ACCT 2302

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• ACCT 2302
• Fundamentals of Accounting II
• Spring 2011
• Lecture 7
• Professor Jeff Yu

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Review The Contribution Format Income Statement
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Review The Contribution Margin Method
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Review The Equation Method
Let B.E.P. in units X
Sales Variable Expenses Fixed Expenses NOI
0
VC/unit X
Price X
B.E.P in sales dollars B.E.P. in Units Price
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CVP Analysis Changes in Break-even Point

• How can a company change its break-even point?
• 1. If fixed costs change by X, then break-even
  point would also change by X (assuming
  everything else remains constant)
• 2. An increase or decrease in CM per unit will
  also change break-even point.

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CVP Analysis predicting profit

• Expected profit (NOI) may change due to
• a change in fixed expenses
• a change in CM per unit (price - VC/unit)
• a change in sales volume
• once the break-even point has been reached, NOI
  will increase by CM per unit for each additional
  unit sold.
• Two approaches to predict profit using CVP
  analysis
• Income Statement approach
• Incremental approach

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Example
Razor Inc. is currently selling 500 scooters per
month. The owner believes that an increase of
10,000 in the monthly advertising budget would
increase sales of scooters to 540 per month. Q
Should the increase in advertising be made?
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Margin of Safety
The amount by which sales can drop before losses
are incurred.

• Margin of Safety in units
• Budgeted or actual units sold Break-even
  point in units
• Margin of Safety in sales dollars
• Budgeted or actual sales Break-even point in
  sales dollars
• Margin of Safety percentage
• Margin of Safety in units / Budgeted or actual
  units sold
• Margin of Safety in sales dollars / Budgeted or
  actual sales

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Example

• Coffee Klatch is an espresso stand in a
  downtown office building. The price of a cup of
  coffee is 1.5 and the variable expense per cup
  is 0.36. The fixed expense per month is 1,140.
  Each month 2,000 cups are sold.
• Q (1) What is the margin of safety in cups?
• (2) Margin of safety in sales dollars?
• (3) Margin of safety percentage?

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Operating Leverage

• A measure of how sensitive net operating
  income is to percentage changes in sales.

Thought Question How will cost structure
(relative proportion of fixed costs) or sales
volume affect the degree of operating leverage?
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Example
Q (1) What is the degree of operating leverage?
(2) If sales increase by 10, net operating
income will increase by ___?
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Sales Mix and Break-even Analysis
The sales mix is the relative proportions in
which a companys multiple products are sold.
Profits will often be greater if high-margin
items make up a larger proportion of total
sales. For simplicity, we assume sales mix is
always CONSTANT, that is, the relative
proportions of each product as a percentage of
total sales do not change as sales volume
changes.
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Example
Okabee Co. makes two products A100 B900.
Q Based on the current sales mix, (1)
What is its break-even point in total sales
dollars? (2) Prepare a contribution format
income statement for Okabee. (3) If sales
increase by 50,000 per month, by how much would
you expect net operating income to increase?
A100 B900 Total
Sales 700,000 300,000 1,000,000
CM Ratio 60 70 ?
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Practice Problem
Razor sells scooters and bicycles. Total fixed
cost is 95,000. Q What is Razors breakeven
point based on the current sales mix (for every 1
bicycle sold, 2 scooters are sold)?
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For Next Class

• Review for Midterm Exam 1

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Homework Problem 1
Acoustic Concepts is currently selling 400
speakers per month monthly sales are 100,000.
Variable cost per speaker is 60 of the speaker
price. The sales manager feels that a 10,000
increase in the monthly advertising budget would
increase monthly sales by 30,000. Q Should
the advertising budget be increased?
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Homework Problem 2
In 2008, Voltar Co. sold 20,000 units of a
special telephone at 60 each, variable expenses
were 900,000 and fixed expenses were 240,000.
Q(1) Sales are expected to increase by
400,000 in 2010. If cost behavior remain
unchanged, by how much will NOI increase in
2010? (2) Compute its margin of safety in
dollars and percentages. (3) Compute its
degree of operating leverage at current sales
volume. (4) If sales increase by 8 in 2011,
by what will NOI increase? (5) If a
high-quality speaker is used, annual sales will
increase by 20, variable cost will increase by
3 per unit, but annual salary of 30,000 paid to
one quality inspector can be eliminated. Should
the change be made?
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Homework Problem 3
Pittman Co. produces two products, A and B.
Product A accounts for 20 of total sales, while
B accounts for 80 of sales. Variable expense
ratios are 75 for A and 50 for B. Pittmans
total fixed cost is 90,000. Q Based on the
current sales mix, (1) What is its break-even
point in total sales? (Hint CM ratio 1
variable expense ratio) (2) Assume the unit
price of product B is 24, how many units of B
should Pittman sell to break even?