The HOW and WHY of Basic Cost Calculations and the Contribution-Margin-Based Income Statement

The HOW and WHY of Calculating the Units Needed to Break Even and to Achieve a Target Profit

Information: Blazin-Boards Company plans to sell 10,000 snowboards at $400 each in the coming year.
Product costs include:

Direct materials per snowboard $80

Direct labor per snowboard $125

Variable overhead per snowboard $15

Total fixed factory overhead $800,000

Variable selling expense is a commission of 5 percent of price; fixed selling and administrative expenses
total $400,000.

1. Calculate the:
a. Variable product cost per unit

b. Selling expense per unit

c. Total variable cost per unit

d. Contribution margin per unit

e. Contribution margin ratio

f. Total fixed expense for the year

2. Prepare a contribution-margin-based income statement for Blazin-Boards Company for the
coming year.

3. What if 13,000 boards could be manufactured and sold next year; how would that affect
operating income? By what percent?

4. Calculate the number of units Blazin-Boards must sell to break even.

5. Calculate the number of units Blazin-Boards must sell to achieve target operating income (profit)
of $240,000.

6. What if Blazin-Boards wanted to achieve a target operating income of $300,000? Would the
number of snowboards be larger or smaller than the number calculated in Requirement 2?
Why?
The HOW and WHY of Calculating Revenue for Break-Even and for a Target Profit

Information: Blazin-Boards Company plans to sell 10,000 snowboards at $400 each in the coming year.
Unit variable cost equals $240. Total fixed costs equal $1,200,000.

1. What is the contribution margin per unit? What is the contribution margin ratio?

2. Calculate the sales revenue needed to break even.

3. Calculate the sales revenue needed to achieve a target profit of $240,000.

4. What if Blazin-Boards had target operating income (profit) of $350,000? Would sales revenue be
larger or smaller than the one calculated in Requirement 3? Why? By how much?
The HOW and WHY of Calculating the Number of Units to Generate an After-Tax Target Profit

Information: Blazin-Boards Company wants to earn $390,000 in net (after-tax) income next year.
Snowboards are priced at $400 each for the coming year. Product costs include:

Direct materials per snowboard $80

Direct labor per snowboard $125

Variable overhead per snowboard $15

Total fixed factory overhead $800,000

Variable selling expense is a commission of 5 percent of price; fixed selling and administrative expense
totals $400,000. Blazin-Boards has a tax rate of 35 percent.

1. Calculate the before-tax profit needed to achieve an after-tax target of $422,500.

2. Calculate the number of boards that will yield operating income calculated in Requirement 1
above.

3. Prepare an income statement for Blazin-Boards Company for the coming year based on the
number of boards computed in Requirement 2.

4. What if Blazin-Boards had a 30 percent tax rate. Would the units sold to reach a $422,500 target
net income be higher or lower than 11,563? Calculate the number of units needed
The HOW and WHY of Calculating Degree of Operating Leverage and Percent Change in Profit

Information: Sharda Company is planning to add a new product line. To do so, the firm can choose to
rely heavily on automation or on labor. Relevant data for a sales level of 10,000 units follow:

Automated System Manual System

Sales 1,000,000 1,000,000
Less: Variable expenses 500,000 800,000
Contribution margin 500,000 200,000
Less: Total fixed expense 375,000 100,000
Operating Income 125,000 100,000
Unit selling price 100 100
Unit variable cost 50 80
Unit contribution margin 50 20

1. Compute the degree of operating leverage for each system.

2. Suppose that sales are 40 percent higher than budgeted. By what percentage will operating
income increase for each system? What will be the increase in operating income for each
system?

3. What if unit sales are 30 percent lower than budgeted? By what percentage will operating
income decrease for each system? What will be the total operating income for each system?
The HOW and WHY of Calculating a Markup on Cost

Information: AudioPro Company, owned and operated by Chris McAnders, sells and installs audio
equipment in homes and vehicles. Direct materials and direct labor costs are easy to trace to the jobs.
Assemblers receive, on average, $12 per hour. AudioPro’s income statement for last year is as follows.

Revenue 350,350
Cost of Goods Sold:
Direct Materials 122,500
Direct Labor 73,500
Overhead 49,000 245,000
Gross Profit 105,350
Selling and Administrative expenses 25,000
Operating income 80,350

Chris wants to find a markup on cost of goods sold that will allow her to earn about the same amount of
profit on each job as was earned last year.

1. What is the markup on cost of goods sold (COGS) that will maintain the same profit as last year?

2. Suppose that Chris wants to expand her company’s product line to include automobile alarm
systems and electronic remote car door openers. She estimates the following costs for the sale
and installation of one electronic remote car door opener.

Direct materials $ 80.60

Direct labor (3 hours × $12) 36.00

Applied overhead 23.40

Total cost $140.00

What is the price Chris will use for this new product given the markup percentage calculated in
Requirement 1?
 3. What if Chris wants to calculate a markup on direct materials cost, since it is the largest cost of
doing business? What is the markup on direct materials cost that will maintain the same profit
as last year? What is the bid price Chris will use for the job given in Requirement 2 if the markup
percentage is calculated on the basis of direct materials cost?

The HOW and WHY of Calculating Cost and Profit by Customer Class

Information: Cobalt, Inc., manufactures vitamin supplements with an average manufacturing cost of
$163 per case (a case contains 100 bottles of vitamins). Cobalt, Inc., sold 250,000 cases last year to the
following three classes of customer.

Customer Price per case Cases Sold

Large drugstore chain 200 125,000
Small local pharmacies 232 100,000
Individual health clubs 250 25,000

The large drugstore chain special labeling costs $0.03 per bottle. The chain orders through electronic
data interchange (EDI), which costs Cobalt about $50,000 annually in operating expenses and
depreciation. Cobalt pays all shipping costs, which amounted to $1.5 million last year.

The small local pharmacies order in smaller lots that require special picking and packing in the factory;
the special handling adds $20 to the cost of each case sold. Sales commissions to the independent
jobbers who sell Cobalt products to the pharmacies average 10 percent of sales. Bad debts expense
amounts to 1 percent of sales.

Individual health clubs purchase vitamins in even smaller lots; the special picking and packaging costs
average $30 per case. There are no sales commissions for the health clubs. Instead, Cobalt advertises in
health club management magazines, accepts orders by phone, and supplies point-of-sale posters and
displays for the clubs. These marketing costs are $100,000 per year. Bad debts expense for this class of
customer averages 10 percent.

1. Calculate the total cost per case for each of the three customer classes.
 2. Using the costs from Requirement1, calculate the profit per case per customer class. Does the
cost analysis support the charging of different prices? Why or why not?

3. What if Cobalt charged the average price per case to all customer classes? How would that
affect the profit percentages?

The HOW and WHY of Calculating Inventory Cost and Preparing the Income Statement Using
Absorption Costing and Variable Costing

Information: Pattison Products, Inc., began operations in October and manufactured 40,000 units during
the month with the following unit costs:

Direct materials $5.00

Direct labor 3.00
Variable overhead 1.50
Fixed overhead* 7.00
Variable marketing cost 1.20
*Fixed overhead per unit 5 $280,000/40,000 units produced = $7.

Total fixed factory overhead is $280,000 per month. During October, 38,400 units were sold at a price of
$24, and fixed marketing and administrative expenses were $130,500.

1. Calculate the cost of each unit using absorption costing.

2. How many units remain in ending inventory? What is the cost of ending inventory using
absorption costing?
3. Prepare an absorption-costing income statement for Pattison Products, Inc., for the month of
October.

4. What if November production was 40,000 units, costs were stable, and sales were 41,000
units? What is the cost of ending inventory? What is operating income for November?

5. Calculate the cost of each unit using absorption costing.

6. How many units remain in ending inventory? What is the cost of ending inventory using
absorption costing?

7. Prepare an absorption-costing income statement for Pattison Products, Inc., for the month of
October.
 8. What if November production was 40,000 units, costs were stable, and sales were 41,000
units? What is the cost of ending inventory? What is operating income for November?

The HOW and WHY of Calculating the Sales Price Variance, the Sales Volume Variance, and the Overall
Sales Variance

Information: Armour Company distributes produce. In May, Armour Company expects to sell 20,000
pounds of produce at an average price of $0.20 per pound. Actual results are 23,000 pounds sold at an
average price of $0.19 per pound.

1. Calculate the sales price variance for May.

2. Calculate the sales volume variance for May.

3. Calculate the overall sales variance for May. Explain why it is favorable or unfavorable.

4. What if May sales were actually 19,000 pounds? How would that affect the sales price variance?
The sales volume variance? The overall sales variance?
The HOW and WHY of Calculating the Contribution Margin Variance

The HOW and WHY of Calculating the Contribution Margin Volume Variance

The HOW and WHY of Calculating the Sales Mix Variance

The HOW and WHY of Calculating the Market Share Variance and the Market Size Variance

Information: Birdwell, Inc., produces and sells two types of bird feeders. The regular type is a simple
plastic and wood model, which can be hung from a tree branch. The deluxe model is a larger, stand-
alone model, which includes a post and a round squirrel shield to prevent squirrels from eating the bird
seed. Budgeted unit sales for the entire bird feeder industry were 20,000 (of all model types), and actual
unit sales for the industry were 23,000.

Budgeted and actual data for the two models are shown below.

Budgeted Amounts:

Regular Model Deluxe Model Total

Sales:
($10 × 1,500) 15,000
($50 × 500) 25,000 40,000
Variable Expenses 9,000 17,500 26,500
Contribution Margin 6,000 7,500 13,500

Actual Amounts:

Regular Model Deluxe Model Total

Sales:
($10 × 1,250) 12,500
($50 × 625) 31,250 43,750
Variable Expenses 7,500 21,875 29,375
Contribution Margin 5,000 9,375 14,375

1. Calculate the contribution margin variance.

2. What if actual units sold of the deluxe bird feeder decreased? How would that affect the
contribution margin variance? What if actual units sold of the deluxe bird feeder increased?
How would that affect the contribution margin variance?
3. Calculate the budgeted average unit contribution margin.

4. Calculate the contribution margin volume variance.

5. What if actual units sold of the deluxe bird feeder decreased? How would that affect the
contribution margin volume variance? What if actual units sold of the deluxe bird feeder
increased? How would that affect the contribution margin volume variance?

6. Calculate the sales mix variance.

7. What if actual units sold of the deluxe bird feeder decreased? How would that affect the sales
mix variance? What if actual units sold of the deluxe bird feeder increased? How would that
affect the sales mix variance?

8. Calculate the market share variance.

9. Calculate the market size variance.

10. What if Birdwell actually sold a total of 2,300 units (in total of the two models)? How would that
affect the market share variance? The market size variance?