Question

The condensed income statement for the Peri and Paul partnership for 2020 is as follows.

Peri Paul Company Income Statement For the Year Ended December 31, 2020
Sales (240,000 units)		$1,200,000
Cost of goods sold		800,000
Gross profit		400,000
Operating expenses
Selling	$280,000
Administrative	150,000	430,000
Net loss		$    (30,000)

A cost behavior analysis indicates that 75% of the cost of goods sold are variable, 42% of the selling expenses are variable, and 40% of the administrative expenses are variable.

Instructions

(Round to nearest unit, dollar, and percentage, where necessary. Use the CVP income statement format in computing profits.)

(a)  

Compute the break-even point in total sales dollars and in units for 2020.

(b)  

Peri has proposed a plan to get the partnership “out of the red” and improve its profitability. She feels that the quality of the product could be substantially improved by spending $0.25 more per unit on better raw materials. The selling price per unit could be increased to only $5.25 because of competitive pressures. Peri estimates that sales volume will increase by 25%. What effect would Peri's plan have on the profits and the break-even point in dollars of the partnership? (Round the contribution margin ratio to two decimal places.)

(c)  

Paul was a marketing major in college. He believes that sales volume can be increased only by intensive advertising and promotional campaigns. He therefore proposed the following plan as an alternative to Peri's: (1) increase variable selling expenses to $0.59 per unit, (2) lower the selling price per unit by $0.25, and (3) increase fixed selling expenses by $40,000. Paul quoted an old marketing research report that said that sales volume would increase by 60% if these changes were made. What effect would Paul's plan have on the profits and the break-even point in dollars of the partnership?

(d)  

Which plan should be accepted? Explain your answer

Answer 1

• Peri's proposal Particulars Current Proposed Formula for Proposed Sales Units          240,000.00               300,000.00 (240000*125%) Selling price $                  5.00 $                      5.25 Sales Revenue $ 1,200,000.00 $       1,575,000.00 (300000*5.25) Less: Variable Cost 75% of COGS $   (600,000.00) $        (600,000.00) (800000*75%) 42% of Selling expenses $   (117,600.00) $        (117,600.00) (280000*42%) 40% of Administrative $      (60,000.00) $          (60,000.00) (150000*40%) Additional Cost on Raw Materials $          (75,000.00) (300000*.25) Total Variable Costs $   (777,600.00) $        (852,600.00) Contribution Margin $      422,400.00 $          722,400.00 (1575000-777600) Less: Fixed Cost 25% of COGS $   (200,000.00) $        (200,000.00) (800000*25%) 58% of Selling Expenses $   (162,400.00) $        (162,400.00) (280000*58%) 60% of Administrative $      (90,000.00) $          (90,000.00) (150000*60%) Total Fixed Cost $   (452,400.00) $        (452,400.00) Net Income $      (30,000.00) $          270,000.00 (722400-452400) Analysis Breakeven Dollars Contribution Margin Ratio 35.20% 45.87% (722400/1575000*100) Breakeven Dollars $ 1,285,225.00 $          985,519.50 (187718*5.25) Breakeven Units Variable cost per unit $                  3.24 $                      2.59 (777600/300000) Contribution Margin per unit $                  1.76 $                      2.41 (722400/300000) Breakeven Units (Rounded)                257,045                     187,718 (452400/2.41) Analysis 1. Variable Cost per unit decreases for an increase in volume 2. Contribution Margin increases due to increase in Selling Price & Units 3. As Contribution Margin per unit increases, Breakeven unit decreases 4. As Breakeven unit decreases, Breakeven in Dollars decrease 5. To a certain range Fixed cost does not change. However the production hits the upper limit of the range, Fixed cost increases and the above analysis does not hold good Paul's Proposal Particulars Current Proposed Formula for Proposed Sales Units          240,000.00               384,000.00 (240000*160%) Selling price $                  5.00 $                      4.75 Sales Revenue $ 1,200,000.00 $       1,824,000.00 (384000*4.75) Less: Variable Cost 75% of COGS $   (600,000.00) $        (600,000.00) (800000*75%) Selling expenses (Refer info in qn) $   (117,600.00) $        (414,720.00) (384000*(.49+.59)) 40% of Administrative $      (60,000.00) $          (60,000.00) (150000*40%) Total Variable Costs $   (777,600.00) $    (1,074,720.00) Contribution Margin $      422,400.00 $          749,280.00 (1824000-1074720) Less: Fixed Cost 25% of COGS $   (200,000.00) $        (200,000.00) (800000*25%) 58% of Selling Expenses $   (162,400.00) $        (122,400.00) (280000*58%)+40000 60% of Administrative $      (90,000.00) $          (90,000.00) (150000*60%) Total Fixed Cost $   (452,400.00) $        (412,400.00) Net Income $      (30,000.00) $          336,880.00 (749280-412400) Analysis Breakeven Dollars Contribution Margin Ratio 35.20% 41.08% (749280/1824000*100) Breakeven Dollars $ 1,285,225.00 $          985,519.50 (187718*5.25) Breakeven Units Variable cost per unit $                  3.24 $                      2.80 (1074720/384000) Contribution Margin per unit $                  1.76 $                      1.95 (749280/384000) Breakeven Units (Rounded)                257,045                     211,487 (412400/1.95) Analysis 1. Variable Cost per unit decreases for an increase in volume 2. Contribution Margin per unit increases due to increase in Selling Price & Units, however, it is not significant 3. As Contribution Margin per unit increases, Breakeven unit decreases 4. As Breakeven unit decreases, Breakeven in Dollars decrease