Diving Wear Ltd makes neoprene wetsuits. The company’s projected income statement for the coming year is as follows: Sales (65,000 units) $15,600,000 Less: Variable costs 8,736,000 Contribution margin 6,864,000 Less: Fixed costs (incl. advertising) 4,011,744 Operating income $2,852,256
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.
Diving Wear Ltd makes neoprene wetsuits. The company’s
statement
Sales (65,000 units) $15,600,000
Less: Variable costs 8,736,000
Contribution margin 6,864,000
Less: Fixed costs (incl. advertising) 4,011,744
Operating income $2,852,256
Required: Show all your workings:
1. Suppose actual sales revenue exceed the estimated amount on the projected income
statement by $612,000. Without preparing a new income statement, determine the
amount by which the profits are underestimated.
2. The company’s management has decided to increase the advertising budget by
$140,000 and reduce the average selling price to $200. These actions will increase sales
revenues by $1 million. Will this improve the company’s financial situation? Prepare a
new income statement to support your answer.
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