ACCT 311 Lecture Notes - Lecture 5: Contribution Margin, Net Income, Operating Leverage

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violetfox768

2 Jul 2018

School

American River College

Department

Accounting

Course

ACCT 311

Professor

Pollard

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Chapter 5: Cost-Volume-Profit Relationships

Student Learning Outcomes:

•Prepare traditional and contribution-margin income statements and define related terms

•Explain cost-volume-profit analysis, degree of operating leverage, and safety margin and

employ each as an analytical tool.

Chapter Outline:

1. Cost-Volume-Profit (CVP) Analysis

•Contribution margin and break-even

– Contribution margin (CM) – the amount remaining from sales after covering variable

expenses that is available to cover variable expenses and generate profit

–Calculation of Contribution margin and Net income

• Sales

•- Variable expenses

•= Contribution margin

•- Fixed expenses

•= Net income (I.e., profit )

–Break-even point – the level of sales at which Profit =

–Methods of calculating profit

•CVP equation method (income statement approach): Profit = (Sales – Variable

expenses) – Fixed expenses

•Contribution margin method:

–Profit = (p-v)q – F or

–Profit = (cm)q – F

•Where capital letters represent total amounts and lower case letters represent per-unit

amounts:

–p is the unit sales price,

–v is the unit variable expense,

–q is the number of units sold,

–cm is the unit contribution margin, and

–F is total Fixed expenses

–Results

•If Sales = 0, then Variable expenses = 0 and Loss = Fixed expenses

•For Sales < break even, Loss = Fixed expenses – (unit cm x units sold); each unit sold

reduces the loss by the amount of the unit cm

•For Sales > break even, Profit = unit cm x the number of additional units sold;

each additional unit sold increases Profit by the amount of the unit cm

•Contribution margin ratio (CM ratio) = Contribution margin/ Sales

–Shows how the CM is affected by change in Sales

1. Cost-volume-profit (CVP) analysis

2. Target profit and break-even analysis

3. Structuring sales commission and sales mix

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Document Summary

Student learning outcomes: prepare traditional and contribution-margin income statements and define related terms, explain cost-volume-profit analysis, degree of operating leverage, and safety margin and employ each as an analytical tool. Chapter outline: cost-volume-profit (cvp) analysis, target profit and break-even analysis, structuring sales commission and sales mix. Contribution margin (cm) the amount remaining from sales after covering variable expenses that is available to cover. Calculation of contribution margin and net income expenses and generate variable profit: sales, - variable expenses, = contribution margin, - fixed expenses, = net income (i. e. , profit. Break-even point the level of sales at which profit = Methods of calculating profit: cvp equation method (income statement approach): profit = (sales variable expenses) fixed expenses, contribution margin method: Profit = (cm)q f: where capital letters represent total amounts and lower case letters represent per-unit amounts: Shows how the cm is affected by change in sales.

Related Questions

The Hampshire Company manufactures umbrellas that sell for$12.50 each. In 2014, the company made and sold 60,000 umbrellas.The company had fixed manufacturing costs of $216,000. It also hadfixed costs for administration of $79,525. The per-unit costs ofeach umbrella are as follows:

Direct Materials: $3.00

Direct Labor: $1.50

Variable Manufacturing Overhead: $0.40

Variable Selling Expenses: $1.10

Using the information above, perform a cost-volume-profit (CVP)analysis by completing the steps below.

1. Compute net income before tax.

2. Compute the unit contribution margin in dollars and thecontribution margin ratio for one umbrella.

3. Calculate the break-even point in units and dollars ofrevenue.

4. Calculate the margin of safety:

In units

In sales dollars

As a percentage

5. Calculate the degree of operating leverage.

6. Assume that sales will increase by 20% in 2015. Calculate thepercentage of before-tax income for this increase. Providecalculations to prove that your percentage increase is correctbased on the operating leverage calculated in step 5.

7. Compute the number of umbrellas that Hampshire is required tosell if it plans to earn $150,000 in income before taxes by usingthe target income formula. Proof your calculation.

8. A company that specializes in tours in England has offered topurchase 5,000 umbrellas at $11 each from Hampshire. The variableselling costs of these additional units will be $1.30 as opposed to$1.10 per unit. Also, this production activity will incur another$15,000 of fixed administrative costs. Should Hampshire agree tosell these additional 5,000 umbrellas to the touring business?Provide calculations to support your decision.

Requirement 1
	Units	Price	Totals
Sales	X	$	$
Variable Costs	X	$	$
Fixed Costs			$
Net Income			$

Requirement 2

Contribution Margin per Unitin Dollars = Selling Price â Variable Costs

Selling Price		Variable Costs	Contribution Margin per Unit



Contribution Margin Ratio =Contribution Margin/Selling Price

Contribution Margin		Selling Price	Contribution Margin Ratio


Requirement 3

Break-Even Point = Fixed Costs/ Contribution Margin

Fixed Costs		Contribution Margin	Break-Even Point in Units (Rounded)


Break-Even Point in Units XSelling Price per Unit = Break-Even Point Sales

Break-Even Point in Units		Selling Price per Unit	Break-Even Point in Sales (Rounded)


Requirement 4A

Margin of Safety in Units =Current Unit Sales â Break-Even Point in Unit Sales

Current Unit Sales		Break-Even Point in Sales	Margin of Safety in Units


Requirement 4B

Margin of Safety in Dollars =Current Sales in Dollars â Break-Even Point Sales in Dollars

Current Sales in Dollars		Break-Even Point in Dollars	Margin of Safety in Dollars


Requirement 4C

Margin of Safety as aPercentage = Margin of Sales in Units / Current Unit Sales

Margin of Safety in Units		Current Unit Sales	Margin of Safety Percentage



Requirement 5

Degree of Operating Leverage =Contribution Margin / Operating Income

Contribution Margin		Operating Income	Operating Leverage



Requirement 6
	Units	$ Per Unit	Totals
Sales	X	$	$
Variable Costs	X	$	$
Fixed Costs			$
Net Income			$

Operating Leverage		Times % Increase	Increase would be XX%


Prior Income	$	From Part 1
Increase	$	Prior Income X XX% Above
Total	$


Requirement 7

Targeted Income = (Fixed Costs+ Target Income) / Contribution Margin

Fixed Costs + Target Income		Divided by Contribution Margin	# of Units (Rounded)
Fixed Costs	$
Target Income	$
Total	$	$	X

		# of Units Above X $ Per Unit
Proof	Revenue	XX,XXX X $XX.XX	$
	Variable Costs	XX,XXX X $X.XX	$
	Contribution Margin		$
	Fixed Costs		$
	Net Income		$


Requirement 8

Sales Mix
	Current	Specialty	Total
Expected Sales Units	X	X
Revenue = Sales X Price	$	$	$
Variable Costs X Units	$	$	$
Contribution Margin	$	$	$
Fixed Costs	$	$	$
Operating Income			$

Prior Net Income FromRequirement 1			$

Additional Operating Income	(Operating Income Above Less Prior Income)		$

Decision With Explanation

redant669

Teri Hall has recently opened Sheer Elegance, Inc., a storespecializing in fashionable stockings. Ms, Hall has justcompleted a course in managerial accounting, and she believes thatshe can apply certain aspects of the course to herbusiness. She is particularly interested in adopting thecost volume-profit (CVP) approach to decisionmaking. Thus, she has prepared the followinganalysis:

Sales price per pair of stockings.................... $2.00

Variable expense per pair of stockings...........$0.80

contribution margin per pair of stockings....... $1.20

Fixed expense per year:

Building rental.................$12,000

Equipment depreciation... 3,000

Selling..............................30,000

Administrative..................15,000

Total fixed expense.........$60,000

Required:

1. How many pairs of stockings must be sold to breakeven? What does this represent in total dollarsales?

2. Prepare a CVP graph or a profit graph for the store from zeropairs up to 70,000 pairs of stockings sold eachyear. Indicate the break-even point on the graph.

3. How many pairs of stockings must be sold to earn a $9.000target profit for the first year?

4.Ms. Hall now has one full-time and one part-time salespersonworking in the store. It will cost her an additional$8,000 per year to convert the part-time position to a full-timeposition. Ms. Hall belieces that the change would bringin an additional $20,000 in sales each yar. Should she convert theposition? Use the incremental approach. (Do not prepare an incomestatement.)

5. Refer to the original data. Actual operatingresults for the first year are as follows:

Sales.........................$125,000

Variable expense....... 50,000

contribution margin.......75,000

Fixed expenses.............60,000

Net operating income..$15,000

a. What is the store's degree of operating leverage?

b. Ms. Hall is confident that with some effort she can increasesales by 20%next year. What would be the expectedpercentage increase in net operating income? Use thedegree of operating leverage concept to compute your answer.

PROBLEM 5-30 Graphing; Incremental Analysis; Operating Leverage [L05-2, L05-4, L05-5, L05-6, LO5-8] Angie Silva has recently opened The Sandal Shop in Brisbane, Australia, a store that specializes in fashionable sandals. Angie has just received a degree in business and she is anxious to apply the principles she has learned to her business. In time, she hopes to open a chain of sandal shops. As a first step, she has prepared the following analysis for her new store: $40 $24 Sales price per pair of sandals ........ Variable expenses per pair of sandals ..... Contribution margin per pair of sandals ...... Fixed expenses per year: Building rental ......... Equipment depreciation .. Selling ....... Administrative ..... Total fixed expenses ...... $15,000 7,000 20,000 18,000 $60,000 Required: 1. How many pairs of sandals must be sold each year to break even? What does this represent in total sales dollars? 2. Prepare a CVP graph or a profit graph for the store from zero pairs up to 4,000 pairs of sandals sold each year. Indicate the break-even point on your graph. 3. Angie has decided that she must earn at least $18,000 the first year to justify her time and effort. How many pairs of sandals must be sold to reach this target profit? 4. Angie now has two salespersons working in the store—one full time and one part time. It will cost her an additional $8,000 per year to convert the part-time position to a full-time position. Angie believes that the change would bring in an additional $25,000 in sales each year. Should she convert the position? Use the incremental approach. (Do not prepare an income statement.) Refer to the original data. During the first year, the store sold only 3,000 pairs of sandals and reported the following operating results: Sales (3,000 pairs) ..... Variable expenses ..... Contribution margin ... Fixed expenses ....... Net operating income..... $120,000 48,000 72,000 60,000 $ 12,000 a. What is the store's degree of operating leverage? b. Angie is confident that with a more intense sales effort and with a more creative adver- tising program she can increase sales by 50% next year. What would be the expected percentage increase in net operating income? Use the degree of operating leverage to compute your answer.

ACCT 311 Lecture Notes - Lecture 5: Contribution Margin, Net Income, Operating Leverage

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