ACCT20200 Chapter Notes - Chapter 5: Earnings Before Interest And Taxes, Operating Leverage
Get access
Related Documents
Related Questions
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.
1. Compute net income before tax.
2. Compute the unit contribution margin in dollars and thecontribution margin ratio for one umbrella.
3. Calculate the break-even point in units and dollars ofrevenue.
4. Calculate the margin of safety:
In units
In sales dollars
As a percentage
5. Calculate the degree of operating leverage.
6. 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.
7. 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.
8. 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.
Requirement 1 | ||||
Units | Price | Totals | ||
Sales | X | $ | $ | |
Variable Costs | X | $ | $ | |
Fixed Costs | $ | |||
Net Income | $ | |||
Requirement 2 | ||||
Contribution Margin per Unitin Dollars = Selling Price â Variable Costs | ||||
Selling Price | Variable Costs | Contribution Margin per Unit | ||
Contribution Margin Ratio =Contribution Margin/Selling Price | ||||
Contribution Margin | Selling Price | Contribution Margin Ratio | ||
Requirement 3 | ||||
Break-Even Point = Fixed Costs/ Contribution Margin | ||||
Fixed Costs | Contribution Margin | Break-Even Point in Units (Rounded) | ||
Break-Even Point in Units XSelling Price per Unit = Break-Even Point Sales | ||||
Break-Even Point in Units | Selling Price per Unit | Break-Even Point in Sales (Rounded) | ||
Requirement 4A | ||||
Margin of Safety in Units =Current Unit Sales â Break-Even Point in Unit Sales | ||||
Current Unit Sales | Break-Even Point in Sales | Margin of Safety in Units | ||
Requirement 4B | ||||
Margin of Safety in Dollars =Current Sales in Dollars â Break-Even Point Sales in Dollars | ||||
Current Sales in Dollars | Break-Even Point in Dollars | Margin of Safety in Dollars | ||
Requirement 4C | ||||
Margin of Safety as aPercentage = Margin of Sales in Units / Current Unit Sales | ||||
Margin of Safety in Units | Current Unit Sales | Margin of Safety Percentage | ||
Requirement 5 | ||||
Degree of Operating Leverage =Contribution Margin / Operating Income | ||||
Contribution Margin | Operating Income | Operating Leverage | ||
Requirement 6 | ||||
Units | $ Per Unit | Totals | ||
Sales | X | $ | $ | |
Variable Costs | X | $ | $ | |
Fixed Costs | $ | |||
Net Income | $ | |||
Operating Leverage | Times % Increase | Increase would be XX% | ||
Prior Income | $ | From Part 1 | ||
Increase | $ | Prior Income X XX% Above | ||
Total | $ | |||
Requirement 7 | ||||
Targeted Income = (Fixed Costs+ Target Income) / Contribution Margin | ||||
Fixed Costs + Target Income | Divided by Contribution Margin | # of Units (Rounded) | ||
Fixed Costs | $ | |||
Target Income | $ | |||
Total | $ | $ | X | |
# of Units Above X $ Per Unit | ||||
Proof | Revenue | XX,XXX X $XX.XX | $ | |
Variable Costs | XX,XXX X $X.XX | $ | ||
Contribution Margin | $ | |||
Fixed Costs | $ | |||
Net Income | $ | |||
Requirement 8 | ||||
Sales Mix | ||||
Current | Specialty | Total | ||
Expected Sales Units | X | X | ||
Revenue = Sales X Price | $ | $ | $ | |
Variable Costs X Units | $ | $ | $ | |
Contribution Margin | $ | $ | $ | |
Fixed Costs | $ | $ | $ | |
Operating Income | $ | |||
Prior Net Income FromRequirement 1 | $ | |||
Additional Operating Income | (Operating Income Above Less Prior Income) | $ | ||
Decision With Explanation |
Feather Friends,Inc., distributes a high-quality wooden birdhouse that sells for$20 per unit. Variable | |||||||
costs are $8 per unit. Andfixed costs total $180,000 per year. | |||||||
FEATHER FRIENDS, INC. | |||||||
Unit price | $20 | ||||||
Variable cost per unit | 8 | ||||||
Annual fixed costs | 180,000 | ||||||
Estimated sales increase | $75,000 | ||||||
Operating results last year: | |||||||
Sales | $400,000 | ||||||
Less variable expenses | 160,000 | ||||||
Contribution margin | 240,000 | ||||||
Less fixed expenses | 180,000 | ||||||
Net operating income | $60,000 | ||||||
Expected percentage sales increase nextyear | 20% | ||||||
Units sold last year | 18,000 | ||||||
percentage reduction in sales price | 10% | ||||||
Increase in advertising expense | $30,000 | ||||||
Expected percentage increase in sales | 33% | ||||||
Increase in sales commission per unit | $1 | ||||||
Required: Answer the following independentquestions. | |||||||
1. What is the product's CM ratio? | |||||||
2. Use the CM ratio todetermine the break-even point in sales dollars. | |||||||
3. Due to an increase indemand, the company estimates that sales will increase by $75,000during the | |||||||
year.By how much should net operating income increase (or net lossdecrease) assuming that fixed | |||||||
costs do notchange? | |||||||
4. Assume that the operatingresult for last were as stated above. | |||||||
a.Compute the degree of operating leverage at the current level ofsales. | |||||||
b.The president expects sales to increase by 20% next year. By whatpercentage should net | |||||||
operatingincome increase? | |||||||
5. Refer to the original data.Assume that the company sold 18,000 units last year. The salesmanager | |||||||
isconvinced that a 10% reduction in the selling price, combined witha $30,000 increase in advertising, | |||||||
wouldcause annual sales in units to increase by one-third. Prepare twocontribution income | |||||||
statements, one showing the results of last year's operations andone showing the results of | |||||||
operations if these changes are made. Would you recommend that thecompany do as the sales | |||||||
managersuggest? | |||||||
6. Refer to the original data.Assume again that the company sold 18,000 units last year. Thepresident | |||||||
doesnot want to change the selling price. Instead, he wants to increasethe sales commission by $1 | |||||||
perunit. He thinks that this move, combined with some increase inadvertising, would increase annual | |||||||
salesby 25%. By how much could advertising be increased with profitsremaining unchanged? Do not | |||||||
prepare an income statement; use the incremental analysisapproach. | |||||||