12. What amount of sales in dollars must Boxware achieve each month in order to break even?
a. $95,000
b. $190,000
c. $285,000
d. $380,000
13. How many units per month must Boxware sell in order to make a $110,000 profit?
a. 500
b. 1,000
c. 1,500
d. 2,000
Use the following information to answer the next three questions: Derek’s Drum Depot (DDD)
wants to add a new line of drumsticks to its product line. The following data apply to the new
drumsticks line.
Budgeted sales 30,000 sets per year
Sales price $5 per set
Variable costs $3 per set
Fixed costs $10,000 per year
14. The break-even point for the new line is _______ sets per year.
a. 500 sets
b. $5,000
c. 15,000 sets
d. 5,000 sets
15. The margin of safety for DDD is
a. 83%
b. 15,000 sets
c. 19%
d. 6,000 sets
16. How many sets of drumsticks must DDD sell to make a profit of $50,000 on the new line?
a. 2,000 units
b. 10,000 units
c. 20,000 units
d. 30,000 units
Use the following data for Fireware Software Corporation to answer the next three questions:
Sales price per unit $44.95
Variable manufacturing cost per unit $17.03
Variable sales commissions per unit $ 3.20
Variable shipping expense per unit $ 1.14
Fixed administrative cost, per month $12,200
Other fixed costs, per month $2,269
Average production 2,100 units per month
17. What is the amount of contribution margin per unit, based on this information?
a. $21.37
b. $23.58
c. $27.92
d. $24.72
18. How many units must Fireware sell in order to break even? (round to the nearest whole unit)
a. 308
b. 500
c. 614
d. 620
19. How many units must Fireware sell in order to make a $50,000 profit? (Round to the nearest whole unit.)
a. 505
b. 1,090
c. 1,708
d. 2,734Solutions to Quiz Questions
Question
Answer
1
A
2
B
3
C
4
D
5
B
6
C
7
C
8
B
9
C
10
B
11
A
12
A
13
C
14
D
15
A
16
D
17
B
18
C
19
D
Demonstration Problems for Chapter 11
Demonstration Problem 11-1
Applying Cost Behavior Concepts to Business Decisions
Art On Tour, Inc. (AOTI) contracts with artists to exhibit their work to the public. AOTI has
agreed to pay a well known artist a $20,000 commission for the right to exhibit his work for one
month.
Required
Part a – Identifying Cost Behavior
1. Determine the total commission cost and the commission cost per person if 1,000, 2,000, or
4,000 people attend the exhibition. Is the commission cost fixed or variable?
2. AOTI sells to patrons books illustrating the artist’s work. The books cost AOTI $5 each.
Determine the total cost of books and the cost per person if 1,000, 2,000, or 4,000 people attend
the exhibition and wish to purchase the books. Is the book cost fixed or variable?
Part b – Operating Leverage and Risk/Reward Relationship
1. AOTI pays an artist a $20,000 commission. It sells 4,000 tickets at $6 each. Prepare an income
statement. Then prepare revised income statements assuming 10 percent more than 4,000 and
10 percent fewer than 4,000 patrons attend the exhibition. Calculate the percentage changes
in revenue and net income if attendance increases or decreases 10 percent.
2. Alternatively, AOTI pays the artist a commission of $5 per ticket sold. It sells 4,000 tickets at
$6 each. Prepare an income statement. Then prepare revised income statements assuming 10
percent more than 4,000 and 10 percent fewer than 4,000 patrons attend the exhibition.
Calculate the percentage change in revenue and net income if attendance increases or decreases
10 percent.
Part c —Fixed and Variable Cost Definitions are Context Sensitive
1. AOTI pays the artist a commission of $20,000 per exhibition. What is the total commission
cost and the commission cost per person if 1,000, 2,000, or 4,000 people attend the exhibition?
(Same as part a.1.)
2. AOTI pays the artist a commission of $20,000 per exhibition. What is the total commission
cost and the commission cost per exhibition if AOTI sponsors 1, 2, or 3 exhibitions?
Demonstration Problem 11-2 Effect of Cost Structure
My Company / Your Company
My Company and Your Company provide rafting tours on Big Bear River. My Company pays
tour guides fixed salaries. It budgets salaries expense at $160,000 per year. Your Company pays
tour guides $40 per rafter served. Rafters are charged $50 per tour. Both companies expect to
carry approximately 4,000 rafters during the year.
Required
a. Prepare budgeted annual income statements for the two companies.
b. In an effort to lure rafters away from Your Company, My Company lowers the price per rafter
to $39. Prepare revised income statements for both companies. Assume that My Company
serves 6,000 rafters who each pay $39 per tour, while Your Company serves only 2,000 rafters
who pay $50 per tour.
c. Assume you are president of Your Company. Offer defensive strategies.
d. Suppose Your Company matches the $39 price set by My Company. Prepare income
statements for both companies assuming that each company serves 4,000 customers.
Demonstration Problem 11-3 Effect of Operating Leverage
Sharon Virgil owns a delivery service company. She charges customers $10 per delivery. The
company’s variable expenses average $2 per delivery and fixed costs are $600 per month. Ms.
Virgil provided 100 deliveries during the most recent month.
Required
a. Prepare an income statement using a contribution margin format.
b. Determine the magnitude of operating leverage. Use your answer to determine the percentage
change in net income if sales increase by 10%.
c. Assume that sales increase by 10% (deliveries increase to 110). Prepare a contribution margin
format income statement assuming 110 deliveries. Calculate the percentage change in net income
and compare your answer with your solution to part b.
Demonstration Problem 11-4 Cost-Volume-Profit Analysis
Jeff Jamail is evaluating a business opportunity to sell cookware at trade shows. Mr. Jamail can
buy the cookware at a wholesale cost of $210 per set. He plans to sell the cookware for $350 per
set. He estimates fixed costs such as plane fare, booth rental cost, and lodging to be $5,600 per
trade show.
Required
a. Determine the number of cookware sets Mr. Jamail must sell at a trade show to break even
(zero profit or loss). Use the following structure to answer this question:
(1) Contribution Margin Per Unit Approach:
a. Determine the amount of the contribution margin per unit.
b. Explain that when the total contribution margin is sufficient to pay for the fixed cost,
Mr. Jamail will break even. Show the computation of break-even in units.
c. Show how to compute the break-even point in number of dollars using the break-even
point in units and the selling price.
d. Confirm the results by preparing an income statement.
(2) Contribution Margin Ratio Approach.
a. Calculate the contribution margin ratio.
b. Use the ratio to calculate the break-even point in sales dollars, then use the results and
the selling price to calculate the break-even point in units.
(3) Equation Approach.
a. Calculate the break-even point in units.
b. Calculate the break-even point in sales dollars.
b. Assume Mr. Jamail desires to earn a profit of $4,900 per show.
(1) Determine the sales volume in units (sets of cookware) necessary to earn the desired profit.
(2) Determine the sales volume in dollars necessary to earn the desired profit.
(3) Using the contribution margin format, prepare an income statement to confirm your
answers to parts 1 and 2.
c. Determine the margin of safety between the sales volume at the break-even point and the sales
volume required to earn the desired profit. Determine the margin of safety both in sales
dollars and as a percentage.
d. After researching the market, Mr. Jamail concludes that the $350 per set selling price is too
high. Customers will likely pay only $310 per set. Mr. Jamail believes he can obtain a cost
reduction from his supplier of $20 per set (variable cost drops from $210 per set to $190 per
set) and still provide the level of quality required to achieve a sales volume of 75 sets. Under
these circumstances, what amount of fixed costs can Mr. Jamail incur and still obtain the
target profit of $4,900? Support your answer with appropriate computations.
Demonstration Problem 11-1 Solution
a.1.
Number of People Attending (a)
1,000
2,000
4,000
Total Commission Cost (b)
$20,000
$20,000
$20,000
Average Commission Cost Per Person (b ÷ a)
$20
$10
$5
Type of cost: because the total commission cost remains constant
at $20,000 regardless of the number of people attending, it is a fixed
cost.
a.2.
1,000
2,000
4,000
$5,000
$10,000
$20,000
$5
$5
$5
Type of cost: because the total cost changes in direct proportion
with the number of people receiving books, it is a variable cost.
b.1.
Number of Tickets Sold
3,600
% Change
4,000
% Change
4,400
Revenue ($6 Per Ticket)
$21,600
(10%)
$24,000
+10%
$26,400
Commission Cost (Fixed)
20,000
20,000
20,000
Net Income
$ 1,600
(60%)
$ 4,000
+60%
$ 6,400
Percentage Change in Revenue: + $2,400 ÷ $24,000 = + 10%
Percentage Change in Net Income: + $2,400 ÷ $4,000 = + 60%
b.2.
Number of Tickets Sold
3,600
% Change
4,000
% Change
4,400
Revenue ($6 Per Ticket)
$21,600
(10%)
$24,000
+10%
$26,400
Commission Cost (Variable)
18,000
20,000
22,000
Net Income
$ 3,600
(10%)
$ 4,000
+10%
$ 4,400
Percentage Change in Revenue: + $2,400 ÷ $24,000 = +10%
Percentage Change in Net Income: + $400 ÷ $4,000 = +10%
Demonstration Problem 11-1 Solution continued
c.1. (Same as part a.1.)
Number of People Attending (a)
1,000
2,000
4,000
Total Commission Cost (b)
$20,000
$20,000
$20,000
Average Commission Cost Per Person (b ÷ a)
$20
$10
$5
Type of cost: because the total commission cost remains constant at
$20,000 regardless of the number of people attending, it is a fixed cost.
c.2.
Number of Exhibitions (a)
1
2
3
Total Expected Commission Cost (a x b)
$20,000
$40,000
$60,000
Cost Per Exhibition (b)
$20,000
$20,000
$20,000
Type of cost: because the total cost changes in direct proportion with
the number of exhibitions, it is a variable cost.
Note carefully, a given cost (the artist’s commission) can be fixed or
variable depending upon the context.Demonstration Problem 11-2
Solution
a.
My
Company
Your
Company
Number of Rafters (a)
4,000
4,000
Revenue ($50 x a)
$200,000
$200,000
Cost of Guides My Company
Fixed
(160,000)
Cost of Guides Your Company ($40 x a)
Variable
(160,000)
Net income
$ 40,000
$ 40,000
b.
My
Company
Your
Company
Number of Rafters (a)
6,000
2,000
Revenue My Company ($39 x a)
$234,000
Revenue Your Company ($50 x a)
$100,000
Cost of Guides My Company
Fixed
(160,000)
Cost of Guides Your Company ($40 x a)
Variable
(80,000)
Net Income
$ 74,000
$ 20,000
My Company was able to increase total revenue because the decrease
in price was offset by an increase in volume. In other words, 6,000
customers paying $39 each produce more revenue ($234,000) than do
Company out of business. My Company stands to gain an additional
$78,000 ($39 x 2,000) of revenue when it takes over Your Company’s
c.
The most common strategy students offer is to create product
differentiation. Many variations of this strategy are possible. Your
Company could use a different type of raft, travel different routes,
Students also commonly suggest cutting costs by paying the tour
guides less. Students often offer strategies involving employees
Occasionally someone suggests a merger. The merged company
could retain the salaried tour guides and dismiss those paid on a
The response that applies most directly to the subject of cost behavior
is for Your Company to match My Company’s price and hold firm. As
d.
My
Company
Your
Company
Number of Rafters (a)
4,000
4,000
Revenue ($39 x a)
$156,000
$156,000
Cost of Guides My Company
Fixed
(160,000)
Cost of Guides Your Company ($40 x a)
Variable
(160,000)
Net Loss
$ (4,000)
$ (4,000)
Demonstration Problem 11-3 Solution
a. Income Statement Using a Contribution Margin Format, Volume
of 100 Deliveries
Revenue ($10 x 100 deliveries)
$1,000
Variable Expenses ($2 x 100 deliveries)
(200)
Contribution Margin
800
Fixed Expenses
(600)
Net Income
$ 200
b. Magnitude of Operating Leverage = Contribution Margin ÷ Net
Income:
Therefore, a 10% increase in sales will produce a 40% (10% x 4)
c. Income Statement Using a Contribution Margin Format, Volume
of 110 Deliveries
Revenue ($10 x 110 deliveries)
$1,100
Variable Expenses ($2 x 110 deliveries)
(220)
Contribution Margin
880
Fixed Expenses
(600)
Net Income
$ 280
(Alternative Net Income − Base Net Income) ÷ Base
($280 − $200) ÷ $200 = 40%
The answer to part c confirms the answer determined in part b.
Demonstration Problem 11-4 Solution
a. Break-even point
(1) Contribution Margin Per Unit Approach
(a) Determine the contribution margin per unit.
Per Unit Contribution Margin
Sales Price
$350
Variable Cost
210
Contribution Margin
$140
(b) When the total contribution margin is sufficient to pay for the
fixed costs, Mr. Jamail will break even. The number of units
required to break even can be computed as follows:
Formula for Computation of Break-Even Point in Units
Fixed Cost
$5,600
⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯⎯
=
⎯⎯⎯⎯
=
40 sets
Contribution Margin Per Unit
$140
(c) The break-even point in number of dollars can be computed as
follows:
Break-Even Point in Sales Dollars
Sales Price Per Unit
$ 350
Times Number of Units
40
Sales Volume in Dollars
$14,000
(d) Confirm the results by preparing an income statement.
Income Statement
Sales (40 x $350)
$14,000
Variable Cost (40 x $210)
(8,400)
Contribution Margin
5,600
Fixed Cost
(5,600)
Net Income
$ 0
Demonstration Problem 11-4 Solution continued
(2) Contribution Margin Ratio Approach