Question

C-V-P Analysis

Discussion Question

Darin Musical Company manufactures and sells parts for musical gadgets. The business earned net income of $420,000 in 2018, when sales was 6,000 units and data for variable cost per unit and total fixed costs were as follows:

Variable expenses per unit:

Fixed expenses:

Required:

Direct Material $20 Direct Labour $50 Variable Manufacturing Overhead $10

Fixed Manufacturing Overhead Fixed Selling Costs

Fixed Administrative Costs

$125,000 $75,000 $100,000

i) Compute the expected selling price per unit, using the equation method.

ii) Given the sales of 6,000 units, prepare a contribution margin income statement for the year ended December 31, 2018, detailing the components of total fixed costs and clearly showing contribution and net income.

iii) Calculate Darin’s break-even point in units and in sales dollars.

iv) The recession in the economy in 2019 is expected to result in a reduction of the number of units sold. By how much can sales decline in units and sales dollars in 2019 without the company making a loss?

v) Given the expected sales of 6,000 units, graph Darin’s CVP relationships clearly showing the breakeven point, the sales revenue line, the fixed cost line, the total cost line, the operating profit area, the operating loss area and the margin of safety in units and sales dollars. [Use a scale of 2 cm to represent 1,000 units on the x-axis and 2cm to represent $200,000 on the y- axis].

vi) The management of Darin Musical Company’s profit objective for the period is to increase operating income by 20% in 2019. They expect per unit data and total fixed costs to remain the same in 2019. Determine the number of units that must be sold to earn this target operating profit. Is this a realistic goal?

vii) Assume that as a result of reorganizing the production process, Darin Musical Company was able to reduce direct material cost per unit by $5 due to a change in the supplier of raw material used in the production process but the expected sales units of 6,000 units would decrease by 10% in spite of an increase in total fixed costs of $87,000. What must the new selling price per unit be if the company wishes to meet the profit objective for 2019?

Answer 1

Determine the expected selling price per unit as shown below: Net income = Sales - Variable expenses - Fixed expenses Sales = Net income + Variable expenses + Fixed expenses Number of units sold * Selling price per unit = $420,000+ $480.000 + $300.000 6,000 units x Selling price per unit = $1.200,000 Selling price per unit = $1.200.000 6,000 units = $200 Thus, the selling price per unit is $200 Note-1: Determine the total variable expenses as shown below: Amount $20 $50 Details Direct material per unit Add: Direct labour per unit Add: Variable manufacturing overhead per unit Total variable expenses per unit [a] Number of units sold [b] Total variable expenses (a x b] $10 $80 6.000 $480.000

Note-2: Determine the total fixed expenses as shown below: (Fixed administrative costs (Fixed manufacturing Fixed selling) Total fixed expenses = overhead costs = $125,000+ $75,000+ $100,000 = $300,000 Prepare a contribution margin income statement as shown below: $1,200.000 Contribution Margin Income Statement For the year ended December 31, 2018 Sales [6,000 units * $200 each] Les: Variable expenses Direct materials [6,000 units X $20] Direct labour [6,000 units $50] Variable manufacturing overhead [6,000 units x $10] Contribution margin Less: Fixed expenses Fixed manufacturing overhead Fixed selling costs Fixed administrative costs Net income $120.000 $300,000 $60.000 $720.000 $125,000 $75.000 $100.000 $420.000 Thus, the net income for the year ended December 31, 2018 is $420,000).

iii) Break-Even Point: In units: Total fixed expenses Break-even point (in units) = Contribution margin per unit $300,000 Contribution margin Number of units sold $300.000 $720,000 6.000 units $300,000 $120 each = 2,500 units

In sales dollars: Total fixed expenses Break-even point in sales dollars) = Contribution margin ratio $300.000 Contribution margin Sales $300,000 $720,000 $1,200,000 $300,000 60% = $500,000 Thus, the break-even point in units is 2,500 units and in sales dollars is $500,000

iv) In the 2019, the company is expecting recession. It is required to determine the number of units and sales dollars that can be declined so that the company cannot make any loss. It implies, it is required to determine the difference between the actual results in the year 2018 and the break-even point. Units that can be declined: Units that can be declined = Number of units sold - Break even point in units) = 6,000 units - 2,500 units = 3,500 units Sales dollars that can be declined: Sales that can be declined = Actual sales dollars - Break even point in sales dollars = $1,200,000 - $500,000 = $700,000 Thus, the units that can be declined are 3,500 units and amount of sales dollars that can be declined is $700,000