Management Accounting Solutions Week 5

Workshop Solutions Question 1 Brown Corporation has sales of 2,000 units at $70 per unit. Variable expenses are 40% of the selling price. If total fixed expenses are $44,000, what is the degree of operating leverage? Solutions Contribution margin = Sales - Variable expenses = (2,000 units × $70 per unit) - (2,000 units × 0.40 × $70 per unit) = $140,000 - $56,000 = $84,000 Net operating income = Contribution margin - Fixed expenses = $84,000 - $44,000 = $40,000 Degree of operating leverage = Contribution margin ÷ Net operating income = $84,000 ÷ $40,000 = 2.1 Question 2 Steeler Corporation is planning to sell 100,000 units for $2.00 per unit and will break even at this level of sales. Fixed expenses will be $75,000. What are the company's variable expenses per unit?7 Solutions Unit sales to break even = Fixed expenses ÷ Unit CM 100,000 units = $75,000 ÷ Unit CM Unit CM = $75,000 ÷ 100,000 units = $0.75 per unit Unit CM = Selling price per unit - Variable expenses per unit $0.75 per unit = $2.00 per unit - Variable expenses per unit Variable expenses per unit = $2.00 per unit - $0.75 per unit = $1.25 per unit Question 3 Menlo Company distributes a single product. The company’s sales and expenses for last month follow: Sales Variable expenses $ Contribution margin Fixed expenses Net operating income Total 310,000 217,000 93,000 72,000 $ Per Unit $ 20 14 $ 6 21,000 Required: 1) What is the monthly break-even point in unit sales and in dollar sales? 2) Without resorting to computations, what is the total contribution margin at the break-even point? 1 3-a) How many units would have to be sold each month to earn a target profit of $42,000? Use the formula method. 3-b) Verify your answer by preparing a contribution format income statement at the target sales level. 4) Refer to the original data. Compute the company's margin of safety in both dollar and percentage terms 5) What is the company’s CM ratio? If monthly sales increase by $99,000 and there is no change in fixed expenses, by how much would you expect monthly net operating income to increase? Solutions: 1. Profit = (Unit CM × Q) − Fixed expenses $0 = (($20 − $14) × Q) − $72,000 $0 = ($6 × Q) − $72,000 $6Q = $72,000 Q = $72,000 ÷ $6 per unit Q = 12,000 units, or at $20 per unit, $240,000 Alternative solution: Unit sales to break even = = Fixed expenses Unit contribution margin $72,000 $6 per unit = 12,000 units or at $20 per unit, $240,000 2. The contribution margin is $72,000 because the contribution margin is equal to the fixed expenses at the break-even point. 3-a. Unit sold to attain target profit = = Target profit + Fixed expenses Unit contribution margin $42,000 + $72,000 $6 per unit 3-b. Sales (19,000 units × $20 per unit) Variable expenses (19,000 units × $14 per unit) Contribution margin Fixed expenses Net profit = 19,000 units $380,000 ($266,000) $114,000 ($72,000) $42,000 4. Margin of safety in dollar terms: Margin of safety in dollars = Total sales − Break even sales = $310,000 − $240,000 = $70,000 2 Margin of safety in percentage terms: Margin of safety percentage = = Margin of safety in dollars Total sales $70,000 $310,000 = 22.58% 5. The CM ratio is 30%. Expected total contribution margin: $409,000 × 30% Present total contribution margin: $310,000 × 30% $ 122,700 93,000 Increased contribution margin $ 29,700 Alternative solution: $99,000 incremental sales × 30% CM ratio = $29,700 Given that the company’s fixed expenses will not change, monthly net operating income will also increase by $29,700. 3 Question 4 Cheryl Montoya picked up the phone and called her boss, Wes Chan, the vice president of marketing at Piedmont Fasteners Corporation: “Wes, I’m not sure how to go about answering the questions that came up at the meeting with the president yesterday.” "What's the problem?" “The president wanted to know the break-even point for each of the company’s products, but I am having trouble figuring them out.” “I’m sure you can handle it, Cheryl. And, by the way, I need your analysis on my desk tomorrow morning at 8:00 sharp in time for the follow-up meeting at 9:00.” Piedmont Fasteners Corporation makes three different clothing fasteners in its manufacturing facility in North Carolina. Data concerning these products appear below: Normal annual sales volume Unit selling price Variable expense per unit Velcro 100,000 $1.65 $1.25 Metal 200,000 $1.50 $0.70 Nylon 400,000 $0.85 $0.25 Total fixed expenses are $400,000 per year. All three products are sold in highly competitive markets, so the company is unable to raise its prices without losing unacceptable numbers of customers. The company has an extremely effective lean production system, so there is no beginning or ending work in process or finished goods inventories. Required: 1. What is the company’s over-all break-even point in dollar sales? 2. Of the total fixed expenses of $400,000, $20,000 could be avoided if the Velcro product is dropped, $80,000 if the Metal product is dropped, and $60,000 if the Nylon product is dropped. The remaining fixed expenses of $240,000 consist of common fixed expenses such as administrative salaries and rent on the factory building that could be avoided only by going out of business entirely. a. What is the break-even point in unit sales for each product? b. If the company sells exactly the break-even quantity of each product, what will be the overall profit of the company? Solutions 1. The overall break-even sales can be determined using the CM ratio. Sales Variable expenses $ Velcro 165,000 125,000 $ Metal 300,000 140,000 $ Nylon 340,000 100,000 Contribution margin $ 40,000 $ 160,000 $ 240,000 Total $ 805,000 365,000 440,000 Fixed expenses 400,000 Net operating income CM ratio = $ Contribution margin = Sales Dollar sales to = Fixed expenses break even CM ratio = $440,000 $805,000 $400,000 0.5466 40,000 = 0.5466 = $732,000 (rounded) 2. The issue is what to do with the common fixed cost when computing the break-evens for the individual products. The correct approach is to ignore the common fixed costs. If the common fixed costs are included in the computations, the break-even points will be overstated for individual products and managers may drop products that in fact are profitable. 4 a. The break-even points for each product can be computed using the contribution margin approach as follows: Velcro $ 1.65 1.25 Unit selling price Variable cost per unit Unit contribution margin (a) $ Product fixed expenses (b) Unit sales to break even (b) ÷ (a) Metal $ 0.40 $ $ 20,000 $ 50,000 Nylon 1.50 0.70 $ 0.85 0.25 0.80 $ 0.60 80,000 $ 100,000 60,000 100,000 b. If the company were to sell exactly the break-even quantities computed above, the company would lose $240,000—the amount of the common fixed cost. This can be verified as follows: Unit sales Velcro 50,000 Metal 100,000 Nylon 100,000 Sales Variable expenses $ 82,500 62,500 $150,000 70,000 $ 85,000 25,000 Contribution margin $ 20,000 $ 80,000 $ 60,000 Fixed expenses Net operating loss Total $ 317,500 157,500 160,000 400,000 $ (240,000) 5