margin of safety in units and in sales dollars.
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.
Benoit Manufacturing Company manufactures and sells parts for various musical gadgets. The following information to a single part which is used in the production of a wind instrument. The business earned Operating Income of $220,000 in 2019, when production was 3,000 units and the president of Darius is under pressure from shareholders to increase operating income in 2020 and is therefore considering the implementation of strategies mainly geared at increasing revenues and or decreasing variable costs. Data for variable cost per unit and total fixed costs were as follows:
|
Variable expenses per unit: Direct materials |
$58 |
|
Direct Labour |
$74 |
|
Variable Manufacturing |
$48 |
|
Fixed expenses: Fixed Manufacturing Overhead |
$215,000 |
|
Fixed Selling Costs |
$65,000 |
|
Fixed Administrative Costs |
$160,000 |
Required:
- Calculate the margin of safety in units and in sales dollars.
- The President of Benoit is under pressure from shareholders to increase operating income by 50% in 2020. Management expects per unit data and total fixed costs to remain the same in 2020. Compute the number of units that would have to be sold in 2020 to reach the shareholders desired profit level. Is this a realistic goal?
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