Chapter 6

> DO IT!

CVP Income Garner Inc. sold 20,000 units and recorded sales of $800,000 for the first quarter of 2014. In
making the sales, the company incurred the following costs and expenses.
Statement
Variable Fixed
Cost of goods sold $250,000 $110,000
Selling expenses 100,000 25,000
Administrative expenses 82,000 73,000
(a) Prepare a CVP income statement for the quarter ended March 31, 2014.
(b) Compute the contribution margin per unit.
(c) Compute the contribution margin ratio.
Solution
Action Plan
(a) Garner Inc.
✔ Use the CVP income
statement format.
Income Statement
For the Quarter Ended March 31, 2014
✔ Use the formula for
contribution margin Sales (20,000 units) $800,000
per unit. Variable expenses
✔ Use the formula for the Cost of goods sold $250,000
contribution margin Selling expenses 100,000
ratio. Administrative expenses 82,000
Total variable expenses 432,000
Contribution margin 368,000
Fixed expenses
Cost of goods sold 110,000
Selling expenses 25,000
Administrative expenses 73,000
Total fixed expenses 208,000
Net income $160,000
(b) Contribution margin per unit:
$368,000 4 20,000 units 5 $18.40 per unit.
(c) Contribution margin ratio:
$368,000 4 $800,000 5 46% (or $18.40 4 $40 5 46%).

Related exercise material: BE6-1, BE6-2, and DO IT! 6-1.

D-1
D-2 DO IT!

> DO IT!

CVP Analysis Krisanne Company reports the following operating results for the month of June.

Krisanne Company
CVP Income Statement
For the Month Ended June 30, 2014
Total Per Unit
Sales (5,000 units) $300,000 $60
Variable costs 180,000 36
Contribution margin 120,000 $24
Fixed expenses 100,000
Net income $ 20,000

To increase net income, management is considering reducing the selling price by 10%,
with no changes to unit variable costs or fixed costs. Management is confident that this
change will increase unit sales by 25%.
Using the contribution margin technique, compute the break-even point in units and dol-
lars and margin of safety in dollars (a) assuming no changes to sales price or costs, and
(b) assuming changes to sales price and volume as described above. (c) Comment on your
findings.

Solution
Action Plan
(a) Assuming no changes to sales price or costs:
✔ Apply the formula for
the break-even point in
Break-even point in units 5 4,167 units (rounded) ($100,000 4 $24).
units. Break-even point in sales dollars 5 $250,000 ($100,000 4.40a).
✔ Apply the formula for Margin of safety in dollars 5 $50,000 ($300,000 2 $250,000).
a
the break-even point in $24 4 $60.
dollars. (b) Assuming changes to sales price and volume:
✔ Apply the formula for Break-even point in units 5 5,556 units (rounded) ($100,000 4 $18b).
the margin of safety in Break-even point in sales dollars 5 $300,000 ($100,000 4 ($18 4 $54)).
dollars. Margin of safety in dollars 5 $37,500 ($337,500c 2 $300,000).
b
$60 2 (.10 3 $60) 2 36 5 $18.
c
5,000 1 (.25 3 5,000) 5 6,250 units, 6,250 units 3 $54 5 $337,500.
(c) The increase in the break-even point and the decrease in the margin of safety indi-
cate that management should not implement the proposed change. The increase in
sales volume will result in contribution margin of $112,500 (6,250 3 $18), which is
$7,500 less than the current amount.

Related exercise material: BE6-3, BE6-4, BE6-5, BE6-6, E6-1, E6-2, E6-3, E6-4, E6-5, and DO IT! 6-2.
 DO IT! D-5

> DO IT!

Variable Costing Franklin Company produces and sells tennis balls. The following costs are available for
the year ended December 31, 2014. The company has no beginning inventory. In 2014,
8,000,000 units were produced, but only 7,500,000 units were sold. The unit selling price
was $0.50 per ball. Costs and expenses were:
Variable costs per unit
Direct materials $0.10
Direct labor 0.05
Variable manufacturing overhead 0.08
Variable selling and administrative expenses 0.02
Annual fixed costs and expenses
Manufacturing overhead $500,000
Selling and administrative expenses 100,000
(a) Compute the manufacturing cost of one unit of product using variable costing.
(b) Prepare a 2014 income statement for Franklin Company using variable costing.

Solution
Action Plan
(a) The cost of one unit of product under variable costing would be:
✔ Recall that under
variable costing, only Direct materials $0.10
variable manufacturing Direct labor 0.05
costs are treated as
Variable manufacturing overhead 0.08
manufacturing
(product) costs. $0.23
✔ Subtract all fixed costs, (b) The variable costing income statement would be as follows.
both manufacturing
overhead and selling Franklin Company
and administrative Income Statement
expenses, as period
costs.
For the Year Ended December 31, 2014
Variable Costing
Sales (7,500,000 3 $0.50) $3,750,000
Variable cost of goods sold (7,500,000 3 $0.23) $1,725,000
Variable selling and administrative expenses
(7,500,000 3 .02) 150,000 1,875,000
Contribution margin 1,875,000
Fixed manufacturing overhead 500,000
Fixed selling and administrative expenses 100,000 600,000
Net income $1,275,000

Related exercise material: BE6-16, BE6-17, BE6-18, BE6-19, E6-17, E6-18, and E6-19.
Do it!
Break-Even Lombardi Company has a unit selling price of $400, variable costs per unit of $240,
Analysis and fixed costs of $180,000. Compute the break-even point in units using (a) a
mathematical equation and (b) contribution margin per unit.
action plan Solution
✔ Apply the formula:
Sales 5 Variable costs 1 (a) The formula is $400Q 5 $240Q 1 $180,000. The break-even point in units
Fixed costs 1 Net income. is 1,125 ($180,000 4 $160).
✔ Apply the formula: Fixed (b) The contribution margin per unit is $160 ($400 2 $240). The formula
costs 4 Contribution margin
per unit 5 Break-even point therefore is $180,000 4 $160, and the break-even point in units is 1,125.
in units.
Related exercise material: BE22-5, BE22-6, E22-4, E22-5, E22-6, E22-7, E22-8, and Do it! 22-3.

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Do it!
Margin of Safety; Mabo Company makes calculators that sell for $20 each. For the coming year, man-
Required Sales agement expects fixed costs to total $220,000 and variable costs to be $9 per unit.
(a) Compute break-even point in units using the mathematical equation.
(b) Compute break-even point in dollars using the contribution margin (CM) ratio.
(c) Compute the margin of safety percentage assuming actual sales are $500,000.
(d) Compute the sales required in dollars to earn net income of $165,000 using the
action plan mathematical equation.
✔ Know the formulas.
✔ Recognize that variable Solution
costs change with sales
volume; fixed costs do not.
(a) Sales 5 Variable costs 1 Fixed costs 1 Net income
$20Q 5 $9Q 1 $220,000 1 $0
✔ Avoid computational
errors.
$11Q 5 $220,000
Q 5 20,000 units
(b) Contribution margin per unit 5 Unit selling price 2 Unit variable costs
$11 5 $20 2 $9
Contribution margin ratio 5 Contribution margin per unit 4 Unit selling price
55% 5 $11 4 $20
Break-even point in dollars 5 Fixed cost 4 Contribution margin ratio
5 $220,000 4 55%
5 $400,000
Actual sales – Break-even sales
(c) Margin of safety 5
Actual sales
$500,000 2 $400,000
5
$500,000
5 20%
(d) Required sales 5 Variable costs 1 Fixed costs 1 Net income
$20Q 5 $9Q 1 $220,000 1 $165,000
$11Q 5 $385,000
Q 5 35,000 units
35,000 units 3 $20 5 $700,000 required sales

Related exercise material: BE22-6, BE22-7, BE22-8, E22-5, E22-6, E22-7, E22-8, E22-9, E22-10, E22-11,
E22-12, E22-13, and Do it! 22-4.
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[The Navigator]
COMPREHENSIVE

Do it!
B.T. Hernandez Company, maker of high-quality flashlights, has experienced
steady growth over the last 6 years. However, increased competition has led Mr.
Hernandez, the president, to believe that an aggressive campaign is needed next
year to maintain the company’s present growth. The company’s accountant has
presented Mr. Hernandez with the following data for the current year, 2012, for
use in preparing next year’s advertising campaign.
Cost Schedules
Variable costs
Direct labor per flashlight $ 8.00
Direct materials 4.00
Variable overhead 3.00
Variable cost per flashlight $15.00
Fixed costs
Manufacturing $ 25,000
Selling 40,000
Administrative 70,000
Total fixed costs $135,000
Selling price per flashlight $25.00
Expected sales, 2012 (20,000 flashlights) $500,000

Mr. Hernandez has set the sales target for the year 2013 at a level of $550,000
(22,000 flashlights).
Instructions
(Ignore any income tax considerations.)
(a) What is the projected operating income for 2012?
(b) What is the contribution margin per unit for 2012?
(c) What is the break-even point in units for 2012?
(d) Mr. Hernandez believes that to attain the sales target in the year 2013, the
company must incur an additional selling expense of $10,000 for advertising
in 2013, with all other costs remaining constant. What will be the break-even
point in dollar sales for 2013 if the company spends the additional $10,000?
(e) If the company spends the additional $10,000 for advertising in 2013, what is
the sales level in dollars required to equal 2012 operating income? action plan
✔ Know the formulas.
Solution to Comprehensive Do it! ✔ Recognize that variable
costs change with sales
(a) volume; fixed costs do not.
Expected sales $500,000 ✔ Avoid computational
Less: errors.
Variable cost (20,000 flashlights 3 $15) $300,000
Fixed costs 135,000 435,000
Projected operating income $ 65,000
(b) Selling price per flashlight $25
Variable cost per flashlight 15
Contribution margin per unit $10
(c) Fixed costs 4 Contribution margin per unit 5 Break-even point in units
$135,000 4 $10 5 13,500 units
 (d) Fixed costs 4 Contribution margin ratio 5 Break-even point in dollars
$145,000 4 40% 5 $362,500
Fixed costs (from 2012) $135,000
Additional advertising expense 10,000
Fixed costs (2013) $145,000
Contribution margin per unit (b) $10
Contribution margin ratio 5 Contribution margin per unit 4 Unit selling price
40% 5 $10 4 $25
(e) Required sales 5 (Fixed costs 1 Target net income) 4 Contribution margin ratio
$525,000 5 ($145,000 1 $65,000) 4 40%

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[The Navigator]

Do it! Review
Classify types of costs. Do it! 22-1 Wyoming Company reports the following total costs at two levels of production.
(SO 1, 3)
5,000 Units 10,000 Units
Indirect labor $ 3,000 $ 6,000
Property taxes 7,000 7,000
Direct labor 27,000 54,000
Direct materials 22,000 44,000
Depreciation 4,000 4,000
Utilities 3,000 5,000
Maintenance 9,000 11,000
Classify each cost as variable, fixed, or mixed.
Compute costs using high-low Do it! 22-2 Blakely Company accumulates the following data concerning a mixed cost, using
method and estimate total cost. units produced as the activity level.
(SO 3) Units Produced Total Cost
March 10,000 $18,000
April 9,000 16,650
May 10,500 18,750
June 8,800 16,200
July 9,500 17,100
(a) Compute the variable and fixed cost elements using the high-low method.
(b) Estimate the total cost if the company produces 8,500 units.
Compute break-even point in Do it! 22-3 Lombardi Company has a unit selling price of $250, variable cost per unit of $160,
units. and fixed costs of $135,000. Compute the break-even point in units using (a) a mathematical
(SO 6) equation and (b) contribution margin per unit.
Compute margin of safety Do it! 22-4 Wales Company makes radios that sell for $30 each. For the coming year, manage-
percentage and required sales. ment expects fixed costs to total $200,000 and variable costs to be $20 per unit.
(SO 8, 9) (a) Compute the break-even point in dollars using the contribution margin (CM) ratio.
(b) Compute the margin of safety percentage assuming actual sales are $750,000.
(c) Compute the sales required in dollars to earn net income of $120,000.
visits).
Problem

Sugartown, Inc. has three product lines in its retail stores: cookies, cakes, and candy. The
allocated fixed costs are based on units sold and are unavoidable. Results of June follow:

Cookies Cakes Candy Total

Units sold 2,400 1,600 2,000 6,000
Revenue 25,000 50,000 75,000 150,000
Variable department costs 12,000 37,000 41,000 90,000
Direct fixed costs 6,200 8,000 19,000 33,200
Allocated fixed costs 5,000 6,500 7,000 18,500
Operating income (loss) $1,800 ($1,500) $8,000 $8,300

Demand of individual products is not affected by changes in other product lines. Prepare
an incremental analysis of the effect of dropping the cakes product line. Determine the
operating income or loss for Sugartown after the cakes product line is dropped.

Solution
Total cake revenue will drop by $50,000 if the cakes product line is eliminated, resulting
in a decline in total profit. The $37,000 of variable costs associated with cakes will be
avoided if this product line is dropped. This decrease in variable costs is a savings which
increases profits, so the $37,000 cost savings is added in the incremental analysis. The
$8,000 of direct fixed costs are directly associated with cakes, and will be avoided if cakes
are dropped. This decrease in direct fixed costs is a savings which increases profits, so
the $8,000 is added. The allocated fixed costs must be absorbed by the other two
products if cakes are dropped, so in total, there will be no change to allocated fixed costs
for the entire company.

Incremental revenue ($50,000)

Incremental savings:
Variable costs 37,000
Direct fixed costs 8,000
Incremental decrease in profit if the 'cakes' product line is dropped ($5,000)
Dropping the cakes product line will result in a drop in operating income for the entire
company from $8,300 to $3,300. This amount can be calculated without recreating the
income statement by combining the original profit with the incremental change in profit
as follows:

New profit = Original operating income +/- Change in operating income =

$8,300 - $5,000 = $3,300
Make or buy

Yoklic Corporation currently manufactures a subassembly for its main product. The
costs per unit are as follows:

Direct materials $ 4.00

Direct labor 30.00
Variable overhead 15.00
Fixed overhead 25.00
Total $74.00

Regina Corp has contacted Yoklic with an offer to sell it 5,000 subassemblies for
$55.00 each.

REQUIRED:

A- Should Yoklic make or buy the subassemblies? Create a schedule that shows the
total quantitative differences between the two alternatives.

B- The accountant decided to investigate the fixed costs to determine whether

any incremental changes would occur if the subassembly were no longer
manufactured. The accountant believes that Yoklic will eliminate $50,000 of
fixed overhead if it accepts the proposal. Does this new information change
the decision? Show your calculations.
C- Ignore the information in part (B). Now suppose Yoklic could use the capacity
released under the buy alternative to make a different subassembly that it
currently purchases from a vendor for $20. The manufacturing engineer
believes that the company can use the existing equipment to manufacture the
subassembly for $13 each (direct materials, direct labor, and variable
overhead). The firm uses about 5,000 of these subassemblies. Create a
schedule that shows the difference between the two alternatives.

Solution: