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25 Minutes, Easy a. b. c. d. PROBLEM 20–7 EASYWRITER Contribution margin per unit: Unit sales price Less: Variable cost per unit ($50,000 40,000 units) Contribution margin per unit $ 1 75 1 25 $ 50 Margin of safety at sales of 45,000 units: Sales revenue ($1.75 45,000 units) Less: Sales revenue at break-even point ($1.75 40,000 units) Margin of safety Estimated operating loss at sales level of 38,000 units: Sales revenue ($1.75 38,000 units) Less: Variable costs ($1.25 38,000 units) Fixed costs (given) Operating income (loss) $ 7 8 7 5 0 7 0 0 0 0 $ 8 7 5 0 $ 6 6 5 0 0 $ 4 7 5 0 0 2 0 0 0 0 6 7 5 0 0 $ (1 0 0 0 ) (1) Unit cost at production level of 40,000 units: Variable cost per unit Fixed cost per unit ($20,000 40,000 units) Total unit cost $ 1 25 50 $ 1 75 (2) Unit cost at production level of 50,000 units: Variable cost per unit Fixed cost per unit ($20,000 50,000 units) Total unit cost $ 1 25 40 $ 1 65 Total cost per unit declines at higher production levels because the fixed manufacturing costs are allocated over a greater number of units. Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 153 40 Minutes, Strong a. Unit contribution margin: Sales price per unit Less: Variable costs per unit: Merchandise Rental commission Unit contribution margin PROBLEM 20–8 SIMON TEGUH $ 0 75 $ 0 25 0 05 Break-even volume in units: Monthly fixed costs: Depreciation ($36,000 .20 1/12) Wages Other Total monthly fixed costs Contribution margin per unit (above) Break-even volume in units ($2,700 $0.45) $ 6 1 5 6 $ 2 7 Break-even volume in dollars: Break-even volume in units (above) Unit sales price Break-even volume in dollars (6,000 units $0.75) b. See following page. c. Sales volume to produce operating income equal to 30% return on investment: Total monthly fixed costs (part a ) Desired operating income ($45,000 30% 1/12) Total desired contribution margin Contribution margin per unit (part a ) Sales volume in units ($3,825 $0.45 per unit) d. 154 0 30 $ 0 45 0 0 0 0 $ 6 0 0 0 0 0 0 0 45 0 6 0 0 0 $ 0 75 $ 4 5 0 0 $ 2 7 0 0 1 1 2 5 $ 3 8 2 5 $ 0 45 8 5 0 0 Sales volume in dollars (8,500 units $0.75 per unit) $ 6 3 7 5 New monthly fixed costs [$2,700 (20 $30)] New contribution margin per unit: Unit sales price Less: Variable costs per unit (only merchandise cost) New break-even volume in units ($3,300 $0.50 per unit) $ 3 3 0 0 $ 0 75 0 25 $ 0 50 6 6 0 0 © The McGraw-Hill Companies, Inc., 2005 PROBLEM 20–8 SIMON TEGUH (concluded) b. SIMON TEGUH Cost-Volume-Profit Chart Monthly Basis 12000 10000 Revenue line Profit area Revenues or Costs 8000 Break-even point 6000 Total cost line 4000 Variable costs 2000 Loss area Fixed costs 0 0 2000 4000 6000 8000 10000 12000 14000 16000 Units sold (through 20 machines) Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 155 30 Minutes, Strong a. PROBLEM 20–9 PRECISION SYSTEMS Variable costs per unit before 15% increase in the cost of direct labor Increase in cost of direct labor, 15% of $20 Variable costs and expenses per unit after 15% increase in the cost of direct labor $ 6 0 3 $ 6 3 Because the contribution margin ratio of 40% is required, the variable costs of $63 per unit must equal 60% of sales price after the wage increase. New sales price, $63 .60 Sales price before increase Required increase in sales price per unit b. $ 1 0 5 1 0 0 $ 5 Unit contribution margin: Sales price per unit Less: Variable costs per unit following 15% increase in direct labor cost (part a ) Unit contribution margin $ 1 0 0 $ 6 3 3 7 Sales volume required to maintain current operating income: Sales Volume = = Fixed Costs + Target Operating Income Unit Contribution Margin $390,000 + $350,000 = 20,000 units $37 c. Current Capacity (20,000 Units) Total contribution margin ($37 per unit) Less: Fixed costs Operating income at full capacity $7 4 0 0 0 0 3 9 0 0 0 0 $3 5 0 0 0 0 After Expansion (25,000 Units) $9 2 5 0 0 0 5 3 0 0 0 0 * $3 9 5 0 0 0 *$390,000 additional depreciation per year on new machinery, $140,000 (20% of $700,000). 156 © The McGraw-Hill Companies, Inc., 2005 35 Minutes, Strong a. PROBLEM 20–10 PERCULA FARMS Raising clownfish will result in the highest operating income. Number of salable fish sale price Total revenue Variable costs: Eggs Feedings Water changes Heating and lighting Total variable costs Total contribution margin Fixed costs: Operating income Clownfish 1 0 0 0 0 0 $ 4 $4 0 0 0 0 0 Angelfish 5 0 0 0 0 $ 1 0 $5 0 0 0 0 0 $ $ 7 3 1 $1 3 $2 6 8 $1 8 5 8 5 4 3 6 0 6 5 7 0 0 2 7 0 7 0 5 0 0 5 5 0 5 0 0 0 0 0 0 0 0 9 1 5 0 1 0 0 2 0 $2 7 9 $2 2 0 8 0 $1 4 0 5 0 0 0 5 5 0 5 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 b. The most important factors in determining operating income are survival rates, and the costs of feeding and water changes. c. and d. Percula will earn the highest operating income by purchasing the new filter material and raising angelfish. Operating income with new filter material: Number of salable fish sale price Total revenue Variable costs: Eggs Feedings Water changes Heating and lighting Total variable costs Total contribution margin Fixed costs: Operating income Clownfish 1 2 0 0 0 0 $ 4 $4 8 0 0 0 0 Angelfish 6 0 0 0 0 $ 1 0 $6 0 0 0 0 0 $ $ 8 3 1 $1 3 $3 4 8 $2 5 Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 5 4 5 4 8 1 8 3 5 0 0 0 5 5 0 5 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 1 6 5 2 $2 3 $3 6 8 $2 7 9 0 0 0 9 0 8 2 5 0 0 0 5 5 0 5 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 157 PROBLEM 20–10 PERCULA FARMS (concluded) Operating income with new heating and lighting equipment: Number of salable fish sale price Total revenue Variable costs: Eggs Feedings Water changes Heating and lighting Total variable costs Total contribution margin Fixed costs: Operating income 158 Clownfish 1 0 5 0 0 0 $ 4 $4 2 0 0 0 0 Angelfish 5 5 0 0 0 $ 1 0 $5 5 0 0 0 0 $ $ 7 3 1 $1 2 $2 9 8 $2 0 5 8 5 0 9 0 8 2 5 7 0 5 7 2 0 2 0 5 0 0 5 5 0 5 0 0 0 0 0 0 0 0 9 1 5 0 1 0 0 1 5 $2 7 4 $2 7 5 8 8 $1 8 7 5 0 0 0 5 5 0 5 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 © The McGraw-Hill Companies, Inc., 2005 35 Minutes, Strong a. b. PROBLEM 20–11 LIFEFIT PRODUCTS Contribution margins of product lines: Shoes ($15 contribution margin $50 sales price) Shorts ($4 contribution margin $5 sales price) 30 % 8 0% (1) Average contribution margin ratio: From shoes (30% contribution margin 80% of sales mix) From shorts (80% contribution margin 20% of sales mix) Average contribution margin ratio 2 4% 1 6% 4 0% (2) Monthly operating income: Total sales Average contribution margin ratio Total contribution margin ($1,000,000 40%) Less: Fixed costs and expenses Operating income (3) Monthly break-even sales volume (in dollars): Fixed costs and expenses Average contribution margin ratio Break-even sales volume ($378,000 40%) c. $10 0 0 0 0 4 $ 4 0 0 0 0 3 7 8 0 0 $ 2 2 0 0 $ $ Assuming new sales mix (shoes, 70%; shorts, 30%) (1) Average contribution margin ratio: From shoes (30% contribution margin 70% of sales) From shorts (80% contribution margin 30% of sales) Average contribution margin ratio (2) Monthly operating income: Total sales Average contribution margin ratio Total contribution margin ($1,000,000 45%) Less: Fixed costs and expenses (3) Monthly break-even sales volume (in dollars): Fixed costs and expenses Average contribution margin ratio Break-even sales volume ($378,000 45%) Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 0 0% 0 0 0 3 7 8 0 0 0 4 0% 9 4 5 0 0 0 2 1% 2 4% 4 5% $10 0 0 0 0 4 $ 4 5 0 0 0 3 7 8 0 0 $ 7 2 0 0 $ $ 0 5% 0 0 0 3 7 8 0 0 0 4 5% 8 4 0 0 0 0 159 PROBLEM 20–11 LIFEFIT PRODUCTS (concluded) d. In the new sales mix, increased sales of shorts have replaced some sales of shoes. Shorts have a much higher contribution margin than shoes. Thus, at a given sales volume, selling shorts instead of shoes provides more contribution margin, contributes more toward operating income, and lowers the sales volume required to break even. 160 © The McGraw-Hill Companies, Inc., 2005 SOLUTIONS TO CASES 20 Minutes, Medium CASE 20–1 MULTIPLE PERSPECTIVES— ATTEND OUR SEMINAR The following are possible reasons you could give each of the individuals to motivate them to come to your seminar: The factory worker who serves as her company’s labor union representative in charge of contract negotiations Knowledge of budgeting and budget processes is a source of empowerment in most organizations. When it comes to negotiating a labor contract, lack of budgetary knowledge can put one at a distinct disadvantage. The factory’s labor union representative will be directly involved in determining one of the company’s largest variable costs—its direct labor. An understanding of cost-volume-profit relationships will enable her to better evaluate the impact of her wage requests on the company’s performance and to better scrutinize what management says they can or cannot do. The purchasing agent in charge of ordering raw materials for a large manufacturing company The purchasing agent is also directly involved with one of the company’s largest variable costs—raw materials inventory. Having a general knowledge of cost-volume-profit relationships will help him to better understand the impact of his actions on company performance. For example, what is the impact on operating income of receiving large quantity discounts from a major supplier? What is the effect of receiving purchase discounts for prompt payment to all vendors? What is the effect on operating income of selecting one supplier over another? What is the net effect of paying a premium for high-quality raw materials given a resulting reduction in waste and scrap? The vice president of sales for a large automobile company The vice president of sales plays a critical role in determining her company’s operating performance. A knowledge of cost-volume-profit relationships will help her to evaluate important questions related to the decisions she must make. For example, given that a target income for the company has been imposed, what sales quotas must she establish for her dealers? Or, conversely, by imposing an established sales quota on the company’s dealers, what changes in operating income can be expected? Given an expected level of sales, how will fixed and variable production costs be affected? The director of research and development for a pharmaceutical company Each year, the director of research and development must request budgetary funding for the development of new products. Investment in research and development represents a significant fixed cost for most pharmaceutical companies. A general understanding of cost-volume-profit relationships will help the director to defend his budget request. By how much will new products increase total sales? What are the variable and fixed costs associated with bringing a new product to market? What is the effect of those costs on operating income? Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 161 40 Minutes, Strong CASE 20–2 DON’T MESS WITH THE PURPLE COW a. Sales (in gallons) required to earn $10,000 per month: Sales (in gallons) required to break even .......................................................................... Sales (in gallons) beyond break-even point required to earn $10,000 per month, $10,000 $7.80 ($8.00 $0.20 bonus) ............................................................................. Sales (in gallons) required to earn $10,000 per month .................................................... b. Projected monthly results for typical drive-in store: Average selling price per gallon ............................................................ Less: Variable cost per gallon ............................................................... Contribution margin per gallon ............................................................ Estimated sales (gallons): If selling price is reduced, 3,000 120% .......................................... If selling price is not reduced, 3,000 110% ................................... Total contribution margin earned ........................................................ Less: Total fixed costs per month ........................................................ Additional fixed cost—advertising............................................. Projected monthly operating income ................................................... Monthly break-even point (in gallons): Total fixed costs per month ............................................................... Contribution margin per gallon ........................................................ Monthly break-even point (total fixed costs contribution margin per gallon) ............................................................................................. (1) Reduce Selling Price $12.80 6.80 $ 6.00 3,600 1,500 1,282 2,782 (2) Increase Advertising Expense $14.80 6.80 $ 8.00 $ 9,600 3,300 $ 26,400 (12,000) (3,000) $ 11,400 $ 12,000 $ 15,000 $ 21,600 (12,000) $6.00 2,000 gallons $8.00 1,875 gallons c. Memo to Management: RE: Alternative marketing proposals: price reductions or additional advertising The Purple Cow should adopt neither of the two proposed marketing strategies. Of these strategies, the increased advertising would be preferable to the reductions in sales prices, as indicated by the computations of projected operating income (part b). However, neither approach is projected to achieve a higher operating income than is currently being achieved with the strategy of paying managers a bonus of 20 cents per gallon for sales in excess of the break-even point. The current profitability of a typical Purple Cow drive-in facility is summarized below. Sales volume in excess of break-even point (in gallons) (3,000 gallons, less 1,500-gallon break-even point)...................................................................................... 1,500 Contribution margin per unit of sales over the break-even point ($14.80 sales price, less $6.80 variable costs, less $0.20 per gallon manager’s bonus) ..................................... $7.80 Operating income under current conditions (1,500 gallons $7.80 per gallon) ............... $11,700 This amount exceeds by $300 the projected monthly operating income from the better of the two proposed new marketing strategies. 162 © The McGraw-Hill Companies, Inc., 2005 20 Minutes, Medium CASE 20–3 BUSINESS WEEK ASSIGNMENT COST-VOLUME-PROFIT AT PUMA AG a. The relationships identified include a reference to volume when discussing the large U.S. market. In addition, note the reference to high contribution margin “style” products and the reference to product mix. b. The product mix will help dampen the risk associated with “style” based products because Puma has products that are in the more stable, well-established sporting goods markets. Traditional sporting goods markets are less affected by trend and style and more affected by performance. Thus, by not having all products in the risky high style markets, Puma is able to minimize the risk to their profits of operating in those style markets. Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 163 SOLUTION TO INTERNET ASSIGNMENT 30 Minutes, Medium INTERNET 20–1 FORD MOTOR COMPANY a. The total number of vehicles sold is calculated by adding together the categories of cars and trucks for worldwide operations. b. The average manufacturing cost per vehicle can be calculated by dividing the cost of goods sold amount by the number of vehicles sold. The average revenue per vehicle can be calculated by dividing the revenue from the sale of vehicles by the number of vehicles sold. Average gross profit per vehicle sold is calculated by subtracting the average manufacturing cost per vehicle sold from the average sales revenue per vehicle sold. c. Contribution margin per vehicle equals the average sales revenue minus only the variable costs of manufacturing. Gross profit per vehicle equals average sales revenue minus all the costs (variable and fixed) of manufacturing. d. In general, it is not possible to calculate contribution margins using only data contained in an annual report. There is not sufficient detail given to separate out the variable costs of manufacturing. The inability to calculate contribution margin highlights the differences in information needs between external users of annual report data and internal managers. 164 © The McGraw-Hill Companies, Inc., 2005