Margin Answer Key

Assignment ch 6. Questions 1. What is meant by a product's contribution margin ratio? How is this ratio useful in planning business operations? Answer The contribution margin ratio is the ratio of contribution margin to total sales revenue. The contribution margin ratio shows the change in contribution margin that will result from a change in total sales. If fixed costs don not change, then a dollar increase in contribution margin will result in a dollar increase in net purposes, knowledge of a product's contribution margin ratio is extremely helpful in forecasting contribution margin and net operating income. 2. Often the most direct route to a business decision is an incremental analysis. What is meant by an incremental analysis? Answer An incremental analysis focuses on the change in revenue, cost, and volume that will result from a particular action. 4. What is meant by the term operating leverage? Answer Operating leverage measures the impact on net operating income of a given percentage changes in sales. The degree of operating leverage at a given level of sales is computed by dividing the contribution margin at that level of sales by the net operating income. 5. What is meant by the term break-even point? Answer Break-even point : The break-even point is the level of sales at which profits are zero. It can also be defined as the point where total revenue equals total cost, and as the point where total contribution margin equals total fixed cost. 7. What is meant by the margin of safety? Answer Margin of safety : The margin of safety is the excess of budgeted (or actual) sales over the break-even volume of sales. It states the amount by which sales can drop before losses begin to be incurred. Exercises 6.1 : Preparing a Contribution Format Income Statement Whirly Corporation’s most recent income statement is shown below : Sales (10,000 units) ..... Variable expenses ..... Contribution margin ... Fixed expenses ..... Net operating income .......... Total Per Unit $350,000 $35.00 200,000 20.00 150,000 $15.00 135,000 $ 15,000 Required: Prepare a new contribution format income statement under each of the following conditions ( COL sider each case independently ) : 1. The sales volume increases by 100 units. 2. The sales volume decreases by 100 units. 3. The sales volume is 9,000 units. Contribution format income statements  This statement is used for identifying net operating income in terms of fixed and variable cost behaviors. It helps the managers in decision making, planning and controlling the internal affairs. Here the contribution approach divides cost into two categories such as fixed and variable cost 1. The sales volume increases by 100 units. Answer Prepare contribution format income statement if sales units increases by 100 units. Particulars Sales Variable expenses Contribution margin Fixed expenses Net operating income Amount ($) 353,500 202.000 151,500 135.000 $16.500 Working Notes : It is given that the sales unit is 10,000, increasing sales unit is 100, price per unit is $35, variable cost per unit is $20, and fixed expense is $135,000. Net operating income =  Sales - Variable expenses - Fixed expenses  = (((Sales units+Increase in sales unit) x Price per unit) - ((Sales units Increase in sales unit) x Variable cost per unit) Fixed expense) = (((10,000 + 100) x $35) - ((10,000 + 100) x $20) $135,000) = $353,500 - $202,000 $135,000 = $16,500 2. The sales volume decreases by 100 units. Answer Prepare contribution format income statement if sales units decreases by 100 units. Particulars Sales Variable expenses Contribution margin Fixed expenses Net operating income Working Notes : Amount ($) 346,500 198.000 148,500 135.000 $13.500 It is given that the sales unit is 10,000, decreasing sales unit is 100. price per unit is $35, variable cost per unit is $20, and fixed expense is $135.000. Net operating income = ( Sales - Variable expenses - Fixed expenses ) = (((Sales units - Decrease in sales unit) x Price per unit) - ((Sales units Decrease in sales unit) x Variable cost per unit) - Fixed expense) = (((10,000-100) x $35) - (10,000-100) x $20) - $135,000) = $346,500 - $198,000 - $135,000 = $13,500 3. The sales volume is 9,000 units. Answer Prepare contribution format income statement if sales units is 9,000 units Particulars Sales Variable expenses Contribution margin Fixed expenses Amount ($) 315,000 180.000 135,000 135.000 Net operating income $0 Working Notes: It is given that the sales unit is 9,000, price per unit is $35. variable cost per unit is $20, and fixed expense is $135,000. Net operating income = ( Sales - Variable expenses - Fixed expenses ) = (Sales units x Price per unit) - ((Sales units x Variable cost per unit) - Fixed expense) = ((9,000 x $35) - (9,000 $20) x135,000) = $315,000 - $180,000 - $135,000 = $0 Exercises 6-5 : Changes in Variable Costs, Fixed Costs, Selling Price, and Volume Data for Hermann Corporation are shown below : Selling price ........ Variable Per Unit $90 63 Percent of Sales 100% 70 expenses ....... Contribution margin ....... $27 30% Fixed expenses are $30,000 per month and the company is selling 2,000 units per month. Required: 1. The marketing manager argues that that a $5.000 increase in the monthly advertising budget would increase monthly sales by $9,000. Should the advertising budget be increased? 2. Refer to the original data. Management is considering using higher-quality components would increase the variable expense by $2 per unit. The marketing manager believes that the higher-quality product would increase sales by 10% per month. Should the higher-quality components be used? 1. The marketing manager argues that that a $5.000 increase in the monthly advertising budget would increase monthly sales by $9,000. Should the advertising budget be increased? Answer Calculate the change in net operating income as shown below : Details Expected total contribution margin per month (2,000 units x $27 per unit) + ($9,000 x 30%) Less: Present total contribution margin per month (2,000 units x $27 per unit) Increase in total contribution margin per month Less: Increase in advertising expense per month Decrease in net operating income per month Amoun t $56,70 0 $54,00 0 $2,700 $5,000 ($2,30 0) Explanation : When any decision is taken about change in fixed cost then the change in contribution margin is to be calculated first to calculate the overall change in net operating income The change in net operating income will decide about whether change in fixed cost is favorable or not. If the net operating income is increased when compared with the present net operating income then the change in fixed cost is accepted. If the net operating income is decreased when compared with the present net operating income then the change in fixed cost is not accepted. Thus, the total net operating income decreased by $ 2,300 per month if the monthly advertising budget increases 2. Refer to the original data. Management is considering using higher-quality components would increase the variable expense by $2 per unit. The marketing manager believes that the higher-quality product would increase sales by 10% per month. Should the higher-quality components be used? Answer Calculate the change in contribution margin as shown below. Details Sales Present 2,000 Expected 2,200 Differ units per month units per month ence Per Per Total Total Unit Unit (c-a) (a) (c) (b) (d) $180,0 $198,0 $18, $90 $90 000 00 00 Less: $126,0 Variable 00 expenses Contribution $54,00 0 margin $63 $143,0 00 $65 $17, 000 $27 $55,00 0 $25 $1,0 00 Explanation: When any decision is taken about change in variable cost then the change in contribution margin is to be calculated The change in contribution margin will decide about whether change in variable cost is favorable or not. If the contribution margin is increased when compared with the present contribution margin then the change in variable cost is accepted. If the contribution margin is decreased when compared with the present contribution margin then the change in variable cost is not accepted. Thus, the total contribution margin is increased by $1,000 per month if the higherquality components are used. Note : Calculate the expected number of units of sale as shown below: Expected number of units for sale = Sales Expected Selling price per unit = (2,000 units x $90) + 10% increase $90 per unit = $ 180,000 + 10% $90 = $198,000 $90 Expected number of units for sale = 2,200 units Thus, the expected number of units for sale is 2,200 units Exercises 6-6 : Compute the Break – Even Point Mauro Products distributes a single product, a woven basket whose selling price is $15 and whose variable expense is $12 per unit. The company’s monthly fixed expense is $4,200. Required: 1. Solve for the company’s break-even point in unit sales using the equation method. 2. Solve for the company’s break-even point in dollar sales using the equation method and the CM ratio. 3. Solve for the company’s break-even point in unit sales using the formula method. 4. Solve for the company’s break-even point in dollar sales using the formula method and the CM ratio. 1. Solve for the company’s break-even point in unit sales using the equation method. Answer Calculate breakeven sales unit by equation method : It is given that the price per unit is $15, variable expense is $12, and fixed cost is 4 Now assume profit to be "0" Profit = (Price per unit - variable expense per unit) x sales unit - Fixed cost 0 = (15-12) sales unit - 4,200 (3) sales unit = 4,200 + 0 sales unit = 4,200 3 = 1,400 Hence, the breakeven sales unit is 1,400 2. Solve for the company’s break-even point in dollar sales using the equation method and the CM ratio. Answer Calculate breakeven sales value by equation method : It is given that the price per unit is $15, variable expense is $12, and fixed cost is 4,200. Now assume profit to be "O", Profit = (Price per unit - variable expense per unit) x sales value - Fixed cost Price per unit 0 = (15-12) s X sales value - 4,200 15 0= 3 X sales value - 4,200 15 (0.2) sales value = 4,200 + 0 sales value = 4,200 0.2 = 21,000 Hence, the breakeven sales value is $21,000 3. Solve for the company’s break-even point in unit sales using the formula method. Answer Breakeven sales unit is calculated below. It is given that the fixed cost is 4,200. price per unit is $15, and variable cost per unit is $12. Breakeven sales unit = Fixed cost (Price per unit - Variable cost per unit) = 4,200 ( 15 – 12 ) = 4,200 3 = 1,400 Hence, the breakeven sales unit is 1,400 4. Solve for the company’s break-even point in dollar sales using the formula method and the CM ratio. Answer Breakeven sales value is calculated below: It is given that the fixed cost is 4,200, price per unit is $15, and variable cost per unit is $12. Breakeven sales value = Fixed cost Price per unit - Variable cost per unit Price per unit = 4,200 15 – 12 15 = 4,200 3 15 = 4,200 0.2 = 21,000 Hence, the breakeven sales value is $21,000