Chapter 11 – Cost-Volume-Profit Analysis: A Managerial Planning Tool

PROBLEM

1. Last year, Baker Ltd produced 30,000 units and sold 28,000 units. Beginning inventory was zero.
During the period, the following costs were incurred:
Indirect labour (variable) $ 60,000
Indirect materials (variable) 30,000
Other variable overhead 90,000
Fixed manufacturing overhead 180,000
Fixed administrative expenses 150,000
Fixed selling expenses 120,000
Variable selling expenses, per unit 40
Direct labour, per unit 80
Direct materials, per unit 20

Compute the dollar amount of ending inventory using:

A. Absorption costing
B. Variable costing

ANS:
A. Variable costs:
Direct materials $ 20.00
Direct labour 80.00
Indirect labour 2.00
Indirect materials 1.00
Other variable overhead 3.00
Variable product costs per unit $ 106.00
Fixed manufacturing overhead 6.00
Total product costs per unit $ 112.00
Inventory units 2,000
Inventory value $224,000

B. Variable product costs per unit $ 106.00

Inventory units 2,000
Inventory value $212,000

PTS: 1 DIF: Moderate

2. During the most recent year, Beaconsville Limited had the following data:
Beginning inventory in units –
Units produced 15,400
Units sold ($125 per unit) 8,200
Variable costs per unit:
Direct materials $ 13
Direct labour 16
Variable overhead 8
Fixed costs:
Fixed overhead per unit produced $ 23
Fixed selling and administrative 185,000
A. How many units are in ending inventory?
B. Using absorption costing, calculate the per-unit product cost. What is the value of ending inventory?
C. Using variable costing, calculate the per-unit product cost. What is the value of ending inventory?
D. Prepare an income statement using absorption costing.
E. Prepare an income statement using variable costing.

ANS:
A. Beginning units + units produced – units sold
7,200 units

B.
Direct materials $13
Direct labour $16
Variable overhead $8
Fixed overhead per unit produced $23
Total product cost $60

Ending inventory value = $60 x 7,200 = 432,000

C.
Direct materials $13
Direct labour $16
Variable overhead $8
Total product cost $37

Ending inventory value = $37 x 7,200 = 266,400

D.
Beaconsville Limited
Absorption-Costing Income Statement
For the Most Recent Year

Sales 1,025,000
Less: Cost of goods sold 492,000
Gross margin 533,000
Less: Selling and administrative expenses 185,000
Operating income 348,000

E.
Beaconsville Limited
Variable-Costing Income Statement
For the Most Recent Year

Sales 1,025,000
Less: Cost of goods sold 303,400
Gross margin 721,600
Less: fixed expenses:
 Overhead 354,200
Selling and administrative expenses 185,000 539,200
Operating income 182,400

PTS: 1 DIF: Challenging

3. The variable costing income statement for Jackson Limited for 2016 is as follows:
Sales (5,000 units) $100,000
Variable expenses:
Cost of goods sold $30,000
Selling (10% of sales) 10,000 40,000
Contribution margin $ 60,000
Fixed expenses:
Manufacturing overhead $24,000
Administrative 14,400 38,400
Operating income $ 21,600

Selected data for 2016 concerning the operations of the company are as follows:
Beginning inventory -0- units
Units produced 8,000 units

Manufacturing costs:
Direct labour $3.00 per unit
Direct materials 1.60 per unit
Variable overhead 1.40 per unit

Prepare an absorption costing income statement for 2016.

ANS:

Jackson Limited
Absorption-Costing Income Statement
2016
Sales $100,000
Less cost of goods sold:
{5,000  [$3.00 + $1.60 + $1.40 + ($24,000/8,000)]} 45,000
Gross profit $ 55,000
Less operating expenses:
Selling expenses $10,000
Administrative expenses 14,400 24,400
Operating income $ 30,600

PTS: 1 DIF: Challenging

4. Prepare a segmented income statement for Montville Limited for the coming year, using variable
costing and the following information:
Leather jackets Suede jackets
Sales 450,000 542,000
Variable cost of goods sold 134,000 213,000
Direct fixed overhead 29,000 38,000
 A sales commission of 2% of sales is paid for each of the two product lines. Direct fixed selling and
administrative expense was estimated to be $32,000 for the leather jackets and $66,000 for the suede
jackets. Common fixed overhead for the factory was estimated to be $83,000 and common selling and
administrative expense was estimated to be $14,000.

ANS:

Montville Limited
Segmented Income Statement
For the Coming Year

Leather jackets Suede jackets Total

Sales 450,000 542,000 992,000
Variable cost of goods sold 134,000 213,000 347,000
Variable selling expense 9,000 10,840 19,840
Contribution margin 307,000 318,160 625,160
Less: direct fixed expenses:
Direct fixed overhead 29,000 38,000 67,000
Direct selling and administrative 32,000 66,000 98,000
Segment margin 246,000 214,160 460,160
Less: common fixed expenses:
Common fixed overhead 83,000
Common selling and administrative 14,000
Operating income 363,160

PTS: 1 DIF: Moderate

5. Maleny Limited produces three products: LMC, DMC, KPC. For the coming year they expect to
produce 160,000 units. Of these, 65,000 will be LMC, 40,000 will be DMC and 55,000 will be KPC.
The following information was provided for the coming year:
LMC DMC KPC
$550 $860 $625
Price
Unit direct materials 250 405 300
Unit direct labour 180 210 205
Unit variable overhead 60 72 55
Unit variable selling expense 45 60 58
Total direct fixed overhead 240,000 425,000 400,000

Common fixed overhead is $984,000 and fixed selling and administrative expenses for Maleny is
$881,000 per year.
A. Calculate the unit variable cost under variable costing.
B. Calculate the unit variable product cost.
C. Prepare a segmented variable-costing income statement for next year.
D. Should Maleny Ltd keep all product lines?

ANS:
A.
LMC DMC KPC
 Unit direct materials $250 $405 $300
Unit direct labour $180 $210 $205
Unit variable overhead $60 $72 $55
Unit variable selling expense $45 $60 $58
Total variable cost $535 $747 $618

B.
LMC DMC KPC
Unit direct materials $250 $405 $300
Unit direct labour $180 $210 $205
Unit variable overhead $60 $72 $55
Total unit variable product cost $490 $687 $560

C.
LMC DMC KPC Total
Sales 35,750,000 34,400,000 34,375,000 104,525,000
Variable cost of goods sold 31,850,000 27,480,000 30,800,000 90,130,000
Variable selling expense 2,925,000 2,400,000 3,190,000 8,515,000
Contribution margin 975,000 4,520,000 385,000 5,880,000
Less: direct fixed overhead 240,000 425,000 400,000 1,065,000
Segment margin 735,000 4,095,000 (15,000) 4,815,000
Less: common fixed expenses:
Common fixed overhead 984,000
Common selling and administrative 881,000
Operating income 2,950,000

D. The company should consider dropping the KPC product line because it has a negative segment
margin.

PTS: 1 DIF: Moderate

6. Ellie Manufacturing Company produces three products: A, B, and C. The income statement for most
recent year is as follows:
Sales $200,000
Less: Variable cost 127,000
Contribution margin $ 73,000
Less fixed cost:
Manufacturing $20,000
Selling and administrative 14,000 34,000
Operating income $ 39,000

The sales, contribution margin ratios, and direct fixed expenses for the three types of products are as
follows:

A B C
Sales $60,000 $40,000 $100,000
Contribution margin ratio 35% 30% 40%
Direct fixed expenses of products $ 8,000 $ 5,000 $4,000
 Prepare income statements segmented by products. Include a column for the entire firm in the
statement.

ANS:

Ellie Manufacturing Company

Income Statement
For the Most Recent Year
A B C Total
Sales $60,000 $40,000 $100,000 $200,000
Less: Variable expenses 39,000 28,000 60,000 127,000
Contribution margin $21,000 $12,000 $ 40,000 $ 73,000
Less: Direct fixed exp. 8,000 5,000 4,000 17,000
Product margin $13,000 $ 7,000 $ 36,000 $ 56,000
Less: Common expenses 17,000
$ 39,000

PTS: 1 DIF: Moderate

7. Dance Unlimited plans to sell 10,000 ballet shoes at $50 each in the coming year. Unit variable cost is
$30 and total fixed cost equals $65,000.
A. Calculate the break-even in ballet shoes.
B. Calculate the break-even in sales dollars.

ANS:
A. $65,000/($50-$30) = 3,250 ballet shoes

B. 3,250 x $50 = $162,500

PTS: 1 DIF: Easy

8. Shamrock Limited plans to sell 3,000 Irish sweaters for $200 each in the coming year. Product costs
include:
Direct materials per sweater $40
Direct labour per sweater 10
Variable overhead per sweater 15
Total fixed factory overhead 20,000

Variable selling expenses are $5 per sweater and fixed selling and administrative expenses total
$12,000.
A. Calculate the total variable cost per unit.
B. Calculate the total fixed expenses for the year.
C. Prepare a contribution margin income statement for Shamrock for the coming year.

ANS:
A. Total variable cost per unit = $40 + $10 + $15 + 5 = $70

B. Total fixed expense = $20,000 + $12,000 = $32,000

C.
Shamrock Limited
Contribution Margin Income Statement
 For the Coming Year

Sales 600,000
Total variable expenses 210,000
Total contribution margin 390,000
Total fixed expense 32,000
Operating income 358,000

PTS: 1 DIF: Easy

9. Newman Company expects to produce and sell 2,000 units next month. Data on costs follows:
Per unit costs:
Selling price $40
Variable manufacturing costs $10
Variable selling costs $ 6

Total costs:
Fixed manufacturing costs $16,000
Fixed selling costs $ 8,000

A. What is the variable cost per unit?

B. What is contribution margin per unit?
C. What is the variable cost ratio?
D. What is the contribution margin ratio?

ANS:
A. Variable cost per unit = $10 + $6 = $16
B. Contribution margin per unit = $40 – $16 = $24
C. Variable cost ratio = $16/$40 = 0.4 or 40%
D. Contribution margin ratio = $24/$40 = 0.6 or 60%

PTS: 1 DIF: Easy

10. McCallen Company expects to produce and sell 500 units next month. Data on costs follows:
Per unit costs:
Selling price $8
Variable manufacturing costs $2.75
Variable selling costs $0.25

Total costs:
Fixed manufacturing costs $1,000
Fixed selling costs $ 125

A. What is the variable cost per unit?

B. What is contribution margin per unit?
C. What is the variable cost ratio?
D. What is the contribution margin ratio?

ANS:
A. Variable cost per unit = $2.75 + $0.25 = $3
B. Contribution margin per unit = $8 – $3 = $5
 C. Variable cost ratio = $3/$8 = 0.375 or 37.5%
D. Contribution margin ratio = $5/$8 = 0.625 or 62.5%

PTS: 1 DIF: Easy

11. Adelaide Ltd provided the following information:

Adelaide Ltd
Projected Income Statement
For the Current Year Ending December 31
Sales (12,000 units) $240,000
Less variable costs:
Variable manufacturing costs $60,000
Variable selling costs 36,000
Total variable costs 96,000
Contribution margin $144,000
Less fixed costs:
Fixed manufacturing costs $85,000
Fixed selling and administrative costs 35,000
Total fixed costs 120,000
Operating income $ 24,000

A. Determine the break-even point in sales dollars.

B. The sales manager believed the company could increase sales by 1,000 units if advertising
expenditures were increased by $15,000. By how much will operating income increase or decrease if
the advertising is increased as suggested?
C. What is the maximum amount the company could pay for advertising if the advertising would
increase sales by 1,000 units?

ANS:
A. $120,000/($20 – $8) = 10,000 units x $20 = $200,000

B. (1,000 x $12) – $15,000 = $3,000 decrease

C. 1,000 x $12 = $12,000

PTS: 1 DIF: Challenging

12. Music Now plans to sell 6,000 MP3 players at $60 each in the coming year. Variable cost per unit is
$12 and total fixed cost is $24,000.
A. Calculate the variable cost ratio.
B. Calculate the contribution margin ratio.
C. Calculate the break-even point in sales dollars.
D. If Music Now has a target profit of $90,000, how many MP3 players will they have to sell?

ANS:
A. $12/$60 = 20%

B. ($60 – $12)/$60 = 80%

C. $24,000/80% = $30,000

D. ($24,000 + $90,000)/($60 – $12) = 2,375 MP3 players

 PTS: 1 DIF: Moderate

13. A company provided the following information:

Sales $500,000
Variable costs $100,000
Fixed costs $200,000

A. What is the contribution margin ratio?

B. What is the level of sales in dollars necessary to generate a profit of $40,000?
C. What is the contribution margin ratio if the sales price is increased by 10%?
D. Using the information in part C, what level of sales in dollars is necessary to generate a profit
of $40,000?

ANS:
A. ($500,000 – $100,000)/$500,000 = 80%

B. ($200,000 + $40,000)/80% = $300,000

C. ($500,000 x 1.1) = $550,000

($550,000 – $100,000)/$550,000 = 81.82%

D. ($200,000 + $40,000)/81.82% = $293,327 rounded

PTS: 1 DIF: Challenging

14. Aaron Company provided the following data for next month:
Selling price per unit $400
Variable manufacturing costs per unit $100
Fixed manufacturing costs per unit $ 80
Variable selling costs per unit $ 60
Fixed selling costs per unit $ 40
Expected production and sales 1,800 units

A. What is contribution margin per unit?

B. What is the contribution margin ratio?
C. What is the break-even point in units?
D. What are the sales in dollars needed to obtain an operating income of $20,000?

ANS:
A. $400 – ($100 + $60) = $240

B. $400 – ($100 + $60) = $240

$240/$400 = 0.60 or 60%

C. $400 – ($100 + $60) = $240

Fixed costs = ($80 + $40) x 1,800 = $216,000
$216,000/$240 per unit = 900 units

D. ($216,000 + $20,000)/60% = $393,333 rounded

PTS: 1 DIF: Moderate

15. Thomas Limited developed the following income statement using a contribution margin approach:

Thomas Limited
Projected Income Statement
For the Current Year Ending December 31
Sales $750,000
Less variable costs:
Variable manufacturing costs $280,000
Variable selling costs 120,000
Total variable costs $400,000
Contribution margin $350,000
Less fixed costs:
Fixed manufacturing costs $130,000
Fixed selling and administrative costs 80,000
Total fixed costs $210,000
Operating income $140,000

The projected income statement was based on sales of 100,000 units. Thomas has the capacity to
produce 120,000 units during the year.
A. Determine the break-even point in units.
B. The sales manager believes the company could increase sales by 8,000 units if advertising
expenditures were increased by $22,000. By how much will income increase or decrease if this plan is
put into effect?
C. What is the maximum amount the company could pay for advertising if the sales would really
increase by 8,000 units?

ANS:
A. $210,000/($7.50 – $4.00) = 60,000 units

B. (8,000 x $3.50) – $22,000 = $6,000 increase

C. 8,000 x $3.50 = $28,000

PTS: 1 DIF: Challenging

16. The following information was extracted from the accounting records of MVP Limited:
Selling price per unit $60
Variable cost per unit $20
Total fixed costs $480,000

A. What is MVP’s break-even point in units?

B. How many units must be sold to earn operating income of $80,000?
C. What is MVP’s break-even point in units if the selling price increases by 20% and the variable
costs decrease by 20%?
D. Using the information in part C, what sales level in dollars is needed to earn an operating
income of $80,000?

ANS:
A. $480,000/($60 per unit – $20 per unit) = 12,000 units

B. ($480,000 + $80,000)/($60 – $20) = 14,000 units

C. ($60  1.2) = $72 new sales price

 ($20  .8) = $16 new variable cost
($72 – $16) = $56 new contribution margin
$480,000/$56 = 8,572 units (rounded)

D. ($480,000 + $80,000)/$56 = 10,000 units

(10,000  $72) = $720,000

PTS: 1 DIF: Challenging

17. Information for Canberra Trading Ltd is as follows:

Sales $500,000
Variable costs $100,000
Fixed costs $200,000

A. What is the break-even point in sales dollars?

B. What sales (in dollars) are needed to generate operating income of $40,000?

ANS:
A. ($500,000 – $100,000)/$500,000 = 80%
$200,000/80% = $250,000

B. ($500,000 – $100,000)/$500,000 = 80%

($200,000 + $40,000)/0.80 = $300,000

PTS: 1 DIF: Easy

18. Noble Limited manufactures two products. Information about the two products are as follows:
Product A Product B
Selling price per unit $80 $30
Variable costs per unit $45 $15
Contribution margin per unit $35 $15

The company expects fixed costs to be $189,000. The firm expects 60% of its sales (in units) to be
Product A (a sales mix of 3:2).
A. Calculate the contribution margin per package.
B. Determine the break-even point in units for Products A and B.
C. Determine the level of sales (in dollars) necessary to generate operating income of $135,000.

ANS:
A. Product A = $35 x 3 = $105
Product B = $15 x 2 = 30
Contribution margin per package = $105 + $30 = $135

B. $189,000/$135 per package = 1,400 packages

Product A units = 1,400 x 3 = 4,200 units
Product B units = 1,400 x 2 = 2,800 units

C. ($189,000 + $135,000)/$135 = 2,400 packages

Product A sales = 2,400 x 3 x $80 = $576,000
Product B sales = 2,400 x 2 x $30 = $144,000
Total sales = $576,000 + $144,000 = $720,000

PTS: 1 DIF: Challenging

19. Travel On Limited sells luggage. The company sells a duffle bag, a carry-on suitcase and a deluxe
suitcase. The price and variable cost for each type of luggage is listed below.
Price Variable Cost
Duffle bag $100 $25
Carry-on $180 $40
Deluxe $300 $120

The total fixed costs for Travel On Inc. equals $60,000. For every 8 duffle bags Travel On sells it sells
3 carry-on suitcases and 1 deluxe suitcase.
A. Calculate the package contribution margin.
B. Calculate the break-even point in units for duffle bags, carry-on suitcases and deluxe suitcases.
C. If Travel On Inc. has a target income for the coming year of $300,000, how many packages will
company have to sell?
D. Based on your answer in Part C, prepare a contribution margin income statement for the coming
year.

E. What is the company’s margin of safety in packages?

ANS:
A.
Price Variable Cost Unit contribution Sales mix Package contribution
margin margin

Duffle bag $100 $25 $75 8 $600

Carry-on $180 $40 $140 3 $420
Deluxe $300 $120 $180 1 $180
$1,200

B. $60,000/1,200 = 50 packages
50 packages x 8 = 400 duffle bags
50 packages x 3 = 150 carry-on suitcases
50 packages x 1 = 50 deluxe suitcases

C. ($60,000 + $300,000)/1,200 = 300 packages

D.
Travel On Limited
Contribution Margin Income Statement
For the Coming Year

Sales $492,000
Total variable expenses 132,000
Total contribution margin $360,000
Total fixed expense 60,000
Operating income $300,000

E. 300 packages – 50 packages = 250 packages is the company’s margin of safety

PTS: 1 DIF: Challenging

20. Lauren Limited manufactures two products. Information about the two product lines for the year is as
follows:
Product X Product Y
Selling price per unit $70 $100
Variable costs per unit $30 $40
Contribution margin per unit $40 $ 60

The company expects fixed costs to be $144,000. The firm expects 60% of its sales (in units) to be
Product X.
Determine the break-even point in units for both Product X and Product Y.

ANS:
Form a package with 3 units of Product X and 2 units of Product Y.
Contribution margin from Product X: $40 x 3 = $120
Contribution margin from Product Y: $60 x 2 = $120

Total package contribution margin = $120 + $120 = $240 per package

break-even packages = $144,000/$240 per package = 600 packages

Product X: 600 packages x 3 = 1,800 units

Product Y: 600 packages x 2 = 1,200 units

PTS: 1 DIF: Moderate

21. Young Manufacturing Company produces the following three products:

Hammers Screwdrivers Saws
Selling price per unit $40 $16 $50
Variable costs per unit $28 $12 $30
Contribution per unit $12 $ 4 $20

Fixed costs are $76,000 per year.

50% of all sales in units are hammers, 30% are screwdrivers, and 20% are saws.
Calculate the following values:
A. break-even point in total units.
B. number of hammers that will be sold at break-even.
C. total sales in units to obtain a target income of $19,000.

ANS:
A. Ave. CM/unit = ($12 x 0.5) + ($4 x 0.3) + ($20 x 0.2) = $11.20
$76,000/$11.20 = 6,786 packages of hammers, screwdrivers, and saws

B. 6,786 x 0.5 = 3,393 hammers

C. ($76,000 + $19,000)/$11.20 = 8,482 packages

PTS: 1 DIF: Moderate

22. Income statements for two different companies in the same industry are as follows:
Company A Company B
Sales $400,000 $400,000
Less: Variable costs 300,000 200,000
Contribution margin $100,000 $200,000
Less: Fixed costs 50,000 150,000
 Operating income $ 50,000 $ 50,000

A. Calculate the degree of operating leverage for each firm.

B. Calculate the margin of safety in dollars for each firm.
C. Determine the operating income for each firm if sales increase by 20%.

ANS:
A. Company A: $100,000/$50,000 = 2
Company B: $200,000/$50,000 = 4

B. Company A:
break-even sales = $50,000/($100,000/$400,000) = $200,000
Margin of safety = $400,000 – $200,000 = $200,000

Company B:
break-even sales = $150,000/($200,000/$400,000) = $300,000
Margin of safety = $400,000 – $300,000 = $100,000

C. Company A:
Increase in operating income = (.20 x 2) x $50,000 = $20,000
Operating income = $50,000 + $20,000 = $70,000

Company B:
Increase in operating income = (.20 x 4) x $50,000 = $40,000
Operating income = $50,000 + $40,000 = $90,000

PTS: 1 DIF: Challenging

23. Newman Company expects to produce and sell 2,000 units next month. Data on costs follows:
Per unit costs:
Selling price $40
Variable manufacturing costs $10
Variable selling costs $ 6

Total costs:
Fixed manufacturing costs $16,000
Fixed selling costs $ 8,000

A. What is the break-even point in units?

B. What is the break-even point in sales dollars?
C. What is the expected operating income for next month?
D. What is the margin of safety in dollars?

ANS:
A. Break-even units = ($16,000 + $8,000)/$24 = 1,000 units

B. Break-even sales dollars = 1,000 x $40 = $40,000

OR
Break-even sales dollars = $24,000/0.6 = $40,000

C. Expected operating income = $80,000 – $32,000 – $24,000 = $24,000

D. Margin of safety = $80,000 – $40,000 = $40,000

 PTS: 1 DIF: Easy

24. McCallen Company expects to produce and sell 500 units next month. Data on costs follows:
Per unit costs:
Selling price $8
Variable manufacturing costs $2.75
Variable selling costs $0.25

Total costs:
Fixed manufacturing costs $1,000
Fixed selling costs $ 125

A. What is the break-even point in units?

B. What is the break-even point in sales dollars?
C. What is the expected operating income for next month?
D. What is the margin of safety in dollars?
E. What is the break-even point in units if fixed manufacturing costs increase by $500?
F. What is the break-even point in units if variable manufacturing costs decrease by $0.75?

ANS:
A. Break-even units = $1,125/$5 = 225 units

B. Break-even sales dollars = $8 x 225 = $1,800

OR
Break-even sales dollars = $1,125/0.625 = $1,800

C. Expected operating income = $4,000 – $1,500 – $1,125 = $1,375

D. Margin of safety in dollars = $4,000 – $1,800 = $2,200

E. ($1,000 + $500 + $125)/$5 = 325 units

F. ($1,000 + $125)/($8 – $2 – $.25) = $1,125/$5.75 = 196 units (rounded)

PTS: 1 DIF: Moderate

25. At a monthly sales volume of $25,000, a company incurs variable costs of $19,000 and fixed costs of
$6,000. Determine each of the following values:
A. Variable cost ratio
B. Contribution margin ratio
C. Monthly break-even dollar sales volume
D. Monthly margin of safety in dollars

ANS:
A. Variable cost ratio = $19,000/$25,000 = 0.76

B. Contribution margin ratio = 1.00 – 0.76 = 0.24

C. Monthly break-even dollar sales volume = $6,000/0.24 = $25,000

D. Monthly sales volume $25,000

Monthly break-even sales volume 25,000
 Monthly margin of safety $ -0-

PTS: 1 DIF: Moderate

26. Arnold Limited has the following information for the current year:
Selling price per unit $10
Variable costs per unit $ 6
Fixed costs $1,000

Prepare a cost-volume-profit graph identifying the following items:

A. total costs line
B. total fixed costs line
C. total variable costs line
D. total revenues line
E. break-even point in sales dollars, indicate the amount
F. break-even point in units, indicate the amount
G. profit area
H. loss area

ANS:

PTS: 1 DIF: Challenging

27. The following information has been provided for Walsh Limited:
Sales price per unit $20
Variable costs per unit $10
Fixed costs $500

Prepare a cost-volume-profit graph identifying the following items:

A. total cost line
B. total fixed cost line
C. total variable cost line
D. total revenue line
E. loss area
F. profit area
G. compute the break-even point in units
 H. compute the break-even point in sales dollars

ANS:
Units Sold Revenue Fixed Costs Total Variable Cost Total Cost
10 200 500 100 600
20 400 500 200 700
30 600 500 300 800
40 800 500 400 900
50 1000 500 500 1000
60 1200 500 600 1100
70 1400 500 700 1200
80 1600 500 800 1300
90 1800 500 900 1400
100 2000 500 1000 1500

Break-even point = 50 units

Break-even point = $1,000

PTS: 1 DIF: Challenging

28. Place Limited had the following income statement for the current year:
Sales $25,000
Variable expenses 15,000
Contribution margin $10,000
Fixed expenses 4,000
Operating income $ 6,000

A. Calculate the operating leverage ratio.

B. If sales increase by 20%, what will be the percentage change in income?
C. If sales increase by $15,000, how much will income increase?

ANS:
A. $10,000/$6,000 = 1.6667

B. 1.6667 x 0.2 = 0.33333, or 33.33% increase

 C. $15,000 x .4 = $6,000

PTS: 1 DIF: Moderate

ESSAY

1. What is the difference between absorption-costing income and variable-costing income?

ANS:
The difference between absorption-costing income and variable-costing income is the treatment of
fixed factory overhead. Absorption costing attaches fixed factory overhead to each unit produced. If
the unit is sold, that portion of fixed factory overhead becomes part of cost of goods sold. If the unit
goes into inventory, it takes that portion of fixed factory overhead into inventory with it. Variable
costing treats fixed factory overhead as a period expense, and does not include it in inventory.

PTS: 1 DIF: Moderate

2. You have just become the controller for Artisan Industries. Artisan produces three different products
and upon review of their internal reports you notice that they have never prepared a segmented income
statement. Explain to the vice president what a segmented income statement consists of and why it can
be useful in decision making.

ANS:
In a segmented income statement fixed expenses are broken down into two classifications: direct fixed
expenses and common fixed expenses. Direct fixed expenses are expenses that are directly traceable to
a segment. Therefore these costs can be avoided because they would vanish if the segment was
eliminated. Common fixed expenses are jointly caused by two or more segments. These costs will
remain even if one of the segments is eliminated. If these costs are just allocated they can give a
distorted picture of segment profitability. With this type of breakdown, the company can determine the
controllable costs and the non-controllable costs which give managers the ability to evaluate each
segment’s contribution to overall firm performance. The profit contribution each segment makes
towards a firm’s common fixed costs is called the segment margin. A segment at the very least should
be able to cover both its own variable and direct fixed costs. If a segment has a negative segment
margin, or can only cover its own variable and direct fixed costs, the company might consider
dropping the product line.

PTS: 1 DIF: Moderate

3. Explain why cost-volume-profit analysis can be useful to managers.

ANS:
Cost-volume-profit (CVP) analysis is a useful tool for planning and decision making. Because CVP
analysis emphasises the interrelationships of costs, quantity sold, and price, it brings together all of the
financial information of the firm. CVP analysis can be a valuable tool to identify the extent and
magnitude of the economic trouble a division is facing and to help pinpoint the necessary solution.
CVP analysis can address many other issues as well, such as the number of units that must be sold to
break even, the impact of an increase in price on profit. Additionally, CVP analysis allows managers to
do sensitivity analysis by examining the impact of various prices or cost levels on profit.

PTS: 1 DIF: Moderate

4. What are the assumptions underlying cost-volume-profit analysis?

 ANS:
Some of the assumptions are as follows:
The analysis assumes a linear revenue function and a linear cost function.
The analysis assumes that price, total fixed costs, and unit variable costs can be accurately identified
and remain constant over the relevant range.
The analysis assumes that what is produced is actually sold.
For multiple-product analysis, the sales mix is assumed to be known.
The selling prices and costs are assumed to be known with certainty.

PTS: 1 DIF: Moderate

5. How can a multi-product firm determine its break-even point?

ANS:
The firm can determine its break-even point by finding the break-even point in sales dollars, or it can
form packages and determine the break-even point for each package, realising that the sales mix must
be determined as well.

PTS: 1 DIF: Moderate

6. As a cost accountant at AE Limited, you have been given a set of data and have been asked to perform
a break-even analysis as well as a sensitivity analysis. Why are these analyses important?

ANS:
A break-even analysis is important to a company for several reasons. First, it tells a company at what
level they will have zero profit. Determining either how many units they have to sell to cover total
costs or how much in sales dollars need to be generated to cover total costs. Companies want to turn a
profit and this information will guide them to the levels of output necessary. This also tells
management if their desired targeted income is achievable in a given time period.
A sensitivity analysis, also known as the 'what-if' technique, shows the impact of changes in various
components of the break-even analysis. This gives management a wealth of useful information in order
to make decisions regarding such things as whether or not an increase in either fixed or variable costs
will make the break-even point unattainable. It will also display the effect of a change in the sales price
or the sales mix.
One poor decision can dramatically affect a business and these analyses are crucial in assisting
management in making sound and logical decisions.

PTS: 1 DIF: Moderate