Chapter 12, Problem 12.23P

To determine

Concept Introduction:

Breakeven point

It measures whether a project will be profitable by equating its total revenues with its total expenses. At break- even point, contribution margin equals fixed expenses which can be depicted as:

  

Break- even point in terms of sales dollars can be computed using the following formula:

  

Contribution margin

It is the difference between total revenue and variable expenses. Contribution margin equals the amount that sales exceed variable costs. It measures how efficiently a company can produce products and maintain low levels of variable cost.

  

Variable expenses

The expenses which are associated with the amount of goods produced or services provided. These vary directly with the production level i.e. company's variable cost increases as the production increases and vice-a-versa.

Fixed expenses

These expenses do not vary with the level of production. They do not change with the amount of goods or services a company produces. They remain same even if the company does not produce any product or provide any service during an accounting period.

Requirement a:

To calculate:

Break- even point expressed in terms of total sales dollars and sales volume

Answer to Problem 12.23P

Break- even point in terms of sales volume= 4,500 units

Break- even point in sales dollars= $67,500

Explanation of Solution

To arrive at break- even point, firstly contribution margin would be calculated using the below- mentioned formula:

  

In the given problem, selling price is given as $15 per unit and Variable expenses as $9 per unit. Thus,

  $Contributionmargin=\$15perunit-\$9perunit=\$6perunit$

At break- even point, contribution margin equals fixed expenses. Fixed expenses are given in the problem as $27,000 per month. Let us assume number of units sold to be x.

  

  

Thus, break- even point in terms of sales volume= 4,500 units.

Now, Break- even point in terms of sales dollars needs to be calculated. We have determined break- even point in terms of sales volume as 4,500 units and selling price per unit is given in the problem as $15 per unit. Therefore,

  

  

Thus, break- even point in terms of sales volume is coming out to be 4,500 units and in sales dollars as $67,500.

To determine

Concept Introduction:

Margin of safety

The excess of actual or budgeted sales over break- even sales volume is called margin of safety. In other words, it is the revenue earned after the company pays all of its fixed and variable costs associated with producing goods or services. It can be calculated using the following formula:

  

Margin of safety ratio can be calculated by subtracting break- even point from the current sales and dividing by the current sales as can be seen below:

  

Breakeven point

It measures whether a project will be profitable by equating its total revenues with its total expenses. At break- even point, contribution margin equals fixed expenses.

Requirement b:

To calculate:

Margin of safety and margin of safety ratio

Answer to Problem 12.23P

Margin of safety= $67,500

Margin of safety ratio= 10%

Explanation of Solution

Firstly margin of safety would be calculated. Current sales are given as $75,000 in the problem and we have calculated Break- even sales as $67,500. Therefore,

  

  $=\$\mathrm{<mn>7</mn><mn>5</mn>},\mathrm{<mn>0</mn><mn>0</mn><mn>0</mn>}-\$\mathrm{<mn>6</mn><mn>7</mn>},\mathrm{<mn>5</mn><mn>0</mn><mn>0</mn>}=\$\mathrm{<mn>7</mn>},\mathrm{<mn>5</mn><mn>0</mn><mn>0</mn>}$

Margin of safety ratio can be calculated using the below- mentioned formula:

  

  $=\left(\$\mathrm{<mn>7</mn><mn>5</mn>},\mathrm{<mn>0</mn><mn>0</mn><mn>0</mn>}-\$\mathrm{<mn>6</mn><mn>7</mn>},\mathrm{<mn>5</mn><mn>0</mn><mn>0</mn>}\right)/\$\mathrm{<mn>7</mn><mn>5</mn>},\mathrm{<mn>0</mn><mn>0</mn><mn>0</mn>}=\mathrm{<mn>1</mn><mn>0</mn>}\%$

Thus, margin of safety is coming out to be $67,500 and margin of safety ratio as 10%.

To determine

Concept Introduction:

Breakeven point

It measures whether a project will be profitable by equating its total revenues with its total expenses. At break- even point, contribution margin equals fixed expenses which can be depicted as:

  

Break- even point in terms of sales dollars can be computed using the following formula:

  

Contribution margin

It is the difference between total revenue and variable expenses. Contribution margin equals the amount that sales exceed variable costs. It measures how efficiently a company can produce products and maintain low levels of variable cost.

  

Variable expenses

The expenses which are associated with the amount of goods produced or services provided. These vary directly with the production level i.e. company's variable cost increases as the production increases and vice-a-versa.

Fixed expenses

These expenses do not vary with the level of production. They do not change with the amount of goods or services a company produces. They remain same even if the company does not produce any product or provide any service during an accounting period.

Requirement c:

To calculate:

Monthly operating income (or loss)

Answer to Problem 12.23P

Monthly operating income of Monterey Co. = $5,400

Explanation of Solution

To arrive at monthly operating income (or loss) of Monterey Co. at sales volume of 5400 units, following equation would be used:

  

In the given problem, selling price is given as $15 per unit and Variable expenses as $9 per unit. Thus,

  $\begin{array}{l}Revenue=5,400units*\$15perunit=\$81,000\hfill \\ Variableexpenses=5,400units*\$9perunit=\$48,600\hfill \\ Contributionmargin=\$81,000-\$48,600=\$32,400\hfill \end{array}$

Further, monthly fixed expenses are given as $27,000. Thus, operating income would be:

  

All the above calculations can be seen from the table given below:

Calculation of monthly operating income (or loss) of Monterey Co. (Amount in $)

Particulars	Per unit	Sales Volume	Amount
Revenue	15	5,400 units	81,000
Less: Variable expenses	9	5,400 units	48,600
Contribution margin	6	5,400 units	32,400
Less: Fixed expenses			27,000
Operating income			5,400

Thus, monthly operating income is coming out to be $5,400.

To determine

Concept Introduction:

Breakeven point

It measures whether a project will be profitable by equating its total revenues with its total expenses. At break- even point, contribution margin equals fixed expenses which can be depicted as:

  

Break- even point in terms of sales dollars can be computed using the following formula:

  

Contribution margin

It is the difference between total revenue and variable expenses. Contribution margin equals the amount that sales exceed variable costs. It measures how efficiently a company can produce products and maintain low levels of variable cost.

  

Variable expenses

The expenses which are associated with the amount of goods produced or services provided. These vary directly with the production level i.e. company's variable cost increases as the production increases and vice-a-versa.

Fixed expenses

These expenses do not vary with the level of production. They do not change with the amount of goods or services a company produces. They remain same even if the company does not produce any product or provide any service during an accounting period.

Requirement d:

To calculate:

Monthly operating income (or loss) if $2 per unit decline in sales price results in increased sales volume to 8,400 units per month

Answer to Problem 12.23P

Monthly operating income of Monterey Co. = $6,600

Explanation of Solution

To arrive at monthly operating income (or loss) if $2 per unit decline in sales price results in increased sales volume to 8,400 units per month, following equation would be used:

  

In the given problem, selling price is given as $15 per unit but there has a decline of $2 per unit, thereby making selling price as $13 per unit. Variable expenses are given as $9 per unit. Thus,

  $\begin{array}{l}Revenue=8,400units*\$13perunit=\$1,09,200\hfill \\ Variableexpenses=8,400units*\$9perunit=\$75,600\hfill \\ Contributionmargin=\$1,09,200-\$75,600=33,600\hfill \end{array}$

Further, monthly fixed expenses are given as $27,000. Thus, operating income would be:

  

All the above calculations can be seen from the table given below:

Calculation of monthly operating income (or loss) of Monterey Co. (Amount in $)

Particulars	Per unit	Sales Volume	Amount
Revenue	13	8,400 units	1,09,200
Less: Variable expenses	9	8,400 units	75,600
Contribution margin	4	8,400 units	33,600
Less: Fixed expenses			27,000
Operating income			6,600

Thus, monthly operating income is coming out to be $6,600.

To determine

Concept Introduction:

Cost-volume-profit analysis

This process is used by the management to predict the future volume of activity, costs incurred, sales made and profits received. It computes how changes in costs and sales will affect income in future periods. Cost-volume-profit analysis looks to determine the break- even for different sales volumes and cost structures on the basis of taking several assumptions which can be useful for taking short-term decisions.

Breakeven point

It measures whether a project will be profitable by equating its total revenues with its total expenses. At break- even point, contribution margin equals fixed expenses.

Requirement e:

Questions to be answered about cost-volume-profit analysis simplifying assumptions before adopting price cut strategy of part d

Answer to Problem 12.23P

• Does increase in sales volume as a result of price cut has any impact on fixed cost?
• Are variable expenses following a linear relationship? That means how variable expenses are moving in relation to sales?

Explanation of Solution

Cost-volume-profit analysis is used by the management to predict the future volume of activity, costs incurred, sales made and profits received. It computes how changes in costs and sales will affect income in future periods. Cost-volume-profit analysis looks to determine the break- even for different sales volumes and cost structures on the basis of taking several assumptions which can be useful for taking short-term decisions.

Questions that need to be answered about cost-volume-profit analysis simplifying assumptions before adopting price cut strategy of part d are given below:

• Does increase in sales volume as a result of price cut has any impact on fixed cost?
• Are variable expenses following a linear relationship? That means how variable expenses are moving in relation to sales?

To determine

Concept Introduction:

Contribution margin

It is the difference between total revenue and variable expenses. Contribution margin equals the amount that sales exceed variable costs. It measures how efficiently a company can produce products and maintain low levels of variable cost.

  

Variable expenses

The expenses which are associated with the amount of goods produced or services provided. These vary directly with the production level i.e. company's variable cost increases as the production increases and vice-a-versa.

Fixed expenses

These expenses do not vary with the level of production. They do not change with the amount of goods or services a company produces. They remain same even if the company does not produce any product or provide any service during an accounting period.

Requirement f

To calculate:

Monthly operating income (or loss) if $1 per unit increase in sales price and $6,000 per month increase in advertising expenses assuming sales volume of 5,400 units per month

Answer to Problem 12.23P

Monthly operating income of Monterey Co. = $4,800

Explanation of Solution

To arrive at monthly operating income (or loss) if $1 per unit increase in sales price and $6,000 per month increase in advertising expenses assuming sales volume of 5,400 units per month, following equation would be used:

  

In the given problem, selling price is given as $15 per unit but there has an increase of $1 per unit, thereby making selling price as $16 per unit. Variable expenses are given as $9 per unit. Thus,

  $\begin{array}{l}Revenue=\text{ 5},400units*\$16perunit=\$86,400\hfill \\ Variableexpenses=\text{ 5},400units*\$9perunit=\$48,600\hfill \\ Contributionmargin=\$86,400-\$48,600=37,800\hfill \end{array}$

Further, monthly fixed expenses are given as $27,000 and it is given that there is an increase of $6,000 per month in advertising expenses, thereby making total fixed expenses as $33,000. Thus, operating income would be:

  

All the above calculations can be seen from the table given below:

Calculation of monthly operating income (or loss) of Monterey Co. (Amount in $)

Particulars	Per unit	Sales Volume	Amount
Revenue	16	5,400 units	86,400
Less: Variable expenses	9	5,400 units	48,600
Contribution margin	7	5,400 units	37,800
Less: Fixed expenses			33,000
Operating income			4,800

Thus, monthly operating income is coming out to be $4,800.

To determine

Concept Introduction:

Contribution margin

It is the difference between total revenue and variable expenses. Contribution margin equals the amount that sales exceed variable costs. It measures how efficiently a company can produce products and maintain low levels of variable cost.

  

Variable expenses

The expenses which are associated with the amount of goods produced or services provided. These vary directly with the production level i.e. company's variable cost increases as the production increases and vice-a-versa.

Fixed expenses

These expenses do not vary with the level of production. They do not change with the amount of goods or services a company produces. They remain same even if the company does not produce any product or provide any service during an accounting period.

Requirement g

To calculate:

Monthly operating income (or loss) assuming sales volume of

1. 5,400 units per month
2. 6,000 units per month

Answer to Problem 12.23P

1. Monthly operating income of Monterey Co. when sales volume of 5,400 units per month= $5,280
2. Monthly operating income of Monterey Co. when sales volume of 6,000 units per month= $8,400

Explanation of Solution

The change in sales force compensation plan would lead to change in fixed expenses as shown below:

Particulars	Amount (In $)
Current fixed expenses	27,000
Decrease in fixed expenses (2 sales people *$2,500)	5,000
Increase in fixed expenses (2 sales people*$400)	800
New fixed expenses	22,800

 1. To arrive at monthly operating income (or loss) when there is change in sales force compensation plan assuming sales volume of 5,400 units per month

There is a commission of $0.80 per unit which will be added to the variable cost of $9 per unit, thereby making variable cost as $9.80 per unit. In the given problem, selling price is given as $15 per unit and there are 5,400 units. Therefore, following equation would be used:

  

  $\begin{array}{l}Revenue=\text{ 5},400units*\$15perunit=\$81,000\hfill \\ Variableexpenses=\text{ 5},400units*\$9.80perunit=\$52,920\hfill \\ Contributionmargin=\$81,000-\$52,920=\text{ \$28},080\hfill \end{array}$

We have calculated new monthly fixed expenses as $22,800. Thus, operating income would be:

  

All the above calculations can be seen from the table given below:

Calculation of monthly operating income (or loss) of Monterey Co. (Amount in $)

Particulars	Per unit	Sales Volume	Amount
Revenue	15	5,400 units	81,000
Less: Variable expenses	9.80	5,400 units	52,920
Contribution margin	5.20	5,400 units	28,080
Less: Fixed expenses			22,800
Operating income			5,280

Thus, monthly operating income is coming out to be $5,280.

 2. To arrive at monthly operating income (or loss) when there is change in sales force compensation plan assuming sales volume of 6,000 units per month

There is a commission of $0.80 per unit which will be added to the variable cost of $9 per unit, thereby making variable cost as $9.80 per unit. In the given problem, selling price is given as $15 per unit and there are 5,400 units. Therefore, following equation would be used:

  

  $\begin{array}{l}Revenue=\text{ 6,0}00units*\$15perunit=\$90,000\hfill \\ Variableexpenses=\text{ 6},000units*\$9.80perunit=\$58,800\hfill \\ Contributionmargin=\$90,000-\$58,800=\text{ \$31},200\hfill \end{array}$

We have calculated new monthly fixed expenses as $22,800. Thus, operating income would be:

  

All the above calculations can be seen from the table given below:

Calculation of monthly operating income (or loss) of Monterey Co. (Amount in $)

Particulars	Per unit	Sales Volume	Amount
Revenue	15	6,000 units	90,000
Less: Variable expenses	9.80	6,000 units	58,800
Contribution margin	5.20	6,000 units	31,200
Less: Fixed expenses			22,800
Operating income			8,400

Thus, monthly operating income is coming out to be $8,400.

To determine

Concept Introduction:

Contribution margin

It is the difference between total revenue and variable expenses. Contribution margin equals the amount that sales exceed variable costs. It measures how efficiently a company can produce products and maintain low levels of variable cost.

  

Variable expenses

The expenses which are associated with the amount of goods produced or services provided. These vary directly with the production level i.e. company's variable cost increases as the production increases and vice-a-versa.

Fixed expenses

These expenses do not vary with the level of production. They do not change with the amount of goods or services a company produces. They remain same even if the company does not produce any product or provide any service during an accounting period.

Requirement h

Strategy to be recommended

Answer to Problem 12.23P

Monthly operating income is coming out to be $8,000 which is $400 less than the operating income in case of sales force compensation plan as calculated in part g ($8,400). Therefore, Monterey Co. should adopt sales force compensation plan instead of increasing advertising expenditure.

Explanation of Solution

Strategy to be recommended when sales volume is 6,000 units per month and instead od chaging sales force compensation plan

In the given problem, Variable cost is $9 per unit, selling price is given as $15 per unit and there are 6,000 units. Therefore, following equation would be used:

  

  $\begin{array}{l}Revenue=\text{ 6},000units*\$15perunit=\$90,000\hfill \\ Variableexpenses=\text{ 6},000units*\$9perunit=\$54,000\hfill \\ Contributionmargin=\$90,000-\$54,000=\text{ \$36,000}\hfill \end{array}$

Monthly fixed expenses are given as $27,000 and there has been an increase in advertisement expenditure by $1,000 per month, thereby making total fixed expenses to the tune of $28,000. Thus, operating income would be:

  

All the above calculations can be seen from the table given below:

Calculation of monthly operating income (or loss) of Monterey Co. (Amount in $)

Particulars	Per unit	Sales Volume	Amount
Revenue	15	6,000 units	90,000
Less: Variable expenses	9	6,000 units	54,000
Contribution margin	6	6,000 units	36,000
Less: Fixed expenses			28,000
Operating income			8,000

Thus, monthly operating income is coming out to be $8,000 which is $400 less than the operating income in case of sales force compensation plan as calculated in part g ($8,400). Therefore, Monterey Co. should adopt sales force compensation plan instead of increasing advertising expenditure.