Ch06 Cost-Volume-Profit Relationships PDF

Preview

Summary

Download Ch06 Cost-Volume-Profit Relationships PDF

Description

Chapter 6 Cost-Volume-Profit Relationships True/False Questions 1. One way to compute the total contribution margin is to add total fixed expenses to net operating income. Ans: True 2. On a CVP graph for a profitable company, the total revenue line will be steeper than the total cost line. Ans: True 3. In two companies making the same product and with the same total sales and total expenses, the contribution margin ratio will be lower in the company with a higher proportion of fixed expenses in its cost structure. Ans: False 4. If the variable expense per unit increases, and all other factors remain constant, the contribution margin ratio will increase. Ans: False 5. The impact on net operating income of any given dollar change in total sales can be estimated by multiplying the CM ratio by the dollar change in total sales. Ans: True 6. A company with sales of $70,000 and variable expenses of $40,000 should spend $10,000 on increased advertising if the increased advertising will increase sales by $20,000. Ans: False

7. The formula for the break-even point is the same as the formula to attain a given target profit for the special case where the target profit is zero. Ans: True

LO: 5; 6

8. An increase in total fixed expenses will not affect the break-even point so long as the contribution margin ratio remains unchanged. Ans: False 9. All other things the same, a reduction in the variable expense per unit will cause the break-even point to rise. Ans: False 10. The unit sales volume necessary to reach a target profit is determined by dividing the target profit by the contribution margin per unit. Ans: False 11. All other things the same, the margin of safety in dollars at a given level of sales will tend to be lower for a capital-intensive company than for a labor-intensive company with high variable expenses. Ans: True

LO: 7

12. The margin of safety in dollars equals the excess of budgeted (or actual) sales over the break-even volume of sales. Ans: True

LO: 7

13. A company with high operating leverage will experience a lower reduction in net operating income in a period of declining sales than will a company with low operating leverage. Ans: False

LO: 8

14. If Q is the quantity of a product sold, P is the price per unit, V is the variable expense per unit, and F is the total fixed expense, then the degree of operating leverage is equal to: [Q(P-V)] ÷ [Q(P-V)-F] Ans: True

LO: 8

15. A shift in the sales mix from products with high contribution margin ratios toward products with low contribution margin ratios will raise the break-even point. Ans: True

LO: 9

Multiple Choice Questions 16. Contribution margin can be defined as: A) the amount of sales revenue necessary to cover variable expenses. B) sales revenue minus fixed expenses. C) the amount of sales revenue necessary to cover fixed and variable expenses. D) sales revenue minus variable expenses. Ans: D 17. Which of the following statements is correct with regard to a CVP graph? A) A CVP graph shows the maximum possible profit. B) A CVP graph shows the break-even point as the intersection of the total sales revenue line and the total expense line. C) A CVP graph assumes that total expense varies in direct proportion to unit sales. D) A CVP graph shows the operating leverage as the gap between total sales revenue and total expense at the actual level of sales. Ans: B

18. If both the fixed and variable expenses associated with a product decrease, what will be the effect on the contribution margin ratio and the break-even point, respectively? A) B) C) D)

Contribution margin ratio Break-even point Decrease Increase Increase Decrease Decrease Decrease Increase Increase

Ans: B

LO: 3; 5

19. Which of the following is true regarding the contribution margin ratio of a single product company? A) As fixed expenses decrease, the contribution margin ratio increases. B) The contribution margin ratio multiplied by the selling price per unit equals the contribution margin per unit. C) The contribution margin ratio will decline as unit sales decline. D) The contribution margin ratio equals the selling price per unit less the variable expense ratio. Ans: B 20. If a company is operating at the break-even point: A) its contribution margin will be equal to its variable expenses. B) its margin of safety will be equal to zero. C) its fixed expenses will be equal to its variable expenses. D) its selling price will be equal to its variable expense per unit. Ans: B

LO: 5; 7

21. At the break-even point: A) sales would be equal to contribution margin. B) contribution margin would be equal to fixed expenses. C) contribution margin would be equal to net operating income. D) sales would be equal to fixed expenses. Ans: B

22. The break-even point would be increased by: A) a decrease in total fixed expenses. B) a decrease in the ratio of variable expenses to sales. C) an increase in the contribution margin ratio. D) none of these. Ans: D 23. Which of the following strategies could be used to reduce the break-even point? Fixed expenses Contribution margin A ) B) C) D )

Increase Decrease Decrease

Increase Decrease Increase

Increase

Decrease

Ans: C 24. Break-even analysis assumes that: A) Total revenue is constant. B) Unit variable expense is constant. C) Unit fixed expense is constant. D) Selling prices must fall in order to generate more revenue. Ans: B 25. Target profit analysis is used to answer which of the following questions? A) What sales volume is needed to cover all expenses? B) What sales volume is needed to cover fixed expenses? C) What sales volume is needed to earn a specific amount of net operating income? D) What sales volume is needed to avoid a loss? Ans: C

26. The margin of safety can be calculated by: A) Sales − (Fixed expenses/Contribution margin ratio). B) Sales − (Fixed expenses/Variable expense per unit). C) Sales − (Fixed expenses + Variable expenses). D) Sales − Net operating income. Ans: A

LO: 7

27. If the degree of operating leverage is 4, then a one percent change in quantity sold should result in a four percent change in: A) unit contribution margin. B) revenue. C) variable expense. D) net operating income. Ans: D

LO: 8

28. Which of the following is the correct calculation for the degree of operating leverage? A) net operating income divided by total expenses. B) net operating income divided by total contribution margin. C) total contribution margin divided by net operating income. D) variable expense divided by total contribution margin. Ans: C

LO: 8

29. Which of the following is an assumption underlying standard CVP analysis? A) In multiproduct companies, the sales mix is constant. B) In manufacturing companies, inventories always change. C) The price of a product or service is expected to change as volume changes. D) Fixed expenses will change as volume increases. Ans: A

LO: 9

30. Hopi Corporation expects the following operating results for next year: Sales........................................................... Margin of safety......................................... Contribution margin ratio........................... Degree of operating leverage.....................

$400,000 $100,000 75% 4

What is Hopi expecting total fixed expenses to be next year? A) $75,000 B) $100,000 C) $200,000 D) $225,000 Ans: D

LO: 1; 3; 8

Solution: Current sales - Breakeven sales = Margin of safety Substituting the given information into the above equation, we will have: $400,000 − Breakeven sales = $100,000 Breakeven sales = $300,000 Breakeven sales = Fixed expenses ÷ Contribution margin ratio Substituting the given information into the above equation, we will have: $300,000 = Fixed expenses ÷ 0.75 Fixed expenses = $225,000

31. Escareno Corporation has provided its contribution format income statement for June. The company produces and sells a single product. Sales (8,400 units).......................... $764,400 Variable expenses........................... 445,200 Contribution margin....................... 319,200 Fixed expenses............................... 250,900 Net operating income..................... $ 68,300 If the company sells 8,200 units, its total contribution margin should be closest to: A) $301,000 B) $311,600 C) $319,200 D) $66,674 Ans: B Solution: Current contribution margin ÷ Current sales in units = Contribution margin per unit $319,200 ÷ 8,400 = $38 contribution margin per unit If 8,200 units are sold, the total contribution margin will be 8,200 × $38, or $311,600. 32. Rovinsky Corporation, a company that produces and sells a single product, has provided its contribution format income statement for November. Sales (5,700 units).............. $319,200 Variable expenses............... 188,100 Contribution margin........... 131,100 Fixed expenses................... 106,500 Net operating income......... $ 24,600 If the company sells 5,300 units, its net operating income should be closest to: A) $24,600 B) $2,200 C) $22,874 D) $15,400 Ans: D

Solution: Current sales dollars ÷ Current sales in units = Sales price per unit $319,200 ÷ 5,700 = $56 sales price per unit Current variable expenses ÷ Current sales in units = Variable expense per unit $188,100 ÷ 5,700 = $33 variable expense per unit Sales (5,300 units × $56)....................... Variable expenses (5,300 units × $33)... Contribution margin.............................. Fixed expenses....................................... Net operating income............................

$296,800 174,900 121,900 106,500 $ 15,400

33. Sorin Inc., a company that produces and sells a single product, has provided its contribution format income statement for January. Sales (4,200 units).......................... $155,400 Variable expenses........................... 100,800 Contribution margin....................... 54,600 Fixed expenses............................... 42,400 Net operating income..................... $ 12,200 If the company sells 4,600 units, its total contribution margin should be closest to: A) $54,600 B) $59,800 C) $69,400 D) $13,362 Ans: B Solution: Current contribution margin ÷ Current sales in units = Contribution margin per unit $54,600 ÷ 4,200 = $13 contribution margin per unit If 4,600 units are sold, the total contribution margin will be 4,600 × $13, or $59,800.

34. Decaprio Inc. produces and sells a single product. The company has provided its contribution format income statement for June. Sales (8,800 units).......................... Variable expenses........................... Contribution margin....................... Fixed expenses............................... Net operating income.....................

$528,000 290,400 237,600 211,700 $ 25,900

If the company sells 9,200 units, its net operating income should be closest to: A) $27,077 B) $49,900 C) $36,700 D) $25,900 Ans: C Solution: Current sales dollars ÷ Current sales in units = Sales price per unit $528,000 ÷ 8,800 = $60 sales price per unit Current variable expenses ÷ Current sales in units = Variable expense per unit $290,400 ÷ 8,800 = $33 variable expense per unit Sales (9,200 units × $60 ).......................... Variable expenses (9,200 units × $33)....... Contribution margin................................... Fixed expenses........................................... Net operating income.................................

$552,000 303,600 248,400 211,700 $ 36,700

35. The Bronco Birdfeed Company reported the following information: Sales (400 cases)............................ $100,000 Variable expenses........................... 60,000 Contribution margin....................... 40,000 Fixed expenses............................... 35,000 Net operating income..................... $5,000 How much will the sale of one additional case add to Bronco's net operating income? A) $250.00 B) $100.00 C) $150.00 D) $12.50 Ans: B Solution: Current contribution margin ÷ Current sales in cases = Contribution margin per case $40,000 ÷ 400 = $100 contribution margin per case If one additional case is sold, net operating income will increase by $100.

36. The margin of safety in the Flaherty Company is $24,000. If the company's sales are $120,000 and its variable expenses are $80,000, its fixed expenses must be: A) $8,000 B) $32,000 C) $24,000 D) $16,000 Ans: B

LO: 3; 5; 7

Solution: Current sales - Breakeven sales = Margin of safety Substituting the given information into the above equation, we will have: $120,000 - Breakeven sales = $24,000 Breakeven sales = $96,000 Sales - Variable expenses = Contribution margin $120,000 - $80,000 = $40,000 Contribution margin ratio = Contribution margin ÷ Sales Contribution margin ratio = $ 40,000 ÷ $120,000 Contribution margin ratio = 0.33333 Breakeven sales = Fixed costs ÷ Contribution margin ratio Substituting the given information into the above equation, we will have: $96,000 = Fixed costs ÷ 0.33333 Fixed costs = $32,000

37. Dodero Company produces a single product which sells for $100 per unit. Fixed expenses total $12,000 per month, and variable expenses are $60 per unit. The company's sales average 500 units per month. Which of the following statements is correct? A) The company's break-even point is $12,000 per month. B) The fixed expenses remain constant at $24 per unit for any activity level within the relevant range. C) The company's contribution margin ratio is 40%. D) Responses A, B, and C are all correct. Ans: C

LO: 3; 5

Solution: Answer A is not correct because: Sales = Variable expenses + Fixed expenses + Profit $100Q = $60Q + $12,000 + $0 $40Q = $12,000 Q = $12,000 ÷ $40 per unit = 300 units 300 units × $100 selling price per unit = $30,000 breakeven sales in dollars Answer B is not correct because fixed costs change as activity level changes Answer C is correct because: Contribution margin per unit = Selling price per unit - Variable expenses per unit = $100 - $60 = $40 Contribution margin ratio = Contribution margin per unit ÷ Selling price per unit Contribution margin ratio = $40 ÷ $100 Contribution margin ratio = 40%

38. Holt Company's variable expenses are 70% of sales. At a $300,000 sales level, the degree of operating leverage is 10. If sales increase by $60,000, the degree of operating leverage will be: A) 12 B) 10 C) 6 D) 4 Ans: D

LO: 3; 8

Solution: Sales.......................................................... Variable expenses ($300,000 × 70%)....... Contribution margin................................. Fixed expenses.......................................... Net operating income...............................

$300,000 210,000 90,000 ? $ ?

Current degree of operating leverage = Current contribution margin ÷ Current net operating income 10 = $90,000 ÷ Current net operating income Current net operating income = $90,000 ÷ 10 = $9,000 Contribution margin = Fixed expenses - Net operating income $90,000 = Fixed expenses - $9,000 Fixed expenses = $90,000 - $9,000 = $81,000 Sales ($300,000 + $60,000)...................... Variable expenses ($360,000 × 70%)....... Contribution margin................................. Fixed expenses.......................................... Net operating income...............................

$360,000 252,000 108,000 81,000 $ 27,000

Degree of operating leverage = Contribution margin ÷ Net operating income = $108,000/$27,000 = 4.0

39. Gayne Corporation's contribution margin ratio is 12% and its fixed monthly expenses are $84,000. If the company's sales for a month are $738,000, what is the best estimate of the company's net operating income? Assume that the fixed monthly expenses do not change. A) $565,440 B) $654,000 C) $88,560 D) $4,560 Ans: D Solution: Sales.......................................................... Variable expenses ($738,000 × 88%)....... Contribution margin ($738,000 × 12%)... Fixed expenses.......................................... Net operating income...............................

$738,000 649,440 88,560 84,000 $ 4,560

40. Jilk Inc.'s contribution margin ratio is 58% and its fixed monthly expenses are $36,000. Assuming that the fixed monthly expenses do not change, what is the best estimate of the company's net operating income in a month when sales are $103,000? A) $23,740 B) $59,740 C) $67,000 D) $7,260 Ans: A Solution: Sales........................................................... $103,000 Variable expenses ($103,000 × 42%)........ 43,260 Contribution margin ($103,000 × 58%).... 59,740 Fixed expenses........................................... 36,000 Net operating income................................. $ 23,740

41. Creswell Corporation's fixed monthly expenses are $29,000 and its contribution margin ratio is 56%. Assuming that the fixed monthly expenses do not change, what is the best estimate of the company's net operating income in a month when sales are $95,000? A) $12,800 B) $24,200 C) $53,200 D) $66,000 Ans: B Solution: Sales........................................................... Variable expenses ($95,000 × 44%)........... Contribution margin ($95,000 × 56%)....... Fixed expenses........................................... Net operating income.................................

$95,000 41,800 53,200 29,000 $24,200

42. Wilson Company prepared the following preliminary budget assuming no advertising expenditures: Selling price....................... Unit sales............................ Variable expenses............... Fixed expenses...................

$10 per unit 100,000 $600,000 $300,000

Based on a market study, the company estimated that it could increase the unit selling price by 15% and increase the unit sales volume by 10% if $100,000 were spent on advertising. Assuming that these changes are incorporated in its budget, what should be the budgeted net operating income? A) $175,000 B) $190,000 C) $205,000 D) $365,000 Ans: C

Source: CPA; adapted

Solution: Sales (110,000 units × $11.50)..................... Variable expenses (110,000 units × $6*)...... Contribution margin...................................... Fixed expenses ($300,000 + $100,000)........ Net operating income....................................

$1,265,000 660,000 605,000 400,000 $ 205,000

* Current variable expenses ÷ Current sales in units = Variable expense per unit $600,000 ÷ 100,000 = $6 variable expense per unit 43. Data concerning Kardas Corporation's single product appear below:

Selling price....................... Variable expenses............... Contribution margin...........

Per Unit $140 28 $112

Percent of Sales 100% 20% 80%

The company is currently selling 8,000 units per month. Fixed expenses are $719,000 per month. The marketing manager believes that a $20,000 increase in the monthly advertising budget would result in a 180 unit increase in monthly sales. What should be the overall effect on the company's monthly net operating income of this change? A) decrease of $160 B) increase of $20,160 C) decrease of $20,000 D) increase of $160 Ans: D Solution:

Sales (8,000 units, 8,180 units × $140).......... Variable expenses ($1,120,000, $1,145,200 × 20%)................ Contribution margin....................................... Fixed expenses................................................ Net operating income.....................................

8,000 units $1,120,000

8,180 units $1,145,200

224,000 896,000 719,000 $ 177,000

229,040 916,160 739,000 $ 177,160

Increase in net operating income: $177,160 - $177,000 = $160

44. Kuzio Corporation produces and sells...