FMA_2016_Carl_S._Warren,_James_M._Reeve,_Jonathan_E._Ducha(BookZZ.org).pdf [304717]
[anonimizat]. [anonimizat]. produces stereo systems. The parts for the stereo Systems are purchased from suppliers for $10 per unit and are assembled Passenger airlineFuelNumber of miles flown by Jason Sound. For Model JS-12, the direct materials costs for the relevant range Of
5,000 to 30,000 units of production are as follows:ManufacturingDirect materialsNumber of units produced
Number Of Units Of Direct Materials Total Direct
HospitalNurse wagesNumber of patients
Model JS-12 Produced Cost per Unit Materials Cost
5,000 units $10 $ 50,000HotelMaid wagesNumber of guests
I O,OOO 10 1 oo,ooo
1 5,000 10 1 50,000 BankTeller wagesNumber of banking transactions
20,000 10 200,000
[anonimizat], or mixed costs.
Cost Behavior
Cost behavior is the manner in which a cost changes as a related activity changes. The behavior of costs is useful to managers for a variety of reasons. [anonimizat]. [anonimizat] a variety Of decisions such as whether to replace a machine. Understanding the behavior Of a cost depends on the following:
Identifying the activities that cause the cost to change. These activities are called activity bases (or activity drivers).
Specifying the range of activity over which the changes in the cost are of interest. This range of activity is called the relevant range.
[anonimizat] a hospital is concerned about planning and controlling patient food costs. A good activity base is the number Of patients who stay overnight in the hospital. [anonimizat], do not consume food. [anonimizat] (the relevant range).
[anonimizat], or mixed costs.
Cop"ight 2016 All Rights May dupliet.l. or in to any the
Chapter 19 [anonimizat]-Profit Ana ysis
lights. puty fm the ri*t at if lights it.
[anonimizat]:
Cost per unit remains the same regardless of changes in the activity base. [anonimizat]. For Model JS-12, the cost per unit is $10.
Total cost changes in proportion to changes in the activity base. For Model JS-12, the direct materials cost for 10,000 units ($100,000) is twice the direct materials cost for 5,000 units ($50,000).
Exhibit 1 illustrates how the variable costs for direct materials for Model JS-12 behave in total and on a per-unit basis as production changes.
Total Variable Cost Graph Dynamic
Exhibit
Unit Variable Cost Graph
$20
$15
$10
$5
$0
10,000 20,000 30,000
Units Produced (Model JS-12) Units Produced (Model JS-12)
Some examples Of variable costs and their related activity bases for various types Of businesses are shown in Exhibit 2.
A salesperson's compensation can be a mixed cost
Fixed costs are costs that remain the same in total dollar amount as the activity base changes. When the activity base is units produced, many factory overhead costs such as straight-line depreciation are classified as fixed costs.
TO illustrate, assume that Minton Inc. manufactures, bottles, and distributes perfume. The production supervisor is Jane Sovissi, who is paid a salary Of $75,000 per year. For the relevant range of 50,000 to 300,000 bottles of perfume, the total fixed cost of $75,000 does not vary as production increases. As a result, the fixed cost per bottle decreases as the units produced increase. This is because the fixed cost is spread over a larger number Of bottles, as follows:
As shown, fixed costs have the following characteristics:
Cost per unit decreases as the activity level increases and increases as the activity level decreases. For Jane Sovissi's salary, the cost per unit decreased from $1.50 for 50,000 bottles produced to $0.25 for 300,000 bottles produced.
Total cost remains the same regardless of changes in the activity base. Jane Sovissi's salary of $75,000 remained the same regardless of whether 50,000 bottles or 300,000 bottles were produced.
Exhibit 3 illustrates how Jane Sovissi's salary (fixed cost) behaves in total and on a per-unit basis as production changes.
Some examples Of fixed costs and their related activity bases for various types Of businesses are shown in Exhibit 4.
Mixed Costs
Mixed costs are costs that have characteristics of both a variable and a fixed cost. Mixed costs are sometimes called semivariable or semifixed costs.
Fixed Costs
comprised of a salary (fixed portion) plus a commission as a percent of sales
To illustrate, assume that Simpson Inc. manufactures sails, using rented machinery. The rental charges are as follows:
Rental Charge = $1 5,000
(variable portion). per year + $1 for each hour used in excess of 10,000 hours
19 887 888
Total Fixed Cost Graph Unit Fixed Cost Graph
Total Machine Hours
For purposes Of analysis, mixed costs are usually separated into their fixed and variable components. The high-low method is a cost estimation method that may be
300,000
incurred the following costs during the past five months:
Units produced Total Cost
June 1,000 units $45,550
July 1,500 52,000 August 2,100 61 ,500
September 1,800 57,500
October 750 41 ,250
The number of units produced is the activity base, and the relevant range is the units produced between June and October. For Kason, the difference between the units produced and the total costs at the highest and lowest levels Of production are as follows:
Units Produced Total Cost
Highest level 2,100 units $61 ,500
Lowest level 750 41,250
= $30,000
Lowest level (750 units) EXHIBIT 7
Total cost = ($15 x Units Produced) + $30,000
– ($15 x 2,000 units) + $30,000 = $30,000 + $30,000 = $60,000
The manufacturing costs of Alex Industries for the first three months of the year follow:
Total Cost Production
January S 80,000 1,000 units
February 125,000 2,500
March 100,000 1,800
Using the high-low method, determine (a) the variable cost per unit and (b) the total fixed cost.
OBJ2 Compute the Cost-Volume-Profit Relationships
contribution margin, the contribution
Cost-volume-profit analysis is the examination of the relationships among selling margin ratio, and the unit
prices, sales and production volume, costs, expenses, and profits. Cost-volume-profit
Setting selling prices
Selecting the mix of products to sell
Choosing among marketing strategies
the same regardless of
Contribution Margin
level.
Contribution margin is especially useful because it provides insight into the profit and decreases
potential Of a company. Contribution margin is the excess Of sales over variable costs, computed as follows:
Contribution Margin = Sales — Variable Costs it.
891
TO illustrate, assume the following data for Lambert Inc.:
Sales 50,000 units
Sales price per unit $20 per unit
Variable cost per unit $12 per unit
Fixed costs $300,000
Exhibit 8 illustrates an income statement for Lambert prepared in a contribution margin format.
it.
Chapter 19 Cost Behavior and Cost-Vol ume-Profit Analysis 893
Molly Company sells 20,000 units at $12 per unit. Variable costs are $9 per unit, and fixed costs are $25,000. Determine the (a) contribution margin ratio, (b) unit contribution margin, and (c) income from operations.
Follow My Example 19-2
892
Income from operations increased from $100,000 to $132,000 when sales increased from to Variable costs as a percentage Of sales are equal to 100% minus the contribution margin ratio. Thus, in the preceding income statement, the variable costs are 60% (100% — 400/0) of sales, or $648,000 ($1,080,000 x 60%). The total contribution margin, $432,000, can also be computed directly by multiplying the total sales by the contribution margin ratio x 40%).
In the preceding analysis, factors other than sales volume, such as variable cost per unit and sales price, are assumed to remain constant. If such factors change, their effect must also be considered.
The contribution margin ratio is also useful in developing business strategies. For example, assume that a company has a high contribution margin ratio and is producing below 100% Of capacity. In this case, a large increase in income from operations can be expected from an increase in sales volume. Therefore, the company might consider implementing a special sales campaign to increase sales. In contrast, a company with a small contribution margin ratio will probably want to give more attention to reducing costs before attempting to promote sales.
Unit Contribution Margin
The unit contribution margin is also useful for analyzing the profit potential of proposed decisions. The unit contribution margin is computed as follows:
Unit Contribution Margin = Sales Price per Unit —Variable Cost per Unit
To illustrate, if Lambert Inc.'s unit selling price is $20 and its variable cost per unit is $12, the unit contribution margin is $8, computed as follows:
Unit Contribution Margin = Sales Price per Unit —Variable Cost per Unit Unit Contribution Margin = $20 — $12 = $8
The unit contribution margin is most useful when the increase or decrease in sales volume is measured in sales units (quantities). In this case, the change in sales volunne (units) multiplied by the unit contribution margin equals the change in income from operations, computed as follows:
Change in Income from Operations = Change in Sales Units x Unit Contribution Margin
TO illustrate, assume that Lambert's sales could be increased by 15,000 units, from 50,000 units to 65,000 units. Lambert's income from operations would increase by $120,000 (15,000 units x $8), computed as follows:
Change in Income from Operations = Change in Sales Units x Unit Contribution Margin Change in Income from Operations = 15,000 units x $8 = $120,000
The preceding analysis is confirmed by the contribution margin income statement Of Lambert that follows, which shows that income increased to $220,000 when 65,000 units are sold. The income statement in Exhibit 8 indicates income of $100,000 when 50,000 units are sold. Thus, selling an additional 15,000 units increases income by $120,000 ($220,000 – $100,000).
Fixed costs .
Income from operations .
Unit contribution margin analysis is useful information for managers. For example, in the preceding illustration, Lambert could spend up to $120,000 for special advertising or other product promotions to increase sales by 15,000 units and still increase income by $100,000, the $220,000 increase in sales minus the $120,000 cost Of special advertising.
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894 Chapter 19 Cost Behavior and Cost-Vol ume-Profit Ana ysis
The following income statement for Baker verifies the break-even point Of 9,000 units:
sales (9,000 units x $25) $225,000
Variable costs (9,000 units x $15)…. 135,000
Contribution margin. . $ 90,000
Fixed costs90,000
Incomefrom operations
25% ($12 – $9) + $12, or ($240,000 – As shown in Baker's income statement, the break-even point is $225,000 (9,000 units x
$3 per unit = $12 – $9$25) of sales. The break-even point in sales dollars can be determined directly as follows:
Sales $240,000
Fixed Costs
Variable costs 180,000 (20,000 units x $9 per unit) Break-Even Sales (dollars) =
Contribution margin $ 60,000 [20,000 units x ($12 – $9)] Contribution Margin Ratio
25,000 The contribution margin ratio can be computed using the unit contribution margin S 35,000 and unit selling price as follows:
Unit Contribution Margin
Practice Exercises:PE 19-2A, PE 19-2B Contribution Margin Ratio —
Unit Selling Price
The contribution margin ratio for Baker is 40%, computed as follows:
Unit Contribution Margin $10
Contribution Margin Ratio =
Unit Selling Price $25
Thus, the break-even sales dollars for Baker Of $225,000 can be computed directly follows:
Fixed Costs $90,000
Break-Even Sales (dollars) == $225,000
Contribution Margin Ratio
The break-even point is affected by changes in the fixed costs, unit variable costs, and the unit selling price.
Effect Of Changes in Fixed Costs Fixed costs do not change in total with changes in the level of activity. However, fixed costs may change because of other factors such as advertising œampaigns, changes in property tax rates, or changes in factory supervisors' salaries.
Changes in fixed costs affect the break-even point as follows:
Increases in fixed costs increase the break-even point.
Decreases in fixed costs decrease the break-even point. This relationship is illustrated in Exhibit 10.
TO illustrate, assume that Bishop co. is evaluating a proposal to budget an additional $100,000 for advertising. The data for Bishop follows:
Current pro osed
Mathematical Approach to
Cost-Volume-Profit Analysis point and sales necessary to
achieve a target profit. The mathematical approach to cost-volume-profit analysis uses equations to determine the following:
Sales necessary to break even
Sales necessary to make a target or desired profit
Break-Even Point
The break-even point is the level of operations at which a company's revenues and expenses are equal, as shown in Exhibit 9. At break-even, a company reports neither income nor a loss from operations.
Break-Even Point
The break-even point in sales units is computed as follows:
Fixed Costs
Break-Even Sales (units)
Unit Contribution Margin
TO illustrate, assume the following data for Baker Corporation:
Fixed costs $90,000
Unit selling price $25
Unit variable cost 15
Unit contribution margin $10
The break-even point for Baker is 9,000 units, computed as follows:
Fixed Costs $90,000
Break-Even Sales (units) == 9,000 units
Unit Contribution Margin $10
895
Bishop's break-even point befopv the additional advertising expense Of $100,000 is 30,000 units, computed as follows:
Fixed Costs $600,000
Break-Even Sales (units) = = 30,000 units
Unit Contribution Margin $20
Bishop's break-even point after the additional advertising expense of $100,000 is 35,000 units, computed as follows:
Fixed Costs $700,000
Break-Even Sales (units) = = 35,000 units
Unit Contribution Margin $20
As shown for Bishop, the $100,000 increase in advertising (fixed costs) requires an additional 5,000 units (35,000 — 30,000) of sales to break even. 2 In other words, an increase in sales of 5,000 units is required in order to generate an additional $100,000 Of total contribution margin (5,000 units x $20) to cover the increased fixed costs.
Effect of Changes in Unit Variable Costs Unit variable costs do not change with changes in the level Of activity. However, unit variable costs may be affected by other factors such as changes in the cost per unit of direct materials, changes in the wage rate for direct labor, or changes in the sales commission paid to salespeople.
Changes in unit variable costs affect the break-even point as follows:
Increases in unit variable costs increase the break-even point.
Decreases in unit variable costs decrease the break-even point.
This relationship is illustrated in Exhibit 11.
To illustrate, assume that Park co. is evaluating a proposal to pay an additional 2% commission on sales to its salespeople as an incentive to increase sales. The data for Park follows:
Current Pro osed
896
If the 2% sales commission proposal is adopted, unit variable costs will increase by $5 ($250 x 2%), from $145 to $150 per unit. This increase in unit variable costs will decrease the unit contribution margin from $105 to $100 ($250 — $150). Thus, Park's break-even point after the additional 2% commission is 8,400 units, computed as follows:
Fixed Costs $840,000
Break-Even Sales (units) 8,400 units
Unit Contribution Margin $100
As shown for Park, an additional 400 units of sales will be required in order to break ewen. This is because if 8,000 units are sold, the new unit contribution margin of $100 provides only $800,000 (8,000 units x $100) Of contribution margin. Thus, $40,000 more contribution margin is necessary to cover the total fixed costs of $840,000. This additional $40,000 of contribution margin is provided by selling 400 more units (400 units x $100).
Effect Of Changes in Unit Selling Price Changes in the unit selling price affect the unit contribution margin and, thus, the break-even point. Specifically, changes in the unit selling price affect the break-even point as follows:
• Increases in the unit selling price decrease the break-even point. • Decreases in the unit selling price increase the break-even point.
This relationship is illustrated in Exhibit 12.
To illustrate, assume that Graham Co. is evaluating a proposal to increase the unit selling price of its product from $50 to $60. The data for Graham follows:
Current Pro osed
Park's break-even point befopv the additional 2% commission is 8,000 units, com puted as follows:
Fixed Costs $840,000
Break-Even Sales (units) 8,000 units
Unit Contribution Margin $105
2 The increase of 5,000 units can also be computed by dividing the increase in fixed costs of Sl 00,000 by the unit contribution margin, $20, as follows: 5,000 units = S 100,000 * it.
Chapter 19 Cost Behavior and Cost-Vol ume-Profit Analysis 897
As shown for Graham, the price increase Of $10 increased the unit contribution margin by $10, which decreased the break-even point by 10,000 units (30,000 units — 20,000 units).
Summary of Effects of Changes on Break-Even Point The break-even point in sales changes in the same direction as changes in the variable cost per unit and fixed costs. In contrast, the break-even point in sales changes in the opposite direction as changes in the unit selling price. These changes on the break-even point in sales are summarized in Exhibit 13.
Nicolas Enterprises sells a product for $60 per unit. The variable cost is $35 per unit, while fixed costs are $80,000. Determine the (a) break-even point in sales units and (b) break-even point in sales units if the selling price were increased to $67 per unit.
Practice Exercises: PE 19-3A, PE 19-3B
Graham's break-even point befopt? the price increase is 30,000 units, computed as follows:
Fixed Costs $600,000
Break-Even Sales (units) — = 30,000 units
Unit Contribution Margin $20
The increase of $10 per unit in the selling price increases the unit contribution margin by $10. Thus, Graham's break-even point after the price increase is 20,000 units, computed as follows:
Fixed Costs $600,000
Break-Even Sales (units) — = 20,000 units Unit Contribution Margin $30
it.
Target Profit
At the break-even point, sales and costs are exactly equal. However, the goal Of most companies is to make a profit.
By modifying the break-even equation, the sales required to earn a target or desired amount of profit may be computed. For this purpose, target profit is added to the break-even equation, as follows:
Fixed Costs + Target profit Sales (units)
Unit Contribution Margin
To illustrate, assume the following data for Waltham Co.:
Unit contribution margin $30
The sales necessary for Waltham to earn the target profit of $100,000 would be 10,000 units, computed as follows:
Fixed Costs + Target profit $200,000 + $ 100,000
Sales (units) = 10,000 units Unit Contribution Margin $30
The following income statement for Waltham verifies this computation:
Sales (10,000 units x $75) $750,000
Variable costs (10,000 units x 545) 450,000
Contribution margin (10,000 units x $30) . $300,000
Fixed costs200,000 Income from operations. . .. $100,000
899 900
cost and then adding the $100,000 total fixed costs to get the second point for the total estimated costs of $400,000 [(10,000 units x $30) + $100,000]. The cost line is drawn upward to the right from $100,000 on the vertical axis through the $400,000 point at the end of the relevant range.
Step 4. The break-even point is the intersection point of the total sales and total cost lines. A vertical dotted line drawn downward at the intersection point indicates the units of sales at the break-even point. A horizontal dotted line drawn to the left at the intersection point indicates the sales dollars and costs at the break-even point.
EXHIBIT 14
Cost-Volume-Profit
Chart
$450,000
$400,000
$350,000
$300,000
$250,000
$200,000
$1 50,000
$100,000
$50,000
$0 o 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 10,000 step 1 Units of Sales
In Exhibit 14, the break-even point for Munoz is $250,000 Of sales, which represents sales Of 5,000 units. Operating profits will be earned when sales levels are to the right Of the break-even point (operating profit area). Operating losses will be incurred when sales levels are to the left of the break-even point (operating loss area).
Changes in the unit selling price, total fixed costs, and unit variable costs can be analyzed by using a cost-volume-profit chart. Using the data in Exhibit 14, assume that Munoz is evaluating a proposal to reduce fixed costs by $20,000. In this case, the total fixed costs would be $80,000 ($100,000 — $20,000).
Under this scenario, the total sales line is not changed, but the total cost line will change. As shown in Exhibit 15, the total cost line is redrawn, starting at the $80,000 point (total fixed costs) on the vertical axis. The second point is determined by multiplying the maximum number Of units in the relevant range, which is found on the far right Of the horizontal axis, by the unit variable costs and adding the fixed costs. For Munoz, this is the total estimated cost for 10,000 units, which is $380,000 [(10,000 units x $30) + $80,000]. The cost line is drawn upward to the right from $80,000 on the vertical axis through the $380,000 point. The revised cost-volume-profit chart in Exhibit 15 indicates that the break-even point for Munoz decreases to $200,000 and 4,000 units Of sales.
Profit-Volume Chart
Another graphic approach to cost-volume-profit analysis is the profit-volume chart.
The profit-volume chart plots only the difference between total sales and total costs (or profits). In this way, the profit-volume chart allows managers to determine the operating profit (Or loss) for various levels Of units sold.
it.
902 Chapter 19 Cost Behavior and Cost-Vol ume-Profit Ana ysis
1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 10,000
Step 1 Units Of Sales
In Exhibit 16, the break-even point for Munoz is 5,000 units of sales, which is equal to total sales of $250,000 (5,000 units x $50). Operating profit will be earned when sales levels are to the right of the break-even point (operating profit area). Operating losses will be incurred when sales levels are to the left Of the break-even point (operating loss area). For example, at sales of 8,000 units, an operating profit of $60,000 will be earned, as shown in Exhibit 16.
The effect of changes in the unit selling price, total fixed costs, and unit variable costs on profit can be analyzed using a profit-volume chart. Using the data in Exhibit 16, consider the effect that a $20,000 increase in fixed costs will have on profit. In this case, the total fixed costs will increase to $120,000 ($100,000 + $20,000), and the maximum operating loss will also increase to $120,000. At the maximum sales of 10,000 units, the maximum operating profit would be $80,000, computed as follows:
sales (10,000 units x $50)
Variable costs (10,000 units x $30) .
Contribution margin (10,000 units x $20)..
Fixed costs .
Revised maximum Operating profit….
profit
A revised profit-volume chart is constructed by plotting the maximum operating loss and maximum operating profit points and drawing the revised profit line. The original and the revised profit-volume charts for Munoz are shown in Exhibit 17.
The revised profit-volume chart indicates that the break-even point for Munoz is 6,000 units of sales. This is equal to total sales of $300,000 (6,000 units x $50). The operating loss area Of the chart has increased, while the operating profit area has decreased. Use of Computers in Cost-Volume-Profit Analysis
With computers, the graphic approach and the mathematical approach to costvolume-profit analysis are easy to use. Managers can vary assumptions regarding selling prices, costs, and volume and can observe the effects of each change on the break-even point and profit. Such an analysis is called a "what if" analysis or
ORPHAN DRUGS
Each year, pharmaceutical companies develop new drugs that cure a variety of physical conditions. In order to be profitable, drug companies must sell enough of a product for a reasonable price to exceed break even. Breakeven points, however, create a problem for drugs, called "orphan drugs," targeted at rare diseases. These drugs are typically expensive to develop and have low sales volumes, making it impossible to achieve break even. TO ensure that orphan drugs are not overlooked, Congress passed the Orphan Drug Act, which provides incentives for pharmaceutical companies to develop drugs for rare diseases that might not generate enough sales to reach break even. The program has been a great success. Since 1982, more than 200 orphan drugs have come to market, including Jacobus Pharmaceuticals Company, Inc.'s drug for the treatment of tuberculosis and Novartis AGs drug for the treatment of Paget's disease.
Graphic Approach to
Cost-Volume-Profit Analysis
Cost-volume-profit analysis can be presented graphically as well as in equation form. Many managers prefer the graphic form because the operating profit or loss for different levels can be easily seen.
Cost-Volume-Profit (Break-Even) Chart
A cost-volume-profit chart, sometimes called a break-even chart, graphically shows sales, costs, and the related profit or loss for various levels of units sold. It assists in understanding the relationship among sales, costs, and operating profit or loss.
To illustrate, the cost-volume-profit chart in Exhibit 14 is based on the following
4 Using a costvolume-profit chart and a profit-volume
chart, determine the break-even point and sales necessary to achieve a target profit.
data for Munoz co.:
Unit contribution margin $20
The cost-volume-profit chart in Exhibit 14 is constructed using the following steps:
Step 1. Volume in units of sales is indieated along the horizontal axis. The range of volume shown is the relevant range in which the company expects to operate. Dollar amounts of total sales and total costs are indicated along the vertical axis.
Step 2. A total sales line is plotted by connecting the point at zero on the left comer of the graph to a second point on the chart. The second point is determined by multiplying the maximum number of units in the relevant range, which is found on the far right of the horizontal axis, by the unit sales price. A line is then drawn through both of these points. This is the total sales line. For Munoz, the maximum number of units in the relevant range is 10,000. The second point on the line is determined by multiplying the 10,000 units by the $50 unit selling price to get the second point for the total sales line of $500,000 (10,000 units x $50). The sales line is drawn upward to the right from zero through the $500,000 point at the end of the relevant range.
Step 3. A total cost line is plotted by beginning with total fixed costs on the vertical axis. A second point is determined by multiplying the maximum number of units in the relevant range, which is found on the far right of the horizontal axis by the unit variable costs and adding the total fixed costs. A line is then drawn through both of these points. This is the total cost line. For Munoz, the maximum number of units in the relevant range is 10,000. The second point on the line is determined by multiplying the 10,000 units by the $30 unit variable
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Chapter 19 Cost Behavior and Cost-Vol ume-Profit Analysis 901
$500,000Revised Cost-VolumeProfit Chart $450,000
$400,000
$350,000
$300,000
$250,000
$200,000
$150,000
$100,000
$50,000
$0 o 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 10,000
Units of Sales
To illustrate, the profit-volume chart for Munoz Co. in Exhibit 16 is based on the same data as used in Exhibit 14. These data are as follows:
Total fixed costs $ 100,000
Unit selling price $50
Unit variable cost 30
Unit contribution margin $20
The maximum operating loss is equal to the fixed costs of $100,000. Assuming that the maximum units that can be sold within the relevant range is 10,000 units, the maximum operating profit is $100,000, computed as follows:
$500,000
300,000
$200,000
Fixed costs 100,000
Maximum
Operating profit. . $100,000 4_
profit
The profit-volume chafi in Exhibit 16 is constructed using the following steps:
Step 1. Volume in units of sales is indicated along the horizontal axis. The range of volume shown is the relevant range in which the company expects to operate. In Exhibit 16, the maximum units of sales is 10,000 units. Dollar amounts indicating operating profits and losses are shown along the vertical axis.
Step 2. A point representing the maximum operating loss is plotted on the vertical axis at the left. This loss is equal to the total fixed costs at the zero level of sales. Thus, the maximum operating loss is equal to the fixed costs of $100,000.
Step 3. A point representing the maximum operating profit within the relevant range is plotted on the right. Assuming that the maximum unit sales within the relevant range is 10,000 units, the maximum operating profit is $100,000.
Step 4. A diagonal profit line is drawn connecting the maximum operating loss point with the maximum operating profit point.
Step 5. The profit line intersects the horizontal zero operating profit line at the breakeven point in units of sales. The area indicating an operating profit is identitied to the right of the intersection, and the area indicating an operating loss
is identified to the left of the intersection.
sensitivity analysis.
19 903
Original ProfitVolume Chart and
Revised ProfitVolume Chart
Original
Chart
1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 10,000
Operating Profit Units of Sales
(Loss)
$125,000
$100,000
80,000
75,000
$50,000
$25,000
Revised
Chart
1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 10 000
Units of Sales
Assumptions of Cost-Volume-Profit Analysis
Cost-volume-profit analysis depends on several assumptions. The primary assumptions are as follows:
Total sales and total costs can be represented by straight lines.
Within the relevant range of operating activity, the efficiency of operations does not change.
Costs can be divided into fixed and variable components.
The sales mix is constant.
There is no change in the inventory quantities during the period.
These assumptions simplify cost-volume-profit analysis. Because they are often valid for the relevant range Of operations, cost-volume-profit analysis is useful for decision making. 3
3 The impact of violating these assumptions is discussed in advanced accounting texts.
it.
Chapter 19 Cost Behavior and Cost-Vol ume-Profit Analysis 905
For break-even analysis, it is useful to think Of Products A and B as components Of one overall enterprise product called E. The unit selling price of E equals the sum Of the unit selling prices of each product multiplied by its sales mix percentage. Likewise, the unit variable cost and unit contribution margin of E equal the sum of the unit variable costs and unit contribution margins of each product multiplied by its sales mix percentage.
For Cascade, the unit selling price, unit variable cost, and unit contribution margin for E are computed as follows:
Product E Product A Product B
Unit selling price of E $100 = ($90XO.8) + ($140XO.2)
Unit variable cost of E 75 = ($70 XOB) + ($95 xo.2)
Unit contribution margin of E $ 25 – ($20 + ($45 xo.2)
Cascade has total fixed costs Of $200,000. The break-even point Of 8,000 units Of E can be determined as follows using the unit selling price, unit variable cost, and unit contribution margin of E:
Fixed Costs $200,000
Break-Even Sales (units) for E — = 8,000 units
Unit Contribution Margin 525
Because the sales mix for Products A and B is 80% and 20% respectively, the break-even quantity of A is 6,400 units (8,000 units x 80%) and B is 1,600 units (8,000 units x 2œ6). The preceding break-even analysis is verified in Exhibit 19.
Products
point
The effects Of changes in the sales mix on the break-even point can be determined by assuming a different sales mix. The break-even point Of E can then be recomputed.
Megan Company has fixed costs of $180,000. The unit selling price, variable cost per unit, and contribution margin per unit for the company's two products are as follows:
Product Selling Price Variable Cost per Unit Contribution Margin per Unit
$160 $100 $60
z 100 80 20
The sales mix for products Q and Z is 75% and 25%, respectively. Determine the break-even point in units of Q and Z.
(Continued)
904
Service
The sales mix for Products A and B is expressed as a percentage of total units sold. For Cascade, a total Of 10,000 (8,000 + 2,000) units were sold during the year.
Therefore, the sales mix is 80% (8,000 + 10,000) for Product A and 20% for Product B (2,000 + 10,000), as shown in Exhibit 18. The sales mix could also be expressed as the ratio 80:20.
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906 Chapter 19 Cost Behavior and Cost-Volume-Profit Ana ysis
Follow My Example 19-5
Unit selling price of E: [$160 x 0.75) +
Unit variable cost of E: [$100 x 0.75) + ($80 x 0.25)] 95
Unit contribution margin of E: $ 50
Break-Even Sales (units) for E — $180,000 * $50 = 3,600 units
Break-Even Sales (units) for Q — 3,600 units of E x 75% = 2,700 units of product Q
Break-Even Sales (units) for Z = 3,600 units of E x 25% = 900 units of Product Z
Practice Exercises: PE 19-5A, PE 19-5B
Operating Leverage
The relationship between a company's contribution margin and income from operations is measured by operating leverage. A company's operating leverage is computed as follows:
Contribution Margin
Operating Leverage =
Income from Operations
The difference between contribution margin and income from operations is fixed costs. Thus, companies with high fixed costs will normally have high operating leverage. Examples of such companies include airline and automotive companies, like Ford Motor Company. Low operating leverage is normal for companies that are labor intensive, such as professional service companies, which have low fixed costs.
To illustrate operating leverage, assume the following data forJones Inc. and Wilson Inc.:
Jones Inc. Wilson Inc.
Sales $400,000
300,000
S 100,000 50,000
$ 50,000
As shown, Jones and Wilson have the same sales, the same variable costs, and the same contribution margin. However, Jones has larger fixed costs than Wilson and, thus, a higher operating leverage. The operating leverage for each company is computed as follows:
Jones Inc.
Contribution Margin $100,000
Operating Leverage 5 Income from Operations $20,000 Wilson Inc.
Contribution Margin $100,000 Operating Leverage =
Income from Operations $50,000
Operating leverage can be used to measure the impact of changes in sales on income from operations. Using operating leverage, the effect of changes in sales on income from operations is computed as follows:
Percent Change in Percent Change in Operating Income from Operations Sales Leverage
TO illustrate, assume that sales increased by 10%, or $40,000 ($400,000 x 10%), for Jones and Wilson. The percent increase in income from operations for Jones and
Wilson is computed as follows:
19 907 908
Margin of Safety
The margin of safety indicates the possible decrease in sales that may occur before an operating loss results. Thus, if the margin of safety is low, even a small decline in sales revenue may result in an operating loss.
The margin of safety may be expressed in the following ways:
Dollars of sales
Units of sales
Percent of current sales
TO illustrate, assume the following data:
Sales $250,000
Sales at the break-even point 200,000
Unit selling price 25
The margin Of safety in dollars of sales is $50,000 ($250,000 — $200,000). The margin of safety in units is 2,000 units ($50,000 + $25). The margin Of safety expressed as a percent of current sales is 20%, computed as follows:
Sales — Sales at Break-Even Point
Margin of Safety =
Sales
$250,000 – $200,000 $50,000
= 20%
$250,000 $250,000
Therefore, the current sales may decline $50,000, 2,000 units, or 20% before an operating loss occurs.
Rachel Company has sales of $400,000, and the break-even point in sales dollars is $300,000. Determine the company's margin of safety as a percent of current sales.
Sales
Practice Exercises: PE 19-7A, PE 19-7B
Variable Costing
The cost of manufactured products consists of direct materials, direct labor, and factory overhead. The reporting Of all these costs in financial statements is called absorption costing. Absorption costing is required under generally accepted accounting principles for financial statements distributed to external users. However, alternative reports may be prepared for decision-making purposes by managers and other internal users. One such alternative reporting is variable costing or direct costing.
In variable costing, the cost Of goods manufactured is composed only Of variable costs. Thus, the cost Of goods manufactured consists Of direct materials, direct labor, and variable factory overhead.
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910 Chapter 19 Cost Behavior and Cost-Vol ume-Profit Ana ysis
EXHIBIT 22
Variable Costing
Income Statement
Exhibit 23 illustrates the absorption costing income statement prepared for Martinez. The absorption costing income statement does not distinguish between variable and fixed costs. All manufacturing costs are included in the cost Of goods sold. Deducting the cost of goods sold from sales yields the gross profit. Deducting the selling and administrative expenses from gross profit yields the income from operations.
Absorption Costing
Income Statement
Jones Inc.
As shown, Jones's income from operations increases by 50%, while Wilson's income from operations increases by only 20%. The validity Of this analysis is shown in the following income statements for Jones and Wilson based on the
330,000 330,000
$110,000 $1 10,000
80,000 50,000
$ 30,000 $ 60,000
The preceding income statements indicate that Jones's income from operations increased from $20,000 to $30,000, a 50% increase ($10,000 + $20,000). In contrast, Wilson's income from operations increased from $50,000 to $60,000, a 20% increase ($10,000 * $50,000).
Because even a small increase in sales will generate a large percentage increase in income from operations, Jones might consider Nvays to increase sales. Such actions could include special advertising or sales promotions. In contrast, Wilson might consider ways to increase operating leverage by reducing variable costs.
The impact of a change in sales on income from operations for companies with
high and low operating leverage is summarized in Exhibit 20.
Tucker Company reports the following data:
Sales
Variable costs
Contribution margin
Fixed costs
Income from operations Determine Tucker Company's operating leverage.
$750,000
500,000
$250,000
187,500 $ 62,500
Practice Exercises:PE 1 9_6A, PE 19_6B
it.
Chapter 19 Cost Behavior and Cost-Vol ume-Profit Analysis 909
In a variable costing income statement, fixed factory overhead costs do not become a part of the cost Of goods manufactured. Instead, fixed factory overhead costs are treated as a period expense. The differences between absorption and variable cost of goods manufactured is summarized in Exhibit 21.
Absorption Versus
Variable Cost Of
Goods Manufactured
The form of a variable costing income statement is as follows:
Sales $xxx
Variable cost of goods sold xxx
Manufacturing margin $xxx
Variable selling and administrative expenses xxx Contribution margin sxxx
Fixed costs:
Fixed manufacturing costs $xxx
Fixed selling and administrative expenses xxx
Income from operations $xxx
Manufacturing mcngin is the excess Of sales over variable cost Of goods sold.
= Sales — Variable Cost of Goods Sold The relationship between variable and absorption costing incomefrom operations
Manufacturing Margin is summarized in Exhibit 24. Variable cost ofgoods sold consists of direct materials, direct labor, and variable factory overhead for the units sold. Contribution margin is the excess of manufacturing margin over variable selling and administrative expenses.
Contribution Margin = Manufacturing Margin — Variable Selling and Administrative Expenses
Subtracting fixed costs from contribution margin yields income from operations.
Income from Operations = Contribution Margin — Fixed Costs
The variable costing income statement facilitates managerial decision making because manufacturing margin and contribution margin are reported directly. As illustrated in this chapter, contribution margin is used in break-even analysis and other analyses.
To illustrate the variable costing income statement, assume that Martinez co. In Exhibits 22 and 23, Martinez manufactured and sold 15,000 units. Thus, the manufactures 15,000 units, which are sold at a price of $50. The related costs and variable and absorption costing income statements reported the same income from expenses for Martinez are as follows: operations Of $100,000. However, assume that only 12,000 units Of the 15,000 units Martinez manufactured were sold. Exhibit 25 shows the related variable and absorpNumber Unit tion costing income statements.
Total Cost Of Units Cost Exhibit 25 shows a $30,000 ($70,000 — $40,000) difference in income from opera-
Manufacturing costs:
Variable.. .. $375,000
Fixed .150,000 Total. . $525,000
Fixed50,000
Total. . $125,000
Exhibit 22 shows the variable costing income statement The computations are shown in parentheses.
tions. This difference is due to the fixed manufacturing costs. All of the $150,000 of 1 5,000 $25 fixed manufacturing costs is included as a period expense in the variable costing state-
15,000 10 ment. However, the 3,000 units of ending inventory in the absorption costing statement
$35 include $30,000 (3,000 units x $10) of fixed manufacturing costs. By being included in inventory, this $30,000 is thus excluded from the current cost of goods sold. Thus, the absorption costing income from operations is $30,000 higher than the income from operations for variable costing.
A similar analysis could be used to illustrate that income from operations under variable costing is greater than income from operations under absorption costing prepared for Martinez. when the units manufactured are less than the units sold.
Under absorption costing, increases or decreases in income from operations can result from changes in inventory levels. For example, for Martinez, a 3,000 increase in ending inventory created a $30,000 increase in income from operations under absorption 19 911
Units Manufactured
Exceed Units Sold
costing. Such increases (decreases) could be misinterpreted by managers using absorption costing as operating efficiencies (inefficiencies). This is one Of the reasons that variable costing is Often used by managers for cost control, pmduct pricing, and pmduction planning. Such uses Of variable costing are discussed in advanced accounting texts.
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Chapter 19 Cost Behavior and Cost-Vol ume-Profit Analysis 913
Wyatt Inc. expects to maintain the same inventories at the end of the year as at the beginning ol' the year. 'l he estimated fixed costs for the year are $288,000, and the estimated variable costs per unit are $14. It is expected that 60,000 units will be sold at a price of $20 per unit. Maximum sales within the relevant range are 70,000 units.
Instructions
What is (a) the contribution margin ratio and (b) the unit contribution margin?
Determine the break-even point in units.
Construct a cost-volume-profit chart, indicating the break-even point.
Construct a profit-volume chart, indieating the break-even point.
What is the margin of safety?
Solution
Sales — Variable Costs
I. a. Contribution Margin Ratio =
Sales
(60,000 units x $20) – (60,000 units x $14)
(60,000 units x $20)
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914 Chapter 19 Cost Behavior and Cost-Vol ume-Profit Ana ysis
= 30%
b. Unit Contribution Margin = Unit Selling Price Unit Variable Costs
= $20 – 514 = 56
Fixed Costs
Break-Even Sales (units) =
Unit Contribution Margin
$288,000
= 48,000 units
$6
Sales and Costs
30,000
$150,000
$1 32,000
10,000 20,000 30,000 40,000 150,000 60,000 70,000
Units of Sales 48,000
19 915916
5. Margin of safety:
EE 19-1 p. 889 PE 19-1B High-low method OBJ. 1
Expected sales (60,000 units x $20)The manufacturing costs of Carrefour Enterprises for the first three months of the year Break-even point (48,000 units x $20) 960,000 follow:
Margin of safety $ 240,000
SHOW
ME HOW
Total Costs Units Produced
EE 19-2 p. 893 PE 19-2A Contribution margin 0B'.2 Michigan Company sells 10,000 units at $100 per unit. Variable costs are $75 per unit, and fixed costs are $125,000. Determine (a) the contribution margin ratio, (b) the unit s HOW contribution margin, and (c) income from operations.
ME HOW
EE 19-2 p. 893 PE 19-2B Contribution margin OBJ. 2 Weidner Company sells 22,000 units at $30 per unit. Variable costs are $24 per unit, and fixed costs are $40,000. Determine (a) the contribution margin ratio, (b) the unit contri-
SHOW bution margin, and (c) income from operations.
ME HOW
EE 19-3 p. 897 PE 19-3A Break-even point OBJ. 3
Describe how total variable costs and unit variable 6. An examination of the accounting records of Clowney
Santana sells a product for $115 per unit. The variable cost is $75 per unit, while fixed costs behave with changes in the level of activity. Company disclosed a high contribution margin ratio costs are $65,000. Determine (a) the break-even
and production at a level below maximum capacity. point in sales units and (b) the break-
Which of the following costs would be classified as Based on this information, suggest a likely means of ME s HOWHOW even point if the selling price were increased to $125 per unit. variable and which would be classified as fixed, if income from operations. Explain. improving units produced is the activity base?
7. If the unit cost of direct materials is decreased, what EE 19-3 p. 897
Direct materials costs effect will this change have on the break-even point? Elrod Inc. sells a product for $75 per unit. The variable cost is $45 per unit, while fixed
Electricity costs of $0.35 per kilowatt-hour 8. Both Austin Company and Hill Company had the same costs are $48,000. Determine (a) the break-even point in sales units and (b) the breakunit sales, total costs, and income from operations SHOW even point if the selling price were increased to $95 per unit.
Describe how total fixed costs and unit fixed costs ME HOW
for the current fiscal year; yet, Austin Company had behave with changes in the level of activity.
a lower break-even point than Hill Company. Explain PE 19-4A Target profit OBJ. 3 EE 19-4 p.898
In applying the high-low method of cost estimation the reason for this difference in break-even points.
Versa Inc. sells a product for $100 per unit. The variable cost is $75 per unit, and fixed to mixed costs, how is the total fixed cost estimated?
9. How does the sales mix affect the calculation of the costs are $45,000. Determine (a) the break-even point in sales units and (b) the break-
If fixed costs increase, what would be the impact break-even point? s HOW even point in sales units if the company desires a target profit of $25,000.
on the (a) contribution margin? (b) income from 10. What does operating leverage measure, and how is ME HOW operations?
it computed? EE 19-4 p. 898 PE 19-4B Target profit OBJ. 3 Scrushy Company sells a product for $150 per unit. The variable cost is $110 per unit, and fixed costs are $200,000. Determine (a) the break-even point in sales units and
SHOW (b) the break-even point in sales units if the company desires a target profit of $50,000.
ME HOW
EE 19-5 p. 905 PE 19-5A Sales mix and break-even analysis
Wide Open Industries Inc. has fixed costs of $475,000. The unit selling price, variable cost per unit, and contribution margin per unit for the company's two products follow:
EE 19-1 889 PE 19-1A High-low method OBJ. 1 s How
ME
The manufacturing costs of Lightfoot Industries for three months of the year follow: HOW
Total Costs Units Produced
Cop"ight 2016
9. Rent on warehouse, $10,000 per month plus $25
EE 19-5 p. 905 PE 19-5B Sales mix and break-even analysis OBJ. 5 per square foot of storage used
Einhorn Company has fixed costs of $105,000. The unit selling price, variable cost per 10. Property insurance premiums, $3,600 per month plus $0.01 for each dollar of property unit, and contribution margin per unit for the company's two products follow: over
11Straight-line depreciation on the production equipment
SHOW
ME HOW Product Selling price Variable Cost per Unit Contribution Margin per Unit 12. Hourly wages of machine operators
$50 $35 $15
Electricity costs, $0.20 per kilowatt-hour zz 60 30 30
Computer chip (purchased from a vendor) The sales mix for products QQ and ZZ is 40% and 60%, respectively. Determine the break-even point in units of QQ and ZZ. Pension cost, $1.00 per employee hour on the job
15.
EX 19-2 Identify cost graphs OBJ. 1
EE 19-6 p. 907 PE 19-6A Operating leverage illustrate various types of cost behavior: The following cost graphs SungSam Enterprises reports the following data:
Cost Graph One Cost Graph Two
Sales $340,000
SHOW
ME HOW Variable costs 180,000
Contribution margin $160,000
Fixed costs 80,000 Income from operations $ 80,000 Determine SungSam Enterprises's operating leverage.
EE 19-6 p. 907 PE 19-6B Operating leverage
Westminster Co. reports the following data:
Sales $875,000
SHOW Variable costs 425,000
ME HOW Cost Graph Three Cost Graph Four
Contribution margin $450,000
Fixed costs 1 50,000 Income from operations $300,000
Determine Westminster Co.'s operating leverage.
EE 19-7 p. 908
Melton Inc. has sales of $1,750,000, and the break-even point in sales dollars is $875,000. Determine the company's margin of safety as a percent of current sales.
SHOW
ME HOW
Electricity costs of $1,000 per month plus $0.10 per kilosvatt-hour
Per-unit cost of straight-line depreciation on factory equipment
919 920 19
v' a. $1.25
SHOW
ME HOW
a. $24.00 per unit
SHOW ME HOW
barrels
a. 18,125 units
SHOW ME HOW
EX 19-4 Identify activity bases OBJ. 1 From the following list of activity bases for an automobile dealership, select the base that would be most appropriate for each of these costs: (1) preparation costs (cleaning, oil, and gasoline costs) for each car received, (2) salespersons' commission of 5% of the sales price for each car sold, and (3) administrative costs for ordering cars. Fixed cost, $600,000
Number of cars sold
Dollar amount of cars ordered
Number of cars ordered
Number of cars on hand
Number of cars received
Dollar amount of cars sold SHOW
ME HOW
Dollar amount of cars received
Dollar amount of cars on hand
EX 19-5 Identify fixed and variable costs OBJ. 1
Intuit Inc. develops and sells software products for the personal finance market, including popular titles such as Quickbooks@ and TurboTax@. Classify each of the following costs and expenses for this company as either variable or fixed to the number of units produced a. 30% and sold:
Packaging costs
Sales commissions SHOW
ME HOW
Property taxes on general offices d. Shipping expenses
b. 35.5%
Straight-line depreciation of computer equipment
President's salary
Salaries of software developers
Salaries of human resources personnel
Wages of telephone order assistants
SHOW
CDs ME HOW
k. Users' guides
EX 19-6 Relevant range and fixed and variable costs
Quigley Inc. manufactures memory chips for electronic toys within a relevant range of 200,000 to 600,000 memory chips per year. Within this range, the following partially completed manufacturing cost schedule has been prepared:
Components produced200,000 400,000 600,000
Total costs:
Total variable costs $
Total fixed costs (k)
Total costs.. Cost per unit:
Variable cost per unit (m) v b. 35,000 units
Fixed cost per unit
Total cost per unit
Complete the cost schedule, identifying each cost by the appropriate letter (a) through (o).
SHOW
ME HOW
Diamond Inc. has decided to use the high-low method to estimate the total cost and the fixed and variable cost components of the total cost. The data for various levels of production are as follows:
Units Produced Total Costs
Cop"ight 2016 it.
Chapter 19 Cost Behavior and Cost-Vol ume-Profit Analysis 921922 Chapter 19
EX 19-12 Break-even sales OBJ. 3
Anheuser-Busch lnBev Companies, Inc., reported the following operating information for a recent year (in millions):
Income from operations
*Before special items
In addition, assume that Anheuser-Busch InBev sold 320 million barrels of beer during the year. Assume that variable costs were 70% of the cost of goods sold and 400/0 of selling, general, and administration expenses. Assume that the remaining costs are fixed. For the following year, assume that Anheuser-Busch InBev expects pricing, variable costs per barrel, and fixed costs to remain constant, except that new distribution and general
office facilities are expected to increase fixed costs by $400 million.
Compute the break-even number of barrels for the current year. Note: For the selling price per barrel and variable costs per barrel, round to the nearest cent. Also, round the break-even to the nearest barrel.
Compute the anticipated break-even number of barrels for the following year.
EX 19-13 Break-even sales OBJ. 3 Currently, the unit selling price of a product is $160, the unit variable cost is $120, and the total fixed costs are $725,000. A proposal is being evaluated to increase the unit selling price to $170. a. Compute the current break-even sales (units).
b. Compute the anticipated break-even sales (units), assuming that the unit selling price is increased and all costs remain constant. v' b. $400,000
EX 19-14 Break-even analysis OBJ. 3 The Junior League of Yadkinville, California, collected recipes from members and published a cookbook entitled Food for Everyone. The book will sell for $18 per copy. The chairwoman of the cookbook development committee estimated that the club needed to sell 2,000 books to break even on its $4,000 investment. What is the variable cost per unit assumed in the Junior League's analysis?
EX 19-15 Break-even analysis 0B'.3
Media outlets such as ESPN and Fox Sports often have Web sites that provide in-depth coverage of news and events. Portions of these Web sites are restricted to members who pay a monthly subscription to gain access to exclusive news and commentary. These Web sites typically offer a free trial period to introduce viewers to the Web site. Assume that during a recent fiscal year, ESPN.com spent $4,200,000 on a promotional campaign for the ESPN.com Web site that offered two free months of service for new subscribers. In addition, assume the following information:
Number of months an average new customer stays with the service
(including the two free months) 14 months Revenue per month per customer subscription $10.00
Variable cost per month per customer subscription $5.00
Determine the number of new customer accounts needed to break even on the cost of the promotional campaign. In forming your answer, (1) treat the cost of the promotional campaign as a fixed cost, and (2) treat the revenue less variable cost per account for the subscription period as the unit contribution margin.
Determine the variable cost per unit and the total fixed cost.
Based on part (a), estimate the total cost for 17,000 units of production.
EX 19-8 High-low method for a service company
Boston Railroad decided to use the high-low method and operating data from the past six months to estimate the fixed and variable components of transportation costs. The activity base used by Boston Railroad is a measure of railroad operating activity, termed gross-ton miles," which is the total number of tons multiplied by the miles moved.
Transportation Costs Gross-Ton Miles
$1776,000
Determine the variable cost per gross-ton mile and the total fixed cost.
EX 19-9 Contribution margin ratio 0B'.2
Segar Company budgets sales of $3,200,000, fixed costs of $700,000, and variable costs of $2,240,000. What is the contribution margin ratio for Segar Company?
If the contribution margin ratio for Domino Company is 35%, sales were $2,100,000, and fixed costs were $400,000, what was the income from operations?
EX 19-10 Contribution margin and contribution margin ratio 0B'.2 For a recent year, McDonald's company-owned restaurants had the following sales and expenses (in millions):
Sales $18,602.5
Food and packaging $ 6,318.2
Payroll 4,710.3
Occupancy (rent, depreciation, etc.) 4,195.2 General, selling, and administrative expenses 2,445.2
17,668.9
Income from operations $ 933.6
Assume that the variable costs consist of food and packaging, payroll, and 40% of the general, selling, and administrative expenses.
What is McDonald's contribution margin? Round to the nearest tenth of a million (one decimal place).
What is McDonald's contribution margin ratio? Round to one decimal place.
How much would income from operations increase if same-store sales increased by $900 million for the coming year, with no change in the contribution margin ratio or fixed costs? Round your answer to the nearest tenth of a million (one decimal place).
EX 19-11 Break-even sales and sales to realize income from operations OBJ. 3
For the current year ended March 31, Benatar Company expects fixed costs of $1,250,000, a unit variable cost of $140, and a unit selling price of $100.
Compute the anticipated break-even sales (units).
Compute the sales (units) required to realize income from operations of $150,000.
it.
Cost Behavior and Cost-Vol ume-Profit Ana ysis
EX 19-16 Break-even analysis for a service company 0B'.3
Sprint Nextel is one of the largest digital wireless service providers in the United States. In a recent year, it had approximately 32.5 million direct subscribers (accounts) that generated revenue of $35,345 million. Costs and expenses for the year were as follows (in millions):
Cost of revenue $20,841
Selling, general, and administrative expenses 9,765
Depreciation 2,239
Assume that 70% of the cost of revenue and 30% of the selling, general, and administrative expenses are variable to the number of direct subscribers (accounts).
What is Sprint Nextel's break-even number of accounts, using the data and assumptions given? Round units (accounts) and per-account amounts to one decimal place.
How much revenue per account would be sufficient for Sprint Nextel to break even if the number of accounts remained constant?
EX 19-17 Cost-volume-profit chart 0B'.4 For the coming year, Loudermilk Inc. anticipates fixed costs of $600,000, a unit variable cost of $75, and a unit selling price of $125. The maximum sales within the relevant range are $2,500,000.
Construct a cost-volume-profit chart.
Estimate the break-even sales (dollars) by using the cost-volume-profit chart constructed in part (a).
—What is the main advantage of presenting the cost-volume-profit analysis in graphic form rather than equation form?
EX 19-18 Profit-volume chart 0B'.4
Using the data for Loudermilk Inc. in Exercise 19-17, (a) determine the maximum posSible operating loss, (b) compute the maximum possible operating profit, (c) construct a profit-volume chart, and (d) estimate the break-even sales (units) by using the profitvolume chart constructed in part (c).
EX 19-19 Break-even chart 0B'.4
Name the following chart, and identify the items represented by the letters (a) through (D:
10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000 100,000
Units of Sales
923 924 19
b. If the margin of safety for Canace Company M"as 20%, fixed costs were $1,875,000, and variable costs were 80% of sales, what was the amount of actual sales (dollars)?
SHOW (Hint: Determine the break-even in sales dollars first.)
ME HOW
EX 19-24 Break-even and margin of safety relationships OBJ. 5 At a recent staff meeting, the management of Boost Technologies Inc. was considering discontinuing the Rocket Man line of electronic games from the product line. The chief financial analyst reported the following current monthly data for the Rocket Man:
Units of sales 420,000 Break-even units 472,500 Margin of safety in units 29,400
a. Beck, 5.0 Beck Inc. and Bryant Inc. have the following operating data:
Beck Inc. Bryant Inc.
Variable costs 750,000
EX 19-21 Sales mix and break-even sales OBJ. 5 Contribution margin $ 500,000 $ 750,000 Fixed costs 400,000 450,000 a. 15,500 units Dragon Sports Inc. manufactures and sells two products, baseball bats and baseball gloves. Income from operations $ 100,000 $ 300,000 The fixed costs are $620,000, and the sales mix is 40% bats and 60% gloves. The unit selling price and the unit variable cost for each product are as follows: a. Compute the operating leverage for Beck Inc. and Bryant Inc. b. How much would income from operations increase for each company if the sales of
Products Unit Selli price Unit Variable Cost
s HOWeach increased by 20%?
ME HOW Bats S 90 $50
Gloves 105 65 c.Why is there a difference in the increase in income from operations for the two companies? Explain.
Compute the break-even sales (units) for the overall product, E.
How many units of each product, baseball bats and baseball gloves, would be sold at Appendix the break-even point? EX 19-26 Items on variable costing income statement
In the following equations, based on the variable costing income statement, identify the items designated by X:
EX 19-22 Break-even sales and sales mix for a service company a. Sales — X = Manufacturing Margin
a. 60 seats Zero Turbulence Airline provides air transportation services between Los Angeles, b. Manufacturing Margin — X = Contribution Margin
California, and Kona, Hawaii. A single Los Angeles to Kona round-trip flight has the fol-
lowing operating statistics: c. Contribution Margin — X = Income from Operations
of the number of seats sold for the round-trip flight.
Cost of goods sold
a. Compute the break-even number of seats sold on a single round-trip flight for the Gross profit . overall product, E. Assume that the overall product mix is 10% business class and 90% economy class tickets.
On June 30, 2016, the end of the first month of operations, Tudor Manufacturing Co. unit during the current year. Its income statement is as follows: prepared the following income statement, based on the variable costing concept:
Sales .
Sales (420,000 units) .
Variable cost of goods sold: ME SHOWHOW
Expenses:
Selling expenses.. .. . .. .. . .. .. Manufacturing margin Administrative expenses.. . Total expenses .
Contribution margin . Income from operations.. .
Fixed costs: The division of costs between variable and fixed is as follows:
Fixed manufacturing costs….
Variable Fixed Fixed selling and administrative expenses 20% Income from operations. .
a. Prepare an absorption costing income statement.
Determine the total variable costs and the total fixed costs for the current year.
Determine (a) the unit variable cost and (b) the unit contribution margin for the current year. 3. Compute the break-even sales (units) for the current year.
Compute the break-even sales (units) under the proposed program for the following year.
Determine the amount of sales (units) that would be necessary under the proposed program to realize the $4,400,000 of income from operations that was earned in the current year. 6. Determine the maximum income from operations possible with the expanded plant.
If the proposal is accepted and sales remain at the current level, what will the income or loss from operations be for the following year?
Based on the data given, would you recommend accepting the proposal? Explain.
PR 19-3A Break-even sales and cost-volume-profit chart OBJ. 3, 4 For the coming year, Cleves Company anticipates a unit selling price of $100, a unit variable cost of $60, and fixed costs of $480,000.
Instructions
Compute the anticipated break-even sales (units).
Compute the sales (units) required to realize a target profit of $240,000.
Construct a cost-volume-profit chart, assuming maximum sales of 20,000 units within the relevant range.
Determine the probable income (loss) from operations if sales total 16,000 units.
PR 19-4A Break-even sales and cost-volume-profit chart OBJ. 3, 4
Last year, Hever Inc. had sales of $500,000, based on a unit selling price of $250. The
q. Janitorial services, $2,200 per month variable cost per unit was $175, and fixed costs were $75,000. The maximum sales within
Hever Inc.'s relevant range are 2,500 units. Hever Inc. is considering a proposal to spend Wages of machine operators an additional $33,750 on billboard advertising during the current year in an attempt to
s. Electricity costs of $0.10 per kilosvatt-hour increase sales and utilize unused capacity.
Property taxes on property, plant, and equipment Instructions
Instructions 1. Construct a cost-volume-profit chart indicating the break-even sales for last year. Verify Classify the preceding costs as either fixed, variable, or mixed. Use the following tabular head- your answer, using the break-even equation.
ings and place an X in the appropriate column. Identify each cost by letter in the cost column. 2. Using the cost-volume-profit chart prepared in part (1), determine (a) the income from operations for last year and (b) the maximum income from operations that could have Fixed Cost Variable Cost Mixed Cost been realized during the year. Verify your answers using the mathematical approach
to cost-volume-profit analysis.
927 928 19
Construct a cost-volume-profit chart indicating the break-even sales for the current year, assuming that a noncancellable contract is signed for the additional billboard advertising. No changes are expected in the unit selling price or other costs. Verify your answer, using the break-even equation.
Using the cost-volume-profit chart prepared in part (3), determine (a) the income from operations if sales total 2,000 units and (b) the maximum income from operations that could be realized during the year. Verify your answers using the mathematical approach to cost-volume-profit analysis.
PR 19-5 A Sales mix and break-even sales OBJ. 5
1.4,030 units Data related to the expected sales of laptops and tablets for Tech Products Inc. for the
The estimated fixed costs for the current year are $2,498,600.
Instructions
Determine the estimated units of sales of the overall (total) product, E, necessary to reach the break-even point for the current year.
Based on the break-even sales (units) in part (1), determine the unit sales of both laptops and tablets for the current year.
Assume that the sales mix was 500/0 laptops and 50% tablets. Compare the break-even point with that in part (1). Why is it so different?
PR 19-6A Contribution margin, break-even sales, cost-volume-profit chart, OB. 2, 3, margin Of safety, and operating leverage
2. 25% Wolsey Industries Inc. expects to maintain the same inventories at the end of 2016 as at the beginning of the year. The total of all production costs for the year is therefore assumed to be equal to the cost of goods sold. With this in mind, the various department heads were asked to submit estimates of the costs for their departments during the year. A summary report of these estimates is as follows:
Estimated Estimated Variable Cost
Fixed Cost (per unit sold)
Cromwell Furniture Company manufactures sofas for distribution to several major retail chains. The following costs are incurred in the production and sale of sofas:
Fabric for sofa coverings
Wood for framing the sofas c. Legal fees paid to attorneys in defense of the company in a patent infringement suit, $25,000 plus $160 per hour
Salary of production supervisor
Cartons used to ship sofas
Rent on experimental equipment, $50 for every sofa produced
Straight-line depreciation on factory equipment
Rental costs of svarehouse, $30,000 per month
Property taxes on property, plant, and equipment
Insurance premiums on property, plant, and equipment, $25,000 per year plus $25 per $25,000 of insured value over $16,000,000
k. Springs
Consulting fee of $120,000 paid to efficiency specialists
Electricity costs of $0.13 per kilosvatt-hour
Salesperson's salary, $80,000 plus 4% of the selling price of each sofa sold
Foam rubber for cushion fillings
Janitorial supplies, $2,500 per month
Employer's FICA taxes on controller's salary of $180,000 Salary of designers
s. Wages of sewing machine operators
Sewing supplies
Instructions
Direct labor .40 Factory overhead $200,000 20 Selling expenses:
Sales salaries and commissions.. . 110,000 8 PR 19-2B Break-even sales under present and proposed conditions
Advertising. 40,0003. 29,375 units Howard Industries Inc., operating at full capacity, sold 64,000 units at a price of $45 per
Travel .12,000 unit during the current year. Its income statement is as follows:
Miscellaneous selling expense . 7,600
Sales
Administrative expenses: .
Office and officers' salaries132,000 SHOW Cost of goods sold ME HOW
Supplies.. . . ….. . .. . ..10,000 4 Gross profit. .
Administrative expenses. . 387,500
It is expected that 21,875 units will be sold at a price of $160 a unit. Maximum sales
Total expenses. . within the relevant range are 27,000 units.
Income from operations .
Instructions
Prepare an estimated income statement for 2016.
What is the expected contribution margin ratio?
Determine the break-even sales in units and dollars.
Construct a cost-volume-profit chart indicating the break-even sales.
The division of costs between variable and fixed is as follows:
Variable Fixed
What is the expected margin of safety in dollars and as a percentage of sales?
Determine the operating leverage.
All Rights it.it.
v' 1. 20,000 units For the coming year, Culpeper Products Inc. anticipates a unit selling price of $150, a Production costs:
unit variable cost of $110, and fixed costs of $800,000. Direct materials . $50.00
Direct labor. .30.00
Instructions6.00
Factory overhead 350,000
Construct a cost-volume-profit chart, assuming maximum sales of 40,000 units within Advertising 1 16,000 the relevant range. Travel .4,000
Determine if sales Miscellaneous selling expense . 2,300 1 .00
Office and officers' salaries .
PR 19-4B Break-even sales and cost-volume-profit chart OBJ. 3, 44.00
v' 1. 3,000 units Last year, Parr Co. had sales of $900,000, based on a unit selling price of $200. The vari-1 .00 able cost per unit was $125, and fixed costs were $225,000. The maximum sales within Total . $96.00
4. Using the cost-volume-profit chart prepared in part (3), determine (a) the income from operations if sales total 6,000 units and (b) the maximum income from operations that could be realized during the year. Verify your answers arithmetically.
CP 19-1 Ethics and professional conduct in business
1.4,500 units PR 19-5B Sales mix and break-even sales OBJ. 5
Edward Seymour is a financial consultant to Cornish Inc., a real estate syndicate. Cornish
Data related to the expected sales of two types of frozen pizzas for Norfolk Frozen Foods Inc. finances and develops commercial real estate (office buildings). The completed projInc. for the current year, which is typical of recent years, are as follows: ects are then sold as limited partnership interests to individual investors. The syndicate makes a profit on the sale of these partnership interests. Edward provides financial in-
Products Unit Selling price Unit Variable Cost Sales Mix formation for the offering prospectus, which is a document that provides the financial
12" Pizza $12 details of the limited partnership offerings. In one of the projects, the bank has
and legal
16" Pizza 15 4 70% (co tin lied)
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financed the construction of a commercial office building at a rate of 10% for the first four years, after which time the rate jumps to 15% for the remaining 20 years of the mortgage. The interest costs are one of the major ongoing costs of a real estate project. Edward has reported prominently in the prospectus that the break-even occupancy for the first four years is 65%. This is the amount of office space that must be leased to cover the interest and general upkeep costs over the first four years. The 65% break-even is very low and thus communicates a low risk to potential investors. Edward uses the 65% break-even rate as a major marketing tool in selling the limited partnership interests. Buried in the fine print of the prospectus is additional information that would allow an astute investor to determine that the break-even occupancy will jump to 95% after the fourth year because of the contracted increase in the mortgage interest rate. Edward believes prospective investors are adequately informed as to the risk of the investment. Comment on the ethical considerations of this situation.
CP 19-2 Break-even sales, contribution margin
"For a student, a grade of 65 percent is nothing to write home about But for the airline … [industry], filling 65 percent of the seats… is the difference between profit and loss.
The [economy] might be just strong enough to sustain all the carriers on a cash basis, but not strong enough to bring any significant profitability to the industry. . For the airlines.. the emphasis will be on trying to consolidate routes and raise ticket prices…
Source: Edwin McDowell, "Empty Seats, Empty Beds, Empty Pockets," The New York Times, January 6, 1992, p. O.
The airline industry is notorious for boom and bust cycles. Why is airline profitability very sensitive to these cycles? Do you think that during a down cycle the strategy to consolidate routes and raise ticket prices is reasonable? What would make this strategy succeed or fail? Why?
CP 19-3 Break-even analysis
Somerset Inc. has finished a new video game, Snowboard Challenge. Management is now considering its marketing strategies. The following information is available:
Anticipated sales price per unit
Variable cost per unit*
Anticipated volume . units
Production costs
Anticipated advertising
*The cost of the video game, packaging, and copying costs.
Two managers, James Hamilton and Thomas Seymour, had the following discussion of ways to increase the profitability of this new offering:
James: I think we need to think of some way to increase our profitability. Do you have any ideas?
Thomas: Well, I think the best strategy would be to become aggressive on price.
James: How aggressive?
Thomas: If we drop the price to $60 per unit and maintain our advertising budget at S I think we will generate total sales of 2,000,000 units.
James: I think that's the wrong way to go. You're giving too much up on price. Instead, I think we need to follow an aggressive advertising strategy.
Thomas: How aggressive?
James: If we increase our advertising to a total of $25,000,000, we should be able to increase sales volume to units without any change in price.
Thomas: I don't think that's reasonable. We'll never cover the increased advertising costs.
Which strategy is best: Do nothing? Follow the advice of Thomas Seymour? Or follow James Hamilton's strategy?
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CHAPTER
20
Variable Costing for
Management Analysis Adobe Systems, Inc.
932 19
CP 19-4 Variable costs and activity bases in decision making
The owner of Warwick Printing, a printing company, is planning direct labor needs for the upcoming year. The owner has provided you with the following information for next year's plans:
One Color Two Color Three Color Four Color Tota I
Number of banners 212 274 616 698 1 ,800
Each color on the banner must be printed one at a time. Thus, for example, a fourcolor banner will need to be run through the printing operation four separate times. The total production volume last year was 800 banners, as follows:
One Color Two Color Three Color Tota I
Number of banners 180 240 380 800
As you can see, the four-color banner is a new product offering for the upcoming year. The owner believes that the expected 1,000-unit increase in volume from last year means that direct labor expenses should increase by 125% (1,000 + 800). What do you think?
CP 19-5 Variable costs and activity bases in decision making
Sales volume has been dropping at Munford Industries. During this time, however, the Shipping Department manager has been under severe financial constraints. The manager knows that most of the Shipping Department's effort is related to pulling inventory from the warehouse for each order and performing the paperwork. The paperwork involves preparing shipping documents for each order. Thus, the pulling and paperwork effort associated with each sales order is essentially the same, regardless of the size of the order. The Shipping Department manager has discussed the financial situation with senior management. Senior management has responded by pointing out that sales volume has been dropping, so that the amount of work in the Shipping Department should be dropping. Thus, senior management told the Shipping Department manager that costs should be decreasing in the department.
The Shipping Department manager prepared the following information:
Sales Number of Sales Volume
Month Volume Customer Orders per Order
January $472,000 1,180
February 475,800 1 ,220 390 March 456,950 1,235 370 April 425,000 1 ,250 340 May 464,750 1 ,430 325 June 421 ,200 1 ,350 312 July 414,000 1 ,380 300
August 430,700 1,475 292
Given this information, how would you respond to senior management?
CP 19-6 Break-even analysis Group Project
Break-even analysis is one of the most fundamental tools for managing any kind of business unit. Consider the management of your university or college. In a group, brainstorm some applications of break-even analysis at your university or college. Identify three areas where break-even analysis might be used. For each area, identify the revenues, variable costs, and fixed costs that would be used in the calculation.
Cop"ight 2016
it.
Describe and illustrate the effects of absorption and variable 2 costing on analyzing income from operations.
Income Analysis Under Absorption and Variable Costing
Describe management's use of absorption and variable costing.
Using Absorption and Variable Costing
Controlling Costs
Pricing Products
Planning Production Analyzing Contribution Margins
Analyzing Market Segments
Use variable costing for analyzing market segments, including
product, territories, and salespersons segments.
Analyzing Market Segments
Sales Territory Profitability Analysis Product Profitability Analysis
Salesperson Profitability Analysis
Use variable costing for analyzing and explaining changes in 5 contribution margin as a result of quantity and price factors.
Contribution Margin Analysis
Describe and illustrate the use of variable costing for service firms.
6 Variable Costing for Service Firms
Reporting Income from Operations Using Variable Costing for a Service Company
Market Segment Analysis for Service Company
Contribution Margin Analysis
ssume that you have three different options for a summer job. How would you evaluate these options? Naturally there are many things to consider, including how much you could earn from each job.
Determining how much you could earn from each job may not be as simple as comparing the wage rate per hour. For example, a job as an office clerk at a local company pays $8 per houL A job delivering pizza pays $10 per hour (including estimated tips), although you must use your own transportation. Another job working in a beach resort
over 500 miles away from your home pays 58 per hour. All three jobs offer 40 hours per week for the whole summer. If these options were ranked according to their pay per hour, the pizza delivery job would be the most attractive. However, the costs associated with each job must also be evaluated. For example, the office job may require thatyou pay for downtown parking and purchase office clothes. The pizza delivery job will require you to pay for gas and maintenance for your car. The resortjob will require you to move to the resort city' and incur additional living costs. On y by considering the costs for each job will you be able to determine which job will provide you with the most income.
not
Just as you should evaluate the re ative income of various choices, a business also evaluates the income earned from its choices. mportant choices include the products offered and the geographical regions to be served.
A company will often evaluate the profitability of products and regions. For example, Adobe Systems Inc., one ofthe largest software companies in the world, determines the income earned from its various product lines, such as Acrobat, Photoshop', Premiee, and Dream-
weavee software. Adobe uses this information to establish product line pricing, as well as sales, support, and development effort Likewise, Adobe evaluates the income earned in the geographic regions it serves, such as the United States, Europe, and Asia. Again, such information aids management in managing revenue and expenses within the regions.
In this chapter, how businesses measure profitability using absorption costing and variable costing is discussed. After illustrating and comparing these concepts, how businesses use them for controlling costs, pricing products, planning production, analyzing market segments, and analyzing contribution margins is described and illustrated.
puly
OBJ
Describe and illustrate reporting income from operations under absorption and variable costing.
Different regions of the world emphasize different approaches to reporting income. For example, Scandinavian companies have a strong variable costing tradition, while German cost accountants have developed some of the most advanced absorption costing practices in the world.
Income from Operations Under Absorption Costing and Variable Costing
Income from operations is one of the most important items reported by a company. Depending on the decision-making needs of management, income from operations can be determined using absorption or variable costing.
Absorption Costing
Absorption costing is required under generally accepted accounting principles for financial statements distributed to external users. Under absorption costing, the cost Of goods manufactured includes direct materials, direct labor, and factory overhead costs. Both fixed and variable factory costs are included as part of factory overhead. In the financial statements, these costs are included in the cost of goods sold (income statement) and inventory (balance sheet).
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The reporting Of income from operations under absorption costing is as follows:
The income statements illustrated in the preceding chapters of this text have used absorption costing.
Variable Costing
For internal use in decision making, managers often use variable costing. Under variable costing, sometimes called direct costing, the cost Of goods manufactured includes only variable manufacturing costs. Thus, the cost of goods manufactured consists Of the following:
Direct materials
Direct labor
Variable factory overhead
Under variable costing,fixed factory overhead costs are not a part of the cost of goods manufactured. Instead, fixed factory overhead costs are treated as a period expense. Exhibit 1 illustrates the differences between absorption costing and variable costing.
The reporting Of income from operations under variable costing is as follows:
Sales sxxx
Variable cost of goods sold
Manufacturing margin sxxx
Variable selling and administrative expenses
Contribution margin $xxx
Fixed costs:
Fixed manufacturing costs sxxx
Fixed selling and administrative expenses
Income from operations SXXX
Manufacturing margin is the excess of sales over variable cost of goods sold:
Manufacturing Margin Sales — Variable Cost of Goods Sold
Variable cost of goods sold consists Of direct materials, direct labor, and variable facton: overhead for the units sold. Contribution margin is the excess Of manufacturing margin over variable selling and administrative expenses:
Contribution Margin Manufacturing Margin — Variable Selling and Administrative Expenses Subtracting fixed costs from contribution margin yields income Dom operations:
Income from Operations Contribution Margin — Fixed Costs
Chapter 20 Variable Costing for Management Analysis 937
Leone Company has the following information for March'
Sales $450,000
Variable cost of goods sold 220,000 Fixed manufacturing costs 80,000
Variable sel ing and administrative expenses 50,000 Fixed selling and administrative expenses 35,000
Determine (a) the manufacturing margin, (b) the contribution margin, and (c) income from operations for Leone Company for the month of March.
$230,000 $450,000 -5220.000)
$180,000 ($230,000 -$50,000)
$65,000 ($180,000 -$80,000- $35,000)
Units Manufactured Equal Units Sold
In Exhibits 2 and 3, Martinez manufactured and sold 15,000 units. Thus, the variable and absorption costing income statements reported the same income from operations Of $100,000. When the number Of units manufactured equals the number Of units sold, income from operations will be the same under both methods.
Units Manufactured Exceed Units Sold
When units manufactured exceed the units sold, the variable costing income from operations will be less than it is for absorption costing. To illustrate, assume that only 12,000 units of the 15,000 units Martinez manufactured were sold.
Exhibit shows the absorption and variable costing income statements when units
936
TO illustrate variable costing and absorption costing, assume that Martinez co. manufactures 15,000 units, which are sold at a price of $50. The related costs and expenses for Martinez are as follows:
Exhibit 2 shows the absorption computations are shown in parentheses.
EXHI BIT 2
Absorption Costing
Income Statement
Absorption costing does not distinguish between variable and fixed costs. All manufacturing Costs are included in the Cost of goods sold. Deducting the Cost of goods sold of $525,000 from sales of $750,000 yields gross profit of $225,000. Deducting selling and administrative expenses of $125,000 from gross profit yields income from operations of SIOO,OOO.
Exhibit 3 shows the variable costing income statement prepared for Martinez. The computations are shown in parentheses.
EXHI BIT 3
Variable Costing
Income Statement
938 Chapter 20 Variable Costing for Management Analysis
Exhibit 4 shows a $30,000 ($70,000 — $40,000) difference in income from operations. This difference is due to the fixed manufacturing costs. All Of the $150,000 Of fixed manufacturing costs is included as a period expense in the variable costing statement. However, the 3,000 units of ending inventory in the absorption costing statement includes $30,000 (3,000 units x $10) Of fixed manufacturing costs. By being included in inventory, this $30,000 is thus excluded from the cost of goods sold. Thus, the absorption costing income from operations is $30,000 higher than the income from operations for variable costing.
Example Exercise 20-2 Variable Costing—Production Exceeds Sales
Fixed manufacturing costs are 540 per unit, and variable manufacturing costs are S 120 per unit. Production was 125,000 units, while sales were 120.000 units. Determine (a) whether variable costing income from operations is less than or greater than absorption costing income from operations, and (b) the difference in variable costing and absorption costing income from operations.
Units Manufactured Less Than Units Sold
When the units manufactured are less than the number Of units sold, the variable costing income from operations will be greater than that of absorption costing. To illustrate, assume that beginning inventory, units manufactured, and units sold for Martinez were as follows:
Beginning _ 5,000 units
Units manufactured during current period 10,000 units
Units sold during the current period at $50 per unit 15,000 units
Number Unit
Total Cost of Units COSt
Fixed 150,000 10,000
Total , $400,000
Fixed . _50,000
Total$125,000
939
Exhibit 5 shows the absorption and variable costing income statement for Martinez when units manufactured are less than units sold.
EX H IB IT 5
Units Manufactured Are Less Than Units
Sold
Exhibit 5 shows a $50,000 ($100,000 — $50,000) difference in income from operations. This difference is due to the fixed manufacturing costs. The beginning inventory under absorption costing includes $50,000 (5,000 units x $10) Of fixed manufacturing costs incurred in the preceding period. By being included in the beginning inventory, this $50,000 is included in the cost of goods sold for the current period. Under variable costing, this $50,000 was included as an expense in an income statement Of a prior period. Thus, the variable costing income from operations is $50,000 higher than the income from operations for absorption costing.
Example Exercise 20-3 Variable Costing—sales Exceed Production OBJ
The beginning inventory is 6,000 units. All of the units that were manufactured during the period and the 6,000 units Of beginning inventory were sold. The beginning inventory fixed manufacturing costs are $60 per unit, and variable manufacturing costs are $300 per unit. Determine (a) whether variable costing income from operations is less than or greater than absorption costing income from operations, and (b) the difference in variable costing and absorption costing income from operations.
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Chapter 20 Variable Costing for Management Analysis 941
Proposal 2: 25,000 Units to Be Manufactured and 20,000 Units to Be Sold
Number Unit
Total Cost Of Units Cost
Manufacturing costs:
Variable. . $ 875,000 25,000 $35
Fixed . 400,000 25,000
Total . $51 Selling and administrative expenses: Variable. 20,000 $ 5 Fixed .
The absorption costing income statements for each proposal are shown in Exhibit 7.
Absorption Costing Income Statements for Two Production Levels
Exhibit 7 shows that if Frand manufactures 25,000 units, sells 20,000 units, and adds the 5,000 units to finished goods inventory (Proposal 2), income from operations will be $280,000. In contrast, if Frand manufactures and sells 20,000 units (Proposal 1), income from operations will be $200,000. In other words, Frand can increase income from operations by $80,000 ($280,000 — $200,000) by simply increasing finished goods inventory by 5,000 units.
The $80,000 increase in income from operations under Proposal 2 is caused by the allocation Of the fixed manufacturing costs Of $400,000 over a greater number of units manufactured. Specifically, an increase in production from 20,000 units to 25,000 units means that the fixed manufacturing cost per unit decreases from $20 ($400,000 + 20,000 units) to $16 ($400,000 + 25,000 units). Thus, the cost Of goods sold when 25,000 units are manufactured is $4 per unit less, Or $80,000 less in total (20,000 units sold x $4). Since the cost of goods sold is less, income from operations is $80,000 more when 25,000 units rather than 20,000 units are manufactured.
Managers should be careful in analyzing income from operations under absorption costing when finished goods inventory changes. Increases in income from operations may be created by simply increasing finished goods inventory. Thus, managers could misinterpret such increases (or decreases) in income from operations as due to changes in sales volume, prices, or costs.
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Effects on Income from Operations
The preceding examples illustrate the effects on income from operations Of using absorption and variable costing. These effects are summarized in Exhibit 6.
Manufacturing costs:
Variable.. . … —
Fixed
Total .
Variable.. . .
Fixed .
Total .
•$400,000 * 20,000 units
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942 Chapter 20 Variable Costing for Management Analysis
Under variable costing, income from operations is $200,000, regardless Of whether 20,000 units or 25,000 units are manufactured. This is because no fixed manufacturing costs are allocated to the units manufactured. Instead, all fixed manufacturing costs are treated as a period expense.
To illustrate, Exhibit 8 shows the variable costing income statements for Frand for the production Of 20,000 units, 25,000 units, and 30,000 units. In each case, the income from operations is $200,000.
Variable Costing Income Statements for Three Production Levels
TAKING AN "ABSORPTION HIT"
Variable manufacturing costs are $100 per unit, and fixed manufacturing costs are $50,000. Sales are estimated to be 4,000 units.
How much would absorption costing income from operations differ between a plan to produce 4,000 units and a plan to produce 5,000 units?
How much would variable costing income from operations differ between the two production plans?
Follow My Example 20-4
$10,000 greater in producing 5,000 units.
There would be no difference in variable
Using Absorption and Variable Costing exceed the variable costs, the
Describe
3 "weekend getaway" pricing
management's
Controlling Costs
All costs are controllable in the long run by someone within a business. However, not all costs are controllable at the same level of management. For example, plant supervisors control the use of direct materials in their departments. They have no control, though, over insurance costs related to the property, plant, and equipment.
For a level of management, controllable costs are costs that can be influenced (increased or decreased) by management at that level. Noncontrollable costs are costs that another level of management controls. This distinction is useful for reporting costs to those responsible for their control.
Variable manufacturing costs are controlled by operating management. In contrast, fixed manufacturing overhead costs such as the salaries Of production supervisors are normally controlled at a higher level Of management. Likewise, control Of the variable and fixed operating expenses usually involves different levels of management. Since fixed costs and expenses are reported separately under variable costing, variable costing reports are normally more useful than absorption costing reports for controlling costs. Pricing Products
Many factors enter into determining the selling price Of a product. However, the cost of making the product is significant in all pricing decisions.
In the short run, fixed costs cannot be avoided. Thus, the selling price of a product should at least be equal to the variable costs of making and selling it. Any price above this minimum selling price contributes to covering fixed costs and generating income. Since variable costing reports variable and fixed costs and expenses separately, it is often more useful than absorption costing for setting short-run prices.
In the long run, a company must set its selling price high enough to cover all costs and expenses (variable and fixed) and generate income. Since absorption costing includes fixed and variable costs in the cost of manufacturing a product, absorption costing is often more useful than variable costing for setting long-term prices.
Planning Production
In the short run, planning production is limited to existing capacity. In many cases, operating decisions must be made quickly before opportunities are lost.
TO illustrate, a company with seasonal demand for its products may have an opportunity to obtain an off-season order that will not interfere with its current production schedule. The relevant factors for such a short-run decision are the additional revenues and the additional variable costs associated with the order. If the revenues from the order exceed the related variable costs, the order will increase contribution margin and, thus, increase the company's income from operations. Since variable costing reports contribution margin, it is often more useful than absorption costing in such cases.
In the long run, planning production can include expanding existing capacity. Thus, when analyzing and evaluating long-run sales and operating decisions, absorption costing, which considers fixed and variable costs, is often more useful.
Analyzing Contribution Margins
For planning and control purposes, managers often compare planned and actual contribution margins. For example, an increase in the price Of fuel could have a significant impact on the planned contribution margins of an airline. The use of variable costing as a basis for such analyses is described and illustrated later in this chapter.
Analyzing Market Segments
Market analysis determines the profit contributed by the market segments Of a company. A market segment is a portion Of a company that can be analyzed using sales,
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Chapter 20 Variable Costing for Management Analysis 945
costs, and expenses to determine its profitability. Examples of market segments include sales territories, products, salespersons, and customers. Variable costing as an aid in decision making regarding market segments is discussed next.
Lancelot20,000 50,000 70,000
Total territory sales . $80,000 $80,000 $160,000
Variable production costs:
Gwenevere (12% of sales) . S 3,600 10,800 Lancelot (12% of sales) . . 6,000 8,400
Total variable production cost by territory . $ 9,600 1 9,200
Promotion
it.
946 Chapter 20 Variable Costing for Management Analysis
Camelot Fragrance manufactures and sells the Gwenevere perfume for women and the Lancelot cologne for men. TO simplify, no inventories are assumed to exist at the beginning or end of March.
Sales Territory Profitability Analysis
An income statement presenting the contribution margin by sales territories is often used in evaluating past performance and in directing future sales efforts. Sales territoty profitability analysis may lead management to do the following:
Reduce costs in lower-profit sales territories
Increase sales efforts in higher-profit territories
To illustrate sales territory profitability analysis, Exhibit 10 shows the contribution margin for the Northern and Southern territories Of Camelot Fragrance Company. As Exhibit 10 indicates, the Northern Territory is generating $34,400 of contribution margin, while the Southern Territory is generating $40,400 Of contribution margin.
Contribution Margin by Sales Territory Report
947
As shown, 62.5% Of the Southern Territory's sales are sales Of Lancelot. Since the Southern Territory's contribution margin ($40,400) is higher (as shown in Exhibit 10) than that of the Northern Territory ($34,400), Lancelot must be more profitable than Gwenevere. To verify this, product profitability analysis is performed.
Product Profitability Analysis
A company should focus its sales efforts on products that will provide the maximum total contribution margin. In doing so, product profitability analysis is often used by management in making decisions regarding product sales and promotional efforts.
To illustrate product profitability analysis, Exhibit 11 shows the contribution margin by product for Camelot Fragrance Company.
Report
Exhibit 11 indicates that Lancelot's contribution margin ratio (58%) is greater than Gwenevere's (38%). Lancelot's higher contribution margin ratio is a result of its lower promotion and sales commissions costs. Thus, management should consider the following:
Emphasizing Lancelot in its marketing plans
Reducing Gwenevere's promotion and sales commissions costs
Increasing the price of Gwenevere
Salesperson Profitability Analysis
A salesperson profitability report is useful in evaluating sales performance. Such a report normally includes total sales, variable cost of goods sold, variable selling expenses, contribution margin, and contribution margin ratio for each salesperson.
Exhibit 12 illustrates such a salesperson profitability report for three salespersons in the Northern Territory of Camelot Fragrance Company. The exhibit indicates that Beth Williams produced the greatest contribution margin ($15,200), but had the lowest contribution margin ratio (38%). Beth sold $40,000 Of product, which is twice as much product as the other two salespersons. However, Beth sold only Gwenevere, which has the lowest contribution margin ratio (from Exhibit 11). The other two salespersons sold equal amounts of Gwenevere and Lancelot. As a result, Inez Rodriguez and Deshawn Thomas had higher contribution margin ratios because they sold more Lancelot. The Northern Territory manager could use this report to encourage Inez and Deshawn to sell more total product, while encouraging Beth to sell more Lancelot.
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Chapter 20 Variable Costing for Management Analysis 949
CHIPOTLE MEXICAN GRILL CONTRIBUTION MARGIN BY STORE
Chipotle Mexican Grill's annual report identifies revenues and costs for its company-owned restaurant operations. Assume that food, beverage, packaging, and labor are variable and that occupancy and other expenses are fixed. A contribution margin and income from operations can be constructed for the restaurants as follows for the year ended December 31, 2013 (in thousands):
Sales$3,214,591
Variable restaurant expenses:
Food, beverage, and packaging…. . $1,073,514
Labor 739,800
The annual report also indicates that Chipotle Mexican Grill has 1 ,595 restaurants, all company-owned. Dividing the numbers above by 1 ,595 yields the contribution margin and income from operations per restaurant as follows (in thousands):
Sales… ….. ….. ….. … $2,015
Variable restaurant expenses.. 1,137
Contribution $ 878
Occupancy and other expenses.. ….. 343
Income from operations$ 535
Chipotle Mexican Grill can use this information for pricing products; evaluating the sensitivity of store profitability to changes in sales volume, prices, and costs; and analyzing profitability by geographic segment.
Source: Chipotle Mexican Grill, Inc. Form TO-K. Annual Report pursuant to Section 1 3 or IS(d) Of the Securities Exchange Act Of 1934. For the fiscal year ended December 31, 2013. Securities and Exchange Commission, Washington D.C. 20549.
Contribution Margin Analysis
Managers Often use contribution margin in planning and controlling operations. In doing so, managers use contribution margin analysis. Contribution margin analysis focuses on explaining the differences between planned and actual contribution margins.
Contribution margin is defined as sales less variable costs. Thus, a difference between the planned and actual contribution margin may be caused by an increase or a decrease in:
Sales
Variable costs
An increase or a decrease in sales or variable costs may in turn be due to an increase or a decrease in the:
Number of units sold
Unit sales price or unit cost
The effects of the preceding factors on sales or variable costs may be stated as follows:
Quantity factor: The effect of a difference in the number of units sold, assuming no change in unit sales price or unit cost. The sales quantity factor and the variable cost quantity factor are computed as follows:
Sales Quantity Factor = (Actual Units Sold — Planned Units of Sales) x Planned Sales Price
Variable Cost Quantity Factor = (Planned Units of Sales — Actual Units Sold) x Planned Unit Cost
948
EX H IB IT 1 2
Contribution Margin by Salesperson Report
Other factors should also be considered in evaluating salespersons' performance. For example, sales growth rates, years Of experience, customer service, territory size, and actual performance compared to budgeted performance may also be important.
The following data are for Moss Creek Apparel:
East West
Shirts….$ 7 Shorts $10
Determine the contribution margin for (a) Shorts and (b) the West Region.
Practice Exercises: PE 20-5A, PE 20-5B
it.
950 Chapter 20 Variable Costing for Management Analysis
• Unit price factor or unit cost factor. The effect of a difference in unit sales price or unit cost on the number of units sold. The unit price factor and unit cost factor are computed as follows:
Unit Price Factor = (Actual Selling Price per Unit — Planned Selling Price per Unit) x Actual Units Sold
Unit Cost Factor = (Planned Cost per Unit — Actual Cost per Unit) x Actual Units Sold
The preceding factors are computed so that a positive amount increases contribution margin and a negative amount decreases contribution margin.
The effects Of the preceding factors on contribution margin are summarized in Exhibit 13.
To illustrate, the following data for the year ended December 31, for Noble Inc., which sells a single product, are used: 1
Use variable
5 costing for Actual Planned analyzing and explaining changes in contribution margin as a result of quantity and price factors.
3.40 3.50
I .30 I .25
Exhibit 14 shows the contribution margin analysis report for Noble Inc. for the year ended December 31. The exhibit indicates that the favorable difference of $25,000 ($350,000 — $325,000) between the actual and planned contribution margins was due in large part to an increase in the quantity sold (sales quantity factor) Of $200,000. This $200,000 increase was partially Offset by a decrease in the unit sales price (unit price factor) of $62,500 and an increase in the amount of variable costs of $112,500 ($75,000 + $37,500).
To simplify, it is assumed that Noble Inc. sells a single product. The analysis would be more complex, butthe principles would be the same, if more than one product were sold.
The preceding factors are computed so that a positive amount increases contribution margin and a negative amount decreases contribution margin.
951
Contribution
Margin Analysis
Report
The contribution margin analysis reports are useful to management in evaluating past performance and in planning future operations. For example, the impact Of the $0.50 reduction in the unit sales price by Noble Inc. on the number Of units sold and on the total sales for the year is useful information in determining whether further price reductions might be desirable.
The contribution margin analysis report also highlights the impact of changes in unit variable costs and expenses. For example, the $0.05 increase in the unit variable selling and administrative expenses might be a result Of increased advertising expenditures. If so, the increase in the number Of units sold could be attributed to both the $0.50 price reduction and the increased advertising.
The actual price for a product was $48 per unit, while the planned price was $40 per unit. The volume increased by 5,000 units to 60,000 actual total units. Determine (a) the quantity factor and (b) the price factor for sales.
$200,000 increase in sales (5,000 units x $40 per unit)
$480,000 increase in sales [($48 — $40) x 60,000 units]
Practice Exercises: PE 20-6A, PE 20-6B
it.
Chapter 20 Variable Costing for Management Analysis 953
Service Industry
Market Segments
To illustrate, a contribution margin report segmented by route is used for Blue Skies Airlines Inc. In preparing the report, the following data for April are used:
Chicago/Atlanta Atlanta/LA LA/Chicag0
952
TO illustrate variable costing for a service company, Blue Skies Airlines Inc., which operates as a small commercial airline, is used. The variable and fixed costs Of Blue
Skies are shown in Exhibit 15.
Costs Of Blue Skies Airlines Inc.
As discussed in Chapter 19, a cost is classified as a fixed or variable cost according to how it changes relative to an activity base. A common activity for a manufacturing firm is the number Of units produced. In contrast, most service companies use several activity bases.
TO illustrate, Blue Skies uses the activity base number ofpassengers for food and beverage service and selling expenses. Blue Skies uses number of miles flown for fuel and wage expenses.
The variable costing income statement for Blue Skies, assummg revenue of is shown in Exhibit 16.
Variable Costing
Income Statement for a Service Company
Unlike a manufacturing company, Exhibit 16 does not report cost of goods sold, inventory, or manufacturing margin. However, as shown in Exhibit 16, contribution margin is reported separately from income from operations.
Market Segment Analysis for Service Company
A contribution margin report for service companies can be used to analyze and evaluate market segments. Typical segments for various service companies are shown in
Exhibit 17.
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954 Chapter 20 Variable Costing for Management Analysis
decreases the ticket price from $400 to $380 beginning May 1. As a result, the number Of tickets sold (passengers) increased from 16,000 to 20,000. However, the cost per mile also increased during May from $20 to $22 due to increasing fuel prices.
The actual and planned results for the Chicago/Atlanta route during May follow. The planned amounts are based on the April results without considering the price change or cost per mile increase. The highlighted numbers indicate changes during May.
Chicago/Atlanta Route
Actual, May Planned, May
Food and beverage service…. . . . . . . . . . . . . . . . . . . . . . . 300,000 240,000 Selling expenses and commissions .
Total
Average ticket price per passenger $400 $1,075 $805
Total passengers served 16,000 7,000 6,600
Total miles flown 56,000 88,000 60,000 Number Of miles flown 56,000
Number Of passengers flown. . 16,000 The variable costs per unit are as follows: per unit:
Fuel $ 20 per mile Ticket price . $400
Wages 30 per mile Fuel expense. . 20
Food and beverage service 15 per passenger Wages expense . 30
Selling 110 per passenger15
110
A contribution margin report for Blue Skies is shown in Exhibit 18. The report is segmented by the routes (city pairs) flown.
Contribution
Margin by Segment Report for a Service
Company
Exhibit 18 indicates that the Chicago/Atlanta route has the lowest contribution margin ratio Of 25%. In contrast, the Atlanta/Los Angeles route has the highest contribution margin ratio Of 30%.
Contribution Margin Analysis
Blue Skies Airlines Inc. is also used to illustrate contribution margin analysis. Specifically, assume that Blue Skies decides to try to improve the contribution margin of its Chicago/Atlanta route during May by decreasing ticket prices. Thus, Blue Skies
Using the preceding data, a contribution margin analysis report can be prepared for the Chicago/Atlanta route for May as shown in Exhibit 19. Since the planned and actual wages and benefits expense are the same ($1,680,000), its quantity and unit cost factors are not included in Exhibit 19.
Contribution Margin
Analysis Report— Service Company
Exhibit 19 indicates that the price decrease generated an additional $1,200,000 in revenue. This consists of $1,600,000 from an increased number of passengers (revenue quantity factor) and a $400,000 revenue reduction from the decrease in ticket price (unit price factor).
955 956
The increased fuel costs (by $2 per mile) reduced the contribution margin by OBJ
$112,000 (unit cost factor). The increased number Of passengers also increased the food and beverage service costs by $60,000 and the selling costs by $440,000 (variable cost quantity factors). The net increase in contribution margin is $588,000 ($2,188,000 – $1,600,000).
lights.
it. the ri*t it.
2.
Variable Costing
absorption costing (934) manufacturing margin (935) sales mix (946) contribution margin (935) market segment (944) unit price (cost) factor (950) contribution margin analysis (949) noncontrollable costs (944) variable cost of goods sold (935) controllable costs (944) quantity factor (949) variable costing (935)
During the current period, McLaughlin Company sold 60,000 units of product at $30 per unit. At the beginning of the period, there were 10,000 units in inventory and McLaughlin
$ 6.70 This $20,000 was included as an expense in a variable costing income statement of
15.50 a prior period. Therefore, none of it is included as an expense in the current period 1 .80 variable costing income statement.
2.00
Total . $26.00
Total . $27.00
What types of costs are customarily included in the 5. Since all costs of operating a business are controlVariable . cost of manufactured products under (a) the absorp- lable, what is the significance of the term nonconFixed . tion costing concept and (b) the variable costing trollable cost?
concept? 6. Discuss how financial data prepared on the basis 2. Which type of manufacturing cost (direct materials, of variable costing can assist management in the
(d) electricity purchased to operate factory equipment, 10. How is the quantity factor for an increase or a (e) salary of factory supervisor, (f) depreciation on decrease in the amount of sales computed in using factory building, (g) direct labor? contribution margin analysis?
4. In the variable costing income statement, how are the 11. Explain why service companies use different fixed manufacturing costs reported, and how are the activity bases than manufacturing companies fixed selling and administrative expenses reported? to classify costs as fixed or variable.
959 960
fixed manufacturing costs are $14.70 per unit, and variable manufacturing costs are $30 per unit. Determine (a) whether variable costing income from operations is less than or greater than absorption costing income from operations, and (b) the difference in variable costing and absorption costing income from operations.
PE 20-4A Analyzing income under absorption and variable costing 0B'.2
p. 937
Variable manufacturing costs are $13 per unit, and fixed manufacturing costs are $75,000. Light Company has the following information for January:
Sales are estimated to be 12,000 units.
Sales $648,000 SHOW a. How much would absorption costing income from operations differ between a plan ME SHOWHOW Variable cost of goods sold 233,200 ME HOW to produce 12,000 units and a plan to produce 15,000 units?
Fixed manufacturing costs 155,500
b. How much would variable costing income from operations differ between the two
Variable selling and administrative expenses 51,800 production plans?
Fixed selling and administrative expenses 36,800
Determine (a) the manufacturing margin, (b) the contribution margin, and (c) income from operations for Light Company for the month of January. EE20-4 p. 943 PE 20-4B Analyzing income under absorption and variable costing 0B'.2 Variable manufacturing costs are $126 per unit, and fixed manufacturing costs are $ 157 ,500. Sales are estimated to be 10,000 units.
EE 20-1 p. 937SHOW a. How much would absorption costing income from operations differ between a plan
ME
Marley Company has the following information for March: HOW to produce 10,000 units and a plan to produce 15,000 units?
Sales 5912,000 b. How much would variable costing income from operations differ between the two
ME s HOWHOW Variable cost of goods sold 474,000 production plans?
Fixed manufacturing costs 82,000
Variable selling and administrative expenses 238,100
Fixed selling and administrative expenses 54,700 EE 20-5 p. 948 PE 20-5A Contribution margin by segment 0B'.4
The following information is for Olivio Coaster Bikes Inc.: Determine (a) the manufacturing margin, (b) the contribution margin, and (c) income from operations for Marley Company for the month of March. North South
ME SHOWHOW Sales volume (units):
Red Dream 50,000 66,000 EE 20-2 p. 938 PE 20-2A Variable costing—production exceeds sales Blue Marauder 112,000 140,000 Fixed manufacturing costs are $60 per unit, and variable manufacturing costs are Sales price:
$150 per unit. Production was 453,000 units, while sales were 426,000 units. Determine Red Dream $480 $500 SHOW (a) whether variable costing income from operations is less than or greater than absorption Blue Marauder $560 $600 ME HOW costing income from operations, and (b) the difference in variable costing and absorption Variable cost per unit:
costing income from operations. Red Dream $248 $248
Blue Marauder $260 $260
EE 20-2 p. 938 PE 20-2B Variable costing—production exceeds sales Determine the contribution margin for (a) Red Dream and (b) North Region.
Fixed manufacturing costs are $44 per unit, and variable manufacturing costs are $100 per unit. Production was 67,200 units, while sales were 50,400 units. Determine (a) whether s HOW variable costing income from operations is less than or greater than absorption costing EE 20-5 p. 948 PE 20-5B Contribution margin by segment 0B'.4 ME HOW income from operations, and (b) the difference in variable costing and absorption costing The following information is for LaPlanche Industries Inc.: income from operations.
ME SHOWHOW Sales volume (units):
EE 20-3 p. 939 PE 20-3A Variable costing—sales exceed production Product XX 45,000 38,000 The beginning inventory is 11,600 units. All of the units that were manufactured during Product YY 60,000 50,000 the period and 11,600 units of the beginning inventory were sold. The beginning inven- Sales price:
s HOW tory fixed manufacturing costs are $32 per unit, and variable manufacturing costs are $72 Product XX $700 $660 ME HOW per unit. Determine (a) whether variable costing income from operations is less than or Product YY $728 $720 greater than absorption costing income from operations, and (b) the difference in variable Variable cost per unit:
costing and absorption costing income from operations. Product XX $336 $336
product YY $360 $360
EE 20-3 p. 939 PE 20-3B Variable costing—sales exceed production Determine the contribution margin for (a) Product YY and (b) West Region.
The beginning inventory is 52,800 units. All of the units that were manufactured during the period and 52,800 units of the beginning inventory were sold. The beginning inventory
ME s HOWHOW (Continued)
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Chapter 20 Variable Costing for Management Analysis 961962 Chapter 20 Variable Costing for Management Analysis
Number of
EE 20-6
Units Unit Cost Tota I Cost
The actual price for a product was $28 per unit, while the planned price was $25 per Manufacturing costs in February beginning inventory: unit. The volume decreased by 20,000 units to 410,000 actual total units. Determine
Variable. .. . (a) the sales quantity factor and (b) the unit price factor for sales.
ME SHOWHOW Fixed .
EE 20-6 p. 951
Variable. .. .
The actual variable cost of goods sold for a product was $140 per unit, while the planned Fixed . variable cost of goods sold was $136 per unit. The volume increased by 2,400 units to
SHOW 14,000 actual total units. Determine (a) the variable cost quantity factor and (b) the unit ME HOW cost factor for variable cost of goods sold.
Variable
Fixed
a. Prepare an income statement according to the absorption costing concept for February. b. Prepare an income statement according to the variable costing concept for February. EX 20-1 Inventory valuation under absorption costing and variable costing c. •—•What is the reason for the difference in the amount of income from opera-
b. Inventory, At the end of the first year of operations, 6,400 units remained in the finished goods tions reported in (a) and (b)? $780,800 inventory. The unit manufacturing costs during the year were as follows:
Direct materials $75 EX 20-4 Cost of goods manufactured, using variable costing and absorption
Direct labor 35 costing OBJ. 1
Fixed factory overhead 15 b. Unit cost Of On December 31, the end of the first year of operations, Frankenreiter Inc. manufactured Variable factory overhead 12 goods manufactured, 25,600 units and sold 24,000 units. The following income statement was prepared, based $275 on the variable costing concept:
Determine the cost of the finished goods inventory reported on the balance sheet under
(a) the absorption costing concept and (b) the variable costing concept. Frankenreiter Inc.
Variable Costing Income Statement
For the Year Ended December 31, 2016
EX 20-2 Income statements under absorption costing and variable costing
Variable cost of goods sold:
a. Income from Frigid Motors Inc. assembles and sells snowmobile engines. The company began operations, $750,000 operations on July 1, 2016, and operated at 100% of capacity during the first month. The of goods manufactured .
Variable cost
following data summarize the results for July: Less inventory, June 30… Variable cost of goods sold
Sales (35,000 units)Manufacturing margin..
s HOW Production costs (42,500 units):
ME HOW Direct materials . Contribution margin. Direct labor…. Fixed costs:
Variable factory overhead . . Fixed manufacturing costs .
Fixed factory overhead 8,075,000 Fixed selling and administrative expenses.
Selling and administrative expenses: Income from operations
Determine the unit cost of goods manufactured, based on (a) the variable costing concept and (b) the absorption costing concept.
Prepare an income statement according to the absorption costing concept.
Prepare an income statement according to the variable costing concept. EX 20-5 Variable costing income Statement
Income from On June 30, the end of the first month of operations, Bastile Company prepared the fol-
c.What is the reason for the difference in the amount of income from opera- operations, $203,000 lowing income statement, based on the absorption costing concept: tions reported in (a) and (b)?
Bastile Company
Absorption Costing Income Statement
EX 20-3 Income Statements under absorption costing and variable costing SHOW For the Month Ended June 30, 2016
ME HOW
b. Income from Bionic Cotton Inc. manufactures and sells high-quality sporting goods equipment under Sales (20,000 units) operations, Slits highly recognizable Cool Cat logo. The company began operations on January 1, 2016, Cost of goods sold: and operated at 1000/0 of capacity (90,000 units) during the first month, creating an ending inventory of 8,000 units. During February, the company produced 82,000 garments during the month but sold 90,000 units at $100 per unit. The February manufacturing Cost of goods sold. . SHOW costs and selling and administrative expenses were as follows: Gross profit. .
ME HOW
(Continued)
963 964
Income from On July 31, of operations, Del Ray Equipment Company operations, prepared the following income statement, based on the variable costing concept: SHOW Direct labor . 316,800 $1,187,500 ME HOW Variable factory overhead . 144,000
Fixed factory overhead 216,000
Del Ray Equipment Company
Variable Costing Income Statement29,400
For the Month Ended July 31 , 201635,500
Variable cost of goods manufactured not change sales, unit variable factory overhead costs, total fixed factory overhead cost, Less inventory, July 31 (12,000 units).. or total selling and administrative expenses.
Variable cost of goods sold .
a. Prepare an estimated income statement, comparing operating results if 28,800 and Manufacturing margin.. . 36,000 units are manufactured in (1) the absorption costing format and (2) the variVariable selling and administrative expenses . able costing format. Contribution margin..
Fixed selling and administrative expenses.. 487,500
Income from operations
EX 20-7 Variable costing income statement
a. Income from The following data were adapted from a recent income statement of Procter & Gamble operations, Company: $11,402
(in millions)
selling, administrative, and other costs for the year.
Marketing, administrative, and other expenses.. . 30,337
$72,765 The finished goods inventories at the beginning and end of the year from the balance Total operating costs…
sheet were as follows:
Income from operations$11,402
$23,760 a. Prepare an income statement according to the variable costing concept for Ansara
Company for 2016.
$5,400
Variable cost of goods sold 3,285
Manufacturing margin $2,1 15 $1 ,850 Variable selling expenses 1 ,035 905
Contribution margin $ 945
Fixed expenses 485 310
Income from operations $ 595 $ 635
In addition, the following sales unit volume information for the period is as follows:
Mountain Monster Desert Dragon
Sales unit volume 5,000 4,850
Prepare a contribution margin by product report. Calculate the contribution margin ratio for each product as a whole percent, rounded to two decimal places.
—•-What advice would you give to the management of PowerTrain Sports Inc. regarding the relative profitability of the two products?
Head Pops Inc. manufactures two models of solar powered noise-canceling headphones: Sun Sound and Ear Bling models. The company is operating at less than full capacity. Market re-
Manufacturing margin 61.60 55.00
Variable selling and administrative expenses 28.00 25.00 EX 20-14 Sales territory and salesperson profitability analysis OBJ. 4
Contribution margin 33.60 30.00 a. Todd Reyes Industries Inc. manufactures and sells a variety of commercial vehicles in the North Fixed manufacturing costs 14.00 12.50 contribution east and South west regions. There are two salespersons assigned to each territory. Higher margin, $887,040
Income from operations 19.60 1 7.50 commission rates go to the most experienced salespersons. The following sales statistics
tional Sun Sound and 30,000 additional Ear Bling headphones are produced and sold,
SHOW
assuming that there is sufficient capacity for the additional production. ME HOW
Average per unit:
Sales price . $96,000 $84,000 $108,ooo $78,000
57,600 33,600 64,800 31,200
12% 16% 12% v' a. Desert Dragon PowerTrain Sports Inc. manufactures and sells two styles of All Terrain Vehicles (ATVs), Units sold . 28 24 24 38 contribution margin, the Mountain Monster, and Desert Dragon from a single manufacturing facility. The manu- Manufacturing margin ratio fracturing facility operates at 100% of capacity. The following per unit information is available for the two products:
(Continued)
967 968
a. 1. Prepare a contribution margin by salesperson report. Calculate the contribution margin ratio for each salesperson.
2. Interpret the report.
b. 1. Prepare a contribution margin by territory report. Calculate the contribution margin for each territory as a percent, rounded to one decimal place.
2. Interpret the report.
a. Electric
$824.92
Sales $2,217 $1,225 $1,234 $5,045 $2,847 $4,562 $2885 $659 $2,132 $3,975 $3,321
In addition, assume the following information:
Building Large Marine &
Construction Cat Core Earth- Electric Power Petroleum
Products Japan Components moving Power Excavation Systems Logistics Power Mining Turbines
Variable cost of goods sold as a percent of sales
Dealer commissions as a percent of sales . . 9% 11% 8% 8% 10% 6% 5% 10% 9% 7% 9% Sales quantity
factor,
Variable promotion expenses (in millions) . 310 120 150 600 200 600 300 75 270 480
Why is the contribution margin ratio for the Publishing segment smaller than for the other segments?
—-Does your answer to (b) mean that the other segments are more profitable businesses than the Publishing segment?
EX 20-17 Contribution margin analysis—sales
Buy Best Inc. sells electronic equipment. Management decided early in the year to reduce the price of the speakers in order to increase sales volume. As a result, for the year ended December 31, the sales increased by $31,875 from the planned level of $1,048,125. The following information is available from the accounting records for the year ended
December 31.
Increase or
Actual Planned (Decrease)
$1,048,125 $31,875 Number of units sold 36,000 32,250 3,750
Sales price $30.00 $32.50 $(2.50)
Variable cost per unit $10.00 $10.00
Prepare an analysis of the sales quantity and unit price factors.
—-1')id the price decrease generate sufficient volume to result in a net increase in contribution margin if the actual variable cost per unit was $10, as planned?
EX 20-18 Contribution margin analysis—sales
The following data for Romero Products Inc. are available:
Difference— Increase or
For the Year Ended December 31 Actual Planned (Decrease)
Use the sales information and the additional assumed information to prepare a contribution margin by segment report. Round to two decimal places. In addition, calculate the contribution margin ratio for each segment as a percentage, rounded to one decimal place.
Prepare a table showing the manufacturing margin, dealer commissions, and variable promotion expenses as a percent of sales for each segment. Round whole percents to one decimal place.
Filmed Entertainment (Warner Bros.) $14,204
Networks (CNN, HBO, WB) 12,018
Publishing (Time, People, Sports Illustrated) 3,436
EX 20-20 Variable costing income statement for a service company OBJ.4,6
Assume that the variable costs as a percent of sales for each segment are as follows :East Coast Railroad Company transports commodities among three routes (city-pairs): Atlanta/Baltimore, Baltimore/Pittsburgh, and Pittsburgh/Atlanta. Significant costs, their cost
Cost Amount Cost Behavior Activity Rate
Labor costs for loading and unloading railcars $ 175,582 Variable $46.00 per railcar
SHOW Direct materials
ME HOW
Direct labor Atlanta/ Baltimore/ Pittsburgh/
Baltimore Pittsburgh Atlanta Total Variable manufacturing cost .
Number of train-miles 12,835 10,200 14,080 37,115 Fixed manufacturing cost
EX 20-21 Contribution margin reporting and analysis for a service company OBJ. 5, 6
The management of East Coast Railroad Company introduced in Exercise 20-20 improved the profitability of the Atlanta/ Baltimore route in May by reducing the price 2. Contribution of a railcar from $600 to $500. This price reduction increased the demand for rail margin, S9Z800 services. Thus, the number of railcars increased by 275 railcars to a total of 700 railcars. This was accomplished by increasing the size of each train but not the number of trains. Thus, the number of train-miles was unchanged. All the activity rates remained unchanged.
Prepare a contribution margin report for the Atlanta/Baltimore route for May. Calculate the contribution margin ratio in percentage terms to one decimal place.
Prepare a contribution margin analysis to evaluate management's actions in May.
Assume that the May planned quantity, price, and unit cost was the same as April
EX 20-22 Variable costing income statement and contribution margin analysis for a service company 0B'.5, 6
The actual and planned data for Underwater University for the Fall term 2016 were as follows:
Actual Planned
Enrollment 4,500 4,125
Tuition per credit hour $120 $135
Credit hours 60,450 43,200
Registration, records, and marketing cost per enrolled student $275 $275
Instructional costs per credit hour $64 $60
Depreciation on classrooms and equipment $825,600 $825,600
Registration, records, and marketing costs vary by the number of enrolled students, while instructional costs vary by the number of credit hours. Depreciation is a fixed cost.
Prepare a variable costing income statement showing the contribution margin and income from operations for the Fall 2016 term.
Prepare a contribution margin analysis report comparing planned with actual performance for the Fall 2016 term.
3. Explain the reason for the difference in the amount of income from operations reported in (1) and (2).
PR 20-2A Income statements under absorption costing and variable costing OBJ. 1, 2
The demand for solvent, one of numerous products manufactured by Mac n' Cheese Industries Inc., has dropped sharply because of recent competition from a similar product. The company's chemists are currently completing tests of various new formulas, and it is anticipated that the manufacture of a superior product can be started on June 1, one month in the future. No changes will be needed in the present production facilities to manufacture the new product because only the mixture of the various materials will be changed.
The controller has been asked by the president of the company for advice on whether to continue production during May or to suspend the manufacture of solvent until June 1. The controller has assembled the following pertinent data:
Mac n' Cheese Industries Inc. Income Statement—solvent
For the Month Ended April 30, 2016
The production costs and selling and administrative expenses, based on production of 4,000 units in April, are as follows:
Direct materials $45 per unit
Direct labor 20 per unit
Variable manufacturing cost 16 per unit
Variable selling and administrative expenses 15 per unit
Fixed manufacturing cost $100,000 for April
Fixed selling and administrative expenses 42,000 for April
Sales for May are expected to drop about 20% below those of the preceding month. No significant changes are anticipated in the fixed costs or variable costs per unit. No extra costs will be incurred in discontinuing operations in the portion of the plant associated with solvent. The inventory of solvent at the beginning and end of May is expected to be inconsequential.
l. b. Income from operations, $38,205
s HOW
ME HOW
l. Sales quantity
Instructions
Direct materials . year and why?
Direct labor 3. Briefly list factors other than contribution margin that should be considered Variable manufacturing cost . in evaluating the performance of salespersons. Fixed manufacturing cost 715,950
Direct materials and $32,240 respectively. If Proposal 3 is selected, it is anticipated that an additional Direct laborannual expenditure of $34,560 for the rental of additional warehouse space would yield
Variable manufacturing cost an additional 130% in Size S sales volume. It is also assumed that the increased producFixed manufacturing cost . 61 9,560 tion of Size S would utilize the plant facilities released by the discontinuance of Size M.
Instructions
Using the absorption costing concept, prepare income statements for (a) March and (b) April.
Using the variable costing concept, prepare income statements for (a) March and (b) April.
a. Explain the reason for the differences in the amount of income from operations in (1) and (2) for March.
b. Explain the reason for the differences in the amount of income from Less operating expenses: operations in (1) and (2) for April. Variable expenses
Fixed expenses
4. Based on your answers to (1) and (2), did Hip and Conscious Clothing
Total operating expenses . Company operate more profitably in March or in April? Explain.
Income from operations
Instructions
Prepare an income statement for the past year in the variable costing format. Use the following headings:
Size
Total
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Chapter 20 Variable Costing for Management Analysis 973974 Chapter 20 Variable Costing for Management Analysis
Data for each style should be reported through contribution margin. The fixed costs should be deducted from the total contribution margin, as reported in the column, to determine income from operations.
Based on the income statement prepared in (1) and the other data presented, determine
ME HOW
Direct labor420,000 Data for each style should be reported through contribution margin. The fixed costs Variable manufacturing cost 156,000 should be deducted from the total contribution margin as reported in the "Total" Fixed manufacturing cost 288,000
facture the new product because only the mixture of the various materials will be changed.
The controller has been asked by the president of the company for advice on whether to continue production during November or to suspend the manufacture of aloe vera hand lotion until December 1. The controller has assembled the following pertinent data:
Smooth Skin Care Products Inc.
Income Statement—Aloe Vera Hand Lotion For the Month Ended October 31, 2016
Per unit:
Sales price .$144 $125
Variable cost of goods sold 55 51
Variable selling and administrative expenses15 11
month. No significant changes are anticipated in the fixed costs or variable costs per unit. No extra costs will be incurred in discontinuing operations in the portion of the plant associated with aloe vera hand lotion. The inventory of aloe vera hand lotion at the beginning and end of November is expected to be inconsequential.
Instructions
1. Prepare an estimated income statement in absorption costing form for November for aloe vera hand lotion, assuming that production continues during the month.
975 976
Prepare an estimated income statement in variable costing form for November for aloe Instructions vera hand lotion, assuming that production continues during the month. 1. Prepare a table indicating contribution margin, variable cost of goods sold as a percent
What would be the estimated loss in income from operations if the aloe vera hand of sales, variable selling expenses as a percent of sales, and contribution margin ratio lotion production were temporarily suspended for November? by salesperson. (Round whole percent to one digit after decimal point.)
What advice should the controller give to management? 2. Which salesperson generated the highest contribution margin ratio for the year and why?
PR 20-3B Absorption and variable costing income statements for two months OBJ. 1, 2 3. Briefly list factors other than contribution margin that should be considered and analysis in evaluating the performance of salespersons.
2. a. Manufacturing During the first month of operations ended July 31 , 2016, Head Gear Inc. manufactured 6,400 margin, $37,440 hats, of which 5,200 were sold. Operating data for the month are summarized as follows: PR 20-5B Variable costing income Statement and effect on income of change in 0B'. 4 operations
Sales$104,000 3. Income from Kimbrell Inc. manufactures three sizes of utility tables—small (S), medium (M), and Manufacturing costs: operations, $106,820 large (L). The income statement has consistently indicated a net loss for the M size, s
ME HOWHOW Direct materials $47,360 and management is considering three proposals: (1) continue Size M, (2) discontinue Size M Direct labor22,400 and reduce total output accordingly, or (3) discontinue Size M and conduct an advertising Variable manufacturing cost 12,160 campaign to expand the sales of Size S so that the entire plant c"apacity can continue to Fixed manufacturing cost . 1 5,360 97,280 be used.
Direct labor14,000 ended December 31, 2016, is as follows:
Variable manufacturing cost 7,600 Size Fixed manufacturing cost . 15,360 66,560 Selling and administrative expenses:
Variable $10,920
Cost
Fixed 5,200 16,1 20 of goods sold:
Variable costs $ 718,500 $1 £24,000 Instructions Fixed costs . 288,000 779,000
Using the absorption costing concept, prepare income statements for (a) July and Total cost of goods sold . (b) August. Gross profit .
Using the variable ccxsting concept, prepare income statements for (a) July and (b) August. Less operating expenses:
Variable expenses .
a. Explain the reason for the differences in the amount of income from
Fixed expenses . operations in (1) and (2) for July.
Total operating expenses
b. Explain the reason for the differences in the amount of income from Income from operations operations in (1) and (2) for August.
4. Based on your answers to (1) and (2), did Head Gear Inc. operate more Instructions profitably in July or in August? Explain. 1. Prepare an income statement for the past year in the variable costing format. Use the following headings:
PR 20-4B Salespersons' report and analysis 0B'.4 Size
l. Crowell Pachec Inc. employs seven salespersons to sell and distribute its product throughout the state. Data Total contribution margin taken from reports received from the salespersons during the year ended June 30 are as follows:
Data
ratio, 44% Variable for each style should be reported through contribution margin. The fixed costs
Total Variable Cost Selling should be deducted from the total contribution margin, as reported in the Sa lesperson Sa les of Goods Sold Expenses column, to determine income from operations.
s L Total
(Continued)
it. it.
Data for each style should be reported through contribution margin. The fixed costs should be deducted from the total contribution margin as reported in the "Total" column. For purposes of this problem, the additional expenditure of $85,050 for the assistant brand manager's salary can be added to the fixed operating expenses.
4. By how much would total annual income increase above its present level if Proposal 3 is accepted? Explain.
Mathews Company manufactures only one product. For the year ended December 31, the contribution margin decreased by $126,000 from the planned level of $540,000. The president of Mathews Company has expressed some concern about this decrease and has requested a follow-up report.
The following data have been gathered from the accounting records for the year ended December 31:
Difference—
979
Jellnick Equipment Inc.
Contribution Margin Analysis by Salesperson
Danica Kyle Richard Tom
Variable cost of goods sold
Manufacturing margin
1. Calculate the manufacturing margin as a percent of sales and the contribution margin ratio for each salesperson.
CP 20-5 Contribution margin analysis
Trans Sport Company sells sporting goods to retailers in three different states—Florida, Georgia, and Tennessee. The following profit analysis by state was prepared by the company:
Florida Georgia Tennessee
Georgia
Fixed manufacturing costs $1 12,500 $225,000 Fixed selling expenses 84,375 135,000 980 20
44,000 Units to Be Manufactured
Number Unit of Units Cost Tota I Cost
Selling and administrative expenses:
Variable .
Fixed .
Total
55,000 Units to Be Manufactured
Number Unit of Units Cost Total Cost
Selling and administrative expenses:
Variable .
Fixed .
Total .
1. In one group, prepare an absorption costing income statement for the year ending December 31, 2016, based on sales of 44,000 units and the manufacture of 44,000 units. In the other group, conduct the same analysis, assuming production of 55,000 units.
2.Explain the difference in the income from operations reported in (1).
3. Compute Pinder's total salary for the year 2016, based on sales of 44,000 units and the manufacture of 44,000 units (Group 1) and 55,000 units (Group 2). Compare your answers.
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