Cost Behaviour and CVP Relationship

Assignment No. 11

Cost and Management Accounting Muhammad Saad Salman

Cost Behaviour and CVP Relationship

January 2

2012Submitted By:

Muhammad Saad SalmanRoll no. 70Section-B

Submitted To:Mr. Ali Shaan

Review Problem 1: Cost Behaviour:

The variable cost per hour = 20,000 / 5000 = $4

Hours of Operating Time5,000 6,000 7,000 8,000

Total Cost: Variable Cost 20,000 24000 28000 32000Fixed Cost 168,000 168,000 168,000 168,000Total Cost 188,000 192,000 196,000 200,000Cost per Hour:Variable Cost 4 4 4 4Fixed Cost 33.6 28 24 21Total Cost Per Hour 37.6 32 28 25


Hours of Operating Time5,000 6,000 7,000 8,000

Total Cost: Variable Cost 20,000 ? ? ?Fixed Cost 168,000 ? ? ?Total Cost 188,000 ? ? ?Cost per Hour: Variable Cost ? ? ? ?Fixed Cost ? ? ? ?Total Cost Per Hour ? ? ? ?

Review Problem 2: High-Low Method:

No. of Patient

AdmittedAdmitting Dept

CostHigh Activity Level (June) 1900 15200

Low Activity Level (November) 1100 12800

Change 800 2400

Variable Cost = Change in cost / Change in activity

= 2400/ 800

= $3 per patient admitted

Now the fixed cost is:

Fixed cost = Total Cost – Variable Cost

= 15200 – (3 x 1900)

= $9500

2nd Part:

The Cost formula is

Y = a + bx

So,

Y = 9500 + 3x


Exercise 5-2: Scatter graph Analysis:

Month

Units Produced

Processing Cost

1 4,500 38,0002 11,000 52,0003 12,000 56,0004 5,500 40,0005 9,000 47,0006 10,500 52,0007 7,500 44,0008 5,000 41,0009 11,500 52,00010 6,000 43,00011 8,500 48,00012 10,000 50,00013 6,500 44,00014 9,500 48,00015 8,000 46,000

4,000 5,000 6,000 7,000 8,000 9,000 10,000 11,000 12,000 13,0000

10,000

20,000

30,000

40,000

50,000

60,000

Scattered Diagram

Units Produced

Pro

cess

ing

Cos

t


By using the straight line formula:

Y=a+bX

Here, if we extend the line it will touch at $30,000, which means that our fixed cost is $30,000. If we take unit produced (activity) at 8,000 we will get:

46,000=30,000+b8,000

B=46,000 – 30,000/8000

B= $2

So $2 is the per unit variable cost.

Exercise 5-6: High-Low Method: Scatter graph Analysis

MonthUnits

ShippedTotal Shipping

ExpenseJanuary 3 1,800February 6 2,300March 4 1,700April 5 2,000May 7 2,300June 8 2,700July 2 1,200

A-Part:

Unit Shipped

Shipping Expense

High Activity Level (June) 8 2,700

Low Activity Level (July) 2 1,200

Change 6 1,500


Variable Cost= Change in Shipping Expense/ Units Shipped

= 1500/6 = $250

Total Fixed cost = Total Cost – Variable Cost

= 2700 – (250*8)

= 2700 – 2000 = $700

So, now

Y=a+bx

Y= 700 + 250 = $950

B-Part:

1 2 3 4 5 6 7 8 90

500

1,000

1,500

2,000

2,500

3,000

Units Shipped

Tot

al S

hip

pin

g E

xpen

se

If we extend the line it will touch at $900 at 0 Unit produce. It means that our Fixed Cost is $900. Now, we will take 500 units shipped at $2000.


Y=a+bX

2000 = 900 + b (500)

2000 - 900 = b (500)

1100/ 500 = b

B = $ 2.2 per unit shipped

C-Part:

The cost of shipping units is likely to depend on the:

1. weight and volume of the units 2. the distance traveled

Because more the weight of the units more you have to pay the amount or more the distance travel you have to pay the more prices.

Exercise 5-13: Identify Cost Behaviour Pattern:

a. 3b. 6c. 11d. 1e. 4f. 10g. 2h. 7i. 9

3. Knowledge of cost behaviour patterns help to a manager in analyzing the cost structure in this manner that he can get the accurate cost structure because every cost don’t behave in a same manner. For example, if one cost is increasing then might be there is a cost which is decreasing so cost pattern really help managers to analyze their company’s performance.


Review Problem: CVP Relationships:

Total Per UnitPercentage

saleSales 1,200,000 60 100%Variable Expense 900,000 45 ?Contribution Margin 300,000 15 ?Fixed Expense 240,000

Net Operating Income 60,000

1. CM Ratio = Unit contribution margin / Unit Selling price

=15 / 60 = 25%

Variable Expense Ratio = Variable expense / Selling Price

= 45 / 60 = 75%

2. Profit = Unit CM x Q – Fixed Expense

0 = (60 – 45) x Q – 240000

15Q = 240000

Q = 16,000 units or at $60 per unit, $960,000

3. Expected increase in contribution margin

= Increase in sales x CM Ratio

= 400000 x 25%

= $100,000

4. Unit Sales to attain the target profit:

= (Target Profit + Fixed Expenses) / CM per unit

= (90000 + 240000) / 15

= 22,000 units


5. Margin of safety in dollars

= Total sales – Break-even Sales

= 1200000 – 960000

= $ 240,000

Margin of safety in percentage

= Margin of safety in dollars / Total sales

= 240000 / 1200000

= 20%

6. Degree of Operating Leverage:

= Contribution Margin / Net operating income

= 300000 / 60000

= 5

b. Expected Increase in Net Operating Income

= Expected Increase in sales x degree of operating leverage

= 8% x 5

= 40%

C. if 8% sales increase then total units will become 21,600

Total Per Unit Percentage saleSales 1,296,000 60 100%Variable Expense 972,000 45 75%Contribution Margin 324,000 15 25%Fixed Expense 240,000Net Operating Income 84,000

Percentage increase in net operating income = (84000 – 60000) / 60000


= 40%

Part 7:

a. A 20% increase in sales would result in 24,000 units being sold. So,

Total Per Unit Percentage saleSales 1,440,000 60 100%Variable Expense 1,152,000 48 80%Contribution Margin 288,000 12 20%Fixed Expense 210,000Net Operating Income 78,000

Unit sales to breakeven = Fixed Expenses / Unit CM

= 210000 / 12

= 17,500 units

Dollar Sales to breakeven = Units to breakeven x per unit price

= 17500 x 60

= $1,050,000

b. Yes, based on these data the changes should be made. The changes increase the company’s net operating income from the present $60,000 to $78,000 per year. Although the changes also result in the higher break-even point (17,500 units as compared to the present 16,000 units), the company’s margin of safety actually becomes greater than before:

Margin of safety in dollars = Total sales – Break-even analysis

= 1,440,000 – 1,050,000

= $390,000

The company’s present margin of safety is $240,000. Thus several benefits will result from the proposed change.


Chapter 6:

Exercise 6-1: Preparing a Contribution Format Income Statement:

Total Units Per UnitSales (10,000 Units) 350,000 10,000 35Variable Expense 200,000 10,000 20Contribution Margin 150,000 15Fixed Expenses 135,000Net Operating Expenses 15,000

The sale volume increase by 100 units

Units Per Unit TotalSales (10,100 Units) 10,100 35 353,500Variable Expense 10,100 20 202,000Contribution Margin 15 151,500Fixed Expenses 135,000Net Operating Expenses 16,500

The Sales volume decrease by 100 units

Units Per Unit TotalSales (10,100 Units) 9,900 35 346,500Variable Expense 9,900 20 198,000Contribution Margin 15 148,500Fixed Expenses 135,000Net Operating Expenses 13,500


The sale volume is 9000 units:

Units Per Unit TotalSales (10,100 Units) 9,000 35 315,000Variable Expense 9,000 20 180,000Contribution Margin 15 135,000Fixed Expenses 135,000Net Operating Expenses 0

Exercise 6-8:

Selling Price Per Unit

Variable Expense Per Unit

Fixed Expense Per Month

Total Units Per Month

30 20 7500 1000

Contribution Income Statement

Sales (1000 units) 30000

Less: VC 20000

Contribution Margin 10000

Less: FC 7500

Net Operating Income 2500

To find out the margin of safety we must calculate the break-even point. So,

Profit= unit CM x Q – Fixed Expenses

0 = (P – V) x Q – 7500

7500 = (30 – 20) x Q

7500 = 10Q

Q = 750 units

So it means that break-even point is at 750 units.


Unit Price Total Units Sales at a Current Volume (1000) 30 1000 30000Sales at Break-even (750) 30 750 22500

Margin of Safety in Dollars 7500

Margin of Safety in percentage = Margin of safety in dollars / Sales at 1000 units

= 7500 / 30000

= 0.25 = 25%

Exercise 6-12:

Total Per UnitSales 450,000 30Variable Expense 180,000 12Contribution Margin 270,000 18Fixed Expense 216,000Net Operating Income 54,000

1. Break-even Analysis:

Profit = Unit CM x Q – Fixed Expenses

0 = (P – V) x Q -216000

0 = 18Q – 216000

Q = 216000/18

Q = 12,000 unit

That was the breakeven analysis in units now the breakeven analysis in dollars is as follow:

Dollar sales to attain breakeven = (Target profit + Fixed Expenses) / CM Ratio


= (0 + 216000) / 0.6

= 216000 / 0.6

= $ 360,000

2. Total contribution margin at breakeven is equal to Fixed Expense i.e. $216,000.

3 rd Part:

Profit = Unit CM x Q – Fixed Expenses

90000 = 18Q – 216000

Q = (216000 + 90000) / 18

Q = 17,000

So we need to sale 17,000 units in order to gain the profit of $90,000.

Total Per UnitUnits need to be

SoldSales 510,000 30 17,000Variable Expense 204,000 12Contribution Margin 306,000 18Fixed Expense 216,000Net Operating Income 90,000

4 th Part:

Total Units at current level = 450000 / 30 = 15,000 units

Unit Price

Total Units

Sales at a Current Volume (15,000) 30 15,000 450000Sales at Break-even (12,000) 30 12,000 360000

Margin of Safety in Dollars 90000


Now, margin of safety in percentage is:

= 90000 / 450000

= 0.2

= 20%

5 th Part:

Company’s CM Ratio = 18 / 30

= 0.6

= 60%

If the fixed expenses are same then company’s net operating income would be increased by:

=50,000 x 60%

= $ 30,000


15% Commission

20% Commission

7.5% Commission Sales 16,000,000 100% 16,000,000 100% 16,000,000 100%Variable Expenses: Manufacturing 7,200,000 7,200,000 7,200,000 Commission 2,400,000 3200000 1200000 Total Variable Expenses 9,600,000 60% 10,400,000 65% 8,400,000 52.5%Contribution Margin 6,400,000 40% 5,600,000 35% 7,600,000 47.5%Fixed Expenses: Manufacturing Overheads 2,340,000 2,340,000 2,340,000

Marketing 120,000 120,000 2,520,000

Administrative 1,800,000 1,800,000 1,725,000 Interest 540,000 540,000 540,000

Total Fixed Expenses 4,800,000 4,800,000 7,125,000

EBIT 1,600,000 800,000 475,000

Income Tax (30%) 480,000 240,000 142,500

Net Income 1,120,000 560,000 332,500


Part 1:

a. Breakeven point in dollar sales at 15% Commission = Fixed Expense / CM Ratio

=4,800,000 / 0.4 = $12,000,000

b. Breakeven point in dollar sales at 20% Commission = Fixed Expense / CM Ratio

=4,800,000 / 0.35 = $13,714,285.7

c. Breakeven point in dollar sales at own sale force = Fixed Expense / CM Ratio

= 7,125,000 / 0.475 = $15,000,000

Part 2:

Well from the above income statement we can see in the 20% commission column that for getting the desire profit of $1,120,000 with 20% commission the EBIT should be 1,600,000.

So, we can compute it as follow:

Dollar sales = (Targeted EBIT + Fixed Expenses) / CM Ratio

= (1,600,000 + 4,800,000) / 0.35

= 6,400,000 / 0.35

= $18,285,714.3


Part 3:

We can get it by comparing both the sales:

0.65X + 4,800,000 = 0.525X + 7,125,000

0.125X = 2,325,000

X = 18,600,000

Part 4:

15% Commission

20% Commission Self

Contribution Margin 6,400,000 5,600,000 7,600,000EBIT 1,600,000 800,000 475,000

Degree Of Operating Leverage 4 7 16

Part 5:

We would continue to use the sales agents for at least one more year, and possibly for two more years. The reasons are as follows:

First, use of the sales agents would have a less dramatic effect on net income.

Second, use of the sales agents for at least one more year would give the company more time to hire competent people and get the sales group organized.

Third, the sales force plan doesn’t become more desirable than the use of sales agents until the company reaches sales of $18,600,000 a year. This level probably won’t be reached for at least one more year, and possibly two years.

Fourth, the sales force plan will be highly leveraged since it will increase fixed costs (and decrease variable costs). One or two years from now, when sales have reached the $18,600,000 level, the company can benefit greatly from this leverage. For the moment, profits will be greater and risks will be less by staying with the agents, even at the higher 20% commission rate.


Cost Behaviour and CVP Relationship

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