ACCY112 s1 2013

TUTORIAL SOLUTION

CVP Analysis

The owner-manager of a small business enterprise was heard to make the following remark: Break-even analysis has little relevance for my business. I am not in business to break even, but to make profits. Do you agree? Explain your position. Can not agree with the opinion expressed by the owner manager who obviously does not fully understand the underlying concepts of CVP. CVP and break-even analysis are about relationships of cost/volume/profit and are essential for future profit planning purposes. Note that B/E is only one aspect of CVP analysis. The break-even point is only the focal point of attention, and the analysis of cost profit behaviour is the essential component. However the break-even point does indicate the range of activity where losses are incurred and profits earned. Cost-volume-profit analysis can be used to maximise profits and can be a proficient tool in so doing. This analysis can be used to supplement other means of planning future profits.

11.

Contribution margin variance analysis is an important control technique of management. Discuss. Contribution margin variance analysis enables management to evaluate why the contribution margin of a given period is different from that planned, or different from a previous period. Management needs to know the causes so that it can decide who and what are responsible, and take steps to correct any problems, thereby exercising control over operations. Changes in the contribution margin will be due to one or a combination of: a variation in selling price per unit sold a variation in the number of units sold a variation in the variable costs of producing and selling each unit. Management should evaluate all of the above and address any unfavourable movements in all variables.

Exercise 11.8

Contribution margin - calculations

ENERGY EXPERIENCES PTY LTD

A.

S = $750 000 / 2500 = $300 / camper V = ($375 000 + $150 000) / 2500 = $210 / camper F = $300 000 300 x = 210 x + 300 000 Page 1 of 6

B.

300 x = 210 x + 300 000 90 x = 300 000 x = 300 000 / 90 x = 3 334 customers 300 (3 000) = 210 (3 000) + 300 000 + P P = $(30 000) To make a profit with 3 000 campers the fixed costs have to be reduced by $30 000, or 10%. Alternatively the variable costs per unit have to be reduced by at least $10 ($30,000 / 3 000). The other option is to increase the price per camper by at least $10 (3 000 * $10). A combination of the above alternatives could be used, particularly if Energy Experiences Pty Ltd wants to do more than break even and make a profit.

C.

Exercise 11.9

CVP analysis
DRILLMASTER LTD

Required: A. What are the variable costs per unit? B. How many units must the company sell to break even? C. What is the break-even point in sales dollars? D. If the company wants to earn a before-tax net profit of $115 000, how many units must be sold? What sales dollar level is required? What is the companys margin of safety at this sales level? E. If the company wants to earn a before-tax net profit of 20% of sales, how many units must be sold? What are the sales dollars? F. Prepare a CVP chart for the company.

A.

Variable costs per unit $160 x (1-0.40) = $96

B.

Break-even sales in units: $512 000/($160 - $96) = 8 000 units

C.

Break-even sales in dollars: $512 000/0.40 = $1 280 000 or 8 000 x $160 = $1 280 000 Units to sell to earn pre-tax profit of $115 000

D.

$512000 $115000 9797 units $64

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Sales $s: 9 797 x $160 = $1 567 520

Margin of safety: Unit sales 9 797 8 000 = 1 797 units Dollar sales $1 567 520 - $1 280 000 = $287 520

E.

S = VC + FC + Target net profit S = 0.65 + $512 000 + 0.25 0.2 S = $512 000 S = $2 560 000 or 16 000 units.

F.

CVP Chart

(Break-even should be $1.28M and Fixed costs $0.512M)

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Problem 11.2

CVP analysis

SLIP SHOD LTD

Required: A. Calculate the break-even point. B. Calculate the number of pairs that must be sold to achieve a profit of $63 000. What is the margin for safety at this sales level? C. Would it be better to sell 16 000 pairs at a selling price of $180 each or 19 000 pairs at a selling price of $160? D. If an additional $63 270 is spent on fixed advertising costs, what level of dollar sales must be attained to earn a new profit of $36 000? Assume that there has been no change in the sales price. E. Assume an income tax rate of 30%. Using the given information, how many pairs of shoes need to be sold to earn an after-tax profit of $37 800?

A.

CM

= =

$180 (22 + 35 + 15 + 18) $90 or 50% = = = $1 125 000/90 = $1 125 000/0.50= $2 250 000 12 500 units $2 250 000

Break even point (units) Break even point (dollars) Check: 12 500 units x $180

B.

Break even point + DNP (units) = Margin of safety =

($1 125 000 + $63 000)/$90 = 13 200 units 13 200 12 500 = 700 units

C.

Total CM 16 000 x ($180-22-35-15-18) Total CM 19 000 x ($160-22-35-15-16) Advantage from 16 000 @ $180

= =

$1 440 000 1 368 000 $ 72 000

D.

Fixed costs

$1 125 000 + $63 270 = = =

$1 188 270

Break even + DNP Sales to earn new profit $2 448 540/$180

($1 188 270 + $36 000)/0.50 $2 448 540 13 603 units

E.

Before tax net profit: $37 800/(1 0.30) $180 x = $90 x + $1 125 000 + $54 000 $90 x = $1 179 000 X = 13 100 pairs of shoes

$54 000

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Problem 11.4

CVP analysis with changes

AEM LTD

Required: A. If the company hires a new salesperson at a salary of $40 000, how much must sales increase in terms of dollars to maintain the companys current profit. B. If sales units increase 25% in the next year and profit increases 50%, would management perform better or worse than expected in terms of profit? Assume that there would be adequate capacity to meet the increased volume without increasing fixed costs. Comment on the variable cost per unit. C. If a new marketing method would increase variable expenses (by an amount you calculate), increase sales units 10%, decrease fixed costs 10% and increase profit by 20%, what would be the companys break-even point in terms of dollar sales if it adopts this new method? Assume that the sales price per unit would not be changed. Round your answer to the nearest whole number.

A.

Required increase in sales $40 000/0.6 (1) (1) Contribution margin/sales 79 680/132 800

= =

$66 667 0.6

B.

Sales units 1.25 (16 000) = SP Sales revenue Variable expense (work back from profit) Contribution margin Fixed costs Profit 1.5 ($39 680) Profit should be: 20 000 (4.98) 40 000

20 000 units $ 8.30 $166 000 66 480 99 520 40 000 $59 520

$59 600

(Management performance is worse by $80). This is accounted for in the increased VC per unit $3.324 - $3.32 = $0.004, e.g. $0.004 x 20 000 = $80.

C.

Adjusted income statement SP $132 800/16 000 = Sales (17 600 x $8.30) Variable expenses (work back from profit) Contribution margin Fixed costs (0.9 x $40 000) Profit (1.20 x $39 680) VC per unit $62 464/17 600 CM = $8.30 - $3.55 = =

$8.30

per unit 146 080 62 464 83 616 36 000 $47 616

$3.55 (rounded) $4.75 or 57.23% Page 5 of 6

Break even point

$36 000/0.5723

$62 904

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