CHAPTER 3 COST-VOLUME-PROFIT ANALYSIS 3-1

Cost-volume-profit (CVP) analysis examines the behavior of total revenues, total costs, and operating income as changes occur in the output level, selling price, variable costs per unit, or fixed costs.

3-2
1. 2. 3. 4. 5. 6.

The assumptions underlying the CVP analysis outlined in Chapter 3 are: Changes in the level of revenues and costs arise only because of changes in the number of product (or service) units produced and sold. Total costs can be divided into a fixed component and a component that is variable with respect to the level of output. When graphed, the behavior of total revenues and total costs is linear (straight-line) in relation to output units within the relevant range. The unit selling price, unit variable costs, and fixed costs are known and constant. The analysis either covers a single product or assumes that the sales mix, when multiple products are sold, will remain constant as the level of total units sold changes. All revenues and costs can be added and compared without taking into account the time value of money.

3-3

Operating income is total revenues from operations for the accounting period minus total costs from operations (excluding income taxes): Operating income = Total revenues Total costs Net income is operating income plus nonoperating revenues (such as interest revenue) minus nonoperating costs (such as interest cost) minus income taxes. Chapter 3 assumes nonoperating revenues and nonoperating costs are zero. Thus, Chapter 3 computes net income as: Net income = Operating income Income taxes

3-4

Contribution margin is computed as the difference between total revenues and total variable costs. Contribution margin per unit is the difference between selling price and variable cost per unit. Contribution-margin percentage is the contribution margin per unit divided by selling price.

3-5 3-6

Three methods to calculate the breakeven point are the equation method, the contribution margin method, and the graph method. Breakeven analysis denotes the study of the breakeven point, which is often only an incidental part of the relationship between cost, volume, and profit. Cost-volume-profit relationship is a more comprehensive term than breakeven analysis.

3-1

3-7

CVP certainly is simple, with its assumption of output as the only revenue and cost driver, and linear revenue and cost relationships. Whether these assumptions make it simplistic depends on the decision context. In some cases, these assumptions may be sufficiently accurate for CVP to provide useful insights. The examples in Chapter 3 (the software package context in the text and the travel agency example in the Problem for Self-Study) illustrate how CVP can provide such insights. In more complex cases, the basic ideas of simple CVP analysis can be expanded.

3-8

An increase in the income tax rate does not affect the breakeven point. Operating income at the breakeven point is zero, and thus no income taxes will be paid at this point.

3-9

Sensitivity analysis is a "what-if" technique that examines how a result will change if the original predicted data are not achieved or if an underlying assumption changes. The advent of spreadsheet software has greatly increased the ability to explore the effect of alternative assumptions at minimal cost. CVP is one of the most widely used software applications in the management accounting area.

3-10 Examples include:

Manufacturingsubstituting a robotic machine for hourly wage workers. Marketingchanging a sales force compensation plan from a percent of sales dollars to a fixed salary. Customer servicehiring a subcontractor to do customer repair visits on an annual retainer basis rather than a per-visit basis.

3-11 Examples include:

Manufacturingsubcontracting a component to a supplier on a per-unit basis to avoid purchasing a machine with a high fixed depreciation cost. Marketingchanging a sales compensation plan from a fixed salary to percent of sales dollars basis. Customer servicehiring a subcontractor to do customer service on a per-visit basis rather than an annual retainer basis.

3-12 Operating leverage describes the effects that fixed costs have on changes in operating
income as changes occur in units sold and hence in contribution margin. Knowing the degree of operating leverage at a given level of sales helps managers calculate the effect of fluctuations in sales on operating incomes.

3-13 CVP analysis is always conducted for a specified time horizon. One extreme is a very
short-time horizon. For example, some vacation cruises offer deep price discounts for people who offer to take any cruise on a day's notice. One day prior to a cruise, most costs are fixed. The other extreme is several years. Here, a much higher percentage of total costs typically is variable. CVP itself is not made any less relevant when the time horizon lengthens. What happens is that many items classified as fixed in the short run may become variable costs with a longer time horizon.

3-2

3-14 A company with multiple products can compute a breakeven point by assuming there is a
constant mix of products at different levels of total revenue.

3-15 Yes, gross margin calculations emphasize the distinction between manufacturing and
nonmanufacturing costs (gross margins are calculated after subtracting fixed manufacturing costs). Contribution margin calculations emphasize the distinction between fixed and variable costs. Hence, contribution margin is a more useful concept than gross margin in CVP analysis.

3-16 (10 min.) CVP computations.

Revenues a. $2,000 b. 2,000 c. 1,000 d. 1,500 Variable Costs $ 500 1,500 700 900 Fixed Costs $300 300 300 300 Total Costs $ 800 1,800 1,000 1,200 Operating Income $1,200 200 0 300 Contribution Margin $1,500 500 300 600 Contribution Margin % 75.0% 25.0% 30.0% 40.0%

3-17 (1020 min.) CVP computations.

a. TCM = Q (USP UVC) = 70,000 ($30 $20) = $700,000 = TCM OI = $700,000 ( $15,000) = $715,000 = Q (USP UVC) = 180,000 ($25 UVC) = $20 = TCM TFC = $900,000 $800,000 = $100,000 = Q (USP UVC) = 150,000 (USP $10) = $12 = TCM TFC = $300,000 $220,000 = $80,000 = TCM (USP UVC) = $120,000 ($20 $14) = 20,000 = TCM OI = $120,000 $12,000 = $108,000 3-3

TFC

b.

TCM $900,000 UVC OI

c.

TCM $300,000 USP OI

d.

TFC

3-4

3-18 (1520 min.) CVP analysis, changing revenues and costs.

1. USP UVC UCM FC Q = = = = = = b. Q = 8% $1,000 = $80 $35 ($17 + $18) $45 $22,000 a month $22,000 FC = UCM $45 489 tickets (rounded up) FC + TOI $22,000 + $10,000 = UCM $45 $32,000 = $45 = 712 tickets (rounded up) $80 $29 ($17 + $12) $51 $22,000 a month FC UCM = $22,000 $51 = 432 tickets (rounded up)

a.

2.

USP UVC UCM FC Q

= = = = =

a.

b.

FC + TOI $22,000 + $10,000 = UCM $51 $32,000 = $51 = 628 tickets (rounded up)

3-5

3-19 (20 min.) CVP, changing revenues and costs. (Continuation of 3-18)
1. Sunshine charges $1,000 per round-trip ticket. Hence, each ticket will yield only a $48 commission. USP = $48 UVC = $29 ($17 + $12) UCM = $19 FC = $22,000 a. Q = FC UCM $22,000 $19 = 1,158 tickets (rounded up) = $22,000 + $10,000 $19 $32,000 = $19 = 1,685 tickets (rounded up) =

b.

FC + TOI UCM

The reduced commission sizably increases the breakeven point and the number of tickets required to yield a target operating income of $10,000: 8% Old Commission (3-18 Requirement 2) 432 628

Breakeven point Attain OI of $10,000

Upper Limit on Commission of $48 1,158 1,685

2. The $5 delivery fee can be treated as either an extra source of revenue (as done below) or as a cost offset. Either approach increases UCM by $5: USP UVC UCM FC a. Q = = = = = $53 ($48 + $5) $29 ($17 + $12) $24 $22,000 FC UCM $22,000 $24 = 917 tickets (rounded up) = = $22,000 + $10,000 $24

b.

FC + TOI UCM

= 1,334 tickets (rounded up) The $5 delivery fee results in a higher contribution margin which reduces both the breakeven point and the tickets sold to attain operating income of $10,000.

3-6

3-20 (20 min.) CVP exercises.

Variable Costs $8,200,000G 8,020,000 8,380,000 8,200,000 8,200,000 8,856,000 7,544,000 9,020,000 7,790,000 Contribution Margin $1,800,000 1,980,000 1,620,000 1,800,000 1,800,000 1,944,000 1,656,000 1,980,000 2,210,000 Fixed Costs $1,700,000G 1,700,000 1,700,000 1,785,000 1,615,000 1,700,000 1,700,000 1,870,000 1,785,000 Budgeted Operating Income $100,000 280,000 (80,000) 15,000 185,000 244,000 (44,000) 110,000 425,000

Revenues Orig. $10,000,000G 1. 10,000,000 2. 10,000,000 3. 10,000,000 4. 10,000,000 5. 10,800,000 6. 9,200,000 7. 11,000,000 8. 10,000,000
Gstands

for given.

3-21 (20 min.) CVP exercises.

1. a. b. 5,000,000 ($0.50 $0.30) $900,000 = $ 100,000 $900,000 $0.50 $0.30 $0.50 = $2,250,000

2. 3. 4. 5. 6.

5,000,000 ($0.50 $0.34) $900,000 = $ (100,000) [5,000,000 (1.1) ($0.50 $0.30)] [$900,000 (1.1)] = $ 110,000 [5,000,000 (1.4) ($0.40 $0.27)] [$900,000 (0.8)] = $ 190,000 $900,000( 1.1) ($0.50 $0.30) = ($900,000 + $20,000) ($0.55 $0.30) = 4,950,000 units 3,680,000 units

3-22 (1015 min.) CVP analysis, income taxes.

1. 2. Operating income = Net income (1 tax rate) = $84,000 (1 0.40) = $140,000 Contribution margin Fixed costs = Operating income Contribution margin $300,000 = $140,000 Contribution margin = $440,000 Revenues 0.80 Revenues 0.20 Revenues Revenues = Contribution margin = $440,000 = $2,200,000

3.

4.

Breakeven point = Fixed costs Contribution margin percentage 3-7

Breakeven point = $300,000 0.20 = $1,500,000 3-23 (2025 min.) CVP analysis, income taxes. 1. Variable cost percentage is $3.20 $8.00 = 40% Let R = Revenues needed to obtain target net income $105000 R 0.40R $450,000 = 1 0.30 0.60R = $450,000 + $150,000 R = $600,000 0.60 R = $1,000,000 Proof: Revenues Variable costs (at 40%) Contribution margin Fixed costs Operating income Income taxes (at 30%) Net income $1,000,000 400,000 600,000 450,000 150,000 45,000 $ 105,000

2.

a.

Sales checks to earn net income of $105,000: $1,000,000 $8 = 125,000 sales checks Sales checks to break even: Contribution margin = $8.00 $3.20 = $4.80 $450,000 $4.80 = 93,750 sales checks

b.

3.

Using the shortcut approach: Unit Change in contribution (1 Tax rate) units margin

Change in net income

New net income Proof:

= (150,000 125,000) $4.80 (1 .30) = $120,000 0.7 = $84,000 = $84,000 + $105,000 = $189,000 $1,200,000 480,000 720,000 450,000 270,000 81,000 $ 189,000

Revenues, 150,000 $8.00 Variable costs at 40% Contribution margin Fixed costs Operating income Income tax at 30% Net income

3-8

3-24 (10 min.) CVP analysis, margin of safety.

1. Breakeven point revenues Contribution margin percentage 2. Contribution margin percentage 0.40 0.40 USP 0.60 USP USP Revenues, 80,000 units $20 Breakeven revenues Margin of safety = = = = = = = Fixed costs Contribution margin percentage $400,000 = 0.40 $1,000,000 Selling price Variable cost per unit Selling price USP $12 USP USP $12 $12 $20 $1,600,000 1,000,000 $ 600,000

3.

3-25 (25 min.) Operating leverage.

1. Let Q denote the quantity of carpets sold a. Breakeven point under Option 1 $500Q $350Q = $5,000 $150Q = $5,000 Q = $5,000 $150 = 34 carpets (rounded) Breakeven point under option 2 $500Q $350Q (0.10 $500Q) = 0 100Q = 0 Q = 0 = $150Q $5,000 = $100Q = $100Q = $5,000 = $5,000 $50 = 100 carpets

b.

2.

Operating income under Option 1 Operating income under Option 2 Find Q such that $150Q $5,000 $50Q Q

For Q = 100 carpets, operating income under both Option 1 and Option 2 = $10,000 3a. For Q > 100, say, 101 carpets, Option 1 gives operating income Option 2 gives operating income So Color Rugs will prefer Option 1. For Q < 100, say, 99 carpets, Option 1 gives operating income Option 2 gives operating income So Color Rugs will prefer Option 2. = $150 101 $5,000 = $10,150 = $100 101 = $10,100

3b.

= $150 99 $5,000 = $100 99 3-9

= $9,850 = $9,900

3-25 (Contd.) 4. Degree of operating leverage = Contributi on margin Operating income $150 100 $10,000 $100 100 $10,000 = 1.5

Under option 1, Degree of operating leverage =

Under option 2, Degree of operating leverage =

1.0

5. The calculations in requirement 4 indicate that when sales are 100 units, a percentage change in sales and contribution margin will result in 1.5 times that percentage change in operating income for option 1, but the same percentage change in operating income for option 2. The degree of operating leverage at a given level of sales helps managers calculate the effect of fluctuations in sales on operating incomes.

3-26 (30 min.) CVP analysis, sensitivity analysis.

1. USP = $30.00 (1 0.30 margin to bookstore) = $30.00 0.70 = $21.00 = $ 4.00 3.15 $ 7.15 variable production and marketing cost variable author royalty cost (0.15 $30.00 0.70)

UVC

UCM FC

= $21.00 $7.15 = $13.85 = $ 500,000 3,000,000 $3,500,000 fixed production and marketing cost up-front payment to Washington

3-10

3-26 (Contd.) Exhibit 3-26A shows the PV graph. EXHIBIT 3-26A PV Graph for Media Publishers

$4,000

FC = $3,500,000 UCM = $13.85 per book sold

3,000
Operating income (000s)

2,000

1,000

0 100,000 200,000 300,000 400,000 500,000

Units sold

-1,000

252,708; $0

-2,000

-3,000
(0; $3.5 million)

-4,000

2.

a.

Breakeven number of units

FC UCM $3,500,000 = $13.85 = 252,708 copies sold (rounded up) = = FC + OI UCM $3,500,000 + $2,000,000 = $13.85 $5,500,000 = $13.85 = 397,112 copies sold (rounded up) 3-11

b.

Target OI

3-26 (Contd.) 3. a. Decreasing the normal bookstore margin to 20% of the listed bookstore price of $30 has the following effects: USP = = = $30.00 (1 0.20) $30.00 0.80 = $24.00 $ 4.00 + 3.60 $ 7.60 variable production and marketing cost variable author royalty cost (0.15 $30.00 0.80)

UVC

UCM

$24.00 $7.60 = $16.40 Breakeven number of units = FC UCM $3,500,000 $16.40

= 213,415 copies sold (rounded) The breakeven point decreases from 252,708 copies in requirement 2 to 213,415 copies. b. Increasing the listed bookstore price to $40 while keeping the bookstore margin at 30% has the following effects: USP = = = $40.00 (1 0.30) $40.00 0.70 = $28.00 $ 4.00 + 4.20 $ 8.20 variable production and marketing cost variable author royalty cost (0.15 $40.00 0.70)

UVC

UCM

$28.00 $8.20 = $19.80 Breakeven number of units $3,500,000 $19.80

= 176,768 copies sold (rounded) The breakeven point decreases from 252,708 copies in requirement 2 to 176,768 copies. c. The answer to requirements 3a and 3b decreases the breakeven point relative to requirement 2 because in each case fixed costs remain the same at $3,500,000 while contribution margin per unit increases.

3-12

3-27 (10 min.) CVP analysis, international cost structure differences.

1.
Annual Fixed Costs (1) Selling Price (2) Variable Manuf. Costs per Sweater (3) Variable Mark/Dist Costs per Sweater (4) Unit Contrib. Margin Breakeven (5)= Point in Units (2) (3) (4) (6) = (1) (5)

Singapore Thailand U.S.

$ 6,500,000 4,500,000 12,000,000

$32 32 32
(a) Breakeven point in units sold

$ 8.00 5.50 13.00

$11.00 11.50 9.00

(b) Breakeven point in revenues (Col. (a) $32

$13 15 10

500,000 300,000 1,200,000

Singapore Thailand U.S. 2. Singapore Thailand U.S.

1

500,000 300,000 1,200,000

Variable Costs

$16,000,000 9,600,000 38,400,000

Fixed Costs Operating Income

Revenues $32 800,000

$25,600,000 25,600,000 25,600,000

2

$15,200,0001 13,600,0002 17,600,0003

$6,500,000 4,500,000 12,000,000

$3,900,000 7,500,000 4,000,000

3

($8 + $11) 800,000

($5.50 + $11.50) 800,000

($13 + $9) 800,000

Thailand has the lowest breakeven pointit has both the lowest fixed costs ($4,500,000) and the lowest variable cost per unit ($17.00). Hence, for a given selling price, Thailand will always have a higher operating income (or a lower operating loss) than Singapore or the U.S. The U.S. breakeven point is 1,200,000 units. Hence, with sales of 800,000 units, it has an operating loss of $4,000,000.

3-13

3-28 (30 min.) Sales mix, new and upgrade customers.

1. USP UVC UCM New Customers $210 90 120 Upgrade Customers $120 40 80

Let S = Number of upgrade customers 1.5S = Number of new customers Revenues Variable costs Fixed costs = Operating income [$210 (1.5S) + $120S] [$90 (1.5S) + $40S] $14,000,000 = OI $435S $175S $14,000,000 = OI Breakeven point is 134,616 units when OI = 0 $260S = $14,000,000 S = 53,846 1.5S = 80,770 134,616 Check Revenues ($210 80,770; $120 53,846) Variable costs ($90 80,770; $40 53,846) Contribution margin Fixed costs Operating income (subject to rounding) 2. When 200,000 units are sold, mix is: New customers (60% 200,000) Upgrade customers (40% 200,000) Revenues ($210 120,000; $120 80,000) Variable costs ($90 120,000; $40 80,000) Contribution margin Fixed costs Operating income 3a. Let S = Number of upgrade customers then S = Number of new customers [$210S + $120S] [$90S + $40S] $14,000,000 = OI 330S 130S = $14,000,000 200S = $14,000,000 S = 70,000 S = 70,000 140,000 units 120,000 80,000 $34,800,000 14,000,000 20,800,000 14,000,000 $ 6,800,000

$23,423,220 9,423,140 14,000,080 14,000,000 $ 0

3-14

3-28 (Contd.) Check Revenues ($210 70,000; $120 70,000) Variable costs ($90 70,000; $40 70,000) Contribution margin Fixed costs Operating income 3b.

$23,100,000 9,100,000 14,000,000 14,000,000 $ 0

Let S = Number of upgrade customers then 9S = Number of new customers [$210 (9S ) + $120S] [$90 (9S ) + $40S] $14,000,000 = OI 2,010S 850S = $14,000,000 1,160S = $14,000,000 S = 12,069 9S = 108,621 120,690 units

Check Revenues ($210 108,621; $120 12,069) Variable costs ($90 108,621; $40 12,069) Contribution margin Fixed costs Operating income (subject to rounding)

$24,258,690 10,258,650 14,000,040 4,000,000 $ 0

3c. As Zapo increases its percentage of new customers, which have a higher contribution margin per unit than upgrade customers, the number of units required to break even decreases: New Customers 50% 60 90 Upgrade Customers 50% 40 10 Breakeven Point 140,000 134,616 120,690

Requirement 3(a) Requirement 1 Requirement 3(b)

3-15

3-29 (20 min.) Athletic scholarships, CVP analysis.

1. Let the number of athletic scholarships be denoted by Q Then, $1,000,000 + $20,000Q = $5,000,000 $20,000Q = $5,000,000 $1,000,000 $20,000Q = $4,000,000 Q = $4,000,000 Q = $4,000,000 $20,000 = 200 scholarships 2. Total budget for next year $4,000,000 Then, $1,000,000 + $20,000Q $20,000Q Q = = = = $5,000,000 (1 0.20) = $5,000,000 0.80 = $4,000,000 $4,000,000 $1,000,000 = $3,000,000 $3,000,000 $20,000 = 150 scholarships

3. Let the scholarship award per student per year be $V Then, $1,000,000 + 200V = $4,000,000 200V = $4,000,000 $1,000,000 = $3,000,000 V = $3,000,000 200 = $15,000

3-16

3-30 (20 min.) Gross margin and contribution margin.

1a. Cost of Goods Sold Fixed Manufacturing Costs Variable Manufacturing Costs $1,600,000 500,000 $1,100,000

Variable manufacturing costs per unit = $1,100,000 200,000 = $5.50 per unit 1b. Total marketing and distribution costs Variable marketing and distribution (200,000 $4) Fixed marketing and distribution costs Selling price $1,150,000 800,000 $ 350,000

2.

= $2,600,000 200,000 units = $13 per unit Variable marketing Variable Contributi on margin Selling = manufactur ing and distributi on per unit price costs per unit costs per unit = $13 $5.50 $4.00 = $3.50

Fixed marketing Contributi on margin Fixed manufactur ing Operating income = Sales and distributi on quantity per unit costs costs = ($3.50 230,000) $500,000 $350,000 = $45,000 Foreman has confused gross margin with contribution margin. He has interpreted gross margin as if it was all variable, and interpreted marketing and distribution costs as all fixed. In fact, the manufacturing costs, subtracted from sales to calculate gross margin, and marketing and distribution costs contain both fixed and variable components. 3. Breakeven point in units Fixed manufactur ing, marketing and distributi on costs Contributi on margin per unit $850,000 = = 242,858 units (rounded up) $3.50 = 242,858 $13 = $3,157,154. =

Breakeven point in revenues

3-17

3-31 (20 min.) CVP analysis, multiple cost drivers.

1a. Operating income
Cost of picture Quantity of Fixed Cost of Number of = Revenues frames picture frames shipment shipments costs = ($45 40,000) ($30 40,000) ($60 1,000) $240,000 = $1,800,000 $1,200,000 $60,000 $240,000 = $300,000

1b. 2.

Operating income

= ($45 40,000) ($30 40,000) ($60 800) $240,000 = $312,000

Denote the number of picture frames sold by Q, then $45Q $30Q 500 $60 $240,000 = 0 $15Q = $30,000 + $240,000 = $270,000 Q = $270,000 $15 = 18,000 units Suppose Susan sold 20,000 frames in 1,000 shipments Operating = ($45 20,000) ($30 20,000) ($60 1,000) $240,000 income = $900,000 $600,000 $60,000 $240,000 = 0

3.

The breakeven point is not unique because there are two cost driversquantity of picture frames and number of shipments. Various combinations of the two cost drivers can yield zero operating income.

3-18

3-32 (1520 min.) Uncertainty, CVP analysis.

1. King pays Foreman $2 million plus $4 (25% of $16) for every home purchasing the pay-perview. The expected value of the variable component is: Demand (1) 100,000 200,000 300,000 400,000 500,000 1,000,000 Payment (2) = (1) $4 $ 400,000 800,000 1,200,000 1,600,000 2,000,000 4,000,000 Probability (3) 0.05 0.10 0.30 0.35 0.15 0.05 Expected payment (4) $ 20,000 80,000 360,000 560,000 300,000 200,000 $1,520,000

The expected value of King's payment is $3,520,000 ($2,000,000 fixed fee + $1,520,000). 2. USP UVC UCM FC Q = = = = = = = $16 $ 6 ($4 payment to Foreman + $2 variable cost) $10 $2,000,000 + $1,000,000 = $3,000,000 FC UCM $3,000,000 $10 300,000

If 300,000 homes purchase the pay-per-view, King will break even.

3-33 (10 min.) CVP analysis, movie production.

1. Fixed costs = $5,000,000 (production cost) Unit variable cost = $0.20 per $1 revenue (marketing fee) Unit contribution margin = $0.80 per $1 revenue a. Breakeven point in revenues = = b. Fixed costs Unit contribution margin per $1 revenue $5,000,000 = $6,250,000 $0.80

Royal Rumble receives 62.5% of box-office receipts. Box-office receipts of $10,000,000 ($6,250,000 62.5%) translate to $6,250,000 in revenues to Royal Rumble. $187,500,000 37,500,000 150,000,000 5,000,000 $145,000,000 3-19

2.

Revenues, 0.625 $300,000,000 Variable costs, 0.20 $187,500,000 Contribution margin Fixed costs Operating income

3-34 (20 min.)

1.

CVP analysis, cost structure differences, movie production.

(Continuation of 3-33)

Contract A Fixed costs for Contract A: Production costs Fixed salary Total fixed costs

$21,000,000 15,000,000 $36,000,000

Unit variable cost = $0.25 per $1 revenue marketing fee Unit contribution margin = $0.75 per $1 revenue Fixed costs Unit contributi on margin per $1 revenue $36,000,000 = = $48,000,000 $0.75 Box-office receipts of $76,800,000 ($48,000,000 62.5%) translate to $48,000,000 in revenues to Royal Rumble. Breakeven point in revenues = Contract B Fixed costs for Contract B: Production costs Fixed salary Total fixed costs Unit variable cost = $0.25 0.15 $0.40

$21,000,000 3,000,000 $24,000,000

per $1 revenue fee to Media Productions per $1 revenue residual to directors/actors per $1 revenue

Unit contribution margin = $0.60 per $1 revenue Breakeven point in revenues = $24, 000,000 = $40,000,000 0.60

Box-office receipts of $64,000,000 ($40,000,000 62.5%) translate to $40,000,000 in revenues to Royal Rumble. Difference in Breakeven Points Contract A has a higher fixed cost and a lower variable cost per sales dollar. In contrast, Contract B has a lower fixed cost and a higher variable cost per sales dollar. In Contract B, there is risk-sharing between Royal Rumble and Savage, Michaels, and Martel that lowers the breakeven point, but results in Royal Rumble receiving less operating income if Feature Creatures 2 is a mega-success.

3-20

3-34 (Contd.) 2. Revenues, 0.625 $300,000,000 Variable costs, 0.40 $187,500,000 Contribution margin Fixed costs Operating income $187,500,000 75,000,000 112,500,000 24,000,000 $ 88,500,000

Feature Creatures 2 has a higher breakeven point and lower operating income at $300 million in box-office receipts than Feature Creatures because of a higher level of fixed costs and a lower unit contribution margin.

3-35 (2030 min.) CVP analysis, shoe stores.

1. In number of pairs: Fixed costs Contribution margin per pair In revenues: Fixed costs Contribution margin % per dollar 2. Revenues, $30 35,000 Variable costs, $21 35,000 Contribution margin Fixed costs Operating income (loss) = $360,000 100% 70% = $1,200,000 = $360,000 $9.00 = 40,000 pairs

$1,050,000 735,000 315,000 360,000 $ (45,000)

An alternative approach is that 35,000 units is 5,000 units below the breakeven point, and the unit contribution margin is $9.00: $9.00 5,000 = $45,000 below the breakeven point 3. Fixed costs: $360,000 + $81,000 = $441,000 Contribution margin per pair = $10.50 a. b. 4. Breakeven point in units = $441,000 = 42,000 pairs $10.50

Breakeven point in revenues = $30 42,000 = $1,260,000

Fixed costs = $360,000 Contribution margin per pair = $8.70 a. Breakeven point in units = $360,000 = 41,380 pairs (rounded up) $8.70 3-21

b. Breakeven point in revenues = $30 41,380 = $1,241,400 3-35 (Contd.) 5. Breakeven point = 40,000 pairs Store manager receives commission on 10,000 pairs. Cost of commission = $0.30 10,000 = $3,000 Revenues, $30 50,000 Variable costs: Cost of shoes Salespeople commission Manager commission Contribution margin Fixed costs Operating income $1,500,000 $975,000 75,000 3,000

1,053,000 447,000 360,000 $ 87,000

An alternative approach is 10,000 units $8.70 = $87,000.

3-22

3-36 (2025 min.) CVP analysis, shoe stores. (Continuation of 3-35)

1. Because the unit sales level at the point of indifference would be the same for each plan, the revenue would be equal. Therefore, the unit sales level sought would be that which produces the same total costs for each plan. Let Q $19.50Q + $360,000 + $81,000 $81,000 Q 2. Sales in units Revenues @ $30.00 Variable costs @ $21.00 and @ $19.50 Contribution margin Fixed costs Operating income = = = = unit sales level $21.00Q + $360,000 $1.50Q 54,000 units

Commission Plan Salary Plan 50,000 60,000 50,000 60,000 $1,500,000 $1,800,000 $1,500,000 $1,800,000 1,050,000 1,260,000 975,000 1,170,000 450,000 540,000 525,000 630,000 441,000 441,000 360,000 360,000 $ 90,000 $ 180,000 $ 84,000 $ 189,000

The decision regarding the plans will depend heavily on the unit sales level that is generated by the fixed salary plan. For example, as part (1) shows, at identical unit sales levels in excess of 54,000 units, the fixed salary plan will always provide a more profitable final result than the commission plan. 3. Let TQ a. = Target number of units = $168,000 = $609,000 = $609,000 $10.50 = 58,000 units = $168,000 = $528,000 = $528,000 $9.00 = 58,667 units (rounded)

$30.00TQ $19.50TQ $441,000 $10.50TQ TQ TQ $30.00TQ $21.00TQ $360,000 $9.00TQ TQ TQ

b.

The decision regarding the salary plan depends heavily on predictions of demand. For instance, the salary plan offers the same operating income at 58,000 units as the commission plan offers at 58,667 units.

3-23

3-37 (10-20 min.) Sensitivity and inflation. (Continuation of 3-36)

1. Revenues, $30 48,000 $18 2,000 $1,440,000 36,000 975,000 73,800

$1,476,000

Variable costs: Goods sold $19.50 50,000 Commission, 5% $1,476,000 Contribution margin Fixed costs Operating income An alternative approach is:

1,048,800 427,200 360,000 $ 67,200

Contribution margin on 48,000 pairs $9.00 Deduct negative contribution margin on unsold pairs, 2,000 [$18.00 ($19.50 + $.90* commission)] Contribution margin Fixed costs Operating income
*5% of $18.00 = $.90

$432,000 4,800 427,200 360,000 $ 67,200

2. Optimal operating income, given perfect knowledge, would be the $432,000 [($30 $19.50 $1.50) 48,000] contribution computed above, minus $360,000 fixed costs, or $72,000. 3. The point of indifference is where the operating incomes are equal. Let X = unit cost per pair that would produce the identical operating income of $67,200. Then: 48,000[$30.00 (X + $1.50)] $360,000 48,000($28.50 X) $360,000 $1,368,000 48,000X $360,000 48,000X X = = = = = $ 67,200 $ 67,200 $ 67,200 $940,800 $19.60

Therefore, any rise in purchase cost in excess of $19.60 per pair increases the operating income benefit of signing the long-term contract. In a shortcut solution, you could take the $4,800 difference between the "ideal" operating income (of $72,000) at the current cost per pair and the operating income under the contract (of $67,200) and divide it by 48,000 units to get 10 cents per pair difference.

3-24

3-38 (30 min.) CVP analysis, income taxes, sensitivity.

1a. In order to break even, Almo Company must sell 500 units. This amount represents the point where revenues equal total costs. Let Q denote the quantity of canopies sold. Revenue = Variable costs + Fixed costs $400Q = $200Q + $100,000 $200Q = $100,000 Q = 500 units The calculation can also be expressed as Breakeven = Fixed Costs Contribution margin per unit = $100,000 $200 = 500 units 1b. In order to achieve its net income objective, Almo Company must sell 2,500 units. This amount represents the point where revenues equal total costs plus the corresponding operating income objective to achieve net income of $240,000. Revenue $400Q $400 Q Q = = = = Variable costs + Fixed costs + Operating income $200Q + $100,000 + [$240,000 (1 0.4)] $200Q + $100,000 + $400,000 2,500 units

2. To achieve its net income objective, Almo Company should select the first alternative where the sales price is reduced by $40, and 2,700 units are sold during the remainder of the year. This alternative results in the highest net income and is the only alternative that equals or exceeds the companys net income objective. Calculations for the three alternatives are shown below. Alternative 1 Revenues Variable costs Operating income Net income Alternative 2 Revenues Variable costs Operating income Net income Alternative 3 Revenues Variable costs Operating income Net income = = = = ($400 350) + ($380 2,000) = $900,000 $200 2,350 = $470,000 $900,000 $470,000 $90,000 = $340,000 $340,000 (1 0.4) = $204,000 3-25 = = = = ($400 350) + ($370 2,200) = $954,000 ($200 350) + ($190 2,200) = $488,000 $954,000 $488,000 $100,000 = $366,000 $366,000 (1 0.4) = $219,600 = = = = ($400 350) + ($360 2,700) = $1,112,000 $200 3,050 = $610,000 $1,112,000 $610,000 $100,000 = $402,000 $402,000 (1 0.4) = $241,200

3-39 (30 min.) Choosing between compensation plans, operating leverage.

1. Variable costs of goods sold as a percentage of revenues = Let breakeven revenues be denoted by $R, then Variable marketing Fixed marketing $R = Variable manuf. + Fixed manuf. + + costs costs costs costs $R = $0.45R + $2,870,000 + $0.18R + $3,420,000 $R $0.45R $0.18R $0.37R R = $2,870,000 + $3,420,000 = $6,290,000 = $6,290,000 = $6,290,000 0.37 = $17,000,000 $11,700,000 = 45% $26,000,000

2. With its own sales force, Marstons fixed marketing costs would increase to $3,420,000 + $2,080,000 = $5,500,000. Variable cost of marketing = 10% of Revenues Let breakeven revenues be denoted by $R, then $R = $0.45R + $2,870,000 + $0.10R + $5,500,000 $R $0.45R $0.10R 0.45R R 3. Revenues Variable manufacturing costs $26,000,000 0.45; 0.45 Variable marketing costs $26,000,000 0.18; 0.10 Contribution margin Fixed costs Fixed manufacturing costs Fixed marketing costs Total fixed costs Operating income Contributi on margin Degree of = operating leverage Operating income = $2,870,000 + $5,500,000 = $8,370,000 = $8,370,000 = $8,370,000 0.45 = $18,600,000 Using Sales Agents $26,000,000 11,700,000 4,680,000 9,620,000 2,870,000 3,420,000 6,290,000 $ 3,330,000 $9,620,000 = 2.89 $3,330,000 Employing Own Sales Staff $26,000,000 11,700,000 2,600,000 11,700,000 2,870,000 5,500,000 8,370,000 $ 3,330,000 $11,700,000 = 3.51 $3,330,000

3-26

3-39 (Contd.) The calculations indicate that at sales of $26,000,000, a percentage change in sales and contribution margin will result in 2.89 times that percentage change in operating income if Marston continues to use sales agents and 3.51 times that percentage change in operating income if Marston employs its own sales staff. The higher contribution margin per dollar of sales and higher fixed costs gives Marston more operating leverage, that is greater benefits (increases in operating income) if revenues increase but greater risks (decreases in operating income) if revenues decrease. 4. Variable costs of marketing Fixed marketing costs = 15% of Revenues = $5,500,000

Operating income = Revenues

Variable Fixed Variable Fixed marketing marketing manuf. costs manuf. costs costs costs

Denote the revenues required to earn $3,330,000 of operating income by $R, then $3,330,000 = $R $0.45R $2,870,000 $0.15R $5,500,000 $3,330,000 + $2,870,000 + $5,500,000 $11,700,000 R = $R $0.45R $0.15R = $0.40R = $11,700,000 0.40 = $29,250,000

3-27

3-40 (1525 min.) Sales mix, three products.

1. Let A = Number of units of A to break even 5A = Number of units of B to break even 4A = Number of units of C to break even Contribution margin Fixed costs = Zero operating income $3A + $2(5A) + $1(4A) $255,000 $17A A 5A 4A Total 2. Contribution margin: A: 20,000 $3 B: 100,000 $2 C: 80,000 $1 Contribution margin Fixed costs Operating income Contribution margin A: 20,000 $3 B: 80,000 $2 C: 100,000 $1 Contribution margin Fixed costs Operating income Let A = 4A = 5A = = 0 = $255,000 = 15,000 units of A = 75,000 units of B = 60,000 units of C = 150,000 units

$ 60,000 200,000 80,000 $340,000 255,000 $ 85,000

3.

$ 60,000 160,000 100,000 $320,000 255,000 $ 65,000

Number of units of A to break even Number of units of B to break even Number of units of C to break even

Contribution margin Fixed costs = Breakeven point $3A + $2(4A) + $1(5A) $255,000 $16A A 4A 5A Total = 0 = $255,000 = 15,938 units of A (rounded) = 63,752 units of B = 79,690 units of C = 159,380 units

Breakeven point increases because the new mix contains less of the higher contribution margin per unit, product B, and more of the lower contribution margin per unit, product C. 3-28

3-41 (30 min.) Multiproduct breakeven, decision making.

1. Breakeven point in 2000 (units) Breakeven point in 2000 (in revenues) 2. =
Fixed Costs Unit Controbution Margin

$495,000 = 16,500 units $50 $20

= 16,500 units $50 = $825,000 in sales revenues

Breakeven point in 2001 (in units) Evenkeel expects to sell 3 units of Plumar for every 2 units of Ridex in 2001, so consider a bundle consisting of 3 units of Plumar and 2 units of Ridex. Unit Contribution Margin from Plumar Unit Contribution Margin from Ridex The contribution margin for the bundle is $30 3 units of Plumar + $10 2 units of Ridex = $110 So bundles to be sold to breakeven = 495,000 = 4,500 bundles $110 2 9,000 units of Ridex $25 $225,000 = = Contribution margin percentage in 2001 = = Total $900,000 = = $50 $20 = $30 $25 $15 = $10

4,500 bundles 3 13,500 units of Plumar $50 $675,000

Selling price Revenue 3.

Contribution margin percentage in 2000

Unit contributi on margin in 2000 Unit selling price in 2000 $30 = 60% $50 Unit conribution margin on bundle in 2001 Selling price of bundle in 2001 $110 $110 = = 55% 3 $50 + 2 $25 $200

The breakeven point in 2001 increases because fixed costs are the same in both years but the contribution margin generated by each dollar of sales revenue at the given product mix decreases in 2001 relative to 2000. 4. Despite the breakeven sales revenue being higher, I would advise Andy Minton to accept Glastons offer. The breakeven points per se are irrelevant because I do not expect Evenkeel to operate in the region of the breakeven dollars. By accepting Glastons offer, Andy has the ability to sell all the 30,00 units of Plumar he expects to sell in 2001 and make more sales of Ridex to Glaston without incurring any more fixed costs. 3-29

3-41 (Contd.) Profits in 2001 with and without Ridex are expected to be as follows: 2001 without Ridex Sales Variable costs Contribution margin Fixed costs Operating profit
1 2

2001 with Ridex $2,000,000 2 900,0004 1,100,000 495,000 $ 605,000

$1,500,0001 600,0003 900,000 495,000 $ 405,000

$50 30,000 units $50 30,000 units + $25 20,000 units 3 $20 30,000 units 4 $20 30,000 units + $15 20,000 units

3-30

3-42 (2025 min.) Sales mix, two products.

1. Let Q 3Q = Number of units of Deluxe carrier to break even = Number of units of Standard carrier to break even

Revenues Variable costs Fixed costs = Zero operating income $20(3Q) + $30Q $14(3Q) $18Q $1,200,000 = $60Q + $30Q $42Q $18Q = $30Q = Q = 3Q = 0 $1,200,000 $1,200,000 40,000 units of Deluxe 120,000 units of Standard

The breakeven point is 120,000 Standard units plus 40,000 Deluxe units, a total of 160,000 units. 2. Unit contribution margins are: Standard: $20 $14 = $6; Deluxe: $30 $18 = $12 a. If only Standard carriers were sold, the breakeven point would be: $1,200,000 $6 = 200,000 units b. If only Deluxe carriers were sold, the breakeven point would be: $1,200,000 $12 = 100,000 units Operating income = 180,000($6) + 20,000($12) $1,200,000 = $1,080,000 + $240,000 $1,200,000 = $120,000

3.

Let Q 9Q

= =

Number of units of Deluxe product to break even Number of units of Standard product to break even = = = = = 0 $1,200,000 $1,200,000 18,182 units of Deluxe (rounded) 163,638 units of Standard

$20(9Q) + $30Q $14(9Q) $18Q $1,200,000 $180Q + $30Q $126Q $18Q $66Q Q 9Q

The breakeven point is 163,638 Standard + 18,182 Deluxe, a total of 181,820 units. The major lesson of this problem is that changes in the sales mix change breakeven points and operating incomes. In this example, the budgeted and actual total sales in number of units were identical, but the proportion of the product having the higher contribution margin declined. Operating income suffered, falling from $300,000 to $120,000. Moreover, the breakeven point rose from 160,000 to 181,820 units.

3-31

3-43 (25 min.) CVP analysis, decision making.

1. Unit selling price Variable manufacturing costs per unit Variable marketing and distribution costs per unit Contribution margin per unit Fixed manufacturing costs Fixed marketing and distribution costs Total fixed costs Breakeven point in units = $105 45 10 $ 50 $ 800,000 600,000 $1,400,000

Total fixed costs $1,400,000 = = 28,000 units Contribution margin per unit $50

Breakeven point in revenues = 28,000 units $105 per unit = $2,940,000 2. Tocchets current operating income is as follows: Revenues, $105 40,000 Variable costs, $55 40,000 Contribution margin Fixed costs Operating income $4,200,000 2,200,000 2,000,000 1,400,000 $ 600,000

Let the fixed marketing and distribution costs be F. We calculate $F when operating income = $600,000 and the selling price is $99. $99 50,000 $55 50,000 $F $4,950,000 $2,750,000 $F $F = $600,000 = $600,000 = $4,950,000 $2,750,000 $600,000 = $1,600,000

Hence the maximum increase in fixed marketing and distribution costs for which Tocchet will prefer to reduce the selling price is $200,000 ($1,600,000 $1,400,000). 3. Let the selling price be $P.

We calculate $P for which, after increasing fixed manufacturing costs by $100,000 to $900,000 and variable manufacturing cost per unit by $2 to $47, operating income = $600,000 $40,000 P $47 40,000 $10 40,000 $900,000 $600,000 = $600,000 $40,000 P $1,880,000 $400,000 $900,000 $600,000 = $600,000 $40,000 P = $600,000 + $1,880,000 + $400,000 + $900,000 + $600,000 $40,000 P = $4,380,000 P = $4,380,000 40,000 = $109.50 Tocchet will consider adding the new features provided the selling price is at least $109.50 per unit. 3-32

3-44 (30-40 min.) CVP analysis, income taxes.

1. Revenues Variable costs Fixed costs Let X = Net income for 2000 20,000($25.00) 20,000($13.75) $135,000 = X 1 0.40 X $500,000 $275,000 $135,000 = 0.60 $300,000 $165,000 $81,000 = X X = $54,000 = Target net income 1 - Tax rate

2.

Let Q = Number of units to break even $25.00Q $13.75Q $135,000 = 0 Q = $135,000 $11.25 = 12,000 units Let X = Net income for 2001 22,000($25.00) 22,000($13.75) ($135,000 + $11,250) $550,000 $302,500 $146,250 $101,250 X = = = X 1 0.40 X 0.60 X 0.60

3.

= $60,750

4.

Let Q = Number of units to break even with new fixed costs of $146,250 $25.00Q $13.75Q $146,250 = 0 Q = $146,250 $11.25 = 13,000 units Revenues = 13,000 $25.00 = $325,000

Alternatively, the computation could be $146,250 divided by the contribution margin percentage of 45% to obtain $325,000. 5. Let S = Required sales units to equal 2000 net income $54000 $25.00S $13.75S $146,250 = 0.6 $11.25S = $236,250 S = 21,000 units Revenues = 21,000 units $25.00 = $525,000 Let A = Amount spent for advertising in 2001 $550,000 $302,500 ($135,000 + A) = $60000 0.6 $550,000 $302,500 $135,000 A = $100,000 $550,000 $537,500 = A A = $12,500 3-33

6.

3-45 (3035 min. or more) Review of Chapters 2 and 3.

This is a challenging question that covers both Chapters 2 and 3. One or both cases can be used as an examination question. (All answers are in thousands of $) Case 1 Case 2 $100 0 75 (G) 75 0 75 25 13 (K)** 2 (J) 15 $ 10 (L) $ $100 5 80 (U) 85 5 80 20 15 (T) 10 25 (5)

Income Statement Revenues Cost of goods sold: Beginning finished goods, 1/1 Cost of goods manufactured Cost of goods available for sale Ending finished goods, 12/31 Cost of goods sold Gross margin Operating costs* Variable Fixed Operating costs Operating income (loss)

*Operating costs include marketing, distribution, customer service, and administrative costs. **Total variable costs of: $70,000 (G I) or $70,000 ($75,000 $18,000) = $13,000

(All answers are in thousands of $) Cost of Goods Manufactured Direct materials costs: Beginning inventory, 1/1 Purchases of direct materials Direct materials available for use Ending inventory, 12/31 Direct materials used Direct manufacturing labor costs Manufacturing overhead costs: Variable costs Fixed costs Manufacturing overhead costs Total manufacturing costs incurred during year Add beginning work in process, 1/1 Total manufacturing costs to 3-34 Case 1 Case 2

$12 15 27 5 22 (H) 30 5 18 (I) 23

$20 50 70 30 (W) 40 15 5 (X) 20 25

75 0

80 9

account for Deduct ending work in process, 12/31 Cost of goods manufactured 3-45 (Contd.) Breakeven Computations Total costs Fixed manufacturing overhead Fixed marketing, distribution, customer service, and administrative costs Total fixed costs Total variable costs Total revenue Total contribution margin Contribution margin percentage Breakeven point in dollars

75 0 $75 (G)

89 9 $80 (U)

$ 90 18 2 (J)* 20 70 100 30 30% $ 67*

$105** 20 10 30 75 100** 25 (V)*** 25% $120 (Y)

*The $67,000 figure is rounded in the tabulation; it should be $66,667. $66,667 .30 = $20,000 total fixed costs $20,000 $18,000 = $ 2,000 **If the loss is $5,000, total costs are $100,000 + $5,000 = $105,000 ***100 75 = 25

3-35

3-46 (2030 min.) CVP analysis under uncertainty.

1. a. At a selling price of $100, the unit contribution margin is ($100 $50) = $50, and it will require the sale of ($200,000 $50) = 4,000 units to break even. The sales in dollars is $400,000, and there is a 2/3 probability of equaling or exceeding this sales level. At a selling price of $70, the unit contribution margin is ($70 $50) = $20, and it will require the sale of ($200,000 $20) = 10,000 units to break even. At the lower price, this sales in dollars is $700,000, and there is a 2/3 probability of equaling or exceeding this sales volume.

b.

Therefore, if you seek to maximize the probability of showing an operating income, you are indifferent between the two strategies. 2. Expected Selling Variable Expected operating income = price per unit costs per unit sales level Fixed costs At a selling price of $100: Expected revenues Expected operating income = $450,000 ($100 4,500) = [($100 $50) 4,500] $200,000 = $25,000

At a selling price of $70: Expected revenues Expected operating income = $750,050 ($70 10,715) = [($70 $50) 10,715] $200,000 = $14,300

A selling price of $100 will maximize the expected operating income.

3-36

3-47 (15 min.) CVP analysis under uncertainty.

1. Both products have the same unit contribution margin: Unit contribution margin = Selling price per unit Variable costs per unit = $10 $8 = $2 = Fixed costs Unit contribution margin $400,000 $2

Breakeven point

= 200,000 units for each product 2. The expected demand for the two umbrellas is: Event (1) Demand 50,000 100,000 200,000 300,000 400,000 500,000 Expected demand Emerald Green (2) (1) (2) Probability Units 0.0 10,000 0.1 40,000 0.2 120,000 0.4 80,000 0.2 50,000 0.1 1.0 300,000 Shocking Pink (3) (1) (3) Probability Units 0.1 5,000 0.1 10,000 0.1 20,000 0.2 60,000 0.4 160,000 0.1 50,000 1.0 305,000

Expected operating income of Emerald Green umbrellas: $2(300,000) $400,000 = $200,000 Expected operating income of Shocking Pink umbrellas: $2(305,000) $400,000 = $210,000 The Shocking Pink umbrellas should be chosen because they have the higher expected operating income. 3. The expected operating income from the two products would be identical. If the choice criterion is to maximize expected operating income, the company will be indifferent between Emerald Green and Shocking Pink umbrellas. However, assume that management considers risk factors. Emerald Green umbrellas, for example, have a 10% chance of selling only 100,000 units, which would result in a net operating loss of $200,000. Also, there is a 30% chance that sales of Emerald Green will exceed 300,000 units. If this event happens, the operating income of Emerald Green umbrellas will be higher than the operating income of Shocking Pink umbrellas. The expected values are important, but the dispersion of the probability distribution is also important. Normally, the wider the dispersion, the greater the risk. Knowledge of the entire probability distribution helps management assess the risk before reaching a decision. 3-37

3-48 (30 min.) Ethics, CVP analysis.

1. Contribution margin percentage = = = Breakeven revenues = = 2. Revenues Variable costs Revenues $5,000,000 $3,000,000 $5,000,000 $2,000,000 = 40% $5,000,000 Fixed costs Contributi on margin percentage $2,160,000 = $5,400,000 0.40

If variable costs are 52% of revenues, contribution margin percentage equals 48% (100% 52%) Breakeven revenues = = Fixed costs Contributi on margin percentage $2,160,000 = $4,500,000 0.48 $5,000,000 2,600,000 2,160,000 $ 240,000

3.

Revenues Variable costs (0.52 $5,000,000) Fixed costs Operating income

4. Incorrect reporting of environmental costs with the goal of continuing operations is unethical. In assessing the situation, the specific Standards of Ethical Conduct for Management Accountants (described in Exhibit 1-7) that the management accountant should consider are listed below. Competence Clear reports using relevant and reliable information should be prepared. Preparing reports on the basis of incorrect environmental costs in order to make the companys performance look better than it is violates competence standards. It is unethical for Bush to not report environmental costs in order to make the plants performance look good. Integrity The management accountant has a responsibility to avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict. Bush may be tempted to report lower environmental costs to please Lemond and Woodall and save the jobs of his colleagues. This action, however, violates the responsibility for integrity. The Standards of Ethical Conduct require the management accountant to communicate favorable as well as unfavorable information.

3-38

3-48 (Contd.) Objectivity The management accountants Standards of Ethical Conduct require that information should be fairly and objectively communicated and that all relevant information should be disclosed. From a management accountants standpoint, underreporting environmental costs to make performance look good would violate the standard of objectivity. Bush should indicate to Lemond that estimates of environmental costs and liabilities should be included in the analysis. If Lemond still insists on modifying the numbers and reporting lower environmental costs, Bush should raise the matter with one of Lemonds superiors. If after taking all these steps, there is continued pressure to understate environmental costs, Bush should consider resigning from the company and not engage in unethical behavior.

3-49 (35 min.) Deciding where to produce.

1. The annual breakeven point in units at the Peoria plant is 73,500 units and at the Moline plant is 47,200 units, calculated as follows. Unit contribution calculation: Peoria Selling price Less variable costs: Manufacturing Commissions Marketing and distribution Contribution margin per unit Fixed costs calculation: Total fixed costs = (Fixed manufacturing costs per unit + Fixed marketing and distribution costs per unit) Production rate per day Normal working days ($30.00 + $19.00) 400 240 = $4,704,000 ($15.00 + $14.50) 320 240 = $2,265,600 $150.00 72.00 7.50 6.50 $ 64.00 Moline $150.00 88.00 7.50 6 .50 $ 48.00

Peoria

Moline = Breakeven calculation: Breakeven units Peoria = =

Fixed costs Contribution margin per unit $4,704,000 $64 = 73,500 units $2,265,600 $48 = 47,200 units

Moline =

3-39

3-49 (Contd.) 2. The operating income that would result from the division production managers plan to produce 96,000 units at each plant is $3,628,800. The normal capacity at the Peoria plant is 96,000 units (400 240); however, the normal capacity at the Moline plant is 76,800 units (320 240). Therefore, 19,200 units (96,000 76,800) will be manufactured at Moline at a reduced contribution of $40.00 per unit ($48 $8). Contribution margin per plant: Peoria, 96,000 $64 Moline, 76,800 $48 Moline, 19,200 $40 Total contribution margin Less total fixed costs, $4,704,000 + $2,265,600 Operating income $ 6,144,000 3,686,400 768,000 10,598,400 6,969,600 $ 3,628,800

3. The optimal production plan is to produce 120,000 units at the Peoria plant and 72,000 units at the Moline plant. The full capacity of the Peoria plant, 120,000 units (400 units 300 days), should be utilized as the contribution from these units is higher at all levels of production than the contribution from units produced at the Moline plant. Contribution margin per plant: Peoria, 96,000 $64 Peoria, 24,000 $61 Moline, 72,000 $48 Total contribution margin Less total fixed costs Operating income

$ 6,144,000 1,464,000 3,456,000 11,064,000 6,969,600 $ 4,094,400

3-40