Understanding the effects of operating leverage HighTech, Inc., andOldTime Co. compete within the same industry and had the following operatingresults in 2012:HighTech, OldTimeInc. Co.Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,100,000 $2,100,000Variable expenses . . . . . . . . . . . . . . . . . . . . . . 420,000 1,260,000Contribution margin . . . . . . . . . . . . . . . . . . . . . $1,680,000 $ 840,000Fixed expenses . . . . . . . . . . . . . . . . . . . . . . . . 1,470,000 630,000Operating income . . . . . . . . . . . . . . . . . . . . . . $ 210,000 $ 210,000Required:a. Calculate the break-even point for each firm in terms of revenue.b. What observations can you draw by examining the break-even point of each firm given that they earned an equal amount of operating income on identical sales volumes in 2012?c. Calculate the amount of operating income (or loss) that you would expect each firm to report in 2013 if sales were to1. Increase by 20%.2. Decrease by 20%.d. Using the amounts computed in requirement c, calculate the increase or decrease in the amount of operating income expected in 2013 from the amount reported in 2012.e. Explain why an equal percentage increase (or decrease) in sales for each firm would have such differing effects on operating income.f. Calculate the ratio of contribution margin to operating income for each firm in 2012. (Hint: Divide contribution margin by operating income.)g. Multiply the expected increase in sales of 20% for 2013 by the ratioof contribution margin to operating income for 2012 computed inrequirement f for each firm. (Hint: Multiply your answer in requirement fby 0.2.)h. Multiply your answer in requirement g by the operating income of $210,000 reported in 2012 for each firm. i. Compare your answer in requirement h with your answer in requirement d. What conclusions can you draw about the effects of operating leverage from the steps you performed in requirements f, g, and h ?
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.
Understanding the effects of operating leverage HighTech, Inc., and
OldTime Co. compete within the same industry and had the following operating
results in 2012:
HighTech, OldTime
Inc. Co.
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,100,000 $2,100,000
Variable expenses . . . . . . . . . . . . . . . . . . . . . . 420,000 1,260,000
Contribution margin . . . . . . . . . . . . . . . . . . . . . $1,680,000 $ 840,000
Fixed expenses . . . . . . . . . . . . . . . . . . . . . . . . 1,470,000 630,000
Operating income . . . . . . . . . . . . . . . . . . . . . . $ 210,000 $ 210,000
Required:
a. Calculate the break-even point for each firm in terms of revenue.
b. What observations can you draw by examining the break-even point of each firm given that they earned an equal amount of operating income on identical sales volumes in 2012?
c. Calculate the amount of operating income (or loss) that you would expect each firm to report in 2013 if sales were to
1. Increase by 20%.
2. Decrease by 20%.
d. Using the amounts computed in requirement c, calculate the increase or decrease in the amount of operating income expected in 2013 from the amount reported in 2012.
e. Explain why an equal percentage increase (or decrease) in sales for each firm would have such differing effects on operating income.
f. Calculate the ratio of contribution margin to operating income for each firm in 2012. (Hint: Divide contribution margin by operating income.)
g. Multiply the expected increase in sales of 20% for 2013 by the ratio
of contribution margin to operating income for 2012 computed in
requirement f for each firm. (Hint: Multiply your answer in requirement f
by 0.2.)
h. Multiply your answer in requirement g by the operating income of $210,000 reported in 2012 for each firm.
i. Compare your answer in requirement h with your answer in requirement d. What conclusions can you draw about the effects of operating leverage from the steps you performed in requirements f, g, and h ?
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