ADM 2341 Lecture Notes - Lecture 7: Earnings Before Interest And Taxes, Operating Leverage

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9 May 2016

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Managerial accounting ch 7: cost volume profit relationship. Managers use this tool to help them understand the interrelationship among cost, volume and profit in an org by focusing on interactions among the following 5 elements. Contribution margin ratio = cm per unit/ sp per unit. Cm ratio = total cm/ total sales. Increase in cm - increase in ad expense. Change in sales - change in variable expenses. Change in fixed costs, sales price and volume. Change in sales - change in variable expenses - change in fixed expense. Profits = (sales - variable expenses) - fixed expenses. Or sales = variable expenses + fixed expenses + profits (0 at break even point) Be point in units sold = fixed expenses/ cm per unit. Be point in total sales dollars = fixed expenses / cm ratio. Sales = variable expenses + fixed expenses + profits. Unit sales to attain target profit = (fixed expenses +target profit)/ cm per unit.

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Basic information
Exhibit 1 Hallstead Jewelers
Income Statements for YearsEnded January 31 (thousands of dollars)
	2003	2004	2006

Sales	$9,000,000	$8,000,000	$11,000,000
Cost of goods sold	4,050,000	3,600,000	4,950,000
Gross margin	$4,950,000	$4,400,000	$6,050,000
Expenses
Selling expense
Salaries	2,021,000	2,081,000	4,085,000
Commissions	450,000	400,000	550,000
Advertising	254,000	250,000	257,000
Administrative expenses	418,000	425,000	535,000
Rent	420,000	420,000	840,000
Depreciation	84,000	84,000	142,000
Miscellaneous expenses	53,000	93,000	122,000
Total expenses	$3,700,000	$3,753,000	$6,531,000
Net income	$1,250,000	$647,000	$(481,000)

Exhibit 2 Hallstead JewelersOperating Statistics

	2003	2004	2006

Sales space (square feet)	10,000	10,000	15,000
Sales per square foot	$900	$800	$733
Sales tickets	5,000	5,000	7,000
Average sales ticket	$1,800	$1,600	$1,571

Assumptions:

Sales price per ticket = $1,572

Variable cost per unit = $786 (cost of goods sold of $707 +Sales commissions of $79)

Complete the table below:

*Alternative #1*	*Per unit*	*Total*	*Per unit*	*Total*
# of sales tickets	7000
Selling price per ticket	$1,572	$11,000,000
Variable cost per ticket	$786	$5,500,000
Contribution margin per ticket	$786	$5,500,000
Total fixed costs	5,981,000
Net income	$(481,000)
Change in net income if accept alternative
Breakeven point in units	7,610

Review of Question #4 requirements. Increase advertisingby $20,000, increase sales revenue (volume) by 2%.

For each question, answer yes or no for each piece ofinformation listed.

Information	For this alternative only, is there a change in this item thataffects calculation of net income? Yes or No	For this alternative only, is there a change in this item thateffects the calculation of the new breakeven point? Yes or No
Selling price per unit
Variable cost per unit
Total fixed costs
Net income
Sales volume

Complete the table below:

*Alternative #3*	*Per unit*	*Total*	*Per unit*	*Total*
# of sales tickets	7000
Selling price per ticket	$1,572	$11,000,000
Variable cost per ticket	$786	$5,500,000
Contribution margin per ticket	$786	$5,500,000
Total fixed costs	5,981,000
Net income	$(481,000)
Change in net income if accept alternative
Breakeven point in units	7,610

Alternatives	Change in Net Income	New Breakeven point in units	Change in Breakeven point in units
#1 Decrease SP, Increase sales volume
#2 Eliminate sales commissions	Increases by $550,000	6,914	Decreases by 696
#3 increase Fixed costs by $20,000 to get increase of 2% salesrevenue (volume)

periwinklemink994

Phoenix Companyâs 2017 master budget included the following fixed budget report. It is based on an expected production and sales volume of 15,000 units.

PHOENIX COMPANY
Fixed Budget Report
For Year Ended December 31, 2017

Machinery repairs (variable cost)

45,000

DepreciationâPlant equipment (straight-line)

300,000

Utilities ($45,000 is variable)

195,000

Plant management salaries

Sales salary (fixed annual amount)

235,000

430,000

General and administrative expenses

Entertainment expense

85,000

440,000

Income from operations

370,000

Prepare flexible budgets for the company at sales volumes of 14,000 and 16,000 units and classify all items listed in the fixed budget as variable or fixed.

PHOENIX COMPANY
Fixed Budget Report
For Year Ended December 31, 2017
	Flexible Budget		Flexible Budget for:
	Variable Amount per Unit	Total Fixed Cost	Units Sales of 14,000	Unit Sales of 16,000

Variable costs









Fixed costs

The companyâs business conditions are improving. One possible result is a sales volume of 18,000 units. The company president is confident that this volume is within the relevant range of existing capacity. How much would operating income increase over the 2017 budgeted amount of $370,000 if this level is reached without increasing capacity?

PHOENIX COMPANY
Forecasted Contribution Margin Income Statement
For Year Ended December 31, 2017
Sales (in units)	15,000	18,000
Contribution margin (per unit)
Contribution margin
Fixed costs
Operating income

An unfavorable change in business is remotely possible; in this case, production and sales volume for 2017 could fall to 12,000 units. How much income (or loss) from operations would occur if sales volume falls to this level? (Enter any loss with minus sign.)

PHOENIX COMPANY
Forecasted Contribution Margin Income Statement
For Year Ended December 31, 2017
Sales (in units)	15,000	12,000
Contribution margin (per unit)
Contribution margin
Fixed costs
Operating income (loss)

byzantiumscorpion900

1. Robbieâs Ribs has the following sales and costinformation:

Average number of pounds sold per year - 39,750
Average selling price per pound of ribs - $11.50
Variable expenses per pound:

Raw material - $3.70

Variable labor and overhead - $3.20

Annual fixed costs:

Production expenses - $37,300

Selling & Administrative expenses $15,186

The companyâs tax rate is 30%. The companyâs costs have slowlybeen rising and profits rapidly falling. Robbie Shaw, companypresident, has asked your help in answering the followingquestions:

What is the contribution margin per pound of ribs? Thecontribution margin ratio?

What is the break-even point in pounds of ribs? In dollars?

How much revenue must be generated to produce $39,749 of pretaxincome? How many pounds of ribs would this level of revenuerepresent?

How much revenue must be generated to produce $24,500 after-taxincome? How many pounds of ribs would this represent?

2. The following is financial information relative to twocompanies in the same industry:

Category	Alpha	Omega
Sales	$10,000,000	$10,000,000
Variable Cost	5,000,000	2,000,000
Contribution Margin	5,000,000	8,000,000
Fixed Costs	3,000,000	6,000,000
Operating Income	$2,000,000	$2,000,000

Calculate the operating leverage for each firm.

If sales increased 10% for each firm, the variable cost per unitdid not change, and the fixed costs did not change, what would bethe change in operating income?

If sales decreased 20% for each firm, the variable cost per unitdid not change, and the fixed costs did not change, what would bethe change in operating income?

Discuss the nuances of operating leverage and its relation torisk.

3. WaterSports USA sells three types of wake boards. Informationrelative to sales in units and dollars are given in the tablebelow:

Sales Category	Wakeman	Jumper	Novice	Total
Sales in Units	1,000	5,000	2,000	8,000
Price per Unit	$200	$150	$100
Variable cost per Unit	$150	$100	$50

Fixed costs are projected to be $100,000. Carry all calculationsto four decimal places.

Compute the contribution margin per unit.

Compute the weighted contribution margin.

Compute the break-even in total units.

Compute the break-even per product.

Discuss briefly the usefulness of the computation in thebusiness world.

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ADM 2341 Lecture Notes - Lecture 7: Earnings Before Interest And Taxes, Operating Leverage

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