CHAPTER 7 Cost-Volume-Profit Analysis

ANSWERS TO REVIEW QUESTIONS

7-1 a. In the contribution-margin approach, the break-even point in units is calculated using the following formula: Break point -even = fixed expenses unit contributi on margin approach, the following profit

b. In the equation equation is used:

sales volume unit sales price in units

ble volume fixed unit varia sales = 0 expense in units expens es

This equation is solved for the sales volume in units. c. In the graphical approach, sales revenue and total expenses are graphed. The break-even point occurs at the intersection of the total revenue and total expense lines. 7-2 The term unit contribution margin refers to the contribution that each unit of sales makes toward covering fixed expenses and earning a profit. The unit contribution margin is defined as the sales price minus the unit variable expense. 7-3 In addition to the break-even point, a CVP graph shows the impact on total expenses, total revenue, and profit when sales volume changes. The graph shows the sales volume required to earn a particular target net profit. The firm's profit and loss areas are also indicated on a CVP graph. 7-4 The safety margin is the amount by which budgeted sales revenue exceeds break-even sales revenue.

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-1

7-5 An increase in the fixed expenses of any enterprise will increase its break-even point. In a travel agency, more clients must be served before the fixed expenses are covered by the agency's service fees. 7-6 A decrease in the variable expense per pound of oysters results in an increase in the contribution margin per pound. This will reduce the company's break-even sales volume. 7-7 The president is correct. A price increase results in a higher unit contribution margin. An increase in the unit contribution margin causes the break-even point to decline. The financial vice president's reasoning is flawed. Even though the break-even point will be lower, the price increase will not necessarily reduce the likelihood of a loss. Customers will probably be less likely to buy the product at a higher price. Thus, the firm may be less likely to meet the lower break-even point (at a high price) than the higher break-even point (at a low price). 7-8 When the sales price and unit variable cost increase by the same amount, the unit contribution margin remains unchanged. Therefore, the firm's break-even point remains the same. 7-9 The fixed annual donation will offset some of the museum's fixed expenses. The reduction in net fixed expenses will reduce the museum's break-even point. 7-10 A profit-volume graph shows the profit to be earned at each level of sales volume. 7-11 The most important assumptions of a cost-volume-profit analysis are as follows: (a) The behavior of total revenue is linear (straight line) over the relevant range. This behavior implies that the price of the product or service will not change as sales volume varies within the relevant range.

McGraw-Hill/Irwin 7-2

2009 The McGraw-Hill Companies, Inc. Solutions Manual

(b) The behavior of total expenses is linear (straight line) over the relevant range. This behavior implies the following more specific assumptions: (1) Expenses can be categorized as fixed, variable, or semivariable. (2) Efficiency and productivity are constant.

(c) In multiproduct organizations, the sales mix remains constant over the relevant range. (d) In manufacturing firms, the inventory levels at the beginning and end of the period are the same. 7-12 Operating managers frequently prefer the contribution income statement because it separates fixed and variable costs. This format makes cost-volume-profit relationships more readily discernible.

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-3

7-13 The gross margin is defined as sales revenue minus all variable and fixed manufacturing expenses. The total contribution margin is defined as sales revenue minus all variable expenses, including manufacturing, selling, and administrative expenses. 7-14 East Company, which is highly automated, will have a cost structure dominated by fixed costs. West Company's cost structure will include a larger proportion of variable costs than East Company's cost structure. A firm's operating leverage factor, at a particular sales volume, is defined as its total contribution margin divided by its net income. Since East Company has proportionately higher fixed costs, it will have a proportionately higher total contribution margin. Therefore, East Company's operating leverage factor will be higher. 7-15 When sales volume increases, Company X will have a higher percentage increase in profit than Company Y. Company X's higher proportion of fixed costs gives the firm a higher operating leverage factor. The company's percentage increase in profit can be found by multiplying the percentage increase in sales volume by the firm's operating leverage factor. 7-16 The sales mix of a multiproduct organization is the relative proportion of sales of its products. The weighted-average unit contribution margin is the average of the unit contribution margins for a firm's several products, with each product's contribution margin weighted by the relative proportion of that product's sales. 7-17 The car rental agency's sales mix is the relative proportion of its rental business associated with each of the three types of automobiles: subcompact, compact, and full-size. In a multi-product CVP analysis, the sales mix is assumed to be constant over the relevant range of activity.

McGraw-Hill/Irwin 7-4

2009 The McGraw-Hill Companies, Inc. Solutions Manual

7-18 Cost-volume-profit analysis shows the effect on profit of changes in expenses, sales prices, and sales mix. A change in the hotel's room rate (price) will change the hotel's unit contribution margin. This contribution-margin change will alter the relationship between volume and profit.

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-5

7-19 Budgeting begins with a sales forecast. Cost-volumeprofit analysis can be used to determine the profit that will be achieved at the budgeted sales volume. A CVP analysis also shows how profit will change if the sales volume deviates from budgeted sales. Cost-volume-profit analysis can be used to show the effect on profit when variable or fixed expenses change. The effect on profit of changes in variable or fixed advertising expenses is one factor that management would consider in making a decision about advertising. 7-20 The low-price company must have a larger sales volume than the high-price company. By spreading its fixed expense across a larger sales volume, the low-price firm can afford to charge a lower price and still earn the same profit as the high-price company. Suppose, for example, that companies A and B have the following expenses, sales prices, sales volumes, and profits.

Company A Sales revenue: 350 units at $10.................... 100 units at $20.................... Variable expenses: 350 units at $6...................... 100 units at $6...................... Contribution margin.................. Fixed expenses......................... Profit........................................

Company B

$3,500 $2,000 2,100 $1,400 1,000 $ 400 600 $1,400 1,000 $ 400

7-21 The statement makes three assertions, but only two of them are true. Thus the statement is false. A company with an advanced manufacturing environment typically will have a larger proportion of fixed costs in its cost structure. This will result in a higher break-even point and

McGraw-Hill/Irwin 7-6

2009 The McGraw-Hill Companies, Inc. Solutions Manual

greater operating leverage. However, the firm's higher break-even point will result in a reduced safety margin. 7-22 Activity-based costing (ABC) results in a richer description of an organization's cost behavior and CVP relationships. Costs that are fixed with respect to sales volume may not be fixed with respect to other important cost drivers. An ABC system recognizes these nonvolume cost drivers, whereas a traditional costing system does not.

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-7

SOLUTIONS TO EXERCISES
EXERCISE 7-23 (20 MINUTES) 1. Break-even point (in units) = 2. = fixed expenses unit contributi on margin

$54,000 = 13,500 pizzas $10 $6 = unit contributi on margin unit sales price

Contribution-margin ratio =

$10 $6 = .4 $10 =

3.

Break-even point (in sales dollars) fixed expenses contributi onmargin ratio =

$54,000 = $135,000 .4

4.

Let X denote the sales volume of pizzas required to earn a target net profit of $60,000. $10X $6X $54,000 = $60,000 $4X = $114,000 X = 28,500 pizzas

McGraw-Hill/Irwin 7-8

2009 The McGraw-Hill Companies, Inc. Solutions Manual

EXERCISE 7-24 (25 MINUTES) Total Sales Variable Contribut Fixed Revenu Expenses ion Expens e Margin es $360,0 $120,000 $240,000 $90,00 00 0 55,0 11,000 44,000 25,00 00 0 320,0 80,000 240,00 60,00 00 c 0 0 160,0 130,000 30,000 30,00 00 0d BreakNet Even Incom Sales e Revenue $150, $135,000 a 000 19,0 31,250b 00 180, 80,000 000 -0- 160,000

1 2 3 4

Explanatory notes for selected items: $135,000 = $90,000 (2/3), where 2/3 is the contributionmargin ratio.
a

$31,250 = $25,000/.80, where .80 is the contribution-margin ratio.

b c

Break-even sales revenue.................................... Fixed expenses................................................... Variable expenses...............................................

$80,000 60,000 $20,000

Therefore, variable expenses are 25 percent of sales revenue. When variable expenses amount to $80,000, sales revenue is $320,000. $160,000 is the break-even sales revenue, so fixed expenses must be equal to the contribution margin of $30,000 and profit must be zero.
d

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-9

EXERCISE 7-25 (25 MINUTES) 1. Cost-volume-profit graph:

Dollars per year $600,00 0 Break-even point: 20,000 tickets Total revenue

$500,00 0

Total expenses Profit area Variable expense (at 30,000 tickets)

$400,00 0 $300,00 0 Loss area

$200,00 0 $100,00 0

Annual fixed expense s

5,000

Tickets sold per 10,000 15,000 20,000 25,000 30,000 year

McGraw-Hill/Irwin 7-10

2009 The McGraw-Hill Companies, Inc. Solutions Manual

EXERCISE 7-25 (CONTINUED) 2. Stadium capacity..................... 6,000 Attendance rate....................... 2/3 Attendance per game............... 4,000 Break -even (tickets) point 20,000 = =5 Attendance per game 4,000 The team must play 5 games to break even.

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-11

EXERCISE 7-26 (25 MINUTES) 1. Profit-volume graph:

McGraw-Hill/Irwin 7-12

2009 The McGraw-Hill Companies, Inc. Solutions Manual

Dollars per year $300,00 0 $200,00 0 $100,00 0 0

Break-even point: 20,000 tickets 5,000

Profit area Tickets sold per year

10,000 15,000 20,000 25,000

$(100,000)

Loss area

$(200,00 0) $(300,00 0) $(360,00 0) Annual fixed expenses

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-13

EXERCISE 7-26 (CONTINUED) 2 . Safety margin: Budgeted sales revenue (10 games 6,000 seats .45 full $20)....... Break-even sales revenue (20,000 tickets $20)..................................... Safety margin..................................................... 3 . $540,00 0 400,00 0 $140,00 0

Let P denote the break-even ticket price, assuming a 10game season and 40 percent attendance: (10)(6,000)(.40)P (10)(6,000)(.40) = 0 ($2) $360,000 24,000P P = $408,000 = $17 per ticket

McGraw-Hill/Irwin 7-14

2009 The McGraw-Hill Companies, Inc. Solutions Manual

EXERCISE 7-27 (25 MINUTES) 1. Break-even point (in units) = = fixed costs unit contributi on margin

2,000,000 p = 4,000 components 1,500 1,000 p p

p denotes Argentinas peso. 2. New break-even point (in units) = 3. =

(2,000,000 p)(1.05) 1,500 1,000 p p

2,100,000 p = 4,200 components 500 p

Sales revenue (7,000 1,500p).................. 10,500,000p Variable costs (7,000 1,000p).................. 7,000,000p Contribution margin...................................3,500,000p Fixed costs................................................. 2,000,000p Net income................................................. 1,500,000p 4. New break-even point (in units) =
2,000,000 p 1,400 1,000 p p

= 5,000 components 5. Analysis of price change decision: Price 1,500p 1,400p Sales revenue: (7,000 1,500p) (8,000 1,400p) Variable costs: 7,000,000 (7,000 1,000p)........... p (8,000 1,000p)........... Contribution margin Fixed expenses
McGraw-Hill/Irwin Managerial Accounting, 8/e

10,500,00 0p

11,200,0 00p 8,000,0 00p 3,200,0 00p 2,000,0 00p 1,200,

3,500,000

2009 The McGraw-Hill Companies, Inc. 7-15

p Net income (loss)........................... 2,000,000 p 1,500,000 p

000p

The price cut should not be made, since projected net income will decline by 300,000p.

McGraw-Hill/Irwin 7-16

2009 The McGraw-Hill Companies, Inc. Solutions Manual

EXERCISE 7-28 (25 MINUTES) 1. (a) Traditional income statement: PACIFIC RIM PUBLICATIONS, INC. INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 20XX Sales............................................. $1,000,000 Less: Cost of goods sold................. Gross margin................................. 250,000 Less: Operating expenses: Selling expenses................... Administrative expenses....... 150,000 Net income.................................... 100,000 (b) Contribution income statement: PACIFIC RIM PUBLICATIONS, INC. INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 20XX Sales............................................. $1,000,000 Less: Variable expenses: Variable manufacturing......... $500,000 Variable selling..................... 50,000 Variable administrative......... 15,000 565,000 Contribution margin...................... $ 435,000 Less: Fixed expenses: Fixed manufacturing.............$ 250,000 Fixed selling.......................... 25,000 Fixed administrative.............. 60,000 335,000 Net income.................................... $ 100,000

750,000 $ $75,000 75,000 $

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-17

2.

contributi on margin Operating leverage (at factor $1,000,000 level) sales = net income $435,000 = = 4.35 $100,000

McGraw-Hill/Irwin 7-18

2009 The McGraw-Hill Companies, Inc. Solutions Manual

EXERCISE 7-28 (CONTINUED) 3. increase operating percentage Percentage increasenet in income = leverage revenue factor insales = 12% 4.35 = 52.2% 4. Most operating managers prefer the contribution income statement for answering this type of question. The contribution format highlights the contribution margin and separates fixed and variable expenses.

EXERCISE 7-29 (30 MINUTES) Answers will vary on this question, depending on the airline selected as well as the year of the inquiry. In a typical year, most airlines report a breakeven load factor of around 65 percent.

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-19

EXERCISE 7-30 (30 MINUTES) 1. Bicycle Type High-quality Mediumquality 2 . Sales mix: High-quality bicycles............................................ Medium-quality bicycles....................................... 3 . Weightedaverage unit contribution margin = ($400 30%) + ($300 70%) 30% 70% Sales Price $1,00 0 600 Unit Variable Cost $600 ($550 + $50) 300 ($270 + $30) Unit Contribution Margin $400 300

= $330 4 . Break -even point units) (in = fixed expenses weighted -average contributi unit onmargin $148,500 = = 450 bicycles $330 BreakEven Sales Volume 135 (450 .30) Sales Price $1,000 600 Sales Revenu e $135,00 0 189,000 $324,00 0

Bicycle Type High-quality bicycles

Medium-quality bicycles 315 (450 .70) Total

5.

Target net income:

2009 The McGraw-Hill Companies, Inc. Solutions Manual

McGraw-Hill/Irwin 7-20

$ 48,500 1 + $99,000 Sales volume required to earn target income$99,000 net of = $330 = 750 bicycles This means that the shop will need to sell the following volume of each type of bicycle to earn the target net income: High-quality........................................ Medium-quality................................... EXERCISE 7-31 (25 MINUTES) 1. The following income statement, often called a commonsize income statement, provides a convenient way to show the cost structure. 225 (750 .30) 525 (750 .70)

Amount Revenue............................. Variable expenses............... Contribution margin............ Fixed expenses................... Net income......................... $1,500,0 00 900,000 $600,000 450,000 $ 150,000

Percent 100 60 40 30 10

2. Decrease in Revenue $300,000 * Contribution Margin Percentage 40% Decrease in Net Income = $120,000

*$300,000 = $1,500,000 20%

40% = $600,000/$1,500,000

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-21

3.

contributi on margin Operating leverage (at factor revenue of$1,500,000 )= net income $600,000 = =4 $150,000 leverage increase operating percentage in revenue factor

4.

Percentage in income change net =

= 25 4 % = 100%

McGraw-Hill/Irwin 7-22

2009 The McGraw-Hill Companies, Inc. Solutions Manual

EXERCISE 7-32 (10 MINUTES) Requireme nt (1) Revenue.............................. Less:........Variable expenses Contribution margin............ Less:............Fixed expenses Net Income (loss)................ $1,875,000 1,125,000 $ 750,000 675,000 $75,000 Requireme nt (2) $ 1,500,000 1,800,000 $ (300,000) 350,000 $ (650,000)

EXERCISE 7-33 (20 MINUTES) 1 . fixed expenses Break -even volumeservice of revenue = contributi on margin ratio $200,000 = = $800,000 .25 target - tax income after net Target before income - tax = 1 tax rate $120,000 = = $200,000 1 .40 Service revenue required to earn target after-tax income of $120,000 target - tax income after net fixed expenses + (1 t) = contributi on margin ratio $120,000 $200,000 + 1 .40 = $1,600,000 = .25

2 .

3 .

4 .

A change in the tax rate will have no effect on the firm's break-even point. At the break-even point, the firm has no profit and does not have to pay any income taxes.

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-23

SOLUTIONS TO PROBLEMS
PROBLEM 7-34 (30 MINUTES) 1. Break-even point in sales dollars, using the contributionmargin ratio: Break -even = point fixed expenses contributi on margin ratio $540,000 + $216,000 $756,000 = = $30 $12 $6 .4 $30 = $1,890,000

2.

Target net income, using contribution-margin approach: fixed expenses + target income net Sales required income$540,000 units to earn of = unit contributi on margin $756,000 + $540,000 $1,296,000 = = $30 $12 $6 $12 = 108,000 units

3.

New unit variable manufacturing cost Break-even point in sales dollars:

Break - even point =

= $12 110% = $13.20

$756,000 $756,000 = $30.00 $13.20 $6.00 .36 $30 = $2,100,000

McGraw-Hill/Irwin 7-24

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-34 (CONTINUED) 4. Let P denote the selling price that will yield the same contribution-margin ratio:
$30.00 $12.00 $6.00 P $13.20 $6.00 = $30.00 P P $19.20 .4 = P .4P= P $19.20 $19.20 .6 = P P = $19.20/.6 P = $32.00

Check: New contribution-margin ratio is:

$32.00 $13.20 $6.00 = .4 $32.00

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-25

PROBLEM 7-35 (30 MINUTES) 1. fixed costs Break -even (in point units) = unit contributi on margin $702,000 = = 135,000 units $25.00 $19.80 fixed cost Break -even (in point sales dollars) = contributi on margin ratio $702,000 = = $3,375,000 $25.00 $19.80 $25.00 Number of sales units required to earn target net profit Margin of safety fixed costs target profit + net unit contributi on margin $702,000 + $390,000 = = 210,000 units $25.00 $19.80 =

2.

3.

4.

= budgeted sales revenue break-even sales revenue = (140,000)($25) $3,375,000 = $125,000

5.

Break-even point if direct-labor costs increase by 10 percent: New unit = $25.00 $8.20 ($4.00)(1.10) contribution margin $6.00 $1.60 = $4.80 Break-even point = fixed costs new contributi unit on margin $702,000 = = 146,250 units $4.80

McGraw-Hill/Irwin 7-26

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-35 (CONTINUED) 6. Contribution margin = ratio unit contributi on margin sales price

$25.00 $19.80 Old contribution- = $25.00 margin ratio = .208 Let P denote sales price required to maintain a contribution-margin ratio of .208. Then P is determined as follows: P $8.20 ($4.00)(1.$6.00 10) $1.60 = .208 P P $20.20 P = .208 .792= $20.20 P P = $25.51 (rounded) Chec k: New contribution margin ratio $25.51 $8.20 ($4.00)(1.$6.00 10) $1.60 $25.51 = .208 (rounded) =

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-27

PROBLEM 7-36 (30 MINUTES) 1. Break-even point in units, using the equation approach: $24X ($15 + $3)X = 0 $1,800,000 $6X = $1,800,000 X =
$1,800,000 $6

= 300,000 units 2. New projected sales = 400,000 110% volume = 440,000 units Net income = (440,000)($24 $18) $1,800,000 = (440,000)($6) $1,800,000 = $2,640,000 $1,800,000 = $840,000 3. Target net income = $600,000 (from original problem data) New disk purchase price = $15 130% = $19.50 Volume of sales dollars required: Volume of sales dollars = required
fixed expenses + target profit net contributimargin on ratio $1,800,000 + $600,000 $2,400,000 = = $24 $19.50 $3 .0625 $24 = $38,400,00 0

McGraw-Hill/Irwin 7-28

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-36 (CONTINUED) 4. Let P denote the selling price that will yield the same contribution-margin ratio:
$24 $15 $3 P $19.50 $3 = $24 P P $22.50 .25= P .25 = P $22.50 P $22.50 .75 = P P = $22.50/.75 P = $30

Check: New contribution-margin ratio is:

$30 $22.50 = .25 $30

5.

The electronic version of the Solutions Manual BUILD A SPREADSHEET SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website: www.mhhe.com/hilton8e .

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-29

PROBLEM 7-37 (30 MINUTES) 1. Unit contribution margin: Sales price Less variable costs: Sales commissions ($32 $ x 5%) 1.60 System variable 8. costs 00 Unit contribution margin.. $32. 00

9. 60 $22. 40

Break-even point = fixed costs unit contribution margin = $1,971,200 $22.40 = 88,000 units 2. Model A is more profitable when sales and production average 184,000 units. Model A Sales revenue (184,000 units x $32.00)... Less variable costs: Sales commissions ($5,888,000 x 5%) System variable costs: 184,000 units x $8.00. 184,000 units x $6.40. Total variable costs.. Contribution margin... Less: Annual fixed costs..
McGraw-Hill/Irwin 7-30

Model B

$5,888, $5,888, 000 000 $ 294,40 0 1,472, 000 1,177, 600 $1,766, $1,472, 400 000 $4,121, $4,416, 600 000 1,971, 2,227, 200 200
2009 The McGraw-Hill Companies, Inc. Solutions Manual

$ 294,40 0

Net income 3.

$2,150, $2,188, 400 800

Annual fixed costs will increase by $180,000 ($900,000 5 years) because of straight-line depreciation associated with the new equipment, to $2,407,200 ($2,227,200 + $180,000). The unit contribution margin is $24 ($4,416,000 184,000 units). Thus: Required sales = (fixed costs + target net profit) unit contribution margin = ($2,407,200 + $1,912,800) $24 = 180,000 units

4.

Let X = volume level at which annual total costs are equal $8.00X + $1,971,200 = $6.40X + $2,227,200 $1.60X = $256,000 X = 160,000 units

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-31

PROBLEM 7-38 (25 MINUTES) 1. Closing of mall store: Loss of contribution margin at Mall Store............. $(108,000) Savings of fixed cost at Mall Store (75%).............. 90,000 Loss of contribution margin at Downtown Store (10%) (14,400) Total decrease in operating income...................... $ (32,400) 2. Promotional campaign: Increase in contribution margin (10%)..................$10,800 Increase in monthly promotional expenses ($180,000/12) (15,000) Decrease in operating income..............................$(4,200) 3. Elimination of items sold at their variable cost: We can restate the November 20x4 data for the Mall Store as follows: Mall Store Items Sold at Their Other Variable Items Cost

McGraw-Hill/Irwin 7-32

2009 The McGraw-Hill Companies, Inc. Solutions Manual

Sales................................................ $180,000* Less: variable expenses..................... 72,000 Contribution margin.......................... $108,000

$180,000* 180,000 $ -0-

If the items sold at their variable cost are eliminated, we have: Decrease in contribution margin on other items (20%) $ (21,600) Decrease in fixed expenses (15%)....................... 18,000 Decrease in operating income............................. $ (3,600) *$180,000 is one half of the Mall Store's dollar sales for November 20x4. 4. The electronic version of the Solutions Manual BUILD A SPREADSHEET SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website: www.mhhe.com/hilton8e .

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-33

PROBLEM 7-39 (40 MINUTES) 1. 2. Sales mix refers to the relative proportion of each product sold when a company sells more than one product. (a) Yes. Plan A sales are expected to total 65,000 units (19,500 + 45,500), which compares favorably against current sales of 60,000 units. (b) Yes. Sales personnel earn a commission based on gross dollar sales. As the following figures show, Cold King sales will comprise a greater proportion of total sales under Plan A. This is not surprising in light of the fact that Cold King has a higher selling price than Mister Ice Cream ($43 vs. $37). Current Unit s Mister Ice Cream 21,0 00 Cold King......... 39,0 00 Total............ 60,0 00 (c) Sale s Mix % Plan A Unit s Sale s Mix 30 % 70 % 100 %

35 19,5 00 65 45,5 % 00 100 65,0 % 00

Yes. Commissions will total $267,800 ($2,678,000 x 10%), which compares favorably against the current flat salaries of $200,000. Mister Ice Cream sales: 19,500 $ units x $37.................................. 721,500 Cold King sales: 45,500 units x $43 1,956,5 00 Total sales............................... $2,678,0 00

McGraw-Hill/Irwin 7-34

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-39 (CONTINUED) (d) No. The company would be less profitable under the new plan. Current Sales revenue: Mister Ice Cream: 21,000 units x $37; $ 19,500 units x $37......................................... 777,00 0 Cold King: 39,000 units x $43; 45,500 units 1,677, x $43............................................................. 000 Total revenue......................................... $2,454, 000 Less variable cost: Mister Ice Cream: 21,000 units x $20.50; $ 19,500 units x $20.50..................................... 430,50 0 Cold King: 39,000 units x $32.50; 45,500 1,267, units x $32.50................................................ 500 Sales commissions (10% of sales revenue). . Total variable cost.................................. Contribution margin....................................... Less fixed cost (salaries)................................ Net income.................................................... Plan A $ 721,50 0 1,956, 500 $2,678, 000

$ 399,75 0 1,478, 750 267, 800 $1,698, $2,146, 000 300 $ $ 756,00 531,70 0 0 200, ---000 ___ $ $ 556,00 531,70 0 0

3.

(a)

The total units sold under both plans are the same; however, the sales mix has shifted under Plan B in favor of the more profitable product as judged by the contribution margin. Cold King has a contribution margin of $10.50 ($43.00 - $32.50), and Mister Ice Cream has a contribution margin of $16.50 ($37.00 $20.50). Plan A Plan B
2009 The McGraw-Hill Companies, Inc. 7-35

McGraw-Hill/Irwin Managerial Accounting, 8/e

Units Mister Ice Cream. Cold King............ Total............... 19,50 0 45,50 0 65,00 0

Sales Mix 30% 70% 100%

Units 39,00 0 26,00 0 65,00 0

Sales Mix 60% 40% 100%

McGraw-Hill/Irwin 7-36

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-39 (CONTINUED) (b) Plan B is more attractive both to the sales force and to the company. Salespeople earn more money under this arrangement ($274,950 vs. $200,000), and the company is more profitable ($641,550 vs. $556,000). Current Plan B $1,443, 000 1,118, 000 $2,561, 000 $ 799,50 0 845, 000 $1,644, 500 $ 916,50 0

Sales revenue: Mister Ice Cream: 21,000 units x $37; $ 39,000 units x $37......................................... 777,00 0 Cold King: 39,000 units x $43; 26,000 units 1,677, x $43............................................................. 000 Total revenue $2,454, ..................................................................... 000 Less variable cost: Mister Ice Cream: 21,000 units x $20.50; $ 39,000 units x $20.50.................................... 430,50 0 Cold King: 39,000 units x $32.50; 26,000 1,267, units x $32.50................................................ 500 Total variable cost $1,698, ..................................................................... 000 Contribution margin....................................... $ 756,00 0 Less: Sales force compensation: Flat salaries 200, ..................................................................... 000 Commissions ($916,500 x 30%) ..................................................................... Net income.................................................... $ 556,00 0

274, 950 $ 641,55 0

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-37

PROBLEM 7-40 (35 MINUTES) 1. Current income: Sales $4,032, revenue 000 ... Less: Variable $1,008, costs 000 Fixed 2,736, 3,744, costs. 000 000 Net $ income 288,00 . 0 CompTronics has a contribution margin of $72 [($4,032,000 - $1,008,000) 42,000 sets] and desires to increase income to $576,000 ($288,000 x 2). In addition, the current selling price is $96 ($4,032,000 42,000 sets). Thus: Required sales = (fixed costs + target net profit) unit contribution margin = ($2,736,000 + $576,000) $72 = 46,000 sets, or $4,416,000 (46,000 sets x $96) 2. If operations are shifted to Mexico, the new unit contribution margin will be $74.40 ($96.00 - $21.60). Thus: Break-even point = fixed costs unit contribution margin = $2,380,800 $74.40 = 32,000 units 3. (a) CompTronics desires to have a 32,000-unit breakeven point with a $72 unit contribution margin. Fixed costs must therefore drop by $432,000 ($2,736,000 $2,304,000), as follows: Let X = fixed costs
McGraw-Hill/Irwin 7-38

2009 The McGraw-Hill Companies, Inc. Solutions Manual

X $72 = 32,000 units X = $2,304,000 (b) As the following calculations show, CompTronics will have to generate a contribution margin of $85.50 to produce a 32,000-unit break-even point. Based on a $96.00 selling price, this means that the company can incur variable costs of only $10.50 per unit. Given the current variable cost of $24.00 ($96.00 $72.00), a decrease of $13.50 per unit ($24.00 $10.50) is needed. Let X = unit contribution margin $2,736,000 X = 32,000 units X = $85.50

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-39

PROBLEM 7-40 (CONTINUED) 4. (a) (b) (c) (d) Increase No effect Increase No effect

PROBLEM 7-41 (45 MINUTES) 1 . Break-even sales volume for each model: annual cost rental Break volume -even = unit contributi on margin (a Standard model: ) $16,000 Break -even volume = = 25,000 tubs $3.50 $2.86 (b Super model: ) $22,000 Break -even volume = = 27,500 tubs $3.50 $2.70 (c ) Giant model: $40,000 Break -even volume = = 40,816 (rounded) tubs $3.50 $2.52

McGraw-Hill/Irwin 7-40

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-41 (CONTINUED) 2. Profit-volume graph:

Dollars per year (in thousands) $40

Profit

$20

Break-even point: 40,816 tubs 10 Loss area 20 30

Profit area

40

50

Tubs sold per year (in thousands)

Loss

($20) Fixed rental cost: $40,000 per year

($40)

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-41

PROBLEM 7-41 (CONTINUED) 3. The sales price per tub is the same regardless of the type of machine selected. Therefore, the same profit (or loss) will be achieved with the Standard and Super models at the sales volume, X, where the total costs are the same. Model Standard............................ Super................................. Variable Cost per Tub $2.86 2.70 Total Fixed Cost $16,000 22,000 16,000 + (2.86 .16X = 6,000 X= 6,000/.16 37,500 Or, stated slightly differently: Volume at which both machines produce the same profit fixed differenti cost al variable differenti cost al $6,000 = $.16 = 37,500 tubs = X=

This reasoning leads to the following equation: 2.86X = 22,000 + 2.70X Rearranging terms yields the following: 2.70)X = 22,000 16,000

Check: the total cost is the same with either model if 37,500 tubs are sold. Standard Variable cost: Standard, 37,500 $2.86. . . $107,250 Super, 37,500 $2.70........ Fixed cost:
McGraw-Hill/Irwin 7-42

Super

$101,250
2009 The McGraw-Hill Companies, Inc. Solutions Manual

Standard, $16,000.............. Super, $22,000................... Total cost..............................

16,000 $123,250

22,000 $123,250

Since the sales price for popcorn does not depend on the popper model, the sales revenue will be the same under either alternative.

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-43

PROBLEM 7-42 (40 MINUTES) 1. CVP graph:

Dollars per year (in millions) 20 18 16 14 12 10 8 6 Loss 4 area 2 50 100 150 200 Break-even point: 80,000 units or $8,000,000 of sales Profit area

Total revenue

Total expenses

Fixed expenses Units sold per year (in thousands)

McGraw-Hill/Irwin 7-44

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-42 (CONTINUED) 2. Break-even point: Contributi on margin = ratio contributi on margin$12,000,00 0 = = .75 sales $16,000,00 0 fixed expenses $6,000,000 Break -even = point = contributi on margin ratio .75 = $8,000,000 = budgeted sales revenue break-even sales revenue = $16,000,000 $8,000,000 = $8,000,000 4. Operating leverage factor (at budgeted sales) Dollar sales required to earn target net profit contributi on margin budgeted (at sales) net income budgeted (at sales) $12,000,00 0 = =2 $6,000,000 = fixed expenses target profit + net contributi on margin ratio $6,000,000 + $9,000,000 = = $20,000,00 0 .75 =

3.

Margin of safety

5.

6.

Cost structure: Sales revenue........................... Variable expenses..................... Contribution margin.................. Fixed expenses......................... Net income............................... Amount $16,000,00 0 4,000,00 0 $12,000,00 0 6,000,00 0 $ 6,000,000 Percent 100.0 25.0 75.0 37.5 37.5

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-45

PROBLEM 7-43 (35 MINUTES) 1. Plan A break-even point = fixed costs unit contribution margin = $33,000 $33* = 1,000 units Plan B break-even point = fixed costs unit contribution margin = $99,000 $45** = 2,200 units * $120 - [($120 x 10%) + $75] ** $120 - $75

2. Operating leverage refers to the use of fixed costs in an organizations overall cost structure. An organization that has a relatively high proportion of fixed costs and low proportion of variable costs has a high degree of operating leverage.

McGraw-Hill/Irwin 7-46

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-43 (CONTINUED) 3. Calculation of contribution margin and profit at 6,000 units of sales: Plan A Plan B Sales revenue: 6,000 units x $120. Less variable costs: Cost of purchasing product: 6,000 units x $75. Sales commissions: $720,000 x 10%... Total variable cost.. Contribution margin Fixed costs . Net income . $720, 000 $450, 000 72, 000 $522, 000 $198, 000 33, 000 $165, 000 $720, 000 $450, 000 ---__ $450, 000 $270, 000 99, 000 $171, 000

Plan A has a higher percentage of variable costs to sales (72.5%) compared to Plan B (62.5%). Plan Bs fixed costs are 13.75% of sales, compared to Plan As 4.58%. Operating leverage factor = contribution margin net income Plan A: $198,000 $165,000 = 1.2 Plan B: $270,000 $171,000 = 1.58 (rounded) Plan B has the higher degree of operating leverage. 4 & 5. Calculation of profit at 5,000 units: Plan A Plan B Sales revenue: 5,000 units x $600,
McGraw-Hill/Irwin Managerial Accounting, 8/e

$600,

2009 The McGraw-Hill Companies, Inc. 7-47

$120. Less variable costs: Cost of purchasing product: 5,000 units x $75.. Sales commissions: $600,000 x 10%... Total variable cost.. Contribution margin Fixed costs Net income .

000 $375, 000 60, 000 $435, 000 $165, 000 33, 000 $132, 000

000 $375, 000 --- __ $375, 000 $225, 000 99, 000 $126, 000

McGraw-Hill/Irwin 7-48

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-43 (CONTINUED) Plan A profitability decrease: $165,000 - $132,000 = $33,000; $33,000 $165,000 = 20% Plan B profitability decrease: $171,000 - $126,000 = $45,000; $45,000 $171,000 = 26.3% (rounded) PneumoTech would experience a larger percentage decrease in income if it adopts Plan B. This situation arises because Plan B has a higher degree of operating leverage. Stated differently, Plan Bs cost structure produces a greater percentage decline in profitability from the drop-off in sales revenue. Note: The percentage decreases in profitability can be computed by multiplying the percentage decrease in sales revenue by the operating leverage factor. Sales dropped from 6,000 units to 5,000 units, or 16.67%. Thus: Plan A: 16.67% x 1.2 = 20.0% Plan B: 16.67% x 1.58 = 26.3% (rounded) 6. Heavily automated manufacturers have sizable investments in plant and equipment, along with a high percentage of fixed costs in their cost structures. As a result, there is a high degree of operating leverage. In a severe economic downturn, these firms typically suffer a significant decrease in profitability. Such firms would be a more risky investment when compared with firms that have a low degree of operating leverage. Of course, when times are good, increases in sales would tend to have a very favorable effect on earnings in a company with high operating leverage.

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-49

PROBLEM 7-44 (45 MINUTES) 1. Break-even point in units: Break point -even = fixed costs unit contributi on margin

Calculation of contribution margins: LaborIntensive Production System $45. 00 $8.40 10.80 7.20 3.00 ComputerAssisted Manufacturi ng System $45.0 0 $7.50 9.00 4.50 3.00

Selling price.................. Variable costs: Direct material........... Direct labor................ Variable overhead...... Variable selling cost... Contribution margin per unit

29. 40 $15. 60

24.0 0 $21.0 0

(a Labor-intensive production system: ) Break -even in point units = $1,980,000 + $750,000 $15.60 $2,730,000 = $15.60 = 175,000 units

(b Computer-assisted manufacturing system: )

McGraw-Hill/Irwin 7-50

2009 The McGraw-Hill Companies, Inc. Solutions Manual

Break -even in point units =

$3,660,000 + $750,000 $21 $4,410,000 = $21 = 210,000 units

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-51

PROBLEM 7-44 (CONTINUED) 2 . Zodiacs management would be indifferent between the two manufacturing methods at the volume (X) where total costs are equal. $29.40X + = $2,730,000 $5.40X = X = $24X + $4,410,000 $1,680,000 311,111 units* *Rounded 3 . Operating leverage is the extent to which a firm's operations employ fixed operating costs. The greater the proportion of fixed costs used to produce a product, the greater the degree of operating leverage. Thus, the computer-assisted manufacturing method utilizes a greater degree of operating leverage. The greater the degree of operating leverage, the greater the change in operating income (loss) relative to a small fluctuation in sales volume. Thus, there is a higher degree of variability in operating income if operating leverage is high. 4 . Management should employ the computer-assisted manufacturing method if annual sales are expected to exceed 311,111 units and the labor-intensive manufacturing method if annual sales are not expected to exceed 311,111 units. Zodiacs management should consider many other business factors other than operating leverage before selecting a manufacturing method. Among these are:

5 .

McGraw-Hill/Irwin 7-52

2009 The McGraw-Hill Companies, Inc. Solutions Manual

 Variability or uncertainty with respect to demand

quantity and selling price. quickly.

The ability to produce and market the new product The ability to discontinue production and marketing of

the new product while incurring the least amount of loss.

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-53

PROBLEM 7-45 (40 MINUTES) 1. In order to break even, during the first year of operations, 10,220 clients must visit the law office being considered by Steven Clark and his colleagues, as the following calculations show. Fixed expenses: Advertising........................................... $ 980,000 Rent (6,000 $56)................................ 336,000 Property insurance............................... 54,000 Utilities................................................ 74,000 Malpractice insurance........................... 360,000 Depreciation ($120,000/4)..................... 30,000 Wages and fringe benefits: Regular wages ($50 + $40 + $30 + $20) 16 hours 360 days $806,400 Overtime wages (200 $30 1.5) + (200 $20 1.5) 15,000 Total wages...............................$821,400 Fringe benefits at 40%...................... 328,560 1,149,960 Total fixed expenses................................. $2,983,960

McGraw-Hill/Irwin 7-54

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-45 (CONTINUED) Break-even point: 0 = revenue variable cost fixed cost 0 = $60X + ($4,000 .2X .3)* $8X $2,983,960 0 = $60X + $240X $8X $2,983,960 $292X = $2,983,960 X = 10,220 clients (rounded) *Revenue calculation: $60X represents the $60 consultation fee per client. ($4,000 .2X .30) represents the predicted average settlement of $4,000, multiplied by the 20% of the clients whose judgments are expected to be favorable, multiplied by the 30% of the judgment that goes to the firm. 2. Safety margin: Safety margin = budgeted sales revenue sales revenue break-even 360 =

Budgeted (expected) number of clients = 50 18,000 Break-even number of clients = 10,220 (rounded)

Safety margin = [($60 18,000) + ($4,000 18,000 .20 .30)] .30)] 10,220) [($60 10,220) + ($4,000 10,220 .20 = [$60 + ($4,000 .20 .30)] (18,000 = $300 7,780 = $2,334,000

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-55

PROBLEM 7-46 (35 MINUTES) 1. $1,250,000 $750,000 Unit contributi on margin = 25,000 units = $20 unit per fixed costs Break -even (in point units) = unit contributi on margin = 2. $300,000 = 15,000 units $20 = = fixed costs target profit + net unit contributi on margin $300,000 + $280,000 = 29,000 units $20

Number of sales units required to earn target net profit

3.

new fixed costs New break -even (in point units) = new contributi unit on margin = $300,000 + ($36,000/6 )* = 19,125 units $20 $4

*Annual straight-line depreciation on new machine $4.00 = $9.00 $5.00 increase in the unit cost of the new part

4.

Number of sales to earn target net profit, given manufacturing changes

new fixed costs target profit + net new contributi unit on margin $306,000 + $200,000 * = $16 = 31,625 units =

*Last year's profit: ($50)(25,000) $1,050,000 = $200,000

McGraw-Hill/Irwin 7-56

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-46 (CONTINUED) unit contributi on margin sales price $20 Old contributi on margin = ratio = .40 $50 * Contributi on margin = ratio *Sales price, given in problem. Let P denote the price required to cover increased directmaterial cost and maintain the same contribution margin ratio:
P $30 $4 * = P P $34 = .60 = P P=

5.

.40 .40 P $34 $56.67 (rounded)

*Old unit variable cost = $30 = $750,000 25,000 units

Increase in direct-material cost = $4

Check: New contributi on margin = ratio $56.67 $4 $30 $56.67 = .40 (rounded)

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-57

PROBLEM 7-47 (40 MINUTES) 1. Date: To: Company From: Today Vice President for Manufacturing, Saturn Game I.M. Student, Controller Memorandum

Subject: Activity-Based Costing The $300,000 cost that has been characterized as fixed is fixed with respect to sales volume. This cost will not increase with increases in sales volume. However, as the activity-based costing analysis demonstrates, these costs are not fixed with respect to other important cost drivers. This is the difference between a traditional costing system and an ABC system. The latter recognizes that costs vary with respect to a variety of cost drivers, not just sales volume. 2. New break-even point if automated manufacturing equipment is installed: Sales price......................................................... $52 Costs that are variable (with respect to sales volume): Unit variable cost (.8 $750,000 25,000).... 24 Unit contribution margin.................................... $28 Costs that are fixed (with respect to sales volume): Setup (300 setups at $100 per setup)........ $ 30,000 Engineering (800 hours at $56 per hour). . . 44,800 Inspection (100 inspections at $90 per inspection) 9,000 General factory overhead.......................... 332,200 Total..................................................... $416,000 Fixed selling and administrative costs........... 60,000 Total costs that are fixed (with respect to sales volume)....................................................... $476,000

McGraw-Hill/Irwin 7-58

2009 The McGraw-Hill Companies, Inc. Solutions Manual

fixed costs Break -even (in point units) = unit contributi on margin = $476,000 $28

= 17,000 units

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-59

PROBLEM 7-47 (CONTINUED) 3. Sales (in units) required to show a profit of $280,000: Number of sales units required to earn target net profit fixed + target profit cost net unit contributi on margin $476,000 + $280,000 = $28 = 27,000 units =

4 .

If management adopts the new manufacturing technology: (a Its break-even point will be higher (17,000 units instead ) of 15,000 units). (b The number of sales units required to show a profit of ) $280,000 will be lower (27,000 units instead of 29,000 units). (c ) These results are typical of situations where firms adopt advanced manufacturing equipment and practices. The break-even point increases because of the increased fixed costs due to the large investment in equipment. However, at higher levels of sales after fixed costs have been covered, the larger unit contribution margin ($28 instead of $20) earns a profit at a faster rate. This results in the firm needing to sell fewer units to reach a given target profit level.

McGraw-Hill/Irwin 7-60

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-47 (CONTINUED) 5 . The controller should include the break-even analysis in the report. The Board of Directors needs a complete picture of the financial implications of the proposed equipment acquisition. The break-even point is a relevant piece of information. The controller should accompany the break-even analysis with an explanation as to why the break-even point will increase. It would also be appropriate for the controller to point out in the report that the advanced manufacturing equipment would require fewer sales units at higher volumes in order to achieve a given target profit, as in requirement (3) of this problem. To withhold the break-even analysis from the controller's report would be a violation of the following ethical standards: (a Competence: Prepare complete and clear reports and ) recommendations after appropriate analysis of relevant and reliable information. (b Integrity: Communicate unfavorable as well as favorable ) information and professional judgments or opinions. (c ) Objectivity: Communicate information fairly and objectively. Disclose fully all relevant information that could reasonably be expected to influence an intended user's understanding of the reports, comments, and recommendations presented.

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-61

PROBLEM 7-48 (45 MINUTES) 1. $810,000 Unit contributi on margin = = $450 ton per 1,800 Break -even volumetons in = = 2. fixed costs unit contributi on margin $495,000 = 1,100 tons $450

Projected net income for sales of 2,100 tons: Projected contribution margin (2,100 $450).. Projected fixed costs....................................... Projected net income...................................... $945,00 0 495,000 $450,00 0

3.

Projected net income including foreign order: Variable cost per ton = $990,000/1,800 = $550 per ton Sales price per ton for regular orders = $1,800,000/1,800 = $1,000 per ton Foreign Order 1,500 $350 Regular Sales 1,500 $450 $675,00 0 $

Sales in tons.................................... Contribution margin per ton: Foreign order ($900 $550).......... Regular sales ($1,000 $550)....... Total contribution margin.................

$525,00 0 Contribution margin on foreign order................ 525,000 Contribution margin on Regular sales................ 675,000

McGraw-Hill/Irwin 7-62

2009 The McGraw-Hill Companies, Inc. Solutions Manual

Total contribution margin.................................. $1,200,000 Fixed costs....................................................... 495,000 Net income....................................................... 705,000

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-63

PROBLEM 7-48 (CONTINUED) 4. New sales territory: To maintain its current net income, Central Pennsylvania Limestone Company just needs to break even on sales in the new territory. Break -even intons point = = 5. fixed in costs new territory unit contributi on margin sales new on in territory $123,000 = 307.5 tons $450$50

Automated production process: Break -even intons point = = $495,000 + $117,000 $450$50 + $612,000 = 1,224 tons $500

Break -even insales point dollars = 1,224 $1,000 ton tons per = $1,224,000 6. Changes in selling price and unit variable cost: New contributi unit on margin = ($1,000)(9 ($550 0%) + $80) = $270 New contributi on margin = ratio $270 ($1,000)(9 0%) = .30 fixed costs target profit + net contributi on margin ratio $495,000 + $189,000 = .30 = $2,280,000

Dollar required sales to earn target profit net =

McGraw-Hill/Irwin 7-64

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-49 (45 MINUTES) 1. TOLEDO TOOL COMPANY BUDGETED INCOME STATEMENT FOR THE YEAR ENDED DECEMBER 31, 20X4 Hedge Clippers Unit selling price........ Variable manufacturing cost. Variable selling cost... Total variable cost..... Contribution margin per unit.................. Unit sales.................. $84 $39 15 $54 $30 50,000 Line Trimmer s $108 $ 36 12 48 50,000 $ $ 60 Leaf Blowers $144 $ 75 18 93 $ $ 51 100,000 Total

Total contribution margin.................... $1,500, 000 Fixed manufacturing overhead................ Fixed selling and administrative costs Total fixed costs...... Income before taxes... Income taxes (40%).... Budgeted net income.

$3,000,0 $5,100,0 00 00

$9,600, 000

$6,000, 000 1,800 ,000 $7,800, 000 $1,800 ,000 720,0 00 $1,080, 000

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-65

2. (a) Unit Contributi on $30 60 51 (b) Sales Proportio n .25 .25 .50

(a) (b) $ 7.50 15.00 25.50 $48.00

Hedge Clippers................. Line Trimmers.................. Leaf Blowers.................... Weighted-average unit contribution margin...... Total sales break = unit to even

total costs fixed weighted -average contributi unit on margin $7,800,000 = = 162,500 units $48

McGraw-Hill/Irwin 7-66

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-49 (CONTINUED) Sales proportions: Sales Total Product Proport Unit Line ion Sales Sales .25 162,50 40,625 0 .25 162,50 40,625 0 .50 162,50 81,250 0 162,500

Hedge Clippers..................... Line Trimmers...................... Leaf Blowers........................ Total....................................

3. (a) (b) Unit Sales Contribu Proport (a) tion ion (b) Hedge Clippers..................... $30 .20 $ 6.00 Line Trimmers*..................... 57 .20 11.40 Leaf Blowers ........................ 36 .60 21.60 Weighted-average unit $39.00 contribution margin.............. *Variable selling cost increases. Thus, the unit contribution decreases to $57 [$108 ($36 + $12 + $3)]. The variable manufacturing cost increases 20 percent. Thus, the unit contribution decreases to $36 [$144 (1.2 $75) $18].

Total sales break = unit to even

total costs fixed weighted - average contributi unit on margin $7,800,000 = = 200,000 units $39

Sales proportions:

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-67

Sales Proporti ons Hedge Clippers.................... .20 Line Trimmers...................... Leaf Blowers........................ Total.................................... .20 .60

Total Unit Sales 200,00 0 200,00 0 200,00 0

Product Line Sales 40,000 40,000 120,000 200,000

McGraw-Hill/Irwin 7-68

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-50 (35 MINUTES) 1 . (a ) Unit contributi on margin = = Break -even (in point units) = = sales variable costs units sold $2,000,000 $1,400,000 = $6 unit per 100,000 fixed costs unit contributi on margin $420,000 = 70,000 units $6 contributi on margin sales revenue $2,000,000 $1,400,000 = .3 $2,000,000

(b )

Contributi on margin = ratio =

fixed costs Break -even (in point sales dollars) = contributi on margin ratio = $420,000 = $1,400,000 .3
fixed costs + = target - tax income after net (1 t) unit contributi on margin

2 .

Number of units of sales required to earn target after-tax net income

$180,000 $420,000 + (1 .4) $720,000 = = $6 $6 = 120,000 units

3 .

If fixed costs increase by $63,000: Break -even (in point units) = $420,000 + $63,000 = 80,500 units $6

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-69

PROBLEM 7-50 (CONTINUED) 4.Profit-volume graph:

Dollars per year $1,500,00 0 $1,000,00 0 $500,00 0 0 Profit area Units sold per year

Break-even point: 70,000 units

25,000 50,000 75,000 100,00 Loss 0 area

$(500,00 0) $(1,000,0 00) $(1,500,0 00)

McGraw-Hill/Irwin 7-70

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-50 (CONTINUED) 5. Number of units of sales required to earn target after-tax net income fixed costs + = target - tax income after net (1 t) unit contributi on margin

$180,000 $420,000 + (1 .5) $780,000 = = $6 $6 = 130,000 units

6.

The electronic version of the Solutions Manual BUILD A SPREADSHEET SOLUTIONS is available on your Instructors CD and on the Hilton, 8e website: WWW.MHHE.COM/HILTON8E .

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-71

PROBLEM 7-51 (35 MINUTES) 1. Contributi on margin = ratio $120.00 $79.20 = .34 $120.00 target - tax income after net fixed expenses + (1 t) = unit contributi on margin $33,120 $475,200 + (1 .40) $530,400 X= = $120.00 $79.20 $40.80 X= 13,000 units 3. Break-even point (in units) for the touring model = $554,400 = 10,500 units $132.00 $79.20

2.

Number of units of sales required to earn target after-tax income

Let Y denote the variable cost of the mountaineering model such that the break-even point for the mountaineering model is 10,500 units. Then we have: $475,200 10,500 = $120.00 Y (10,500) ($120.00 = $475,200 Y) $1,260,000 Y = $475,200 10,500 10,500 $784,800 Y= Y = $74.74 (rounded) Thus, the variable cost per unit would have to decrease by $4.46 ($79.20 $74.74).

McGraw-Hill/Irwin 7-72

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-51 (CONTINUED) 4. New break -even = point $475,200 110% $120.00 ($79.20)(9 0%) $522,720 = $48.72 = 10,729 (rounded) units

5.

Weightedaverage unit contribution margin Break-even point

= (50%$52.80) + (50% $40.80) = $46.80 fixed costs = weighted -average contributi unit on margin $514,800 = = 11,000 (or units 5,500 each of type) $46.80

PROBLEM 7-52 (45 MINUTES) 1. SUMMARY OF EXPENSES Expenses per Year (in thousands) Variable Fixed $ $3,510 10,800 3,600 2,880 810 $ $7,200 14,400 3,600 (1,200) $ 13,200 3,000 $10,800 (3,600)

Manufacturing.................................. Selling and administrative................. Interest............................................ Costs from budgeted income statement......................................... If the company employs its own sales force: Additional sales force costs............ Reduced commissions [(.15 .10) $24,000]........................................... Costs with own sales force................ If the company sells through agents: Deduct cost of sales force............... Increased commissions [(.225 .10) $24,000]........................................
McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-73

Costs with agents paid increased commissions.....................................

$ 16,200

$7,200

McGraw-Hill/Irwin 7-74

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-52 (CONTINUED) total expenses fixed Break sales -even dollars = contributi on margin ratio total variable expenses Contributi onmargin = 1 ratio sales revenue (a ) Contributi on margin = 1 ratio $14,400,00 0 $24,000,00 0 = 1 .60 = .40

$7,200,000 Break -even dollars sales = .40 = $18,000,00 0 (b ) $13,200,00 0 $24,000,00 0 = 1 .55 = .45 $10,800,00 0 Break -even dollars sales = .45 = $24,000,00 0 Contributi on margin = 1 ratio total costs target fixed + income before income taxes Required dollars sales = contributi on margin ratio Contributi on margin = 1 ratio $16,200 $24,000 = 1 .675 = .325 $7,200,000 + $2,400,000 .325 $9,600,000 = .325 = $29,538,46 2(rounded)
2009 The McGraw-Hill Companies, Inc. 7-75

2 .

Required dollarsbreak = sales to even

McGraw-Hill/Irwin Managerial Accounting, 8/e

PROBLEM 7-52 (CONTINUED) 3 . The volume in sales dollars (X) that would result in equal net income is the volume of sales dollars where total expenses are equal. Total expenses with agents paid increased commission = total expenses with own sales force

$16,200,00 0 $13,200,00 0 X + $7,200,000 = X + $10,800,00 0 $24,000,00 0 $24,000,00 0 .675 + $7,200,000X + $10,800,00 X = .55 0 .125 = $3,600,000 X X = $28,800,00 0 Therefore, at a sales volume of $28,800,000, the company will earn equal before-tax income under either alternative. Since before-tax income is the same, so is after-tax net income. A different approach to the solution seeks to equate total profit (instead of total expenses). This approach uses the contribution-margin ratio, as follows: $ 4 0 0 0 - $ 6 0 ,0 0 2 ,0 0 0 1 ,2 0 0 $ 4 0 ,0 0 2 ,0 0 0 $ 4 0 ,0 0 - $ 3 0 ,0 0 2 ,0 0 0 1 ,2 0 0 X-$ ,2 0 0 = 7 0 ,0 0 X-$ 0 0 ,0 0 1 ,8 0 0 $ 4 0 ,0 0 2 ,0 0 0

..3 5 -$ ,2 0 0 = 5 -$ 0 0 ,0 0 2 X 7 0 ,0 0 ..4 X 1 ,8 0 0 .1 5 =$ ,6 0 0 2 X 3 0 ,0 0 X=$ 8 0 ,0 0 2 ,8 0 0

McGraw-Hill/Irwin 7-76

2009 The McGraw-Hill Companies, Inc. Solutions Manual

PROBLEM 7-53 (45 MINUTES) 1. a. In order to break even, Columbus Canopy Company must sell 500 units. This amount represents the point where revenue equals total costs. Revenue = variable + fixed costs costs $800X$400X = + $200,000 $400X$200,000 = X = 500 units b. In order to achieve its after-tax profit objective, Columbus Canopy Company must sell 2,500 units. This amount represents the point where revenue equals total costs plus the before-tax profit objective. Revenue = variable + fixed costs costs before profit + - tax $800X$400X = + $200,000 + [$480,000 .4)] (1 $800X$400X = + $200,000 + $800,000 $400X$1,000,000 = X = 2500 , units 2. To achieve its annual after-tax profit objective, management should select the first alternative, where the sales price is reduced by $80 and 2,700 units are sold during the remainder of the year. This alternative results in the highest profit and is the only alternative that equals or exceeds the companys profit objective. Calculations for the three alternatives follow.

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-77

PROBLEM 7-53 (CONTINUED) Alternative (1): Re venue($ )( )+ ($ )( ,700 = 800350 7202 ) = $ ,224 2 ,000 Variable = $4003,050 cost = $1,220,000 Before profit$2,224,000 - tax = $1,220,000 $200,000 = $804,000 After profit$ ,000 (1 .4 - tax = 804 ) = $ ,400 482 Alternative (2): Re venue($ )( )+ ($ )( ,200 = 800350 7402 ) = $ ,908 1 ,000 Variable = ($400)(350) )( cost ($ 2,200) 350 = $910,000 Before profit$1,908,000 - tax = $910,000 $200,000 = $798,000 After profit$798 (1 .4 - tax = ,000 ) = $ ,800 478 Alternative (3): Re venue($ )( )+ ($ )( ,000 = 800350 7602 ) = $ ,800 1 ,000 Variable = $4002,350 cost = $940,000 Before profit $1,800,000 - tax = $940,000 $180,000 = $680,000 After profit $ 8 ,000 (1 .4 - tax = 60 ) = $ ,000 408

McGraw-Hill/Irwin 7-78

2009 The McGraw-Hill Companies, Inc. Solutions Manual

SOLUTIONS TO CASES
CASE 7-54 (50 MINUTES) 1. The break-even point is 16,900 patient-days calculated as follows: SUSQUEHANNA MEDICAL CENTER COMPUTATION OF BREAK-EVEN POINT IN PATIENT-DAYS: PEDIATRICS FOR THE YEAR ENDED JUNE 30, 20X6 Total fixed costs: Medical center charges............................................ $3,480,000 Supervising nurses.............................($30,000 4) 120,000 Nurses ($24,000 10).................................. Aids ($10,800 20).................................. Total fixed costs...................................................... $4,056,000 Contribution margin per patient-day: Revenue per patient-day......................................... Variable cost per patient-day: ($7,200,000 $360 = 20,000 patient-days) ($2,400,000 20,000 patient-days)...................... Contribution margin per patient-day........................ Break-even point in patientdays total costs fixed $4,056,000 = contributi on margin patient per -day $240 = 16,900 patient days = $360

240,000 216,000

120 $240

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-79

CASE 7-54 (CONTINUED) 2.Net earnings would decrease by $728,000, calculated as follows: SUSQUEHANNA MEDICAL CENTER COMPUTATION OF LOSS FROM RENTAL OF ADDITIONAL 20 BEDS: PEDIATRICS FOR THE YEAR ENDED JUNE 30, 20X6 Increase in revenue (20 additional beds 90 days $360 charge per day) $ 648,000 Increase in expenses: Variable charges by medical center (20 additional beds 90 days $120 per day).... 216,000 Fixed charges by medical center ($3,480,000 60 beds = $58,000 per bed) ($58,000 20 beds)........................................... 1,160,000 Salaries (20,000 patient-days before additional 20 beds + 20 additional beds 90 days = 21,800, which does not exceed 22,000 patient-days; therefore, no additional personnel are required).. -0Total increase in expenses........................................ $1,376,000 Net change in earnings from rental of additional 20 beds $ (728,000)

McGraw-Hill/Irwin 7-80

2009 The McGraw-Hill Companies, Inc. Solutions Manual

CASE 7-55 (50 MINUTES) 1. Break-even point for 20x4, based on current budget:
Contributimargin = on ratio $15,000,00 0 $9,000,000 $3,000,000 = .20 $15,000,00 0 fixed expenses Break - even point = contributimargin on ratio $150,000 = = $750,000 .20

2.

Break-even point given employment of sales personnel: New fixed expenses: Previous fixed expenses................................. Sales personnel salaries (3 x $45,000)............ Sales managers salaries (2 $120,000)......... Total.............................................................. New contribution-margin ratio: Sales............................................................. ...............................................$15,000,000 Cost of goods sold.......................................... ...................................................9,000,000 Gross margin................................................. 6,000,000 Commissions (at 5%)...................................... Contribution margin....................................... ...................................................5,250,000 Contributi on margin = ratio Estimated -even = break point $5,250,000 = .35 $15,000,00 0 $150,000 135,000 240,000 $525,000

$ 750,000 $

fixed expenses contributi on margin ratio $525,000 = = $1,500,000 .35

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-81

CASE 7-55 (CONTINUED) 3. Assuming a 25% sales commission: New contribution-margin ratio: Sales............................................................. ...............................................$15,000,000 Cost of goods sold.......................................... ...................................................9,000,000 Gross margin................................................. ...................................................6,000,000 Commissions (at 25%).................................... ...................................................3,750,000 Contribution margin....................................... ...................................................2,250,000 Contributi on margin = ratio Sales volume in dollars required to earn after-tax net income $2,250,000 = .15 $15,000,00 0

target - tax income after net fixed expenses + (1 t) = contributimargin on ratio $1,995,000 $150,000 + (1 .3) $3,000,000 = = .15 .15 = $20,000,00 0

Check: Sales....................................... $ 20,000,000 Cost of goods sold (60% of sales) 12,000,000 Gross margin........................... $ 8,000,000 Selling and administrative expenses: Commissions........................ $ 5,000,000 All other expenses (fixed)..... 150,000 5,150,000
McGraw-Hill/Irwin 7-82

2009 The McGraw-Hill Companies, Inc. Solutions Manual

Income before taxes................. 2,850,000 Income tax expense (30%)........ Net income.............................. 1,995,000

$ 855,000 $

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-83

CASE 7-55 (CONTINUED) 4. Sales dollar volume at which Lake Champlain Sporting Goods Company is indifferent: Let X denote the desired volume of sales. Since the tax rate is the same regardless of which approach management chooses, we can find X so that the companys before-tax income is the same under the two alternatives. (In the following equations, the contribution-margin ratios of .35 and .15, respectively, were computed in the preceding two requirements.) .35X $525,000 = .15X $150,000 .20X = $375,000 X = $375,000/.20 X = $1,875,000 Thus, the company will have the same before-tax income under the two alternatives if the sales volume is $1,875,000. Check: Alternatives Employ Sales Pay 25% Personn Commissi el on Sales............................................. $1,875,0 00 $1,875,0 00 1,125,00 1,125,00 0 0 $ $ 750,000 750,000

Cost of goods sold (60% of sales)...

Gross margin................................. Selling and administrative

McGraw-Hill/Irwin 7-84

2009 The McGraw-Hill Companies, Inc. Solutions Manual

expenses: Commissions.............................. All other expenses (fixed)........... Income before taxes...................... Income tax expense (30%)............. Net income.................................... *$1,875,000 5% = $93,750 $1,875,000 25% = $468,750

93,750* 525,000 $ 131,250 39,375 $91,875 468,750 150,000 $ 131,250 39,375 $91,875

McGraw-Hill/Irwin Managerial Accounting, 8/e

2009 The McGraw-Hill Companies, Inc. 7-85