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ACC 406 Chapter Notes - Chapter 4: Sensitivity Analysis, Operating Leverage, Contribution Margin

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greyporcupine303
28 Jun 2018
School
Ryerson University
Department
Accounting
Course
ACC 406
Professor
Vanessa Magness

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ACC – Chapter 4 – Cost volume-profit analysis: A managerial planning tool
Cost volume profit (CVP) analysis estimates how changes in costs, sales volume, and price affect
a company’s profit
Break even point – the point where total revenue equals total cost
The income statement format that is based on the separation of costs in fixed and variable
components is called the contribution margin income statement
Contribution margin – defined as the excess of sales over variable cost
Contribution margin = sales – variable costs
Contribution margin refers to the amount left after the variable costs are covered to contribute
toward the fixed costs, any remaining contribution margin increases income
Contribution margin ratio – indicates the percentage of each sales dollar available to cover
fixed costs and to provide income from operations
Your CRM + your VCR (variable cost ratio) should always = 1
Contribution margin ratio = contribution margin/sales
Change in income from operations = change in sales dollars x contribution margin ratio
Unit contribution margin – also useful for analyzing profit potential of proposed decisions
Unit contribution = sales price per unit – variable cost per unit
Change in income from operations = change in sales units x unit contribution margin
Operating income equation
Operating income = sales – total variable expense – total fixed expenses
Operating income = (price x # of units sold) – (variable cost per unit x # of units sold) – total
fixed cost
Break-even units = total fixed cost/ (price – variable cost per unit)
The variable cost ratio – is the proportion of each sales dollar that must be used to cover
variable costs
If fixed cost equals contribution margin, then operating income is $0 (breakeven)
Break even sales dollars
Break-even sales = total fixed expenses / contribution margin ratio
Number of units to sell to earn a targeted income
# of units to earn target income = (fixed cost + target income) / (price – variable cost per unit)
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Document Summary

Acc chapter 4 cost volume-profit analysis: a managerial planning tool. Cost volume profit (cvp) analysis estimates how changes in costs, sales volume, and price affect a company"s profit. Break even point the point where total revenue equals total cost. The income statement format that is based on the separation of costs in fixed and variable components is called the contribution margin income statement. Contribution margin defined as the excess of sales over variable cost. Contribution margin refers to the amount left after the variable costs are covered to contribute toward the fixed costs, any remaining contribution margin increases income. Contribution margin ratio indicates the percentage of each sales dollar available to cover fixed costs and to provide income from operations. Your crm + your vcr (variable cost ratio) should always = 1. Change in income from operations = change in sales dollars x contribution margin ratio. Unit contribution margin also useful for analyzing profit potential of proposed decisions.

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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 – 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 – 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 – 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

Phoenix Company’s 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
Sales $ 3,150,000
Cost of goods sold
Direct materials $ 945,000
Direct labor 225,000
Machinery repairs (variable cost) 45,000
Depreciation—Plant equipment (straight-line) 300,000
Utilities ($45,000 is variable) 195,000
Plant management salaries 200,000 1,910,000
Gross profit 1,240,000
Selling expenses
Packaging 90,000
Shipping 105,000
Sales salary (fixed annual amount) 235,000 430,000
General and administrative expenses
Advertising expense 125,000
Salaries 230,000
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 company’s 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)

1)The manager of Able Car Inspection reviewed his monthlyoperating costs for the past year. His costs range from $4,100 for1,100 inspections to $3,700 for 700 inspections.

1. Calculate variable cost per inspection. use the high-lowmethod. round to the nearest cent

2. calculate the total fixed costs

3. write the equation and calculate the operating costs for 900inspections

4. Draw a graph illustrating your total cost under this plan.show your costs at 700, 900, and 1,100 inspections

--------------------------------------------------

2) For its top managers, Airborn Travel formats its incomestatements as follows:

Airborn Travel

contribution margin income statement

three months ended March 31, 2012

Sales revenue $318500

Variable costs $111475

contribution margin 207025

fixed costs 176000

operating income $31025

Airborn's relevant range is between sales of $253000 and$366000

1) calculate the contribution margin ratio

2) Prepare two contribution margin income statements: one at the$253000 level and one at the $366,000 level. (Hint: the proportionof each sales dollar that goes toward variable costs is constantwithin the relevant range.) enter losses with a minus sign orparentheses

3) compute breakeven sales in dollars.

---------------------------------------------------------------

3) Hang Ten, Co., produces sports socks. The company has fixedcosts of $91,080 and variable costs of $0.81 per package. Eachpackage sells for $1.80.

1. Compute the contribution margin per package and thecontribution margin ratio. (round answers to 2 decimal places)

2. Find the breakeven point in units and in dollars, using thecontribution margin approach.