Mowen 2ce Solutions - ch04

CHAPTER 4
COST-VOLUME-PROFIT ANALYSIS:
A MANAGERIAL PLANNING TOOL
DISCUSSION QUESTIONS
1. CVP analysis allows managers to focus on 8. Packages of products, based on the ex-
selling prices, volume, costs, profits, and pected sales mix, are defined as a single
sales mix. Many different “what-if” questions product. Selling price and cost information
can be asked to assess the effect of chang- for this package can then be used to carry
es in key variables on profits. out CVP analysis.
2. The units sold approach defines sales vol- 9. This statement is wrong; break-even analy-
ume in terms of units of product and gives sis can be easily adjusted to focus on target
answers in these same terms. The unit con- profit.
tribution margin is needed to solve for the
10. The basic break-even equation is adjusted
break-even units. The sales revenue ap-
for target profit by adding the desired target
proach defines sales volume in terms of
revenues and provides answers in these profit to the total fixed costs in the numera-
same terms. The overall contribution margin tor. The denominator remains the contribu-
ratio can be used to solve for the break-even tion margin per unit.
sales dollars. 11. A change in sales mix will change the con-
3. Break-even point is the level of sales activity tribution margin of the package (defined by
where total revenues equal total costs, or the sales mix), and thus will change the
where zero profits are earned. units needed to break even.
4. At the break-even point, all fixed costs are 12. Margin of safety is the sales activity in excess
covered. Above the break-even point, only of that needed to break even. The higher the
variable costs need to be covered. Thus, margin of safety, the lower the risk.
contribution margin per unit is profit per unit,
provided that the unit selling price is greater 13. Operating leverage is the use of fixed costs
than the unit variable cost (which it must be to extract higher percentage changes in prof-
for break even to be achieved). its as sales activity changes. It is achieved by
increasing fixed costs while lowering variable
5. Variable cost ratio = Variable costs/Sales costs. Therefore, increased leverage implies
Contribution margin ratio increased risk, and vice versa.
= Contribution margin/Sales 14. Sensitivity analysis is a “what-if” technique
Contribution margin ratio that examines the impact of changes in un-
= 1 – Variable cost ratio derlying assumptions on an answer. A com-
pany can input data on selling prices, varia-
6. No. The increase in contribution is $9,000 ble costs, fixed costs, and sales mix and set
(0.3 × $30,000), and the increase in advertis- up formulas to calculate break-even points
ing is $10,000. If the contribution margin ratio
and expected profits. Then, the data can be
is 0.40, then the increased contribution is
varied as desired to see what impact chang-
$12,000 (0.4 × $30,000). This is $2,000
above the increased advertising expense, so es have on the expected profit.
the increased advertising would be a good 15. A declining margin of safety means that
decision. sales are moving closer to the break-even
7. Sales mix is the relative proportion sold of point. Profit is going down, and the possibil-
each product. For example, a sales mix of ity of loss is greater. Managers should ana-
3:2 means that three units of one product lyze the reasons for the decreasing margin
are sold for every two of the second product. of safety and look for ways to increase reve-
nue and/or decrease costs.
Copyright © 2015 by Nelson Education Ltd. 4-1

CORNERSTONE EXERCISES
Cornerstone Exercise 4–1
1. Variable cost per unit = Direct materials + Direct labour

+ Variable factory overhead + Variable selling expense
= $30 + $5 + $12 + $2
= $49
2. Total fixed expense = $14,000 + $15,400 = $29,400
3. Head-First Company
Contribution Margin Income Statement
For the Coming Year
Total Per Unit
Sales ($70 × 5,000 helmets).................................. $350,000 $70
Total variable expense ($49 × 5,000) ................... 245,000 49
Total contribution margin .................................... 105,000 $21
Total fixed expense............................................... 29,400
Operating income ................................................ $ 75,600
Total fixed cost

1. Break-even units =
(Price - Unit variable cost)
$29,400
=
($70 - $49)
= 1,400 helmets
At Break-Even
Total
Sales ($70 × 1,400 helmets)....................................................... $98,000
Total variable expense ($49 × 1,400) ........................................ 68,600
Total contribution margin ......................................................... 29,400
Total fixed expense.................................................................... 29,400
Operating income ...................................................................... $ 0
4-2 Copyright © 2015 by Nelson Education Ltd.

Variable cost per unit

1. Variable cost ratio =
Price
$49
=
$70
= 0.70, or 70%
(Price - Variable cost per unit)

2. Contribution margin ratio =
Price
Contribution margin per unit

=
Price
($70 - $49)
=
$70
= 0.30, or 30%
For the Coming Year
Percent
of Sales
Sales ($70 × 5,000 helmets).................................. $350,000 100%
Total variable expense ($49 × 5,000) ................... 245,000 70
Total contribution margin .................................... 105,000 30
Total fixed expense............................................... 29,400
Operating income ................................................ $ 75,600
Total fixed cost

1. Break-even sales dollars =
Contribution margin ratio
$29,400
=
0.30
= $98,000

Cornerstone Exercise 4–4 (Concluded)
At Break-Even
Total
Sales ........................................................................................... $98,000
Total variable expense ($98,000 × 0.70) ................................... 68,600
(Total fixed cost + Target income)

(Price - Unit variable cost
($29,400 + $81,900)
=
($70 - $49)
= 5,300 helmets
At 5,300 Helmets Sold
Total
Sales ($70 × 5,300 helmets)....................................................... $371,000
Total variable expense ($49 × 5,300) ........................................ 259,700
Operating income ...................................................................... $ 81,900
(Total fixed cost + Target income)

1. Sales for target income =
($29,400 + $81,900)
=
0.30
= $371,000

At Sales Revenue of $371,000
Total
Sales ........................................................................................... $371,000
Total variable expense ($371,000 × 0.70) ................................. 259,700
Operating income ...................................................................... $ 81,900
3. A Contribution Margin Income Statement helps managers make better

decisions in that it focuses their attention on those areas that are easiest to
control. Variable costs are usually more easily controlled than fixed costs.
1. Any package with 5 bicycle helmets for every 1 motorcycle helmet is fine; for
example, 5:1, or 10:2, or 30:6. Throughout the rest of this exercise, we will use
5:1.
Unit Unit Package Unit

Variable Contribution Sales Contribution
Product Price Cost Margin Mix Margin
Bicycle helmet $ 70 $ 49 $21 5 $105
Motorcycle helmet 220 143 77 1 77
Package total $182

Fixed cost
2. Break-even packages =
Package contribution margin
$54,600
=
$182
= 300 packages
Break-even bicycle helmets = Number of packages × Sales mix amount

= 300 × 5
= 1,500
Break-even motorcycle helmets = Number of packages × Sales mix amount

= 300 × 1
= 300
At Break-Even
Total
Sales [($70 × 1,500) + ($220 × 300)] .......................................... $171,000
Total variable expense [($49 × 1,500) + ($143 × 300)] ............. 116,400
($570,000 - $388,000)
$570,000
= 0.3193
Total fixed cost

Break-even sales dollars =
Contributi on margin ratio
$54,600
=
0.3193
= $170,999

At Break-Even Sales Dollars
Total
Sales ........................................................................................... $170,999
Total variable expense ($170,999 × 0.6807) ............................. 116,399
1. Margin of safety in units = Budgeted units – Break-even units

= 5,000 – 1,400
= 3,600
2. Margin of safety in sales revenue = Budgeted sales – Break-even sales

= $350,000 – $98,000
= $252,000
Total contribution margin

Degree of operating leverage =
Operating income
$105,000 *
=
$75,600
= 1.4
* 5,000 × ($70 - $49)

1. Percent change in operating income = DOL × % Change in sales

= 1.4 × 15%
= 21%
2. Expected operating income = Original income + (% Change × Original income)

= $75,600 + (0.21 × $75,600)
= $91,476

EXERCISES
Exercise 4–12
1. Direct materials .......................................................................... $ 5.85

Direct labour ............................................................................... 2.10
Variable overhead ...................................................................... 3.15
Variable selling and administrative expense ........................... 2.40
Unit variable cost ....................................................................... $13.50
Unit contribution margin = Price – Unit variable cost
= $24.00 – $13.50
= $10.50
$10.50
2. Contribution margin ratio = = 0.4375, or 43.75%
$24
$13.50
Variable cost ratio = = 0.5625, or 56.25%
$24
3. Break-even units ($78,000 + $56,925) / ($24 - $13.50) = 12,850
4. Sales ($24 × 12,850) ................................................................... $308,400

Variable costs ($13.50 × 12,850) ............................................... 173,475
Total contribution margin .................................................... 134,925
Less: Fixed expenses ($78,000 + $ 56,925).............................. 134,925
Operating income ................................................................. $ 0
Exercise 4–13
1. Unit variable cost = $19.00 × 0.60 = $11.40
Unit contribution margin = $19.00 – $11.40 = $7.60
$874,000
2. Break-even units = = 115,000
$7.60

Exercise 4–13 (Concluded)
3. Break-even sales revenue = $19.00 × 115,000 = $2,185,000

OR
$874,000
Break-even sales revenue = = $2,185,000
0.40
4. Sales ........................................................................................... $2,185,000

Less: Variable costs (0.6 x $2,185,000) .................................... 1,311,000
Contribution margin .................................................................. 874,000
Less: Fixed costs ....................................................................... 874,000
5. Break-even operations always result in a profit of zero.
Exercise 4–14
Contribution margin
Sales
$63,000
= = 0.20, or 20%
$315,000
2. Variable cost ratio = $252,000 / $315,000 = 0.80 or 80%

OR
Variable cost ratio = 1 – Contribution margin ratio = 1.00 – 0.20 = 0.80
Fixed cost
3. Break-even sales revenue =
$24,150
= = $120,750
0.20

Exercise 4–15
1. Cameco Company—Income Statement for Last Year

Sales ($35 × 27,000) ................................................................... $945,000
Variable cost ($23.75 × 27,000) ................................................. 641,250
Less: Fixed expenses ................................................................ 315,000
Operating income (loss) ............................................................ $ (11,250)
2. Break-even units = $315,000 / ($35.00 – $23.75) = 28,000
3. Units to earn target income = ($315,000 + $24,750) / ($35.00 – $23.75) =

30,200
Exercise 4–16
($131,650 + $18,350)
($2.45 - $1.65)
$150,000
=
$0.80
= 187,500
2. Unit variable cost includes all variable costs on a unit basis:

Direct materials..................................................................... $0.27
Direct labour ......................................................................... 0.58
Variable overhead................................................................. 0.63
Variable selling ..................................................................... 0.17
Unit variable cost.................................................................. $1.65
Unit variable manufacturing cost includes the variable costs of production on
a unit basis:
Direct materials..................................................................... $0.27
Direct labour ......................................................................... 0.58
Variable overhead................................................................. 0.63
Unit variable manufacturing cost ........................................ $1.48
Unit variable cost is used in CVP because it includes all variable costs, not
just manufacturing costs.

($131,650 + $18,350 + $12,600)

3. Units to earn $12,600 =
($2.45 - $1.65)
= 203,250
4. Sales revenue to earn $12,600 = 203,250 × $2.45 = $497,962.50

or
$131,650 + $18,350 + $12,600 = $162,600 ÷ .3265* = $498,009
*contribution margin ratio = ($2.45 - $1.65) ÷ $162,600 = .3265 (rounded)
Exercise 4–17
1. Break-even units = ($347,475 + $473,085) / ($9.42 - $5.48) = 208,264
2. Expected sales in units ............................................................. 570,000

Break-even units ........................................................................ (208,264)
Margin of safety (in units) ......................................................... 361,736
3. Expected sales revenue ($9.42 × 570,000) ............................... $5,369,400

Break-even sales revenue* ....................................................... 1,961,847
Margin of safety (in dollars) ...................................................... $3,407,553
*Break-even revenue = Price × Break-even units = $9.42 × 208,264 units

Exercise 4–18
A B C D
Sales $15,000 $15,600* $16,250* $10,600
Total variable costs 5,000 11,700 9,750 5,300*
Total contribution margin 10,000 3,900 6,500* 5,300*
Total fixed costs 9,500* 4,000 6,136* 4,452
Operating income (loss) $ 500 $ (100)* $ 364 $ 848
Units sold 3,000* 1,300 125 1,000

Price per unit $5.00 $12* $130 $10.60*
Variable cost per unit $1.67* $9 $78* $5.30*
Contribution margin per unit $3.33* $3 $52* $5.30*
Contribution margin ratio 67%* 25%* 40% 50%*
Break even in units 2,853* 1,333* 118* 840*
*Designates calculated amount.
(Note: Calculated break-even units that include a fractional amount have been
rounded to the nearest whole unit.)
Exercise 4–19
$141,750
1. Variable cost ratio = = 0.45, or 45%
$315,000
$173,250
Contribution margin ratio = = 0.55, or 55%
$315,000
2. Because all fixed costs are covered by break even, any revenue above break
even contributes directly to operating income.
Sales  Contribution margin ratio = Increased operating income
$30,000 × 0.55 = $16,500
Therefore, operating income will be $16,500 higher.

$63,000
3. Break-even sales revenue = = $114,545 (rounded to the nearest
0.55
dollar)
Sales ........................................................................................... $114,545

Less: Variable cost ($114,545 × 0.45) ....................................... 51,545
Contribution margin ............................................................. 63,000
Less: Fixed cost ......................................................................... 63,000
Operating income ................................................................. $ 0
4. Expected sales ........................................................................... $315,000

Break-even sales........................................................................ 114,545
Margin of safety .................................................................... $200,455
5. Sales revenue ............................................................................. $280,000

Break-even sales........................................................................ 114,545
Margin of safety .................................................................... $165,455
Exercise 4–20
1. Sales mix is 2:1 (twice as many DVDs are sold as equipment sets).
2. Variable Sales Total

Product Price – Cost = CM × Mix = CM
DVDs $12 $4 $8 2 $16
Equipment sets 15 6 9 1 9
Total $25
$70,000
Break-even packages = = 2,800
$25
Break-even DVDs = 2 × 2,800 = 5,600
Break-even equipment sets = 1 × 2,800 = 2,800

Exercise 4–21
1. Sales mix is 2:1:4 (twice as many DVDs will be sold as equipment sets, and
four times as many yoga mats will be sold as equipment sets).

DVDs $12 $4 $8 2 $16
Equipment sets 15 6 9 1 9
Yoga mats 18 13 5 4 20
Total $45
$118,350
$45
Break-even DVDs = 2 × 2,630 = 5,260
Break-even equipment sets = 1 × 2,630 = 2,630
Break-even yoga mats = 4 × 2,630 = 10,520
3. Switzer Company
Income Statement
For the Coming Year
Sales ........................................................................................... $555,000
Less: Total variable costs ......................................................... 330,000
Less: Total fixed costs .............................................................. 118,350
Operating income ................................................................. $106,650
$225,000
Contribution margin ratio = = 0.405, or 40.5%
$555,000
$118,350
Break-even revenue = = $292,222
0.405
4. Margin of safety = $555,000 – $292,222 = $262,778

Exercise 4–22
1. Sales mix is 3:5:1 (three times as many small basics will be sold as carved
models, and five times as many large basics will be sold as carved models).

Small basic $180 $105 $75 3 $225
Large basic 300 225 75 5 375
Carved model 525 412 113 1 113
Total $713
$669,750
Break-even packages = = 940 (rounded up)
$713
Break-even small basic models = 3 × 940 = 2,820
Break-even large basic models = 5 × 940 = 4,700
Break-even carved models = 1 × 940 = 940
3. Sonora Company
Income Statement
For the Coming Year
Sales ........................................................................................... $25,650,000
Less: Total variable costs ......................................................... 18,520,000
Contribution margin ............................................................. 7,130,000
Less: Total fixed costs .............................................................. 669,750
Operating income ................................................................. $ 6,460,250
$7,130,000
Contribution margin ratio = = 0.2780, or 27.80%
$25,650,00 0
$669,750
Break-even revenue = = $2,409,173
0.2780
4. Margin of safety = $25,650,000 – $2,409,173 = $23,240,827

Exercise 4–23
$35,000
$30,000
Revenue and Cost
$25,000 X
$20,000
$15,000
$10,000 X
$5,000
$0
0 500 1,000 1,500 2,000 2,500 3,000 3,500
Units Sold
Break-even point = 2,500 units; + line is total revenue, and X line is total cost.

Exercise 4–23 (Continued)
2. a. Fixed costs increase by $5,000:
$40,000
X
$35,000
$30,000
Revenue and Cost
$25,000
$20,000
$15,000 X
$10,000
$5,000
$0
0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000
Units Sold
Break-even point = 3,750 units

2. b. Unit variable cost increases to $7:
$50,000
$40,000
Revenue and Cost
X
$30,000
$20,000
X
$10,000
$0
0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000
Units Sold

2. c. Selling price increases to $12:
$60,000
$50,000
Revenue and Cost
$40,000
$30,000
$20,000 X
$10,000
X
$0
0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000
Units Sold

2. d. Both fixed costs and unit variable cost increase:
$70,000
$60,000
X
Revenue and Cost
$50,000
$40,000
$30,000
$20,000 X
$10,000
$0
0 1,000 2,000 3,000 4,000 5,000 6,000 7,000
Units Sold
Exercise 4–24
$486,000
1. Unit contribution margin = = $27
18,000
$540,000
Break-even units = = 20,000 units
$27
2. Operating income = 30,000 × $27 = $810,000
$27
3. Contribution margin ratio = = 0.45, or 45%
$60
$540,000
Break-even sales revenue = = $1,200,000
0.45
Profit = ($200,000 × 0.45) – $54,000 = $36,000

Exercise 4–25
$1,833,300
1. Break-even sales dollars = = $3,160,862
0.58 *
$2,610,000
*Contribution margin ratio = = 0.58, or 58%
$4,500,000
2. Margin of safety = $4,500,000 – $3,160,862 = $1,339,138
Contribution margin
3. Degree of operating leverage =
Operating income
$2,610,000
=
$776,700
= 3.36
4. Percent change in operating income = 3.36 × 0.20 = 0.67

New operating income = $776,700 + (0.67 × $776,700) = $1,297,089
Exercise 4–26
1. Variable Sales Package

Vases $100 $75 $25 2 $ 50
Figurines 175 105 70 1 70
Total $120
$75,000
Break-even packages = = 625
$120
Break-even vases = 2 × 625 = 1,250
Break-even figurines = 1 × 625 = 625

2. The new sales mix is 3 vases to 2 figurines.

Variable Sales Package
Vases $100 $75 $25 3 $ 75
Figurines 175 105 70 2 140
Total $215
$88,150
Break-even packages = = 410
$215
Break-even vases = 3 × 410 = 1,230
Break-even figurines = 2 × 410 = 820
3. It is better to use contribution margin ratio in determining break-even for a

multi-product company because it makes the calculations easier when dealing
with sales mix.
Exercise 4–27
$6,720,000
1. a. Variable cost per unit = = $19.20
350,000
$1,680,000
b. Contribution margin per unit = = $4.80
350,000
$4.80
c. Contribution margin ratio = = 0.20, or 20%
$24.00
$1,512,000
d. Break-even units = = 315,000
$4.80
$1,512,000
e. Break-even sales dollars = = $7,560,000
0.20
OR
Break-even sales dollars = 315,000 × $24 = $7,560,000

($1,512,000 + $300,000)
2. Units for target income = = 377,500
$4.80
3. Additional operating income = $50,000 × 0.20 = $10,000
4. Margin of safety in units = 350,000 – 315,000 = 35,000 units

Margin of safety in sales dollars = $8,400,000 – $7,560,000 = $840,000
$1,680,000
5. Degree of operating leverage = = 10.0
$168,000
6. New operating income = $168,000 + [(10 × 0.10) ($168,000)] = $336,000

PROBLEMS
Problem 4–28
Fixed cost
= $1,792,000 / ($50 -$30)
$1,792,000
=
$20
= 89,600 units
2. Units for target profit = ($1,792,000 + $1,600,000) / $20
$3,392,000
=
$20
= 169,600 units
$20
3. Contribution margin ratio = = 0.40
$50
With additional sales of $125,000, the additional profit would be 0.40 ×

$125,000 = $50,000.
4. Current units = $6,200,000 = 124,000 units

$50
Margin of safety in units = 124,000 – 89,600 = 34,400 units

Problem 4–29
Fixed cost
$96,000
=
($10 - $5)
= 19,200 units
($96,000 - $13,500)
($10 - $5)
= 16,500 units
3. The reduction in fixed costs reduces the break-even point because less con-
tribution margin is needed to cover the new, lower fixed costs. Operating in-
come goes up, and the margin of safety also goes up.
Problem 4–30
$5,760,000
1. Unit contribution margin = = $15
384,000
$3,000,000
Break-even point = = 200,000 units
$15
$15
Contribution margin ratio = = 0.3
$50
$3,000,000
Break-even sales = = $10,000,000
0.3
OR
= $50 × 200,000 = $10,000,000
2. Increased contribution margin ($3,000,000 × 0.3) ................... $900,000

Less: Increased advertising expense ...................................... 300,000
Increased profit..................................................................... $600,000

Problem 4–30 (Concluded)
3. $945,000 × 0.3 = $283,500
4. We can simply focus on increased sales revenue to determine profitability be-

cause any increase in profit will automatically add the gross margin of those
sales to profit.
5. Margin of safety = $19,200,000 – $10,000,000 = $9,200,000
$5,760,000
6. = 2.09 (operating leverage)
$2,760,000
20% × 2.09 = 41.8% (profit increase)
Problem 4–31
1. Sales mix:
$300,000
Squares: = 10,000 units
$30
$2,500,000
Circles: = 50,000 units
$50
Variable Contribution Sales Total

Product Price – Cost* = Margin × Mix = CM
Squares $30 $10 $20 1 $ 20
Circles 50 10 40 5 200
Package $220
$100,000
* = $10
10,000
$500,000
= $10
50,000
$1,628,000
Break-even packages = = 7,400 packages
$220
Break-even squares = 7,400 × 1 = 7,400
Break-even circles = 7,400 × 5 = 37,000

2. New mix:
Product Price – Cost = Margin × Mix = CM
Squares $30 $10 $20 3 $ 60
Circles 50 10 40 5 200
Package $260
$1,628,000
Break-even packages = = 6,262 packages
$260
Break-even squares = 6,262 × 3 = 18,786
Break-even circles = 6,262 × 5 = 31,310
3. Increase in contribution margin for squares (25,000 × $20) ... $ 500,000

Decrease in contribution margin for circles (5,000 × $40)...... (200,000)
Increase in total contribution margin ................................. 300,000
Less: Additional fixed expenses .............................................. 245,000
Increase in income ............................................................... $ 55,000
Kenno would gain $55,000 by increasing advertising for the squares. This
is a good strategy.
Problem 4–32
$58,500
($0.36 - $0.27)
Margin of safety in units = 830,000 – 650,000 = 180,000
2. Sales revenue ($0.36 × 830,000) ............................................... $298,800

Total variable cost ($0.27 × 830,000) ........................................ 224,100
Operating income ................................................................. $ 16,200
($58,500 + $36,000)
3. Units for target profit =
($0.36 - $0.27)
= 1,050,000

4. Operating income = Sales – (Variable cost ratio × Sales) – Fixed cost

0.20 Sales = Sales – (0.75 × Sales) – $58,500
0.20 Sales = 0.25 Sales – $58,500
$58,500 = (0.25 Sales – 0.20 Sales)
$58,500 = 0.05 Sales
Sales = $1,170,000
Problem 4–33
$302,616
1. Contribution margin ratio = = 0.54, or 54%
$560,400
$150,000
2. Break-even revenue = = $277,778
0.54
3. $560,400 × 110% = $616,440

$257,784 × 110% = 283,562
$332,878
$332,878
$616,440
The contribution margin ratio remains at 0.54.
4. Additional variable expense: $560,400 × 0.03 = $16,812

New contribution margin = $302,616 – $16,812 = $285,804
$285,804
New contribution margin ratio = = 0.51
$560,400
$150,000
Break-even revenue = = $294,118
0.51
The effect is to increase the break-even revenue.

5. Present contribution margin ..................................................... $302,616

Projected contribution margin* ................................................ 326,604
Increase in contribution margin/profit ..................................... $ 23,988
*($560,400 + $80,000) × 0.51 = $326,604
Operating leverage will decrease from 19.8 ($302,616/$152,616) to 18.5

($326,604/$176,604) because the increase in the contribution margin of $23,988
is exactly equal to the increase in the operating income, which results in a de-
crease in the operating leverage.
Alonzo should pay the commission because profit would increase by $23,988.
Problem 4–34
Fixed cost
1. Revenue =
(1 - Variable rate)
$150,000
=
(1/3)
= $450,000
2. Of total sales revenue, 60 percent is produced by floor lamps and 40 percent

by desk lamps.
$360,000
= 12,000 units
$30
$240,000
= 12,000 units
$20
Thus, the sales mix is 1:1.


Floor lamps $30 $20.00 $10.00 1 $10.00
Desk lamps 20 13.33 6.67 1 6.67
Package $16.67
Fixed cost
Number of packages =
(Package contribution margin)
$150,000
=
$16.67
= 8,998 packages
Floor lamps: 1 × 8,998 = 8,998

Desk lamps: 1 × 8,998 = 8,998
Contribution margin
3. Operating leverage =
Operating income
$200,000
=
$50,000
= 4.0
Percentage change in profits = 4.0 × 40% = 160%

4. The theory behind the operating leverage concept is that a company will in-
crease its profit in direct relationship to the relationship between its fixed
costs and its variable costs. The more fixed costs a company has the more
impact an increase in revenues will have on profit because its fixed costs have
been covered.
Problem 4–35
1. Door Handles Trim Kits

CM $12 – $9 = $3 $8 – $5 = $3
CM ratio $3/$12 = 0.25 $3/$8 = 0.375

2. Contribution margin:
($3 × 20,000) + ($3 × 40,000) $180,000
Less: Fixed costs 146,000
Operating income $ 34,000
3. Sales mix (from Requirement 2): 1 door handle to 2 trim kits
Price – V = CM × Sales Mix = Total CM

Door handle $12 $9 $3 1 $3.00
Trim kit 8 5 3 2 6.00
Package $9.00
$146,000
$9
Door handles = 1 × 16,222 = 16,222
Trim kits = 2 × 16,222 = 32,444
4. Revenue (70,000 × $8)................................................................ $560,000

Variable cost (70,000 × $5) ........................................................ 350,000
Fixed costs ................................................................................. 111,000
Yes, operating income is $65,000 higher than when both door handles and trim
kits are sold.

Problem 4–36
$300,000
$14*
$406,000
* = $14
29,000
Break-even in dollars = 21,429 × $42** = $900,018

OR
$300,000
= = $900,000
(1/3)
The difference is due to rounding.
$1,218,000
** = $42
29,000
2. Margin of safety = $1,218,000 – $900,000 = $318,000
3. Sales ........................................................................................... $1,218,000

Variable cost (0.45 × $1,218,000) .............................................. 548,100
Fixed costs ................................................................................. 550,000
$550,000
Break-even in units = = 23,810
$23.10*
$550,000
Break-even in sales dollars = = $1,000,000
0.55**
$669,900
* = $23.10
29,000
$669,900
** = 55%
$1,218,000

Problem 4–37
Variable costs
1. Variable cost ratio =
Sales
$353,400
= = 0.38, or 38%
$930,000
(Sales - Variable costs)
Contribution margin ratio =
Sales
($930,000 - $353,400)
=
$930,000
= 0.62, or 62%
$310,000
2. Break-even sales revenue = = $500,000
0.62
3. Margin of safety = Sales – Break-even sales

= $930,000 – $500,000 = $430,000
4. Contribution margin from increased sales = ($7,500)(0.62) = $4,650

Cost of advertising = $5,000
No, the advertising campaign is not a good idea, because the company’s op-
erating income will decrease by $350 ($4,650 – $5,000).
Problem 4–38
1. Income = Revenue – Variable cost – Fixed cost

$0 = 1,500P – $300(1,500) – $120,000
$0 = 1,500P – $450,000 – $120,000
$570,000 = 1,500P
P = $380
$160,000
2. = 128,000
($3.50 - Unit variable cost)
Unit variable cost = $2.25

Problem 4–39
1. Contribution margin per unit = $5.60 – $4.20*

= $1.40
*Variable costs per unit:
$0.70 + $0.35 + $1.85 + $0.34 + $0.76 + $0.20 = $4.20
$1.40
$5.60
($32,300 + $12,500)
2. Break-even in units = = 32,000 boxes
$1.40
Break-even in sales = 32,000 × $5.60 = $179,200
OR
($32,300 + $12,500)
= = $179,200
0.25
3. Sales ($5.60 × 35,000) ................................................................ $196,000

Variable cost ($4.20 × 35,000) ................................................... 147,000
Fixed cost ................................................................................... 44,800
4. Margin of safety = $196,000 – $179,200 = $16,800
$44,800
5. Break-even in units = = 22,400 boxes
($6.20 - $4.20)
New operating income = $6.20(31,500) – $4.20(31,500) – $44,800
= $195,300 – $132,300 – $44,800 = $18,200
Yes, operating income will increase by $14,000 ($18,200 – $4,200).
Problem 4–40
$100,000
1. Company A: =2
$50,000
$300,000
Company B: =6
$50,000

2. Company A Company B
$50,000 $250,000
X= X=
(1 - 0.8) (1 - 0.4)
$50,000 $250,000
X= X=
0.2 0.6
X = $250,000 X = $416,667
Company B must sell more than Company A to break even because it must
cover $200,000 more in fixed costs (it is more highly leveraged).
3. Company A: 2 × 50% = 100%

Company B: 6 × 50% = 300%
The percentage increase in profits for Company B is much higher than Com-
pany A’s increase because Company B has a higher degree of operating lev-
erage (i.e., it has a larger amount of fixed costs in proportion to variable costs
as compared to Company A). Once fixed costs are covered, additional revenue
must cover only variable costs, and 60 percent of Company B’s revenue above
break even is profit, whereas only 20 percent of Company A’s revenue above
break even is profit.
Problem 4-41
1. Total sales = $500,000 + $1,080,000 + $2,760,000 + $3,600,000 = $7,940,000
Total variable costs = $300,000 + $630,000 + $1,650,000 + $2,350,000 + $25,000

+ $150,000 + $240,000 + $213,000 = $5,558,000
Contribution margin = $7,940,000 - $5,558,000 = $2,382,000
Contribution margin % = $2,382,000 / $7,940,000 = 30%
Total fixed costs = $25,000 + $220,000 + $300,000 + $300,000 + $64,200 +

$50,000 + $50,000 + $150,000 + $270,000 = $1,429,200
Revenue needed to break-even = $1,429,200 /.30 = $4,764,000

Problem 4-41 (Continued)
2. Contribution Margin Per Product
Product A Product B Product C Product D

Revenue $500 $1,800 $9,200 $36,000
Variable
Product 300 1,050 5,500 23,500
Sell/Admin 25 250 800 2,130
Contribution $175 $ 500 $2,900 $10,370
Package of products: A= 10; B= 6; C= 3; D= 1
Contribution per package: (10 x 175) + (6 x 500) + (3 x 2,900) + (1 x 10,370) =

$23,820
Packages required to break-even:
Fixed costs ($1,429,200) divided by contribution per package ($23,820) = 60.
Quantity of each product: A=60 x 10 = 600; B= 60 x 6 = 360; C= 60 x 3 = 180; D=

60 x 1 = 60.
Calculation to check: Revenue = (600 x $500) + (360 x $1,800) + (180 x $9,200) +

(60 x $36,000) = $300,000 + $648,000 + $1,656,000 + $2,160,000) = $4,764,000.
3. After-tax profit of $1,625,000 is pre-tax profit of ($1,625,000 divided by (1 - .35))

or $2,500,000.
Fixed costs plus target profit = $1,429,200 + $2,500,000 = $3,929,200.
Target revenues = $3,929,200 divided by gross margin percentage of .30 or

$13,096,667.

Problem 4-41 (Concluded)
4. After-tax profit of $1,300,000 is pre-tax profit of $2,000,000.
Target units are calculated by taking the fixed costs plus the target pre-tax
profit divided by the contribution margin per package and then calculating the
number of each unit in a package.
Fixed costs ($1,429,200) plus target profit ($2,000,000) = $3,429,200.
Target packages: $3,429,200 / $23,820 = 144 packages (rounded)
By product: A: 10 x 144 = 1440; B: 6 x 144 = 864; C: 3 x 144 = 432; D: 1 x 144 =

144.

Problem 4–42
1. Contribution margin calculated in Problem 4-41 was:
Revenue $7,940,000
Less: Variable costs 5,558,000
Contribution $2,382,000
Revised contribution margin

Revenue $7,940,000
Less: Variable costs 6,113,800
Contribution $1,826,200
Contribution margin % 23%
Revised contribution margin by product
Product A: $500 – [1.1 (300 + 25)] = $ 142.50

Product B: $1,800 – [1.1 ($1,050 + 250)] = $ 370.00
Product C: $9,200 – [1.1 ($5,500 + $800)] = $2.270.00
Product D: $36,000 – [1.1 ($23,500 + $2,130)] = $7,807.00
Revised contribution by package
Product A: 10 x $142.50 = $ 1,425

Product B: 6 x $370.00 = $ 2,220
Product C: 3 x $2,270.00 = $ 6.810
Product D: 1 x $7,807.00 = $ 7,807
Total revised package contribution $18,262
Revised fixed costs $1,429,200 + $1,000,000 = $2,429,200
Revised breakeven in revenues: $2,429,200 /.23 = $10,561,739
Revised packages to breakeven: $2,429,200 / $18.262 = 133 packages (round-

ed)
Per product: A: 133 x 10 = 1,330; B: 133 x 6 =798; C: 133 x 3 =399; D: 133 x 1 =

133.

2. Revised sales revenue = ($500 x 900) + ($1,800 x 400) + ( $9,200 x 500) +

($36,000 x 200) = $12,970,000
Revised contribution
Product A $142.50 x 900 = $128,250
Product B $370.00 x 400 = $148,000
Product C $2,270 x 500 = $1,135,000
Product D $7,807 x 200 = $1,561,400
Total revised contribution $2,972,650
Revised contribution margin % = $2,972,650 / $12,970,000 = 22.92%
New break even in revenue: $2,429,200 / 22.92% = $10,598,604
Revised sales mix is: A; 9; B: 4; C: 5; D: 2
Revised package contribution: (9 x $142.50) + (4 x $370) + (5 x $2,270) + (2

$7,807) = $29,727 (rounded)
Revised packages to breakeven: $2,429,200 / $29,727 = 82 packages (rounded)
Revised units to break even: A: 82 x 9 = 738; B: 82 x 4 = 328; C: 82 x 5 = 410; D:

82 x 2 = 164.
3. Using the changes outlined in part 1:
Pre-tax net income is: $2,470,000 / .65 = $3,800,000
Fixed cost plus target income = $2,429,200 + $3,800,000 = $6,229,200
Revenue to meet new target: $6,229,200 / .23 (from 1 above) = $27,083,478
Using changes outlined in part 2:
Fixed costs plus target pre-tax income = $6,229,200
New contribution margin % (from 2 above) = 22.92%
Revenues needed to meet target: $6,229,200 / .2292 = $27,178,010

Problem 4–43
1. Contribution margin ratios:
$23,910
May of current year = = 0.549, or 54.9%
$43,560
$23,400
May of prior year = = 0.561, or 56.1%
$41,700
2. Break-even point in sales dollars (in thousands):
$20,330
May of current year = = $37,031
0.549
$13,800
May of prior year = = $24,599
0.561
3. Margin of safety (in thousands):

May of current year = $43,560 – $37,031 = $6,529
May of prior year = $41,700 – $24,599 = $17,101
4. Clearly, the sharp rise in fixed costs from the prior year to the current year has
had a strong impact on the break-even point and the margin of safety. Bisson-
ette will need to ensure that tight cost control is exercised since the margin of
safety is much slimmer. Still, the decision to go with the OEM investment pro-
gram could pay large dividends in the future. Note that the margin of safety
and break-even point give the company important information on the potential
risk of the venture but do not tell it the upside potential.

PROFESSIONAL EXAMINATION PROBLEM*
Professional Examination Problem 4–44
a. CM/unit = $4 - $2.40 = $1.60

After-tax net income = [(390,000 × 1.60) - $440,000].6
= ($624,000 – $440,000).6
= $110,400
b. $440,000 / $1.60
= 275,000 boxes
c. Current CM ratio = $1.60 / $4 = 40%

New variable costs = $2 × 1.15 + $0.40 = $2.70
Let SP = new selling price

(SP - $2.70) / SP = 0.4
SP - $2.70 = 0.4SP
SP – 0.4SP = $2.70
0.6SP = $2.70
SP = $4.50
d. CM = $4 - $2.70 = $1.30
CM ratio = $1.30 / $4 = 32.5%
Desired operating income = $110,400 / .6 = $184,000
Desired sales volume = ($184,000 + $440,000) / 0.325

= $1,920,000
e. Let X = volume of boxes
1.30X – 440,000 = $4X(0.10) / 0.60

1.30X – 440,000 = 0.6667X
0.6333X = $440,000
X = $440,000 / 0.6333
= 694,737 boxes
* © 2010 CMA Ontario. Reproduced with Permission.

CASES
Case 4–45
1. Let X be a package of 3 Grade I cabinets and 7 Grade II cabinets.
0.3X($3,400) + 0.7X($1,600) = $1,600,000
X = 748 packages
Grade I: 0.3 × 748 = 224 units
Grade II: 0.7 × 748 = 524 units
2. Variable Contribution Sales Total

I $ 3,400 $ 2,686 $714 3 $2,142
II 1,600 1,328 272 7 1,904
Package 21,400 17,354 $4,046
Direct fixed costs — I $ 95,000

Direct fixed costs — II 95,000
Common fixed costs 35,000
Total fixed costs $225,000
$225,000
= 56 packages
$4,046
Grade I: 3 × 56 = 168
Grade II: 7 × 56 = 392

Case 4–45 (Continued)

I $ 3,400 $ 2,444 $956 3 $2,868
II 1,600 1,208 392 7 2,744
Package 21,400 15,788 $5,612
$21,400X = $1,600,000 – $600,000
X = 47 packages remaining
Grade I: 3 × 47 = 141
Grade II: 7 × 47 = 329
Additional contribution margin:
141($956 – $714) + 329($392 – $272) $73,602
Increase in fixed expenses 44,000
Increase in operating income $29,602
($225,000 + $44,000)
Break-even point: = 48 packages
$5,612
Grade I: 3 × 48 = 144
Grade II: 7 × 48 = 336
If the new break-even point is the revised break-even point for the current
year, therefore total fixed costs must be reduced by the contribution margin
already earned (through the first five months) to obtain the units that must be
sold for the last seven months. These units would then be added to those sold
during the first five months:
Contribution margin earned = $600,000 – (83* × $2,686) – (195* × $1,328)
= $118,102
*224 – 141 = 83; 524 – 329 = 195
($225,000 + $44,000 - $118,102)
X= = 27 packages
$5,612
From the first five months, 28 packages were sold (83/3 or 195/7). Thus, the re-
vised break-even point is 55 packages (27 + 28)—in units, 165 of I and 385 of
II.

Case 4–45 (Concluded)

I $3,400 $2,686 $714 1 $714
II 1,600 1,328 272 1 272
Package 5,000 4,014 $986
New 7-month sales revenue $1,000,000 × 130% = $1,300,000
$5,000X = $1,300,000
X = 260 packages
Thus, 260 units of each cabinet will be sold during the rest of the year.
Effect on profits:
Change in contribution margin:
$714(260 – 141) – $272(329 – 260) $66,198
Increase in fixed costs:
$70,000(7/12) 40,833
Increase in operating income $25,365
Fixed cost
X =
(Price - Variable cost)
$295,000
=
$986
= 299 packages (or 299 of each cabinet)
The break-even point is computed as follows:
($295,000 - $118,102)
X =
$986
$176,898
=
$986
= 179 packages (179 of each)
To this, add the units already sold, yielding the revised break-even point:
I: 83 + 179 = 262
II: 195 + 179 = 374

Case 4–46
Per-unit product contribution analysis
T-shirts Sweatshirts Fleece
Jackets
Revenue $6.50 $16.00 $38.50
Materials 1.50 3.00 12.00
Direct labour 2.50 3.00 8.00
Variable selling 0.65 1.60 3.85
Contribution 1.85 8.40 14.65
Product per package 5 3 2
Contribution per package $9.25 $25.20 $29.30
Package revenues = ($6.50 x 5) + ($16.00 x 3) + ($38.50 x 2) = $157.50
Total contribution per package = $9.25 + $25.20 + $29.30 = $63.75
Contribution margin % = $63.75 / $157.50 = 40.48%
Fixed costs: $300,000 + $150,000 + $250,000 = $700,000
Break-even revenues = Fixed costs / contribution margin %
Break-even revenues = $700,000 / .4048 = $1,729,249
Target profit of $140,000 after tax is ($140,000 /.6) = $233,333 pre-tax.
Revenue to achieve target = profit fixed costs plus pre-tax target / Contribution
margin %
Revenue is $700,000 + $233,333 / .4048 = $2,305.665
Packages to achieve break-even $700,000 / $63.75 = 10,981

Units: 54,905 t-shirts (10,981 x 5); 32,943 sweatshirts (10,981 x 3); 21,962 fleece
(10,981 x 2).
Packages to achieve target profit $933,333 / $63.75 = 14,641
Units: 73,105 t-shirts (14,641 x 5); 43,863 sweatshirts (14,641 x 3); 29,242 fleece
(14,641 x 2).
Case 4–47
Fixed expense
1. Break-even point =
(Price-Variable cost)
$100,000
First process: = 5,000 cases
($30 - $10)
$200,000
Second process: = 8,333 cases
($30 - $6)
2. Income = X(Price – Variable cost) – Fixed cost

X($30 – $10) – $100,000 = X($30 – $6) – $200,000
$20X – $100,000 = $24X – $200,000
$100,000 = $4X
X = 25,000 cases
The manual process is more profitable if sales are less than 25,000 cases; the
automated process is more profitable at a level greater than 25,000 cases. It is
important for the manager to have a sales forecast to help in deciding which
process should be chosen.

3. The right to decide which process should be chosen belongs to the divisional
manager. Donna has an ethical obligation to report the correct information to
her superior. By altering the sales forecast, Donna unfairly and unethically in-
fluenced the decision-making process. Managers certainly have a moral obli-
gation to assess the impact of their decisions on employees, and every effort
should be taken to be fair and honest with employees. Donna’s behaviour,
however, is not justified by the fact that it helped a number of employees re-
tain their employment. First, Donna had no right to make that decision. Donna
certainly has the right to voice her concerns about the impact of automation
on the employees’ well-being. In so doing, perhaps the divisional manager
would come to the same conclusion, even though the automated system ap-
pears to be more profitable. Second, the choice to select the manual system
may not be the best for the employees anyway. The divisional manager may
possess more information, making the selection of the automated system the
best alternative for all concerned, provided the sales volume justifies its selec-
tion. For example, if the automated system is viable, the divisional manager
may have plans to retrain and relocate the displaced workers in better jobs
within the company. Third, her motivation for altering the forecast seems more
driven by her friendship with Hussan Khalil than any legitimate concerns for
the layoff of other employees. Donna should examine her reasoning carefully
to assess the real reasons for her behaviour. Perhaps in so doing, the conflict
of interest that underlies her decision will become apparent.

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CHAPTER 4

Copyright © 2015 by Nelson Education Ltd. 4-1

Cornerstone Exercise 4–1

1. Variable cost per unit = Direct materials + Direct labour

2. Total fixed expense = $14,000 + $15,400 = $29,400

Cornerstone Exercise 4–2

Total fixed cost

4-2 Copyright © 2015 by Nelson Education Ltd.

Variable cost per unit

(Price - Variable cost per unit)

Contribution margin per unit

Cornerstone Exercise 4–4

Total fixed cost

Copyright © 2015 by Nelson Education Ltd. 4-3

Cornerstone Exercise 4–5

(Total fixed cost + Target income)

Cornerstone Exercise 4–6

(Total fixed cost + Target income)

4-4 Copyright © 2015 by Nelson Education Ltd.

3. A Contribution Margin Income Statement helps managers make better

Cornerstone Exercise 4–7

Unit Unit Package Unit

Copyright © 2015 by Nelson Education Ltd. 4-5

Break-even bicycle helmets = Number of packages × Sales mix amount

Break-even motorcycle helmets = Number of packages × Sales mix amount

Cornerstone Exercise 4–8

Total fixed cost

4-6 Copyright © 2015 by Nelson Education Ltd.

Cornerstone Exercise 4–9

1. Margin of safety in units = Budgeted units – Break-even units

2. Margin of safety in sales revenue = Budgeted sales – Break-even sales

Cornerstone Exercise 4–10

Total contribution margin

Copyright © 2015 by Nelson Education Ltd. 4-7

1. Percent change in operating income = DOL × % Change in sales

2. Expected operating income = Original income + (% Change × Original income)

4-8 Copyright © 2015 by Nelson Education Ltd.

1. Direct materials .......................................................................... $ 5.85

3. Break-even units ($78,000 + $56,925) / ($24 - $13.50) = 12,850

4. Sales ($24 × 12,850) ................................................................... $308,400

1. Unit variable cost = $19.00 × 0.60 = $11.40

Unit contribution margin = $19.00 – $11.40 = $7.60

Copyright © 2015 by Nelson Education Ltd. 4-9

3. Break-even sales revenue = $19.00 × 115,000 = $2,185,000

4. Sales ........................................................................................... $2,185,000

5. Break-even operations always result in a profit of zero.

2. Variable cost ratio = $252,000 / $315,000 = 0.80 or 80%

4-10 Copyright © 2015 by Nelson Education Ltd.

1. Cameco Company—Income Statement for Last Year

2. Break-even units = $315,000 / ($35.00 – $23.75) = 28,000

3. Units to earn target income = ($315,000 + $24,750) / ($35.00 – $23.75) =

2. Unit variable cost includes all variable costs on a unit basis:

Copyright © 2015 by Nelson Education Ltd. 4-11

($131,650 + $18,350 + $12,600)

4. Sales revenue to earn $12,600 = 203,250 × $2.45 = $497,962.50

1. Break-even units = ($347,475 + $473,085) / ($9.42 - $5.48) = 208,264

2. Expected sales in units ............................................................. 570,000

3. Expected sales revenue ($9.42 × 570,000) ............................... $5,369,400

4-12 Copyright © 2015 by Nelson Education Ltd.

Units sold 3,000* 1,300 125 1,000

Copyright © 2015 by Nelson Education Ltd. 4-13

Sales ........................................................................................... $114,545

4. Expected sales ........................................................................... $315,000