CHAPTER 19 (FIN MAN); CHAPTER 4 (MAN) COST … Content... · CHAPTER 19 (FIN MAN); CHAPTER 4 (MAN)...

1. Total variable costs change in proportion to changes in the level of activity. Unit variable costs remain the same regardless of the level of activity.

2. a. Variable costsb. Variable costs

3. Total fixed cost remains the same regardless of changes in the level of activity. Fixed cost per unitdecreases as the activity level increases and increases as the activity level decreases.

4. Mixed costs are costs that have characteristics of both a variable and a fixed cost. The high-lowmethod uses the highest and lowest activity levels and their related costs to estimate the variablecost per unit and the fixed cost. The total fixed cost does not change with changes in activity level.Thus, the difference in the total cost between the highest and lowest levels of activity is the changein the total variable cost. Dividing this difference by the difference in activity level is an estimateof the variable cost per unit. The fixed cost is then estimated by subtracting the total variable costsfrom the total costs for the level of activity.

5. a. No impact on the contribution margin.b. Income from operations would decrease.

6. A high contribution margin ratio, coupled with idle capacity, indicates a potential for increased income from operations if additional sales can be made. A large percentage of each additional sales dollar would be available, after providing for variable costs, to cover promotion efforts and to increase income from operations. Thus, a substantial sales promotion campaign should be considered in order to expand sales to maximum capacity and to take advantage of the low ratio of variable costs to sales.

7. Decreases in unit variable costs, such as a decrease in the unit cost of direct materials, will decrease the break-even point.

8. Austin Company had lower fixed costs and a higher percentage of variable costs to sales than did Hill Company. Such a situation resulted in a lower break-even point for Austin Company.

9. The individual products are treated as components of one overall enterprise product. These components are weighted by the sales mix percentages when determining the contribution margin. Therefore, the sales mix affects the contribution margin and thus the break-evenpoint.

10. Operating leverage measures the relationship between a company’s contribution marginand income from operations. The difference between contribution margin and income fromoperations is fixed costs. Thus, companies with high fixed costs will normally have a high operating leverage. Low operating leverage is normal for companies that are labor intensive, such as professional service companies, which have low fixed costs.

It is computed as follows:

Contribution MarginIncome from Operations=Operating Leverage

CHAPTER 19 (FIN MAN); CHAPTER 4 (MAN)COST BEHAVIOR AND COST-VOLUME-PROFIT ANALYSIS

DISCUSSION QUESTIONS

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CHAPTER 19 Cost Behavior and Cost-Volume-Profit Analysis

PE 19–1A (FIN MAN); PE 4–1A (MAN)a. $23 per unit = ($700,000 – $240,000) ÷ (30,000 units – 10,000 units)

b. $10,000 = $700,000 – ($23 × 30,000 units), or $240,000 – ($23 × 10,000 units)

PE 19–1B (FIN MAN); PE 4–1B (MAN)a. $50 per unit = ($440,000 – $300,000) ÷ (5,500 units – 2,700 units)

b. $165,000 = $440,000 – ($50 × 5,500 units), or $300,000 – ($50 × 2,700 units)

PE 19–2A (FIN MAN); PE 4–2A (MAN)a. 37.5% = ($80 – $50) ÷ $80, or ($480,000 – $300,000) ÷ $480,000

b. $30 per unit = $80 – $50

c. Sales……………………………………… $480,000 (6,000 units × $80 per unit)Variable costs…………………………… 300,000 (6,000 units × $50 per unit)Contribution margin…………………… $180,000 (6,000 units × $30 per unit)Fixed costs……………………………… 50,000Income from operations………………… $130,000

PE 19–2B (FIN MAN); PE 4–2B (MAN)a. 20% = ($30 – $24) ÷ $30, or ($660,000 – $528,000) ÷ $660,000

b. $6 per unit = $30 – $24

c. Sales……………………………………… $660,000 (22,000 units × $30 per unit)Variable costs…………………………… 528,000 (22,000 units × $24 per unit)Contribution margin…………………… $132,000 (22,000 units × $6 per unit)Fixed costs……………………………… 40,000Income from operations………………… $ 92,000

PRACTICE EXERCISES



PE 19–3A (FIN MAN); PE 4–3A (MAN)a. 1,500 units = $45,000 ÷ ($90 – $60)

b. 900 units = $45,000 ÷ ($110 – $60)

PE 19–3B (FIN MAN); PE 4–3B (MAN)a. 1,600 units = $48,000 ÷ ($75 – $45)

b. 960 units = $48,000 ÷ ($95 – $45)

PE 19–4A (FIN MAN); PE 4–4A (MAN)a. 1,000 units = $25,000 ÷ ($80 – $55)

b. 1,800 units = ($25,000 + $20,000) ÷ ($80 – $55)

PE 19–4B (FIN MAN); PE 4–4B (MAN)a. 5,000 units = $200,000 ÷ ($150 – $110)

b. 6,250 units = ($200,000 + $50,000) ÷ ($150 – $110)

PE 19–5A (FIN MAN); PE 4–5A (MAN)Unit selling price of E: [($150 × 0.70) + ($100 × 0.30)] = $135.00Unit variable cost of E: [($100 × 0.70) + ($75 × 0.30)] = 92.50Unit contribution margin of E: $ 42.50

Break-Even Sales (units) = 12,000 units = $510,000 ÷ $42.50

Break-Even Sales (units) for AA = 12,000 units of E × 70% = 8,400 units of Product AABreak-Even Sales (units) for BB = 12,000 units of E × 30% = 3,600 units of Product BB

PE 19–5B (FIN MAN); PE 4–5B (MAN)Unit selling price of E: [($50 × 0.40) + ($60 × 0.60)] = $56.00Unit variable cost of E: [($35 × 0.40) + ($30 × 0.60)] = 32.00Unit contribution margin of E: $24.00

Break-Even Sales (units) = 4,375 units = $105,000 ÷ $24.00

Break-Even Sales (units) for QQ = 4,375 units of E × 40% = 1,750 units of Product QQBreak-Even Sales (units) for ZZ = 4,375 units of E × 60% = 2,625 units of Product ZZ



PE 19–6A (FIN MAN); PE 4–6A (MAN)Contribution Margin $160,000

Income from Operations $80,000

PE 19–6B (FIN MAN); PE 4–6B (MAN)Contribution Margin $450,000

Income from Operations $300,000

PE 19–7A (FIN MAN); PE 4–7A (MAN)

= ($1,200,000 – $960,000) ÷ $1,200,000 = 20%

PE 19–7B (FIN MAN); PE 4–7B (MAN)

Margin of Safety = ($550,000 – $385,000) ÷ $550,000 = 30%

Margin of Safety =Sales – Sales at Break-Even Point

Sales

Operating Leverage

Operating Leverage

Margin of Safety

Margin of Safety

=Sales – Sales at Break-Even Point

Sales

= 2

= = = 1.5

= =



Ex. 19–1 (FIN MAN); Ex. 4–1 (MAN)1. Fixed 9. Fixed2. Fixed 10. Variable3. Variable 11. Variable4. Variable 12. Mixed5. Fixed 13. Variable6. Variable 14. Variable7. Variable 15. Mixed8. Variable

Ex. 19–2 (FIN MAN); Ex. 4–2 (MAN)a. Cost Graph Three d. Cost Graph Twob. Cost Graph Four e. Cost Graph Twoc. Cost Graph One

Ex. 19–3 (FIN MAN); Ex. 4–3 (MAN)1. e 4. f2. b 5. d3. c 6. a

Ex. 19–4 (FIN MAN); Ex. 4–4 (MAN)1. e2. f3. c

For 3. (c) is better than (b) because the administrative costs would be the same for expensive and inexpensive cars.

EXERCISES



Ex. 19–5 (FIN MAN); Ex. 4–5 (MAN)a. Fixed g. Variableb. Fixed h. Variablec. Variable i. Fixedd. Fixed j. Variablee. Fixed* k. Variablef. Variable

* The developer salaries are fixed because they are more variable to the number of titles or releases, rather than the number of units sold. For example, a title could sell one copy or a million copies, and the salaries of the developers would not be affected.

Ex. 19–6 (FIN MAN); Ex. 4–6 (MAN)Components produced………… 400,000 480,000 600,000

Total costs: Total variable costs………… $160,000 (d) $192,000 (j) $240,000Total fixed costs……………… 240,000 (e) 240,000 (k) 240,000Total costs…………………… $400,000 (f) $432,000 (l) $480,000

Cost per unit: Variable cost per unit…………(a) $ 0.40 (g) $ 0.40 (m) $ 0.40Fixed cost per unit……………(b) 0.60 (h) 0.50 (n) 0.40Total cost per unit……………(c) $ 1.00 (i) $ 0.90 (o) $ 0.80

Supporting calculations:a. $0.40 ($160,000 ÷ 400,000 units)b. $0.60 ($240,000 ÷ 400,000 units)d. $192,000 ($0.40 × 480,000)e. $240,000 (fixed costs do not change with volume)g. $0.40 ($192,000 ÷ 480,000 units; variable costs per unit do not change with

changes in volume)

h. $0.50 ($240,000 ÷ 480,000 units)j. $240,000 ($0.40 × 600,000 units)k. $240,000 (fixed costs do not change with volume)m. $0.40 ($240,000 ÷ 600,000 units; variable costs per unit do not change with

changes in volume)n. $0.40 ($240,000 ÷ 600,000 units)



Ex. 19–7 (FIN MAN); Ex. 4–7 (MAN)

$165,00010,000 units

The fixed cost can be determined by subtracting the estimated total variable cost from the total cost at either the highest or lowest level of production, as follows:

Total Cost = (Variable Cost per Unit × Units Produced) + Fixed Costs

Highest level:

$690,000 = ($16.50 × 18,100 units) + Fixed Costs$690,000 = $298,650 + Fixed Costs$391,350 = Fixed Costs

Lowest level:

$525,000 = ($16.50 × 8,100 units) + Fixed Costs$525,000 = $133,650 + Fixed Costs$391,350 = Fixed Costs

b. Total Cost = (Variable Cost per Unit × Units Produced) + Fixed Costs

Total cost for 12,000 units:

Variable cost:Units……………………………………………… 12,000Variable cost per unit………………………… $16.50Total variable cost…………………………… $198,000Fixed costs……………………………………… 391,350Total cost……………………………………… $589,350

=

Variable Cost per Unit =

=Variable Cost per Unita.

$16.50 per unitVariable Cost per Unit =

Difference in Total CostsDifference in Units Produced

$690,000 – $525,00018,100 units – 8,100 units

×



Ex. 19–8 (FIN MAN); Ex. 4–8 (MAN)

The fixed costs can be determined by subtracting the estimated total variable cost from the total cost at either the highest or lowest level of gross-ton mile, as follows:

Total Cost = (Variable Cost per Gross-Ton Mile × Gross-Ton Miles) + Fixed Costs

Highest level:

$1,750,000 = ($1.80 × 750,000 gross-ton miles) + Fixed Costs$1,750,000 = $1,350,000 + Fixed Costs$400,000 = Fixed Costs

Lowest level:

$1,255,000 = ($1.80 × 475,000 gross-ton miles) + Fixed Costs$1,255,000 = $855,000 + Fixed Costs$400,000 = Fixed Costs

Ex. 19–9 (FIN MAN); Ex. 4–9 (MAN)a. Sales…………………………$2,750,000

Variable costs…………… 1,760,000Contribution margin………$ 990,000

$990,000$2,750,000

b. Sales…………………………………………………… Contribution margin ratio…………………………… Contribution margin………………………………… Less fixed costs……………………………………… Income from operations………………………………

Variable Cost perGross-Ton Mile =

=Variable Cost perGross-Ton Mile Difference in Gross-Ton Miles

Difference in Total Costs

750,000 gross-ton miles – 475,000 gross-ton miles$1,750,000 – $1,255,000

275,000 gross-ton miles

ContributionMargin Ratio =

Sales – Variable CostsSales

Variable Cost perGross-Ton Mile = =

$495,000$1.80 per gross-ton miles

$ 224,000356,000

ContributionMargin Ratio = = 36%

$1,450,00040%

$ 580,000×



Ex. 19–10 (FIN MAN); Ex. 4–10 (MAN)

a. Sales (in millions)…………………………………………………………………… $16,233

Variable costs (in millions):Food and packaging…………………………………………………………… $ 5,300Payroll…………………………………………………………………………… 4,121General, selling, and administrative expenses (40% × $2,334)………… 934

Total variable costs………………………………………………………… $10,355

Contribution margin (in millions)………………………………………………… $ 5,878

$5,878 million$16,233 million

c. Same-store sales increase (in millions)……………………………………Contribution margin ratio (in millions) [from part (b)]…………………

Increase in income from operations (in millions)………………………

Note to Instructors: Part (c) emphasizes “same-store sales” because of the assumption of no change in fixed costs. McDonald’s will also increase sales from opening new stores. However, the impact on income from operations for these additional store sales would need to include an increase in fixed costs into the calculation.

Ex. 19–11 (FIN MAN); Ex. 4–11 (MAN)

$900,000$120 – $75

b. Sales (units) =Fixed Costs + Target ProfitUnit Contribution Margin

22,500 unitsSales (units) = =$900,000 + $112,500

$120 – $75

a. Break-Even Sales (units) =Fixed Costs

Unit Contribution Margin

Break-Even Sales (units) = = 20,000 units

$294 million

$811 million36.2%

Contribution Margin Ratio = = 36.2%

Sales – Variable CostsSalesb. =Contribution Margin Ratio

×



Ex. 19–12 (FIN MAN); Ex. 4–12 (MAN)Total Cost Variable Cost Variable Cost

(in millions) Percentage (in millions)Cost of goods sold………………………… $16,151.0 × 70% = $11,305.7Selling, general and administrative……… 9,249.0 × 40% = 3,699.6

Total Cost Variable Cost Fixed Cost(in millions) (in millions) (in millions)

Cost of goods sold………………………… $16,151.0 – $11,305.7 = $ 4,845.3Selling, general and administrative……… 9,249.0 – 3,699.6 = 5,549.4

Total fixed cost………………………… $10,394.7

Number ofTotal Amount Barrels Per Unit(in millions) (in millions) Amount

Net sales……………………………………… $36,297.0 ÷ 300 = $120.99Variable cost of goods sold……………… 11,305.7 ÷ 300 = 37.69Variable selling, general and 3,699.6 ÷ 300 = 12.33

administrative………………………………

146,466,112 barrels

The variable costs per unit are determined by multiplying the total amount of each cost by the variable cost percentage (70% for cost of goods sold and 40% for selling, general and administrative costs), then dividing by the number of barrels.

1 ($16,151,000,000 × 30%) + ($9,249,000,000) × 60%2 $36,297,000,000 ÷ 300,000,0003 ($16,151,000,000 × 70%) ÷ 300,000,0004 ($9,249,000,000 × 40%) ÷ 300,000,000

151,397,774 barrels

Ex. 19–13 (FIN MAN); Ex. 4–13 (MAN)

a. Break-Even Sales (units) =

23,000 units$125 – $105

Break-Even Sales (units) = =

Break-Even Sales (units) = = 18,400 units$130 – $105

$460,000

b.

Fixed CostsUnit Contribution Margin

Fixed Costs

Break-Even Sales (units) =


$460,000

b. =Break-Even Sales (units)


a. Break-Even Sales (units) =

$10,394,700,000 + $350,000,000$120.99 – $37.69 – $12.33

=


$10,394,700,000$120.99 – $37.69 – $12.33

=1

3 42



Ex. 19–14 (FIN MAN); Ex. 4–14 (MAN)

$4,000$18 – $X

$4,000 = 2,000 × ($18 – $X)

$4,0002,000 units

Ex. 19–15 (FIN MAN); Ex. 4–15 (MAN)The cost of the promotional campaign is the fixed cost in this analysis, since we’re trying to determine the break-even adoption rate of the campaign.

The contribution margin earned per new subscriber is essentially the revenue earned less the variable cost over the 12-month subscription period.

Revenue: (12 mos. – 2 free mos.) × $10/mo. = $100 per new accountVariable cost: 12 mos. × $6.25/mo. = $75 per new account

Note: The variable cost is for 12 months since the costs are incurred, even duringthe free months.

The break-even number of subscribers necessary to cover the fixed cost of the promotion would be computed as follows:

Therefore, if ESPN.com yielded more than 100,000 new subscribers out of the promotional campaign, the costs of the campaign would be covered.

Fixed Costs

Variable cost per unit:



=

$2 = $18 – $X

=

$16

2,000 units

$100 – $75



$18 – $X

= 100,000 accounts

Contribution Margin per Unit

=

=Break-Even Sales (units)

$2,500,000Break-Even

Fixed Costs

Break-Even =

=Break-Even Sales (units)



Ex. 19–16 (FIN MAN); Ex. 4–16 (MAN)

Break-Even = 32.2 million (rounded) accounts1 Revenue per account (in millions):

$32,563 million ÷ 33.3 million = $977.9 (rounded)2 Variable cost per account (in millions, except variable cost per account):

Cost of revenue……………………………………………… $17,492 × 75% = $13,119.0Selling, general, and administrative expenses………… 9,418 × 25% = 2,354.5

Total variable cost…………………………………………… $15,473.5Divided by number of accounts…………………………… ÷ 33.3

Variable cost per account (rounded)……………………… $ 464.7

3 Fixed costs (in millions):

Cost of revenue……………………………………………… $17,492 × 25% = $ 4,373.0Selling, general, and administrative expenses………… 9,418 × 75% = 7,063.5

Depreciation…………………………………………………… 5,074 × 100% = 5,074.0

Total fixed costs……………………………………………… $16,510.5

=

=

X =

Note to Instructors: The rate charged per minute and the number of average minutes of digital service influence the revenue per account. An interesting question is whether the costs are variable to the number of minutes or number of accounts. If we assume that the costs are variable to the number of minutes, then the break-even analysis revolves around the number of minutes. More likely, the costs are more variable to the number of accounts for this business (mostly customer acquisition and service costs), while the variable cost per minute is likely to be small.

=

$16,510.5 millionX – $464.7

Revenue per Account – Variable Cost per Account

$977.9 – $464.7

33.3X $31,985.0

$960.5 (rounded)

$16,510.5 million33.3X – $15,474.5

Fixed CostRevenue per Account – Variable Cost per Account

=33.3 million accounts

b. Break-Even =

Fixed Costsa.

Break-Even =$16,510.5 million

Break-Even

2

3

1



Ex. 19–17 (FIN MAN); Ex. 4–17 (MAN)a.

b. $1,500,000 (the intersection of the total sales line and the total costs line)

c. The graphic format permits the user (management) to visually determine the break-even point and the operating profit or loss for any given level of sales.

$0

$500,000

$1,000,000

$2,000,000

$2,500,000

0 4,000 8,000 12,000 16,000 20,000

Sale

s an

d C

osts

Units of Sales

Break-Even Point

Operating Profit Area Total Sales Line

Total Costs

Operating Loss Area

$600,000

$1,500,000



Ex. 19–18 (FIN MAN); Ex. 4–18 (MAN)a. $600,000 (total fixed costs)

b. Sales (20,000 units × $125)……………………………… $2,500,000Fixed costs………………………………………………… $ 600,000Variable costs (20,000 units × $75)……………………… 1,500,000 2,100,000Income from operations…………………………………… $ 400,000

* 20,000 units = $2,500,000 maximum sales/$125 unit selling price

c.

d. 12,000 units (the intersection of the profit line and the horizontal axis)

Ex. 19–19 (FIN MAN); Ex. 4–19 (MAN)Cost-volume-profit charta. break-even point d. total costs lineb. operating loss area e. operating profit areac. total fixed costs f. total sales line

*

($600,000)

($500,000)

($400,000)

($300,000)

($200,000)

($100,000)

$0

$100,000

$200,000

$300,000

$400,000

0 5,000 10,000 15,000 20,000

Ope

ratin

g Pr

ofit

(Los

s)

Units of Sales

Break-Even Point

Operating Loss Area

Operating Profit Area

Profit Line

12,000



Ex. 19–20 (FIN MAN); Ex. 4–20 (MAN)Profit-volume charta. break-even pointb. total fixed costsc. operating loss aread. maximum operating profite. profit linef. operating profit area

Ex. 19–21 (FIN MAN); Ex. 4–21 (MAN)a. Unit Selling Price of E = ($90 × 40%) + ($105 × 60%)

Unit Selling Price of E = $36 + $63 = $99Unit Variable Cost of E = ($50 × 40%) + ($65 × 60%)Unit Variable Cost of E = $20 + $39 = $59

Unit Contribution Margin of E = $99 – $59 = $40

$620,000$40

b. 6,200 units of baseball bats (15,500 units × 40%)9,300 units of baseball gloves (15,500 units × 60%)


Break-Even Sales (units) =Fixed Costs




Ex. 19–22 (FIN MAN); Ex. 4–22 (MAN)a. Unit contribution margin of overall product (E):

Unit selling price of E [(20% × $1,000) + (80% × $200)]………………………… $360Unit variable cost of E [(20% × $100) + (80% × $75)]…………………………… 80Unit contribution margin of E…………………………………………………………$280

Fixed costs of the New York City to George Town, Grand Cayman round-trip flight:Fuel………………………………………………… $10,400Flight crew salaries…………………………… 4,300Depreciation……………………………………… 10,500Total fixed costs………………………………… $25,200

Break-even sales (units) of overall product:

$25,200$280 per seat

b. Business class break-even (90 seats × 20%)……………………………… 18 seatsEconomy class break-even (90 seats × 80%)……………………………… 72 seatsTotal break-even………………………………………………………………… 90 seats

Ex. 19–23 (FIN MAN); Ex. 4–23 (MAN)a. (1) Margin of Safety (dollars) = Sales – Sales at Break-Even Point

Margin of Safety (dollars) = $880,000 – $660,000 = $220,000

Margin of Safety (percentage) = $220,000 ÷ $880,000 = 25%

b. The break-even point (S) is determined as follows:

Break-Even Sales (dollars) = Total Fixed Costs + Total Variable Costs (at Break-Even)Break-Even Sales (dollars) = Total Fixed Costs + 60% Break-Even Sales (dollars)Break-Even Sales (dollars) = $2,325,000 + 60% Break-Even Sales (dollars)Break-Even Sales (dollars) – 60% Break-Even Sales (dollars) = $2,325,00040% Break-Even Sales (dollars) = $2,325,000Break-Even Sales (dollars) = $5,812,500

If the margin of safety is 25%, the actual sales are determined as follows:Sales = Break-Even Sales (dollars) + (Sales × Margin of Safety)Sales (dollars) = $5,812,500 + 25% SalesSales – 25% Sales = $5,812,50075% Sales = $5,812,500Sales = $7,750,000

(2)

= = 90 seats (tickets)Break-Even Sales (units)

Sales – Sales at Break-Even PointSales

Margin of Safety (percentage) =

=Fixed Costs

Unit Contribution MarginBreak-Even Sales (units)



Ex. 19–24 (FIN MAN); Ex. 4–24 (MAN)If 420,000 units are sold and sales at the break-even point are 472,500 units,there is no margin of safety.

Ex. 19–25 (FIN MAN); Ex. 4–25 (MAN)a. Beck Inc.:

$500,000$100,000

Bryant Inc.:

$750,000$300,000

b. Beck Inc.’s income from operations would increase by 100% (5.0 × 20%), or $100,000 (100% × $100,000), and Bryant Inc.’s income from operationswould increase by 50% (2.5 × 20%), or $150,000 (50% × $300,000).

c. The difference in the increases of income from operations is due to the difference in the operating leverages. Beck Inc.’s higher operating leverage means that its fixed costs are a larger percentage of contribution margin than are Bryant Inc.’s. Thus, increases in sales increase operating profit at a faster rate for Beck Inc. than for Bryant Inc.

Appendix Ex. 19–26 (FIN MAN); Appendix Ex. 4–26 (MAN)a. Variable cost of goods soldb. Variable selling and administrative expensesc. Fixed costs

Contribution MarginIncome from Operations

=

=

Contribution MarginIncome from OperationsOperating Leverage

= 5.0

Operating Leverage = = 2.5

Operating Leverage

Operating Leverage =



Appendix Ex. 19–27 (FIN MAN); Appendix Ex. 4–27 (MAN)a.

Sales $4,440,000Variable cost of goods sold:

Variable cost of goods manufactured $2,988,000Less ending inventory (24,000 units × $24.90) 597,600

Variable cost of goods sold 2,390,400Manufacturing margin $2,049,600Variable selling and administrative expenses 115,200Contribution margin $1,934,400Fixed costs:

Fixed manufacturing costs $ 132,000Fixed selling and administrative expenses 172,800 304,800

Income from operations $1,629,600

Computations:Variable cost of goods manufactured: $3,120,000 – $132,000 = $2,988,000

Units Sold = Units Manufactured – Units in Ending Inventory96,000 = Units Manufactured – 24,000120,000 = Units Manufactured

Unit cost of ending inventory:Variable cost of goods manufactured per unit:

$2,988,000 ÷ 120,000 units manufactured = $24.90

Thus, variable cost of goods sold could alternatively be calculated:$2,390,400 = 96,000 units × $24.90/unit

Fixed selling and administrative expenses: $288,000 – $115,200 = $172,800

b. Absorption costing income from operations……………………………………$1,656,000Variable costing income from operations……………………………………… 1,629,600Difference……………………………………………………………….…………… $ 26,400

Note: The difference between the two income numbers can be reconciledas follows:

Unit change in inventory…………………………… 24,000 unitsFixed manufacturing cost per unit………………… $1.10 ($132,000 ÷ 120,000 units)Income from operations difference……………… $26,400

RHYS COMPANYIncome Statement—Variable CostingFor the Month Ended July 31, 2014

×



Appendix Ex. 19–28 (FIN MAN); Ex. 4–28 (MAN)a.

Sales $7,450,000Cost of goods sold:

Cost of goods manufactured (500,000 units × $14.32) $7,160,000Less ending inventory (80,000 units × $14.32) 1,145,600

Cost of goods sold 6,014,400Gross profit $1,435,600Selling and administrative expenses ($80,000 + $75,000) 155,000Income from operations $1,280,600

Computations:Cost of goods manufactured: $7,000,000 + $160,000 = $7,160,000

Unit cost of ending inventory:Total cost of goods manufactured:

$7,160,000 ÷ 500,000 units manufactured = $14.32

Variable costing income from operations……………………………………… $1,255,000Absorption costing income from operations…………………………………… 1,280,600Difference……………………………………………………………………………… $ 25,600

b. Note: The difference between the two income numbers can be reconciledas follows:

Unit change in inventory…………………………… 80,000 unitsFixed manufacturing cost per unit……………… $0.32 ($160,000 ÷ 500,000 units)Income from operations difference……………… $25,600

TUDOR MANUFACTURING CO.Income Statement—Absorption Costing

For the Month Ended June 30, 2014

×



Prob. 19–1A (FIN MAN); Prob. 4–1A (MAN)

Fixed Variable MixedCost Cost Cost Cost

a. Xb. Xc. Xd. Xe. Xf. Xg. Xh. Xi. Xj. Xk. Xl. X

m. Xn. Xo. Xp. Xq. Xr. Xs. Xt. X

PROBLEMS



Prob. 19–2A (FIN MAN); Prob. 4–2A (MAN)1. Variable Variable

Total Cost Cost Percentage CostCost of goods sold………………… $6,200,000 × 60% = $3,720,000Selling expenses…………………… 3,400,000 × 75% = 2,550,000Administrative expenses………… 1,550,000 × 60% = 930,000

Variable FixedTotal Cost Cost Cost

Cost of goods sold………………… $6,200,000 – $3,720,000 = $2,480,000Selling expenses…………………… 3,400,000 – 2,550,000 = 850,000Administrative expenses………… 1,550,000 – 930,000 = 620,000

Total cost…………………………… $7,200,000 $3,950,000

Total NumberAmount of Units Per Unit

Net sales……………………………… $16,800,000 ÷ 120,000 = $140.00Variable costs……………………… 7,200,000 ÷ 120,000 = 60.00Contribution margin………………… $ 9,600,000 $ 80.00

2. a. $60 ($7,200,000 ÷ 120,000 units)b. $80 ($140 – $60)

$3,950,000$80 per unit

6. Sales ($16,800,000 + $2,800,000)………………………… Less: Fixed costs $5,200,000

Variable costs (140,000* units × $60)…………… 8,400,000Income from operations……………………………………

* ($2,800,000 ÷ $140) + 120,000

7. Present operating income………………………………… Less additional fixed costs………………………………… Income from operations……………………………………

1,250,000$4,400,000

13,600,000$ 6,000,000

$5,650,000

Sales (units) $5,200,000 + $5,650,000 =$80 per unit=

$19,600,000

4. Break-EvenSales (units) = Fixed Costs


65,000 units$3,950,000 + $1,250,000$80 per unit

Sales (units) Fixed Costs + Target ProfitUnit Contribution Margin

3. Fixed CostsUnit Contribution Margin

Break-EvenSales (units) = = 49,375 units

5.

Break-EvenSales (units) =

=

Break-EvenSales (units) = =

135,625 units



Prob. 19–2A (FIN MAN); Prob. 4–2A (MAN) (Concluded)8. In favor of the proposal is the possibility of increasing income from operations

from $5,650,000 to $6,000,000. However, there are many points against theproposal, including:

a. The break-even point increases by 15,625 units (from 49,375 to 65,000).

b. The sales necessary to maintain the current income from operations of $5,650,000 would be 135,625 units, or $2,187,500 (15,625 units × $140) in excessof 2014 sales.

c. If future sales remain at the 2014 level, the income from operations of $5,650,000 will decline to $4,400,000.

The company should determine the sales potential if the additional product is produced and then evaluate the advantages and the disadvantages enumerated above, in light of these sales possibilities.



Prob. 19–3A (FIN MAN); Prob. 4–3A (MAN)

$480,000$40*

*$100 unit selling price – $60 unit variable cost

$720,000$40

3.

4. Sales (16,000 × $100)…………………………… $1,600,000Total fixed costs…………………………………Total variable costs (16,000 × $60)…………… 1,440,000Income from operations………………………… $ 160,000

1. Break-Even Sales (units) =Total Fixed Costs



= 18,000 units

2. Sales (units) =Fixed Costs + Target ProfitUnit Contribution Margin

Sales (units) =

960,000

=

$480,000

$480,000 + $240,000$40

Total Fixed CostsUnit Selling Price – Unit Variable Cost

=

$0

$500,000

$1,000,000

$1,500,000

$2,000,000

0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 18,000 20,000

Sale

s an

d C

osts

Units of Sales

Sales Total Costs

Operating Loss Area


Break-Even Point

$1,200,000



Prob. 19–4A (FIN MAN); Prob. 4–4A (MAN)1.

= 1,000 units

= 30%

$75,00030%

or= 1,000 units × $250 per unit= $250,000

$250,000

Unit Selling Price – Unit Variable CostUnit Selling Price

$250 Unit Selling Price – $175 Unit Variable Cost$250 Unit Selling Price

Contribution Margin Ratio

=

Break-Even (dollars)




=

=

=


Total Fixed Costs

=

Unit Selling Price

=Total Fixed Costs

Unit Selling Price – Unit Variable Cost

Total Fixed CostsUnit Contribution Margin

$75,000$250 Unit Selling Price – $175 Unit Variable Cost

=Unit Contribution Margin

=

=

Break-Even Units:

Break-Even Dollars:

Break-Even Sales (units)

Break-Even (units)

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

0 500 1,000 1,500 2,000 2,500

Sale

s an

d C

osts

Units of Sales

Total Sales Total Costs

Break-Even Point


Operating Loss Area

$250,000

$75,000



Prob. 19–4A (FIN MAN); Prob. 4–4A (MAN) (Continued)2.

Units sold: $500,000 ÷ $250 per unit = 2,000 unitsa. b.

2,000 units 2,500 units

Sales…………………………………………………………………… $500,000 $625,000Variable costs………………………………………………………… $350,000 $437,500Fixed costs…………………………………………………………… 75,000 75,000Total costs…………………………………………………………… $425,000 $512,500Income from operations…………………………………………… $ 75,000 $112,500

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

0 500 1,000 1,500 2,000 2,500

Sale

s an

d C

osts

Units of Sales

Total Sales

Total Costs


Break-Even Point

Operating Loss Area

$512,500

$425,000

$625,000

a..

b.

$75,000



Prob. 19–4A (FIN MAN); Prob. 4–4A (MAN) (Continued)3.

Break-Even Units:

= 1,450 units

Break-Even Dollars:

= 30%

orBreak-Even (dollars) = 1,450 units × $250 per unit = $362,500

=

=

= $362,500


Break-Even (units) =$75,000 + $33,750

Break-Even Sales (units) =Total Fixed Costs

=Total Fixed Costs


=

=

$250 – $175


Contribution Margin RatioUnit Contribution Margin

$250 Unit Selling Price – $175 Unit Variable Cost

Unit Selling Price

$250 Unit Selling Price


Break-Even (dollars)$75,000 + $33,750

30%

Break-Even (dollars) =Total Fixed Costs


$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

0 500 1,000 1,500 2,000 2,500

Sale

s an

d C

osts

Units of Sales

Total Sales

Total Costs


Operating Loss Area

Break-Even Point

$362,500

1,450

$108,750



Prob. 19–4A (FIN MAN); Prob. 4–4A (MAN) (Concluded)4.

a. b.2,000 units 2,500 units

Sales…………………………………………………………………… $500,000 $625,000Variable costs………………………………………………………… $350,000 $437,500Fixed costs…………………………………………………………… 108,750 108,750Total costs…………………………………………………………… $458,750 $546,250Income from operations…………………………………………… $ 41,250 $ 78,750

$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

0 500 1,000 1,500 2,000 2,500

Sale

s an

d C

osts

Units of Sales

Total Sales

Total Costs

a.

b.


Break-Even Point

Operating Loss Area

$546,250

$458,750

$625,000

$108,750



Prob. 19–5A (FIN MAN); Prob. 4–5A (MAN)(Overall product is labeled E.)1. Unit Selling Price of E [($1,600 × 40%) + ($850 × 60%)]………………………………$1,150

Unit Variable Cost of E [($800 × 40%) + ($350 × 60%)]……………………………… 530Unit Contribution Margin of E…………………………………………………………… $ 620

$2,498,600$620 per unit

2. 4,030 units of E × 40% = 1,612 units of laptops4,030 units of E × 60% = 2,418 units of tablet PCs

3. Unit selling price of E [($1,600 × 50%) + ($850 × 50%)]………………………………$1,225Unit variable cost of E [($800 × 50%) + ($350 × 50%)]……………………………… 575Unit contribution margin of E…………………………………………………………… $ 650

$2,498,600$650

3,844 units of E × 50% = 1,922 units of laptops3,844 units of E × 50% = 1,922 units of tablet PCs

The break-even point is lower in this scenario than in part (1) because the sales mix is weighted toward the product with the higher contribution margin per unit of product.



=Fixed Costs


3,844 units

=

==

4,030 unitsBreak-Even Sales (units) =




Prob. 19–6A (FIN MAN); Prob. 4–6A (MAN)1.

Sales (21,875 × $160) $3,500,000Cost of goods sold:

Direct materials (21,875 × $46) $1,006,250Direct labor (21,875 × $40) 875,000Factory overhead [$200,000 + (21,875 × $20)] 637,500

Cost of goods sold 2,518,750Gross profit $ 981,250Expenses:

Selling expenses:Sales salaries and commissions

[$110,000 + (21,875 × $8)] $285,000Advertising 40,000Travel 12,000Miscellaneous selling expense

[$7,600 + (21,875 × $1)] 29,475Total selling expenses $366,475

Administrative expenses:Office and officers’ salaries $132,000Supplies [$10,000 + (21,875 × $4)] 97,500Miscellaneous administrative expense

[$13,400 + (21,875 × $1)] 35,275Total administrative expenses 264,775

Total expenses 631,250Income from operations $ 350,000

WOLSEY INDUSTRIES INC.Estimated Income Statement

For the Year Ended December 31, 2014



Prob. 19–6A (FIN MAN); Prob. 4–6A (MAN) (Continued)

$875,000$3,500,000

$525,000$160 – $120

$525,00025%

Break-Even Sales (dollars) = 13,125 units × $160 per unit = $2,100,000

2. Contribution Margin Ratio =Sales – Variable Costs

Sales

= =

=

3. Break-Even Sales (units) =Fixed Costs


Contribution Margin Ratio =$3,500,000 – (21,875 × $120)

= = $2,100,000

= 25%


Break-Even Sales (dollars) =Fixed Costs


13,125 units

$3,500,000



Prob. 19–6A (FIN MAN); Prob. 4–6A (MAN) (Concluded)4.

5. Margin of safety:In dollars:

Expected sales (21,875 × $160)………………………………… $3,500,000Break-even point (13,125 × $160)……………………………… 2,100,000Margin of safety………………………………………………… $1,400,000

As a percentage of sales:

$1,400,000$3,500,000

$875,000$350,000

Margin of Safety

Contribution Margin

40%==

=Margin of SafetySales – Sales at Break-Even Point

Sales

=21,875 units × $40

$350,000

Income from Operations

= = 2.5

6. Operating Leverage =

Operating Leverage

$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$3,500,000

$4,000,000

$4,500,000

0 3,000 6,000 9,000 12,000 15,000 18,000 21,000 24,000 27,000

Sale

s an

d C

osts

Units

Sales Total Costs


Break-Even Point

Operating Loss Area

$2,100,000

13,125

$525,000



Prob. 19–1B (FIN MAN); Prob. 4–1B (MAN)

Fixed Variable MixedCost Cost Cost Cost

a. Xb. Xc. Xd. Xe. Xf. Xg. Xh. Xi. Xj. Xk. Xl. X

m. Xn. Xo. Xp. Xq. Xr. Xs. Xt. X



Prob. 19–2B (FIN MAN); Prob. 4–2B (MAN)1. Total Variable Cost Variable

Cost Percentage CostCost of goods sold…………………… $1,400,000 × 75% = $1,050,000Selling expenses……………………… 400,000 × 60% = 240,000Administrative expenses…………… 387,500 × 80% = 310,000

Total Variable FixedCost Cost Cost

Cost of goods sold…………………… $1,400,000 – $1,050,000 = $350,000Selling expenses……………………… 400,000 – 240,000 = 160,000Administrative expenses…………… 387,500 – 310,000 = 77,500

Total cost…………………………… $1,600,000 $587,500

NumberTotal Amount of Units Per Unit

Net sales……………………………… $2,880,000 ÷ 64,000 = $45.00Variable costs………………………… 1,600,000 ÷ 64,000 = 25.00Contribution margin………………… $1,280,000 $20.00

2. a. $25 ($1,600,000 ÷ 64,000 units)b. $20 ($45 – $25)

$587,500$20 per unit

$1,492,500$20 per unit

6. Sales ($2,880,000 + $900,000)…………………………… Less: Fixed costs………………………………………… $ 800,000

Variable costs (84,000* units × $25)………… 2,100,000Income from operations……………………………………

* ($900,000 ÷ $45) + 64,000

7. Present operating income………………………………… Less additional fixed costs……………………………… Income from operations……………………………………

212,500$480,000

2,900,000$ 880,000

$692,500

5.

Break-EvenSales (units)

Sales (units) $800,000 + $692,500$20 per unit


=

4. Break-EvenSales (units) =

3. Fixed CostsUnit Contribution Margin

Break-EvenSales (units) = = 29,375 units

$3,780,000

= =

40,000 units

74,625 units

=

Fixed Costs + Target Profit

$587,500 + $212,500$20 per unit

Sales (units)

=

=

Break-EvenSales (units) =




Prob. 19–2B (FIN MAN); Prob. 4–2B (MAN) (Concluded)8. In favor of the proposal is the possibility of increasing income from operations

from $692,500 to $880,000. However, there are many points against theproposal, including:

a. The break-even point increases by 10,625 units (from 29,375 to 40,000).

b. The sales necessary to maintain the current income from operations of $692,500 would be 74,625 units, or $478,125 (10,625 units × $45) in excessof 2014 sales.

c. If future sales remain at the 2014 level, the income from operations of $692,500 will decline to $480,000.

The company should determine the sales potential if the additional product is produced and then evaluate the advantages and the disadvantages enumerated above, in light of these sales possibilities.




$800,000$40*

*$150 unit selling price – $110 unit variable cost

$1,100,000$40 per unit

3.

4. Sales (32,000 × $150)…………………………… $4,800,000Total fixed costs………………………………… $ 800,000Total variable costs (32,000 × $110)………… 3,520,000 4,320,000Income from operations………………………… $ 480,000

= Unit Selling Price – Unit Variable Cost

1. Break-Even Sales (units) =Total Fixed Costs


Total Fixed Costs

$800,000 + $300,000Sales (units) =

2. Sales (units) =Total Fixed Costs + Target Profit


27,500 units

20,000 units

==

$40 per unit

Break-Even Sales (units) = =

$0

$1,000,000

$2,000,000

$3,000,000

$4,000,000

$5,000,000

$6,000,000

$7,000,000

Sale

s and

Cos

ts

Units of Sales

Sales Total Costs

Operating Loss Area

Break-Even Point





Break-Even Units:

= 3,000 units

Break-Even Dollars:

= 37.5%

$225,00037.5%

orBreak-Even (dollars) = 3,000 units × $200 per unit

= $600,000

Unit Selling Price

= $600,000

=

$200 Unit Selling Price


Total Fixed Costs

Break-Even (dollars) =

Break-Even (units) =

Contribution Margin Ratio =

Contribution Margin Ratio =Unit Contribution Margin

Break-Even (dollars) =Total Fixed Costs


1.


$200 Unit Selling Price – $125 Unit Variable Cost$225,000



Break-Even Sales (units) =Total Fixed Costs

=

$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

$1,400,000

0 1,500 3,000 4,500 6,000 7,500

Sale

s an

d C

osts

Units of Sales

Total Sales

Total Costs

Break-Even Point


Operating Loss Area

$225,000



Prob. 19–4B (FIN MAN); Prob. 4–4B (MAN) (Continued) 2.


Sales………………………………………………………………… $900,000 $1,500,000Variable costs……………………………………………………… $562,500 $ 937,500Fixed costs………………………………………………………… 225,000 225,000Total costs………………………………………………………… $787,500 $1,162,500Income from operations………………………………………… $112,500 $ 337,500

$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

$1,400,000

$1,600,000

0 1,500 3,000 4,500 6,000 7,500

Sale

s an

d C

osts

Units of Sales

Total Sales

Total Costs


Break-Even Point

Operating Loss Area

$787,500

$1,500,000

$1,162,500

$900,000 a.

b.

$225,000



Prob. 19–4B (FIN MAN); Prob. 4–4B (MAN) (Continued)3.

= 4,500 units

= 37.5%

or= 4,500 units × $200 per unit = $900,000

= $900,000





$200 Unit Selling Price – $125 Unit Variable Cost$200 Unit Selling Price

=

Unit Selling Price

= Total Fixed Costs

= Unit Selling Price – Unit Variable CostTotal Fixed Costs

=

= $225,000 + $112,500

=




=

=Break-Even (dollars)

Total Fixed CostsContribution Margin Ratio

$225,000 + $112,50037.5%


Break-Even Dollars:

Break-Even Units:


Break-Even (units)

$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

$1,400,000

$1,600,000

0 1,500 3,000 4,500 6,000 7,500

Sale

s an

d C

osts

Units of Sales

Total Sales

Total Costs


Operating Loss Area

Break-Even Point

$900,000

$337,500



Prob. 19–4B (FIN MAN); Prob. 4–4B (MAN) (Concluded)4.


Sales………………………………………………………………… $1,200,000 $1,500,000Variable costs……………………………………………………… $ 750,000 $ 937,500Fixed costs………………………………………………………… 337,500 337,500Total costs……………………………………………………………$1,087,500 $1,275,000Income from operations………………………………………… $ 112,500 $ 225,000

$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

$1,400,000

$1,600,000

0 1,500 3,000 4,500 6,000 7,500

Sale

s an

d C

osts

Units of Sales

Total Sales

Total Costs

a.

b. Operating Profit Area

Break-Even Point

Operating Loss Area

$1,500,000

$1,275,000

$1,087,500

$337,500



Prob. 19–5B (FIN MAN); Prob. 4–5B (MAN)(Overall product is labeled E.)1. Unit Selling Price of E [($12 × 30%) + ($15 × 70%)]……………………………………$14.10

Unit Variable Cost of E [($3 × 30%) + ($4 × 70%)]…………………………………… 3.70Unit Contribution Margin of E…………………………………………………………… $10.40

$46,800$10.40 per unit

2. 4,500 units of E × 30% = 1,350 units of 12-inch pizza4,500 units of E × 70% = 3,150 units of 16-inch pizza

3. Unit selling price of E [($12 × 50%) + ($15 × 50%)]……………………………………$13.50Unit variable cost of E [($3 × 50%) + ($4 × 50%)]……………………………………… 3.50Unit contribution margin of E…………………………………………………………… $10.00

$46,800$10.00

4,680 units of E × 50% = 2,340 units of 12-inch pizza4,680 units of E × 50% = 2,340 units of 16-inch pizza

The break-even point is higher in scenario 2 because the mix changes to be less weighted toward the higher contribution margin per unit product in part (3).


=

=Fixed Costs


4,680 units

=

=

Break-Even Sales (units) =Fixed Costs


=

4,500 unitsBreak-Even Sales (units)



Prob. 19–6B (FIN MAN); Prob. 4–6B (MAN)1.

Sales (12,000 × $240) $2,880,000Cost of goods sold:

Direct materials (12,000 × $50) $600,000Direct labor (12,000 × $30) 360,000Factory overhead [$350,000 + (12,000 × $6)] 422,000

Cost of goods sold 1,382,000Gross profit $1,498,000Expenses:

Selling expenses:Sales salaries and commissions

[$340,000 + (12,000 × $4)] $388,000Advertising 116,000Travel 4,000Miscellaneous selling expense

[$2,300 + (12,000 × $1)] 14,300Total selling expenses $522,300

Administrative expenses:Office and officers’ salaries $325,000Supplies [$6,000 + (12,000 × $4)] 54,000Miscellaneous administrative expense

[$8,700 + (12,000 × $1)] 20,700Total administrative expenses 399,700

Total expenses 922,000Income from operations $ 576,000

BELMAIN CO.Estimated Income Statement

For the Year Ended December 31, 2014



Prob. 19–6B (FIN MAN); Prob. 4–6B (MAN) (Continued)

$1,728,000$2,880,000

$1,152,000$240 – $96

$1,152,00060%

Break-Even Sales (dollars) = 8,000 units × $240 per unit = $1,920,000

3. Break-Even Sales (units) =Fixed Costs


2. Contribution Margin Ratio =Sales – Variable Costs

Sales

Break-Even Sales (dollars) =Fixed Costs


= = $1,920,000

8,000 units

60%

$2,880,000Contribution Margin Ratio =$2,880,000 – (12,000 × $96)

= =

= =




Prob. 19–6B (FIN MAN); Prob. 4–6B (MAN) (Concluded)4.

5. Margin of safety:In dollars:

Expected sales (12,000 units × $240)………………………… $2,880,000Break-even point (8,000 units × $240)………………………… 1,920,000Margin of safety………………………………………………… $ 960,000

As a percentage of sales:

$960,000$2,880,000

$1,728,000$576,000

* Unit Contribution = Unit Selling Price – Unit Variable Cost$144 = $240 – $96

6.

=

=Margin of SafetySales – Sales at Break-Even Point

Sales

=Margin of Safety

Contribution MarginIncome from Operations

= = 3$576,000

33.3%

Operating Leverage =12,000 units × $144*

Operating Leverage =

$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$3,500,000

$4,000,000

$4,500,000

0 2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 18,000

Sale

s an

d C

osts

Units

Sales Total Costs


Break-Even Point

Operating Loss Area

$1,920,000

$1,152,000



CP 19–1 (FIN MAN); CP 4–1 (MAN)In an absolute sense, Edward’s actions are devious. He is clearly attempting to use the first four-year scenario, which is favorable, as a way to market the partnerships. They are really longer-term investments. After the first four years, the risk increases dramatically. The break-even occupancy becomes much more difficult to achieve at 95% than it does at 65%. Focusing on the 65%and remaining silent about the increase to 95% is deceptive. One might argue “let the buyer beware.” After all, the information is in the fine print. A littlespadework would reveal the longer-term reality of these partnerships. This is not a compelling argument. Clearly, Edward is putting some favorable spin on this offering. It’s likely that this will come back to haunt him in a court of law.Some investors may claim they were defrauded by less than complete disclosure. Edward has a responsibility to provide objective information. The integrity standard requires that Edward communicate constraints that would preclude the successful performance of an activity. Also, Edward must communicate unfavorable as well as favorable information. Clearly, the increase in the mortgage rate and its impact on the break-even point is unfavorable information that should be given as muchvisibility as the favorable 65% break-even information.

CASES & PROJECTS



CP 19–2 (FIN MAN); CP 4–2 (MAN)The airline industry has a high operating leverage. This means that fixed costs are a large part of the cost structure. The break-even volume is apparently around 65% of capacity. When the volume falls below 65%, the industry loses money. As the percentage increases above 65%, the industry becomes very profitable. There is a difference between profitability and cash flow. Since a large part of the cost structure in airlines is fixed costs, this means that depreciation makes up a large part of the expense base. Depreciation is a noncash expense. Therefore, it is likely that the industry is not profitable but has positive cash flow at capacity use that is below break-even. There is a point, however, where the industry will not generate sufficient cash to maintain operations.

The airline strategy of raising ticket prices and consolidating routes may be a successful strategy; however, there are a number of considerations. First, the higher ticket prices would increase the revenue per passenger-mile and reduce the break-even occupancy percentage only if it is assumed that there is no change in passenger volume. However, this is unlikely. The revenue from price increases would need to increase faster than the lost revenue from lower traffic volume for a price increase to lower break-even. To raise ticket prices, the airline would have to minimize the impact on lost volume. This might be possible for fareincreases targeted to business travelers that need to fly, regardless of ticket price.The airline can minimize volume losses by keeping fares lower for nonbusinesstravelers. Restrictions such as allowing reduced fares only on round-trip fares thatgo over a Saturday night achieve this objective, since business travelers do not wish to be out of town over the weekend. Likewise, requiring higher fares for seats reserved with little advance notice would also achieve this objective, since much business travel cannot be planned weeks in advance.

The strategy of consolidating routes attacks a major cost of airlines. The number of flights and terminals served drives fuel and airport ground- and terminal-related costs. Therefore, consolidating routes by either reducing the number of terminals served and/or the number of flights is a method of achieving some economies of scale. For example, an airline could consolidate three flights departing in the morning from Tulsa to Dallas into just two flights departing in the morning. This would reduce the airline’s costs but would increase the airline passengers’ inconvenience. This strategy works only if there is little loss in revenue by going to two flights, meaning that the people bumped from the third flight go to the other two, rather than a competitor. Alternatively, an airline flying into LaGuardia and Newark airports in the New York metropolitan area might decide to fly into only one of the terminals in order to reduce ground-related costs. Again, this strategy would only be successful if there was little loss in revenue relative to the cost savings.



CP 19–3 (FIN MAN); CP 4–3 (MAN)Do-Nothing Strategy:

Revenue – Variable Costs – Fixed Costs = Profit($80 × 1,000,000) – ($35 × 1,000,000) – $35,000,000 = Profit$80,000,000 – $35,000,000 – $35,000,000 = $10,000,000

Thomas’s Strategy:Revenue – Variable Costs – Fixed Costs = Profit($60 × 2,000,000) – ($35 × 2,000,000) – $35,000,000 = Profit$120,000,000 – $70,000,000 – $35,000,000 = $15,000,000

James’s Strategy:Revenue – Variable Costs – Fixed Costs = Profit($80 × 1,400,000) – ($35 × 1,400,000) – $45,000,000 = Profit$112,000,000 – $49,000,000 – $45,000,000 = $18,000,000

James’s strategy, which is to maintain the price but increase advertising, appears superior.

CP 19–4 (FIN MAN); CP 4–4 (MAN)The direct labor costs are not variable to the increase in unit volume. The unit volume is the wrong activity base for direct labor costs. The “number of impressions” is a more accurate reflection of the direct labor cost. An impression is a separate printing color application on the banners. Thus, the analysis should be done as follows:

One ThreeColor Color Total

Number of banners 212 616 1,800Number of impressions 212 1,848 5,400

Last year’s impressions: 1,800 (180 + 480 + 1,140)

Thus, a 125% assumed increase from the unit volume information will understate the potential increase in direct labor cost.

Total increase:

TwoColor274548

5,400 – 1,8001,800 = 200%

ColorFour

6982,792



CP 19–5 (FIN MAN); CP 4–5 (MAN)The Shipping Department manager should respond by pointing out that the activities performed by his department are not related to sales volume but to sales orders. The orders require inventory pulling and sorting activities as well as paperwork activities. Thus, even though the sales volume is decreasing, the number of sales orders processed has increased from 1,180 to 1,475 (25%) over the last eight months. The reason for this increase in sales orders is that customers are ordering lower quantities per order than in the past. Thus, it is no wonder that the Shipping Department manager is experiencing financialpressure. The amount of work performed by the department is increasing, even though sales volume is down.

CP 19–6 (FIN MAN); CP 4–6 (MAN)There are many possible applications of break-even analysis in a school environment. Below are just a few possible ideas.

Revenue Fixed Costs Variable Costs

1 Break-even number Student tuition Faculty salary, space Supplies, copyingof students in a class for a class costs

2 Break-even sales Book sales Manager’s salary, Cashier salaries, in the bookstore space costs cost of books

3 Break-even daily Meal revenue Salaries, space Food costsmeal revenues

4 Break-even students Room revenue Space, staff salaries, Janitorial costsin a dorm utilities

5 Break-even number Ticket and Space, staff Clean-up costs, of tickets sold for a concession salaries, utilities concession costsbasketball game revenue

6 Break-even number Network user fees Network depreciation, User support, of users on a computer network maintenance, electricitynetwork trunk line lease costs

7 Break-even number Ticket revenue Concert hall Salaries of some of tickets sold for a depreciation, salaries of support staff, very concert season musicians, utilities few variable costs

expense

Break-Even Analysis


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