Cost and Managerial Accounting Unit 5: Module 10

Here are data for Balartistry Company: Operating income: $100,000 Degree of operating leverage: 5.0 Assuming that sales go down by 10%, what is Balartistry's operating income?

$50,000 Step 1: A decrease in sales of 10% means that operating income goes down. 50% = 10% × 5 degree of operating leverage Step 2: An operating income decrease of 50% means that operating income will be half of the original amount. $50,000 = $100,000 × 0.50

The contribution margin for a company is $25 per unit, the sales price is $50 per unit, and fixed costs are $100,000. What must the revenue be to make a target net income of $200,000?

$600,000 Correct! The correct formula for calculating the target level of income is as follows: Step 1: (Fixed costs + target level net income) divided by the contribution margin per unit [($100,000 + $200,000)/25 = 12,000]. Step 2: Multiply that answer by the selling price per unit (12,000 × $50 = $600,000).

Here are data for Quiet Flag Industries: Operating income: $60,000 Degree of operating leverage: 3.0 What is Quiet Flag's computed operating income, assuming that sales go up by 10%?

$78,000 The increase in net income is equal to the degree of operating leverage, which is three, times the amount that sales go up. In this case, sales go up by 10%, equaling $6,000. With the operating leverage of three, the increase in sales would be three times $6,000 for a total of $18,000. $18,000 plus $60,000 is equal to $78,000.

Here are data for Freedom Rock Bicycles: Fixed costs: $20,000 Sales: $800,000 at $40 per unit Variable costs: $20 per unit What is Freedom Rock Bicycle's breakeven point in units sold?

1,000 units Breakeven is equal to fixed costs divided by contribution margin (sales price per unit less variable cost per unit). $20,000/($40 − $20) = 1,000 units.

The contribution margin for a company is $25 per unit, the sales price is $50 per unit, and fixed costs are $100,000. How many units must be sold to make a target net income of $200,000?

12,000 units Correct! The correct formula for calculating the target level of income is (fixed costs + target level net income) divided by the contribution margin per unit. In this case, that is $100,000 plus $200,000 divided by $25 per unit or 12,000 units.

Here are data for Freedom Rock Bicycles: Fixed costs: $20,000 Sales: $800,000 at $40 per unit Variable costs: $20 per unit What is Freedom Rock Bicycle's margin of safety in units?

19,000 units Freedom Rock Bicycle has fixed costs of $20,000 and a contribution margin of $20 per unit (sales price per unit minus variable cost per unit). Therefore, its breakeven point is 1,000 units or $20,000/$20 = 1,000 units. At sales of 800,000 with a price per unit of $40, Freedom Rock Bicycle is selling 20,000 units or 19,000 units more than its breakeven number of units. Therefore, its margin of safety is extremely healthy at 19,000 units.

Here are data for Orange Zest Café: Sales: $200,000 Operating income: 50,000 Fixed operating costs: 70,000 Variable operating costs: 80,000 The controller for Orange Zest Café wants to compute one number that will summarize the extent to which the company has fixed costs in its cost structure. What is Orange Zest Café's computed degree of operating leverage?

2.40 200,000-80,000=120,000-70,000=50,000 120,000/50,00=2.4

Assume that Picalo Company has the following performance data for the past period: Sales price of $10 per unit Current sales of 20,000 units Variable costs of $6 per unit Fixed costs of $18,400 Given these performance data, what is the calculated break-even level of sales in units and the company's current margin of safety in units?

4,600 units breakeven; 15,400 units margin of safety Breakeven is fixed costs of $18,400 divided by the contribution margin of $4 ($10 − $6), or a total of 4,600 units. Margin of safety is current sales of 20,000 units minus breakeven of 4,600 units, which is 15,400 units.

The sales manager of Bullzai Company has been told that she will be fired unless the company's profit this year is at least $90,000. With the help of a friend in the controller's office, the sales manager has decided to estimate what level of sales will be required to reach this $90,000 profit target. Here are data for Bullzai Company: Breakeven sales revenue: $250,000 Fixed costs: $150,000 What is the calculated sales revenue necessary for Bullzai to generate a net income of $90,000?

400,000 Contribution margin must equal $150,000. Variable cost must equal $100,000. Variable cost ratio must equal 40% ($100,000/$250,000). Let R equal the sales revenue necessary for a target profit of $90,000. R - 0.40R - $150,000 = $90,000 0.60R = $240,000 R = $400,000

Endothon reported these data: Price per unit: $20 Fixed cost per month: $6,000 Variable cost per unit: $11 How many units must Endothon sell each month to reach a target profit of $39,000?

5,000 units Correct! The formula is fixed costs + target income or $45,000 divided by the contribution margin which is $9 ($20 − $11) or $45,000/$9 = 5,000 units.

Wild Parsley Company has a degree of operating leverage of 3.0. Yellow Leaf Company has a degree of operating leverage of 2.0. How much will net income increase for the two companies if sales for each company increases by 20%?

60% for Wild Parsley and 40% for Yellow Leaf The formula for how much net income will increase if sales increase is operating income times percentage increase in sales equals percentage increase in net income? Wild Parsley: 3 × 20% = 60% Yellow Leaf: 2 × 20% = 40%

Here are data for Alliah Company: Total sales revenue: $250,000 Number of units sold: 50,000 Net income: $50,000 Fixed costs: $100,000 What is the calculated number of units that Alliah must sell to generate a net income of $170,000?

90,000 units With the information for Alliah Company, you can calculate the variable cost per unit, which you will need to calculate the target level of income. The current sales price must be $5 per unit or $250,000/50,000 units. At this level of sales, the company made $50,000, or $1 per unit sold. The fixed costs were $100,000, which means that variable costs must have been $2 per unit because it took $2 per unit at a sales level of 50,000 units to cover the $100,000 of fixed costs. The contribution margin must therefore be $3 per unit. You can check this by calculating the profit as $250,000 in sales − $100,000 fixed costs − $100,000 variable costs ($2 × 50,000 units) = $50,000 profit. To achieve 170,000 in profit, Alliah Company would need to sell 90,000 units, calculated as $100,000 fixed costs plus $170,000 target income divided by contribution margin of $3, or $270,000/$3 = 90,000 units.

Freedom Rock Bicycle runs a guide service to some of Utah's national parks and scenic back country. Freedom Rock Bicycle has many pieces of equipment including four-wheel drive vehicles, side-by-side ATVs, and four-wheelers. Guests reserve day trips and even weeks of sight-seeing with Freedom Rock Bicycle. The company's costs and revenues for last year were as follows: Revenues: $4,500,000 Fixed expenses: 1,000,000 Variable expenses: 3,000,000 Based on these data, what is Freedom Rock Bicycle's margin of safety (in dollars) and degree of operating leverage?

$1,500,000 and 3.0 In this case, the contribution margin is $1,500,000, which is sales revenue less variable costs. Operating income is $500,000, which is contribution margin less fixed expenses. So, the operating leverage is $1,500,000/$500,000 = 3.0. To get margin of safety you must first calculate breakeven sales. In this case, the contribution margin ratio is 1/3 ($1,500,000 / $4,500,000). Since fixed costs are $1,000,000, it takes three times that much to break even, which is $3,000,000. Since current sales are $4,500,000 and breakeven sales is $3,000,000, the margin of safety is $1,500,000.

Here are data for Whole Pine Company: Sales: $200,000 Operating income: 70,000 Fixed operating costs: 48,000 Variable operating costs: 80,000 Sales in units: 10,000 The chief executive officer (CEO) of Whole Pine Company is nervous about the company's future. She is expecting a sales decrease this year. She wants to know how low sales can go before Whole Pine suffers a loss. What is Whole Pine's computed margin of safety in sales dollars?

$120,000 Selling price per unit = $200,000/10,000 units = $20 per unit Variable cost per unit = $80,000/10,000 units = $8 per unit Let x be the breakeven number of units. Breakeven calculation: $20x - $8x - $48,000 = $0 $12x = $48,000 x = 4,000 units Breakeven Sales: 4,000 units × $20 per unit = $80,000 Margin of Safety = Current Sales - Breakeven Sales Margin of Safety = $200,000 - $80,000 = $120,000

Freedom Rock Bicycle runs a guide service to some of Utah's national parks and scenic back country. Freedom Rock Bicycle has many pieces of equipment including four-wheel drive vehicles, side-by-side ATVs, and four-wheelers. Guests reserve day trips and even weeks of sight-seeing with Freedom Rock Bicycle. The Company's costs and revenues for last year were as follows: Revenues: $4,500,000 Fixed expenses: 1,000,000 Variable expenses: 3,000,000 What is Freedom Rock Bicycle's breakeven point in sales revenue and at what level of sales would it need to make $1,000,000?

Breakeven point $3,000,000; Target income $6,000,000 Correct! Because revenues are $4,500,000 and variable costs are $3,000,000, or two-thirds of sales, the contribution margin is $1,500,000, or one-third of sales. Thus, to break even, since fixed costs are $1,000,000 and the contribution margin is one-third of revenues, it would take three times the fixed costs or $3,000,000 to break even. To make $1,000,000 in target income, once fixed costs are covered it would take another $3,000,000 in revenue since the contribution margin is one-third or a total of $6,000,000 in sales.

What is the formula for calculating margin of safety in dollars?

Current sales - Breakeven sales = Margin of safety

Here are contribution margin income statements for five companies: Firm 1 Firm 2 Firm 3 Firm 4. Firm 5 Sales $100,000 $200,000 $300,000 $400,000 $500,000 Variable costs (60,000) (120,000) (240,000) (200,000)(300,000) Contribution margin $40,000 $80,000 $60,000 $200,000 $200,000 Fixed costs (30,000) (65,000) (40,000) (120,000) (120,000) Operating income $10,000 $15,000 $20,000 $80,000 $80,000 Interest expense (6,000) (12,000) (18,000) (24,000) (30,000) Net income $4,000 $3,000 $2,000 $56,000 $50,000 Which company has the highest degree of operating leverage?

Firm 2 The company with the highest degree of operating leverage has the highest operating risk. Degree of operating leverage is computed as contribution margin divided by operating income. Firm 1 Firm 2 Firm 3 Firm 4 Firm 5 CM $40,000 $80,000 $60,000 $200,000 $200,000 OIncome $10,000 $15,000 $20,000 $80,000 $80,000 Degree of operating leverage 4.0 5.3 3.0 2.5 2.5

Which formula calculates how many units would be necessary to reach a target level of net income?

Fixed costs plus target net income divided by contribution margin per unit

Filler Rox Company is concerned about current tariffs being put in place by different countries where it operates. Filler Rox's management wants to know how the company could handle an inability to get the raw materials it needs to make products. When considering how a shock like this could affect Filler Rox's profitability, which of the following tools would be most helpful?

Margin of safety