Question

Vin Diesel owns the Fredonia Barber Shop. He employs four barbers and pays each a base rate of $1,250 per month. One of the barbers serves as the manager and receives an extra $500 per month. In addition to the base rate, each barber also receives a commission of $4.50 per haircut. Other costs are as follows.

Advertising	$200 per month
Rent	$1,100 per month
Barber supplies	$0.30 per haircut
Utilities	$175 per month plus $0.20 per haircut
Magazines	$25 per month

Vin currently charges $10 per haircut.

Instructions

(a)  

Determine the variable costs per haircut and the total monthly fixed costs.

(a) VC $5

(b)  

Compute the break-even point in units and dollars.

(c)  

Prepare a CVP graph, assuming a maximum of 1,800 haircuts in a month. Use increments of 300 haircuts on the horizontal axis and $3,000 on the vertical axis.

(d)  

Determine net income, assuming 1,600 haircuts are given in a month.

Answer 1

Concepts and reason

Cost Volume Profit (CVP) Analysis: CVP analysis is one of the techniques of decision making to achieve the targeted profits by changing different variables. The analysis observes the relationships among cost, volume of output, and profit which provides the basis for the manager to take effective steps about the future profits.

Contribution margin: It is the difference between Sales revenue and total variable costs. The amount of contribution margin is contributed to cover fixed costs and provide operating income.

Breakeven analysis: This is one of the techniques of decision accounting which determines the particular level of activity where the total costs and the total revenues of a firm are equal. The relationship between cost, profit and sales volume provides the basis for the manager to take effective steps about the future profits. The breakeven analysis uses the contribution margin approach.

Fundamentals

Sales revenue: Sales revenue is the total income earned by an organization by selling goods or rendering services.

Fixed costs: These are the costs which remain constant throughout the process of manufacturing or for the services rendered. They are incurred irrespective of number of units produced.

Variable costs: Variable costs are direct costs that vary according to the business activities. It is generally referred to as unit-level costs which vary according to the number of units.

Contribution margin is the excess of revenue over the variable costs. It is calculated as the difference between the sales and variable costs.

Use the following formula to calculate contribution margin:

${\rm{Contribution Margin}} = {\rm{Sales}} - {\rm{Variable cost}}$

Contribution margin ratio: The contribution margin ratio is the ratio of contribution margin to total sales.

Use the following formula to calculate contribution margin ratio:

${\rm{Contribution margin ratio}} = \frac{{{\rm{Contribution}}\,{\rm{margin}}}}{{{\rm{Sales}}}} \times 100$

Breakeven point: The breakeven point is a point where revenue of the company equals the total cost incurred. In other words, the point of sales at which there is no profit or loss is called as Break Even Point (BEP). Hence, at the point of breakeven, the profit of any company will be zero.

Use the following formula to calculate breakeven points in units:

${\rm{Breakeven point in units}}\, = \frac{{{\rm{Fixed costs}}}}{{{\rm{Contribution margin per unit}}}}{\rm{ }}$

Use the following formula to calculate breakeven points in dollars:

${\rm{Breakeven sales in dollars}} = \frac{{{\rm{Fixed costs }}}}{{{\rm{Contribution margin ratio}}}}$

Net income: The net income is the excess of revenues over expenses after adjusting for depreciation and taxes. Net income will appear in the bottom of the income statement of the company.

Use the following formula to calculate net income:

${\rm{Net}}\,{\rm{income}}\,{\rm{ = Net sales revenue }} - {\rm{ Variable costs }} - {\rm{ Fixed costs }}$

(a).1

Calculate the amount of variable cost per haircut.

$\begin{array}{c}\\{\rm{Variable cost per haircut = Baber supplies + Utilities + Commission}}\\\\{\rm{ = \$ 0}}{\rm{.30 + \$ 0}}{\rm{.20 + \$ 4}}{\rm{.50}}\\\\{\rm{ = }}\,{\rm{\$ 5}}{\rm{.00}}\\\end{array}$

(a).2

Calculate the amount of total monthly fixed costs.

$\begin{array}{c}\\{\rm{Total monthly fixed costs = }}\left( \begin{array}{l}\\{\rm{Baber's base rate + Manager's salary + Advertising }}\\\\{\rm{ + Rent + Utilities + Magazines}}\\\end{array} \right)\\\\{\rm{ = \$ 5,000}}\left( {4 \times \$ 1,250} \right){\rm{ + \$ 500 + \$ 200 + \$ 1,100 + \$ 175 + \$ 25}}\\\\{\rm{ = }}\,{\rm{\$ 7,000}}\\\end{array}$

(b).1

Calculate the amount of breakeven point in units as below:

$\begin{array}{c}\\{\rm{Breakeven point in units}}\, = \frac{{{\rm{Fixed costs}}}}{{{\rm{Contribution margin per unit}}}}{\rm{ }}\\\\ = \frac{{\$ 7,000}}{{\$ 5}}\\\\ = 1,400\,{\rm{haircuts}}\\\end{array}$

Working note:

Calculate the amount of contribution margin per unit.

$\begin{array}{c}\\{\rm{Contribution margin per unit}} = {\rm{Sales per unit}} - {\rm{Variable cost per unit}}\\\\{\rm{ = \$ 10}} - \$ 5\\\\ = \$ 5\\\end{array}$

(b).2

Calculate the amount of breakeven point in dollars as below:

$\begin{array}{c}\\{\rm{Breakeven sales in dollars}} = \frac{{{\rm{Fixed costs }}}}{{{\rm{Contribution margin ratio}}}}\\\\ = {\rm{ }}\frac{{\$ 7,000{\rm{ }}}}{{\left( {\frac{{\$ 10 - \$ 5}}{{\$ 10}}} \right)}}\\\\ = \$ 14,000\\\end{array}$

(c)

Prepare cost-volume-profit (CVP) graph.

(d)

Calculate the amount of net income as below:

$\begin{array}{c}\\{\rm{Net}}\,{\rm{income}}\,{\rm{ = Net sales revenue }} - {\rm{ Variable costs }} - {\rm{ Fixed costs }}\\\\\,\,\,\,\, = \,\left[ {\left( {\$ 10 \times 1,600} \right) - \left( {\$ 5 \times 1,600} \right)} \right] - \$ 7,000\\\\ = \$ 16,000 - \$ 8,000 - \$ 7,000\\\\ = \$ 1,000\\\end{array}$

Hence, the amount of net income is $1,000.

Ans: Part (a).1

The amount of variable cost per haircut is $5.

Part (a).2

The total monthly fixed costs is $7,000.

Part (b).1

The breakeven point in units is 1,400 haircuts.

Part (b).2

The breakeven point in dollars is $14,000.

Part (c)

Part (d)

The amount of net income is $1,000.