3-47 CVP analysis, income taxes, sensitivity. (CMA, adapted) Thompson Engine Company manufactures and sells diesel engines for use in small farming equipment. For its 2017 budget, Thompson Engine Company estimates the following: Selling price $ 7,000 Variable cost per engine $ 2,000 Annual fixed costs $5,560,000 Net income $ 900,000 Income tax rate 40% The first-quarter income statement, as of March 31, reported that sales were not meeting expectations. During the first quarter, only 300 units had been sold at the current price of $7,000. The income statement showed that variable and fixed costs were as planned, which meant that the 2017 annual net income projection would not be met unless management took action. A management committee was formed and presented the following mutually exclusive alternatives to the president: a. Reduce the selling price by 15%. The sales organization forecasts that at this significantly reduced price, 1,400 units can be sold during the remainder of the year. Total fixed costs and variable cost per unit will stay as budgeted. b. Lower variable cost per unit by $750 through the use of less-expensive direct materials. The selling price will also be reduced by $800, and sales of 1,130 units are expected for the remainder of the year. c. Reduce fixed costs by 5% and lower the selling price by 25%. Variable cost per unit will be unchanged. Sales of 1,500 units are expected for the remainder of the year. 1. If no changes are made to the selling price or cost structure, determine the number of units that Thompson Engine Company must sell (a) to break even and (b) to achieve its net income objective. 2. Determine which alternative Thompson Engine Company should select to achieve its net income objective. Show your calculations.
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
3-47 CVP analysis, income taxes, sensitivity. (CMA, adapted) Thompson Engine Company manufactures
and sells diesel engines for use in small farming equipment. For its 2017 budget, Thompson Engine Company
estimates the following:
Selling price $ 7,000
Variable cost per engine $ 2,000
Annual fixed costs $5,560,000
Net income $ 900,000
Income tax rate 40%
The first-quarter income statement, as of March 31, reported that sales were not meeting expectations.
During the first quarter, only 300 units had been sold at the current price of $7,000. The income statement
showed that variable and fixed costs were as planned, which meant that the 2017 annual net income projection
would not be met unless management took action. A management committee was formed and presented
the following mutually exclusive alternatives to the president:
a. Reduce the selling price by 15%. The sales organization
price, 1,400 units can be sold during the remainder of the year. Total fixed costs and variable cost per
unit will stay as budgeted.
b. Lower variable cost per unit by $750 through the use of less-expensive direct materials. The selling
price will also be reduced by $800, and sales of 1,130 units are expected for the remainder of
the year.
c. Reduce fixed costs by 5% and lower the selling price by 25%. Variable cost per unit will be unchanged.
Sales of 1,500 units are expected for the remainder of the year.
1. If no changes are made to the selling price or cost structure, determine the number of units
that Thompson Engine Company must sell (a) to break even and (b) to achieve its net income
objective.
2. Determine which alternative Thompson Engine Company should select to achieve its net income objective.
Show your calculations.
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