SAN BEDA COLLEGE COLLEGE OF ARTS AND SCIENCES DEPARTMENT OF ACCOUNTANCY AND TAXATION MANAGERIAL ACCOUNTING PART 1 COST-VOLUME-PROFIT

T RELATIONSHIPS Contribution Income Statement: Separates expenses into variable and fixed. Sales variable expenses = contribution margin. Contribution margin fixed expenses = net income (loss). Same revenue and net income (loss) as absorption income statement. Contribution Margin: The amount of sales available to cover fixed expenses with any remaining contribution margin providing profits. If the contribution margin is not sufficient to cover fixed expenses, there will be a net loss for the period. Contribution Margin Ratio: Sales, variable expenses and contribution margin are all variable, and therefore may be expressed as a percent of revenue. The contribution margin ratio is calculated as the contribution margin peso as a percent of sales peso. In a company producing a single product, this relationship applies to either total sales peso and total contribution margin or per-unit sales peso and contribution margin peso. In a company producing multiple products, each product will have its own unique contribution margin ratio, with the contribution margin for the entire company calculated only for total contribution margin peso as a percent of total sales peso. The variable expense ratio is the complement to the contribution margin ratio. It represents the percent of sales peso not included in the contribution margin ratio. Break Even Point: At the breakeven point: Operating income = 0 Total revenue = total expenses Fixed expenses = contribution margin The breakeven point is expressed in sales peso and units sold. The link between the two is selling price per unit, meaning that breakeven units sold x selling price per unit = breakeven sales. Breakeven problems are made more complex because some information is given in per-unit amounts, other information is given in total peso and still other information is not peso but units sold. Determined using the following approach o Formula = o Contribution Margin = o Graphical Revenue Line the line that starts from zero Cost Line the line that start from the fixed costs and increased by the variable costs per unit sold. BEP = Intersection of the two lines. Target Profit: Rather than setting operating income at zero, target profit calculations assume a certain operating income and calculate the sales peso and units sold necessary to achieve it. The same equations are used as to calculate the breakeven point, except that a non-zero operating income term is included in the numerator. Margin of Safety: The margin of safety is the excess of budgeted or actual sales over the break even volume of sales. M. B. GUIA

It is expressed as both the dollar amount of the difference and as a percent of budgeted or actual sales.

Operating Leverage: Operating leverage quantifies, at a given level of sales, the percent change in operating income caused by a percent change in sales. Leverage calculations are a two-step process: o First, calculate the Degree of Leverage or Leverage Factor = o Second, percentage change in net income % = % Multiproduct Company: Weighted Average Contribution Margin o Sales Mix Computation Total Sales Unit Sales o Contribution Margin CM% CM per unit Computation of the Break-even point using the WACM Allocation of the total Break-even point using the sales mix.

==================================================== Practice Problems: Problem 1: Lowman Corporation sells only one product with a selling price of P200 and a variable cost of P80 per unit. The companys monthly fixed expense is P60,000. Required: 1. Determine the breakeven point in units sold and sales peso. 2. The corporation would like to achieve a profit of P30,000 next year. Problem 2: Star Products sells pillows for P90 per unit. The variable expenses are P63 per pillow and the fixed costs are P135,000 per month. The company sells 8,000 pillows per month. The sales manager is recommending a 10% reduction in selling price which he believes will produce a 25% increase in the number of pillows sold each month. Required: 1. Prepare contribution margin income statements for current operating conditions and if the proposed changes are made. 2. Determine the margin of safety under current operating conditions. 3. Compute the degree of leverage under current operating conditions and the expected operating income if sales increase 10%. Problem 3: Marketbasket, Inc. produces only one product, organic fruit baskets, which it sells for P72 each. Unit variable costs are P32 and total fixed expenses are P15,000. Actual sales for the month of May totaled 2,000 units. Required: Compute the margin of safety in units and peso for the company for May. Problem 4: Match Company reports the following results for the month of November: Units sold 10,000 Sales P600,000 Variable costs 420,000 Contribution margin 180,000 Fixed costs 110,000 Net income P 70,000 Management is considering the following independent courses of action to increase net income. a) Increase selling price by 6% with no change in units sold. b) Reduce variable costs to 65% of sales. c) Reduce fixed costs by P20,000 Required: Determine the net income under each course of action.

Problem 5: True or False 1. Contribution margin is equal to fixed costs at the break-even point. 2. Break-even units can be found by dividing fixed costs by unit contribution margin. 3. Target units equals fixed costs plus target profit divided by the unit contribution margin. 4. The target sales level equals fixed costs plus variable costs divided by the contribution margin ratio. 5. The margin of safety is the difference between actual sales and budgeted sales. 6. Managers can use cost-volume-profit analysis to evaluate changes in cost structure. 7. The degree of operating leverage can be multiplied by a change in sales to determine change in profit. 8. In multiproduct cost-volume-profit analysis, a break-even point must be calculated separately for each product. 9. If the unit contribution margin is P1 and unit sales are 15,000 units above the break-even volume, then net income will be P15,000. 10. A target net income is calculated by taking actual sales minus the margin of safety. 11. If variable costs per unit are 70% of sales, fixed costs are P290,000 and target net income is P70,000, required sales are P1,200,000. Problem 6: Multiple Choice Questions: 1. What component of the profit equation should be set equal to zero to find the breakeven point? a) Total sales revenue b) Total variable costs c) Total fixed costs d) Profit 2. The profit equation is a) Unit price Q Unit variable costs Q Total fixed costs = Profit b) Unit price Q Unit variable costs Q + Total fixed costs = Profit c) (Unit price Unit variable costs Total fixed costs) Q = Profit d) Unit price Q + Unit variable costs Q + Total fixed costs = Profit 3. The formula for break-even point in terms of units is a) Total variable costs/Unit contribution margin b) Total fixed costs/Contribution margin ratio c) Total fixed costs/Unit contribution margin d) Total variable costs/Total fixed costs 4. Jones Corp has a selling price of P15, variable costs of P10 per unit, and fixed costs of P25,000. How many units must be sold to break-even? a) 5,000 b) 10,000 c) 2,500 d) 1,667 5. Allen Inc. has a contribution margin of 40% and fixed costs of P120,000. What is the break-even point? a) P48,000 b) P300,000 c) P200,000 d) P72,000 6. Last month Kelly Company had a P30,000 profit on sales of P250,000. Fixed costs are P60,000 a month. How much would sales have to decrease for Kelly to break even? a) P90,000 b) P83,333 c) P166,667 d) P280,000 7. Paris, Inc. has fixed costs of P200,000, sales price of P50, and variable cost of P30 per unit. How many units must be sold to earn profit of P50,000? a) 2,500 b) 10,000 c) 12,500 d) 20,000 8. Pearl Company has sales of P400,000, variable costs of P12 per unit, fixed costs of P100,000, and a target profit of P60,000. How many units were sold? a) 10,000 b) 15,000 c) 20,000 d) 25,000 9. Bowl Corp has fixed costs of P20,000 and a contribution margin ratio of 40%. Currently, sales are P75,000. What is Bowl's margin of safety? a) P20,000 b) P25,000 c) P30,000 d) P50,000 10. Gordy Inc. currently sells 15,000 units a month for P50 each, has variable costs of P20 per unit, and fixed costs of P300,000. Gordy is considering increasing the price of its units to P60 per unit. This will not affect costs, but demand is expected to drop 20%. Should Gordy increase the cost of its product? a) Yes, profit will increase P30,000. c) No, profit will decrease P150,000. b) Yes, profit will increase P150,000 d) No, profit will decrease P30,000 11. George, Inc. currently sells 15,000 units a month for P50 each, has variable costs of P20 per unit, and fixed costs of P300,000. George is considering increasing the price of its units to P60 per unit. If the price is changed, how many units will George need to sell for profit to remain the same as before the price change? a) 10,000 b) 11,250 c) 12,000 d) 12,500 12. A company is debating whether to change its cost structure so that fixed costs increase from P300,000 to P400,000, but variable costs decrease from P5 per unit to P4 per unit. If it were to implement the

change at its current production level of 100,000, profit would not change. What would happen to the company's profit if the change were implemented and production increased to 125,000? a) It will stay the same c) It will decrease. b) It will increase d) It could increase or decrease 13. Degree of operating leverage is calculated as a) profit divided by contribution margin. c) profit divided by break-even sales. b) break-even sales divided by profit d) contribution margin divided by profit 14. France Corp has a contribution margin of P450,000 and profit of P150,000. If sales increase 20%, by how much will profits increase? a) 20% b) 30% c) 60% d) 90% 15. Nelly Corp sells two products. Product A sells for P100 per unit, and has unit variable costs of P60. Product B sells for P70 per unit, and has unit variable costs of P50. Currently, Nelly sells three units of product B for every one unit of product A sold. Nelly has fixed costs of P750,000. How many units would Nyota have to sell to earn a profit of P250,000? a) 40,000 units of A and 40,000 units of B c) 30,000 units of A and 10,000 units of B b) 10,000 units of A and 30,000 units of B d) 20,000 units of A and 20,000 units of B Problem 7: The Hungry Hound restaurant sells red wine, white wine and champagne. Wine sales for December were as follows: Red White Champagne Bottles sold 100 40 60 Average selling price P80 P45 P60 Variable Costs P40 P15 P15 The wine directors salary is P36,000 per year plus tips which average P160 per month. Required: a) Prepare an income statement by type of wine and in total for December. b) Prepare a breakeven income by type of wine and in total statement for December. Problem 8: Bird Shelters, Inc., distributes a high-quality wooden birdhouse that sells for P15.00 per unit. Variable costs are P4.50 per unit, and fixed costs total P135,000 per year. Required: Answer the following independent questions: 1. What is the products CM ratio? 2. Use the CM ratio to determine the break-even point in sales peso. 3. Due to an increase in demand, the company estimates that sales will increase by P56,250 during the next year. By how much should net operating income increase (or net operating loss decrease), assuming that fixed costs do not change? 4. Assume that the operating results for last year were: Sales P300,000 Less variable expenses 90,000 Contribution margin 210,000 Less fixed expenses 135,000 Net operating income P 75,000 a. Compute the degree of operating leverage at the current level of sales. b. The president expects sales to increase by 25% next year. By what percentage should net operating income increase? 5. Refer to the original data. Assume that the company sold 16,500 units last year. The sales manager is convinced that a 5% reduction in the selling price, combined with a P22,500 increase in advertising, would cause annual sales in units to increase by one-third. Prepare two contribution format income statements, one showing the results of last years operations and one showing the results of operations if these changes are 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 16,500 units last year. The president does not want to change the selling price. Instead, he wants to increase the sales commission by P0.75 per unit. He thinks that this move, combined with some increase in advertising, would increase annual sales by 20%. By how much could advertising be increased with profits remaining unchanged? Do not prepare an income statement; use the incremental analysis approach. Problem 9: Peninsula Novelty, Inc., of Palau makes two products, Hawaiian Fantasy and Tahitian Joy. Present revenue, cost, and sales data for the two products follow: Hawaiian Tahitian Fantasy Joy

Selling price per unit P20.00 P25.00 Variable expenses per unit P14.00 P10.00 Number of units sold annually 25,000 10,000 Fixed expenses total P270,000 per year. The Republic of Palau uses the U.S. dollar as its currency. Required: 1. Assuming the sales mix given above, do the following: a. Prepare a contribution format income statement showing both dollar and percent columns for each product and for the company as a whole. b. Compute the break-even point in peso for the company as a whole and the margin of safety in both peso and percent. 2. The company has just developed a new product to be called Samoan Delight. Assume that the company could sell 12,000 units at P17.50 each. The variable expenses would be P14.00 each. The companys fixed expenses would not change. a. Prepare another contribution format income statement, including sales of the Samoan Delight (sales of the other two products would not change). b. Compute the companys new break-even point in peso and the new margin of safety in both peso and percent. Problem 10: Yellowstone Souvenirs sells a large variety of tee shirts and sweatshirts. Sheryl Buggs, the owner, is thinking of expanding her sales by hiring local high school students, on a commission basis, to sell sweatshirts bearing the name and mascot of the local high school. These sweatshirts would have to be ordered from the manufacturer six weeks in advance, and they could not be returned because of the unique printing required. The sweatshirts would cost Ms. Buggs P7.50 each with a minimum order of 100 sweatshirts. Any additional sweatshirts would have to be ordered in increments of 100. Since Ms. Buggs plan would not require any additional facilities, the only costs associated with the project would be the costs of the sweatshirts and the costs of the sales commissions. The selling price of the sweatshirts would be P11.00 each. Mr. Hooper would pay the students a commission of P1.00 for each sweatshirt sold. Required: 1. To make the project worthwhile, Ms. Buggs would require a P2,000 profit for the first three months of the venture. What level of sales in units and in peso would be required to reach this target net operating income? Show all computations. 2. Assume that the venture is undertaken and an order is placed for 100 sweatshirts. What would be Ms. Buggs break-even point in units and in sales peso? Show computations and explain the reasoning behind your answer. Problem 11: Norris Corporation produces toys and other items for use in beach and resort areas. A small, inflatable toy has come onto the market that the company is anxious to produce and sell. The new toy will sell for P5.50 per unit. Enough capacity exists in the companys plant to produce 20,000 units of the toy each month. Variable costs to manufacture and sell one unit would be P2.75, and fixed costs associated with the toy would total P70,000 per month. The companys Marketing Department predicts that demand for the new toy will exceed the 20,000 units that the company is able to produce. Additional manufacturing space can be rented from another company at a fixed cost of P5,000 per month. Variable costs in the rented facility would total P3.00 per unit, due to somewhat less efficient operations than in the main plant. Required: 1. Compute the monthly break-even point for the new toy in units and in total dollar sales. Show all computations in good form. 2. How many units must be sold each month to make a monthly profit of P3,000? 3. If the sales manager receives a bonus of 5 cents for each unit sold in excess of the break-even point, how many units must be sold each month to earn a return of 4.9% on the monthly investment in fixed costs?