CVP Analysis in a Professional Service Firm Leary and O’Donnell, a local CPA firm, has beenasked to bid on a contract to perform audits for three counties in its home state. Because existing staffare fully scheduled, if the firm is awarded the contract, it must hire one new staff member at a salaryof $52,000 to handle the additional workload. The managing partner is convinced that obtaining thecontract will lead to additional new clients from the respective counties. Expected new work (excluding the three counties) is 750 hours at an average billing rate of $90.00 per hour. Other informationfollows about the firm’s current annual revenues and costs:Firm volume in hours (normal) 30,750Fixed costs $575,000Variable cost $35.00/hrShould the firm win the contract, the audits of the three counties will require 950 hours ofexpected work.Required1. If the managing partner’s expectations are correct, what is the lowest bid the firm can submit and stillexpect to increase annual net income? What would be the hourly billing rate for the county audit jobsjust to break even on all the new business?2. If the contract is obtained at a price of $44,000, what is the minimum number of hours of new businessin addition to the county work that must be obtained for the firm to break even on total new business?What is the margin of safety (MOS) regarding the county audit job proposal?
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
CVP Analysis in a Professional Service Firm Leary and O’Donnell, a local CPA firm, has been
asked to bid on a contract to perform audits for three counties in its home state. Because existing staff
are fully scheduled, if the firm is awarded the contract, it must hire one new staff member at a salary
of $52,000 to handle the additional workload. The managing partner is convinced that obtaining the
contract will lead to additional new clients from the respective counties. Expected new work (excluding the three counties) is 750 hours at an average billing rate of $90.00 per hour. Other information
follows about the firm’s current annual revenues and costs:
Firm volume in hours (normal) 30,750
Fixed costs $575,000
Variable cost $35.00/hr
Should the firm win the contract, the audits of the three counties will require 950 hours of
expected work.
Required
1. If the managing partner’s expectations are correct, what is the lowest bid the firm can submit and still
expect to increase annual net income? What would be the hourly billing rate for the county audit jobs
just to break even on all the new business?
2. If the contract is obtained at a price of $44,000, what is the minimum number of hours of new business
in addition to the county work that must be obtained for the firm to break even on total new business?
What is the margin of safety (MOS) regarding the county audit job proposal?
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