Chapter 4 - Cost Volume Profit
If fixed costs are equal to 0, what is the relationship between a company's contribution margin and operating income?
What is: They are equal
Define relevant costing and explain why it's important to utilize this concept in business.
What is:
Dollars that are in the future and different between alternatives.
Why: 1. Focus on only important factors that matter to the decision.
2. Don't waste time.
Fixed manufacturing overhead costs are recognized as period costs when incurred using
Variable costing
Emma's posters has the following information:
Sales $6,750
Variable cost per unit $5
Fixed costs $1,900
Operating income $1,100
What is the sales volume?
750 units - WORK backwards (start at operating inc)
Sales $6,750
VC 3,750 (6,750 - 3000)
CM $3,000 (OI 1,100 + FC 1,900)
Fixed costs 1,900 (given)
Operating inc 1,100 (given)
As variable costs are $3,750 and the cost per unit is $5, quantity = $3,750/5 = 750
The opportunity cost of holding significant inventory includes what?
- Missed investments in other businesses;
- Missed rental income on the space
etc.
What are two reasons companies would use variable costing?
- Focus management attention on short term controllable (variable) costs;
- Provide no incentive for inventory build up
- Easier
Retro Records was to earn an after tax profit of $112,500. The unit selling price is $20 and the variable cost per unit is $8. Fixed costs are $180,000 and the company's tax rate is 25%. How many records must Retro sell to achieve its income target?
27,500 records
Pretax profit = $112,500 / .75 = $150,000
150,000 + $180,000 = $330,000 /
$12 (CM unit = $20 - 8)
= 27,500 records
Pella Industries currently produces 1,000 units of a part needed for its product, incurring the following costs:
Direct Materials $50,000
Direct Labor 16,000
Variable Overhead 32,000
Fixed Overhead 18,000
If Pella Industries purchases the component externally, $10,000 of the fixed costs can be avoided. At what external price per unit for would Pella be indifferent between choosing to outsource (buy) instead of insource (make)?
Make
DM $50,000
DL 16,000
OH 32,000
Fixed OH 18,000
Total 116,000
Buy:
Purchase price XXXX
Fixed costs 8,000
Total to spend 116,000
Total purchase $108,000 / 1000 = 108
During 2025, KM Construction sold 10,000 units, with beginning and ending units for the year of 1,000. Manufacturing costs were as follows: Variable Fixed
Mfg costs per unit $11.00 $7.00
Operating costs/unit $3.00 $2.50
What is the difference in operating income between absorption and variable costing for the year?
0 - The difference in income is based on the change in inventory. As the quantity of inventory did not change during the year, there is no difference in income.
Emanuel's Electronics Co. has the following results for the month: Revenues equal $6,500, contribution margin equals $3,900, and fixed costs equal $3,300. Revenues are expected to grow by 10% next month. Using the principle of degree of operating leverage (DOL) and based on the projected revenue increase, what can Emanuel's Electronics expect in operating income next month?
$990
The DOL is calculated as contribution margin divided by operating income, or $3,900 ÷ $600 = 6.5. The sales increase of 10% must be multiplied by the DOL of 6.5 to get the multiplier to apply to operating income expected under 10% sales growth. That means operating income must be multiplied by 1.65 to arrive at expected operating income under the new revenue assumption. New operating income = $600 × $1.65 = $990.
Helmer's Rockets manufactures a standard and premium model. Weekly demand is 100 units for the standard, and 70 for the premium model. The following per unit data apply:
Standard Premium
Contribution margin $18 $20
MH required 3 4
Labor hours required 6 10
There are only 496 machine hours available per week. How many rockets of each type should Helmer produce?
100 standard, 49 premium Standard Premium
CM/CR $6 (1st) $5
Demand 100
* MH needed/unit 3
= MH used 300
Left over MH 196
/ MH per unit 4
Premium rockers made = 49
BioClinic sells its product for $80 per unit. During 2025, it produced 120,000 units and sold 105,000 units. Costs per unit are: direct materials $25, direct labor $10, variable overhead $5, and variable operating expenses $3. Fixed costs are $840,000 manufacturing overhead, and $75,000 operating expenses. What is the contribution margin using variable costing?
$3,885,000
Sales 105,000 * $80 = $8,400,000
Variable COS 105,000 * $40 = 4,200,000
Variable operating 105,000 * $3 = 315,000
CONTRIBUTION MARGIN $3,885,000
Minke Medical Machines sells three types of hospital equipment. Information on these machines is as follows:
Xray 50% of total sales CM/U $600
MRI 30% of total sales CM/U $400
CT Scan 20% of total sales CM/U $700
Total fixed costs for the year are $2,240,000. Based on this information, what would the expected break-even point for Minke Medical Machines be for the year?
4,000 units
The weighted average contribution margin is $560 as calculated here: ($600 × .50) + ($400 × .30) + ($700 × .20) = $300 + $120 + $140 = $560 WACM. This WACM is then divided into the annual fixed costs to determine the annual break-even point; $2,240,000 ÷ $560 = 4,000 units.
Clinton sells 2 products, A and B, is is considering dropping Product B. If product B is dropped, sales of product A are expected to increase 40%. Equipment rental will decrease $300 per month if product B is dropped. What is the impact of dropping Product B?
A B Total
Sales $10,000 $8,000 $18,000
Variable COS 4,500 3,200 7,700
Equipment rental 300 2,600 2,900
Allocated overhead 1,000 2,100 3,100
Operating income $4,200 $100 $4,300
$2,300 decrease in income
Clinton income without Product B
Sales $14,000 (40% increase from A)
Variable COS 6,300 (40% increase from A)
Equip rent 2,600 (300 decrease)
Overhead 3,100 (no change - fixed)
Operating income $2,000
This is $2,300 lower than the income including B
The following information applies to Beets Corporation:
Units produced 50,000
Beginning Inventory 1,000 Units
Ending Inventory 5,000 units
Direct materials per unit $20
Direct labor per unit $12
Variable manufacturing overhead per unit $5
Fixed manufacturing overhead $200,000
Variable operating expenses per unit $7
Fixed operating expenses $80,000
What is cost of sales using absorption costing? What is the difference in operating income between absorption and variable costing?
1. COS Absorption - $1,886,000
2. Difference in income = 16,000, ABS higher
Units sold 1,000 + 50,000 - 5,000 = 46,000
* cost/unit
DM $20, DM $12, VOH $5, FOH $4 (a) = $41
= Cost of sales $1,886,000
(a) $200,000/50,000 produced = $4U
2. Ending inventory 5,000 units
- Beg inventory 1,000
Change in inventory Quantity 4,000 units
* FOH per unit $4
= Difference in income $16,000 (ABS higher)