Accounting 410 Final: Chapter 19

To better understand how CVP analysis works, let's assume that shipping costs have increased significantly causing the unit variable cost to increase by 10%, what effect will this have on Desossa's break-even point?

A 10% increase in variable costs increases the per unit variable cost to $72.60 [$66 + ($66 X 10%)]. The new contribution margin per unit is therefore $47.40 ($120 - $72.60). Thus the new break-even point in units is calculated as follows: Fixed cost ÷ Contribution margin per unit = Break-even point in units $99,900 ÷ $47.40 = 2,108 units

How do you calculate required sales in units and dollars?

Assuming Desossa's management has a target net income of $108,000, the required sales in units and dollars to achieve its target net income are calculated as follows: (Fixed cost + Target net income) ÷ Contribution margin per unit = Required sales in units ($99,900 + $108,000) ÷ $54 = 3,850 units (Fixed cost + Target net income) ÷ Contribution margin ratio = Required sales in dollars ($99,900 + $108,000) ÷ .45 = $462,000

What are the conditions for net income to be greater at any level of units sold?

At any level of units sold, net income will be greater if more high contribution margin units are sold than low contribution margin units. An analysis of these relationships generally shows that a shift from low-margin sales to high-margin sales may increase net income, even though there is a decline in total units sold.

How are break-even sales conputed?

Break-even sales can be computed for a mix of two or more products by determining the weighted-average unit contribution margin of all the products. Assume that Seth Inc. sells tables and chairs in a ratio of four chairs for every one table. The sales mix in percentages is 20% (1/5) for tables and 80% (4/5) for chairs. The following is the per unit data for Seth Inc.: Unit Data Tables Chairs Selling price $100 $20 Variable costs 60 10 Contribution margin $ 40 $10 Sales mix-units 20% 80% Fixed costs = $192,000 To compute break-even for Seth Inc., we use the weighted-average unit contribution margin as follows: Tables Chairs ($40 X .20) + ($10 X .80) = $16 Weighted - Average Break - even Point Fixed Costs ÷ Unit in Units Contribution Margin $192,000 ÷ $16 = 12,000 units To break even, Seth must sell 2,400 (12,000 X 20%) tables and 9,600 (12,000 X 80%) chairs.

What is the Contribution Margin?

Contribution margin is the amount of revenue remaining after deducting variable costs. It is often stated both as a total amount and on a per unit basis.

What does a cost structure refer to?

Cost structure refers to the relative proportion of fixed versus variable costs that a company incurs. In most cases, increased reliance on fixed costs increases a company's risk. When sales are increasing, profits can increase at a high rate, but when sales decline, losses can also increase at a high rate. Companies can change their cost structure by using more sophisticated robotic equipment and reducing it later, or vice versa. The equipment would increase the fixed costs whereas labor increases variable costs.

How do you calculate Margin of safety in dollars / the ratio?

Desossa's margin of safety in dollars or as a ratio is calculated as follows: Actual (expected) sales - Break-even sales = Margin of safety in dollars $420,000 - $222,000 = $198,000 Margin of safety in dollars ÷ Actual (expected) sales = Margin of safety ratio $198,000 ÷ $420,000 = 47.1%

How do you calculate the break-even point in units and dollars?

Fixed cost ÷ Contribution margin per unit = Break-even point in units $99,900 ÷ $54 = 1,850 units Fixed cost ÷ Contribution margin ratio = Break-even point in dollars $99,900 ÷ .45 = $222,000

When fragrance sales recently went flat, retailers turned up the heat on fragrance manufacturers. They reduced the amount of floor space devoted to fragrances, and chose the fragrance with the highest contribution margin per square foot for a given period of time. What is the limited resource for a retailer, and what implication does this have for sales mix?

For retailers, the limited resource is not just shelf space, but shelf space per day. At first you might think that a product that is small and has a high contribution margin would be the product of choice. But you also have to factor in the amount of time that a product sits on the shelf. For example, suppose the following; Product A and B are the same size; product A has twice the contribution margin as product B, but A sits on the shelf five times as long as product B. In this case, once time spent on the shelf is taken into account, B's superior turnover more than makes up for its lower contribution margin.

Analysts closely watch the "conversion rate" when analyzing an Internet business. This rate is computed by dividing the number of people who buy something at an Internet site by the number of people who visit the site. Conversion rates have an obvious effect on the break-even point. Studies show that conversion rates increase if the site has an easy-to-use interface, fast-performing screens, a convenient ordering process, and advertising that is clear. Besides increasing their conversion rates, what steps can online merchants use to lower their break-even points?

In theory, one of the principal advantages of online retailers is that they can minimize their investment in "bricks and mortar" and thus minimize their fixed costs. Some online merchants never even handle the merchandise they sell. Instead, they simply provide a centralized location for customers to view merchandise and to place orders. The online retailer then forwards the order to the supplier, and the supplier ships it directly to the customer. However, some online merchants who originally planned on employing this model have since found it necessary to build their own warehouses and distribution centers to ensure timely and dependable product delivery. This increases their fixed costs, and consequently increases their break-even point.

What does operating leverage refer to?

Operating Leverage refers to the extent to which a company's net income reacts to a given change in sales

Warren Buffet recently purchased Burlington Northern Railroad for 31% above its market value. The company has fixed costs of approximately 50 - 60%, and therefore huge operating leverage. Railroads have barriers to entry, are an energy-efficient method of transportation, and there are a limited number of railroads operating. Why did Warren Buffett think that this was good time to invest in railroad stocks?

Railroads have extremely high fixed costs. Mr. Buffett bought Burlington Northern Railroad at the bottom of a recession. He is counting on the railroad's high operating leverage to provide large profits once the economy rebounds.

What is the sales mix?

Sales mix is the relative percentage in which a company sells its multiple products. For example, if 80% of Company A's unit sales are shoes and the other 20% are jeans, its sales mix is 80% shoes to 20% jeans.

What does the Cost-Volume-Profit do?

The Cost-Volume-Profit (CVP) income statement classifies costs as variable or fixed and computes a contribution margin.

Desossa Music Player's CVP income statement shows that total contribution margin (sales minus variable expenses) is $175,000, and the company's contribution margin per unit is $50 What is the contribution margin ratio?

The contribution margin ratio is 45%... 54/120 (contribution margin / sales)

What does the degree of operating leverage provide, and what is the formula?

The degree of operating leverage provides a measure of a company's earnings volatility and can be used to compare companies. The formula is: Contribution Margin ÷ Net Income = Degree of Operating Leverage

Zoom kitchen, a chain of four restaurants in the Chicago area, is known for serving sizable portions of meat and potatoes. During the past four years salad sales have increased from 18% of its sales mix to 40%. This has pleased company management because the contribution margin on salads is much higher than on meat. Why do you suppose restaurants are so eager to sell beverages and desserts?

There is a reason why servers at restaurants keep your beverage glass full, and why they wave the dessert tray in your face at the end of the meal. Both of these items traditionally have very high contribution margins and require very minimal investments in fixed costs. As a consequence they are a great mechanism by which a company can hit its break-even point.

What happens when a company has limited resource?

When a company has limited resources (e.g., floor space, raw materials, direct labor hours), management must decide which products to make and sell in order to maximize net income. Assume that Seth Inc. has limited machine capacity which is 2,600 hours per month. Relevant data consist of the following: Tables Chairs Contribution margin per unit $40 $10 Machine hours required per unit .8 .16 The contribution margin per unit of limited resource is calculated as follows: Tables Chairs Contribution margin per unit (a) $40 $10 Machine hours required (b) .8 .16 Contribution margin per unit of limited resource [(a) ÷ (b)] $50 $62.50 If Seth Inc. increases machine capacity hours by 400 hours per month, it would be better to use the hours to produce more chairs. Tables Chairs Machine hours (a) 400 400 Contribution margin per unit of limited resource (b) $ 50 $ 62.50 Contribution margin [(a) X (b)] $20,000 $25,000