Astro Co. sold 19,800 units of its only product and incurred a $48,292 loss (ignoring taxes) for the current year, as shown here. During a planning session for year 2020’s activities, the production manager notes that variable costs can be reduced 50% by installing a machine that automates several operations. To obtain these savings, the company must increase its annual fixed costs by $148,000. The maximum output capacity of the company is 40,000 units per year.
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.
Astro Co. sold 19,800 units of its only product and incurred a $48,292 loss (ignoring taxes) for the current year, as shown here. During a planning session for year 2020’s activities, the production manager notes that variable costs can be reduced 50% by installing a machine that automates several operations. To obtain these savings, the company must increase its annual fixed costs by $148,000. The maximum output capacity of the company is 40,000 units per year.
| ASTRO COMPANY Contribution Margin Income Statement For Year Ended December 31, 2019 |
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| Sales | $ | 738,540 | |||
| Variable costs | 590,832 | ||||
| Contribution margin | 147,708 | ||||
| Fixed costs | 196,000 | ||||
| Net loss | $ | (48,292 | ) | ||
Compute the sales level required in both dollars and units to earn $180,000 of target pretax income in 2020 with the machine installed and no change in unit sales price
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