SOLUTION
Requirement 1
Variable Cost
Percent of Revenue
Financial planner
8%
Advertising
13%
Supplies and postage
3%
Usage fees
6%
Total
30%
If variable costs are 30% of revenues, then the contribution margin ratio is 70% of revenues.
Fixed costs = $8,900 + $2,000 + $2,400 + $1,000 + $2,800 + $17,900 = $35,000
Fixed costs + Target profit
$50,000
Requirement 1, cont.
Required sales in units
=
Required sales in dollars
Sales price per unit
Fixed costs + Target profit
P20-41B, cont.
Requirement 2
Net sales revenue
–
Variable costs
–
Fixed costs
=
Operating income
=
=
=
$47,600 / $700
=
($1,000 × 30%
Required sales in units
=
Required sales in units
×
Sales price per unit
=
68 trades
×
$1,000 per trade
=
$68,000
Requirement 3
$60,000
$70,000
$80,000
Breakeven
Point
P20-41B, cont.
Requirement 4
Required sales in units
=
Required sales in dollars
Sales price per unit
=
$50,000
=
25 trades
$2,000 per trade
Required sales in units
=
trades) / 50 trades].
P20-42B Calculating breakeven point for two products, margin of safety, and operating leverage
Learning Objectives 2, 4, 5
3. $81,000
The contribution margin income statement of Creative Donuts for May 2016 follows:
Creative sells two dozen plain donuts for every dozen custard-filled donuts. A dozen plain donuts sells
for $4.00, with a variable cost of $1.60 per dozen. A dozen custard-filled donuts sells for $8.00, with a
variable cost of $3.20 per dozen.
Requirements
1. Calculate the weighted-average contribution margin.
2. Determine Creative’s monthly breakeven point in dozens of plain donuts and custard-filled donuts.
Prove your answer by preparing a summary contribution margin income statement at the breakeven
level of sales. Show only two categories of costs: variable and fixed.
3. Compute Creative’s margin of safety in dollars for May 2016.
4. Compute the degree of operating leverage for Creative Donuts. Estimate the new operating income if
total sales increase by 40%. (Round the degree of operating leverage to four decimal places and the
final answer to the nearest dollar. Assume the sales mix remains unchanged.)
5. Prove your answer to Requirement 4 by preparing a contribution margin income statement with a
40% increase in total sales. (The sales mix remains unchanged.)
SOLUTION
Requirement 1
Plain
Donuts
Custard-Filled
Donuts
Total
Sales price per unit
$ 4.00
$ 8.00
Variable cost per unit
1.60
3.20
2.40
4.80
Sales mix in units
Contribution margin
$ 4.80
$ 9.60
Weighted-average contribution margin per unit
($9.60 per unit / 3 units)
$ 3.20
Requirement 2
Required sales in units
=
Fixed costs + Target profit
Contribution margin per unit
$3.20 per unit
Required sales in plain donuts
=
=
6,000 dz. plain donuts
=
=
3,000 dz. custard-filled donuts
Requirement 2, cont.
CREATIVE DONUTS
Contribution Margin Income Statement
Sales Revenue
[($4.00/dz. × 6,000 dz.) + ($8.00/dz. × 3,000 dz.)]
$ 48,000
Variable Costs
[($1.60/dz. × 6,000 dz.) + ($3.20/dz. × 3,000 dz.)]
Contribution Margin
Fixed Costs
Operating Income
$ 0
Requirement 3
Breakeven sales in dollars = $48,000 (from Requirement 2)
$129,000
P20-42B, cont.
Requirement 4
Degree of operating leverage
=
Contribution margin
Operating income
$77,400
=
1.5926
$48,600
Requirement 5
CREATIVE DONUTS
Contribution Margin Income Statement
For the Month Ended May 31, 2016
Continuing Problem
P20-43 Computing breakeven sales and sales needed to earn a target profit; performing sensitivity
analysis
This problem continues the Daniels Consulting situation from Problem P19-44 of Chapter 19. Daniels
Consulting provides consulting service at an average price of $120 per hour and incurs variable cost of
$60 per hour. Assume average fixed costs are $3,900 a month.
Requirements
1. What is the number of hours that must be billed to reach the breakeven point?
2. If Daniels desires to make a profit of $4,500, how many consulting hours must be completed?
3. Daniels thinks it can reduce fixed cost to $3,190 per month, but variable cost will increase to $62 per
hour. What is the new breakeven point in hours?
SOLUTION
Requirement 1
Required sales in units
=
Fixed costs + Target profit
Contribution margin per unit
=
Requirement 2
Required sales in units
=
Fixed costs + Target profit
Contribution margin per unit
Contribution margin per unit
Comprehensive Problem for Chapters 16–20
The Savannah Shirt Company makes two types of T-shirts: basic and custom. Basic shirts are plain
shirts without any screen printing on them. Custom shirts are created using the basic shirts and then
adding a custom screen printing design.
The company buys cloth in various colors and then makes the basic shirts in two departments, Cutting
and Sewing. The company uses a process costing system (weighted-average method) to determine the
production cost of the basic shirts. In the Cutting Department, direct materials (cloth) are added at the
beginning of the process and conversion costs are added evenly through the process. In the Sewing
Department, no direct materials are added. The only additional material, thread, is considered an
indirect material because it cannot be easily traced to the finished product. Conversion costs are added
evenly throughout the process in the Sewing
Department. The finished basic shirts are sold to retail stores or are sent to the Custom Design
Department for custom screen printing.
The Custom Design Department creates custom shirts by adding screen printing to the basic shirt. The
department creates a design based on the customer’s request and then prints the design using up to four
colors. Because these shirts have the custom printing added, which is unique for each order, the
additional cost incurred is determined using job order costing, with each custom order considered a
separate job.
For March 2016, the Savannah Shirt Company compiled the following data for the Cutting and
Sewing Departments:
For the same time period, the Savannah Shirt Company compiled the following data for the Custom
Design Department:
The Savannah Shirt Company has previously determined that creating and programming the design cost
$75 per design. This is a one-time charge. If a customer places another order with the same design, the
customer is not charged a second time. Additionally, the cost to print is $0.50 per color per shirt.
Requirements
1. Complete a production cost report for the Cutting Department and the Sewing Department. What is
the cost of one basic shirt?
revenue, and the total cost of goods sold for the basic shirts.
4. Calculate the total revenue and total cost of goods sold for all sales, basic and custom.
5. Assume the company sold only basic shirts (no custom designs) and incurred fixed costs of $1,403
per month.
a. Calculate the contribution margin per unit, contribution margin ratio, required sales in units to
break even, and required sales in dollars to break even.
b. Determine the margin of safety in units and dollars.
SOLUTION
Requirement 1
THE SAVANNAH SHIRT COMPANY
Production Cost Report―CUTTING DEPARTMENT
Month Ended March 31, 2016
Equivalent Units
UNITS
Whole
Units
Transferred
In
Direct
Materials
Conversion
Costs
Units to account for:
Beginning work-in-process
0
Started in production
Total units to account for
Units accounted for:
Completed and transferred out
Ending work-in–process
0
n/a
Total units accounted for
COSTS
Transferred
In
Direct
Materials
Conversion
Costs
Total
Costs
Costs to account for:
Beginning work-in-process
n/a
$ 0
$ 0
$ 0
Costs added during period
n/a
7,350
Total costs to account for
n/a
$ 2,445
$ 7,350
Divided by: Total EUP
n/a
Cost per equivalent unit
Costs accounted for:
Completed and transferred out
$ 2,445
$ 7,350
Ending work-in–process
Total costs accounted for
n/a
$ 2,445
$ 7,350
Comprehensive Problem, cont.
Requirement 1, con’t.
THE SAVANNAH SHIRT COMPANY
Production Cost Report―SEWING DEPARTMENT
Month Ended March 31, 2016
Equivalent Units
UNITS
Whole
Units
Transferred
In
Direct
Materials
Conversion
Costs
Units to account for:
Beginning work-in-process
250
Transferred in
1,500
Total units to account for
1,750
Units accounted for:
Completed and transferred out
1,250
Ending work-in–process
500
Total units accounted for
1,750
COSTS
Costs to account for:
Beginning work-in-process
Costs added during period
1,650
Total costs to account for
$ 10,525
Divided by: Total EUP
Cost per equivalent unit
Costs accounted for:
Completed and transferred out
Ending work-in–process
Total costs accounted for
$ 10,525
Comprehensive Problem, cont.
Requirement 2
Job
367
368
369
370
Totals
Quantity
50
250
150
100
Design Fee
Yes
No
Yes
Yes
Number of Colors
COSTS:
Basic shirt
($6.10 × Quantity)
Design Cost
($75 per order)
75
0
75
75
Printing Cost
($0.50 per color × Nbr. of Colors × Qty.)
100
250
225
100
Total Cost
480
1,775
1,215
785
$ 4,255
Cost per Shirt
(Total Cost / Quantity)
Sales Price per Shirt
(Cost per Shirt × 1.60)
Total Sales
(Sales Price per Shirt × Quantity)
768
Requirement 3
Sales price per unit
($6.10 per shirt × 1.40)
$8.54
Total Cost of Goods Sold
(1,250 basic shirts × $6.10 per shirt)
$ 7,625
Total Sales Revenue
(Total COGS × 1.40)
10,675
Total Gross Profit
(Total Revenue – Total COGS)
3,050
Requirement 4
Basic Shirts
Sales Revenue
$ 6,808
Cost of Goods Sold
Gross Profit
$ 2,553
Comprehensive Problem, cont.
Requirement 5a
Contribution margin per unit
=
Sales price
–
Variable costs
=
$8.54
–
$6.10
=
$2.44
Contribution margin ratio
=
/
Net sales revenue
=
/
=
28.57%
Fixed costs + Target profit
$1,403 + $0
Required sales in dollars
=
Required sales in units
×
Sales price per unit
=
575 shirts
×
$8.54
=
$4,910.50
Requirement 5b
Expected sales
Breakeven sales
=
Margin of safety in units
=
675 shirts
Margin of safety in units
×
Sales price per unit
=
Margin of safety in dollars
675 shirts
×
$8.54
=
Comprehensive Problem, cont.
Requirement 5c
$10,000
$12,000
Comprehensive Problem, cont.
Requirement 5d
Required sales in dollars
=
Fixed costs + Target profit
Contribution margin ratio
=
=
Fixed costs + Target profit
Requirement 6
Target cost
=
Target sales price
–
Desired profit
=
$1.25
–
($1.25 × 0.40)
=
$1.25
–
=
$0.75
greater than the desired 40%.
Critical Thinking
Decision Case 20-1
Steve and Linda Hom live in Bartlesville, Oklahoma. Two years ago, they visited Thailand. Linda, a
Requirements
1. Compute the annual breakeven number of meals and sales revenue for the restaurant.
2. Compute the number of meals and the amount of sales revenue needed to earn operating income of
$75,600 for the year.
3. How many meals must the Homs serve each night to earn their target profit of $75,600?
4. What factors should the Homs consider before they make their decision as to whether to open the
restaurant?
SOLUTION
Requirement 1
Annual fixed costs = $150,000
–
–
Fixed costs
=
($45 × Nbr. of meals)
–
($15 × Nbr. of meals)
–
$150,000
=
=
=
=
$150,000 / $30
=
Monthly fixed costs = $5,100 + $4,000 + $800 + $300 + $2,300 = $12,500
Breakeven sales in units = 5,000 meals
Required sales in dollars
=
Required sales in units
×
Sales price per unit
=
5,000 meals
×
$45 per meal
=
$225,000
Requirement 2
Unit contribution margin
=
Net sales revenue per meal
–
Variable costs per meal
=
$45 per meal
–
$15 per meal
=
$30 per meal
Contribution margin per unit
Required sales in dollars
=
Required sales in units
×
Sales price per unit
=
7,520 meals
×
$45 per meal
=
$338,400
Decision Case 20-1, cont.
Requirement 3
Nbr. of operating days
=
5 days per week
×
50 weeks
=
250 days
Required meals per day
=
/
=
/
=
30.08 meals per day, rounded up to 31 meals per day
Requirement 4
Target profit of $75,600 appears to be realistic if the restaurant can attract customers. The
restaurant has adequate seating for 56 meals per night (7 tables × 4 seats × 2 seatings), and the
Hom’s only need to serve 31 meals per night to achieve their target income.
Ethical Issue 20-1
You have just begun your summer internship at Omni Instruments. The company supplies sterilized
surgical instruments for physicians. To expand sales, Omni is considering paying a commission to its
sales force. The controller, Matthew Barnhill, asks you to compute: (1) the new breakeven sales figure,
and (2) the operating profit if sales increase 15% under the new sales commission plan. He thinks you
can handle this task because you learned CVP analysis in your accounting class.
Requirements
1. How would your error affect breakeven sales and operating income under the proposed sales
commission plan? Could this cause the president to reject the sales commission proposal?
2. Consider your ethical responsibilities. Is there a difference between: (a) initially making an error and
(b) subsequently failing to inform the controller?
3. Suppose you tell Matthew Barnhill of the error in your analysis. Why might the consequences not be
as bad as you fear? Should Barnhill take any responsibility for your error? What could Barnhill have
done differently?
4. After considering all the factors, should you inform Barnhill or simply keep quiet?
SOLUTION
Requirement 1
Omitting the fixed marketing expenses understates fixed costs. This means the breakeven point
Requirement 2
The initial error was an unintentional mistake. The initial error may reflect a lack of competence,
Requirement 3
Informing the controller may not result in such a negative outcome, especially if the new plan
Ethical Issue 20-1, cont.
Requirement 4
In addition to the ethical issue of informing the controller or not, another factor should be
If the intern does not inform Barnhill, then the error may remain undetected and the intern will
have to live with this uncertainty. A more likely outcome is that the error will be discovered
Team Project 20–1
Select a nearby company. Arrange an interview for your team with a managerial accountant, a
controller, or another accounting/finance officer of the company.
Requirements
Before your team conducts the interview, research the company and answer the following questions:
1. Is this a service, merchandising, or manufacturing company? What is its primary product or service?
At the interview, ask the above questions and compare your team’s answers to the company’s answers.
Then ask the following questions:
5. How does the company determine the sales prices of products and services?
6. What is the company’s cost structure? Does the company have relatively high or low fixed costs?
7. What is the company’s sales mix? Has the sales mix changed recently? If so, what caused the
change?
Your team should summarize your findings in a short paper. Provide any exhibits that enhance your
explanations. Provide proper references and a works cited page.
SOLUTION