ACC 330 Lecture Notes - Lecture 3: Iron Ore, Operating Leverage, Sensitivity Analysis

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28 Jul 2019

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Cvp provides structure to answer a variety of what-if scenarios. That question cannot be properly answered without doing this type of analysis. The margin of safety calculation answers a very important question: If budgeted revenues are above the breakeven point, how far can they fall before the breakeven point is reached. In other words, how far can they fall before the company will begin to lose money. An indicator of risk, the margin of safety (mos), measures the distance between budgeted sales and breakeven sales: Mos = budgeted sales be sales. The mos ratio removes the firm"s size from the output, and expresses itself in the form of a percentage: Mos ratio = mos budgeted sales. Managers make strategic decisions that affect the cost structure of the company. The cost structure is simply the relationship of fixed costs and variable costs to total costs.

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PROBLEM 5-22 Basics of CVP Analysis; Cost Structure [LO5-1, L05-3, L05-4, L05-5, L05-6] Due to erratic sales of its sole product—a high-capacity battery for laptop computers—PEM, Inc., has been experiencing difficulty for some time. The company's contribution format income state- ment for the most recent month is given below: Sales (19,500 units X $30 per unit) ..... Variable expenses .. Contribution margin. Fixed expenses ... Net operating loss ... ....... $585,000 409,500 175,500 180,000 $ (4,500) Required: 1. Compute the company's CM ratio and its break-even point in both unit sales and dollar sales. 2. The president believes that a $16,000 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $80,000 increase in monthly sales. If the president is right, what will be the effect on the company's monthly net operating income or loss? (Use the incremental approach in preparing your answer.) 3. Refer to the original data. The sales manager is convinced that a 10% reduction in the selling price, combined with an increase of $60,000 in the monthly advertising budget, will double 4. unit sales. What will the new contribution format income statement look like if these changes are adopted? Refer to the original data. The Marketing Department thinks that a fancy new package for the laptop computer battery would help sales. The new package would increase packaging costs by 75 cents per unit. Assuming no other changes, how many units would have to be sold each month to earn a profit of $9,750? 5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $72,000 each month a. Compute the new CM ratio and the new break-even point in both unit sales and dollar sales. b. Assume that the company expects to sell 26,000 units next month. Prepare two contribu- tion format income statements, one assuming that operations are not automated and one assuming that they are. (Show data on a per unit and percentage basis, as well as in total, for each alternative.) c. Would you recommend that the company automate its operations? Explain.

Quiz 5 Name:________________________

Part I: True or False Question and Fill in Blank.

1. T or F: The planning horizon for a discretionary fixed costusually encompasses many years.

2. Tor F: Committed fixed costs are those that relate to theinvestment in facilities, equipment and the basic organizationalstructure of a company.

3. T or F: The high-low method uses cost and activity data fromjust two extreme volume levels (periods) to establish a costformula.

4. T or F: On an income statement prepared by the traditionalapproach, costs are organized and presented according tofunction.

5. T or F: Contribution margin is defined as sales lessdiscretionary fixed costs.

6. T or F: The contribution format is widely used for preparingexternal financial statements.

7. T or F: Reynold Enterprises sells a single product for $25.The variable expense per unit is $15 and the fixed expense per unitis $5 at the current level of sales. The company's net operatingincome will increase by $5 if one more unit is sold over BEP.

8. T or F: Incremental analysis is an analytical approach thatfocuses on those items of revenue and cost that will change as aresult of a decision.

9. T or F: On a CVP graph for a profitable company, the totalrevenue line will be steeper than the total expense line.

10. T or F: The impact on net operating income of a given dollarchange in sales can be computed by applying the contribution marginratio to the dollar change in sales.

11. T or F: The larger the contribution margin ratio, thesmaller the amount of sales required to cover a given amount offixed expenses.

12. T or F: Fawn Company's margin of safety is $90,000. If thecompany's sales drop by $80,000, it will still have positive netoperating income.

13. T or F: The margin of safety can be defined as the amount bywhich sales can decrease before losses are incurred by the company.

14. Mark Company currently sells a video recorder with a sellingprice of $300 per unit. The variable expense per unit is $175 andfixed expenses are $100,000. If the company reduces variableexpenses by $20 per unit and increases the fixed expenses by$10,000, the break-even point will __increase or decrease__.

15. The degree of operatingleverage is computed by dividing contribution margin by______________.

16. The variable expenseper unit is $12 and the selling price per unit is $40. Then thecontribution margin ratio

is _____________%.

17. Long Companyâsvariables expenses are 60% of sales. A $1,200 increase in thecompanyâs fixed expenses will

increasethe break-even point in sales by $ _______________.

Part II: Classification of Costs asPeriod or Product Cost (@1/2)

1. ______________Depreciation on salespersonsâ cars.

2. ______________Rent on equipment used in the factory.

3. ______________Lubricants used for maintenance of machines.

4. ______________Salaries of finished goods warehouse personnel.

5. ______________Soap and paper towels used by factory workers at the end of ashift.

6. ______________Factory supervisorsâ salaries.

7. ______________Heat, water, and power consumed in the factory.

8. ______________Advertising costs.

9. ______________Workersâ compensation insurance on factory employees.

10. ______________ Attractivelydesigned box for packaging the companyâs product.

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LOOKING FOR SOLUTION TO PART 2,3,4

Section I: Cost-Volume-Profit Analysis

The Hampshire Company manufactures umbrellas that sell for$12.50 each. In 2014, the company made and sold 60,000 umbrellas.The company had fixed manufacturing costs of $216,000. It also hadfixed costs for administration of $79,525. The per-unit costs ofeach umbrella are as follows:

Direct Materials: $3.00

Direct Labor: $1.50

Variable Manufacturing Overhead:$0.40

Variable Selling Expenses: $1.10

Using the information above, perform a cost-volume-profit (CVP)analysis by completing the steps below. All CVP calculations shouldbe completed in the Hampshire Company Spreadsheet. Note:The CVP analysis satisfies Part A of Section I.

Compute net income before tax.

Compute the unit contribution margin in dollars and thecontribution margin ratio for one umbrella.

Calculate the break-even point in units and dollars of revenue.Note: This is a required part of the CVP analysis andsatisfies Part C of Section I.

Calculate the margin of safety:

In units

In sales dollars

As a percentage

Calculate the degree of operating leverage.

Assume that sales will increase by 20% in 2015. Calculate thepercentage of before-tax income for this increase. Providecalculations to prove that your percentage increase is correctbased on the operating leverage calculated in step 5.

Compute the number of umbrellas that Hampshire is required tosell if it plans to earn $150,000 in income before taxes by usingthe target income formula. Proof your calculation.

A company that specializes in tours in England has offered topurchase 5,000 umbrellas at $11 each from Hampshire. The variableselling costs of these additional units will be $1.30 as opposed to$1.10 per unit. Also, this production activity will incur another$15,000 of fixed administrative costs. Should Hampshire agree tosell these additional 5,000 umbrellas to the touring business?Provide calculations to support your decision.

Additionally, complete Parts B and D of Section I as outlined inthe Final Project Guidelines and Rubric document.

Section II: Inventory Management

The information below represents the beginning and endinginventory amounts along with the production and sales for the monthin umbrella units.

Beginning Inventory: 0 Umbrellas

Production: 80,000 Umbrellas

Sales: 60,000 Umbrellas

Ending Inventory: 20,000Umbrellas

Using the information provided above and the costs and salesinformation provided in Section I, complete the following in theHampshire Company Spreadsheet in order to assist you in respondingto all components of Section II:

Prepare a variable costing income statement.

Prepare an absorption costing income statement.

Additionally, complete Parts A through E of Section II asoutlined in the Final Project Guidelines and Rubric document.

Section III: Benchmarking

The management of the Hampshire Company would like to implementbenchmarking. Standard costs have been established and arepresented below. You will want to complete a variance analysis toinclude efficiency and price variances for materials (cloth andhandle assemblies) and labor based on the following data:

Units Produced = 80,000

Units Sold = 60,000

Direct Materials Purchased and Used

Actual square yards of cloth purchased and used: 128,000

Actual price incurred per yard: $1.25

Actual handles purchased and used: 80,808

Actual price per handle/rib/stretcher assembly: $0.99

Direct Manufacturing Labor Used

Actual direct labor hours used: 15,748

Actual price per hour: $7.62

Direct labor costs: $120,000

Standard Rates

Standard labor hours per unit: 0.20

Standard labor price per hour: $7.50

Square yards material per unit: 1.50

Standard price per yard: $1.15

Handle/rib/stretcher assembly per unit: 1

Standard price per handle assembly: $1.05

Companies can use variance analysis and benchmarking to measureperformance within their own company and against competitors. Thiscan be done by setting standards/budgets and comparing a completedvariance analysis to results from prior periods or comparing themto competitorsâ results. Using the information provided above,complete the following calculations (steps 1 and 2) in theHampshire Company Spreadsheet. This will assist you in respondingto all components of Section III.

Calculate price variances for material and labor and denotewhether they are favorable or unfavorable.

Calculate efficiency variances for material and labor and denotewhether they are favorable or unfavorable.

In order to measure performance and make use of the varianceanalysis completed, management understands the need to compareresults with their competitors. Following the steps outlined below,you will research benchmarking and propose the most effectiveapproach for your company. Respond to Parts A through C of SectionIII as outlined in the Final Project Guidelines and Rubricdocument.

Section IV: Alternative Costing Method

Hampshire has always produced stick umbrellas. However, it isconsidering expanding its production to include collapsibleumbrellas. This consideration has been spurred by Tours Today, atouring company that is interested in providing its customers withcollapsible umbrellas imprinted with its logo. The management atHampshire is currently working out a deal with the touring companyto produce 3,000 collapsible umbrellas and believes it can sellthose umbrellas for $14.00 each. Here are the costs that can bedirectly traced to this special order:

Direct Materials: $9,300

Direct Labor Hours: 600

Hourly Rate of Direct labor:$8.00

In the traditional costing approach, overhead is applied at therate of $24.60 per labor hour. This expansion in production willadd additional overhead costs. The total overhead costs (assumingproduction of the stick and collapsible umbrellas) to include thecost pools and cost drivers are provided in Table 2.

An alternative costing method that might benefit Hampshire isthe implementation of activity-based costing (ABC).Hampshire would like to implement an ABC approach to analyze theproduction of this special order of collapsible umbrellas. Thecontroller has assembled the following information:

	Stick	Collapsible
Units Sold	60,000	3,000
Selling Price	$12.50	$14.00
Direct Material Cost per Unit	$3	$3.10
Direct Labor Cost per Hour	$7.50	$8.00
Variable Manufacturing Overhead	$0.40	$0.40
Variable Selling Costs	$1.10	$1.10
Labor Hours per Unit	0.2	0.2
Sales Orders	120	1
Purchase Orders	50	3
Production Runs	45	6
Material Moves	86	10
Machine Setups	130	6
Machine Hours	525	32
Inspections	200	10
Shipments	60	3

Table 1: Direct Cost Information and Activities

Activity	Activity Cost	Activity Cost Driver
Order Processing	$35,000	Number of Sales Orders
Purchasing	$36,000	Number of Purchase Orders
Material Handing	$28,000	Material Moves
Machine Setup	$14,000	Machine Setups
Production	$99,000	Production Runs
Assembly	$80,000	Machine Hours
Inspecting	$11,000	Number of Inspections
Shipping	$7,500	Number of Shipments

Table 2: Activity Cost Pools and Cost Drivers

Another alternative to traditional costing and ABC istime-driven activity-based costing (TDABC). You will need todetermine which of these three methods would be the best approachfor the Hampshire Company. The following article may assist you inyour analysis: Time-Driven Activity-Based Costing. Additionally,you may want to use the Shapiro Library to conduct further researchon the three methods. You will need to defend your position whenanswering the prompts for the written portion of this section.

Using the information provided above, complete the following inthe Hampshire Company Spreadsheet in order to assist you inresponding to all components of Section IV:

1.Calculate the allocation rates foreach cost driver using ABC.

2.Use the traditional costing approachto calculate the total cost and the unit cost of the stick andcollapsible umbrellas.

3.Use ABC to compute the total costsand the unit cost for the stick and collapsible umbrellas.

4.Compute the difference between theproduct cost per stick and collapsible umbrellas using the unitcost that you computed with the traditional approach and the onethat you computed using ABC.

Based on your calculations from steps 1â4, respond to Parts Athrough C in Section IV as outlined in the Final Project Guidelinesand Rubric document.

Section V: Memo to Management

The management of the Hampshire Company is very interested inmeasuring performance. They would like you to recommend a strategyto increase business performance. They are not sure whether theyshould focus on product differentiation or cost leadership.Research additional performance tools to include the balancedscorecard. During your research, consider what performancemeasurements you would use based on the four perspectives. Provideexamples.

In your recommendation, you will want to include the outcome ofyour previous quantitative analysis and research performed relatedto cost-volume-profit (CVP), variable and absorption costing,just-in-time (JIT), standard costs, variances, and benchmarking.You will want to review key points and make recommendations basedon your current research and prior analysis completed and researchperformed.

Your two- to three-page memo to management must be submitted asa Word document and must include your responses to Parts A throughC of Section V as outlined in the Final Project Guidelines andRubric document.

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ACC 330 Lecture Notes - Lecture 3: Iron Ore, Operating Leverage, Sensitivity Analysis

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