Ch. 5 Notes & HW PDF

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Professor Burt - Chapter 5 Lecture Notes & HW Solutions...

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Chapter 5 - Cost-Volume-Profit Relationships ● Assumptions of Basic CVP Analysis ○ Selling price is constant ○ Costs are linear and can be accurately divided into variable and fixed elements ○ In multi product companies, the sales mix is constant and in manufacturing companies, inventories do not change ● Contribution Income Statement ○ Helpful to managers in judging the impact on profits of changes in selling price, cost, or volume ○ Contribution Margin (CM) is the amount remaining from sales revenue after variable expenses have been deducted ○ CM is then used to cover fixed expenses and then any remaining CM contributed to Net Operating Income ■ Sales ■ Less: Variable Expenses ■ Contribution Margin ■ Less: Fixed Expenses ■ Net Operating Income ● Profit = (Sales - Variable Expenses) - Fixed Expenses ● The Contribution Approach ○ Sales, variable expenses, and contribution margin can also be expressed on a per unit basis. ● Unit CM: Selling Price Per Unit - Variable Expenses Per Unit ● CVP Graph

○ ● Cost structure refers to the relative proportion of fixed and variable costs in an organization

● Cost Structure and Profit Stability ○ An advantage of a high fixed cost structure is that income will be higher in good years compared to companies with lower proportion of fixed costs ○ A disadvantage of a high fixed cost structure is that income will be lower in bad years compared to companies with lower proportion of fixed costs. ○ Companies with low fixed cost structures enjoy greater stability in income across good and bad years. ● Contribution Margin Ratio ○ = Total Contribution Margin / Total Sales ○ = CM per unit / SP per unit ■ CM Ratio means for every $1 increase in sales, total contribution will increase x cents ○ Profit = (CM Ratio x Sales) - Fixed Expenses ○ Change in Profit = (CM Ratio x Change in Sales) - Change in Fixed Expenses

● Variable Expense Ratio ○ = Total Variable Expenses / Sales ○ = 1 - CM Ratio ● Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. An average of 2,100 cups are sold each month. What is the CM Ratio for Coffee Klatch? ○ a. 1.319 b. 0.758 c. 0.242 d. 4.139 ○ CM Ratio = ($1.49-$0.36) / $1.49

● Determining the break-even point (unit sales) ○ Profits = 0 and Contribution Margin = Fixed Costs ○ (Unit CM x Quantity) - Fixed Expenses ○ Unit Sales to Break even = Fixed Expenses / CM per unit ● Determining the break-even point (dollar sales) ○ Profit = CM Ratio x Sales - Fixed Expenses ○ Dollar Sales to Break Even = Fixed Expenses / CM Ratio Example: Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. An average of 2,100 cups are sold each month. What is the break-even in sales dollars? ● $1,300 / ((1.49-.36)/1.49) = $1,715 Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. An average of 2,100 cups are sold each month. What is the break-even sales in units? ● $1,300 / 1.13 = 1,150 cups Target Profit ● Unit Sales to attain target profit = (Target Profit + Fixed Expenses) / CM per unit ● Dollar Sales to attain target profit = (Target Profit + Fixed Expenses) / CM Ratio

Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. Use the formula method to determine how many cups of coffee would have to be sold to attain target profits of $2,500 per month ● (2500 + 1300) / 1.13 = 3,363 cups Coffee Klatch is an espresso stand in a downtown office building. The average selling price of a cup of coffee is $1.49 and the average variable expense per cup is $0.36. The average fixed expense per month is $1,300. Use the formula method to determine the sales dollars that must be generated to attain target profits of $2,500 per month. ● (2500 + 1300) / ((1.49-.36)/1.49) = $5,013 cups ● Margin of Safety ○ Margin of Safety (in $) ■ Actual Sales - Break even Sales ○ Margin of Safety (in %) ■ Margin of Safety in dollars / Actual Sales

Oslo Company prepared the following contribution format income statement based on a sales volume of 1,000 units (the relevant range of production is 500 units to 1,500 units): Sales Variable expenses Contribution margin Fixed expenses

$

20,000 12,000 8,000 6,000

Net operating income

$

2,000

What is the contribution margin per unit? ● CM Per Unit = Sales Per Unit - Variable Per Unit ● Sales per Unit = Sales / Units Sold ○ $20,000 / 1000 = $20 units ● Variable per Unit = Variable / Units sold ○ $12,000 / 1000 = $12 units ● CM Per Unit = $8 What is the contribution margin ratio? ● CM’s Ratio = Contribution Margin / Sales ○ $8,000 / $20,000 = 40% What is the variable expense ratio? ● 1-0.4 = 60% If sales increase to 1,001 units, what would be the increase in net operating income? ● Increase in Sales (units) x CM per unit = 1* $8 = $8 If sales decline to 900 units, what would be the net operating income? ● Sales (units) * Selling Price per unit = 900*20 = $18000 ● Variable (units) * Variable Price per unit = 900*12 = $10800 ● Less (Fixed Expenses): $6000 = ○ Net Operating Income: $1,200 If the selling price increases by $2 per unit and the sales volume decreases by 100 units, what would be the net operating income? ● Sales per unit: $20 → $22, Decrease in volume: 1000 → 900 ○ $22*900 = $19,800 ○ $12*900 = $10,800 -

○ Less (Fixed Expenses): $6,000 = ■ $3000 If the variable cost per unit increases by $1, spending on advertising increases by $1,500, and unit sales increase by 250 units, what would be the net operating income? ● Sales per unit $20*1250 = $25000 ● Variable cost per unit $12 → $13*1250 = $16250 ● Fixed Expenses: $6000 + $1500 = $7500 ○ Net Operating Income: $1250 What is the break-even point in unit sales? ● Break-even point = Fixed Expenses / CM Unit Price ○ $6000 / 8 = 750 units What is the break-even point in dollar sales? ● Break-even point = Fixed Expenses / CM Ratio ○ $6000 / 0.4 = $15,000 How many units must be sold to achieve a target profit of $5,000? ● Target Profit = (Target Profit + Total Costs) / (Sales per unit - Variable per unit) ○ X = (5000 +6000) / (20-12) = 11,000 / 8 = 1375 What is the margin of safety in dollars? What is the margin of safety percentage? ● Margin of Safety (in $) ○ Actual Sales - Break even Sales = $20,000 - $15,000 = $5000 ● Margin of Safety (in %) ○ Margin of Safety in dollars / Actual Sales = 5,000 / 20,000 = 25% What is the degree of Operating Leverage? ● Degree of Operating Leverage = Contribution Margin / (Total Sales - Variable Expense - Fixed Expense) ○ $8000 / $20000 - $12,000 - $6000 = 4 Problems 13-15 (skipped

Last month when Holiday Creations, Inc., sold 50,000 units, total sales were $200,000, total variable expenses were $120,000, and fixed expenses were $65,000. Required: 1. What is the company’s contribution margin (CM) ratio? 2. What is the estimated change in the company’s net operating income if it can increase total sales by $1,000? ● Contribution Margin = Sales - Variable Expenses = (200,000 - 120,000) = 80,000 ● Contribution Margin Ratio: Contribution Margin / Sales = 80,000 / 200,000 = 40% ● Increase in Sales * CM Ratio = ($1000 * .4) = $400 ○ Change in Net Operating Income = 400 Mauro Products distributes a single product, a woven basket whose selling price is $15 per unit and whose variable expense is $12 per unit. The company’s monthly fixed expense is $4,200. Required: 1. Calculate the company’s break-even point in unit sales. 2. Calculate the company’s break-even point in dollar sales. 3. If the company's fixed expenses increase by $600, what would become the new break-even point in unit sales? In dollar sales? ● Break even point in unit sales ○ Fixed Expenses / CM per unit = $4,200 / (15-12 = 3) = 1400 units ● Break even point in dollar sales ○ Fixed Expenses / CM Ratio = $4,200 / .2 = $21000 ■ CM Ratio = (15-12) / 15 = 20% ● New Break even point in unit sales ○ $4,800 / 3 ● New Break even point in dollar sales ○ $4,800 / .2

How much will net operating income increase (decrease) per month if the monthly advertising budget increases by $5,000 and monthly sales increase by $9,000?

Original Sales Price per unit x units Sold

90*2000

180,000

Less Variable Expenses

63*2000

126,000

Less Fixed Expenses

30000

30000

Net Operating Income

24000

Additional Units Sold = 9000 / 90 = 100 units New Sales Price per unit x units Sold

90*2100

189,000

Less Variable Expenses

63*2100

132200

Less Fixed Expenses

30000 + 5000

35000

Net Operating Income

21,700

Net Operating Income = 24,000 - 21,700 = $2,300 less than original

Should the advertising budget be increased? - NO

Refer to the original data. How much will net operating income increase (decrease) per month if the company uses higher-quality components that increase the variable expense by $2 per unit and increase unit sales by 10%.

Original Sales Price per unit x units Sold

90*2000

180,000

Less Variable Expenses

63*2000

126,000

Less Fixed Expenses

30000

30000

Net Operating Income

24000

Variable Expenses: $63 → $65 10% increase in unit sales: 2000(1.10) → 2200 New Sales Price per unit x units Sold

90*2200

$198,000

Less Variable Expenses

65*2200

$143000

Less Fixed Expenses

30000

30000

Net Operating Income

25,000

Dynamic Amount

Sure Shot %

Amount

Total %

Amount

%

Sales

$150,000

100

$250,000

100

400000

100

Variable Expenses

$30,000

20

$160,000

64

190,000

47.5

Contribution Margin

$120,000

80

90,000

36

210,000

52.5%

Fixed Expenses

$183,750

Net Operating Income

$26,250

● ●

Sales - Variable Expenses = Contribution Margin Contribution Margin = CM Ratio x Sales

What is the company's break-even point in dollar sales based on the current sales mix? ● Fixed Expenses / CM Ratio ○ 183,750 / .525 = $350,000 If sales increase by $100,000 a month, by how much would you expect the monthly net operating income to increase? ● Increase in Sales x CM % = 100,000*.525 = 52,500 Miller Company’s contribution format income statement for the most recent month is shown below:

Sales (20,000 units) Variable expenses Contribution margin Fixed expenses Net operating income

Total $ 300,000 180,000 120,000

Per Unit $ 15.00 9.00 $

6.00

70,000 $ 50,000

Required: (Consider each case independently): 1. What is the revised net operating income if unit sales increase by 15%? 2. What is the revised net operating income if the selling price decreases by $1.50 per unit and the number of units sold increases by 25%? 3. What is the revised net operating income if the selling price increases by $1.50 per unit, fixed expenses increase by $20,000, and the number of units sold decreases by 5%? 4. What is the revised net operating income if the selling price per unit increases by 12%, variable expenses increase by 60 cents per unit, and the number of units sold decreases by 10%?

1. Net Operating Income

Sales Price per unit x units Sold

20,000(1.15) = 23000*15

345,000

Less Variable Expenses

9*23000

207,000

Less Fixed Expenses

70,000

70,000

Net Operating Income

68,000

2. Net Operating Income

Sales Price per unit x units Sold

20,000*1.25 = 25,000*13.50

$337,500

Less Variable Expenses

9*25,000

225000

Less Fixed Expenses

70,000

70,000

Net Operating Income

42,500

3. Net Operating Income

Sales Price per unit x units Sold

(20,000*.95)*16.50

313,500

Less Variable Expenses

9*19000

171000

Less Fixed Expenses

70,000+20,000

90000

Net Operating Income

52,500

4. Net Operating Income

Sales Price per unit x units Sold

(15*1.12)*(20,000*.9)

302,400

Less Variable Expenses

9.60*18000

172,800

Less Fixed Expenses

70,000

70,000

Net Operating Income

59600

Lindon Company is the exclusive distributor for an automotive product that sells for $40 per unit and has a CM ratio of 30%. The company’s fixed expenses are $180,000 per year. The company plans to sell 16,000 units this year. Required: 1. What are the variable expenses per unit? 2. What is the break-even point in unit sales and in dollar sales? 3. What amount of unit sales and dollar sales is required to attain a target profit of $60,000 per year? 4. Assume that by using a more efficient shipper, the company is able to reduce its variable expenses by $4 per unit. What is the company’s new break-even point in unit sales and in dollar sales? What dollar sales is required to attain a target profit of $60,000? 1. Variable expense per unit ● Contribution Margin = CM Ratio x Sales ○ .3(640,000) = $192,000 ● Sales - Contribution Margin = Variable Expenses ○ $640,000 - 192,000 = $448000 ● $448,000 / 16,000 = $28 2. Break-even point in units ● Fixed Expenses / CM per unit ○ 180,000 / (40-28 = 12) = 15,000 -

Break-even point in dollar sales ● Fixed Expenses / CM Ratio ○ 180,000 / .3 = 600,000

3. Unit sales needed to attain target profit ● Target Profit = (Total Cost + Target Profit) / Total CM per unit ○ (60,000 + 180,000) / 12 = 20,000 -

Dollar sales needed to attain target profit ○ Target Profit = (Total Cost + Target Profit) / Total CM Ratio ○ (60,000 + 180,000) / 0.3 = $800,000

4. New break-even point in unit sales ● VR: 28 → 24 ○ 180,000 / (40-24 = 16) = 11250 ●

New break-even point in dollar sales ○ Sales Price x New break-even sales ■ 40 x 11250 = $450,000

●

Dollar sales needed to attain target profit ○ To make $60,000, they need to make 60,000 / 16 = 3750 units ○ (11250 + 3750) * 40 = $600,000...