BTB110

Fall, 2010

Cost-Volume-Profit Analysis (Break-Even)

Let’s illustrate thedifference between gross margin and contribution margin withthe following information:companyhad Net Sales of $600,000 duringthe past year. Itsinventory of goods was the samequantity at the beginning and at theend of year. Its Cost of Goods Sold consisted of $120,000 of variable costs and $200,000 of fixed costs.Its selling and administrative expenses were $40,000 of variable and $150,000 offixedexpenses.

The company’sGross Marginis: Net Sales of $600,000 minus its Cost of Goods Sold of $320,000 ($120,000 + $200,000)for a Gross Profit of $280,000 ($600,000 - $320,000). The Gross Margin or Gross Profit Percentage is the Gross Profit of $280,000 divided by $600,000, or 46.7%.

The company’sContribution Marginis: Net Sales of $600,000 minusthe variable product costs of $120,000and the variable expenses of $40,000 for a Contribution Margin of $440,000. The Contribution Margin Ratio is 73.3% ($440,000 divided by $600,000).

Another aspect of cost-volume-profit relationships is that it can be used to determine the break-even point, and can also be used to target profit.

  • Sales price per unit = $250
  • Variable cost per unit = $150
  • Total fixed expenses = $35,000
  • Target Profit = $40,000
  • Q = Number (Quantity) of units sold
  1. With this data, determine the break-even point in units and dollars.
  2. Use this data to determine the number of units required to be sold in order to target a profit of $40,000
  3. Use both the CVP equation method and the contribution margin approach.

Voltar Company manufactures and sells a telephone answering machine. The Company'scontribution margin format income statementfor the most recent year is given below:

Total / Per Unit / Percent of Sales
Sales (20,000 units) / $1,200,000 / $60 / 100%
Less variable expenses / 900,000 / 45 / ?%
------/ ------/ ------
Contribution margin / 300,000 / $15 / ?%
Less fixed expenses / 240,000 / ======/ ======
------
Net operating income / $60,000
======

Management is anxious to improve the company's profit performance. Assume that next year management wants the company to earn a minimum profit of $90,000. How many units will have to be sold to meet the target profit figure?

Formula of CM Ratio:

Formula or equation of CM ratio is as follows:

[ CM Ratio = Contribution Margin / Sales ]

Thisratio is extensively used in cost-volume profit calculations.

Calculation / Computation of Contribution Margin Ratio:

Example:

Consider the followingcontribution margin income statementof A. Q. Asem Private Ltd.in which sales revenues, variable expenses, and contribution margin are expressed as percentage of sales.

Total / Per Unit / Percent of Sales
Sales (400 units) / $100,000 / $250 / 100%
Less variable expenses / 60,000 / 150 / 60%
------/ ------/ ------
Contribution margin / $40,000 / $100 / 40%
======/ ======
Less fixed expenses / 35,000
------
Net operating income / $5,000
======
Calculate contribution margin ratio

According to above data of A. Q. Asem private Ltd. the computations are:

Contribution Margin Ratio = (Contribution Margin / Sales) × 100

= ($40,000 / $100,000) × 100

= 40%

In a company that has only one product such as for A. Q. Asem, theCM ratio can also be calculated as follows

Contribution Margin Ratio = (Unit contribution margin / Unit selling price) × 100

= ($100 / $250) × 100

= 40%

Problem 2

A company producing a single article sells it at $10 each. The marginal cost of production is $ 6 each and fixed cost is $ 400 per annum. You are required to calculate the following:

  • Profits for annual sales of 1 unit, 50 units, 100 units and 400 units
  • Breakeven sales
  • Sales to earn a profit of $ 500
  • Profit at sales of 3,000 units
  • New breakeven point if sales price is reduced by 10%

Problem 3

The following budget data apply to Newberry’s Nutrition:

Sales (100,000 units) $1,000,000

Costs

Direct materials $300,000

Direct labor 200,000

Fixed factory overhead 100,000

Variable factory overhead 150,000

Marketing and administration 160,000

Total costs 910,000

Budgeted pretax income $90,000

Direct labor workers are paid hourly wages and go home when there is no work. The marketing

and administration costs include $50,000 that varies proportionately with production volume. Assume

that sales and production volumes are equal.

e

A. Compute the number of units that must be sold to break-even.

B. Compute the number of units that must be sold to achieve a target income of $120,000,

Problem 4

Beakeven, target profit, cost changes, selling price Laraby Company produces a single product.

It sold 25,000 units last year with the following results.

Sales $625,000

Variable costs 375,000

Fixed costs 150,000

Income before taxes 100,000

In an attempt to improve its product, Laraby’s managers are considering replacing a component part that

costs $2.50 with a new and better part costing $4.50 per unit during the coming year. A new machine

would also be needed to increase plant capacity. The machine would cost $18,000 and have a useful

life of 6 years with no salvage value. The company uses straight-line depreciation on all plant assets.

A. What was Laraby Company’s breakeven point in units last year?

B. How many units of product would Laraby Company have had to sell in the past year to

earn $77,000 in profit?

C. If Laraby Company holds the sales price constant and makes the suggested changes, how

many units of product must be sold in the coming year to break even?

D. If Laraby Company holds the sales price constant and makes the suggested changes, how many

units of product will the company have to sell to make the same profit as last year?

E. If Laraby Company wishes to maintain the same contribution margin ratio, what selling

price per unit of product must it charge next year to cover the increased materials costs?