Income statements for two different companies in the same industry are as follows: Elgin, Inc Hobart, Inc. Sales: $600,000 $600,000 Less: Variable costs: 360,000 120,000 Contribution margin: $240,000 $480,000 Less: Fixed Costs: 120,000 360,000 Operating income $120,000 $120,000 REQUIRED: 1. Compute the degree of operating leverage for each company. 2. Compute the break-even point for each company. Explain why the break-even point for Hobart, Inc., is higher. 3. Suppose that both companies experience a 30 percent increase in revenues. Compute the percentage change in profits for each company. Explain why the percentage increase in Hobart’s profits is so much greater than that of Elgin.
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.
Income statements for two different companies in the same industry are as follows:
Elgin, Inc Hobart, Inc.
Sales: $600,000 $600,000
Less: Variable costs: 360,000 120,000
Contribution margin: $240,000 $480,000
Less: Fixed Costs: 120,000 360,000
Operating income $120,000 $120,000
REQUIRED:
1. Compute the degree of operating leverage for each company.
2. Compute the break-even point for each company. Explain why the break-even point for Hobart, Inc., is higher.
3. Suppose that both companies experience a 30 percent increase in revenues. Compute the percentage change in profits for each company. Explain why the percentage increase in Hobart’s profits is so much greater than that of Elgin.
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