Pacheco Winery produces 800,000 bottles/year of its wine, which it sells wholesale for $1.75/bottle. The winery’s variable costs of production are as follows: Labor, $0.53/bottle; Raw materials, $0.55/bottle; and Bottle hardware (i.e., bottles, corks, foil, and labels), $0.17/bottle. Pacheco’s fixed annual costs are as follows: Selling expenses, $45,000; general & administrative expenses, $115,000; Depreciation expense, $47,000; other fixed expenses, $75,000. Interest expense is $41,000/year. Provide an annual income statement for producing 800,000 bottles/year. Include the winery’s gross profit (i.e., annual dollar sales minus variable costs of production), earnings before interest and taxes (EBIT), earnings before taxes (EBT), earnings after taxes (EAT). At the bottom of the income statement, add (1) the sales and cost data on which the analysis is based, the number of units for the earnings before interest and taxes to equal zero (EBIT = 0) calculated by the algebraic method, and the pre-tax percentage return on sales (i.e., EBT/annual $ sales)
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.
Pacheco Winery produces 800,000 bottles/year of its wine, which it sells wholesale for $1.75/bottle.
The winery’s variable costs of production are as follows: Labor, $0.53/bottle; Raw materials, $0.55/bottle; and Bottle hardware (i.e., bottles, corks, foil, and labels), $0.17/bottle.
Pacheco’s fixed annual costs are as follows: Selling expenses, $45,000; general & administrative expenses, $115,000;
- Provide an annual income statement for producing 800,000 bottles/year. Include the winery’s gross profit (i.e., annual dollar sales minus variable costs of production), earnings before interest and taxes (EBIT), earnings before taxes (EBT), earnings after taxes (EAT). At the bottom of the income statement, add (1) the sales and cost data on which the analysis is based, the number of units for the earnings before interest and taxes to equal zero (EBIT = 0) calculated by the algebraic method, and the pre-tax percentage return on sales (i.e., EBT/annual $ sales). (Use a tax rate of 40% to calculate tax and EAT.)
- Show the values for gross profit, EBIT, EBT, EAT, and the pre-tax percentage return on sales if the winery sells only the number of bottles required for the earnings before taxes to equal zero (EBT = 0). Do this part of the problem in the next column of your worksheet after the results for part a so that the results for parts a and b can be easily compared. Include the break-even point on your worksheet.
- Show the values for gross profit, EBIT, EBT, EAT, and pre-tax percentage return on sales if the winery increases its production and sales to 850,000 bottles/year and all other input data remains the same. Do this in the next column after part b. Include the break-even point on your worksheet.
- If the winery increases its sales to 850,000 bottles/year, what should be its selling price ($/bottle) if it wants to achieve a pre-tax return on sales of 11.00%? (Assume all other input data remains the same.) Include the values for gross profit, EBIT, EBT, EAT, and pre-tax percentage return on sales. Do this in the next column after part c. Include the break-even point on your worksheet.
- The management of Pacheco Winery is concerned about the impact of changes in the cost of material on their return on sales. Prepare a one-variable input table to analyze the sensitivity of the pre-tax percentage return on sales to changes in the raw material cost. Use raw material costs of $0.52, $0.54, $0.56, $0.58, and $0.60/bottle and sales of 850,000 bottles/year at the wholesale price determined in part d. (Assume all other input data remains the same.) Place the one-variable input table below the work for parts a to d.
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