ACG 2071 - Managerial Accounting

Study Probes - Chapter 7

Problems

1. Aukens Company produces homework machines. During July of 2004, Aukens produced and sold 600 units at \$40 per unit. At July’s level of production, it costs Aukens \$18 variable costs per unit and fixed costs of \$5 per unit. How much will total sales be if Aukens earns a profit of \$8,000?

Total fixed costs at 600 units = \$5 x 600 units = \$3,000

Total fixed costs at all other levels of production = \$3,000

 Selling price -  Variable costs - Fixed costs = Net income \$40 X ─ \$18 X ─ \$3,000 = \$8,000 X = 500 units \$40 x 500 units = \$20,000

2.  Parker Plants provided the following information relating to the production and sales of 500 plants: Sales, \$15,000; Variable product costs, \$3,800; variable operating expenses, \$2,000; fixed product costs, \$2,500; and fixed operating expenses, \$1,500.

A.  How many cents out of every sales dollar is available to cover fixed expenses and to go towards profit for Parker Plants?

This question describes the nature of the CM ratio.

[\$15,000 ─ \$3,800 ─ \$2,000] / \$15,000 = 61.33% or 61.33 cents out of every sales dollar

B. If Parker sells 600 plants, how much is available to cover fixed expenses and to go towards profit for Parker Plants?

This question describes the nature of total CM at 600 units of activity:

Selling price per unit: \$15,000/500 = \$30 per plant

VC per unit: [\$3,800 + \$2,000]/500 = \$11.60 per plant

Total CM at 600 units = [\$30 ─ \$11.60]*600 = \$11,040

C.  How much is available to cover fixed expenses and to go towards profit if Parker sells 1 more plant?

[\$30 ─ \$11.60]*1 = \$18.40

3.  Best Buy has a contribution margin ratio of 32%, a contribution margin per unit of \$5, and fixed costs of \$21,160.

A.    How much is sales revenue when Best Buy achieves a target profit of \$7,000?                        _

0.32 x - 21,160 = 7,000

x = \$88,000

B  How much does Best Buy’s profit increase for each \$800 increase in revenue?

\$800*0.32 = \$256

4. Outdoor Fun incurred the following costs in producing and selling 6,000 lawn chairs during 2009:

 Sales (6,000*\$21.80) \$130,800 Fixed costs (6,000*\$3.40) \$20,400 Variable costs (6,000*\$13.30) \$79,800

A.  If 150 more chairs are produced and sold, by how much will profit increase?

CM per unit = \$21.80 - \$13.30 = \$8.50

Increase in profit = \$8.50*150 = \$1,275

B.  How many chairs must be sold to breakeven?

21.80X - 13.30X - 20,400 = 0

x = 2,400 chairs

C. By how many units can Outdoor Fun's sales drop before the company loses his 'cushion'?

This question is asking for margin of safety.

Margin of safety = Current sales - BE sales = 6,000 ─ 2,400 = 3,600 units

5. Donough Company had the following income statement:

 Sales revenue (800 units) \$80,000 Cost of goods sold: Fixed costs \$20,000 Variable costs 18,500 38,500 Gross profit \$41,500 Operating expenses: Fixed costs 12,000 Variable costs 13,500 25,500 Operating income \$16,000

A.  How much is Donough's contribution margin?
Sales less variable costs: \$80,000 - \$18,500 - \$13,500 = \$48,000

B.  How many units must Donough sell in order to break even?

CM per unit = \$48,000/800 = \$60

\$60 X - [\$20,000 + \$12,000] = 0

X = 534 units

6. Evans Company makes and sells cologne. This product has a unit sales price of \$40 and a unit variable cost of \$24. Fixed expenses are \$32,000 per month.

A.  Calculate the contribution margin ratio.
(\$40 - \$24)/\$40 = .40 or 40%

B. Calculate the contribution margin of each unit.
\$40 - \$24 = \$16

C. How many units must Evans sell to break even?
\$32,000/\$16 = 2,000 units

D. How much will total sales be at break even?
2,000 x \$40 = \$80,000

E. How much will total variable costs be at break even?
2,000 x \$24 = \$48,000

F. How many units must Evans sell in order to report income before taxes of \$28,000?
(\$32,000 + \$28,000)/\$16 = 3,750 units

G. If the company sells 3,500 units, how much is:

A.  the total contribution margin?

3,500 x \$16 = \$56,000

B. income for the period?

(\$40 x 3,500) - (\$24 x 3,500) - \$32,000 = \$24,000

C. The margin of safety in dollars?

Difference in sales: \$140,000 - \$80,000 = \$60,000

7.  Allen Company sells homework machines for \$100 each. Variable costs per unit are \$75 and total fixed costs are \$62,000. Allen is considering the purchase of new equipment that would increase fixed costs to \$84,000, but decrease the variable costs per unit to \$60. At that level Allen Company expects to sell 3,000 units next year.

What is Allen’s break-even point in units if it purchases the new equipment?

 SP – VC – FC = 0 \$100X - \$60X – 84,000 = 0 X   =   2,100 units

Assuming the new equipment is acquired, by how much can Allen's sales drop before he loses his 'cushion'? (i.e., How many units can Allen's sales drop before he loses his 'cushion'?)

Margin of safety = Current sales in units - breakeven sales in units

= 3,000 units - 2,100 units = 900 units

8.   Smith Company produces desk lamps. The budget information for June indicated that production and sales of 800 units at \$25 per unit would generate variable costs of \$15 per unit and fixed costs of \$7.50 per unit.

A.  How much is the contribution margin of each desk lamp?

Sales price - variable costs = CM: \$25 - \$15 = \$10

B.   How many lamps must be sold to generate profit of \$5,000?

Fixed costs = \$7.50 x 800 = \$6,000

SP - VC - FC = profit

\$25x - \$15x - \$6,000 = \$5,000

x = 1,100 units

At 800 units, the fixed cost per unit was \$7.50, however, since fixed costs stay the same in total over any activity level, the total fixed cost will be \$6,000 of level. Both fixed and variable costs can be expressed as total costs or unit costs.

C.   How much sales dollars must Smith generate to break even?

SP - VC - FC = \$0

\$25x - \$15x - 6,000 = \$0

x = 600 units

600 units x \$25 selling price per unit = \$15,000 revenue

D.   Suppose Smith operates at \$5,000 profit during June. By how many units can sales decline before Smith would incur a net loss?

Units sold at \$5,000 profit level (from part B) = 1,100 units

Units sold at breakeven (from part C) = 600 units

Margin of safety = 1,100 - 600 = 500 units

E.   What is the accounting name of the concept you calculated in part D? Margin of safety

9. Margulais, Inc. produces guitars. The selling price is \$2,000 per unit and the variable costs are \$1,500 per guitar. Fixed costs per month are \$40,000. If Margulais sells 10 more units beyond breakeven, how much does profit increase as a result?

(\$2,000 - \$1,500) x 10 = \$5,000

10. Panera Bread sells a box of bagels for with a contribution margin of 62.5%. Its fixed costs are \$150,000 per year. How much sales dollars does Panera Bread need to break-even per year if bagels are its only product?

0.625x = 150,000; so x = \$240,000

11. When fixed costs are \$100,000 and variable costs are 20% of the selling price, then how much are breakeven sales?

Since VC = 20%, then CM = 80%:

\$100,000/80% = \$125,000

12. Olsen Drug Stores has three product lines: Drugs (\$500,000 sales, 25% contribution margin ratio), Cosmetics (\$250,000 sales, 50% contribution margin ratio), and Housewares (\$100,000 sales, 30% contribution margin ratio). How much is profit expected to increase if drug sales increase by \$80,000 and the other product levels stay the same?

\$80,000 x .25 = \$20,000

13. The following is from Regetta Cos income statement for last month:
 Sales (50,000 units) \$2,000,000 Variable expenses 1,400,000 Fixed costs 339,000 Operating income \$ 261,000

Calculate the break even point in units.

SP per unit = \$2,000,000/50,000 = \$40

VC per unit = \$1,400,000/50,000 = \$28

SP x = VC x - FC = 0

40x - 28x - 339,000 = 0

x = 28,250 units

Calculate margin of safety in units.

Units at current level = 50,000

Units at break even = 28,250

Margin of safety in units = 50,000 - 28,250 = 21,750 units

14. - Martin’s variable costs are 35% of sales. Its selling price is \$100 per unit. If Martin sells one unit more than break even units, how much will profit increase?

Increase in profit = contribution margin = \$100 - (35%*\$100) = \$65

15.  A firm makes and sells a single product. Monthly fixed expenses are \$19,500, monthly unit sales are 3,000, and the unit contribution margin is \$20. How much is monthly net profit?

\$20(3,000) - \$19,500 = \$40,500

16. A company with a single product has a contribution margin rate of 24%. Total units sold for 2004 was 100. If total fixed costs are \$84,000, what is the company's sales volume in dollars at break-even?

\$84,000/24% = \$350,000

17. Schwan, Inc. is a nonprofit organization that captures alligators from residential ponds and releases them in a remote habitat. Fixed costs are \$20,000. The cost of capturing each gator is \$40.00 each. Schwan is funded by a local philanthropy in the amount of \$48,000 for 2003. How many gators can Schwan capture during 2003 under its current funding?

Total costs = Variable costs + Fixed costs

\$48,000 = \$40 X + \$20,000

X = 700 gators

18. Moore Company has fixed costs of \$200,000 and variable costs are 60% of sales. How much will Moore report as sales when its net income equals \$20,000?

Since VC = 60% of sales, CM = 40% of sales.

Profit equation: 40%x - 200,000 = 20,000

Sales = x = \$550,000

19. The following is Tyler Corporation's contribution income statement for last month:

 Sales \$4,000,000 Less variable expenses 2,800,000 Contribution margin 1,200,000 Less fixed expenses 720,000 Net income \$ 480,000

The company has no beginning or ending inventories. What is the company’s margin of safety?

Problem 36 -Zweig Company produces paint brushes, which it sells for \$8 each. Each brush costs \$2 to make. During March, 3,000 brushes were sold. Fixed costs for March were \$1 per unit for a total of \$3,000 for the month.

A. How much is the contribution margin ratio for Zweig Company?

(\$8 - \$2)/\$8 = .75 or 75%

B. How much is the monthly break-even level of sales in dollars for Zweig?

8x - 2x - 3,000 = 0

x = 500 units

500(\$8) = \$4,000

C.  How much does Zweig’s operating income increase for each \$1,000 increase in revenue per month?

CM Ratio x Revenue = 75%(from #10) x \$1,000 = \$750

D.  If variable costs decrease by 20%, and fixed costs increase by 20%, what happens to the break-even level of units per month for Zweig?

Using the profit equation:

8x - (80%)(2x) - (120%)(3,000) = 0

x = 562.5 units

Increase = 562.5 units - 500 units = 62.5 units increase

20.  A company requires \$600,000 in sales to meet its target net income. Its contribution margin is 40%, and fixed costs are \$80,000. How much is the targeted net income?

Since CM% = 40%, then VC% = 60% (Because total costs = 100%)'

SP  - VC  - FC = ?

\$600,000 - .60(\$600,000) - \$80,000 = \$160,000

21. Bell Brushes produces hair brushes which are sold for \$20 each. The variable costs are \$8 per brush. Fixed costs per month are \$4,800. If Bell sells 10 more units beyond breakeven, how much does profit increase as a result?

[\$20 - \$8] x 10 = \$120

22. Moore Company has fixed costs of \$200,000 and variable costs are 60% of sales. How much will Moore report as sales when its net income equals \$20,000?

If VC = 60%, then CM = 40%.

0.40X - 200,000 = 20,000

X = \$550,000

Multiple Choice Questions

1. In the graph of CVP, the breakeven point is the

A.   point where the variable costs line crosses the fixed costs line.

B.   point where the sales revenue line crosses the total costs line.

C.   point where the variable costs line crosses the sales line.

D.   point where the variable cost line, the fixed cost line, and the sales line all meet.

2,  H55 Company sells two products, beer and wine. Beer has a 10 percent profit margin and wine has a 12 percent profit margin. Beer has a 27 percent contribution margin and wine has a 25 percent contribution margin. If customers want to buy only one product and beer sells for \$4, while wine sells for \$5, which product should H55 push to customers?

A.    Beer

.       B.    Wine

C.    The product that has the higher sales price

D.    It should sell an equal quantity of both.

E.    Selling either results in the same additional income for the company.

Sell the product with the higher contribution per unit of product. Beer = \$*27% = \$1.08; Wine = \$5*25% = \$1.25

3.  What most likely occurs when variable costs per unit increase?

A. The breakeven point will decrease

B. The selling price will decrease

C. The fixed cost per unit increase

D. Breakeven sales will increase

CM per unit will go down, so you must sell more units to get the same amount of sales.

4. Cost-volume-profit analysis assumes all EXCEPT

A.   all costs are variable or fixed.

B.   units manufactured equal units sold.

C.   total variable costs remain the same over the relevant range.

D.   total fixed costs remain the same over the relevant range.

Only variable costs per unit remain the same, not total variable costs.

5.  The break-even point is the point where

A. total sales revenue equals total expenses.

B. total contribution margin equals total fixed expenses.

C. both A and B are true.

D. neither A nor B is true.

6. A business's normal operating range, which excludes extremely high and low volumes that are not likely to be encountered, is the

A. Margin of safety.

B. Contribution margin.

C. Break-even point.

D. Relevant range

7. When graphing cost-volume-profit data on a CVP graph

A.    Units are plotted on the horizontal axis; costs on the vertical axis

B.    Units are plotted on the vertical axis; costs on the horizontal axis

C.    Both units and costs are plotted on the horizontal axis.

D.    Both units and cost are plotted on the vertical axis

Use the information that follows to answer the next two questions.

Gessel’s CVP analysis resulted in the following graph of its costs related to producing widgets during June:

 0 100 200 300 400 500 600 700

8. Gessel’s break even point in units is about

A.   2,500 units

B.   350 units

C.   250 units

D.   not enough information provided

Where B and C lines cross is the BEP. Units are on the vertical axis at 350 units.

9.  Total costs to produce 200 units is approximately

A.   \$2,000

B.   \$3,000

C.   \$4,000

D.   \$1,300

Line C is the total cost line. It is approximately \$4,000 at 200 units.

10. Todd Company sells two products, Fred and Barney. Fred has a 40 percent contribution margin and Barney has a 20 percent contribution margin. If customers plan to spend a total of \$50, what should Todd Company do?

A.    It should sell more Barney units.

B.    It should sell more Fred units.

C.    It should sell an equal number of each.

D.    No recommendation can be made from the data given

Products with higher contribution margin ratios contribute a larger portion of each sales dollar to profits.

11. When other factors remain constant, a decrease in sales price

1. increases the number of units needed to earn profits.

2. decreases the number of units needed to earn profits.

3. has no effect on the number of units needed to earn profits.

4. causes management to make irrational decisions.

Less selling price means smaller contribution margin.

12. A firm will break even when

1. Revenues = variable costs – fixed costs

2. Its sales exceed its fixed costs.

.Revenues = variable costs + fixed cost

D.  Either b or c

Algebra is used to view the profit equation in different formats.

13. In cost-volume-profit analysis, all costs are classified into which two categories?

a. fixed costs and variable costs
b. sunk costs and fixed costs
c. opportunity costs and sunk costs
d. product and period costs

Answer D would be appropriate for GAAP basis income statements.

14. Which of the following would have no effect on the break-even point in units?

A.    Sales volume increases

B.    Sales price increases

C.    Fixed costs increases

D.    Variable cost per unit decreases

No matter what the sales volume, the number of units to be sold to break even stay the same. An increase in sales volume causes CM to increase which impacts the BEP.

15.   Why must a company determine what its relevant range is?

A.   It directly impacts the indirect cost allocated to a product or service.

B.   It is a relevant cost.

C.     GAAP requires companies to report this information.

D.     Cost behavior outside of the relevant range is generally distorted

The relevant range is the normal activity level. Costs may change outside of this range because of economies of scale.

16.   Which is not part of a CVP graph?

A.  Total cost line                          C.  Revenue line

B.  Fixed cost line                         D.   Variable cost line

You will not find a separate variable cost line on a CVP graph because the cost line includes both fixed and variable.

17. Which of the following would have no effect on the break-even point in units?

A.    Sales price is reduced.

B.    Sales price increases

C.    Fixed costs increases

D.    Variable cost per unit decreases

E.    None of these. They all affect the break-even point.

18.  Which of the following statements is true when making decisions using CVP analysis?

A.   As long as the contribution margin is a positive number, net income will be positive.

B.   As long as variable costs are more than fixed costs, net income will be negative.

C.   As long as the contribution margin is greater than fixed costs, net income will be positive.

D.   As long as the sales price per unit is greater than fixed costs per unit, net income will be positive.

Since CM less FC = profits, this amount will be positive when CM is greater than FC. Answer A is wrong because if fixed costs are greater than CM, then the company will have a net loss. Answer B does not address sales which could likely be less than the total of VC and FC. Answer D is wrong because it does not consider that VC could be large enough to cause Revenue to be less than total costs, creating a loss.

19. Carver Company’s management established its target net income for the year. What did Carver do?

A.    It estimated its break-even income level for the year.

B.    It calculated its contribution margin.

C.    It allocated its costs to cost objects.

D.    It established its desired annual income for its product lines.

Target net income a level of net income that the company hopes to achieve.

20.What is a relevant range of activity?

A.    The geographical locations in which the company operates

B.    The activity level at which profits are maximized

C.    The levels of activity over which the company expects to operate

D.    The level of activity in which all costs are constant

This is the range we expect variable costs per unit and fixed costs in total to stay the same.

21. Max, Inc. was evaluating its margin of safety. Which one of the following is true?

A.    The margin of safety ignores fixed costs.

B.    The higher the margin of safety, the lower the operating leverage.

C.    The higher the margin of safety, the lower the amount of sales revenue.

D.    The higher the margin of safety, the more cushion the company has.

Margin of safety = the amount by which sales at the current profit level exceed sales at break even. This is a calculation of sales, not costs. Operating leverage relates to the proportion of fixed compared to variable costs which has no direct relation to sales.  Margin of safety is a cushion for management in that it is the amount by which sales can drop before a manager incurs a loss.

22.  In CVP analysis, what does the term "cost" mean?

A.    It includes all fixed and variable costs of products, but excludes period costs.

B.    It includes all costs which are part of cost of goods sold, plus variable operating expenses.

C.    It includes all manufacturing costs and operating expenses.

D.    It includes only manufacturing costs.
Manufacturing costs are product costs which include both fixed and variable. Operating expenses are period costs which include both fixed and variable.

23.    Which statement describes a fixed cost?

A.    It varies in total at every level of activity.

B.    The unit cost varies directly to the activity level.

C.    Its unit cost varies inversely to the level of activity.

D.    It remains the same per unit regardless of activity level.

Answer D is wrong because fixed cost "per unit" declines as activity increases. Only fixed costs in total remain the same at different levels of activity.

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