Download The condensed income statement for the Terri and

The condensed income statement for the Terri and Jerry partnership for 2008 is as
follows:
Terri and Jerry Company
Income statement
For the year ended December 31, 2008
Sales (200,000 units) $1,200,000
Cost of goods sold 800,000
Gross Profit &n bsp; 400,000
Selling expenses $280,000
Administrative Expenses 160,000 440,000
Net loss &nbs p; (40,000)
A cost behavior analysis indicates that 75% of the cost of goods sold are variable, 50% of
the selling expenses are variable, and 25% of the administrative expenses are variable.
Instructions
(Round to the nearest unit, dollar, and percentage, where necessary. Use the cost volume
profit income statement format in computing profits.)
(a) Compute the break even point in total sales, dollars, and in units for 2008.
(b) Terri has proposed a plan to get the partnership “out of the red” and improve its
profitability. She feels the quality of the product could be substantially improved by
spending $0.25 more per unit on better raw materials. The selling price per unit could be
increased only $6.25 because of competitive pressures. Terri estimates that sales volumes
will increase by 30%. What effect would Terri’s plan have on the profits and the break
even point in dollars of the partner ship? (Round the contribution margin ratio to two
decimal places.)
(c) Jerry was a marketing major in college. He believes that sales volume can be
increased only by intensive advertising and promotional campaigns. He therefore
proposed the following plan as an alternative to Terri’s. (1) Increase variable selling
expenses to $0.79 per unit, (2) lower the selling price per unit by $0.30, and (3) increase
fixed selling expenses by $35,000. Jerry quoted an old marketing research report that said
that sales volumes would increase by 60% if these changes were made. What effect
would Jerry’s plan have on the profits and the break-even point in dollars of the
partnership?
(d) Which plan should be accepted? Explain your answer in a 1 page double-spaced paper
explaining the problem and the solution. Pretend that the person reading it knows
absolutely nothing about accounting or finance.
Solution
(a)
The variable costs per unit are:
Cost of goods sold ($600,000 ÷ 200,000) .................................................
Selling expenses ($140,000 ÷ 200,000) ....................................................
Administrative expenses ($40,000 ÷ 200,000) ........................................
Total ................................................................................................
Fixed Costs are:
Cost of goods sold ($800,000 X .25) ........................................................
Selling expenses ($280,000 X .50) ...........................................................
Administrative expenses ($160.000 X .75) .............................................
$3.00
.70
.20
$3.90
$200,000
140,000
120,000
$460,000
The break-even points are:
X = ($3.90 ÷ $6.00) X + $460,000
X = .65X + $460,000
.35X = $460,000
X = $1,314,286 (rounded)
$6.00X = $3.90X + $460,000
$2.10X = $460,000
X = 219,048 units (rounded)
(b)
Variable unit cost of goods sold = $3.25
($600,000 ÷ 200,000 = $3.00; $3.00 + $.25)
Sales volume = 260,000 units (200,000 X 130%)
Total sales = 260,000 X $6.25 = $1,625,000
Net income computation:
Sales ............................................................................
Variable expenses
Cost of goods sold .............................................
(260,000 X $3.25)
Selling expenses ................................................
(260,000 X $.70)
Administrative expenses
(260,000 X $.20) ...........................................
Total variable expenses..........................
Contribution margin ..................................................
Fixed expenses
$1,625,000
$845,000
182,000
52,000
1,079,000
546,000
Cost of goods sold .............................................
Selling expenses ................................................
Administrative expenses ..................................
Total fixed expenses ...............................
Net income ..................................................................
$200,000
140,000
120,000
460,000
$
86,000
X = ($1,079,000 ÷ $1,625,000)X + $460,000
X = .66X + $460,000
.34X = $460,000
X = $1,352,941 (rounded)
Profits and the break-even point would both increase.
(c)
Sales [320,000 (1) X ($6.00 – $.30)] .....................................
Variable expenses
Cost of goods sold .......................................................
(320,000 X $3.00)
Selling expenses (320,000 X $.79) .............................
Administrative expenses
(320,000 X $.20) .....................................................
Total variable expenses....................................
Contribution margin ............................................................
Fixed expenses
Cost of goods sold .......................................................
Selling expenses ..........................................................
($140,000 + $35,000)
Administrative expenses ............................................
Total fixed expenses .........................................
Net income ............................................................................
$1,824,000
$960,000
252,800
64,000
1,276,800
547,200
$200,000
175,000
120,000
495,000
$
52,200
(1) Sales volume = 200,000 X 160% = 320,000
X = ($1,276,800 ÷ $1,824,000)X + $495,000
X = .70X + $495,000
.30X = $495,000
X = $1,650,000
Profits and the break-even point would both increase.
(d) Terri’s plan should be accepted. It produces a higher net income and a lower
break-even point than Jerry’s plan