Portmann Company, operating at full capacity, sold 1,000,000 units at a price of $186 per unit during the current year. Its income statement is as follows: Sales $186,000,000 Cost of goods sold (99,000,000) Gross profit $87,000,000 Expenses: Selling expenses $14,000,000 Administrative expenses 12,400,000 Total expenses (26,400,000) Operating income $60,600,000
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.
Portmann Company, operating at full capacity, sold 1,000,000 units at a price of $186 per unit during the current year. Its income statement is as follows:
| Sales | $186,000,000 | ||
| Cost of goods sold | (99,000,000) | ||
| Gross profit | $87,000,000 | ||
| Expenses: | |||
| Selling expenses | $14,000,000 | ||
| Administrative expenses | 12,400,000 | ||
| Total expenses | (26,400,000) | ||
| Operating income | $60,600,000 |
The division of costs between variable and fixed is as follows:
| Variable | Fixed | |||
| Cost of goods sold | 70% | 30% | ||
| Selling expenses | 75% | 25% | ||
| Administrative expenses | 50% | 50% |
Management is considering a plant expansion program for the following year that will permit an increase of $11,160,000 in yearly sales. The expansion will increase fixed costs by $3,500,000 but will not affect the relationship between sales and variable costs.
Required:
6. Determine the maximum operating income possible with the expanded plant.
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