tratford Company distributes a lightweight lawn chair that sells for $15 per unit. Variable expenses are $6 per unit, and fixed expenses total $180,000 annually. Required: Answer the following independent questions: 1. What is the product’s CM ratio? 2. Use the CM ratio to determine the break-even point in sales dollars. 3. The company estimates that sales will increase by
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.
Stratford Company distributes a lightweight lawn chair that sells for $15 per unit. Variable expenses are $6 per unit, and fixed expenses total $180,000 annually.
Required:
Answer the following independent questions:
1. What is the product’s CM ratio?
2. Use the CM ratio to determine the break-even point in sales dollars.
3. The company estimates that sales will increase by $45,000 during the coming year due to increased demand. By how much should net operating income increase?
4. Assume that the operating results for last year were as follows:
Sales . . . . . . . . . . . . . . . . . . . . . . . $360,000
Variable expenses. . . . . . . . . . . . . 144,000
Contribution margin . . . . . . . . . . . . 216,000
Fixed expenses . . . . . . . . . . . . . . . 180,000
Net operating income . . . . . . . . . . $ 36,000
Sales (13,500 units at $20 per unit) . . . . . . . $270,000
Variable expenses . . . . . . . . . . . . . . . . . . . . 189,000
Contribution margin . . . . . . . . . . . . . . . . . . . 81,000
Fixed expenses . . . . . . . . . . . . . . . . . . . . . . 90,000
Net operating loss . . . . . . . . . . . . . . . . . . . . $ (9,000)
a. Compute the degree of operating leverage at the current level of sales.
b. The president expects sales to increase by 15% next year. By how much should net operating income increase?
5. Refer to the original data. Assume that the company sold 28,000 units last year. The sales manager is convinced that a 10% reduction in the selling price, combined with a $70,000 increase in advertising expenditures, would increase annual unit sales by 50%. Prepare two contribution format income statements, one showing the results of last year’s operations and
one showing what the results of operations would be if these changes were made. Would you recommend that the company do as the sales manager suggests?
6. Refer to the original data. Assume again that the company sold 28,000 units last year. The president feels that it would be unwise to change the selling price. Instead, he wants to increase the sales commission by $2 per unit. He thinks that this move, combined with some increase in advertising, would double annual unit sales. By how much could advertising be increased with profits remaining unchanged? Do not prepare an income statement; use the incremental analysis approach.
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