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Hilton 13e SM Ch07

This document summarizes key concepts from Chapter 7 of a managerial accounting textbook, including: - Cost-volume-profit analysis examines the relationship between sales volume, costs, and profits. It can be used to calculate the break-even point and analyze how changes in variables affect profits. - The contribution margin is sales revenue minus variable costs and represents the contribution to fixed costs and profits. - Cost-volume-profit graphs show how profits change with sales volume and can indicate target profit levels. - Operating leverage compares total contribution margin to net income and indicates how much profits increase with sales volume changes due to high fixed costs.

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0% found this document useful (0 votes)
265 views72 pages

Hilton 13e SM Ch07

This document summarizes key concepts from Chapter 7 of a managerial accounting textbook, including: - Cost-volume-profit analysis examines the relationship between sales volume, costs, and profits. It can be used to calculate the break-even point and analyze how changes in variables affect profits. - The contribution margin is sales revenue minus variable costs and represents the contribution to fixed costs and profits. - Cost-volume-profit graphs show how profits change with sales volume and can indicate target profit levels. - Operating leverage compares total contribution margin to net income and indicates how much profits increase with sales volume changes due to high fixed costs.

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You are on page 1/ 72

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:

b. In the equation approach, the following profit equation is used:

fixed
expense
s
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.
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.

Managerial Accounting, 13/e7-1


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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.
(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.
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

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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.
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.
7-19 Budgeting begins with a sales forecast. Cost-volume-profit 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.

Managerial Accounting, 13/e7-3


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Company A Company B

Sales revenue:
350 units at $10 $3,500
100 units at $20 $2,000
Variable expenses:
350 units at $6 2,100
100 units at $6 600
Contribution margin $1,400 $1,400
Fixed expenses 1,000 1,000
Profit $ 400 $ 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 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.

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SOLUTIONS TO EXERCISES
EXERCISE 7-23 (25 MINUTES)

Total Break-Even
Sales Variable Contribution Fixed Net Sales
Revenue Expenses Margin Expenses Income Revenue
1 $160,000a $40,000 $120,000 $30,000 $90,000 $40,000
2 80,000 65,000 15,000 15,000b -0- 80,000
3 120,000 40,000 80,000 30,000 50,000 45,000c
4 110,000 22,000 88,000 50,000 38,000 62,500d

Explanatory notes for selected items:


a
Break-even sales revenue $40,000
Fixed expenses 30,000
Variable expenses $10,000

Therefore, variable expenses are 25 percent of sales revenue.

When variable expenses amount to $40,000, sales revenue is $160,000.


b
$80,000 is the break-even sales revenue, so fixed expenses must be equal to the
contribution margin of $15,000 and profit must be zero.

$45,000 = $30,000 ÷ (2/3), where 2/3 is the contribution-margin ratio.


c

d
$62,500 = $50,000/.80, where .80 is the contribution-margin ratio.

EXERCISE 7-24 (20 MINUTES)

1. Break-even point (in units) =

= = 8,000 pizzas

2. Contribution-margin ratio =

= = .5

Managerial Accounting, 13/e7-5


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EXERCISE 7-24 (CONTINUED)

3. Break-even point (in sales dollars) =

= = $80,000
4. Let X denote the sales volume of pizzas required to earn a target net profit of
$65,000.
$10X – $5X – $40,000= $65,000
$5X = $105,000
X = 21,000 pizzas

EXERCISE 7-25 (25 MINUTES)

1. Break-even point (in units) =

= = 4,000 components
p denotes Argentina’s peso

2. New break-even point (in units) =

= = 4,400 components
3. Sales revenue (5,000 × 3,000p) 15,000,000p
Variable costs (5,000 × 2,000p) 10,000,000p
Contribution margin 5,000,000p
Fixed costs 4,000,000p
Net income 1,000,000p

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EXERCISE 7-25 (CONTINUED)

4. New break-even point (in units) =


= 8,000 components
5. Analysis of price change decision:
Price
3,000p 2,500p
Sales revenue: (5,000 × 3,000p) 15,000,000p
(6,200 × 2,500p) 15,500,000p
Variable costs: (5,000 × 2,000p)
(6,200 × 2,000p) Contribution margin 10,000,000p 12,400,000p
Fixed expenses 3,100,000p
Net income (loss) 4,000,000p
5,000,000p (900,000p)

4,000,000p

1,000,000p

The price cut should not be made, since projected net income will decline.

Managerial Accounting, 13/e7-7


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EXERCISE 7-26 (25 MINUTES)

1. Cost-volume-profit graph:

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Dollars per year
Total revenue
$300,000

Break-even point:
$250,000 20,000 tickets
Total expenses
Profit
area Variable
$200,000 expense
(at 30,000
tickets)

$150,000

$100,000 Loss area Annual


fixed
expenses

$50,000

Tickets
sold per
5,000 10,000 15,000 20,000 25,000 30,000 year

Managerial Accounting, 13/e7-9


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7-10 Solutions Manual
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EXERCISE 7-26 (CONTINUED)

2. Stadium capacity 10,000


Attendance rate × 50%
Attendance per game 5,000

The team must play 4 games to break even.

Managerial Accounting, 13/e7-11


© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
EXERCISE 7-27 (25 MINUTES)

1. Profit-volume graph:

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Dollars per year

$150,000

$100,000

$50,000
Break-even point:
20,000 tickets

0 Tickets sold
5,000 10,000 15,000 20,000 25,000 per year
Profit
area
Loss
area
$(50,000)

$(100,000)

Annual fixed
expenses
$(150,000)

$(180,000)

Managerial Accounting, 13/e7-13


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7-14 Solutions Manual
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EXERCISE 7-27 (CONTINUED)

2. Safety margin:

Budgeted sales revenue


(12 games × 10,000 seats × .30 full × $10) $360,000
Break-even sales revenue
(20,000 tickets × $10) 200,000
Safety margin $160,000

3. Let P denote the break-even ticket price, assuming a 12-game season and 50 percent
attendance:

(12)(10,000)(.50)P – (12)(10,000)(.50)($1) – $180,000 = 0


60,000P = $240,000
P = $4 per ticket

Managerial Accounting, 13/e7-15


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EXERCISE 7-28 (25 MINUTES)

1. (a) Traditional income statement:


EUROPA PUBLICATIONS, INC.
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 20XX
Sales $2,000,000
Less: Cost of goods sold 1,500,000
Gross margin $ 500,000
Less: Operating expenses:
Selling expenses $150,000
Administrative expenses 150,000 300,000
Net income $ 200,000

(b) Contribution income statement:


EUROPA PUBLICATIONS, INC.
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 20XX
Sales $2,000,000
Less: Variable expenses:
Variable manufacturing $1,000,000
Variable selling 100,000
Variable administrative 30,000 1,130,000
Contribution margin $ 870,000
Less: Fixed expenses:
Fixed manufacturing $ 500,000
Fixed selling 50,000
Fixed administrative 120,000 670,000
Net income $ 200,000

2.

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EXERCISE 7-28 (CONTINUED)

3.

= 10% × 4.35
= 43.5%

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)

1.
Sales Unit Unit
Bicycle Type Price Variable Cost Contribution Margin
High-quality $500 $300 ($275 + $25) $200
Medium-quality 300 150 ($135 + $15) 150

2. Sales mix:

High-quality bicycles 25%


Medium-quality bicycles 75%

3. Weighted-average unit
contribution margin = ($200 × 25%) + ($150 × 75%)
= $162.50
4.

Break-Even Sales
Bicycle Type Sales Volume Sales Price Revenue
High-quality bicycles 100 (400 × .25) $500 $ 50,000
Medium-quality bicycles 300 (400 × .75) 300 90,000
Total $140,000

EXERCISE 7-29 (CONTINUED)

Managerial Accounting, 13/e7-17


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5. Target net income:

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 175 (700 × .25)
Medium-quality 525 (700 × .75)

EXERCISE 7-30 (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.

EXERCISE 7-31 (25 MINUTES)

1. The following income statement, often called a common-size income statement,


provides a convenient way to show the cost structure.

Amount Percent
Revenue $500,000 100
Variable expenses 300,000 60
Contribution margin $200,000 40
Fixed expenses 150,000 30
Net income $ 50,000 10

2.
Decrease in Contribution Margin Decrease in
Revenue Percentage Net Income
$75,000* × 40%† = $30,000

*$75,000 = $500,000 × 15%



40% = $200,000/$500,000

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EXERCISE 7-31 (CONTINUED)

3.

4.

EXERCISE 7-32 (10 MINUTES)

Requirement (1) Requirement (2)


Revenue $600,000 $ 500,000
Less:Variable expenses 360,000 600,000
Contribution margin $240,000 $ (100,000)
Less:Fixed expenses 210,000 125,000
Net Income (loss) $ 30,000 $ (225,000)

EXERCISE 7-33 (20 MINUTES)

1.

target after−tax net income $ 48,000


2. Target before−tax income= = =$ 64,000
1−tax rate 1−.25

Managerial Accounting, 13/e7-19


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EXERCISE 7-33 (CONTINUED)
target after −tax net income $ 48,000
¿ expenses+ $ 120,000+
3. Service revenue required to earn (1−t) 1−.25
¿ = =$
target after-tax income of $48,000 contribution margin ratio .20

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.

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SOLUTIONS TO PROBLEMS
PROBLEM 7-34 (30 MINUTES)

1. Break-even point in units, using the equation approach:

$16X – ($10 + $2)X – $600,000 = 0


$4X = $600,000

X =

= 150,000 units

2. New projected sales volume = 200,000 × 110%


= 220,000 units
Net income = (220,000)($16 – $12) – $600,000

= (220,000)($4) – $600,000

= $880,000 – $600,000 = $280,000

3. Target net income = $200,000 (from original problem data)

New disk purchase price = $10 × 130% = $13

Volume of sales dollars required:

Volume of sales dollars required

Managerial Accounting, 13/e7-21


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PROBLEM 7-34 (CONTINUED)

4. Let P denote the selling price that will yield the same contribution-margin ratio:

Check: New contribution-margin ratio is:

5. The Build a Spreadsheet Excel file can be downloaded from the Connect Instructor
Library: Build a Spreadsheet 07-34.xls

PROBLEM 7-35 (30 MINUTES)

1. Break-even point in sales dollars, using the contribution-margin ratio:

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PROBLEM 7-35 (CONTINUED)

2. Target net income, using contribution-margin approach:

3. New unit variable manufacturing cost = $8 × 110%


= $8.80
Break-even point in sales dollars:

4. Let P denote the selling price that will yield the same contribution-margin ratio:

Check: New contribution-margin ratio is:

PROBLEM 7-36 (30 MINUTES)

Managerial Accounting, 13/e7-23


© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
1. Unit contribution margin:
Sales price………………………………… $64.00
Less variable costs:
Sales commissions ($64 x 5%)…… $ 3.20
System variable costs……………… 16.00 19.20
Unit contribution margin……………….. $44.80

Break-even point = fixed costs ÷ unit contribution margin


= $985,600 ÷ $44.80
= 22,000 units

2. Model no. 4399 is more profitable when sales and production average 46,000 units.

Model Model
No. 6754 No. 4399

Sales revenue (46,000 units x $64.00)……... $2,944,000 $2,944,000


Less variable costs:
Sales commissions ($2,944,000 x 5%)… $ 147,200 $ 147,200
System variable costs:……………………
46,000 units x $16.00…………………. 736,000
46,000 units x $12.80…………………. 588,800
Total variable costs……………………….. $ 883,200 $ 736,000
Contribution margin…………………………... $2,060,800 $2,208,000
Less: Annual fixed costs…………………….. 985,600 1,113,600
Net income……………………………………… $1,075,200 $1,094,400

3. Annual fixed costs will increase by $90,000 ($450,000 ÷ 5 years) because of straight-
line depreciation associated with the new equipment, to $1,203,600 ($1,113,600 +
$90,000). The unit contribution margin is $48 ($2,208,000 ÷ 46,000 units). Thus:

Required sales = (fixed costs + target net profit) ÷ unit contribution margin
= ($1,203,600 + $956,400) ÷ $48
= 45,000 units

4. Let X = volume level at which annual total costs are equal


$16.00X + $985,600 = $12.80X + $1,113,600
$3.20X = $128,000
X = 40,000 units

PROBLEM 7-37 (35 MINUTES)

7-24 Solutions Manual


© McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.
1. Current income:

Sales revenue………………………... $3,360,000


Less: Variable costs………………… $ 840,000
Fixed costs……………………. 2,280,000 3,120,000
Net income……………………………. $ 240,000

Advanced Electronics has a contribution margin of $60 [($3,360,000 - $840,000) ÷


42,000 sets] and desires to increase income to $480,000 ($240,000 x 2). In addition,
the current selling price is $80 ($3,360,000 ÷ 42,000 sets). Thus:

Required sales = (fixed costs + target net profit) ÷ unit contribution margin
= ($2,280,000 + $480,000) ÷ $60
= 46,000 sets, or $3,680,000 (46,000 sets x $80)

2. If operations are shifted to Mexico, the new unit contribution margin will be $62 ($80 -
$18). Thus:

Break-even point = fixed costs ÷ unit contribution margin


= $1,984,000 ÷ $62
= 32,000 units

3. (a) Advanced Electronics desires to have a 32,000-unit break-even point with a


$60 unit contribution margin. Fixed cost must therefore drop by $360,000
($2,280,000 - $1,920,000), as follows:

Let X = fixed costs


X ÷ $60 = 32,000 units
X = $1,920,000

(b) As the following calculations show, Advanced Electronics will have to


generate a contribution margin of $71.25 to produce a 32,000-unit break-even
point. Based on an $80.00 selling price, this means that the company can
incur variable costs of only $8.75 per unit. Given the current variable cost of
$20.00 ($80.00 - $60.00), a decrease of $11.25 per unit ($20.00 - $8.75) is
needed.

Let X = unit contribution margin


$2,280,000 ÷ X = 32,000 units
X = $71.25

PROBLEM 7-37 (CONTINUED

Managerial Accounting, 13/e7-25


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4. (a) Increase

(b) No effect

(c) Increase

(d) No effect

PROBLEM 7-38 (40 MINUTES)

1. Sales mix refers to the relative proportion of each product sold when a company
sells more than one product.

2. (a) Yes. Plan A sales are expected to total 65,000 units (45,500 + 19,500), 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, Deluxe sales will comprise a greater proportion of
total sales under Plan A. This is not surprising in light of the fact that Deluxe
has a higher selling price than Basic ($86 vs. $74).

Current Plan A

Sales Sales
Units Mix Units Mix

Deluxe……... 39,000 65% 45,500 70%


Basic………. 21,000 35% 19,500 30%
Total 60,000 100% 65,000 100%

(c) Yes. Commissions will total $535,600 ($5,356,000 x 10%), which compares
favorably against the current flat salaries of $400,000.

Deluxe sales: 45,500 units x $86… $3,913,000


Basic sales: 19,500 units x $74….. 1,443,000
Total………………………………. $5,356,000

PROBLEM 7-38 (CONTINUED)

(d) No. The company would be less profitable under the new plan.

Current Plan A

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Sales revenue:
Deluxe: 39,000 units x $86; 45,500 units x $86… $3,354,000 $3,913,000
Basic: 21,000 units x $74; 19,500 units x $74….. 1,554,000 1,443,000
Total revenue……………………………………. $4,908,000 $5,356,000
Less variable cost:
Deluxe: 39,000 units x $65; 45,500 units x $65… $2,535,000 $2,957,500
Basic: 21,000 units x $41; 19,500 units x $41….. 861,000 799,500
Sales commissions (10% of sales revenue)……. 535,600
Total variable cost……………………………… $3,396,000 $4,292,600
Contribution margin…………………………………….. $1,512,000 $1,063,400
Less fixed cost (salaries)………………………………. 400,000 ----
Net income………………………………………………... $1,112,000 $1,063,400

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. Deluxe has a contribution margin of $21 ($86 - $65),
and Basic has a contribution margin of $33 ($74 - $41).

Plan A Plan B

Sales Sales
Units Mix Units Mix

Deluxe……... 45,500 70% 26,000 40%


Basic………. 19,500 30% 39,000 60%
Total…… 65,000 100% 65,000 100%

PROBLEM 7-38 (CONTINUED)

(b) Plan B is more attractive both to the sales force and to the company.
Salespeople earn more money under this arrangement ($549,900 vs. $400,000)
and the company is more profitable ($1,283,100 vs. $1,112,000).

Current Plan B
Sales revenue:
Deluxe: 39,000 units x $86; 26,000 units x $86… $3,354,000 $2,236,000
Basic: 21,000 units x $74; 39,000 units x $74….. 1,554,000 2,886,000
Total revenue……………………………………. $4,908,000 $5,122,000
Less variable cost:
Deluxe: 39,000 units x $65; 26,000 units x $65… $2,535,000 $1,690,000
Basic: 21,000 units x $41; 39,000 units x $41….. 861,000 1,599,000
Total variable cost……………………………… $3,396,000 $3,289,000
Contribution margin…………………………………….. $1,512,000 $1,833,000

Managerial Accounting, 13/e7-27


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Less: Sales force compensation:
Flat salaries…………………………………………... 400,000
Commissions ($1,833,000 x 30%)………………… 549,900
Net income ……………………………………………….. $1,112,000 $1,283,100

PROBLEM 7-39 (35 MINUTES)

1. Plan A break-even point = fixed costs ÷ unit contribution margin


= $22,000 ÷ $22*
= 1,000 units

Plan B break-even point = fixed costs ÷ unit contribution margin


= $66,000 ÷ $30**
= 2,200 units

* $80 - [($80 x 10%) + $50]


** $80 - $50

2. Operating leverage refers to the use of fixed costs in an organization’s 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.

PROBLEM 7-39 (CONTINUED)

3. Calculation of contribution margin and profit at 6,000 units of sales:

Plan A Plan B

Sales revenue: 6,000 units x $80………………. $480,000 $480,000


Less variable costs:
Cost of purchasing product:
6,000 units x $50…………………….…… $300,000 $300,000
Sales commissions: $480,000 x 10%……... 48,000 ----
Total variable cost……………………….. $348,000 $300,000
Contribution margin……………………………… $132,000 $180,000
Fixed costs…………………………………………. 22,000 66,000
Net income…………………………………………. $110,000 $114,000

Operating leverage factor = contribution margin ÷ net income


Plan A: $132,000 ÷ $110,000 = 1.2
Plan B: $180,000 ÷ $114,000 = 1.58 (rounded)

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Plan B has the higher operating leverage factor.

4 & 5. Calculation of profit at 5,000 units:


Plan A Plan B

Sales revenue: 5,000 units x $80………………. $400,000 $400,000


Less variable costs:
Cost of purchasing product:
5,000 units x $50………………………….. $250,000 $250,000
Sales commissions: $400,000 x 10%……... 40,000 ----
Total variable cost……………………….. $290,000 $250,000
Contribution margin……………………………… $110,000 $150,000
Fixed costs………………………………………… 22,000 66,000
Net income…………………………………………. $ 88,000 $ 84,000

Plan A profitability decrease:


$110,000 - $88,000 = $22,000; $22,000 ÷ $110,000 = 20%

Plan B profitability decrease:


$114,000 - $84,000 = $30,000; $30,000 ÷ $114,000 = 26.3% (rounded)

PROBLEM 7-39 (CONTINUED)

Consolidated 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 B’s 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

Managerial Accounting, 13/e7-29


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times are good, increases in sales would tend to have a very favorable effect on
earnings in a company with high operating leverage.

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PROBLEM 7-40 (30 MINUTES)

1.

2.

3. Number of sales units required to


earn target net profit

4. Margin of safety = budgeted sales revenue – break-even sales revenue


= (120,000)($25) – $2,250,000 = $750,000

5. Break-even point if direct-labor costs increase by 8 percent:

New unit contribution margin = $25.00 – $10.50 – ($5.00)(1.08) – $3.00 – $1.30


= $4.80

Break-even point

Managerial Accounting, 13/e7-31


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PROBLEM 7-40 (CONTINUED)

6. Contribution margin ratio

Old contribution-margin ratio

Let P denote sales price required to maintain a contribution-margin ratio of .208. Then
P is determined as follows:

Check: New contribution-


margin ratio

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PROBLEM 7-41 (40 MINUTES)

1. CVP graph:

Managerial Accounting, 13/e7-33


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Total revenue
Dollars per year
(in millions)

10
9 Profit
Break-even point: area
8 80,000 units or
$4,000,000 of sales
7
Total expenses
6
5
4
3
Loss
2 area
Fixed expenses
1
Units sold per year
50 100 150 200 (in thousands)

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Managerial Accounting, 13/e7-35
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PROBLEM 7-41 (CONTINUED)

2. Break-even point:

3. Margin of safety = budgeted sales revenue – break-even sales revenue


= $8,000,000 – $4,000,000 = $4,000,000

4. Operating leverage factor


(at budgeted sales)

5. Dollar sales required to


earn target net profit

6. Cost structure:

Amount Percent
Sales revenue $8,000,000 100.0
Variable expenses 2,000,000 25.0
Contribution margin $6,000,000 75.0
Fixed expenses 3,000,000 37.5
Net income $3,000,000 37.5

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PROBLEM 7-42 (35 MINUTES)

1. (a)

(b)

target after −tax net income $ 90,000


¿ costs+ $ 210,000+
2. Number of units of sales required (1−t) (1−.25)
¿ =
to earn target after-tax net income unit contribution margin❑ $3

3. If fixed costs increase by $31,500:

Managerial Accounting, 13/e7-37


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PROBLEM 7-42 (CONTINUED)

4. Profit-volume graph:

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Dollars per year

$750,000

$500,000

Profit
area

$250,000
Break-even point: Units sold
70,000 units per year

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

$(250,000)

$(500,000)

$(750,000)

Managerial Accounting, 13/e7-39


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PROBLEM 7-42 (CONTINUED)
target after −tax net income $ 90,000
¿ costs+ $ 210,000+
5. Number of units of sales (1−t) (1−.2) $ 322,500
¿ = = =
required to earn target unit contribution margin❑ $3 $ 3❑
after-tax net income

6. The Build a Spreadsheet Excel file can be downloaded from the Connect Instructor
Library: Build a Spreadsheet 07-42.xls

PROBLEM 7-43 (40 MINUTES)

1. In order to break even, during the first year of operations, 10,220 clients must visit the
new law office as the following calculations show.

Fixed expenses:
Advertising $ 490,000
Rent (6,000 × $28) 168,000
Property insurance 27,000
Utilities 37,000
Malpractice insurance 180,000
Depreciation ($60,000/4) 15,000
Wages and fringe benefits:
Regular wages
($25 + $20 + $15 + $10) × 16 hours × 360 days $403,200
Overtime wages
(200 × $15 × 1.5) + (200 × $10 × 1.5) 7,500
Total wages $410,700
Fringe benefits at 40% 164,280 574,980
Total fixed expenses $1,491,980

PROBLEM 7-43 (CONTINUED)

Break-even point:
0 = revenue – variable cost – fixed cost
0 = $30X + ($2,000 × .2X × .3)* – $4X – $1,491,980
0 = $30X + $120X – $4X – $1,491,980
$146X = $1,491,980
X = 10,220 clients (rounded)

Managerial Accounting, 13/e7-41


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*Revenue calculation:

$30X represents the $30 consultation fee per client. ($2,000 × .2X × .30) represents the
predicted average settlement of $2,000, 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 − break-even sales revenue

Budgeted (expected) number of clients = 50 × 360 = 18,000

Break-even number of clients = 10,220 (rounded)

Safety margin = [($30 × 18,000) + ($2,000 × 18,000 × .20 × .30)]


– [($30 × 10,220) + ($2,000 × 10,220 × .20 × .30)]
= [$30 + ($2,000 × .20 × .30)] × (18,000 – 10,220)
= $150 × 7,780
= $1,167,000

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PROBLEM 7-44 (45 MINUTES)

1. Break-even point in units:

Calculation of contribution margins:

Computer-Assisted Labor-Intensive
Manufacturing System Production System
Selling price $30.00
$30.00
Variable costs:
Direct material $5.00 $5.60
Direct labor 6.00 7.20
Variable overhead 3.00 4.80
Variable selling cost 2.00 16.00 2.00
19.60
Contribution margin per unit $14.00
$10.40

(a) Computer-assisted manufacturing system:

(b) Labor-intensive production system:

Managerial Accounting, 13/e7-43


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PROBLEM 7-44 (CONTINUED)

2. Celestial Products, Inc. would be indifferent between the two manufacturing


methods at the volume (X) where total costs are equal.

$16X + $2,940,000 = $19.60X + $1,820,000

$3.60X = $1,120,000

X = 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.

5. Celestial Products’ management should consider many other business factors


other than operating leverage before selecting a manufacturing method. Among
these are:

● Variability or uncertainty with respect to demand quantity and selling price.

● The ability to produce and market the new product quickly.

● The ability to discontinue production and marketing of the new product while
incurring the least amount of loss.

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PROBLEM 7-45 (45 MINUTES)

1. Break-even sales volume for each model:

(a) Economy model:

(b) Regular model:

(c) Super model:

Managerial Accounting, 13/e7-45


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PROBLEM 7-45 (CONTINUED)

2. Profit-volume graph:

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Dollars per year (in
thousands)

$20

Pro
fit
Break-even point:
40,816 tubs
$10
Tubs sold
0 10 20 30 40 50 per year
(in thousands)
Loss Profit
area area
Lo
($10)
ss

Fixed rental cost: $20,000 per year


($20)

Managerial Accounting, 13/e7-47


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PROBLEM 7-45 (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 Economy and Regular
models at the sales volume, X, where the total costs are the same.
Variable Cost Total
Model per Tub Fixed Cost
Economy $1.43 $ 8,000
Regular 1.35 11,000

This reasoning leads to the following equation: 8,000 + 1.43X = 11,000 + 1.35X

Rearranging terms yields the following: (1.43 – 1.35)X = 11,000 – 8,000


.08X = 3,000
X = 3,000/.08
X = 37,500
Or, stated slightly differently:

Volume at which both machines


produce the same profit

Check: the total cost is the same with either model if 37,500 tubs are sold.

Economy Regular
Variable cost:
Economy, 37,500 × $1.43 $53,625
Regular, 37,500 × $1.35 $50,625
Fixed cost:
Economy, $8,000 8,000
Regular, $11,000 11,000
Total cost $61,625 $61,625

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

Managerial Accounting, 13/e7-49


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PROBLEM 7-46 (35 MINUTES)

1.

2. Number of sales units required


to earn target net profit

3.

*Annual straight-line depreciation on new machine



$2.00 = $4.50 – $2.50 increase in the unit cost of the new part

4. Number of sales units required


to earn target net profit, given
manufacturing changes

*Last year's profit: ($25)(25,000) – $525,000 = $100,000

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PROBLEM 7-46 (CONTINUED)

5.

*Given in problem.

Let P denote the price required to cover increased direct-material cost and maintain
the same contribution margin ratio:

*Old unit variable cost = $15 = $375,000 ÷ 25,000 units



Increase in direct-material cost = $2

Check:

Managerial Accounting, 13/e7-51


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PROBLEM 7-47 (40 MINUTES)

1. Memorandum

Date: Today

To: Vice President for Manufacturing, Jupiter Game Company

From: I.M. Student, Controller

Subject: Activity-Based Costing

The $150,000 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 $26


Costs that are variable (with respect to sales volume):
Unit variable cost (.8 × $375,000 ÷ 25,000) 12
Unit contribution margin $14

Costs that are fixed (with respect to sales volume):


Setup (300 setups at $50 per setup) $ 15,000
Engineering (800 hours at $28 per hour) 22,400
Inspection (100 inspections at $45 per inspection) 4,500
General factory overhead 166,100
Total $208,000
Fixed selling and administrative costs 30,000
Total costs that are fixed (with respect to sales volume) $238,000

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PROBLEM 7-47 (CONTINUED)

3. Sales (in units) required to show a profit of $140,000:

Number of sales units required


to earn target net profit

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 $140,000 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 ($14 instead of $10) earns a profit at a faster rate. This results
in the firm needing to sell fewer units to reach a given target profit level.

Managerial Accounting, 13/e7-53


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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: Provide decision support information and recommendations that are
accurate, clear, concise, and timely.
(b) Integrity: Refrain from engaging in any conduct that would prejudice carrying out
duties ethically.

(c) Credibility: Communicate information fairly and objectively. Disclose all relevant
information that could reasonably be expected to influence an intended user's
understanding of the reports, analyses, and recommendations.

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PROBLEM 7-48 (25 MINUTES)

1. Closing of Downtown Store:

Loss of contribution margin at Downtown Store


$(36,000)
Savings of fixed cost at Downtown Store (75%) 30,000
Loss of contribution margin at Mall Store (10%)
(4,800)
Total decrease in operating income
$(10,800)

2. Promotional campaign:

Increase in contribution margin (10%) $ 3,600


Increase in monthly promotional expenses ($60,000/12)
(5,000)
Decrease in operating income
$(1,400)

3. Elimination of items sold at their variable cost:

We can restate the November 20x1 data for the Downtown Store as follows:

Downtown Store
Items Sold at
Their
Variable Cost Other Items
Sales $60,000* $60,000*
Less: variable expenses 60,000
24,000
Contribution margin $ -0- $
36,000

If the items sold at their variable cost are eliminated, we have:


Decrease in contribution margin on other items (20%) $
(7,200)
Decrease in fixed expenses (15%) 6,000
Decrease in operating income $
(1,200)

*$60,000 is one half of the Downtown Store's dollar sales for November 20x1.

Managerial Accounting, 13/e7-55


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3. The Build a Spreadsheet Excel file can be downloaded from the Connect Instructor
Library: Build a Spreadsheet 07-48.xls

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PROBLEM 7-49 (45 MINUTES)

1.
CINCINNATI TOOL COMPANY
BUDGETED INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 20X2
Hedge
Weeders Clippers Leaf Blowers Total
Unit selling price $28 $36 $48
Variable manufacturing cost $13 $12 $25
Variable selling cost 5
4 6
Total variable cost $18
$16 $31
Contribution margin per unit $10 $20 $17
Unit sales × 50,000 × 50,000 × 100,000
Total contribution margin $500,000
$1,000,000 $1,700,000 $3,200,000

Fixed manufacturing overhead


$2,000,000
Fixed selling and
administrative costs 600,000
Total fixed costs
$2,600,000
Income before taxes $600,000
Income taxes (40%)
240,000
Budgeted net income $
360,000

2.
(a) (b)
Unit Sales
Contribution Proportion (a) × (b)
Weeders $10 .25 $ 2.50
Hedge Clippers 20 .25 5.00
Leaf Blowers 17 .50 8.50
Weighted-average unit
contribution margin $16.00

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PROBLEM 7-49 (CONTINUED)

Sales proportions:

Sales Total Unit Product Line


Proportion Sales Sales
Weeders .25 162,500 40,625
Hedge Clippers .25 162,500 40,625
Leaf Blowers .50 162,500 81,250
Total 162,500

3.
(a) (b)
Unit Sales
Contribution Proportion (a) × (b)
Weeders $10 .20 $ 2.00
Hedge Clippers* 19 .20 3.80
Leaf Blowers† 12 .60 7.20
Weighted-average unit contribution margin $13.00

*Variable selling cost increases. Thus, the unit contribution decreases to


$19 [$36 – ($12 + $4 + $1)].

The variable manufacturing cost increases 20 percent. Thus, the unit contribution
decreases to $12 [$48 – (1.2 × $25) – $6].

Sales proportions:

Sales Total Unit Product Line


Proportions Sales Sales
Weeders .20 200,000 40,000
Hedge Clippers .20 200,000 40,000
Leaf Blowers .60 200,000 120,000
Total 200,000

Managerial Accounting, 13/e7-59


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PROBLEM 7-50 (45 MINUTES)

1.

2. Projected net income for sales of 2,100 tons:

Projected contribution margin (2,100 × $225) $472,500


Projected fixed costs 247,500
Projected net income $225,000

3. Projected net income including foreign order:


Variable cost per ton = $495,000/1,800 = $275 per ton

Sales price per ton for regular orders = $900,000/1,800 = $500 per ton

Foreign Regular
Order Sales
Sales in tons 1,500 1,500
Contribution margin per ton:
Foreign order ($450 – $275) × $175
Regular sales ($500 – $275) × $225
Total contribution margin $262,500 $337,500

Contribution margin on foreign order $262,500


Contribution margin on regular sales 337,500
Total contribution margin $600,000
Fixed costs 247,500
Net income $352,500

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PROBLEM 7-50 (CONTINUED)

4. New sales territory:

To maintain its current net income, Ohio Limestone Company just needs to break
even on sales in the new territory.

5. Automated production process:

6. Changes in selling price and unit variable cost:

Managerial Accounting, 13/e7-61


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PROBLEM 7-51 (35 MINUTES)

1.

target after −tax net income $ 22,08


¿ expenses+ $ 316,800+
2. Number of units of sales required (1−t) (1−.25
¿ X=
to earn target after-tax income unit contribution margin❑ $ 80.00−$ 52.80

3. Break-even point (in units) for the


mountaineering model

Let Y denote the variable cost of the touring model such that the break-even point
for the touring model is 10,500 units.

Then we have:

Thus, the variable cost per unit would have to decrease by $2.97 ($52.80 – $49.83).

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PROBLEM 7-51 (CONTINUED)

4. $ 316,800× 110 % $ 348,480


New break−even point = = =10,729 units(rounded )
$ 80.00−($ 52.80)(90 %) $ 32.48

5. Weighted-average unit
contribution margin

Break-even point

PROBLEM 7-52 (45 MINUTES)

1. SUMMARY OF EXPENSES

Expenses per Year


(in thousands)
Variable Fixed
Manufacturing $ 7,200 $2,340
Selling and administrative 2,400 1,920
Interest 540
Costs from budgeted income statement $ 9,600 $4,800
If the company employs its own sales force:
Additional sales force costs 2,400
Reduced commissions [(.15 – .10) × $16,000] (800)
Costs with own sales force $ 8,800 $7,200
If the company sells through agents:
Deduct cost of sales force (2,400)
Increased commissions [(.225 – .10) × $16,000] 2,000
Costs with agents paid increased commissions $ 10,800 $4,800

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PROBLEM 7-52 (CONTINUED)

(a)

(b)

Required sales dollars=total ¿ costs+target income before income taxes ¿


2. contribution marginratio

$ 10,800
Contribution marginratio=1− =1−.675=.325 Required sales dollars ¿ earn same net income=
$ 16,000

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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 = total expenses


with agents paid with own sales
increased force
commission

Therefore, at a sales volume of $19,200,000, the


company will earn equal before-tax income under
either alternative. Since before-tax income is the
same, so is after-tax net income.

Managerial Accounting, 13/e7-65


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SOLUTIONS TO CASES
CASE 7-53 (50 MINUTES)

1. The break-even point is 16,900 patient-days calculated as follows:

COMPUTATION OF BREAK-EVEN POINT


IN PATIENT-DAYS: PEDIATRICS
FOR THE YEAR ENDED JUNE 30, 20X2

Total fixed costs:


Medical center charges
$2,900,000
Supervising nurses ($25,000 × 4)
100,000
Nurses ($20,000 × 10)
200,000
Aids ($9,000 × 20) 180,000
Total fixed costs
$3,380,000
Contribution margin per patient-day:
Revenue per patient-day $300
Variable cost per patient-day:
($6,000,000 ÷ $300 = 20,000 patient-days)
($2,000,000 ÷ 20,000 patient-days) 100
Contribution margin per patient-day $200

Break-even point
in patient-days

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CASE 7-53 (CONTINUED)

2. Net earnings would decrease by $606,660, calculated as follows:

COMPUTATION OF LOSS FROM RENTAL


OF ADDITIONAL 20 BEDS: PEDIATRICS
FOR THE YEAR ENDED JUNE 30, 20X2

Increase in revenue
(20 additional beds × 90 days × $300 charge per day) $
540,000

Increase in expenses:
Variable charges by medical center
(20 additional beds × 90 days × $100 per day) $
180,000

Fixed charges by medical center


($2,900,000 ÷ 60 beds = $48,333 per bed, rounded)
($48,333 × 20 beds)
966,660

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) -0-
Total increase in expenses
$1,146,660
Net change in earnings from rental of additional 20 beds $
(606,660)

Managerial Accounting, 13/e7-67


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CASE 7-54 (45 MINUTES)

1. a. In order to break even, Oakley must sell 500 units. This amount represents the
point where revenue equals total costs.

b. In order to achieve its after-tax profit objective, Oakley must sell 2,500 units. This
amount represents the point where revenue equals total costs plus the before-tax
profit objective.

Revenue=variable costs+ ¿ costs+before−tax profit $ 400 X=$ 200 X + $ 100,000+[$ 300,000÷ (1−. 2

2. To achieve its annual after-tax profit objective, Oakley should select the first
alternative, where the sales price is reduced by $40 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 company’s profit objective. Calculations
for the three alternatives follow.

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CASE 7-54 (CONTINUED)

Alternative (1):

Revenue=($ 400)(350)+($ 360)(2,700)=$ 1,112,000 Variable cost =$ 200× 3,050=$ 610,000 Before−ta

Alternative (2):

Revenue=($ 400)(350)+($ 370)(2,200)=$ 954,000 Variable cost =($ 200)(350)+($ 175)(2,200)=$ 455,

Alternative (3):

Revenue=($ 400)(350)+($ 380)(2,000)=$ 900,000 Variable cost =$ 200 × 2,350=$ 470,000 Before−tax

Managerial Accounting, 13/e7-69


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Case 7-55 (50 minutes)
1. Break-even point for 20x2, based on current budget:

2. Break-even point given employment of sales personnel:


New fixed expenses:

Previous fixed expenses $ 100,000


Sales personnel salaries 90,000
Sales manager's salary 160,000
Total $ 350,000

New contribution-margin ratio:

Sales $10,000,000
Cost of goods sold 6,000,000
Gross margin $ 4,000,000
Commissions (at 5%) 500,000
Contribution margin $ 3,500,000

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CASE 7-55 (CONTINUED)

3. Assuming a 25% sales commission:

New contribution-margin ratio:

Sales $10,000,000
Cost of goods sold 6,000,000
Gross margin $ 4,000,000
Commissions (at 25%) 2,500,000
Contribution margin $ 1,500,000

Sales volume in dollars


required to earn after-tax
net income

Check (all figures rounded to the nearest dollar):

Sales $ 13,333,333
Cost of goods sold (60% of sales)
8,000,000
Gross margin $ 5,333,333
Selling and administrative expenses:
Commissions $ 3,333,333
All other expenses (fixed) 100,000
3,433,333
Income before taxes $
1,900,000
Income tax expense (30%)
570,000
Net income $ 1,330,000

Managerial Accounting, 13/e7-71


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CASE 7-55 (CONTINUED)

4. Sales dollar volume at which Niagara Falls 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 company’s 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 – $350,000 = .15X – $100,000

.20X = $250,000

X = $250,000/.20

X = $1,250,000

Thus, the company will have the same before-tax income under the two alternatives
if the sales volume is $1,250,000.

Check:

Alternatives
Employ
Sales Pay 25%
Personnel Commission
Sales $1,250,000 $1,250,000
Cost of goods sold (60% of sales) 750,000 750,000
Gross margin $ 500,000 $500,000
Selling and administrative expenses:
Commissions 62,500* 312,500†
All other expenses (fixed) 350,000 100,000
Income before taxes $ 87,500 $87,500
Income tax expense (30%) 26,250 26,250
Net income $ 61,250 $61,250

*$1,250,000 × 5% = $62,500

$1,250,000 × 25% = $312,500

7-72 Solutions Manual


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