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SOLUTION
(20 min.) Gross margin and contribution margin.
1. Ticket sales ($24
´
525 attendees) $12,600
2. Ticket sales ($24
´
1,050 attendees) $25,200
3-53 Ethics, CVP analysis. Megaphone Corporation produces a molded plastic casing,
M&M101, for many cell phones currently on the market. Summary data from its 2017 income
statement are as follows:
Joshua Kirby, Megaphone’s president, is very concerned about Megaphone Corporation’s poor
profitability. He asks Leroy Gibbs, production manager, and Tony DiNunzo, controller, to see if
there are ways to reduce costs.
After 2 weeks, Leroy returns with a proposal to reduce variable costs to 55% of revenues by
reducing the costs Megaphone currently incurs for safe disposal of wasted plastic. Tony is
concerned that this would expose the company to potential environmental liabilities. He tells
Leroy, “We would need to estimate some of these potential environmental costs and include them
in our analysis.” “You can’t do that,” Leroy replies. “We are not violating any laws. There is
some possibility that we may have to incur environmental costs in the future, but if we bring it
up now, this proposal will not go through because our senior management always assumes these
costs to be larger than they turn out to be. The market is very tough, and we are in danger of
shutting down the company and costing all of us our jobs. The only reason our competitors are
making money is because they are doing exactly what I am proposing.”
Required:
1. Calculate Megaphone Corporation’s breakeven revenues for 2017.
2. Calculate Megaphone Corporation’s breakeven revenues if variable costs are 55% of
revenues.
3. Calculate Megaphone Corporation’s operating income for 2017 if variable costs had been 55%
of revenues.
4. Given Leroy Gibbs’s comments, what should Tony DiNunzo do?
SOLUTION
(30 min.) Ethics, CVP analysis.
1. Contribution margin percentage =
Revenues osts
Revenues
Variable c
=
$5, 000, 000 $3, 250, 000
$5,000,000
-
=
$1,750,000
$5,000,000
= 35%
Breakeven revenues =
percentagemargin on Contributi
costs Fixed
=
$1,890,000
0.35
= $5,400,000
2. If variable costs are 55% of revenues, contribution margin percentage equals 45%
(100% 55%)
Breakeven revenues =
percentagemargin on Contributi
costs Fixed
=
$1,890,000
0.45
= $4,200,000
3. Revenues $5,000,000
4. Incorrect reporting of environmental costs with the goal of continuing operations is
Competence
Clear reports using relevant and reliable information should be prepared. Preparing reports on
Integrity
The management accountant has a responsibility to avoid actual or apparent conflicts of interest
Credibility
The management accountant’s Standards of Ethical Conduct require that information should be
3-54 Deciding where to produce. (CMA, adapted) Portal Corporation produces the same
power generator in two Illinois plants, a new plant in Peoria and an older plant in Moline. The
following data are available for the two plants:
All fixed costs per unit are calculated based on a normal capacity usage consisting of 240
working days. When the number of working days exceeds 240, overtime charges raise the
variable manufacturing costs of additional units by $3.00 per unit in Peoria and $8.00 per unit in
Moline.
Portal Corporation is expected to produce and sell 192,000 power generators during the
coming year. Wanting to take advantage of the higher operating income per unit at Moline, the
company’s production manager has decided to manufacture 96,000 units at each plant, resulting
in a plan in which Moline operates at maximum capacity (320 units per day × 300 days) and
Peoria operates at its normal volume (400 units per day × 240 days).
Required:
1. Calculate the breakeven point in units for the Peoria plant and for the Moline plant.
2. Calculate the operating income that would result from the production manager’s plan to
produce 96,000 units at each plant.
3. Determine how the production of 192,000 units should be allocated between the Peoria and
Moline plants to maximize operating income for Portal Corporation. Show your calculations.
SOLUTION
(35 min.) Deciding where to produce.
Peoria Moline
Selling price $150.00 $150.00
Variable cost per unit
Manufacturing $72.00 $88.00
Fixed costs per unit
Manufacturing 30.00 15.00
1.
Annual fixed costs = Fixed cost per unit
´
Daily
´
($49
´
400 units
´
240 days;
´
´
¸
¸
2.
Normal annual volume (units)
CM from overtime production units
(0; 19,200
´
$40)
0 768,000
Total contribution margin 6,144,000 4,454,400
3. The optimal production plan is to produce 120,000 units at the Peoria plant and 72,000
units at the Moline plant. The full capacity of the Peoria plant, 120,000 units (400 units × 300
days), should be used because the contribution from these units is higher at all levels of
production than is the contribution from units produced at the Moline plant.
Contribution margin per plant:
Peoria, 96,000 × $64 $ 6,144,000
The contribution margin is higher when 120,000 units are produced at the Peoria plant and
Try It 3-1 Solution
Equation Method:
Selling Quantity of Variable cost Quantity of Fixed Operating
price units sold per unit units sold costs income
é ù
æ ö æ ö æ ö æ ö
´ - ´ - =
ê ú
ç ÷ ç ÷ ç ÷ ç ÷
è ø è ø è ø è ø
ë û
Operating income =
Contribution Method:
Operating income = $100 × 2,000 – $150,000 = $50,000
Try It 3-2 Solution
Breakeven Fixed costs $150,000 1,500 units
number of units Contribution margin per unit $100 per unit
= = =
Breakeven revenues Breakeven number of units Selling price
1,500 units $500 per unit $750, 000
= ´
= ´ =
(b)
Selling Quantity of Variable cost Quantity of Fixed Operating
price units sold per unit units sold costs income
é ù
æ ö æ ö æ ö æ ö
´ - ´ - =
ê ú
ç ÷ ç ÷ ç ÷ ç ÷
è ø è ø è ø è ø
ë û
(Equation 1)
We denote by Q the unknown quantity of units Bernard Windows must sell to earn an
operating income of $100,000. Selling price is $500, variable cost per package is $400, fixed
Target Target
Target net income Tax rate
operating income operating income
Target net income (Target operating income) (1 Tax rate)
Target net income $63,000
Target operating income 1 Tax rate 1
æ æ æ æ
= ´
æ æ æ æ
æ æ æ æ
= ´
= =
$90,000
0.30
=
In other words, to earn a target net income of $63,000, Bernard Windows’s target operating
Proof: Target operating income $90,000
The key step is to take the target net income number and convert it into the corresponding target
operating income number. We can then use equation 1 to determine the target operating income
Budgeted Breakeven
Margin of safety $1,200,000 $750, 000 $450,000
revenues revenues
Margin of Budgeted Breakeven 2, 400 1,500 900 units
safety (in units) sales (units) sales (units)
= - = - =
= - = - =
The margin of safety indicates that sales would have to decrease by 900 units and revenues by
$450,000 before the breakeven point is reached.
Sometimes margin of safety is expressed as a percentage:
( )
Margin of safety in dollars
Margin of safety percentage Budgeted or actual revenues
=
In our example, margin of safety percentage
$450,000 37.5%
$1, 200, 000
= =
Try It 3-5 Solution
At any given level of sales,
Degree of Contribution margin
operating leverage Operating income
=
The following table shows the degree of operating leverage at sales of 2,500 units for the two
options.
Option 1
No Commission
Option 2
5% Commission
1. Selling price $ 500 $ 500
2. Variable cost ($400; $400 + 0.05 × $500) $ 400 $ 425
3. Contribution margin per unit $ 100 $ 75
These results indicate that, when sales are 2,500 units, a 1% change in sales and contribution
margin will result in 2.5% change in operating income for Option 1. For Option 2, a 1% change
We assume that the budgeted sales mix (2,500 units of Chad Windows sold for every 1,000 units
of Musk Windows sold, that is, a ratio of 5:2) will not change at different levels of total unit
Each bundle yields a contribution margin of $650, calculated as follows:
Number of Units of
Chad Windows and
Musk Windows in
Each Bundle
Contribution Margin
per Unit for Chad
Windows and Musk
Windows
Contribution
Margin of the
Bundle
Chad Windows 5 $100 $500
Musk Windows 2 75 150
Total $650
To compute the breakeven point, we calculate the number of bundles Bernard needs to sell.
Breakeven Fixed costs $195,000
point in 300 bundles
Contribution margin per bundle $650 per bundle
bundles
= = =
The breakeven point in units of Chad Windows and Musk Windows is as follows:
The breakeven point in dollars for Chad Windows and Musk Windows is as follows:
When there are multiple products, it is often convenient to use the contribution margin
percentage. Under this approach, Bernard also calculates the revenues from selling a bundle of 5
units of Chad Windows and 2 units of Musk Windows:
Number of Units of
Chad Windows and
Musk Windows in Each
Bundle
Selling Price for Chad
Windows and Musk
Windows
Revenue of the
Bundle
Contribution
margin Contribution margin of the bundle $650 0.203125, or 20.3125%
percentage for Revenue of the bundle $3, 200
the bundle
= = =
Breakeven Fixed costs $195, 000 $960, 000
revenues Contribution margin % for the bundle 0.203125
= = =
Number of bundles Breakeven revenues $960,000
required to be sold 300 bundles
Revenue per bundle $3, 200 per bundle
to break even
= = =
The breakeven point in units and dollars for Chad Windows and Musk Windows are as follows:
