which actual or estimated sales exceed the break-even sales. Margin of safety is useful to measuring risk. Margin of safety calculate by following formulas:
Operating Leverage:
It is the use of fixed cost to increase the percentage changes in profits as sales activity changes
The sales, which are generated beyond the break-even point, are profitable to company, hence it can be said that Increase in the margin of safety reduces the risk.
Increase in operating leverage increase the fixed cost, proportionally sales are to be increased, if not proportionally sales are increased then risk will be increased.

Question 3

(2011 CPA Exam) Black Co.'s breakeven point was $780,000. Variable expenses averaged 60% of sales, and the margin of safety was $130,000. What was Black's contribution margin?

A) $364,000
B) $546,000
C) $910,000
D) $1,300,000

Answer 3

Breakeven point refers to a point where the company earns no profit, nor incurred any loss. At this point the fixed cost of the company is equal to the Contribution margin of the company. The company earns only that much of profit which can be used to pay only the fixed cost incurred.
Since margin of safety and the breakeven sales are given we can calculate the total sales through the following formulae:
Since, the variable cost margin of the total sales is 60%, it is obvious that the contribution margin is 40% of the total sales.
Thus,
Hence, it is proved that the
is the correct answer
Note: All figures are in $.

Question 4

What is the variable cost ratio? The contribution margin ratio? How are the two ratios related?

Question 5

Break-Even in Sales Revenue, Margin of Safety
Sports-Reps, Inc., represents professional athletes and movie and television stars. The agency had revenue of $12,345,000 last year, with total variable costs of $5,678,700 and fixed costs of $2,192,400.
Required:
1. What is the contribution margin ratio for Sports-Reps based on last year's data? What is the break-even point in sales revenue?
2. What was the margin of safety for Sports-Reps last year?
3. One of Sports-Reps's agents proposed that the firm begin cultivating high school sports stars around the nation. This proposal is expected to increase revenue by $230,000 per year, with increased fixed costs of $122,500. Is this proposal a good idea? Explain.

Question 6

(2011 CPA Exam) The following information data pertain to a manufacturing company:

What is the break-even level in sales dollars?

A) $30,000
B) $40,000
C) $50,000
D) $80,000

Question 7

Degree of Operating Leverage, Percent Change in Profit
Ringsmith Company is considering two different processes to make its product-process 1 and process 2. Process 1 requires Ringsmith to manufacture subcomponents of the product in-house. As a result, materials are less expensive, but fixed overhead is higher. Process 2 involves purchasing all subcomponents from outside suppliers. The direct materials costs are higher, but fixed factory overhead is considerably lower. Relevant data for a sales level of 30,000 units follow:

Required:
1. Compute the degree of operating leverage for each process.
2. Suppose that sales are 20 percent higher than budgeted. By what percentage will operating income increase for each process? What will be the increase in operating income for each system? What will be the total operating income for each process?
3. What if unit sales are 10 percent lower than budgeted? By what percentage will operating income decrease for each process? What will be the total operating income for each process?

Question 8

Why does the activity-based costing approach to CVP analysis offer more insight than the conventional approach does?

Question 9

(2011 CPA Exam) A company produces and sells two products. The first product accounts for 75% of sales and the second product accounts for the remaining 25% of sales. The first product has a selling price of $10 per unit, variable costs of $6 per unit, and allocated fixed costs of $100,000. The second product has a selling price of $25 per unit, variable costs of $13 per unit, and allocated fixed costs of $212,000. At the break-even point, what number of units of the first product will have been sold?

A) 52,000
B) 39,000
C) 25,000
D) 14,625

Question 10

If the contribution margin increases from 30 to 35 percent of sales, what will happen to the break-even point, and why will this occur?

Question 11

Break-Even in Units, After-Tax Target Income, CVP Assumptions
Campbell Company manufactures and sells adjustable canopies that attach to motor homes and trailers. The market covers both new unit purchases as well as replacement canopies. Campbell developed its 2013 business plan based on the assumption that canopies would sell at a price of $400 each. The variable costs for each canopy were projected at $200, and the annual fixed costs were budgeted at $120,000. Campbell's after-tax profit objective was $225,000; the company's effective tax rate is 40 percent.
While Campbell's sales usually rise during the second quarter, the May financial statements reported that sales were not meeting expectations. For the first five months of the year, only 350 units had been sold at the established price, with variable costs as planned, and it was clear that the 2013 after-tax profit projection would not be reached unless some actions were taken. Campbell's president assigned a management committee to analyze the situation and develop several alternative courses of action. The following mutually exclusive alternatives, labeled A, B, and C, were presented to the president:
A. Lower the variable costs per unit by $25 through the use of less expensive materials and slightly modified manufacturing techniques. The sales price will also be reduced by $30, and sales of 2,200 units for the remainder of the year are forecast.
B. Reduce the sales price by $40. The sales organization forecasts that with the significantly reduced sales price, 2,700 units can be sold during the remainder of the year. Total fixed and variable unit costs will stay as budgeted.
C. Cut fixed costs by $10,000, and lower the sales price by 5 percent. Variable costs per unit will be unchanged. Sales of 2,000 units are expected for the remainder of the year.
Required:
1. Determine the number of units that Campbell Company must sell in order to break even assuming no changes are made to the selling price and cost structure.
2. Determine the number of units that Campbell Company must sell in order to achieve its after-tax profit objective.
3. Determine which one of the alternatives Campbell Company should select to achieve its annual after-tax profit objective. Be sure to support your selection with appropriate calculations.
4. The precision and reliability of CVP analysis are limited by several underlying assumptions. Identify at least four of these assumptions. ( CMA adapted )

Question 12

Break-Even in Units
Don Masters and two of his colleagues are considering opening a law office in a large metropolitan area that would make inexpensive legal services available to those who could not otherwise afford these services. The intent is to provide easy access for their clients by having the office open 360 days per year, 16 hours each day from 7:00 a.m. to 11:00 p.m. The office would be staffed by a lawyer, paralegal, legal secretary, and clerk-receptionist for each of the two 8-hour shifts.
In order to determine the feasibility of the project, Don hired a marketing consultant to assist with market projections. The results of this study show that if the firm spends $500,000 on advertising the first year, the number of new clients expected each day would have the following probability distribution:

Don and his associates believe these numbers are reasonable and are prepared to spend the $500,000 on advertising. Other pertinent information about the operation of the office is as follows.
The only charge to each new client would be $30 for the initial consultation. All cases that warranted further legal work would be accepted on a contingency basis with the firm earning 30 percent of any favorable settlements or judgments. Don estimates that 20 percent of new client consultations will result in favorable settlements or judgments averaging $2,000 each. Repeat clients are not expected during the first year of operations.
The hourly wages of the staff are projected to be $25 for the lawyer, $20 for the paralegal, $15 for the legal secretary, and $10 for the clerk-receptionist. Fringe benefit expenses will be 40 percent of the wages paid. A total of 400 hours of overtime is expected for the year; this will be divided equally between the legal secretary and the clerk-receptionist positions. Overtime will be paid at one and one-half times the regular wage, and the fringe benefit expense will apply to the full wages.
Don has located 6,000 square feet of suitable office space, which rents for $28 per square foot annually. Associated expenses will be $22,000 for property insurance and $32,000 for utilities.
It will be necessary for the group to purchase malpractice insurance, which is expected to cost $180,000 annually. The initial investment in office equipment will be $60,000; this equipment has an estimated useful life of four years. The cost of office supplies has been estimated to be $4 per expected new client consultation.
Required:
1. Determine how many new clients must visit the law office being considered by Don Masters and his colleagues in order for the venture to break even during its first year of operations.
2. Using the information provided by the marketing consultant, determine if it is feasible for the law office to achieve break-even operations. (CMA adapted)

Question 13

Suppose a firm with a contribution margin ratio of 0.3 increased its advertising expenses by $10,000 and found that sales increased by $30,000. Was it a good decision to increase advertising expenses? Why is this simple problem an important one for businesspeople to understand?

Question 14

CVP: Before- and After-Tax Targeted Income
Head-Gear Company produces helmets for bicycle racing. Currently, Head-Gear charges a price of $230 per helmet. Variable costs are $80.50 per helmet, and fixed costs are $1,255,800. The tax rate is 25 percent. Last year, 14,000 helmets were sold.
Required:
1. What is Head-Gear's net income for last year?
2. What is Head-Gear's break-even revenue? (Round to the nearest dollar.)
3. Suppose Head-Gear wants to earn before-tax operating income of $900,000. How many units must be sold? (Round to the nearest unit.)
4. Suppose Head-Gear wants to earn after-tax net income of $650,000. How many units must be sold? (Round to the nearest unit.)
5. Suppose the income tax rate rises to 35 percent. How many units must be sold for HeadGear to earn after-tax income of $650,000? (Round to the nearest unit.)

Question 15

Using a Computer Spreadsheet to Solve Multiple-Product Break-Even: Varying Sales Mix
More-Power Company has projected sales of 75,000 regular sanders and 30,000 mini-sanders for next year. The projected income statement is as follows: 3

Required:
1. Set up the given income statement on a spreadsheet (e.g., Excel™). Then, substitute the following sales mixes, and calculate operating income. Be sure to print the results for each sales mix (a through d).

2. Calculate the break-even units for each product for each of the preceding sales mixes.

Question 16

Contribution Margin, Break-Even Units, Contribution Margin Income Statement, Margin of Safety
Zebra Company manufactures custom-designed skins (covers) for iPods® and other portable MP3 devices. Variable costs are $10.80 per custom skin, the price is $16, and fixed costs are $66,560.
Required:
1. What is the contribution margin for one custom skin?
2. How many custom skins must Zebra Company sell to break even?
3. If Zebra Company sells 13,000 custom skins, what is the operating income?
4. Calculate the margin of safety in units and in sales revenue if 13,000 custom skins are sold.

Question 17

CVP, Before- and After-Tax Targeted Income
Sara Pacheco is a sophomore in college and earns a little extra money by making beaded key ring accessories. She sells them on Saturday mornings at the local flea market. Sara charges $5 per unit and has unit variable costs (beads, wire rings, etc.) of $2. Her fixed costs consist of small pliers, a glue gun, etc., which cost her $90.
Required:
1. Calculate Sara's break-even units.
2. Prepare a profit-volume graph for Sara.
3. Prepare a cost-volume-profit graph for Sara.

Question 18

Contribution Margin: Unit Amounts
Consider the following information on four independent companies.

Required:
Calculate the correct amount for each question mark. Be sure to round any fractional breakeven units up to the next whole number.

Question 19

Variable Costs, Contribution Margin, Contribution Margin Ratio
Super-Tees Company plans to sell 12,000 T-shirts at $16 each in the coming year. Product costs include:

Variable selling expense is the redemption of a coupon, which averages $0.80 per T-shirt; fixed selling and administrative expenses total $19,000.
Required:
1. Calculate the:
a. Variable product cost per unit
b. Total variable cost per unit
c. Contribution margin per unit
d. Contribution margin ratio (rounded to four significant digits)
e. Total fixed expense for the year
2. Prepare a contribution-margin-based income statement for Super-Tees Company for the coming year.
3. What if the per unit selling expense increased from $0.80 to $1.75? Calculate the new values for the following:
a. Variable product cost per unit
b. Total variable cost per unit
c. Contribution margin per unit
d. Contribution margin ratio (rounded to four significant digits)
e. Total fixed expense for the year

Question 20

Define the term sales mix, and give an example to support your definition.

Question 21

Break-Even in Sales Revenue, Changes in Variables
Carmichael Corporation is in the process of preparing next year's budget. The pro forma income statement for the current year is as follows:

Required:
1. What is the break-even sales revenue (rounded to the nearest dollar) for Carmichael Corporation for the current year?
2. For the coming year, the management of Carmichael Corporation anticipates an 8 percent increase in variable costs and a $60,000 increase in fixed expenses. What is the break-even point in dollars for next year? (CMA adapted)

Question 22

Break-Even in Sales Revenue, Variable-Costing Ratio, Contribution Margin Ratio, Margin of Safety
Hammond Company runs a driving range and golf shop. The budgeted income statement for the coming year is as follows.

Required:
1. What is Hammond's variable cost ratio? Its contribution margin ratio?
2. Suppose Hammond's actual revenues are $200,000 greater than budgeted. By how much will before-tax profits increase? Give the answer without preparing a new income statement.
3. How much sales revenue must Hammond earn in order to break even? What is the expected margin of safety? (Round your answers to the nearest dollar.)
4. How much sales revenue must Hammond generate to earn a before-tax profit of $130,000? An after-tax profit of $90,000? (Round your answers to the nearest dollar.) Prepare a contribution margin income statement to verify the accuracy of your last answer.

Question 23

Explain how CVP analysis can be used for managerial planning.

Question 24

Break-Even in Units
Gelbart Company manufactures gas grills. Fixed costs amount to $16,335,000 per year. Variable costs per gas grill are $225, and the average price per gas grill is $600.
Required:
1. How many gas grills must Gelbart Company sell to break even?
2. If Gelbart Company sells 46,775 gas grills in a year, what is the operating income?
3. If Gelbart Company's variable costs increase to $240 per grill while the price and fixed costs remain unchanged, what is the new break-even point?

Question 25

Assumptions and Use of Variables
Choose the best answer for each of the following multiple-choice questions.
1. Cost-volume-profit analysis includes some simplifying assumptions. Which of the following is not one of these assumptions?
a. Cost and revenues are predictable.
b. Cost and revenues are linear over the relevant range.
c. Changes in beginning and ending inventory levels are insignificant in amount.
d. Sales mix changes are irrelevant.
2. The term relevant range, as used in cost accounting, means the range
a. over which costs may fluctuate
b. over which cost relationships are valid
c. of probable production
d. over which production has occurred in the past 10 years
3. How would the following be used in calculating the number of units that must be sold to earn a targeted operating income?

4. Information concerning Korian Corporation's product is as follows:

Assuming that Korian increased sales of the product by 20 percent, what should the operating income be?
a. $20,000
b. $24,000
c. $32,000
d. $80,000
5. The following data apply to McNally Company for last year:

McNally wants to sell an additional 50,000 units at the same selling price and contribution margin. By how much can fixed costs increase to generate additional profit equal to 10 percent of the sales value of the additional 50,000 units to be sold?
a. $50,000
b. $57,500
c. $67,500
d. $125,000
6. Bryan Company's break-even point is 8,500 units. Variable cost per unit is $140, and total fixed costs are $297,500 per year. What price does Bryan charge?
a. $140
b. $35
c. $175
d. Cannot be determined from the above data

Question 26

Changes in Break-Even Points with Changes in Unit Prices
Salamanca produces and sells refrigerator magnets to be sold as novelty items by resorts. Last year, Salamanca sold 198,400 units. The income statement for Salamanca, Inc., for last year is as follows:

Required:
1. Compute the break-even point in units and in revenues. Compute the margin of safety in sales revenue for last year.
2. Suppose that the selling price decreases by 8 percent. Will the break-even point increase or decrease? Recompute the break-even point in units. (Round up to the nearest whole unit.)
3. Suppose that the variable cost per unit decreases by $0.20. Will the break-even point increase or decrease? Recompute the break-even point in units. (Round up to the nearest whole unit.)
4. Can you predict whether the break-even point increases or decreases if both the selling price and the unit variable cost decrease? Recompute the break-even point in units incorporating both of the changes in Requirements 2 and 3. (Round up to the nearest whole unit.)
5. Assume that total fixed costs increase by $50,000. (Assume no other changes from the original data.) Will the break-even point increase or decrease? Recompute it. (Round up to the nearest whole unit.)

Question 27

Break-Even Units: Units for Target Profit
Jay-Zee Company makes an in-car navigation system. Next year, Jay-Zee plans to sell 16,000 units at a price of $320 each. Product costs include:

Variable selling expense is a commission of 5 percent of price; fixed selling and administrative expenses total $116,400.
Required:
1. Calculate the sales commission per unit sold. Calculate the contribution margin per unit.
2. How many units must Jay-Zee Company sell to break even? Prepare an income statement for the calculated number of units.
3. Calculate the number of units Jay-Zee Company must sell to achieve target operating income (profit) of $333,408.
4. What if the Jay-Zee Company wanted to achieve a target operating income of $322,000? Would the number of units needed increase or decrease compared to your answer in Requirement 3? Compute the number of units needed for the new target operating income.

Question 28

Explain how CVP analysis developed for single products can be used in a multiple-product setting.

Question 29

Contribution Margin, CVP, Net Income, Margin of Safety
Nail Glow, Inc., produces novelty nail polishes. Each bottle sells for $5.90. Variable unit costs are as follows:

Fixed overhead costs are $34,475 per year. Fixed selling and administrative costs are $6,720 per year. Nail Glow sold 35,000 bottles last year.
Required:
1. What is the contribution margin per unit for a bottle of nail polish? What is the contribution margin ratio? (Round to four significant digits.)
2. How many bottles must be sold to break even? What is the break-even sales revenue?
3. What was Nail Glow's operating income last year?
4. What was the margin of safety in revenue?
5. Suppose that Nail Glow, Inc., raises the price to $6.50 per bottle, but anticipated sales will drop to 28,750 bottles. What will the new break-even point in units be? Should Nail Glow raise the price? Explain.

Question 30

Break-Even, After-Tax Target Income, Margin of Safety, Operating Leverage
Faldo Company produces a single product. The projected income statement for the coming year, based on sales of 200,000 units, is as follows:

Required:
1. Compute the unit contribution margin and the units that must be sold to break even. Suppose that 30,000 units are sold above the break-even point. What is the profit?
2. Compute the contribution margin ratio and the break-even point in dollars. Suppose that revenues are $200,000 greater than expected. What would the total profit be?
3. Compute the margin of safety in sales revenue.
4. Compute the operating leverage. Compute the new profit level if sales are 20 percent higher than expected.
5. How many units must be sold to earn a profit equal to 10 percent of sales?
6. Assume the income tax rate is 40 percent. How many units must be sold to earn an after-tax profit of $180,000?

Question 31

Describe the difference between the units-sold approach to CVP analysis and the sales- revenue approach.

Question 32

Contribution Margin Ratio, Break-Even Sales Revenue, Sales Revenue for Target Profit
Schylar Pharmaceuticals, Inc., plans to sell 130,000 units of antibiotic at an average price of $22 each in the coming year. Total variable costs equal $1,086,800. Total fixed costs equal $8,000,000.
(Round all ratios to four significant digits, and round all dollar amounts to the nearest dollar.)
Required:
1. What is the contribution margin per unit? What is the contribution margin ratio?
2. Calculate the sales revenue needed to break even.
3. Calculate the sales revenue needed to achieve a target profit of $245,000.
4. What if the average price per unit increased to $23.50? Recalculate:
a. Contribution margin per unit
b. Contribution margin ratio (rounded to four decimal places)
c. Sales revenue needed to break even
d. Sales revenue needed to achieve a target profit of $245,000

Question 33

Operating Leverage
Income statements for two different companies in the same industry are as follows:

Required:
1. Compute the degree of operating leverage for each company.
2. Compute the break-even point for each company. Explain why the break-even point for Quintex, Inc., is higher.
3. Suppose that both companies experience a 50 percent increase in revenues. Compute the percentage change in profits for each company. Explain why the percentage increase in Quintex's profits is so much greater than that of Trimax.

Question 34

Basic CVP Concepts
Katayama Company produces a variety of products. One division makes neoprene wetsuits. The division's projected income statement for the coming year is as follows:

Required:
1. Compute the contribution margin per unit, and calculate the break-even point in units. Repeat, using the contribution margin ratio.
2. The divisional manager has decided to increase the advertising budget by $140,000 and cut the average selling price to $200. These actions will increase sales revenues by $1 million. Will this improve the division's financial situation? Prepare a new income statement to support your answer.
3. Suppose sales revenues exceed the estimated amount on the income statement by $612,000. Without preparing a new income statement, determine by how much profits are underestimated.
4. How many units must be sold to earn an after-tax profit of $1.254 million? Assume a tax rate of 34 percent. (Round your answer up to the next whole unit.)
5. Compute the margin of safety in dollars based on the given income statement.
6. Compute the operating leverage based on the given income statement. (Round to three significant digits.) If sales revenues are 20 percent greater than expected, what is the percentage increase in profits?

Question 35

Break-Even Sales: Sales for Target Profit
Health-Temp Company is a placement agency for temporary nurses. It serves hospitals and clinics throughout the metropolitan area. Health-Temp Company believes it will place temporary nurses for a total of 23,500 hours next year. Health-Temp charges the hospitals and clinics $90 per hour and has variable costs of $75.60 per hour (this includes the payment to the nurse). Total fixed costs equal $321,000.
Required:
1. Calculate the contribution margin per unit and the contribution margin ratio.
2. Calculate the sales revenue needed to break even.
3. Calculate the sales revenue needed to achieve a target profit of $100,000.
4. What if Health-Temp had target operating income (profit) of $110,000? Would sales revenue be larger or smaller than the one calculated in Requirement 3? Why? By how much?

Question 36

Why might a multiple-product firm choose to calculate just overall break-even revenue rather than the break-even quantity by product?

Question 37

CVP Analysis of Multiple Products
Steinberg Company produces commercial printers. One is the regular model, a basic model that is designed to copy and print in black and white. Another model, the deluxe model, is a color printer-scanner-copier. For the coming year, Steinberg expects to sell 90,000 regular models and 18,000 deluxe models. A segmented income statement for the two products is as follows:

Required:
1. Compute the number of regular models and deluxe models that must be sold to break even.
2. Using information only from the total column of the income statement, compute the sales revenue that must be generated for the company to break even. (Round the contribution margin ratio to four significant digits and the sales revenue to the nearest dollar.)

Question 38

CVP Analysis: Sales-Revenue Approach, Pricing, After-Tax Target Income
Mahan Consulting is a service organization that specializes in the design, installation, and servicing of mechanical, hydraulic, and pneumatic systems. For example, some manufacturing firms, with machinery that cannot be turned off for servicing, need some type of system to lubricate the machinery during use. To deal with this type of problem for a client, Mahan designed a central lubricating system that pumps lubricants intermittently to bearings and other moving parts.
The operating results for the firm for the previous year are as follows:

In the coming year, Mahan expects variable costs to increase by 4 percent and fixed costs to increase by 3 percent.
Required:
1. What is the contribution margin ratio (rounded to three significant digits) for the previous year?
2. Compute Mahan's break-even point for the previous year in dollars.
3. Suppose that Mahan would like to see a 6 percent increase in operating income in the coming year. What percent (on average) must Mahan raise its bids to cover the expected cost increases and obtain the desired operating income? Assume that Mahan expects the same mix and volume of services in both years.
4. In the coming year, how much revenue must be earned for Mahan to earn an after-tax profit of $175,000? Assume a tax rate of 40 percent.

Question 39

Define the term break-even point.

Question 40

Break-Even in Units, Target Income, New Unit Variable Cost, Degree of Operating Leverage, Percent Change in Operating Income
Reagan, Inc., has developed a chew-proof dog bed-the Tuff-Pup. Fixed costs are $204,400 per year. The average price for the Tuff-Pup is $36, and the average variable cost is $22 per unit. Currently, Reagan produces and sells 20,000 Tuff-Pups annually.
Required:
1. How many Tuff-Pups must be sold to break even?
2. If Reagan wants to earn $95,900 in profit, how many Tuff-Pups must be sold? Prepare a variable-costing income statement to verify your answer.
3. Suppose that Reagan would like to lower the break-even units to 12,000. The company does not believe that the price or fixed cost can be changed. Calculate the new unit variable cost that would result in break-even units of 12,000. (Round to the nearest cent.)
4. What is Reagan's current contribution margin and operating income? Calculate the degree of operating leverage (round your answer to four decimal places). If sales increased by 10 percent next year, what would the percent change in operating income be? What would the new total operating income for next year be?

Question 41

After-Tax Target Income: Profit Analysis
X-Cee-Ski Company recently expanded its manufacturing capacity, which will allow it to produce up to 21,000 pairs of cross-country skis of the mountaineering model or the touring model. The Sales Department assures management that it can sell between 9,000 and 14,000 pairs of either product this year. Because the models are very similar, X-Cee-Ski will produce only one of the two models.
The following information was compiled by the Accounting Department:

Fixed costs will total $320,000 if the mountaineering model is produced but will be only
$220,000 if the touring model is produced. X-Cee-Ski is subject to a 40 percent income tax rate.
Required:
1. If X-Cee-Ski Company desires an after-tax net income of $48,000, how many pairs of touring model skis will the company have to sell?
2. Suppose that X-Cee-Ski Company decided to produce only one model of skis. What is the total sales revenue at which X-Cee-Ski Company would make the same profit or loss regardless of the ski model it decided to produce?
3. If the Sales Department could guarantee the annual sale of 12,000 pairs of either model, which model would the company produce, and why? (CMA adapted)

Question 42

Multiple Products, Break-Even Analysis, Operating Leverage, Segmented Income Statements
Ironjay, Inc., produces two types of weight-training equipment: the Jay-flex (a weight machine that allows the user to perform a number of different exercises) and a set of free weights. Ironjay sells the Jay-flex to sporting goods stores for $200. The free weights sell for $75 per set. The projected income statement for the coming year follows:

The owner of Ironjay estimates that 40 percent of the sales revenues will be produced by sales of the Jay-flex, with the remaining 60 percent by free weights. The Jay-flex is also responsible for 40 percent of the variable expenses. Of the fixed expenses, one-third are common to both products, and one-half are directly traceable to the Jay-flex line.
Required:
1. Compute the sales revenue that must be earned for Ironjay to break even.
2. Compute the number of Jay-flex machines and free weight sets that must be sold for Ironjay to break even.
3. Compute the degree of operating leverage for Ironjay. Now, assume that the actual revenues will be 40 percent higher than the projected revenues. By what percentage will profits increase with this change in sales volume?
4. Ironjay is considering adding a new product-the Jay-rider. The Jay-rider is a cross between a rowing machine and a stationary bicycle. For the first year, Ironjay estimates that the Jay- rider will cannibalize 600 units of sales from the Jay-flex. Sales of free weight sets will remain unchanged. The Jay-rider will sell for $180 and have variable costs of $140. The increase in fixed costs to support manufacture of this product is $5,700. Compute the number of Jay-flex machines, free weight sets, and Jay-riders that must be sold for Ironjay to break even. For the coming year, is the addition of the Jay-rider a good idea? Why or why not? Why might Ironjay choose to add the Jay-rider anyway?

Question 43

After-Tax Profit Targets
Olivian Company wants to earn $420,000 in net (after-tax) income next year. Its product is priced at $275 per unit. Product costs include:

Variable selling expense is $14 per unit; fixed selling and administrative expense totals $290,000.
Olivian has a tax rate of 40 percent.
Required:
1. Calculate the before-tax profit needed to achieve an after-tax target of $420,000.
2. Calculate the number of units that will yield operating income calculated in Requirement 1 above. (Round to the nearest unit.)
3. Prepare an income statement for Olivian Company for the coming year based on the number of units computed in Requirement 2.
4. What if Olivian had a 35 percent tax rate? Would the units sold to reach a $420,000 target net income be higher or lower than the units calculated in Requirement 3? Calculate the number of units needed at the new tax rate. (Round dollar amounts to the nearest dollar and unit amounts to the nearest unit.)

Question 44

How do income taxes affect the break-even point and CVP analysis?

Question 45

CVP with Activity-Based Costing
Busy-Bee Baking Company produces a variety of breads. The average price of a loaf of bread is $1. Costs are as follows:

Other data:

Required:
1. Compute the break-even point in units using conventional analysis.
2. Compute the break-even point in units using activity-based analysis.
3. Suppose that Busy-Bee could reduce the setup cost by $100 per setup and could reduce the number of maintenance hours needed to 1,000. How many units must be sold to break even in this case? (Round answer up to whole units.)

Question 46

Break-Even in Units and Sales Dollars, Margin of Safety
Drake Company produces a single product. Last year's income statement is as follows:

Required:
1. Compute the break-even point in units and sales revenue.
2. What was the margin of safety for Drake Company last year?
3. Suppose that Drake Company is considering an investment in new technology that will increase fixed costs by $250,000 per year, but will lower variable costs to 45 percent of sales. Units sold will remain unchanged. Prepare a budgeted income statement assuming Drake makes this investment. What is the new break-even point in units, assuming the investment is made?

Question 47

Explain why contribution margin per unit becomes profit per unit above the break-even point.

Question 48

Break-Even for a Service Firm
Jonah Graham owns and operates The Green Thumb Company (GTC), which provides live plants and flower arrangements to professional offices. Jonah has fixed costs of $3,240 per month for office/greenhouse rent, advertising, and a delivery van. Variable costs for the plants, fertilizer, pots, and other supplies average $24 per job. GTC charges $60 per month for the average job.
Required:
1. How many jobs must GTC average each month to break even?
2. What is the operating income for GTC in a month with 88 jobs? With 95 jobs?
3. Jonah faces a tax rate equal to 25 percent. How many jobs must Jonah have per month to earn an after-tax income of $1,200? (Round your answer to whole units.)
4. Suppose that Jonah's fixed costs increase to $3,400 per month and he decides to increase the price to $75 per job. What is the new break-even point in number of jobs per month? (Round your answer to the nearest whole number of jobs.)

Question 49

CVP with Activity-Based Costing and Multiple Products
Busy-Bee Baking Company produces a variety of breads. The plant manager would like to expand production into sweet rolls as well. The average price of a loaf of bread is $1. Anticipated price for a package of sweet rolls is $1.50. Costs for the new level of production are as follows:

Other data:

Busy-Bee believes it can sell 600,000 loaves of bread and 200,000 packages of sweet rolls in the coming year.
Required:
1. Prepare a contribution-margin-based income statement for next year. Be sure to show sales and variable costs by product and in total.
2. Compute the break-even sales for the company as a whole using conventional analysis.
3. Compute the break-even sales for the company as a whole using activity-based analysis.
4. Compute the break-even units of each product in units. Does it matter whether you use conventional analysis or activity-based analysis? Why or why not?
5. Suppose that Busy-Bee could reduce the setup cost by $100 per setup and could reduce the number of maintenance hours needed to 1,000. How many units of each product must be sold to break even in this case? (Round answers up to whole units.)

Question 50

CVP Analysis, Impact of Activity-Based Costing
Salem Electronics currently produces two products: a programmable calculator and a tape recorder. A recent marketing study indicated that consumers would react favorably to a radio with the Salem brand name. Owner Kenneth Booth was interested in the possibility. Before any commitment was made, however, Kenneth wanted to know what the incremental fixed costs would be and how many radios must be sold to cover these costs.
In response, Betty Johnson, the marketing manager, gathered data for the current products to help in projecting overhead costs for the new product. The overhead costs based on 30,000 direct labor hours follow. (The high-low method using direct labor hours as the independent variable was used to determine the fixed and variable costs.)

The following activity data were also gathered:


Betty was told that a plantwide overhead rate was used to assign overhead costs based on direct labor hours. She was also informed by engineering that if 20,000 radios were produced and sold (her projection based on her marketing study), they would have the same activity data as the recorders (use the same direct labor hours, machine hours, setups, and so on).
Engineering also provided the following additional estimates for the proposed product line:

Upon receiving these estimates, Betty did some quick calculations and became quite excited. With a selling price of $26 and just $18,000 of additional fixed costs, only 4,500 units had to be sold to break even. Since Betty was confident that 20,000 units could be sold, she was prepared to strongly recommend the new product line.
Required:
1. Reproduce Betty's break-even calculation using conventional cost assignments. How much additional profit would be expected under this scenario, assuming that 20,000 radios are sold?
2. Use an activity-based costing approach, and calculate the break-even point and the incremental profit that would be earned on sales of 20,000 units.
3. Explain why the CVP analysis done in Requirement 2 is more accurate than the analysis done in Requirement 1. What recommendation would you make?

Question 51

Multiple-Product Break-Even and Target Profit
Vandenberg, Inc., produces and sells two products: a ceiling fan and a table fan. Vandenberg plans to sell 30,000 ceiling fans and 70,000 table fans in the coming year. Product price and cost information includes:

Common fixed selling and administrative expenses total $85,000.
Required:
1. What is the sales mix estimated for next year (calculated to the lowest whole number for each product)?
2. Using the sales mix from Requirement 1, form a package of ceiling fans and table fans. How many ceiling fans and table fans are sold at break-even?
3. Prepare a contribution-margin-based income statement for Vandenberg, Inc., based on the unit sales calculated in Requirement 2.
4. What if Vandenberg, Inc., wanted to earn operating income equal to $14,400? Calculate the number of ceiling fans and table fans that must be sold to earn this level of operating income. (Hint: Remember to form a package of ceiling fans and table fans based on the sales mix and to first calculate the number of packages to earn an operating income of $14,400.)

Question 52

Explain how a change in sales mix can change a company's break-even point.

Question 53

(2010 CPA Exam) A company that produces 10,000 units has fixed costs of $300,000, variable costs of $50 per unit, and a sales price of $85 per unit. After learning that its variable costs will increase by 20 percent, the company is considering an increase in production to 12,000 units. Which of the following statements is correct regarding the company's next steps?

A) If production is increased to 12,000 units, profits will increase by $50,000.
B) If production is increased to 12,000 units, profits will increase by $100,000.
C) If production remains at 10,000 units, profits will decrease by $50,000.
D) If production remains at 10,000 units, profits will decrease by $100,000.

Question 54

ABC and CVP Analysis: Multiple Products
Good Scent, Inc., produces two colognes: Rose and Violet. Of the two, Rose Data concerning the two products follow:

The company uses a conventional costing system and assigns overhead costs to products using direct labor hours. Annual overhead costs follow. They are classified as fixed or variable with respect to direct labor hours.

Required:
1. Using the conventional approach, compute the number of cases of Rose and the number of cases of Violet that must be sold for the company to break even.
2. Using an activity-based approach, compute the number of cases of each product that must be sold for the company to break even.

Question 55

A restaurant owner who had yet to earn a monthly profit said, "The busier we are, the more we lose." What do you think is happening in terms of contribution margin?

Question 56

Break-Even in Sales Revenue
Big Red Motors, Inc., employs 15 sales personnel to market its line of luxury automobiles. The average car sells for $75,000, and a 6 percent commission is paid to the salesperson. Big Red Motors is considering a change to the commission arrangement where the company would pay each salesperson a salary of $1,600 per month plus a commission of 2 percent of the sales made by that salesperson. What is the amount of total monthly car sales at which Big Red Motors would be indifferent as to which plan to select? ( CMA adapted )

Question 57

(2009 CPA Exam) A ceramics manufacturer sold cups last year for $7.50 each. Variable costs of manufacturing were $2.25 per unit. The company needed to sell 20,000 cups to break even. Net income was $5,040. This year the company expects the price per cup to be $9.00, variable manufacturing costs to increase 33.3 percent, and fixed costs to increase 10 percent. How many cups (rounded) does the company need to sell this year to break even?

A) 17,111
B) 17,500
C) 19,250
D) 25,667