AFM481 Lecture Notes - Lecture 12: Gross Margin, Contribution Margin, Operating Margin

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lilacmouse857

28 Jun 2018

School

University of Waterloo

Department

Accounting & Financial Management

Course

AFM481

Professor

Joyce Tian

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BEP = total fixed costs / contribution margin per unit

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Graph method

We assumed that total costs and total revenue behave in a linear fashion, we need only two

points to plot the line representing each of them

•

Fixed and variable costs

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Start at point A

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e.g. 40 units sold (40 x 120 + 2000 = 6800)

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The total costs line is the straight line from point A through point B

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Total costs line

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Start at point C

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e.g. at 40 units sold, 200 * 40 = 8,000

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The total revenues line is the straight line from C to D

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Total revenues line

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Profit or loss at any sales level can be determined by the vertical distance between the two lines

at that level

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Instead of expressing contribution margin as a dollar amount, we can do percentage

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e.g. 40% of the $1 contributes to paying fixed cost

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Tells us how many pennies per $1 of revenue contribute to paying fixed costs

•

The contribution margin percentage enables us to solve for values with partial data•

Contribution margin percentage: breakeven point in revenue

Using the previous example, we want $1500 as target operating income. (remember $0 is the BEP)•

Using CVP to calculate a target operating income

Alternatively, we can use contribution margin per unit to solve for Q

•

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Document Summary

Bep = total fixed costs / contribution margin per unit. We assumed that total costs and total revenue behave in a linear fashion, we need only two points to plot the line representing each of them. Start at point a e. g. 40 units sold (40 x 120 + 2000 = 6800) The total costs line is the straight line from point a through point b. Start at point c e. g. at 40 units sold, 200 * 40 = 8,000. The total revenues line is the straight line from c to d. Profit or loss at any sales level can be determined by the vertical distance between the two lines at that level. Instead of expressing contribution margin as a dollar amount, we can do percentage. Tells us how many pennies per of revenue contribute to paying fixed costs e. g. 40% of the contributes to paying fixed cost.

Related Questions

1)The manager of Able Car Inspection reviewed his monthlyoperating costs for the past year. His costs range from $4,100 for1,100 inspections to $3,700 for 700 inspections.

1. Calculate variable cost per inspection. use the high-lowmethod. round to the nearest cent

2. calculate the total fixed costs

3. write the equation and calculate the operating costs for 900inspections

4. Draw a graph illustrating your total cost under this plan.show your costs at 700, 900, and 1,100 inspections

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2) For its top managers, Airborn Travel formats its incomestatements as follows:

Airborn Travel

contribution margin income statement

three months ended March 31, 2012

Sales revenue $318500

Variable costs $111475

contribution margin 207025

fixed costs 176000

operating income $31025

Airborn's relevant range is between sales of $253000 and$366000

1) calculate the contribution margin ratio

2) Prepare two contribution margin income statements: one at the$253000 level and one at the $366,000 level. (Hint: the proportionof each sales dollar that goes toward variable costs is constantwithin the relevant range.) enter losses with a minus sign orparentheses

3) compute breakeven sales in dollars.

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3) Hang Ten, Co., produces sports socks. The company has fixedcosts of $91,080 and variable costs of $0.81 per package. Eachpackage sells for $1.80.

1. Compute the contribution margin per package and thecontribution margin ratio. (round answers to 2 decimal places)

2. Find the breakeven point in units and in dollars, using thecontribution margin approach.

Treadlight produces two types of exercise treadmills: regularand deluxe. The exercise craze is such that TreadLight could useall its available machine hours to produce either model. The twomodels are processed through the same production departments. Datafor both models is as follows:

Sale Price: Deluxe per unit ($1,010), Regular per unit($560)

Costs:

Direct materials: deluxe per unit ($320), Regular per unit($90)

direct labor: deluxe per unit ($82), regular per unit ($184)

variable manufacturing overhead: deluxe per unit ($240), regularper unit ($80)

fixed manufacturing overhead *: deluxe per unit ($126), regularper unit ($42)

variable operating expenses: deluxe per unit ($117) , regularper unit ($69)

total cost: deluxe per unit ($885), regular per unit ($465)

operating income: deluxe per unit ($125), regular per unit($95)

*allocated on the basis of machine hours

a. Which model should Treadlight produce? (Hint: TreadLight canproduce either 1 deluxe treadmill or 3 regular treadmills permachine hour.)

Prepare the product mix analysis

Treadlight

Product Mix Analysis

Sales price per unit: deluxe:_______,regular:________

variable costs per unit:deluxe:______,regular:_______

contribution margin per unit: deluxe:______,regular:______

units that can be produced each machine hour: deluxe:______,regular:_______

contribution margin per machine hour: deluxe:______,regular:_______

b. Should Treadlight produce both models? If so, compute the mixthat will maximize operating income.

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Members of the board of directors of Safety Step have receivedthe following operating income data for the year ended May 31,2012:

Safety Step

income statement

For the year ended May 31, 2012

Sales Revenue: Product line industrial systems ($350000),product line household systems ($360,000), total ($710,000)

cost of goods sold:

variable: product line industrial systems (34000), product linehousehold systems (47,000), total (81,000)

fixed: product line industrial systems (230,000), product linehousehold systems (69,000), total (299,000)

total cost of goods sold: product line industrial systems($264000), product line household systems(116,000), total(380000)

gross profit: product line industrial systems ($86,000), productline household systems (244,000), total (330,000)

marketing and administrative expenses:

variable: product line industrial systems (69,000), product linehousehold systems (76,000), total (145000)

fixed: product line industrial systems (41000), product linehousehold systems (24,000), total (65,000)

total marketing administrative exp.: product line industrialsystems (110,000), product line household systems (100,000),Total($210,000)

operating income (loss): product line industrial systems(-$24,000), product line household systems ($144,000), total$120,000

Members of the board are surprised that the industrial systemsproduct line is losing money. They commission a study to determinewhether the company should drop the line. Company accountantsestimate that dropping industrial systems will decrease fixed costof goods sold by $81,000 and decrease fixed marketing andadministrative expenses by $14,000.

1. prepare an incremental analysis to show whether Safety Stepshould drop the industrial systems product line. fill in theblanks.

Safety Step

incremental analysis of dropping a product line

expected decrease in revenues--

dropping industrial systems sales ________

expected decrease in expenses:

variable expenses:

cost of goods sold ________

marketing and administrative expenses _________

fixed expenses:

cost of goods sold _________

marketing and administrative expenses __________

expected decrease in total expenses __________

__________(expected decrease or expected increase) in operatingincome _____________

2. Prepare contribution margin income statements to show SafetyStep's total operating income under the two alternatives: (a) withthe industrial systems line and (b) without the line . Compare thedifference between the two alternatives' income numbers to youranswer to requirement 1.

3. What have you learned from the comparison in requirement2?

Question 7

Thanas Toy Bhd, makes two products, Hawaiian Fantasy andTahitian Joy. Present revenue, cost and sales data for two productsfollow:

	Avengers Toy	Madagascar Toy
Selling price per unit	RM15	RM100
Variable expenses per unit	RM9	RM20
Number of units sold monthly	20,000	5,000

Fixed expenses total RM475,800 per year. Required:

a. Assuming the sales mixgiven below above, do the following:

Prepare a contribution format income statement showing bothdollar and percent columns for each product and for the company asa whole.

ii.Compute the break-even point indollars for the company as a whole and the margin of safety in bothdollars and percent.

The company has developed a new product to be called SeafoodToy. Assume that the company could sell 10,000 units at RM45 each.The variable expenses would be RM36 each. The companyâs fixedexpenses would not change.

Prepare another contribution format income statement, includingsales of the Seafood (sales of other two products would notchange).

Compute the companyâs new break-even point in dollars and thenew margin of safety in both dollars and percent.

The president of the company examines your figures and says, âthereâs something strange here, our fixed costs havenât changed andyou show greater total contribution margin if we add the newproduct, but you also show our break-even point going up. Withgreater contribution margin, the break-even point should go down,not up. Youâve made a mistake somewhere.â Explain to the presidentwhat has happened.

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AFM481 Lecture Notes - Lecture 12: Gross Margin, Contribution Margin, Operating Margin

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