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Test Bank Docx Chapter.4 Cost Volume Profit Analysis 1e

CHAPTER 4

COST-VOLUME-PROFIT ANALYSIS

CHAPTER LEARNING OBJECTIVES

Calculate the contribution margin and break-even sales point.
Describe CVP analysis, its assumptions, the relevant range, and the margin of safety.
Practice using the standard and modified break-even formulas, with and without target profit and taxes, in CVP calculations.
Modify the break-even formula for scenarios with multiple products.
Demonstrate how sensitivity analysis assists decision-makers in answering “what-if” questions.
Apply CPV analysis in service and nonprofit organizations.

Current count is:

Knowledge: 42

Comprehension: 32

Application: 110

Analysis: 11

Evaluation: 2

Synthesis: 0

Total: 197

Number and percentage of questions:

Easy: 52 questions, 26 percent (target of 25%)

Medium: 126 questions, 64 percent (target of 65%)

Hard: 19 questions, 10 percent (target of 10%)

Question types:

Multiple Choice: 121

Brief Exercises: 28

Exercises: 20

Problems: 9

Short Answer: 19

MULTIPLE CHOICE QUESTIONS

Contribution margin is defined as revenue less
1. all costs.
2. variable costs.
3. fixed costs.
4. cost of goods sold.

Ans: B, LO 1, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: Contribution margin is defined as revenue less variable costs.

Total fixed costs are $24,000. The selling price per unit is $10, while variable costs per unit

are $6. Break even in units is

1. 1,500.
2. 4,000.
3. 6,000.
4. 8,000.

Ans: C, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Knowledge, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Break-even is equal to fixed costs ($24,000) divided by contribution margin per unit ($10 − $6 = $4) = 6,000 units.

To break even is to generate enough in sales revenue to cover
1. fixed costs only.
2. variable costs only.
3. fixed and variable costs with no profit.
4. fixed and variable costs with a small profit left over.

Ans: C, LO 1, Bloom: K, Difficulty: Easy, AACSB: Analytic, AICPA: FC: Measurement Analysis and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: At break-even, sales less all costs equals zero.

Atoll Fish Market has fixed costs of $60,000. Variable cost per fish sold is $5, while the selling

price per fish is $15. What is operating income (loss) if 7,100 fish are sold?

1. ($49,000)
2. ($41,000)
3. $11,000
4. $46,500

Ans: C, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: First calculate breakeven, which is 6,000 units (fixed costs of $60,000 ÷ unit contribution margin of $10 ($15 − $5). Actual unit sales are 7,100

units, which is 1,100 units above break-even; 1,100 units unit contribution margin of $10 = $11,000.

In calculating the contribution margin, variable selling and administrative costs are
1. ignored in the calculation, as they are period costs.
2. included in the variable costs.
3. included in the fixed costs.
4. included in the variable costs, but only if they are directly related to the product.

Ans: B, LO 1, Bloom: C, Difficulty: Easy, AACSB: Knowledge, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management.

Solution: Contribution margin is sales less variable costs, including both variable costs and all selling and administrative variable costs.

Natalia is excited, as she has just reached her break-even point. The selling price per unit of the rubber exercise ball she developed is $28. At this sales volume, her variable cost is $7, while her fixed cost is $12 per unit. When Natalia sells one more unit, she will generate additional income of
1. $7.
2. $16.
3. $21.
4. $28.

Ans: C, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The contribution margin per unit is $21 (sales price of $28 less variable cost of $7). The $12 fixed cost per unit is irrelevant in this problem.

Fred’s break-even point for his “Fred’s Fantastic” (FF) sport drink is 19,000 bottles per year. Fred thinks the market for his FF drink is closer to 15,000 bottles per year. Therefore, Fred would like to reduce his break-even point. Fred should
1. decrease his variable costs.
2. increase his fixed costs.
3. decrease his selling price.
4. increase his variable costs.

Ans: A, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Knowledge, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management.

Solution: Breakeven is calculated as fixed costs divided by contribution margin per unit (sales less variable costs). Fred should reduce his variable costs,

thereby increasing his contribution margin for each bottle of FF sold. Increasing fixed costs or decreasing his selling price will generate a higher break-even

point, which is not the objective.

Terabyte Visions charges $7,500 for each new website that it develops. Its total fixed costs per year are $324,000, while its variable costs are $1,500 per website. What is Terabyte Visions’ break-even point?
1. 43 websites
2. 54 websites
3. 100 websites
4. 216 websites

Ans: B, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Breakeven is calculated as fixed costs ($324,000) divided by contribution margin per unit (sales less variable costs, or $7,500 − $1,500 =

$6,000). $324,000 ÷ $6,000 = 54 websites as the annual break-even point.

Which of the following is an example of a variable cost?
1. Insurance expense
2. Property taxes
3. Depreciation expense
4. Material used to make the product

Ans: D, LO 1, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC: Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management.

Solution: If you do not make the product, you will not incur material costs. All of the other costs will be incurred, even if no product is made.

Delfynn Dynamics Inc. reports the following financial information for the month: Revenues of

$2.5 million, total variable costs of $1.25 million, total fixed costs of $1.0 million, 5,000 units

sold, and a variable cost per unit of $250. Which of the following is correct?

1. Gross margin equals $250,000.
2. Break-even point equals 4,000 units.
3. Contribution margin equals $1.5 million.
4. Contribution margin equals $1.75 million.

Ans: B LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Since revenues equal $2.5 million and units sold equal 5,000, each item is sold at a price of $500. Variable costs per unit are $250, so the

contribution margin per unit sold equals $250. The break-even point is the point at which sufficient units are sold to equal fixed costs. Fixed costs are $1.0

million. Therefore, the break-even point is $1,000,000 ÷ $250 = 4,000 units.

Discount Electronics, a new company in the area, has reported break-even sales for its first

month of operation. This means which of the following?

1. Revenues were equal to fixed costs.
2. Revenues were equal to variable costs.
3. Variable costs were equal to fixed costs.
4. Contribution margin was equal to fixed costs.

Ans: D, LO 1, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: Break-even is achieved when contribution margin (revenues less variable costs) equals fixed costs.

When a company has a contribution margin equaling total fixed costs, it is operating at
1. zero gross margin.
2. break-even point.
3. zero contribution margin.
4. positive pretax income.

Ans: B, LO 1, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: Break-even represents the point at which contribution margin is equal to, or covers, total fixed costs.

Riker Video Ltd. sold 450 Blu-ray units last month at a selling price of $600 each. Riker

incurred unit variable costs of $250, and the company has total monthly fixed costs of $157,500. Which of the following statements is correct?

1. Riker operated at a loss for the month.
2. Riker was at break-even for the month.
3. Riker operated at a profit for the month.
4. Riker had a gross margin for the month of $112,500.

Ans: B, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis, Reporting & Control: Cost Accounting.

Solution: Break-even represents the point at which contribution margin is equal to, or covers, total fixed costs. Contribution margin per unit equals the unit

selling price of $600 less unit variable costs of $250, or $350 per unit. Total contribution margin in terms of dollars is equal to $350 per unit × 450 units sold

= $157,500. Since this total contribution margin of $157,500 is equal to fixed costs of $157,500, Riker Video Ltd. is operating at break-even.

Licard Wineries Inc. sold 700 bottles of vintage burgundy in April at a price of $120 each. Licard incurs $45 in variable costs for each bottle of vintage burgundy and has total monthly fixed costs of $50,000. Which of the following statements is correct?
Licard operated at a loss of $2,500 for the month.
Licard operated at a profit of $2,500 for the month.
Licard operated at its break-even point for the month.
Licard operated at a level at which contribution margin was less than fixed costs.

Ans: B, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis, Reporting & Control: Cost Accounting.

Solution: Profit represents contribution margin exceeding fixed costs. Contribution margin is equal to the selling price per unit of $120 less variable costs

per unit of $45, equaling $75 per bottle. Since 700 bottles were sold in April, total contribution margin in dollars equals $75 × 700 = $52,500. Fixed costs for

the month are $50,000. Total contribution margin in dollars of $52,500 less monthly fixed costs of $50,000 results in profit for the month of $2,500.

Which of the following statements regarding break-even analysis is accurate?
1. Break-even analysis will help a company to determine profit at various levels of sales and costs.
2. Break-even analysis will help determine the sales volume point after which a company will begin to earn a profit.
3. Break-even analysis is often used in identifying areas where costs can be reduced or eliminated to help increase profit.
4. Once break-even in units is determined, the break-even dollars can be calculated by multiplying the break-even in units by the variable costs per unit.

Ans: B, LO 1, Bloom: K, Difficulty: Medium, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: Determining the break-even point is important because it identifies how much product must be sold before a company will begin earning profit.

This information can be used along with other data, such as estimated sales volume, to help the company make decisions on product pricing and cost

structure to promote profitability.

Wow Wireless produces and distributes two mobile devices. One is of extremely high quality, and the other is mid-range and more affordable. Information on these two items follows:

High-quality: Total fixed costs are $90,000, variable costs are $500 per unit, and unit selling price is $800.

Mid-range: Total fixed costs are $88,000, variable costs are $130 per unit, and unit selling price is $350.

What is the break-even point in units for each device?

1. Break-even is 450 units for both items.
2. Break-even is 800 units for both items.
3. Break-even is 400 units for the high-quality device and 300 units for the mid-range device.
4. Break-even is 300 units for the high-quality device and 400 units for the mid-range device.

Ans D: LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: High quality: Contribution margin per unit is equal to sales price per unit minus variable costs per unit, or $800 − $500 = $300 per unit. Fixed costs

of $90,000 ÷ contribution margin per unit of $300 = break-even in units of 300. Mid-range: Contribution margin per unit is equal to sales price per unit minus

variable costs per unit, or $350 − $130 = $220 per unit. Fixed costs of $88,000 ÷ Contribution margin per unit of $220 = Break-even in units of 400.

Which of the following statements regarding break-even analysis is correct?
1. Break-even analysis is required for all businesses and is used to forecast profitability.
2. Break-even analysis is simply a starting point in identifying the feasibility of any one

business idea.

1. Break-even analysis is used to determine the point at which contribution margin equals

variable costs.

1. Break-even analysis is used to determine the point at which contribution margin equals

targeted income.

Ans: B, LO 1, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: The break-even calculation is simply a starting point in identifying the feasibility of any one business idea.

Which statement regarding break-even analysis is true?
1. Break-even in sales dollars is reached when sales revenues equal fixed expenses.
2. Break-even in sales dollars is the point at which sales dollars equal total variable costs.
3. Once break-even in units is determined, the degree of operating leverage is established.
4. Once break-even in units is determined, the break-even dollars can be determined by

simply multiplying the break-even in units by the unit selling price.

Ans: D, LO 1, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: Break-even in sales revenue dollars is equal to the break-even point in units times theunit selling price.

The calculation of break-even in units is determined by dividing
1. fixed costs by contribution margin per unit.
2. variable costs by contribution margin per unit.
3. total costs and expenses by sales price per unit.
4. sales revenues by total operating income per unit.

Ans: A, LO 1, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Break-even in units is calculated by dividing total fixed costs by the contribution margin per unit.

Gerry’s Gyros had the following results last month: Sales revenues equal $4,000, direct costs of labor and food ingredients were $2,100, other cost of goods sold were $200, and fixed period expenses equal $700 per month. Which of the following statements is correct?
1. Gerry’s gross margin is equal to $1,900.
2. Gerry’s gross margin is equal to $1,700.
3. Gerry’s operating income is equal to $1,700.
4. Gerry’s degree of operating leverage is 4.25.

Ans: B, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting, Strategy, Planning & Performance: Cost Management.

Solution: The gross margin is equal to sales revenues minus all costs of goods sold. Therefore, total gross margin = $4,000 − $2,100 − $200 = $1,700.

Bethany’s Bakery sells freshly baked pies at a price of $12 each, has variable costs of $6 per pie produced, and has total fixed costs for the year of $14,400. The monthly break-even point for Bethany’s Bakery is which of the following?
300 pies
200 pies
500 pies
420 pies

Ans: B, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Break-even is equal to the following formula: First, find the contribution margin by unit by taking price per unit minus variable cost per unit, or $12

− $6 = $6. Next, find monthly break-even point by taking total fixed costs (14,400 ÷ 12 months = $1,200 per month) divided by contribution margin per unit:

$1,200 ÷ $6 = 200 pies.

When a company experiences an increase in its variable per unit product costs, and no other

changes occur, which of the following will happen?

1. Fixed costs will decrease by an amount proportional to the increase in variable costs.
2. Contribution margin will decline, profit will decline, and the break-even point will rise.
3. Contribution margin will remain the same despite changes in the variable cost structure
4. Contribution margin will increase, profit will decline, and the break-even point will drop.

Ans: B, LO 1, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: When variable costs increase, the contribution margin falls. This results in a higher break-even point.

Which of the following is an important difference between a gross margin income statement and a contribution margin income statement?
1. The gross margin income statement shows details of fixed and variable costs, while a contribution margin income statement does not.
2. The contribution margin shows direct production costs, while a gross margin income statement does not.
3. A contribution margin income statement is more likely to be presented in a set of a company’s external financial statements than a gross margin income statement.
4. The contribution margin income statement shows details of fixed and variable costs, while a gross margin income statement does not.

Ans: D, LO 1, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: The contribution margin income statement shows details of variable costs and contribution margin to overall profit. It is not intended to be an all-

encompassing measure of a company's profitability. However, the contribution margin can be used to examine variable production costs, to evaluate the

profitability of an item, and to calculate how to improve its profitability. A gross margin income statement shows the deduction of total product costs, or cost

of goods sold, from revenue and does not necessarily show the details of variable costs or the contribution to profit of each additional dollar of sales

revenue as does as contribution margin income statement.

Which of the following statements regarding gross margin and contribution margin is correct?
1. If there are no variable period operating expenses to consider, the contribution margin is

always greater or equal to the gross margin.

1. The contribution margin includes all costs of goods sold, both fixed and variable, while the

gross margin does not.

1. The gross margin includes all variable product costs, while the contribution margin does

not.

1. The gross margin is never represented as a line item on the income statement, while the

contribution margin is.

Ans: A, LO 1, Bloom: K, Difficulty: Medium, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: The essential difference between the contribution margin and gross margin is that fixed overhead costs are not included in the contribution

margin. This means that the contribution margin is always higher than the gross margin, if there are no variable period operating expenses. The classic

measure of the profitability of goods and services sold as represented on the income statement is gross margin, which is revenues minus the cost of goods

sold. Contribution margin is not shown as a line item on the income statement.

Which of the following statements regarding gross margin and contribution margin is true?
1. The contribution margin is always less than the gross margin.
2. The contribution margin includes all fixed costs, while the gross margin does not.
3. The gross margin includes all cost of goods sold, while the contribution margin does not.
4. The contribution margin is often represented as a line item on the income statement, while the gross margin is not.

Ans: C, LO 1, Bloom: K, Difficulty: Medium, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: The essential difference between the contribution margin and the gross margin is that the gross margin includes all cost of goods sold items, while

the contribution margin does not. The classic measure of the profitability of goods and services sold as represented on the income statement is gross

margin, which is equal to revenues minus the cost of goods sold.

Corner Cupcakes Co. is selling cupcakes for $10 for a box of one dozen. Corner has fixed costs equaling $108,000 per year, and its accountant has calculated the contribution margin ratio on each box of donuts to be 60% of the selling price. Based on this information, which of the following statements is correct?
1. The monthly break-even point is 1,800 boxes sold.
2. The monthly break-even point is 1,600 boxes sold.
3. The monthly break-even point is 1,500 boxes sold.
4. The monthly break-even point is 1,400 boxes sold.

Ans: C, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Break-even is equal to the point at which sales in units multiplied by contribution margin is equal to total fixed costs. If fixed costs equal $108,000

per year, then they equal $9,000 per month (108,000 per year ÷ 12 months). The break-even point is therefore equal to the point at which contribution

margin is $9,000 per month. If each box sells for $10 and the contribution margin is 60%, then the contribution margin per box of donuts sold is $6.00 ($10

× 60%). If fixed costs are $9,000 per month and the contribution margin per box is $6.00, then $9,000 ÷ $6.00 = a break-even point of 1,500 boxes per

month.

Uptown Upholstering Inc. has the following results for the month: Revenues equal $3,500, variable manufacturing costs equal $800, and fixed manufacturing overhead costs equal $900. Which of the following statements is correct?
1. Monthly gross margin is equal to $900.
2. Monthly gross margin is equal to $1,800.
3. Monthly contribution margin is equal to $1,800.
4. Operating income for the month is equal to $2,700.

Ans: B, LO 1, Bloom: AP Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement Analysis and Interpretation, IMA: Reporting & Control: Cost

Accounting, Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution: The gross margin equals sales revenues minus variable manufacturing costs less all fixed manufacturing overhead costs. Therefore, gross margin

equals $3,500 − $800 − $900 = $1,800

As a result of cost increases imposed by its primary supplier, Fast-Fly Fishing Supplies Inc. has experienced an increase in its direct or variable costs per unit that will result in a decrease of 2% in the contribution margin ratio. Operating income last month, before the cost increase, was $2,500 based on sales revenues of $32,000 and fixed costs of $15,500. If sales revenues increase next month by 5%, and the new variable costs come into effect, what can Fast-Fly anticipate in terms of operating profit?
1. $3,288
2. $2,728
3. $4,108
4. $3,109

Ans: B, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting, Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution: Last month, before the variable cost increase, total variable costs were equal to sales revenues of $32,000 minus total fixed costs of $15,500

minus operating profit of $2,500, amounting to $14,000. This means that the contribution margin ratio last month was equal to $18,000 ($32,000 − $14,000)

÷ $32,000, for a total contribution margin ratio of 56.25%. The increase in variable costs will reduce the contribution margin ratio by 2%; therefore, it will

drop to 54.25%. If sales revenues increase next month by 5%, this will result in total sales revenues of $32,000 × 1.05 = $33,600. If the contribution margin

on this sales revenue is 54.25%, the contribution margin in dollars will be 0.5425 × $33,600 = $18,228. Subtracting fixed costs of $15,500 from this amount

will result in operating income of $2,728.

Which of the following is an accurate statement regarding gross margin and contribution

margin?

1. All variable costs are subtracted from sales to arrive at both the contribution margin and the gross margin.
2. All fixed and variable costs are subtracted from sales to arrive at both the gross margin and the contribution margin.
3. Contribution margin and gross margin represent the same concept and therefore the terms may be used interchangeably.
4. Gross margin is reached by subtracting both variable and fixed manufacturing costs from sales, while contribution margin is reached by subtracting all variable costs from sales.

Ans: D, LO 1, Bloom: K, Difficulty: Easy, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting, Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution: Cost of goods sold includes both variable and fixed manufacturing costs. Gross margin is calculated by subtracting cost of goods sold from sales.

Therefore, gross margin is equal to sales less variable and fixed manufacturing costs.

Corner Cupcakes Co. is selling cupcakes for $8 for a box of one dozen. Corner has fixed costs equaling $60,000 per year, and its accountant has calculated the monthly break-even at 1,000 boxes sold. Which of the following statements is correct based on this information?
1. Variable costs equal $3 per box, and contribution margin is $5 per box.
2. Variable costs equal $5 per box, and contribution margin is $3 per box.
3. Variable costs equal $4 per box, and contribution margin is $4 per box.
4. Variable costs equal $4.50 per box, and contribution margin is $3.50 per box.

Ans: A, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting, Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution: Break-even is equal to the point at which sales in units multiplied by contribution margin equals total fixed costs. If fixed costs equal $60,000 per

year, then they equal $5,000 per month ($60,000 ÷ 12 months). If the break-even point is equal to 1,000 boxes per month, then contribution margin is equal

to $5,000 ÷ 1,000 = $5 per box. This means that variable costs are equal to the selling price per box of $8 minus the contribution margin of $5, or $3 per

box. Therefore, variable costs equal $3 per box, and contribution margin is $5 per unit.

The contribution margin income statement will show which of the following calculations?
1. Sales revenues minus operating income
2. Sales revenues minus manufacturing costs
3. Sales revenues minus fixed costs
4. Sales revenues minus variable costs

Ans: D, LO 1, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: The contribution margin income statement shows contribution margin, not gross margin. Therefore, this statement shows sales revenues minus

variable costs.

What is the contribution margin (CM) ratio?
1. The difference between a company's sales revenues and variable costs, expressed as a percentage of sales revenues
2. The measurement of a company’s direct operating leverage, expressed as a percentage of sales revenues
3. The difference between a company’s sales revenues and production costs or cost of goods sold, expressed as a percentage of sales revenues
4. The difference between a company's sales revenues and net income after taxes, expressed as a percentage of sales revenues

Ans: A, LO 1, Bloom: C, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: The contribution margin (CM) ratio is the difference between a company's sales revenues and variable costs, expressed as a percentage of sales

revenues.

Corner Cupcakes Co. is selling cupcakes for $8 for a box of four. Corner has fixed costs equaling $105,600 per year, and its accountant has calculated the contribution margin ratio on each box of donuts to be 55%. Based on this information, which of the following statements is correct?
1. The monthly break-even point is 2,100 boxes sold.
2. The monthly break-even point is 1,900 boxes sold.
3. Operating profit will be $880 if 2,200 boxes are sold next month.
4. Operating profit will be $1,280 if 2,200 boxes are sold next month.

Ans: C, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting, Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution: Break-even is equal to the point at which sales in units multiplied by contribution margin is equal to total fixed costs. If fixed costs equal $105,600

per year, then they equal $8,800 per month ($105,600 ÷ 12 months). The break-even point is therefore the point at which contribution margin is $8,800 per

month. If each box sells for $8 and the contribution margin ratio per box is 55%, then the contribution margin per box of donuts sold is $4.40 ($8 × 55%). If

fixed costs are $8,800 per month, then $8,800 ÷ $4.40 = a break-even point of 2,000 boxes per month. If 2,200 boxes of donuts are sold in a given month,

this will result in a contribution margin of $4.40 × 2,200 boxes = $9,680. This amount minus the monthly fixed costs of $8,800 equals $880 of operating

profit for the month.

Corner Cupcakes Co. is selling cupcakes for $8 for a box of four. Corner has fixed costs equaling $8,800 per month, and its accountant has calculated the contribution margin ratio on each box of donuts to be 55%. Based on this information, which of the following statements is correct?
1. If fixed costs increase by $1,760 per month, the break-even sales point will increase by 400 boxes.
2. If fixed costs increase by $2,500 per month, the break-even sales point will increase by 150 boxes.
3. If fixed costs increase by $1,760 per month, the break-even sales point will increase by 200 boxes.
4. If fixed costs increase by $1,500 per month, the break-even sales point will increase by 500 boxes.

Ans: A, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting, Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution: Break-even is equal to the point at which sales in units multiplied by contribution margin is equal to total fixed costs. If fixed costs are $8,800 per

month, and each box sells for $8 with a contribution margin ratio of 55%, then the contribution margin per box of donuts sold is $4.40 ($8 × 55%), and the

break-even point is 2,000 boxes per month ($8,800 ÷ $4.40). If fixed costs increase by $1,760 per month, then fixed costs become $10,560 ($8,800 +

$1,760), and the break-even point becomes 2,400 boxes ($10,560 ÷ $4.40), representing an increase of 400 boxes of donuts sold.

Corner Cupcakes Co. is selling cupcakes for $8 for a box of four. Corner has fixed costs equaling $8,800 per month, and its accounting firm has determined the contribution margin ratio on each box of donuts to be 55%. Corner is currently averaging monthly sales of 2,600 boxes of donuts and the company has a tax rate of 40%. Based on this information, Corner Cupcakes has been averaging monthly net income after taxes of
1. $1,404.
2. $1,584.
3. $1,464.
4. $1,554.

Ans: B, LO 1 and 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control:

Cost Accounting, Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution: 2,600 boxes times $8 per box is equal to $20,800 of sales revenues. If the contribution margin ratio is 55%, the contribution margin in dollars is

equal to $20,800 × 55% = $11,440. Subtracting fixed costs of $8,800 gives operating income of $2,640. If the company has a 40% tax rate, then taxes will

equal $2,640 × 40% = $1,056. Subtracting the tax amount from operating income will result in net income of $2,640 − $1,056 = $1,584.

Hopalong Hot Dog Stand has had the following average results for the past several months: Its selling price per hot dog is $3. Total monthly sales revenues have been $6,000, direct costs of labor and food ingredients have been $2,500 per month, variable indirect costs have been $500 per month, and fixed costs have been $1,500 per month. If Hopalong experiences a $150 per month increase in insurance costs, what will this increase do to its break-even point?
1. Break-even point will increase by 150 hot dogs per month.
2. Break-even point will increase by 200 hot dogs per month.
3. Break-even point will increase by 100 hot dogs per month.
4. Break-even point will increase by 225 hot dogs per month.

Ans: C, LO 1, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting, Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution: Hopalong currently has a contribution margin ratio of 50%. The per-month calculations follow: Contribution margin = $6,000 in sales revenues −

$2,500 in direct labor and ingredients costs − $500 in variable indirect costs = $3,000. Contribution margin ratio = $3,000, contribution margin ÷ $6,000,

sales revenues = 50% CM ratio. The break-even point before insurance cost increases equals the total fixed costs of $1,500 per month divided by the

contribution margin for each hot dog sold, or $3 × 50% = $1.50. Therefore, monthly break-even is $1,500 divided by $1.50, or 1,000 hot dogs. If insurance

costs (a fixed cost) increase by $150 per month, this will require the sale of 1,100 hot dogs: $1,650 fixed costs ($1,500 fixed cost + $150 insurance) ÷ $1.50

contribution margin per hot dog, an increase of 100 hot dogs. This can also be calculated by dividing the increased fixed insurance costs of $150 by the

$1.50 contribution margin per hot dog.

Sammy’s Snow Cone Stand has been selling an average of 850 snow cones per week

over the first five months of this year. Sammy’s sells each cone for $2. Each snow cone

incurs variable costs of $0.75, and Sammy’s weekly fixed costs are $900. What

is the stand’s weekly margin of safety in units?

1. 95 cones
2. 80 cones
3. 130 cones
4. There is no margin of safety since Sammy’s is not breaking even.

Ans: C, LO 2, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: Margin of safety is equal to current or forecasted sales level minus break-even point in units sold. Break-even point is calculated by first solving for

contribution margin per unit, which is calculated as price per unit minus various cost per unit, then by dividing fixed costs by contribution margin per unit.

Thus, contribution margin per snow cone is calculated as $2.00 − $0.75 = $1.25. The weekly break-even point is calculated as $900 per week ÷ $1.25 per

cone = 720 snow cones. Since Sammy’s has been selling an average of 850 snow cones a week, the margin of safety can be calculated as 850 − 720 =

130 snow cones.

Which of the following statements regarding margin of safety is correct?
1. If fixed expenses increase, a company’s margin of safety will increase.
2. If the break-even point for sales drops, then a company’s margin of safety will increase.
3. The margin of safety represents the point at which contribution margin exceeds variable costs.
4. The margin of safety can be measured only in sales dollars and is the point at which a company begins to earn a profit.

Ans: B, LO 2, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Decision Analysis.

Solution: The margin of safety can be measured in sales dollars or in units and is the difference between actual, targeted, or projected sales and break-even sales. As break-even declines, margin of safety will increase.

The margin of safety is equal to the amount that current or budgeted sales levels exceed which one of the following?
1. Operating profit
2. Break-even sales
3. Fixed costs
4. Net income

Ans: B, LO 2, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: The margin of safety is calculated by subtracting break-even sales revenue from current or budgeted sales levels. This calculation shows the

amount of sales revenues above the breakeven point, or the total number of sales dollars that can be lost before the company begins to lose money.

Iggy’s Ice Cream Shop has been selling an average of 500 banana splits per week for the past several months. If Iggy’s price per banana split is $4, each split’s variable costs are $1, and weekly fixed costs are $1,200, what is Iggy’s current margin of safety on banana splits?
1. 200 banana splits
2. 100 banana splits
3. 400 banana splits
4. There is no margin of safety since Iggy’s is not breaking even.

Ans: B, LO 2, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Margin of safety is current or forecasted unit sales levels minus the break-even point in units sold. Break-even point is equal to total fixed costs

divided by contribution margin. Contribution margin is equal to selling price per unit less variable cost per unit, or $4 − $1 = $3. Fixed costs of $1,200 per

week divided by the contribution margin of $3 per split is equal to a weekly break-even point of 400 banana splits. Since Iggy’s has been selling an average

of 500 banana splits a week, the margin of safety can be calculated as 500 − 400 = 100.

Which of the following statements regarding margin of safety is correct?
1. The margin of safety can be measured in sales dollars or in units and is the difference between actual or projected sales and break-even sales.
2. The margin of safety can be measured in sales dollars or in units and represents the point at which a company begins to earn income from operations.
3. The margin of safety can be measured in sales dollars or in units and represents the point at which contribution margin exceeds variable costs and expenses.
4. The margin of safety can only be measured in sales dollars and represents the point at which the gross profit margin exceeds targeted levels of fixed costs and expenses.

Ans: A, LO 2, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting, Strategy, Planning & Performance: Decision Analysis.

Solution: The margin of safety can be measured in sales dollars or in units and is the difference between actual, targeted, or projected sales and break-

even sales.

Which of the following statements regarding margin of safety is not correct?
1. If break-even point for sales increases, then a company’s margin of safety will increase.
2. If the break-even point for sales drops, then a company’s margin of safety will increase.
3. The margin of safety in sales dollars represents the difference between total sales dollars and break-even point in sales dollars
4. The margin of safety can be measured in both sales dollars and units.

Ans: A, LO 2, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting, Strategy, Planning & Performance: Decision Analysis.

Solution: The margin of safety can be measured in sales dollars or in units and is the difference between actual, targeted, or projected sales and break-

even sales. As break-even declines, margin of safety will increase.

The margin of safety is important information because it can help a company’s management determine which of the following?
1. Where to cut fixed costs in order to ensure profitability
2. How much the company is exceeding break-even sales revenue levels
3. How much the company needs in sales revenues to meet company’s profit targets and objectives
4. How to forecast profit and expenses and what operating income can be expected based on different sales levels

Ans: B, LO 2, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting, Strategy, Planning & Performance: Decision Analysis.

Solution: The margin of safety can be measured in sales dollars or in units and is the difference between actual, targeted, or projected sales and break-even sales. The margin of safety is the level of current or forecasted sales revenue that exceeds the break-even point.

Corner Cupcakes Co. is selling cupcakes for $8 for a box of four. Corner has fixed costs equaling $8,800 per month, and its accounting firm has determined the contribution margin ratio on each box of donuts to be 55%. Corner is currently averaging monthly sales of 2,600 boxes of donuts, and the company has a tax rate of 40%. Based on this information, which of the following statements is correct?
1. Corner Cupcakes currently has a margin of safety of 450 boxes of donuts.
2. Corner Cupcakes currently has a margin of safety of $3,000 in monthly sales revenues.
3. Corner Cupcakes currently has a margin of safety of 400 boxes of donuts.
4. Corner Cupcakes currently has a margin of safety of $4,800 in monthly sales revenues.

Ans: D, LO 2, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting, Strategy, Planning & Performance: Decision Analysis.

Solution: The margin of safety is the amount, either in dollars or in units, that current sales levels exceed the break-even point. Break-even is equal to the

point at which sales in units multiplied by contribution margin is equal to total fixed costs. If fixed costs are $8,800 per month, and each box sells for $8 with

a contribution margin of 55%, then the contribution margin per box of donuts sold is $4.40 ($8 × 55%), and the break-even point is 2,000 boxes per month

($8,800 ÷ $4.40). If current sales are 2,600 boxes per month, then the margin of safety is 600 boxes, or $4,800 per month (600 × $8) in sales revenues.

The relationship between a company’s revenues, costs, volume of sales, and consequently profit, is called
1. sensitivity analysis.
2. cost-volume-profit (CVP) analysis.
3. data analysis.
4. margin of safety analysis.

Ans: B, LO 2, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting

Solution: The relationship between a company’s revenues, costs, volume of sales, and consequently profit, is referred to as cost-volume-profit (CVP)

analysis.

A company’s relevant range
1. is unlimited with regards to production capacity.
2. has a lower limit depending on how much capacity the company has and how much the market demands the product.
3. is a band of activity with a specific relationship between activity levels and the cost being measured, where fixed cost remain fixed and variable costs per unit are constant.
4. is a band of activity with a specific relationship between activity levels and the cost being measured, where fixed cost can vary and variable costs are fixed.

Ans: C, LO 2, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: A company’s relevant range is a band of activity with a specific relationship between activity levels and the cost being measured, where fixed cost

remain fixed and variable costs are constant.

Which of the following items would not appear on a CVP graph?
1. Fixed cost line
2. Variable cost line
3. Total revenue line
4. Total cost line

Ans: B, LO 2, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: The CVP graph includes lines for fixed cost, total revenue and total cost, but does not show a separate line for variable cost. The variable cost is

Included in the total cost line, which begins from the fixed cost line. The area between the total cost line and the fixed cost line represents the variable

costs at different activity levels.

Given the following CVP Graph, what does the point labeled A indicate for this company?

Dollars -

Sales and Costs

Sales in units

1. Net income
2. Net loss
3. Break-even point
4. Total Revenues = Total variable costs

Ans: C, LO 2, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: The point at which the total cost line intersects the total revenue line, point A, is called the break-even point.

Given the following CVP Graph, what does the Line labeled F represent for this company?

Dollars -

Sales and Costs

Sales in units

1. Total sales revenue
2. Total costs
3. Total fixed costs
4. Total variable costs

Ans: A, LO 2, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: The line labeled Line F in the CVP graph represents the total sales revenue given that it starts at 0 and is upward sloping, increasing with the

sales units.

Given the following CVP Graph, where would a company experience a profit?

Dollars -

Sales and Costs

Sales in units

1. Between points A and B
2. At point B
3. At point A
4. Any point above point A

Ans: D, LO 2, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: The point at which the total cost line intersects the total revenue line, point A, is the break-even point. Above this point, the company will

experience profit.

Armand has opted to sell his famous funnel cakes at the local farmer’s market instead of opening his own store. After his first month, he summarized the following financial data: unit variable cost per funnel cake was $2 and the monthly rental fee for the space at the market which includes electricity is $700. Armand initially decided to set the selling price per unit for each funnel cake at $4. If the sales for the first month were 500 funnel cakes, what was Armand’s margin of safety in units?
1. 150 units
2. 350 units
3. 500 units
4. 650 units

Ans: A, LO 2, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Margin of safety is current or forecasted unit sales levels minus the break-even point in units sold. Break-even point is equal to total fixed costs

divided by contribution margin. Contribution margin is equal to selling price per unit less variable cost per unit, or $4 − $2 = $2. Fixed costs of $700 per

month divided by the contribution margin of $2 per funnel cake is equal to a monthly break-even point of 350 funnel cakes. Since Armand sold 500 funnel

cakes in the first month, the margin of safety can be calculated as 500 − 350 = 150.

Hopalong Hot Dog Stand had the following results last month: Sales revenues were $6,000, variable costs were $3,000, and fixed costs were $1,500 per month. If Hopalong wants to achieve a targeted operating income goal of $3,000 next month, how much in total sales revenue will be required?
1. $5,000
2. $5,500
3. $9,000
4. $7,500

Ans: C, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The contribution margin is equal to sales revenues minus all variable costs. For Hopalong, last month’s contribution margin is calculated as

$6,000 – $3,000 = $3,000, and the contribution margin ratio as $6,000 ÷ $3,000 = 50%. With fixed costs of $1,500, operating profit was $1,500 last month.

To reach a targeted operating income level of $3,000, Hopalong will have to generate sufficient sales revenues that carry a 50% contribution margin ratio to

offset the $1,500 of fixed costs, and still generate the $3,000 in targeted operating profit. Therefore, $3,000 of target profit plus $1,500 of fixed costs is

equal to $4,500. This amount divided by the contribution margin ratio of 50% is equal to $9,000. Thus, sales revenues must be $9,000 to achieve a target

operating income of $3,000.

Petros’s Greek Food Stand had the following results last month: Sales revenues were $4,000, variable costs of were $2,000, and the fixed costs for Petros’s stand were $1,000 per month. If Petros’s cost structure remains the same and Petros wishes to achieve his targeted operating income goal of $2,000 next month, how much in total sales revenue will Petros require?
1. $5,000
2. $5,500
3. $6,000
4. $7,500

Ans: C, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Contribution margin is equal to sales revenues minus the variable costs, thus $4,000 – $2,000 = $2,000. Contribution margin ratio = $2,000

variable costs ÷ $4,000 sales revenues = 50%. With fixed costs of $1,000, operating profit was $1,000 last month. To reach a targeted operating income

level of $2,000, Petros will have to generate sufficient sales revenues that carry a 50% contribution margin ratio to offset his $1,000 of fixed costs, and still

generate the $2,000 in targeted operating profit. Therefore, $2,000 of target profit plus $1,000 of fixed costs is equal to $3,000. This amount divided by the

contribution margin ratio of 50% is equal to $6,000. Sales revenues must be $6,000 to achieve a target operating income of $2,000.

Carrot Jewelry is considering two mutually exclusive product lines, either an emerald ring or a ruby bracelet, which will be introduced next year. The board of directors of the company has established a target net income of $30,000 for the new product line but wishes to maximize profit in any case. For the emerald ring line, Carrot expects to sell 200 rings during the year at a selling price per ring of $1,500. Estimated variable costs are $800 per ring, and fixed costs will amount to $90,000 for the year. For the ruby bracelet line, the company anticipates sales of 500 units at a selling price of $1,100 per bracelet. Fixed costs will amount to $110,000 for the year, and the variable costs will also be $800 each. Carrot Jewelry will have a tax rate of 30% next year. Which one of the following statements is correct?
1. Carrot should produce and sell rings even though this will result in a $5,000 shortfall in targeted net income.
2. Carrot should produce and sell bracelets, since the income from bracelets will exceed the income from rings and exceed the targeted net income by $20,000.
3. Carrot should produce and sell bracelets, since the bracelets will generate more net income than the rings and exceed targeted net income by $5,000.
4. Carrot should produce and sell rings, since rings will generate more net income than bracelets and will exceed targeted net income by $5,000.

Ans: D, LO 3, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: If Carrot produces and sells rings, the contribution margin per ring sold will be $1,500 − $800 = $700. With 200 rings sold, this will produce a

contribution margin of $700 × 200 = $140,000. If fixed costs are $90,000, then total pretax income will be $140,000 − $90,000 = $50,000. At a 30% tax rate,

tax will be 30% × $50,000 = $15,000, resulting in net income of $50,000 − $15,000 = $35,000. This exceeds targeted net income by $5,000. If Carrot

produces and sells bracelets, the contribution margin per bracelet sold will be $1,100 − $800 = $300. With 500 bracelets sold, this will produce a

contribution margin of $300 × 500 = $150,000. If fixed costs are $110,000, then total pretax income will be $150,000 − $110,000 = $40,000. At a 30% tax

rate, tax will be 30% × $40,000 = $12,000, resulting in net income of $40,000 − $12,000 = $28,000. This is less than net income targeted by the board of

directors. Therefore, Carrot should sell the emerald rings.

Carrot Jewelry is considering two mutually exclusive product lines, based on either an emerald ring or a ruby bracelet, to introduce next year. The board of directors of the company has established a target net income of $30,000 for the new product line but wishes to maximize profit in any case. For the emerald ring line, Carrot expects to sell 200 rings during the year at a selling price per ring of $1,500. Estimated variable costs are $800 per ring, and fixed costs will amount to $90,000 for the year. For the ruby bracelet line, the company anticipates sales of 500 units at a selling price of $1,100 per bracelet. Fixed costs will come to $110,000 for the year, and the variable costs will also be $800 each. Carrot Jewelry will have a tax rate of 30% next year. How much more or less will Carrot have to spend in fixed costs on the proposed bracelet line in order for it to have the same net income as the ring product line?
1. Carrot will need to reduce fixed costs on the bracelet line by $10,000.
2. Carrot will need to reduce fixed costs on the bracelet line by $12,000.
3. Carrot will need to spend $12,000 more in fixed costs on the bracelet line.
4. Carrot will need to spend $15,000 more in fixed costs on the bracelet line.

Ans: A, LO 3, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: If Carrot produces and sells rings, the contribution margin per ring sold will be $1,500 − $800 = $700. With 200 rings sold, this will produce a

contribution margin of $700 × 200 = $140,000. If fixed costs are $90,000, then total pretax income will be $140,000 − $90,000 = $50,000. At a 30% tax rate,

tax will be 30% × $50,000 = $15,000, resulting in net income of $50,000 − $15,000 = $35,000. If Carrot produces and sells bracelets, the contribution

margin per bracelet sold will be $1,100 − $800 = $300. With 500 bracelets sold, this will produce a contribution margin of $300 × 500 = $150,000. In

order to match the income generated by the ring product line, fixed costs will have to be reduced to $100,000 so that total pretax income will be $150,000 −

$100,000 = $50,000. Then, as with the ring line, tax will be 30% × $50,000 = $15,000, resulting in net income of $50,000 − $15,000 = $35,000. Therefore,

fixed costs must be reduced on the bracelet line from $110,000 to $100,000, or by $10,000, in order for the bracelet line to generate the same net income

as the ring product line.

In order to determine the sales revenue level needed to reach a specific target income goal, it is necessary to add the targeted income amount to what other element before dividing the sum by contribution margin?
1. Variable costs
2. Overhead costs
3. Fixed costs
4. Contribution margin

Ans: C, LO 3, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: In order to determine required sales revenue levels, the targeted income should be added to fixed costs and the sum of these divided by

contribution margin.

Target profit is added to what other financial statement line item, or element, to determine the numerator in the overall target contribution margin (CM) calculation in break-even analysis?
1. Fixed costs
2. Variable costs
3. Operating profit
4. Net income after taxes

Ans: A, LO 3, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: Adjusting the break-even calculation to allow for a target profit simply means adding it to the numerator along with fixed costs. The addition of the

target profit in the numerator represents a new, higher hurdle to surmount with the existing CM per unit or CM ratio.

Corner Cupcakes Co. is selling cupcakes for $10 for a box of one dozen. Corner has fixed costs equaling $120,000 per year, and its accounting firm has determined the contribution margin ratio on each box of donuts to be 50%. Corner is currently averaging monthly sales of 2,500 boxes of donuts, and the company has a tax rate of 25%. Based on this information, Corner Cupcakes has been averaging monthly net income of
1. $1,975
2. $1,875
3. $1,625
4. $1,825

Ans: B, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: 2,500 boxes times $10 per box is equal to $25,000 of sales revenues. If the contribution margin is 50%, then contribution margin in dollars is

equal to $25,000 × 50% = $12,500. Subtracting fixed costs of $10,000 per month ($120,000 per year ÷ 12 months) results in operating income of $2,500. If

the company has at a 25% tax rate, then taxes will equal $2,500 × 25% = $625. Subtracting the tax amount from operating income results in net income of

$2,500 − $625 = $1,875.

Jinx Company wishes to sell enough products to earn a profit of $200,000. If the unit selling price is $20, unit variable cost is $11, and total fixed costs are $700,000, how many units must be sold to earn target net income of $200,000?
1. 45,000 units
2. 85,909 units
3. 100,000 units
4. 900,000 units

Ans: C, LO: 3, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA FN: Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: (Total Fixed Costs + Net Income) / unit contribution margin = Number of units that must be sold to earn net income) = ($700,000 + $200,000)/

($20 - $11) = 100,000 units.

Indigo Industries has fixed costs of $180,000 and contribution margin is 40% of sales. How much will Indigo report as sales when its net income equals $60,000?
1. $150,000
2. $300,000
3. $450,000
4. $600,000

Ans: D, LO: 3, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA FN: Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: (Fixed costs + Target Net Income / Contribution Margin Ratio = Sales to for target net income = ($180,000 + $60,000) / 40% = $600,000

Retro Records wants to sell enough records to earn a profit of $150,000. If the unit selling price is $20, unit variable cost is $8, and total fixed costs are $180,000, how many records must Retro Records sell to earn the desired net income of $150,000?
1. 16,500 units
2. 27,500 units
3. 41,250 units
4. 50,200 units

Ans: B, LO: 3, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA FN: Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: (Fixed Costs + Target Net Income) / Contribution margin per unit = Units to be sold to earn net income) = ($180,000 + $150,000) / ($20 - $8) =

27,500 units.

Ginseng Corporation reported the following results from the sale of 10,000 units in July: sales $600,000, variable costs $360,000, fixed costs $80,000, and net income $41,500. Assume that Ginseng expects to increase the selling price by 5% on August 1. How many units will have to be sold by Ginseng in July to maintain the same level of net income?
1. 4,200
2. 4,500
3. 4,750
4. 5,000

Ans: B, LO: 3, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA FN: Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: (Fixed costs + Target Net income) / (Adj. Selling price per unit – variable cost per unit) = Units to be sold for desired net income = ($80,000 +

41,500) / (($600,000 /10,000) x 1.05) – ($360,000 /10,000)) = 4,500

Aspire Appliances desires to earn a target net income of $500,000 for next year. If it has fixed costs of $2,000,000 and variable costs are 60% of sales, what are the required sales?
1. $3,750,000
2. $4,166,667
3. $5,000,000
4. $6,250,000

Ans: D, LO: 3, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA FN: Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: (Fixed Costs + Net Income) / Contribution Margin Ratio = Required sales for desired net income = ($2,000,000 + $500,000)/(1-.60) = $6,250,000

Vespa, Inc. requires sales of $4,000,000 to cover its fixed costs of $520,000 and to earn net income of $1,000,000. What is Vespa’s contribution margin ratio?
1. 25%
2. 32%
3. 38%
4. 62%

Ans: C, LO: 3, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA FN: Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: (Required Sales = (Fixed Costs + Target Net Income) / Contribution Margin Ratio; $4,000,000 = ($520,000 + $1,000,000) / CM%;

CM% = Contribution Margin Ratio = .38 or 38%.

When working with multiple products and a sales mix, information required to determine overall break-even point includes which of the following?
1. Target net income
2. Target operating profit
3. Selling and administrative expenses
4. Weighted average contribution margin

Ans: D, LO 4, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting

Solution: When working with multiple products and a sales mix of these products, an average contribution margin, called the weighted average contribution

margin (WACM), is needed in the denominator for the break-even calculation.

Crusher Machinery Inc. sells three heavy-duty construction machines. Information on these machines is as follows:

Bulldozer 30% of total sales Unit contribution margin of $40

Crane 50% of total sales Unit contribution margin of $45

Dump truck 20% of total sales Unit contribution margin of $50

Based on this information, what is the weighted-average contribution margin per unit (WACM)?

$43.00
$44.50
$46.50
$47.50

Ans: B, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting , Strategy, Planning & Performance: Decision Analysis.

Solution: The weighted average contribution margin (WACM) is calculated as: (CM x Sales mix for bulldozer) + (CM x Sales mix for crane) + (CM x Sales

mix for dump truck), or ($40 x .30) + ($45 x .50) + ($50 x .20) = $12.00 + $22.50 + $10.00 = 0.445, or $44.50.

Crusher Machinery Inc. sells three heavy-duty construction machines. Information on these machines is as follows:

Bulldozer 30% of total sales Unit contribution margin of $40

Crane 50% of total sales Unit contribution margin of $45

Dump truck 20% of total sales Unit contribution margin of $50

Total fixed costs for the year are $890,000. Based on this information, what would be the

expected break-even point for Crusher for the year?

19,000 units
19,778 units
20,000 units
21,000 units

Ans: C, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The weighted average contribution margin (WACM) for these three machines is calculated as: (CM x Sales mix for bulldozer) + (CM x Sales mix

for crane) + (CM x Sales mix for dump truck), or ($40 x .30) + ($45 x .50) + ($50 x .20) = $12.00 + $22.50 + $10.00 = $44.50. This WACM is then divided

into the annual fixed costs to determine the annual break-even point; $890,000 ÷ $44.50 = 20,000 units.

The weighted average contribution margin (WACM) is most useful when working with which of the following?
1. Products with low variable costs
2. Products with high contribution margins
3. Multiple products or product lines with a known sales mix
4. Multiple products that are profitable even with high break-even points

Ans: C, LO 4, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: When working with multiple products and a sales mix of these products, an average contribution margin, called the weighted average contribution

margin (WACM), is needed for the break-even calculation.

Which of the following statements regarding sales mix is accurate?
Sales mix is a necessary piece of information when calculating fixed costs.
Sales mix is an important concept for a company that specializes in only one product.
In order to use sales mix in a break-even analysis, the percentages of sales of the individual products, when added together, must total 100%.
When calculating break-even for a company with multiple products, the sales mix and

the weighted average contribution margin (WACM) do not need to be known.

Ans: C, LO 4, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: Sales mix is expressed as a ratio or percentage and shows how much each product or product line contributes to overall sales. Overall sales are

represented at 100%, and each individual product’s sales is a portion, or percentage, of this total. When added together, the individual products’ sales

percentages will total 100% of the firm’s sales.

Calloway Computers sells three types of computers. Information on these is as follows:

Laptop 25% of total sales Unit contribution margin of $30

Tablet 55% of total sales Unit contribution margin of $25

Desktop 20% of total sales Unit contribution margin of $20

If the sales mix information and individual contribution margins given above remain the same,

and fixed costs over the final three months of the year are $50,500, what is the expected

break-even point for Calloway for this period?

1,800 units
1,980 units
2,000 units
2,020 units

Ans: C, LO 4, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: The weighted average contribution margin (WACM) is calculated as: (CM × Sales mix for laptop) + (CM × Sales mix for tablet) + (CM × Sales mix

for desktop) = ($30 x .25) + ($25 x .55) + ($20 x .20) = $7.50 + $13.75 + $4.00 = $25.25. The $50,500 of fixed costs divided by the weighted- average

contribution margin (WACM) results in a break-even point for Calloway of $50,500 ÷ $25.25 = 2,000 units.

The concept of sales mix is best used when a company
1. is selling multiple products.
2. has a high degree of operating leverage.
3. has experienced a large increase in fixed costs.
4. has experienced a large increase in variable costs.

Ans: A, LO 4, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: The sales mix is a concept that is particularly useful when a company is selling a number of different products that have different sales prices, variable costs, and resulting contribution margins.

A weighted average contribution margin is a very useful statistic for a company that has which of the following?
1. A dwindling contribution margin
2. An increasing proportion of fixed costs in its cost structure.
3. Insufficient sales to reach break-even
4. Multiple product lines with a sales mix

Ans: D, LO 4, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: In working with multiple products and a sales mix of these products, an average contribution margin is very useful and is needed for the break-

even calculation. This average contribution margin is called the weighted average contribution margin (WACM).

Crest Computing. Inc. sells three types of computing devices. Information on these is as follows:

Laptop 25% of total sales Unit contribution margin of $40

Tablet 60% of total sales Unit contribution margin of $45

Desktop 15% of total sales Unit contribution margin of $35

Based on this information, what is the weighted average contribution margin (WACM)?

$43.50
$44.50
$42.25
$43.75

Ans: C, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: The weighted average contribution margin (WACM) is calculated as: (UCM x Sales mix for laptop) + (UCM x Sales mix for tablet) + (UCM x Sales

mix for desktop), thus ($40 x .25) + ($45 x .60) + ($35 x .15) = $10.00 + $27.00 + $5.25 = $42.25.

Crest Computing. Inc. sells three types of computing devices. Information on these is as follows:

Laptop 25% of total sales Unit contribution margin of $40

Tablet 60% of total sales Unit contribution margin of $45

Desktop 15% of total sales Unit contribution margin of $35

If the fixed costs over the last three months of the year are $219,700, what is the expected

break-even point for this same period?

4,200 units
4,882 units
5,200 units
5,493 units

Ans: C, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: The weighted average contribution margin (WACM) is calculated as: (CM x Sales mix for laptop) + (CM x Sales mix for tablet) + (CM x Sales mix

for desktop), thus ($40 x .25) + ($45 x .60) + ($35 x .15) or ($10.00 + $27.00 + $5.25) = $42.25. The fixed costs divided by the WACM will result in the

break-even point for the period; $219,700 ÷ $42.25 = 5,200 units to break even for the last three months of the year.

In order to calculate the weighted-average contribution margin (WACM) for a group of different products, which of the following pieces of information is needed?
1. Fixed costs per unit of product sold
2. The degree of operating leverage
3. Overhead costs for each different product
4. The sales mix for the different products

Ans: D, LO 4, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: When working with multiple products and a sales mix of these products, an average contribution margin, called the weighted average contribution

margin (WACM), is needed for the break-even calculation. The WACM cannot be calculated without sales mix information.

What is the weighted average contribution margin (WACM) per unit?
1. The difference between a company's fixed costs and variable costs, expressed as a per unit amount based on units sole.
2. The measurement of a company’s direct operating leverage, expressed as a per unit amount based on units sold.
3. The sum of the unit contribution margin for each product multiplied by its respective sales mix percentage.
4. The difference between a company's net sales revenues and net income, divided by total sales units.

Ans: C, LO 4, Bloom: C, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: The weighted average contribution margin per unit is the sum of the unit contribution margin for each product multiplied by its respective sales mix

percentage of each of the company’s products.

Last month, Everest Environmental Services had revenues amounting to $50,000, while direct labor and other variable costs were $25,000 and fixed costs were $20,000. Everest has an income tax rate of 42%. Based on this information, which statement is correct about last month’s results?
1. Everest had a gross margin of $30,000 and operating income of $25,000.
2. Everest had a contribution margin of $5,000 and net income after tax of $3,360.
3. Everest operated last month with a margin of safety of $10,000 in sales revenues.
4. Everest operated last month with a margin of safety of $15,000 in sales revenues.

Ans: C, LO 1, 2, 4, & 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Everest had sales revenues of $50,000 with direct costs of $25,000. This means it had a contribution margin of $50,000 − $25,000 = $25,000,

resulting in a 50% contribution margin ratio ($25,000 ÷ $50,000). Break-even is equal to the amount of sales revenues needed to offset fixed costs of

$20,000 while carrying a 50% contribution margin ratio. Therefore, $20,000 ÷ 50% = $40,000 of revenues are needed to break-even. If sales revenues are

$50,000, Everest margin of safety in sales revenues is calculated as 50,000 − $40,000 = $10,000.

Genesis Corporation sells three types of snowboards with the following information:

	Unit Selling Price	Unit Variable Cost	Sales Mix
Beginner	$40	$10	50%
Novice	$50	$15	20%
Expert	$80	$20	40%

What is the weighted-average contribution margin for Genesis Corporation?

Ans: B, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Before computing the weighted-average contribution margin, the unit contribution margin for each snowboard must be computed. Beginner,

($40 - $10) is $30, Novice ($50 - $15) is $35, and Expert ($$80 - $20) is $60. The weighted-average contribution margin (WACM) is then calculated as:

(CM x Sales mix for Beginner) + (CM x Sales mix for Novice) + (CM x Sales mix for Expert), thus ($30 × .50) + ($35 × .20) + ($60 × .40) or ($15.00 +

$7.00 + $24.00) = $46.00.

Genesis Corporation sells three types of snowboards with the following information:

	Unit Selling Price	Unit Variable Cost	Sales Mix
Beginner	$40	$10	50%
Novice	$50	$15	20%
Expert	$80	$20	40%

What is the break-even point for Genesis Corporation if total fixed costs are $883,200?

14,245 units
15,771 units
19,200 units
21,029 units

Ans: C, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Before computing the weighted-average contribution margin, the unit contribution margin for each snowboard must be computed. Beginner,

($40 - $10) is $30, Novice ($50 - $15) is $35, and Expert ($$80 - $20) is $60. The weighted-average contribution margin (WACM) is then calculated as:

(CM x Sales mix for Beginner) + (CM x Sales mix for Novice) + (CM x Sales mix for Expert), thus ($30 × .50) + ($35 × .20) + ($60 × .40) or ($15.00 +

$7.00 + $24.00) = $46.00. The fixed costs divided by the WACM will result in the break-even point for the period; $883,200 ÷ $46.00 = 19,200 units.

Which statement regarding degree of operating leverage (DOL) is correct?
DOL is calculated as contribution margin divided by operating income.
DOL is calculated as gross margin divided by net income after taxes.
DOL is calculated as pretax income before interest and tax divided by sales revenues.
DOL is calculated as net income divided by total fixed manufacturing costs.

Ans: A, LO 5, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting & Control: Cost

Accounting.

Solution: The degree of operating leverage (DOL) is calculated as contribution margin divided by operating income.

Emanuel’s Electronics Co. has the following results for the month: Revenues equal $6,500, contribution margin equals $3,900, and operating income equals $600. 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?
1. $900
2. $990
3. $1,500
4. $2,200

Ans: B, LO 5, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: 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.

The accounting staff of LaForge Enterprises has computed a degree of operating leverage (DOL) of 3.5 for last month’s results based on revenues of $5,500 and variable costs of $2,000. What were total fixed costs?
1. $950
2. $1,000
3. $2,300
4. $2,500

Ans: D, LO 5, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The DOL is calculated as contribution margin (revenues minus variable costs) divided by operating income. Therefore, a DOL of 3.5 = (5,500 −

2,000) ÷ operating income, which can be calculated as 3500 ÷ 3.5 = 1,000. For Operating income to be $1,000 based on a Contribution Margin of $3,500,

Fixed Costs would have to be $3,500 − $1,000 = $2,500.

Degree of operating leverage (DOL) is most often used in what form of business analysis?
1. Income analysis
2. Sensitivity analysis
3. Competitive analysis
4. Liquidity and working capital analysis

Ans: B, LO 5, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: The degree of operating leverage (DOL) is most frequently used in sensitivity analysis to help analysts plan their operations and answer “what-if”

questions.

Which of the following statements regarding a relatively high degree of operating leverage is correct?
1. Firms with higher operating leverage will see a slower decline in profits as sales volume decreases.
2. Firms with higher operating leverage will see a steeper increase in variable costs as sales volume increases.
3. Firms with higher operating leverage will see a steeper increase in operating profit as sales volume increases.
4. Firms with higher operating leverage will see a steeper increase in fixed costs and expenses as sales volume increases.

Ans: C, LO 5, Bloom: C, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: The degree of operating leverage acts as a multiplier of sales revenues changes. As the degree of operating leverage increases, so does the

multiplier effect. Therefore, firms with higher operating leverage will see a steeper increase in operating profit as sales volume increases.

If all other variables remain the same and a company experiences a change in fixed expense levels which of the following statements regarding the degree of operating leverage (DOL) is correct?
An increase in fixed expenses will result in a decrease in the degree of operating leverage.
An increase in fixed expenses will result in no change to the degree of operating leverage.
A decrease in fixed costs and expenses will result in a higher degree of operating leverage.
A decrease in fixed costs and expenses will result in a lower degree of operating leverage.

Ans: D, LO 5, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The degree of operating leverage (DOL) is calculated as contribution margin divided by operating income. When fixed costs decrease, this will

result in higher operating income with no change to contribution margin. Dividing a contribution margin that is unchanged by an operating income that has

increased will result in a lower degree of operating leverage.

Increasing fixed costs will have what impact on a company’s degree of operating leverage (DOL)?
1. DOL will increase.
2. DOL will decrease.
3. DOL will be unchanged.
4. DOL is impacted only by changes in variable costs.

Ans: A, LO 5, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The degree of operating leverage (DOL) is calculated as contribution margin divided by operating income. When fixed costs increase, this will

result in lower operating income. Therefore, dividing a contribution margin that is unchanged by an operating income that has decreased will result in a

higher degree of operating leverage, and DOL will increase.

Donatello’s Donut Shop sells boxes of a dozen donuts for $9, has variable costs of $5 per box and has fixed costs of $8,000 per month. Last month, Donatello’s had an operating profit of $2,000. Which of the following statements is correct?
1. If Donatello’s had sold 2,500 boxes last month, it would have hit the break-even point.
2. If Donatello’s sold 3,000 boxes last month, its operating profit would have been $3,000.
3. If Donatello’s has an increase in sales of 10%, it can expect operating profit of $2,500.
4. If Donatello’s has an increase in sales of 5%, it can expect operating profit of $2,500.

Ans: D, LO 5, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The degree of operating leverage (DOL) is calculated as contribution margin divided by operating income. If operating profit was $2,000 and fixed

costs were $8,000, then contribution margin was equal to $10,000 last month. This means that the degree of operating leverage (DOL) for Donatello was its

contribution margin of $10,000 ÷ operating income of $2,000 = 5.0. Operating income can be predicted based on a given sales revenue increase. In this

case, 5% times the degree of operating leverage of 5.0 equalsa 25% increase in expected operating profit, or $2,000 × 1.25 = $2,500.

Which of the following statements regarding sensitivity analysis is accurate?
Sensitivity analysis will help a company to determine profit at various levels of sales and costs.
Sensitivity analysis will help determine the sales volume point at which a company will begin to earn a profit.
Sensitivity analysis is often used in identifying areas where costs can be reduced or eliminated to help increase profit.
Sensitivity analysis is used to help identify areas where a company can improve its operations and its ability to manage debt.

Ans: A, LO 5, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: Sensitivity analysis helps management plan company business by answering “what-if” questions involving projected profitability at various levels

of sales revenues, costs, and expenses.

Which of the following statements regarding degree of operating leverage (DOL) is correct?
DOL is considered to be a percentage of sales revenues.
DOL is considered to be a multiplier.
DOL is calculated as net income divided by sales revenues.
DOL is calculated as operating income divided by variable costs.

Ans: B, LO 5, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Business Applications.

Solution: The degree of operating leverage (DOL) is a multiplier that acts on changes in sales and is determined by dividing contribution margin by

operating income.

Mike’s Maintenance Co. had the following results last month: Revenues were $9,500, contribution margin totaled $4,500, and operating income was $500. Revenues are expected to grow by 5% next month. Using the principle of degree of operating leverage (DOL) and based on the projected revenue increase, what can Mike’s expect in operating income next month?
1. $650
2. $700
3. $725
4. $850

Ans: C, LO 5, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Quantitative Methods.

Solution: DOL is equal to contribution margin divided by operating income, or $4,500 ÷ $500 = 9.0. The projected revenues increase of 5% must be

multiplied by the DOL of 9.0 to get the multiplier to apply to the operating income expected under a scenario of 5% sales revenue growth. Thus, operating

income must be multiplied by 9.0 × 5%, or 1.45, to arrive at expected operating income under the new revenue assumption. Last month’s operating income

of $500 × 1.45 = $725 in projected operating income.

Brandy’s Books is operating with a degree of operating leverage (DOL) of 5.0 for last month’s results based on revenues of $7,000 and variable costs of $3,500. What were total fixed costs last month?
1. $2,750
2. $2,800
3. $2,900
4. $2,500

Ans: B, LO 5, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The DOL is calculated as contribution margin divided by operating income. Contribution margin = Revenues − Variable costs, thus $7,000 −

$3,500 = $3,500. A contribution margin of $3,500 divided by a DOL of 5 equals an operating income of $700. Fixed costs would thus be $3,500 − $700 =

$2,800.

Which of the following statements regarding fixed costs and degree of operating leverage (DOL) is correct?
A decrease in fixed costs of 50% will cause the DOL to increase by 50%.
An increase in fixed costs of 30% will cause the DOL to decrease by 60%.
An increase in fixed costs typically represents an investment in infrastructure by a company and results in a higher DOL.
An increase in fixed costs typically represents an investment in infrastructure by a company and results in a lower DOL.

Ans: C, LO 5, Bloom: C, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The degree of operating leverage (DOL) is calculated as contribution margin divided by operating income. As fixed expenses increase, operating

income falls. When operating income falls, contribution margin is divided by a lower operating income figure, and the result is a higher DOL. Thus, when a

company makes an investment in infrastructure and its fixed costs increase, the DOL will increase.

Which of the following statements regarding a relatively high degree of operating leverage is correct?
1. Firms with a relatively low fixed cost structure will have a higher degree of operating leverage.
2. Firms with a higher degree of operating leverage will see a steeper increase in fixed costs as sales volume increases.
3. Firms with higher degrees of operating leverage are less risky and more likely to earn a profit than those with lower degrees of operating leverage.
4. Firms with a higher degree of operating leverage will see a steeper increase in operating profit as sales volume increases.

Ans: D, LO 5, Bloom: C, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: The degree of operating leverage acts as a multiplier of sales revenues changes. As the degree of operating leverage increases, so does the

multiplier effect. Therefore, firms with a higher degree operating leverage will see a steeper increase in operating profit as sales volume increases. Firms

with higher degrees of operating leverage are riskier than firms with lower degrees of operating leverage, since greater levels of fixed costs must be offset

by higher sales levels for firms with higher degrees of operating leverage.

If a company experiences a change in operating income levels due to a change in period expenses, which of the following statements regarding the degree of operating leverage (DOL) is correct?
1. An increase in operating income due to decreased fixed period expenses will result in an increase in the degree of operating leverage.
2. An increase in operating income due to a decrease in fixed period expenses will result in no change to the degree of operating leverage.
3. A decrease in operating income due to an increase in fixed period expenses will result in an increase in the degree of operating leverage.
4. A decrease in operating income due to an increase in fixed period expenses will result in a lower degree of operating leverage.

Ans: C, LO 5, Bloom: C, Difficulty: Easy AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: The degree of operating leverage (DOL) is calculated as contribution margin divided by operating income. When operating income drops due to

an increase in fixed period expenses, the denominator of the equation drops, and the result is a larger number for DOL. Therefore, when operating income

drops, DOL increases.

Which of the following statements regarding the degree of operating leverage (DOL) is correct?
1. Assuming no other changes occur, an increase in fixed costs will result in a lower DOL.
2. Fixed costs are unrelated to operating leverage.
3. Assuming no other changes occur, a decrease in fixed costs will result in a lower DOL.
4. DOL is entirely dependent on the levels of variable costs.

Ans: C, LO 5, Bloom: C, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: The degree of operating leverage (DOL) is calculated as contribution margin divided by operating income. As fixed expenses decrease, operating

income increases. Dividing contribution margin by a higher operating income level will result in a lower degree of operating leverage. Thus, when a

company reduces its fixed costs, the DOL will decrease.

Which of the following statements regarding a relatively high degree of operating leverage (DOL) is correct?
1. Firms with a relatively low proportion of variable costs will have a higher degree of operating leverage.
2. Firms with higher degrees of operating leverage will see a lower increase in operating income as sales volume increases.
3. Firms with higher degrees of operating leverage are less risky and more likely to earn a profit than those with lower degrees of operating leverage.
4. Firms with higher degrees of operating leverage are riskier than those with lower degrees of operating leverage, since there are more fixed costs to overcome.

Ans: D, LO 5, Bloom: C, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: The degree of operating leverage acts as a multiplier of sales revenues changes. As the degree of operating leverage increases, so does the

Multiplier effect. Therefore, firms with higher operating leverage will see a steeper increase in operating profit as sales volume increases. Firms with

Higher degrees of operating leverage are riskier than firms with lower DOLs because higher levels of fixed costs must be offset by higher sales and

Contribution margins.

Which of the following statements regarding the degree of operating leverage (DOL) is correct?
1. An increase in fixed costs, with no other changes, will result in a decrease in the degree

of operating leverage.

1. An increase in operating income will have no impact on the degree of operating leverage.
2. A decrease in operating income will result in a decrease in the degree of operating leverage.
3. An increase in fixed costs, with no other changes, will result in an increase in the degree

of operating leverage.

Ans: D, LO 5, Bloom: C, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The degree of operating leverage (DOL) is calculated as contribution margin divided by operating income. When fixed costs increase, operating

income drops, and the denominator of the equation drops. Therefore, when fixed costs increase and operating income drops, degree of operating leverage

increases.

Which of the following is a characteristic of a business whose operating income level is relatively high compared to its contribution margin?
1. The business has relatively high fixed costs.
2. The business has a relatively high degree of operating leverage (DOL).
3. The business has relatively low variable costs.
4. The business has relatively low fixed costs.

Ans: D, LO 5, Bloom: K, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, Strategy, Planning &

Performance: Decision Analysis.

Solution: If a company has operating income that is relatively high compared to its contribution margin, its fixed costs are relatively low, since operating

profit is equal to contribution margin minus fixed costs. The degree of operating leverage (DOL) in such cases is relatively low, since DOL is equal to

contribution margin divided by operating income, and dividing by a higher denominator will result in a lower DOL.

Increasing fixed costs and assuming no other changes will have what impact on a company’s degree of operating leverage (DOL)?
1. DOL will rise.
2. DOL will drop.
3. DOL will be unchanged.
4. DOL is impacted only by changes in variable costs.

Ans: A, LO 5, Bloom: C, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The degree of operating leverage (DOL) is calculated as contribution margin divided by operating income. An increase in fixed costs will result in

lower operating income. Dividing a contribution margin that is unchanged by an operating income that has decreased will result in a higher degree of

operating leverage. In other words, DOL will increase.

Assuming no other variables change, decreasing fixed costs will have what impact on a company’s degree of operating leverage (DOL)?
1. DOL will increase.
2. DOL will decrease.
3. DOL will be unchanged.
4. DOL is impacted only by changes in variable costs.

Ans: B, LO 5, Bloom: C, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Business Applications.

Solution: The degree of operating leverage (DOL) is calculated as contribution margin divided by operating income. When fixed costs decrease, operating

income will increase. Dividing a contribution margin that is unchanged by an operating income that has increased will result in a lower degree of operating

leverage.

Artem CPA Accounting LLP provides standard financial statement review services for clients at a price of $25,000. Artem has variable costs of $13,000 per review and fixed costs of $120,000 per month. Last month, Artem had an operating profit of $36,000. Which of the following statements is correct?
1. Artems conducted 15 reviews last month.
2. Artems conducted 10 reviews last month.
3. Artems has a degree of operating leverage of 4.33.
4. If Artems conducts 20 reviews next month, it can expect operating profit of $38,000.

Ans: C, LO 5 and 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: We can start by adding operating profit of $36,000 to fixed costs of $120,000 to arrive at operating income of $156,000 for the month. Dividing this

amount by the contribution margin of $12,000 ($25,000 sales – $13,000 variable expenses) yields the number of audits performed: $156,000 ÷ $12,000 =

13. The degree of operating leverage (DOL) is calculated as contribution margin divided by operating income. Therefore, DOL is equal to contribution

margin of $156,000 ÷ $36,000 = 4.33.

Artem CPA Accounting LLP provides standard financial statement review services for clients at a price of $25,000. Artem has variable costs of $13,000 per review and fixed costs of $120,000 per month. Last month, Artem had an operating profit of $36,000. Artem has an effective tax rate of 30%. If Artem would like to attain its net income after-tax goal of $84,000 next month, how many audits will the firm need to conduct?
30
15
25
20

Ans: D, LO 3 and 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: If Artem wishes to achieve its net income after-tax goal of $84,000 and the firm’s tax rate is 30%, then its pretax operating income level will need

to be $84,000 ÷ (1 − the tax rate of 30%) = $84,000 ÷ 70% = $120,000. Target income of $120,000 + fixed costs of $120,000 = $240,000. Dividing this

amount by the contribution margin of $12,000 ($25,000 sales − $13,000 variable expenses) yields the number of audits: $240,000 ÷ $12,000 = 20 audits.

Artem will need to conduct 20 audits next month to achieve its net income goal.

Eugene’s Environmental Consulting Service LLP had the following operating results last month: Service revenues amounted to $25,000, variable costs were $12,000, and fixed costs were $10,000 for the month. Based on this information which of the following statements about last month is correct?
Contribution margin was $12,000, and operating profit was $2,000
Contribution margin was $13,000, and operating profit was $3,000.
Eugene’s operated at break-even.
Eugene’s had a degree of operating leverage of 4.0.

Ans: B, LO 1, 5 & 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Quantitative Methods.

Solution: Service revenues of $25,000 less variable costs of $12,000 results in a contribution margin of $13,000. Contribution margin of $13,000 minus

$10,000 of fixed costs is equal to operating profit of $3,000 last month.

Eugene’s Environmental Consulting Service LLP had the following operating results last month: Service revenues amounted to $25,000, variable costs were $12,000, and fixed costs were $10,000 for the month. Based on this information which of the following statements about last month is correct?
Contribution margin was $15,000, and operating profit was $5,000.
Contribution margin was $14,000, and operating profit was $4,000.
Eugene’s operated at break-even.
Eugene’s had a degree of operating leverage of 4.33.

Ans: D, LO 1, 5 & 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Service revenues of $25,000 less variable costs of $12,000 results in a contribution margin of $13,000. A contribution margin of $13,000 −

$10,000 of fixed costs = operating profit of $3,000 last month. Degree of operating leverage (DOL) is equal to a contribution margin of $13,000 ÷ operating

income of $3,000 = 4.33.

Eugene’s Environmental Consulting Service LLP had the following operating results last month: Service revenues amounted to $25,000, variable costs were $12,000, and fixed costs were $10,000 for the month. Eugene’s anticipates a 5% increase in service revenues next month and expects its cost structure to remain constant. Based on this information, which of the following statements is correct?
1. Contribution margin last month was $10,000.
2. Total operating profit next month will be $3,650.
3. Operating profit last month amounted to a total of $4,500.
4. Eugene’s had a degree of operating leverage of 4.0 last month.

Ans: B, LO 1, 5 & 6, Bloom: AP, Difficulty: Hard, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Service revenues of $25,000 less variable costs of $12,000 results in a contribution margin of $13,000. A contribution margin of $13,000 minus

$10,000 of fixed costs is equal to operating profit of $3,000 last month. Degree of operating leverage (DOL) is equal to a contribution margin of $13,000

divided by operating income of $3,000, or 4.33. The DOL of 4.33 then needs to be multiplied by the 5% sales increase, which comes to 0.2165. Adding 1 to

this factor gives an amount of 1.2165, and multiplying this by last month’s operating income of $3,000 yields an amount of $3,649.50, or $3,650 rounded,

as the anticipated operating income next month.

Eugene’s Environmental Consulting Service LLP had the following operating results last month: Service revenues amounted to $25,000, variable costs were $12,000, and fixed costs were $10,000 for the month. Eugene has a 40% tax rate. Based on this information, which of the following statements is correct?
Contribution margin last month was $15,000.
Total operating profit last month amounted to $5,000.
Net income last month amounted to $1,800.
Eugene’s experienced a net loss for the month.

Ans: C, LO 1, 5 & 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Service revenues of $25,000 − variable costs of $12,000 = contribution margin of $13,000. Contribution margin of $13,000 − $10,000 of fixed

costs = operating profit of $3,000 last month. At a tax rate of 40%, this would result in taxes of 0.4 × $3,000 = $1,200, leaving a total of net income after

taxes of $1,800.

Casey Business Consulting provides management consulting evaluations for clients at a price of $15,000 upon completion. Casey has variable costs of $8,000 per evaluation and fixed costs of $70,000 per month. Last month, Casey had an operating profit of $21,000. Which of the following statements is correct?
Casey completed 15 evaluations last month.
Casey completed 13 evaluations last month.
Casey has a degree of operating leverage of 0.50.
Casey will need to complete 20 evaluations next month to break-even.

Ans: B, LO 5 and 6, Bloom: AP, Difficulty: Hard, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Casey completed 13 evaluations last month. This is calculated by adding operating profit of $21,000 to fixed costs of $70,000 for a total of

$91,000. Next, we solve for the contribution margin, by subtracting variable costs from revenue, or $15,000 − $8,000 = $7,000. Thus, the number of

evaluations is solved as $91,000 ÷ 7,000 = 13. The degree of operating leverage (DOL) is calculated as contribution margin divided by operating income.

Therefore, DOL is equal to $7,000 ÷ $21,000 = 0.33.

Casey Business Consulting provides management consulting evaluations for clients at a price of $15,000 upon completion. Casey has variable costs of $8,000 per evaluation and fixed costs of $70,000 per month. Last month, Casey had an operating profit of $21,000. Casey has an effective tax rate of 40%. If Casey would like to attain its net income goal of $42,000 next month, how many consulting evaluations will the firm need to complete?
20 evaluations
15 evaluations
25 evaluations
18 evaluations

Ans: A, LO 3 and 6, Bloom: AP, Difficulty: Hard, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: If Casey wishes to achieve a net income goal of $42,000 and the firm’s tax rate is 40%, then its pretax operating income level will need to be

$42,000 ÷ (1 minus the tax rate of 40%) = $42,000 ÷ 60% = $70,000. Target pretax income of $70,000 + fixed costs of $70,000 = $140,000. Dividing this

amount by the contribution margin of $7,000 per audit ($15,000 sales − $8,000 variable costs) yields the number of evaluations: $140,000 ÷ $7,000 = 20

evaluations.

If an environmental consulting firm is on track to reach its targeted operating profit for the

month, and billable hours on a project end up exceeding the original estimate, what will be the result?

1. The operating plan will need revision.
2. Operating income will likely exceed the plan.
3. Operating income will likely fall short of the plan.
4. Net income will fall short of the plan.

Ans: B, LO 3 and 6, Bloom: C, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Business Applications.

Solution: For a consulting firm, billable hours are the equivalent of sales; they are what will generate revenues and income for the firm. Therefore, if billable

hours exceed estimates, the result is likely to be more revenues, along with operating income that is higher than planned.

Eugene’s Environmental Consulting Service LLP had the following operating results last month. Service revenues amounted to $50,000, variable costs were $24,000, and fixed costs were $10,000 for the month. Based on this information,

which of the following statements is correct about last month’s results?

Contribution margin was $26,000, and operating profit was $16,000.
Contribution margin was $40,000, and operating profit was $30,000.
Eugene’s operated at a loss last month.
Eugene’s had a degree of operating leverage (DOL) of 5.625.

Ans: A, LO 1, 5 & 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Eugene’s had 160 hours of direct labor at $150 per hour, equal to total variable costs of $24,000. Service revenues of $50,000 minus variable

costs of $24,000 result in a contribution margin of $26,000. A contribution margin of $26,000 minus $10,000 of fixed costs is equal to operating profit of

$16,000 last month. Degree of operating leverage is equal to contribution margin divided by operating margin, so DOL = $26,000 ÷ $16,000 = 1.625.

Counters and Green, CPAs, LLP had revenues last month of $46,000 with the only variable costs consisting of 100 hours of staff labor at $130 per hour and 50 hours of partner-level labor at $200 per hour. Fixed costs are $120,000 for the year. Based on this information, which of the following statements about last month’s results is correct?
Contribution margin was $20,000, and operating profit was $10,000.
Contribution margin was $18,000, and operating profit was $8,000.
Margin of safety was $26,000.
Degree of operating leverage was 2.769.

Ans: C, LO 1, 2, 5 & 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The company had labor costs of $23,000 last month: (100 hours of staff labor × $130 per hour) + (50 hours of partner-level labor × $200 per hour)

= $13,000 + $10,000 = $23,000. Total variable costs thus amounted to $23,000. Service revenues of $46,000 less variable costs of $23,000 resulted in a

contribution margin of $23,000. Contribution margin of $23,000 less $10,000 of fixed costs per month ($120,000 per year ÷ 12 months) equaled operating

profit of $13,000 for the month. The degree of operating leverage (DOL) is equal to contribution margin of $23,000 ÷ operating income of $13,000 = 1.769,

which is not a given answer. Margin of safety is equal to the amount of current sales revenues that exceeds the break-even point in revenues. Break-even

in revenues for the month is equal to fixed costs for the month of $10,000 ÷ contribution margin ratio of 50% ($23,000/$46,000) = $20,000. Therefore, the

margin of safety is equal to current revenues of $46,000 less the break-even sales revenue amount of $20,000, or $26,000.

Counters and Green, CPAs, LLP had service revenues last month of $46,000, with the only variable costs consisting of 100 hours of staff labor at $130 per hour and 50 hours of partner-level labor at $200 per hour. Fixed costs are $120,000 for the year. The company anticipates a 10% increase in service revenues next month and expects its cost structure to remain consistent with last month’s levels. Based on this information, which of the following statements is correct?
Total operating profit next month will be $13,000.
Total operating profit next month will be $12,300.
Total operating profit next month will be $15,300.
The degree of operating leverage was 1.5 last month.

Ans: C, LO 1, 5 & 6, Bloom: AP, Difficulty: Hard, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The company had labor costs of $23,000 last month: (100 hours of staff labor × $130 per hour) + (50 hours of partner-level labor × $200 per hour)

= $13,000 + $10,000 = $23,000. Total variable costs thus amounted to $23,000. Service revenues of $46,000 less variable costs of $23,000 resulted in a

contribution margin of $23,000. Contribution margin of $23,000 less $10,000 of fixed costs per month ($120,000 per year ÷ 12 months) equaled operating

profit of $13,000 last month. The degree of operating leverage (DOL) is equal to contribution margin of $23,000 ÷ operating income of $13,000 = 1.769. If

sales increase by 10%, the DOL 1.769 needs to be multiplied by the 10% growth amount (1.769 x .1 = 0.1769). The next step is to add 1 to this amount (1

+ 0.1769 = 1.1769). This intermediate value of 1.1769 is often referred to as the multiplier. The final step is to multiply the 1.1769 by last month’s operating

income of $13,000: 1.1769 × $13,000 = $15,299.70, which rounds to $15,300. Therefore, $15,300, as rounded, will be the anticipated operating income

next month.

Counters and Green, CPAs, LLP had revenues last month of $46,000 with the only variable costs consisting of 100 hours of staff labor at $130 per hour and 50 hours of partner-level labor at $200 per hour. Fixed costs are $120,000 for the year. The firm has a 30% tax rate. Based on this information, the firm’s net income last month was
1. $9,000.
2. $8,100.
3. $9,100.
4. $8,700.

Ans: C, LO 1 and 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The company had labor costs of $23,000 last month: (100 hours of staff labor × $130 per hour) + (50 hours of partner-level labor × $200 per hour)

= $13,000 + $10,000 = $23,000. Total variable costs thus amounted to $23,000. Service revenues of $46,000 − variable costs of $23,000 = a contribution

margin of $23,000. Contribution margin of $23,000 − $10,000 of fixed costs per month ($120,000 per year ÷ 12 months) = operating profit of $13,000 last

month. At a tax rate of 30%, this would result in taxes of 0.3 × $13,000 = $3,900, leaving a total net income after taxes of $9,100.

Environmental Plus Consulting provides environmental safety consulting evaluations for clients at a price of $10,000 upon completion. Environmental Plus has variable costs of $5,000 per evaluation and fixed costs of $1,800,000 per year. Environmental Plus has an effective tax rate of 30%. If company management wants to reach a net income goal of $50,000 next month, approximately how many safety evaluations will the firm need to complete?
40
44
50
55

Ans: B, LO 3 and 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: If Environmental Plus wishes to achieve a net income goal of $50,000 and the firm’s tax rate is 30%, then its pretax operating income level will

need to be $50,000 ÷ (1 minus the tax rate of 30%) = $50,000 ÷ 70% = $71,429. Target pretax income of $71,429 + fixed costs of ($1,800,000 per year

divided by 12 or) $150,000 = $221,529. $221,529 ÷ the contribution margin of ($10,000 – $5,000), or $5,000 per evaluation = 44.3.

If an accounting firm experiences a substantial increase in the costs of staffing various audit engagements, what is a possible result?
1. The firm will see a reduction in the break-even sales point.
2. The firm will see a reduction in the margin of safety.
3. The firm will see a reduction in total fixed and total variable costs.
4. The firm will see a reduction in monthly sales revenues.

Ans: B, LO 3 and 6, Bloom: C, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Solution: For a consulting firm, labor costs are variable costs, and any increase in these costs will result in a lower contribution margin. This means that the

break-even point will rise as the contribution margin declines and the current margin of safety will drop, since it requires more sales revenues to reach

the break-even point.

Counters and Black, CPAs, LLP had revenues last month of $70,000. Their variable labor costs consisted of 100 hours of partner-level labor at $150 per hour and 400 hours of staff labor at $50 per hour. Other variable costs were $2,000 for the month, and fixed costs are $336,000 on an annual basis. Based on this information, which of the following statements about last month’s results is correct?
1. Operating profit was $2,000.
2. Margin of safety was $12,802.
3. Margin of safety was $10,602.
4. Degree of operating leverage was 6.2.

Ans: C, LO 1, 5 & 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The company had labor costs of $35,000 last month: (100 hours of partner-level labor × $150 per hour) + (400 hours of staff labor × $50 per hour)

= $15,000 + $20,000 = $35,000. There was an additional variable cost component of $2,000. Therefore, total variable costs were $37,000 for the month.

Service revenues of $70,000 − variable costs of $37,000 = contribution margin of $33,000. Contribution margin of $33,000 − $28,000 of fixed costs per

month ($336,000 per year ÷ 12 months) = operating profit of $5,000 last month. The degree of operating leverage (DOL) = contribution margin of $33,000 ÷

operating income of $5,000, or 6.6. Margin of safety is equal to the amount of current sales revenues that exceeds the break-even point in revenue dollars.

Break-even in revenues for the month is equal to fixed costs for the month of $28,000 ÷ the contribution margin ratio of ($33,000 ÷ $70,000) or 47.14% =

$59,398 as rounded to the nearest whole dollar. Therefore, the margin of safety is equal to current revenues of $70,000 last month minus the break-even

sales revenue amount of $59,398, or $10,602.

Counters and Black, CPAs, LLP had service revenues last month of $70,000. Their variable labor costs consisted of 100 hours of partner-level labor at $150 per hour and 400 hours of staff labor at $50 per hour. Other variable costs were $2,000 for the month, and fixed costs are $336,000 on an annual basis. The firm anticipates a 10% increase in service revenues next month and expects that its cost structure will remain consistent with last month’s levels. Based on this information, which of the following statements is correct?
Total operating profit next month will be $8,200.
Total operating profit next month will be $8,300.
The degree of operating leverage was 6.0 last month.
The degree of operating leverage was 6.5 last month.

Ans: B, LO 1, 5 & 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The company had labor costs of $35,000 last month: (100 hours of partner-level labor × $150 per hour) + (400 hours of staff labor × $50 per hour)

= $15,000 + $20,000 = $35,000. There was an additional variable cost component of $2,000. Therefore, total variable costs were $37,000 for the month.

Service revenues of $70,000 less variable costs of $37,000 results in a contribution margin of $33,000. Contribution margin of $33,000 − $28,000 of fixed

costs per month ($336,000 per year ÷ 12 months) is equal to operating profit of $5,000 last month. The degree of operating leverage (DOL) is equal to

contribution margin of $33,000 ÷ operating income of $5,000 = 6.6. If service revenues increase by 10% next month, this results in a multiplier of 6.6 × 0.1 =

0.66. Adding 1 to this factor and multiplying 1.66 by the $5,000 of operating profit last month will result in anticipated operating profit of $8,300 next month.

Counters and Brown, CPAs, LLP had revenues last month of $100,000 with variable labor costs of $50,000 and an additional variable cost of $4,000 for materials and supplies. Fixed costs are $144,000 for the year. The firm has a 25% tax rate. Based on this information, the firm’s net income last month was
$34,000.
$25,500.
$28,500.
$32,100.

Ans: B, LO 1, 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: The company had total variable costs amounting to $50,000 + $4,000 = $54,000. Service revenues of $100,000 − variable costs of $54,000 =

contribution margin of $46,000. Contribution margin of $46,000 − $12,000 of fixed costs per month ($144,000 per year ÷ 12 months) is equal to operating

profit of $34,000 last month. At a tax rate of 25%, this would result in taxes of 0.25 × $34,000 = $8,500, leaving total net income of $25,500.

Landis Landscaping is offering lawn-cuts for $40 per lawn. Landis has fixed costs equaling $108,000 per year, and its accountant has calculated the contribution margin ratio on each lawn mowed to be 60%. Based on this information, which of the following statements is correct?
If fixed costs increase by $1,200 per month, the break-even sales point will increase by 50 lawns cut.
If fixed costs increase by $1,200 per month, the break-even sales point will increase by 100 lawns cut.
If fixed costs increase by $600 per month, the break-even sales point will increase by 50 lawns cut.
If fixed costs increase by $1,800 per month, the break-even sales point will increase by 50 lawns cut.

Ans: A, LO 1, 6, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: Break-even is equal to the point at which sales in units multiplied by contribution margin is equal to total fixed costs. If fixed costs are equal to

$108,000 per year, or $9,000 per month, and each lawn cut sells for $40 with a contribution margin of 60%, then the contribution margin per lawn cut sold is

$40 × 60% = $24.00, and the break-even point is $9,000 ÷ $24.00 = 375 lawn cuts per month. If fixed costs increase by $1,200 per month, then the break-

even point becomes $9,000 + $1,200 = $10,200 ÷ $24.00 = 425 lawn cuts, an increase of 50 lawns cut over the original break-even point of 375 lawns cut.

If a consulting firm experiences a substantial increase in fixed period expenses, and no other changes occur, what is the probable result?
1. The firm will see a reduction in the break-even sales point.
2. The firm will see an increase in the margin of safety.
3. The firm will see an increase in the degree of operating leverage.
4. The firm will see an increase in monthly service revenues.

Ans: C, LO 5, 6, Bloom: C, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Business Applications.

Solution: An increase in fixed period expenses will lower operating income if all other variables remain the same. This applies to both service firms and

manufacturing companies. A decrease in operating income results in a lower denominator in the degree of operating leverage (DOL) formula. This will lead

to a higher DOL.

Which of the following is the most appropriate measure of the outputs of Zach’s Accounting LLP to use when conducting cost-volume-profit (CVP) analysis?
1. Number of engagements completed
2. Number of employees utilized on a given engagement
3. Billable employee hours directly related to an engagement
4. Calculated operating income following a reduction in revenues

Ans: C, LO 6, Bloom: C, Difficulty: Easy, AACSB: Knowledge, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Business Applications.

Solution: CVP analysis, for consulting firms and other professional service providers such as accounting firms and legal services, is oriented around the

output of billable hours.

BRIEF Exercises

Ready Set Go Inc. reports the following financial information for the month: Variable costs of $2,500,000; fixed costs of $1,000,000; 2,000 units sold; selling price per unit of $2,000; and variable cost per unit of $1,250. What is the total contribution margin for Ready Set Go Inc.?

Ans: N/A, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: Contribution margin equals $1,500,000.

Solution: With a selling price per unit of $2,000, and 2,000 units sold, total revenues = $2,000 × 2,000 units = $4,000,000. Contribution margin is equal to total revenues less total variable costs: $4,000,000 − $2,500,000 = $1,500,000.

Pepe’s Pizza Parlor sells deep-dish pizzas at a unit selling price of $25, has unit variable costs of $5 per pizza, and has total fixed costs per month of $12,000. What will the monthly break-even point be for Pepe’s?

Ans: N/A, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: 600 pizzas

Solution: Break-even point in units is equal to total fixed costs divided by the unit contribution margin. Fixed costs are $12,000 per month. Unit contribution margin is equal to unit selling price per unit less unit variable cost, or $25 − $5 = $20. Monthly break-even point is thus, calculated as $12,000 ÷ $20 = 600 pizzas.

Ellis Electrical Products serves both residential and commercial clients. Annual financial information for Ellis is as follows:

	Commercial	Residential	Total
Sales Revenues	$800,000	$500,000	$1,300,000
Variable Costs	200,000	125,000	325,000
Contribution Margin	600,000	375,000	975,000
Fixed Costs			300,000
Operating Profit			$675,000

Calculate the break-even point in sales revenue dollars for Ellis Electrical Products.

Ans: N/A, LO: 1 and 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Ans: Break-even point is sales revenue dollars = $400,000

Solution: The break-even point in sales dollars is calculated by dividing fixed costs by the contribution margin ratio. The contribution margin ratio is calculated by dividing the contribution margin (sales revenues minus variable costs) by sales revenues.

	Commercial	Residential	Total
Sales Revenues	$800,000	$500,000	$1,300,000
Variable Costs	200,000	125,000	325,000
Contribution Margin	600,000	375,000	975,000
Contribution Margin Ratio			$975,000 ÷ $1,300,000 = 75%

The break-even point in sales revenues is equal to fixed costs of $300,000 ÷ 0.75 (the 75% contribution margin ratio) = $400,000.

Ellis Electrical Products serves both residential and commercial clients. Annual financial information for Ellis is as follows:

	Commercial	Residential	Total
Sales Revenues	$800,000	$500,000	$1,300,000
Variable Costs	200,000	125,000	325,000
Contribution Margin
Fixed Costs			300,000
Operating Profit

All variable costs are product costs, and the total fixed costs of $300,000 are made up of fixed product costs of $100,000 and selling and general expenses of $200,000.

What is Ellis Electrical’s contribution margin in dollars and as a percentage? What is Ellis Electrical’s gross profit margin in dollars and as a percentage?

Ans: N/A, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: Contribution margin in dollars and as a percentage = $975,000 and 75%; Gross margin in dollars and as a percentage = $875,000 and 67.31%

Solution:

Contribution margin is equal to total sales revenues minus total variable costs. For Ellis, this is equal to $1,300,000 − $325,000 = $975,000. The contribution margin ratio, or percentage, is equal to $975,000 ÷ sales revenues of $1,300,000 = 75%.

Gross profit margin is equal to sales revenues minus all product costs. Therefore, gross profit margin for Ellis is equal to sales revenues of $1,300,000 minus variable product costs of $325,000 minus fixed product costs of $100,000 = $875,000. The gross profit margin percentage is equal to $875,000 ÷ $1,300,000 = 67.31%.

Barton Beverages Inc. sells cases of bottled water at $25 each and has variable costs of $10 for each case of water. If fixed costs per month are $30,000, what is Barton’s break-even point in terms of cases of water sold?

Ans: N/A, LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: Break-even point = 2,000 cases of water per month

Solution:

Break-even is equal to fixed costs divided by contribution margin per unit sold. For Barton, this is $30,000 ÷ ($25 − $10), or $15 per case. Therefore, $30,000 ÷ $15

= break-even point of 2,000 cases of water per month.

Evermore Electrical Products serves both residential and commercial clients.

Annual financial information for Evermore is as follows:

	Commercial	Residential	Total
Sales Revenues	$800,000	$500,000	$1,300,000
Variable Costs	200,000	125,000	325,000
Contribution Margin	600,000	375,000	975,000
Fixed Costs			300,000
Operating Profit			$ 675,000

Calculate the break-even point in sales revenue and the margin of safety in sales revenue dollars for Evermore Electrical Products.

Ans: N/A, LO 2 and 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: Break-even point in sales revenue = $400,000 and Margin of Safety = $900,000

Solution:

The margin of safety is calculated by subtracting the break-even point in sales dollars from total sales revenues. To determine the break-even in sales dollars, it is necessary to first calculate the contribution margin ratio.

	Commercial	Residential	Total
Sales Revenues	$800,000	$500,000	$1,300,000
Variable Costs	200,000	125,000	325,000
Contribution Margin	600,000	375,000	975,000
Contribution Margin Ratio			$975,000 ÷ $1,300,000 = 75%

The break-even point in sales revenues is equal to fixed costs of $300,000 ÷ 0.75 (the 75% contribution margin ratio) = $400,000.

The margin of safety in sales revenue dollars thus equals total sales revenues of $1,300,000 minus the break-even sales dollar amount of $400,000, or $900,000.

Barton Beverages Inc. sells cases of bottled water at $25 each and has variable costs of $10 for each case of water. Fixed costs per month are $30,000, and the accountants at Barton have reported to management that operating profit last month was $3,375. What is Barton’s current margin of safety in terms of sales revenue dollars?

Ans: N/A, LO 2, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Quantitative Methods

Ans: Margin of Safety = $5,625

Solution: Margin of safety is equal to the amount by which current sales revenue level exceed the break-even point. Break-even is equal to fixed costs divided by contribution margin per unit sold. For Barton, the contribution margin per case is $15 ($25 sales price minus $10 variable costs). Therefore, $30,000 divided by $15 is equal to a break-even point of 2,000 cases of water per month. In terms of sales revenue, break-even is 2,000 cases multiplied by $25 per case, equaling $50,000 per month. If operating profit was $3,375 for the month, then contribution margin was equal to $30,000 of fixed costs plus the operating profit of $3,375 $33,375. If the contribution margin is equal to $15 per case, and each case sells for $25, this amounts to a CM ratio of $15 divided by $25, equaling 60%. Therefore, in order to generate a total contribution margin of $33,375, sales revenues of $33.375 divided by 60% or 0.6 $55,625 would be necessary. The margin of safety is then calculated as $55,625 minus $50,000 $5,625 in sales revenue dollars.

For Ginger Company, sales are $2,400,000 (8,000 units), fixed expenses are $480,000, and the unit contribution margin is $120. What is the margin of safety in dollars for Ginger Company?

Ans: N/A, LO 2, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: Margin of Safety in dollars = $1,200,000

Solution: First, Break-even sales units must be computed: (Fixed Expenses/Contribution margin per unit = Break even sales in units; Then, the unit selling price must be computed: Budgeted (Expected) Sales / units = Selling price; Last, the break-even sales are computed, and deducted from the actual or expected sales to determine the Margin of Safety: Break even sales in units x Unit selling price = Break-Even Sales in Dollars; Budgeted (Expected) Sales - Break-Even Sales in Dollars = Margin of Safety); $480,000/$120 = 4,000; $2,400,000/8,000= $300; 4,000 x $300 = $1,200,000; $2,400,000 - $1,200,000 = $1,200,000

Benny’s Bakery Shop has been selling an average of 600 cakes per month for the past six months. If Benny’s price per cake is $12, each cake has variable costs of $8, and monthly fixed costs are $1,200, what is Benny’s expected margin of safety on cakes for the current month?

Ans: N/A, LO 2, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: 300 cakes

Solution: Margin of safety is current or forecasted unit sales levels minus the break-even point in units sold. Break-even point is equal to total fixed costs divided by contribution margin. Unit contribution margin is equal to unit selling price less unit variable cost, or $12 − $8 = $4. Fixed costs of $1,200 per month divided by the unit contribution margin of $4 per cake is equal to a monthly break-even point of 300 cakes. Since Benny’s has been selling an average of 600 cakes per month, the margin of safety can be calculated as 600 − 300 = 300 cakes.

Petunia’s Plantery has been selling an average of 750 plants per week over the past two months of this year. Petunia’s sells each plant for $3. Each plant has a unit variable cost of $0.75, and Petunia’s weekly fixed costs are $900. What is the Petunia’s weekly margin of safety in sales units and sales dollars?

Ans: N/A, LO 2, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: Margin of Safety (Units) = 350 units Margin of Safety (dollars) = $1,050

Solution: Margin of safety is equal to current or forecasted sales level minus break-even point in units sold. Break-even point is calculated by first solving for unit contribution margin, which is calculated as unit selling price minus unit variable cost, then by dividing fixed costs by unit contribution margin. Thus, contribution margin per plant is calculated as $3.00 − $0.75 = $2.25. The weekly break-even point is calculated as $900 per week ÷ $2.25 per plant = 400 plants per week. Since Petunia’s has been selling an average of 750 plants per week, the margin of safety in sales units can be calculated as 750 − 400 = 350 units. The Margin of Safety in dollars can be computed by converting the unit contribution margin to a contribution margin ratio, unit CM $2.25/$3.00, Unit SP = 75% with break-even sales dollars computed as Fixed Costs/ CM ratio = $900/.75 = $1,200; Margin of Safety in dollars = Actual sales, $2,250 (750 plants x Unit SP, $3) – Break-even sales dollars, $1,200 = $1,050 or 350 Margin of Safety Units x Unit SP, $3 = $1,050.

Elverly Electrical Products serves both residential and commercial clients. Annual financial information for Elverly is as follows:

	Commercial	Residential	Total
Sales Revenues	$800,000	$500,000	$1,300,000
Variable Costs	200,000	125,000	325,000
Contribution Margin	600,000	375,000	975,000
Fixed Costs			300,000
Operating Profit			$ 675,000

If Elverly company management decides on a target operating profit of $900,000, what amount of sales revenues will be required?

Ans: N/A, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: Required Sales Revenue for Target Profit of $900,000 = $1,600,000

Solution:

In order to reach a targeted income goal, the targeted income amount must be added to total fixed costs, and that sum must be divided by the contribution margin ratio. Contribution margin equals sales revenues minus variable costs.

	Commercial	Residential	Total
Sales Revenues	$800,000	$500,000	$1,300,000
Variable Costs	200,000	125,000	325,000
Contribution Margin	600,000	375,000	975,000
Contribution Margin Ratio			$975,000 ÷ $1,300,000 = 75%

The targeted income of $900,000 is added to total fixed costs of $300,000 to give a total of $1,200,000. This amount is then divided by 0.75 (the 75% contribution margin ratio), resulting in a sales revenue amount of $1,600,000. That is the amount required to generate a targeted operating income of $900,000.

Jingle Company wishes to sell enough ornaments to earn a profit of $100,000. If the unit selling price is $10, unit variable cost is $4, and total fixed costs are $80,000, how many units must be sold to earn pre-tax target profit of $100,000? If the current tax rate is 20%, how many ornaments must be sold by Jingle to earn an after-tax profit of $100,000?

Ans: N/A, LO: 3, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA FN: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Ans: 30,000 units (pretax) 34,167 units (after-tax)

Solution: (Total Fixed Costs + Net Income)/unit contribution margin = Number of units that must be sold to earn pre-tax profit) = ($80,000 + $100,000)/($10 - $4) = 30,000 units.

(Total Fixed Costs + Net Income (1- tax rate)/unit contribution margin = Number of units that must be sold to earn after-tax profit) = [$80,000 + {$100,000/(1 - .20)}]/($10 - $4) = 34,167 units.

Aramingo Corporation has fixed costs of $260,000 and the contribution margin ratio is 40% of sales. How much will Aramingo report as required sales to earn a target operating income of $90,000?

Ans: N/A, LO: 3, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA FN: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning

& Performance: Cost Management and Decision Analysis.

Ans: $875,000

Solution: (Fixed costs + Target Operating Income) ÷ Contribution Margin Ratio = Required Sales for target operating income = ($260,000 + $90,000) ÷ 40% = $875,000

Memorable Moments wants to sell enough custom gifts to earn a profit of $250,000. If the unit selling price per gift is $40, unit variable cost is $27, and total fixed costs are $101,000, how many custom gifts must be sold to earn the desired operating income of $250,000?

Ans: N/A, LO: 3, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA FN: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning

& Performance: Cost Management and Decision Analysis.

Ans: 27,000 units

Solution: (Fixed Costs + Target Operating Income) / Contribution margin per unit = Units to

be sold to earn income) = ($101,000 + $250,000) / ($40 - $27) = 27,000 units.

Alpha Corporation reported the following results from the sale of 10,000 units in May: sales $500,000, variable costs $270,000, fixed costs $110,000, and operating income $120,000. Assume that Alpha expects to increase the selling price by 6% on June 1. How many units will have to be sold by Alpha in June to maintain the same level of operating income?

Ans: N/A, LO: 3, Bloom: AP, Difficulty: Medium, Min: 3, AACSB: Analytic, AICPA FN: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: 8,847

Solution: (Fixed costs + Target Operating Income) / (Adj Selling price per unit – variable cost per unit) = Units to be sold for desired operating income = ($110,000 + 120,000) / [($500,000 /10,000) x 1.06) – ($270,000 /10,000)] = 8,847 (rounded)

Ellis Electrical Products serves both residential and commercial clients. Annual financial information for Ellis is as follows:

	Commercial	Residential	Total
Sales Revenues	$800,000	$500,000	$1,300,000
Variable Costs	200,000	125,000	325,000
Contribution Margin	600,000	375,000	975,000
Fixed Costs			300,000
Operating Profit			$ 675,000

If variable costs for the residential business increase by 20%, what is the new contribution margin ratio percentage for Ellis Electrical Products?

Ans: N/A, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: The new contribution margin ratio becomes 73.08%.

Solution:

The new contribution margin ratio percentage is equal to the total contribution margin of the commercial and residential businesses or the company contribution margin, divided by the total sales revenues from both divisions.

If variable costs for the residential business increase by 20%, then total variable costs will be $125,000 × 1.2 = $150,000. The financial information for Ellis will then become the following:

	Commercial	Residential	Total
Sales Revenues	$800,000	$500,000	$1,300,000
Variable Costs	200,000	150,000	350,000
Contribution Margin	600,000	350,000	950,000
Contribution Margin Ratio			$950,000 ÷ $1,300,000 = 73.08%

The new contribution margin ratio for Ellis Electrical Products becomes 73.08%.

Barton Beverages Inc. sells cases of bottled water at $25 each and has variable costs of $10 for each case of water. Fixed costs per month are $30,000. Barton management is considering adding a new bottled water product line that will be sold at $30 a case and have variable costs of $15 per case. Fixed costs would increase by $5,000 per month, and the new line would comprise 60% of Barton’s sales revenues going forward. What would be Barton’s weighted average contribution margin after the new bottled water line is introduced?

Ans: N/A, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: $15

Solution: The weighted average contribution margin is equal to the sales mix percentage of each product multiplied by its contribution margin percentage, with all results added together. The original bottled water line has a unit contribution margin of $15 (Unit SP, $25 – Unit VC, $10). This line will drop to only 40% of total sales, so $15 × 40% = $6. The new product line will have a unit contribution margin of $15 (Unit SP, $30 – Unit VC, $15) and will make up a total of 60% of the total sales mix, so $15 × 60% = $9. Therefore, the total weighted average contribution margin is equal to $6 + $9 = $15.

Tensa Corporation manufactures cameras. It has fixed costs of $2,120,000. Tensa’s sales mix and unit contribution margins are shown below:

Sales Mix Unit Contribution Margin

Tourist Model 35% $ 40

Amateur Model 40% $ 70

Professional Model 25% $ 140

Compute the weighted-average contribution margin for this product mix.

Ans: N/A, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Ans: $77

Solution:

Weighted-Average

Sales Mix × Contribution Margin Contribution Margin

Tourist Model 35% × $ 40 $14

Amateur Model 40% × $ 70 $28

Professional Model 25% × $ 140 $35

$77

Minke Medical Machines sells three types of hospital equipment. Information on these machines is as follows:

Xray 50% of total sales Unit contribution margin of $600

MRI 30% of total sales Unit contribution margin of $400

CT Scan 20% of total sales Unit contribution margin of $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?

Ans: N/A, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Decision Analysis.

Ans: 4,000 units

Solution: The weighted average contribution margin (WACM) for these three machines is calculated as: (Unit CM x Sales mix for Xray) + (Unit CM x Sales mix for MRI) + (Unit CM x Sales mix for CT Scan), or ($600 x .50) + ($400 x .30) + ($700 x .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.

Big Mountain Sporting Goods has two divisions: Sporting Goods and Camping and Hunting Gear. The sales mix is 60% for Sporting Goods and 40% for Camping and Hunting Gear. Big Mountain incurs $2,660,000 in fixed costs. The unit contribution margin for Sporting Goods is $300, while for Camping and Hunting Gear it is $500. What is the weighted-average contribution margin per unit and break-even point in units for Big Mountain Sporting Goods?

Ans: N/A, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: Weighted-average contribution margin per unit = $380; Breakeven units = 7,000 units

Solution: The weighted average contribution margin (WACM) for these two divisions is calculated as: (Unit CM x Sales mix for Sporting Goods) + (Unit CM x Sales mix for Camping and Hunting Gear) or ($300 x .60) + ($500 x .40) = $180 + $200 = $380 WACM. This WACM is then divided into the annual fixed costs to determine the annual break-even point; $2,660,000 ÷ $380 = 7,000 units.

Elvis Electrical Products serves both residential and commercial clients. Annual financial information for Elvis is as follows:

	Commercial	Residential	Total
Sales Revenues	$800,000	$500,000	$1,300,000
Variable Costs	200,000	125,000	325,000
Contribution Margin	600,000	375,000	975,000
Fixed Costs			300,000
Operating Profit			$ 675,000

What is Elvis’s current degree of operating leverage?

Ans: N/A, LO 5, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: DOL = 1.4444

Solution: Degree of operating leverage (DOL) is calculated by dividing contribution margin by operating profit. Therefore, DOL = $975,000 ÷ $675,000 = 1.4444.

Ellis Electrical Products serves both residential and commercial clients. Annual financial information for Ellis is as follows:

	Commercial	Residential	Total
Sales Revenues	$800,000	$500,000	$1,300,000
Variable Costs	200,000	125,000	325,000
Contribution Margin	600,000	375,000	975,000
Fixed Costs			300,000
Operating Profit			$675,000

If total sales revenues increase by 10%, what operating profit can Ellis expect to generate?

Ans: N/A, LO 5, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: Operating profit of $772,500 (or $772,497 depending on method used)

Solution:

To calculate an expected operating profit based on a sales revenue percentage change, the percentage change must be multiplied by the degree of operating leverage (DOL) to generate a factor to apply to the current level of operating income.

In this case, the DOL is calculated by dividing contribution margin of $975,000 by operating profit of $675,000 = 1.4444.

Multiplying the expected sales revenue percentage increase of 10% by 1.4444 gives a factor of 14.444%, which means that operating profit will increase by 14.444% if sales revenues increase by 10%. Current operating profit of $675,000 increased by 14.444% (or multiplied by 1.14444) is equal to an expected operating profit of $772,497. A way to check this calculation is to increase the original sales revenues of $1,300,000 by 10% (multiply by 1.1), which equals $1,430,000. This level of sales revenues will still carry a contribution margin of 75%; therefore, contribution margin = $1,430,000 × 75% (or .75) = $1,072,500. Subtracting the fixed costs of $300,000 from this amount gives total operating profit of $772,500, which is essentially the same amount with a minor $3 difference due to the rounding of the DOL factor.

Ajax Company has operating income of $4,000 and a degree of operating leverage (DOL) of 3.0 anticipates an increase of 10% in sales revenues next month. The company can expect to generate what amount of operating income next month?

Ans: N/A, LO 5, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: $5,200

Solution: A degree of operating leverage (DOL) of 3.0 multiplied by a 10% increase in sales revenues results in a lever, or multiplier, of 30%. A 30% increase in the base operating income of $4,000 results in operating income of $4,000 x 1.3 = $5,200.

Catherine Consulting Inc. had service revenues last month of $30,000, variable costs of $15,000 and fixed selling and administrative expenses of $5,000. What is the firm’s degree of operating leverage (DOL)?

Ans: N/A, LO 5 and 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: DOL = 1.5

Solution: DOL is equal to contribution margin divided by operating income. Thus, DOL = ($30,000 − $15,000) ÷ ($15,000 − $5,000) = $15,000 ÷ $10,000 = 1.5.

Catherine Consulting Inc. had service revenues last month of $30,000, variable costs

of $15,000 and fixed costs of $5,000. If the firm anticipated service revenue growth ser service serof 10% next month, what would be its anticipated operating profit?

Ans: N/A, LO 5 and 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Quantitative Methods.

Ans: New operating income amount of $11,500 if service revenues increase by 10%.

Solution: Operating profit based on revenue growth is equal to the revenue growth percentage multiplied by the degree of operating leverage (DOL). This factor is then multiplied by the current operating income to arrive at an anticipated operating income. DOL is equal to contribution margin divided by operating income. Thus, DOL = ($30,000 − $15,000) ÷ ($15,000 − $5,000) = $15,000 ÷ $10,000 = 1.5. If revenue growth is 10%, then 10% multiplied by 1.5 results in a growth factor, or lever, of 15%. Therefore, operating income will increase by 15% if service revenues grow by 10%. Operating profit last month was $30,000 − $15,000 − $5,000 = $10,000. Applying a 15% increase to $10,000, or $10,000 × 1.15, will equal a new operating income amount of $11,500 if service revenues increase by 10%.

Philabundance provides charitable meals to the families in need in the Delaware Valley. Weekly, the nonprofit entity provides 90,000 meals to families. The variable cost per meal is $3.00 and the weekly total fixed costs for the organization are $5,000. How much funding is needed by the Philabundance organization on a weekly basis to support its operations? (Hint: Compute Break-even Sales at net income = $0)

Ans: N/A, LO 5 and 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: $275,000 of funding required on a weekly basis to support operations

Solution: Net Income = Service Revenue – Variable Costs – Fixed Costs = $0; Service Revenue (Funding) = Variable Costs, (90,000 Meals x $3 per meal) + $5,000 = $275,000 of funding required on a weekly basis to support operations.

ZZZ Best CPAs provides the following accounting services to its customers: tax preparation and audits. The sales mix for the services is 70% tax preparation and 30% audits. If the contribution margins per unit for tax preparation is $100 and for audits, is $300, what is the break-even point for ZZZ Best CPA’s if its annual fixed costs are $900,000?

Ans: N/A, LO 4, 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: Weighted-average contribution margin per unit = $160; Breakeven units = 5,625 services

Solution: The weighted average contribution margin (WACM) for these two services is calculated as: (Unit CM x Sales mix for tax preparation) + (Unit CM x Sales mix for audits) or ($100 x .70) + ($300 x .30) = $70 + $90 = $160 WACM. This WACM is then divided into the annual fixed costs to determine the annual break-even point; $900,000 ÷ $160 = 5,625 services.

Joey plans to start his own snow-shoveling business to help save for his college fund. He plans to charge customers $30 per driveway. To begin his business, he has purchased the necessary equipment which will result in monthly fixed costs of $100. His variable costs include fuel and oil for the equipment, which translates to a unit variable cost of $5 per customer. If Joey projects that he can provide services to his neighborhood, with weekly snowfalls, of 20 customers per week, or 80 customers per month, what amount of operating income will Joey recognize in his first month of operations?

Ans: N/A, LO 1, 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Ans: $1,900

Solution: Sales Revenue – Variable Costs – Fixed Costs = Operating Income; (80 x $30) – (80 x $5) – $100 = $2,400 - $400 - $100 = $1,900.

Exercises

Emerald City Jewelers has two products it is currently producing and selling. One is a

necklace, and one is a bracelet. Information on these two items follows:

Necklace: Total fixed costs are $70,000, variable costs are $50 per unit, and the unit selling price is $120.

Bracelet: Total fixed costs are $60,000, variable costs are $40 per unit, and the unit selling price is $100.

What is the break-even point in units for each of these jewelry items?

LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance:

Cost Management and Decision Analysis.

Ans: Break-even is 1,000 units for each of the two items, necklace and bracelet.

Solution: Necklace: Contribution margin per unit is equal to sales price per unit minus variable costs per unit, or $120 − $50 = $70. Fixed costs of $70,000 divided by contribution margin per unit of $70 is equal to break-even in units of 1,000. Bracelet: Contribution margin per unit is equal to sales price per unit minus variable costs per unit, or $100 − $40 = $60. Fixed costs of $60,000 divided by contribution margin per unit of $60 is equal to break-even in units of 1,000. Each item has a break-even point of 1,000 units.

As a result of cost increases imposed by its primary supplier, Fly Fishing Fanatics Supplies Inc. has experienced an increase in its variable direct per unit costs that will result in a contribution margin ratio that is 3 percentage points lower than previous levels. Operating income last month, before the cost increase, was $5,500 based on sales revenues of $50,000 and fixed costs of $20,000. If sales revenues increase next month by 5%, and the new variable costs come into effect, what can Fly Fishing Fanatics anticipate in terms of operating profit?

LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance:

Cost Management and Decision Analysis.

Ans: $5,200

Solution: Last month, before the variable cost increase, total variable costs were $24,500 (sales revenues of $50,000 less total fixed costs of $20,000 less operating profit of $5,500). This means that the contribution margin last month was equal to $50,000 − $24,500 = $25,500, resulting in a contribution margin ratio of 51.0% ($25,500 ÷ $50,000). The increase in variable costs will reduce the contribution margin ratio by 3%; therefore, it will drop to 48.0%. If sales revenues increase next month by 5%, total sales revenues will increase by $52,500 ($50,000 × 1.05). If the contribution margin on this sales revenue is 48.0%, the contribution margin in dollars will be $25,200 (0.48 × $52,500). Subtracting fixed costs of $20,000 from this amount will result in operating income of $5,200.

Zapple, Ltd. is producing and distributing a new computer-based game that it sells for $75 a unit. Zapple’s fixed costs are $43,750 per month, and the company’s accountants have determined that the monthly break-even in units is 1,250. What is the monthly unit variable cost and unit contribution margin for Zapple, Ltd.?

LO 1, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance:

Cost Management and Decision Analysis.

Ans: Variable costs equal $40 per unit, and contribution margin is $35 per unit.

Solution: At the break-even point, sales in units multiplied by contribution margin equal total fixed costs. If fixed costs are $43,750 per month, and the break-even point is 1,250 units, contribution margin is equal to $43,750 ÷ 1,250 = $35 per unit. This means that variable costs are equal to the unit sales price of $75 minus the contribution margin of $35, or $40 per unit. Therefore, variable costs equal $40 per unit, and contribution margin is $35 per unit.

Crest Canoe Co. produces and distributes three types of oars to accompany its various canoe product lines. Financial information for the past year on these three products is as follows:

	Paddler	Stroker Ace	Super Driver	Total
Price per Unit	$50	$120	$400
Units Sold	4,000	3,000	2,000
Variable Costs per Unit	$20	$50	$90
Fixed Product Costs	$40,000	$60,000	$110,000
Total Fixed Selling & Admin Costs				$304,000
Income Tax Rate				25%

Assuming that Crest’s overall sales mix for its oars remains the same, calculate and provide the following additional information:

What is the current weighted average contribution margin per unit? (Round to 2 decimal places)
What is the break-even point in sales units?
What is the current overall gross profit margin?

Ans: N/A, LO 1, 4 and 5, Bloom: AP, Difficulty: Hard, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation; IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution:

To determine the current weighted average contribution margin, it is first necessary to compute the sales mix for the products. Total units sold is 9,000 (4,000 + 3,000 + 2,000), so the sales mix for Paddler would be 45% (4,000/9,000), for the Stroker Ace, 33% (3,000/9,000) and for the Super Driver, 22% (2,000/9,000). The current weighted average contribution margin (WACM) is equal to the sum of the weighted average contribution margins of all three products. Therefore, the WACM = [.45 × ($50 − $20)] + [.33 × ($120 − $50)] + [.22 × ($400 − $90)] = $105.80.
The break-even point is sales revenue units is equal to total fixed costs divided by the weighted average (total) contribution margin. Total fixed costs are equal to selling and administrative costs of $304,000 + total fixed product costs of $210,000 ($40,000 + $60,000 + $110,000) = $514,000. The total weighted average contribution margin is equal to the total weighted average contribution margin (WACM) of $105.80. Total fixed costs of $514,000 divided by the WACM of $105.80 comes to a break-even sales in units of 4,858 as rounded to the nearest whole unit.
The current overall gross margin is equal to contribution margin minus any additional product costs. Therefore, the contribution margin of $950,000 {[($50 - $20) x 4,000] + [($120 - $50) x 3,000] + [($400 - $90) x 2,000]} minus additional fixed product costs of ($40,000 + $60,000 + $110,000) = total gross profit margin of $740,000.
Crest Canoe Co. produces and distributes three types of oars to accompany its various canoe product lines. Financial information for the past year on these three products is as follows:

	Paddler	Stroker Ace	Super Driver	Total
Price per Unit	$50	$120	$400
Units Sold	4,000	3,000	2,000
Variable Costs per Unit	$20	$50	$90
Fixed Product Costs	$40,000	$60,000	$110,000
Selling & Admin Costs				$304,000
Income Tax Rate				25%

Assuming that Crest’s overall sales mix for its oars remains the same, calculate and provide the following additional information:

What is Crest Canoe’s degree of operating leverage (DOL)? (Round to 4 decimal places)
What is Crest’s operating income after taxes?
What is the margin of safety in terms of sales revenue dollars? (Hint: Compute the contribution margin ratio for the company (total).)

Ans: N/A, LO 1, 2, 3, 4, and 5, Bloom: AP, Difficulty: Hard, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy,

Planning & Performance: Cost Management and Decision Analysis.

Solution:

DOL is equal to the total contribution margin divided by operating income. The total contribution margin is equal to the sum of the contribution margins of all three products. Therefore, the total contribution margin is equal to [4,000 × ($50 − $20)] + [3,000 × ($120 − $50)] + [2,000 × ($400 − $90)] = $950,000. Operating income is equal to the total contribution margin minus any additional fixed product costs minus any fixed selling and administrative costs. This amounts to $950,000 − ($40,000 + $60,000 + $110,000) − $304,000 = $436,000. DOL is equal to $950,000 ÷ $436,000 = 2.1789.
Operating income after taxes is equal to operating income (pretax income) minus income taxes. Taxes are calculated by multiplying pretax operating income by the effective tax rate. Therefore, if operating income is $436,000 and the tax rate is 25%, then income taxes are $436,000 × 25% = $109,000. This tax amount subtracted from the $436,000 pretax operating income amounts to total operating income of $327,000.
Crest’s margin of safety is equal to the excess of current total sales revenue dollars above the break-even sales amount. The break-even point in sales revenue dollars is equal to total fixed costs divided by the weighted average (total) contribution margin percentage. Total fixed costs are equal to $304,000 of selling and administrative costs plus total fixed product costs of $210,000 ($40,000 + $60,000 + $110,000) = $514,000. The total contribution margin ratio for Crest Canoe Co. is equal to the total contribution margin of $950,000 divided by the total sales revenues for the three products. Total sales revenues equal (4,000 × $50) + (3,000 × $120) + (2,000 × $400) = $1,360,000. So, the company contribution margin ratio is $950,000 divided by total sales revenues of $1,360,000 = 69.85%. Total fixed costs of $514,000 divided by the company contribution margin ratio of 69.85% comes to a break-even sales revenue amount of $735,863, rounded to the nearest whole dollar. Therefore, the margin of safety is equal to current sales revenues of $1,360,000 − break-even sales revenues of $735,863 = $624,137.
Crest Canoe Co. produces and distributes three types of oars to accompany its various canoe product lines. Financial information for the past year on these three oars is as follows:

	Paddler	Stroker Ace	Super Driver	Total
Price per Unit	$50	$120	$400
Units Sold	4,000	3,000	2,000
Variable Costs per Unit	$20	$50	$90
Fixed Product Costs	$40,000	$60,000	$110,000
Selling & Admin Costs				$304,000
Income Tax Rate				25%

Assuming that Crest’s overall sales mix for its oars remains the same and fixed costs increase by $100,000 per year, calculate and provide the following additional information:

What is Crest Canoe’s degree of operating leverage (DOL)? (Round to 4 decimal places)
What is Crest’s operating income after taxes?
What is the current margin of safety in terms of sales revenue dollars? (Hint: Compute the contribution margin ratio for the company (total).Round to nearest whole dollar)

Ans: N/A, LO 1, 2, 3, 4, and 5, Bloom: AP, Difficulty: Hard, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution:

DOL is equal to the contribution margin divided by operating income. The current contribution margin is equal to the sum of the contribution margins of all three products. Therefore, the contribution margin is equal to [4,000 × ($50 − $20)] + [3,000 × ($120 − $50)] + [2,000 × ($400 − $90)] = $950,000. Operating income is equal to the contribution margin minus any additional fixed product costs minus any fixed selling and administrative costs. This amounts to $950,000 − ($40,000 + $60,000 + $110,000) − $304,000 minus an additional $100,000 for the expected increase to fixed costs = $336,000. DOL is equal to total contribution margin of $950,000 ÷ $336,000 = 2.8274.
Net income after taxes is equal to operating income (pretax income) minus income taxes. Taxes are calculated by multiplying pretax operating income by the effective tax rate. If operating income is $336,000 and the tax rate is 25%, then income taxes are $336,000 × 25% = $84,000. This tax amount subtracted from the $336,000 pretax operating income amounts to total net income of $252,000.
Crest’s margin of safety is equal to the excess of current total sales revenue dollars

above the break-even sales amount. The break-even point in sales revenue dollars

is equal to total fixed costs divided by the company (total) contribution margin

percentage. Total fixed costs are equal to $304,000 of selling and administrative

costs plus total fixed product costs of $40,000 + $60,000 + $110,000 + an

additional $100,000 for the expected increase to fixed costs = $614,000. The total weighted average contribution margin percentage is equal to the total contribution margin of $950,000 divided by the total sales revenues for the three products. Total sales revenues are equal to (4,000 × $50) + (3,000 × $120) + (2,000 × $400) = $1,360,000. So, the contribution margin ratio for the company is $950,000 divided by total sales revenues of $1,360,000 = 69.85%. Total fixed costs of $614,000 ÷ company contribution margin ratio of 69.85% comes to a break-even sales revenue amount of $879,026, as rounded to the nearest whole dollar. Therefore, the margin of safety is equal to current sales revenues of $1,360,000 minus break-even sales revenues of $879,026 = $480,974.

Crest Canoe Co. produces and distributes three types of oars to accompany its various canoe product lines. Financial information for the past year on these three oars is as follows:

	Paddler	Stroker Ace	Super Driver	Total
Price per Unit	$50	$120	$400
Units Sold	4,000	3,000	2,000
Variable Costs per Unit	$20	$50	$90
Fixed Product Costs	$40,000	$60,000	$110,000
Selling & Admin Costs				$304,000
Income Tax Rate				25%

Assuming that Crest’s overall sales mix for its oars remains the same and fixed costs increase by $120,000 per year, calculate and provide the following additional information:

What is Crest Canoe’s break-even point in terms of sales dollars? (Hint: Compute the contribution margin ratio for the company (total). Round to nearest whole dollar.)
What is Crest’s operating income?
What is Crest’s degree of operating leverage (DOL)? (Round to 4 decimal places.)

Ans: N/A, LO 1, 2, 4, and 5, Bloom: AP, Difficulty: Hard, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution:

The break-even point in sales units is equal to total fixed costs divided by the weighted average contribution margin per unit. Total fixed costs are equal to $304,000 of selling and administrative costs plus total fixed product costs of $40,000 + $60,000 + $110,000 + an additional $120,000 for the expected increase to fixed costs = $634,000. The current weighted average contribution margin (WACM) is equal to the sum of the contribution margins of all three products. First, the total contribution margin for Crest Canoe Co. is computed as, [4,000 × ($50 − $20)] + [3,000 × ($120 − $50)] + [2,000 × ($400 − $90)] = $950,000; the company (total) contribution margin ratio is equal to the total contribution margin of $950,000 divided by the total sales revenues for the company. Total sales revenue is thus, equal to (4,000 × $50) + (3,000 × $120) + (2,000 × $400) = $1,360,000. So, the company (total) contribution margin ratio is $950,000 total contribution margin divided by total sales revenues of $1,360,000 = 69.85%. Total fixed costs of $634,000 divided by the company (total) contribution margin ratio of 69.85% results in a break-even sales revenue amount of $907,659, rounded to the nearest whole dollar.
Operating income is equal to contribution margin minus all fixed costs and expenses. Therefore, contribution margin of $950,000 − fixed costs of ($40,000 + $60,000 + $110,000) − $304,000 minus an additional $120,000 for the expected increase to fixed costs = a total operating income amount of $316,000.
DOL is equal to the contribution margin divided by operating income. The current contribution margin is equal to the sum of the contribution margins of all three products. Therefore, the contribution margin = [4,000 × ($50 − $20)] + [3,000 × ($120 − $50)] + [2,000 × ($400 − $90)] = $950,000. Operating income is equal to the contribution margin minus any additional fixed product costs minus any fixed selling and administrative costs. This amounts to $950,000 − ($40,000 + $60,000 + $110,000) − $304,000 minus an additional $120,000 for the expected increase to fixed costs = $316,000. DOL is equal to $950,000 ÷ $316,000 = 3.0063
Crest Canoe Co. produces and distributes three types of oars to accompany its various canoe product lines. Financial information for the past year on these three oars is as follows:

	Paddler	Stroker Ace	Super Driver	Total
Price per Unit	$50	$120	$400
Units Sold	4,000	3,000	2,000
Variable Costs per Unit	$20	$50	$90
Fixed Product Costs	$40,000	$60,000	$110,000
Selling & Admin Costs				$304,000
Income Tax Rate				25%

Assume that Crest’s overall sales mix for its oars remains the same. What are the required sales revenue levels if management sets the following operating income target levels?

Target operating income of $300,000.
Target operating income of $400,000.
Target operating income of $500,000.

Ans: N/A, LO 3 and 4 Bloom: AP, Difficulty: Hard, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution:

The total sales revenues necessary to reach specified targeted operating income levels are calculated by adding the targeted operating income value to total fixed costs and dividing the amount by the overall contribution margin percentage. Crest’s total fixed costs equal $40,000 + $60,000 + $110,000 + 304,000 = $514,000. This amount added to the first targeted operating income amount of $300,000 = $814,000. The current weighted average contribution margin (WACM) is equal to the sum of the contribution margins of all three products. The WACM is equal to [4,000 × ($50 − $20)] + [3,000 × ($120 − $50)] + [2,000 × ($400 − $90)] = $950,000. The total or weighted average contribution margin percentage is equal to the total weighted average contribution margin (WACM) of $950,000 divided by the total sales revenues for the three products. Total sales revenues are equal to (4,000 × $50) + (3,000 × $120) + (2,000 × $400) = $1,360,000. So, the total or WACM percentage is $950,000 ÷ total sales revenues of $1,360,000 = 69.85%. Therefore, $814,000 ($514,000 + 3300,000) ÷ 69.85% = total required sales revenues of $1,165,354, as rounded to the nearest whole dollar.
Using the process laid out in part a but targeting operating income of $400,000 requires the following calculations: Total fixed costs of $514,000 plus targeted operating income of $400,000 amounts to a total of $914,000. Dividing this amount by the WACM ratio of 69.85% results in a required sales revenue amount of $1,308,518 to generate targeted operating income of $400,000.
Using the process laid out under part a but targeting operating income of $500,000 requires the following calculations: Total fixed costs of $514,000 plus targeted operating income of $500,000 amounts to a total of $1,014,000. Dividing this amount by the total or WACM ratio of 69.85% results in a required sales revenue amount of $1,451,682 to generate targeted operating income of $500,000.
Dynamic Designs has fixed costs of $380,000 and produces one graphic arts product with a selling price of $80 and variable costs of $42 per unit. The firm’s maximum production capacity is 20,000 units, and it anticipates selling 15,000 units.
1. What will be Dynamic’s expected operating income based on 15,000 units sold?
2. If sales increase to the firm’s maximum production capacity, what will be its operating income?
3. What will sales revenue levels have to be to reach management’s operating income goal of $342,000?
4. How much will this be in required unit sales?

Ans: N/A, LO 1 and 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution:

Operating income is equal to total sales revenues minus total variable costs minus total fixed costs. If each unit sold is priced at $80, and variable costs equal $42 per unit, then the contribution margin is equals $38. If 15,000 units are sold, then the total contribution margin is 15,000 × $38 = $570,000. Subtracting fixed costs of $380,000 results in total operating profit of $190,000.
If sales in units reach capacity of 20,000 units, total contribution margin increases to 20,000 × $38 = $760,000. Subtracting total fixed costs of $380,000 from this amount results in operating income of $380,000.
If management targets operating income of $342,000, this target income amount must be added to total fixed costs and divided by the contribution margin percentage: $342,000 + $380,000 = $722,000. Contribution margin ratio is calculated as contribution margin per unit of $38 ÷ sales price per unit of $80 = 47.5%. Therefore, 722,000 ÷ 47.5% = required sales revenue amount of $1,520,000.
The required total sales revenue amount of $1,520,000 divided by the per unit sales price of $80 is equal to the required amount of 19,000 units sold.
Dynamic Designs has fixed costs of $380,000 and produces one graphic arts product with a selling price of $80 and variable costs of $42 per unit. Dynamic is currently selling 18,000 units.
What is Dynamic’s break-even point in units sold?
What is Dynamic’s margin of safety in terms of sales revenue dollars?
If Dynamic has an effective tax rate of 20%, what is its current net income?

Ans: N/A, LO 1, 2 and 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning

& Performance: Cost Management and Decision Analysis.

Solution:

Break-even is equal to fixed costs divided by contribution margin. Dynamic’s contribution margin is $80 − $42 = $38 per unit sold. With fixed costs of $380,000, this means that $380,000 ÷ $38 per unit = 10,000 units is the break-even point.
The margin of safety is equal to the excess of current sales revenues above the break-even point. With break-even at 10,000 units and a current sales level of 18,000 units, this results in a margin of safety of 8,000 units. With a sale price of $80 each, the margin of safety in sales revenue dollars is equal to $80 × 8,000 units = $640,000.
Operating income is equal to the current contribution margin of $38 per unit × 18,000 units = $684,000. Subtracting total fixed costs of $380,000 from this amount results in operating income of $304,000. If the tax rate is 20%, then taxes equal $304,000 × 20% = $60,800. Taxes of $60,800 subtracted from operating income of $304,000 results in net income after taxes of $243,200.
Dynamic Designs has fixed costs of $380,000 and produces one graphic arts product with a selling price of $80 and variable costs of $42 per unit. Dynamic is currently selling 18,000 units.
What is Dynamic Design’s degree of operating leverage (DOL)? (Round to 2 decimal places)
If sales revenues are expected to increase by 10%, what will be the expected operating profit?
Based on the (b) above, what would be Dynamic’s expected net income if its effective tax rate is 30%?

Ans: N/A, LO 1, 3, 4, and 5, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy,

Planning & Performance: Cost Management and Decision Analysis.

Solution:

Degree of operating leverage is calculated as contribution margin divided by operating income. Dynamic’s contribution margin is $80 − $42 = $38 per unit sold, and the company is selling 18,000 units. Therefore, the contribution margin is equal to $684,000. Subtracting total fixed costs of $380,000 results in total operating income of $304,000. Contribution margin of $684,000 divided by operating income of $304,000 results in a DOL of 2.25.
If the DOL is 2.25, a 10% increase in sales revenue will result in a factor, or lever, of 2.25 × 10% = 22.5%. This means that operating income would increase by 22.5% on a sales revenue increase of 10%. Current operating income is equal to $304,000, so an increase of 22.5% (multiplying by 1.225) results in operating income of $372,400 on a 10% sales revenue increase.
If sales increase by 10%, the new operating income level will be $372,400. If Dynamic has an effective tax rate of 30%, then taxes will be 30% × $372,400 = $111,720. Subtracting these tax dollars from the $372,400 of operating income results in net income after taxes of $260,680.
Laminex Ltd. manufactures a coffee table that sells for $250 per unit. The company has variable costs of $150 per unit and total fixed costs of $100,000 per period.
What is the break-even point in terms of units sold?
If current sales levels are 1,200 units, what is the margin of safety in sales revenue dollars?
If current sales levels are 1,200 units, what is Laminex’s degree of operating leverage?

Ans: N/A, LO 1, 2, 3 and 5, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy,

Planning & Performance: Cost Management and Decision Analysis.

Solution:

The break-even point in units sold is equal to total fixed costs divided by the contribution margin per unit. Total fixed costs are equal to $100,000. The contribution margin per unit is equal to $250 − $150 = $100 per unit. Dividing total fixed costs of $100,000 by $100 of contribution margin per table sold results in a break-even point in unit sales of 1,000.
With a current unit sales level of 1,200 and a break-even point of 1,000, the margin of safety is 200 units, resulting in 200 × $250 = $50,000 of sales revenues as a safety margin.
DOL is equal to the contribution margin divided by operating income. The current contribution margin is equal to $250 − $150 per unit = $100 per unit. If current sales levels are 1,200 units, then total contribution margin is equal to 1,200 × $100 = $120,000. Subtracting total fixed costs of $100,000 from this amount results in operating income of $20,000. Contribution margin of $120,000 divided by operating income of $20,000 yields a DOL of 6.0.
Laminex Ltd. manufactures a coffee table that sells for $250 per unit. The company has variable costs of $150 per unit and total fixed costs of $100,000 per period. Laminex is currently selling 1,200 units per period.
What is the current net income after taxes for Laminex if its effective tax rate is 25%?
Management anticipates that fixed costs will increase $10,000 per period due to general salary increases to office staff. How does this change the break-even point?

Ans: N/A, LO 1, 3, and 4 Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement Analysis and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution:

If current sales levels are at 1,200 units and contribution margin per unit sold is equal to $250 − $150 = $100, then 1,200 × $100 = total contribution margin of $120,000. Subtracting total fixed costs of $100,000 from this amount results in operating income of $20,000. If Laminex has a tax rate of 25%, then income taxes are equal to $20,000 × 25% = $5,000. Subtracting this tax amount from operating income results in net income after taxes of $15,000.
The break-even point in units sold is equal to total fixed costs divided by the contribution margin per unit. Total fixed costs are equal to $100,000, and contribution margin per unit is equal to $250 − $150 = $100 per unit. Dividing $100,000 by $100 results in a break-even point in unit sales of 1,000. If fixed costs increase by $10,000, the break-even calculation becomes $110,000 of total fixed costs ÷ $100 of contribution margin per table, resulting in a new break-even point of 1,100 units. With a selling price of $250 per table, this equates to total sales revenues of $275,000. Thus, the break-even point has increased by a total of 100 units or $25,000.
Premium Plumbing Products serves both residential and commercial clients. Annual financial information for Premium is as follows:

	Commercial	Residential	Total
Sales Revenues	$2,000,000	$1,500,000	$3,500,000
Variable Costs	1,000,000	700,000	1,700,000
Contribution Margin	1,000,000	800,000	1,800,000
Fixed Costs			900,000
Operating Profit			$ 900,000

If variable costs for the residential business increase by 10%, what is the new total contribution margin ratio for the company? (Hint: Compute the contribution margin ratio for the company (total). Round to 2 decimal places)
What is the new total operating income amount?

Ans: N/A, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution:

The total or company contribution margin ratio is equal to the total contribution margin of both of the commercial and residential businesses divided by the total sales revenues from both divisions.

If variable costs for the residential business increase by 10%, total variable costs would equal $700,000 × 1.1 = $770,000. The financial information for Premium then becomes the following:

	Commercial	Residential	Total
Sales Revenues	$2,000,000	$1,500,000	$3,500,000
Variable Costs	1,000,000	770,000	1,770,000
Contribution Margin	1,000,000	730,000	1,730,000
Contribution Margin Ratio			$1,730,000 ÷ $3,500,000 = 49.43%

The company (total) contribution margin ratio becomes 49.43%.

With no changes other than the $70,000 increase in residential variable costs, operating profit decreases by $70,000, from $900,000 to $830,000.
Premium Plumbing Products serves both residential and commercial clients. Annual financial information for Premium is as follows:

	Commercial	Residential	Total
Sales Revenues	$2,000,000	$1,500,000	$3,500,000
Variable Costs	1,000,000	700,000	1,700,000
Contribution Margin	1,000,000	800,000	1,800,000
Fixed Costs			900,000
Operating Profit			$ 900,000

If variable costs for the residential business increase by 10%, what is the new degree of operating leverage (DOL)? (Round to 4 decimal places)
If Premium has an effective tax rate of 20%, what is the new net income after tax amount?

Ans: N/A, LO 3 and 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution:

If variable costs for the residential business increase by 10%, total variable costs would increase to $700,000 × 1.1 = $770,000. The financial information for Premium then becomes the following:

	Commercial	Residential	Total
Sales Revenues	$2,000,000	$1,500,000	$3,500,000
Variable Costs	1,000,000	770,000	1,770,000
Contribution Margin	1,000,000	730,000	1,730,000
Fixed Costs			900,000
Operating Profit			$ 830,000

The DOL is calculated as contribution margin ÷ operating profit = $1,730,000 ÷ $830,000 = 2.0843.

If operating profit is $830,000 and Premium has a tax rate of 20%, taxes amount to $830,000 × 20% = $166,000. This tax amount subtracted from operating profit results in net income after tax of $664,000.
Addison Accounting LLP has the following financial information for its two primary business lines:

	Audit	Consulting	Total
Service Revenues	$1,900,000	$2,300,000	$4,200,000
Variable Costs	900,000	1,250,000	2,150,000
Contribution Margin	1,000,000	1,050,000	2,050,000
Fixed Costs			950,000
Operating Profit			$1,100,000

What is Addison’s current degree of operating leverage (DOL)? (Round to 4 decimal places.
What is the contribution margin ratio for Addison Accounting LLP? (Hint: Compute the contribution margin ratio for the company (total). Round to 2 decimal places)
If the sales mix holds, and Addison management targets operating profit of $2,000,000, what level of total service revenue will be required?

Ans: N/A, LO 4, 5 and 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning

& Performance: Cost Management and Decision Analysis.

Solution:

Degree of operating leverage (DOL) is calculated by dividing contribution margin by operating profit. Therefore, DOL is equal to $2,050,000 ÷ $1,100,000 = 1.8636.
The contribution margin ratio for Addison Accounting LLP amounts to $2,050,000 ÷ $4,200,000 = 48.81%
If target operating profit is set at $2,000,000, this amount needs to be added to total fixed costs of $950,000, amounting to $2,950,000. This amount divided by the contribution margin ratio from (b) of 48.81% results in total required service revenues of $6,043,843, as rounded to the nearest whole dollar.
Barton Beverages Inc. sells cases of bottled water at $25 each, has variable costs of $10 for each case of water, and has fixed costs of $30,000 per month. If Barton decides to invest in its infrastructure and fixed costs increase by $15,000 per month, how many more cases of water will Barton need to sell to break-even?

Ans: N/A, LO 1,5 Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Quantitative Methods.

Solution: Break-even is equal to fixed costs divided by unit contribution margin. For Barton before the fixed costs increase, the contribution margin is $15 ($25 − $10) per case. The break-even point is $30,000 ÷ $15 = 2,000 cases of water per month. If fixed costs increase by $15,000 per month, then $15,000 divided by the contribution margin of $15 per case of water equals an additional 1,000 cases of water required to be sold each month to break-even.

Barton Beverages Inc. sells cases of bottled water at $25 each and has variable costs of $10 for each case of water. Fixed costs per month are $30,000, and the accountants at Barton have reported to management that operating income last month was $3,375.
What is Barton’s current degree of operating leverage (DOL)? (Round to 2 decimal places)
If Barton is able to reduce its fixed costs by $3,000 per month, what is its new DOL? (Round to 3 decimal places)

Ans: N/A, LO 1, 2 and 5, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning

& Performance: Cost Management and Decision Analysis.

Solution:

DOL is equal to contribution margin divided by operating income: $33,375 of contribution margin ($30,000 + $3,375) divided by operating income of $3,375 equals 9.89.
If Barton trims fixed costs by $3,000 per month, operating income will change to $6,375, provided all other variables remain the same. DOL will then be calculated as contribution margin remaining at $33,375 divided by the new operating income amount of $6,375, yielding a DOL of 5.235.
Elmira’s Environmental Consulting Service LLP had the following operating results last month: Service revenues amounted to $50,000, variable costs were $24,000, and fixed costs were $10,000 for the month. Based on this information, compute the following amounts:
Contribution margin (total and ratio)
Operating income
Degree of operation leverage (Round to 3 decimal places)
Break-even point in dollars (Round to nearest whole dollar)

Ans: N/A, LO 1, 5 & 6, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution:

Service revenues of $50,000 minus variable costs of $24,000 result in a total contribution margin of $26,000, and contribution margin ratio of 52% = Total contribution margin ÷ Service revenue = $26,000 ÷ $50,000.
A contribution margin of $26,000 (from a) minus $10,000 of fixed costs is equal to operating income of $16,000 last month.
Degree of operating leverage is equal to contribution margin divided by operating income, so DOL = $26,000 ÷ $16,000 = 1.625.
Break-even point in sales dollars = Fixed costs ÷ Contribution margin ratio = $10,000 ÷ .52 = $19,231 (rounded)
Clemens Business Consulting provides management-consulting evaluations for clients at a price of $15,000 upon completion. Clemens has variable costs of $10,000 per evaluation and fixed costs of $90,000 per month. Last month, Clemens had an operating income of $21,000. Clemens has an effective tax rate of 20%. If Clemens would like to attain its net income goal of $80,000 next month, how many consulting evaluations will the firm need to complete?

Ans: N/A, LO 3 and 6, Bloom: AP, Difficulty: Hard, AACSB: Analytic, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning &

Performance: Cost Management and Decision Analysis.

Solution: If Clemens wishes to achieve a net income goal of $80,000 and the firm’s tax rate is 20%, then its pretax operating income level will need to be $80,000 ÷ (1 minus the tax rate of 20%) = $80,000 ÷ 80% = $100,000. Target pretax income of $100,000 + fixed costs of $90,000 = $190,000. Dividing this amount by the contribution margin of $5,000 per audit ($15,000 sales − $10,000 variable costs) yields the number of evaluations: $190,000 ÷ $5,000 = 38 evaluations.

PROBLEMS

SoniCo operates the Annabell Lee, a riverboat that provides a 2-hour cruise down the St. John River and a buffet dinner for up to 90 guests. On average, 80 guests make reservations and pay the $55 charge per cruise. While the company offers a cash bar, it provides soft drinks at no charge. An outside catering service provides the food, setup, and cleanup for the dinners and charges SoniCo a catering fee. The average costs incurred per guest for each cruise include the following:

Food and soft drinks	$25.85
Catering fee	1.10
Supplies (restroom, cleaning, etc.)	1.65

Each dinner cruise takes guests 8 miles down the river, followed by a return trip. The cost of boat fuel is $4 per gallon, and the riverboat uses 2.5 gallons per mile. The average number of dinner cruises per month is 25.

Annual fixed costs include the following:

Insurance	$ 9,600
Depreciation	14,400
Mooring	7,920
Maintenance	9,430
Captain and crew’s salaries	33,302
Registration and license fees	900

Calculate the contribution margin per cruise.
Calculate the break-even point in revenue dollars for a month.
What amount will be reported as contribution margin on the company’s monthly income statement if there are 84 guests on each cruise? Briefly explain what information the answer provides to managers.
If the average number of guests on each cruise is 84, as indicated in part c, what effect will this have on the break-even point in revenue dollars per month? Briefly explain.
Why is a lower break-even point considered to be more favorable than a higher break-even point? Explain.

Ans: N/A, LO 1, Bloom: AP, Difficulty: Hard, AACSB: Analytic, Communication, AICPA: PC, Communication, AICPA: FC, Measurement, Analysis, and

Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution:

	Variable cost per guest:
	Food and soft drinks		$25.85
	Catering fee		1.10
	Supplies		1.65
	Cost per guest		$28.60

	Total annual fixed costs:
	Fuel (8 × $4 × 2.5 × 2 × 25 × 12)		$ 48,000
	Insurance		9,600
	Depreciation		14,400
	Mooring		7,920
	Maintenance		9,430
	Captain and crew’s salaries		33,302
	Registration and license fees		900
	Total annual fixed costs		$123,552

Contribution margin per cruise =

= Number of guests × (Revenue fee per guest − Variable cost per guest)

= 80 × ($55 − $28.60)

= $2,112

Total monthly fixed costs = $123,552 ÷ 12 = $10,296

Break-even point in revenue dollars = (Total monthly fixed costs ÷ Contribution margin per guest) × Revenue per guest = [$10,296 ÷ ($55 − $28.60)] × $55

= $21,450

Contribution margin = Monthly guests × Contribution margin per guest = 84 × ($55 − $28.60) × 25 = $55,440; During the current month, the company has $55,440 available to cover fixed costs and to contribute to profit.
The break-even point is the same regardless of the number of guests that take each river cruise. Break-even simply means that total costs equal total revenues. The only factors that can change the break-even point are the amount charged to each guest on the dinner cruise, the variable cost per guest, and the total fixed costs.
If a break-even point is lower, the company can start making a profit with fewer sales than if the break-even point was higher. The earlier a company begins to make a profit, the more total profit it will generate each month.
Waldo’s Water World is distributing replacement water coolers in the Montreal area for $150 per cooler. Waldo’s fixed costs are equal to $60,000 per month, and the Waldo’s accounting staff has calculated the monthly break-even in units to be 750.
1. Given this information, compute the variable cost per unit and the contribution margin per unit.
2. Using the amounts computed in part (a), prepare a contribution margin income statement proving that breakeven occurs at this level of sales.

Ans: N/A, LO 1, Bloom: AP, Difficulty: Hard, AACSB: Analytic, Communication, AICPA: PC, Communication, AICPA: FC, Measurement, Analysis, and

Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Ans: Variable costs equal $70 per unit, and contribution margin is $80 per unit.

Solution: Break-even in units is the point at which sales in units multiplied by contribution margin is equal to total fixed costs. If fixed costs are $60,000 per month, and the break-even point is 750 units, then contribution margin is equal to $60,000 ÷ 750 = $80 per unit. This means that unit variable costs are equal to the unit price per cooler of $150 minus the contribution margin of $80, or $70 per unit. Therefore, variable costs equal $70 per unit, and contribution margin is $80 per unit.

Solution:

Sales Revenue ($150 x 750 units)	$112,500
Less: Variable Costs ($70 x 750 Units)	52,500
Contribution Margin	60,000
Less: Fixed Costs	60,000
Net Income (Loss)	$0

Hooper’s Hot Dog Stand has had the following average results for the past several months: Its selling price per hot dog is $4. Total monthly sales revenues have been $8,000, variable product costs have been $3,000 per month, variable period costs have been $500 per month, and fixed costs have been at $2,250 per month. Hooper’s expects to have a $450 per month increase in fixed period costs beginning next month.
1. What was the operating income for the past several months with the given information?
2. What is Hooper’s current break-even point?
3. How will this cost increase affect Hooper’s break-even point?

Ans: N/A, LO 1, Bloom: AP, Difficulty: Hard, AACSB: Analytic, Communication, AICPA: PC, Communication, AICPA: FC, Measurement, Analysis, and

Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Ans:

Operating Income = $2,250
Break-even point currently = 1,000 hot dogs.
Break-even point will increase by 200 hot dogs per month.

Solution:

Operating Income = Sales Revenue – Variable Costs (Direct + Indirect) – Fixed Costs = $8,000 – ($3,000 + $500) - $2,250 = $2,250
Hopalong currently has a contribution margin ratio of 56.25%. This is calculated as follows: Contribution margin = $8,000 in sales revenues − $3,000 in direct labor and ingredients costs − $500 in variable indirect costs = $4,500 contribution margin. Contribution margin ratio = $4,500 contribution margin ÷ $8,000 sales revenues per month = 0.5625, or 56.25%. The break-even point before expense increases is the total fixed costs of $2,250 per month divided by the contribution margin for each hot dog sold, which is $4.00 × 56.25% = $2.25. Therefore, monthly break-even is $2,250 ÷ $2.25 = 1,000 hot dogs.
If period expenses (fixed costs) increase by $450 per month, this will require an additional sales volume of $450 ÷ $2.25 of contribution margin per hot dog = 200 additional hot dogs each month.
Clark Craven started his own business, Craven Haven, last summer. He sells ice cream bars on Panama City Beach on the weekend for $4 each. Each bar has a variable cost of $1.80. Total fixed costs include primarily costs related to the rolling freezer cart and total $396 per month. During June, the business had 264 customers.
Calculate the break-even point in units and the break-even point in sales revenue for a month.
Prepare a break-even chart for Craven Haven using the template provided. Label the x- and y-axes, the three lines, and the break-even point.
What causes the total cost line to slope upward in a straight line on a CVP graph within the relevant range?
By how much can Craven Haven’s revenue decline before a loss is incurred during June?
If total fixed costs increase, what is the effect on the margin of safety? Explain.

Ans: N/A, LO 1, 2, Bloom: AP, Difficulty: Hard, AACSB: Analytic, Communication, AICPA: PC, Communication, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution:

Break-even point in units = Total monthly fixed costs ÷ Contribution margin per unit

= $396 ÷ ($4.00 − $1.80)

= 180 bars

Break-even point in sales dollars = Number of bars to be sold × Selling price per unit

= 180 bars × $4.00

= $720

Plot the break-even point in units lined up vertically with the x-axis at 180 units, and the break-even point in sales dollar lined up horizontally with the y-axis at $720.

Within the relevant range, the activity—or the number of units—increases at a constant rate, at the same variable cost per unit, also called the slope. Total fixed costs do not change, so the upward-sloping nature of the total cost line increases solely due to the change in the activity, the number of units.

Margin of safety = Current sales level – Break-even sales level

= (264 × $4) – (180 × $4)

= $336

When total fixed costs increase, the break-even point increases. This increases the number of units that must be sold before the company begins generating a profit. In turn, the gap between the break-even point and the number of units the company is currently selling becomes smaller, which reduces the margin of safety.

Accent produces reading lamps and sells each for $18 to distributors. Accent’s June income statement follows:

Sales		$172,800
Variable product costs	$77,760
Fixed product costs	38,016	115,776
Gross margin		57,024
Variable selling and admin costs	12,096
Fixed selling and admin costs	8,640	20,736
Operating income		$ 36,288

Accent’s income tax rate is 30%.

How much sales revenue must Accent generate to achieve a target profit after taxes of $25,000?
How much contribution margin will Accent generate when the company generates profit after taxes of $25,000?
What effect does an increase in the income tax rate from 30% to 32% have on the break-even point? Explain.
Accent’s manager is planning to give each of its hourly production employees a 5% raise and plans to offset it with an increase in the selling price of each lamp by 5%. During June, the direct labor cost totaled $34,992. Provide the manager with insight into the effect of this increase on profitability.
Why do the two 5% changes in part d not offset each other, resulting in no change in the contribution margin?

Ans: N/A, LO 1, 3, 4, and 5, Bloom: AP, Difficulty: Hard, AACSB: Analytic, Communication, AICPA: PC, Communication, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution

Contribution margin ratio = Contribution margin ÷ Sales revenue

= ($172,800 − $77,760 − $12,096) ÷ $172,800

= 48%

Sales dollars to earn target profit

= [Total fixed costs + (Target profit ÷ (1 – tax rate)] ÷ Contribution margin ratio

= [$38,016 + $8,640) + ($25,000 ÷ (1 – 30%)] ÷ 48%

= $171,604.76

Contribution margin = Sales revenue – Variable costs

= $171,604.76 – (52% × $171,604.76) = $82,370.28 = $82,370

There is no effect on the break-even point when a change in the income tax rate occurs at break-even. Because total costs equal total revenue at the break-even point, operating income is zero, and no tax is incurred.
Contribution margin with the changes = Sales revenue – Variable costs

= ($172,800 × 105%) – [{($77,760 − $34,992) + $12,096} + ($34,992 × 105%)]

= $181,440 – $91,606 = $89,834

Increase in profitability = New contribution margin – Original contribution margin

= $89,834 – ($172,800 − $77,760 − $12,096)

= $6,890

The contribution margin will increase by $6,890 if the changes are made.

The increase in variable costs does not offset the increase in revenue for two reasons. First, only a portion of the variable costs will increase: those for direct labor. Second, adding 5% to revenue increases revenue more than adding 5% to costs increases costs.
Speed Tek produces two models of professional swim goggles—Jet and Spirit—both with fog-free acrylic lenses. Speed Tek has a 30% income tax rate. Information regarding the products is summarized for the month of May in the following table:

	Jet	Spirit	Total
Number of units	2,400	1,600	4,000
Sales revenue	$36,000	$31,500	$67,500
Variable costs	20,682	18,270	38,952
Contribution margin	$15,318	$13,230	28,548
Fixed costs			19,989
Operating income			$ 8,559

The company’s sales mix is expected to remain stable over the next year.

Complete the following statement:

For every __________ pairs of Jet goggles, Speed Tek sells _________ pairs of Spirit goggles.

How many total goggles is Speed Tek expected to sell at break-even? (Round to zero decimal places)
When calculating break-even points with multiple products, why is the weighted average contribution margin necessary?
The management team of Speed Tek expects sales volume and total fixed costs to increase by 10% during June. Determine the number of total goggles that Speed Tek must now sell to break-even in June.
Based on your answer to part d, would you recommend the company make the change? Briefly explain why or why not.

Ans: N/A, LO 1, 4, Bloom: AP, Difficulty: Hard, AACSB: Analytic, Communication, AICPA: PC, Communication, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution

Units of Jet: Units of Spirit = 2,400 : 1,600 → 3 : 2

For every three pairs of Jet goggles, Speed Tek sells two pairs of Spirit goggles.

Sales mix percentages:

Jet: 2,400 ÷ (2,400 + 1,600) = 60%

Spirit: 1,600 ÷ (2,400 + 1,600) = 40%

Contribution margin per unit:

Jet: Contribution margin ÷ Number of units = $15,318 ÷ 2,400 = $6.383

Spirit: Contribution margin ÷ Number of units = $13,230 ÷ 1,600 = $8.269

WACM per unit:

Product	Contribution Margin	Sales Mix	WACM
Jet	6.383 x	60% =	$3.830
Spirit	8.269 x	40% =	3.308
Total WACM			$7.138

Break-even point for both products = Total fixed costs ÷ WACM per unit

= $19,989 ÷ $7.138 = 2,800.36

= 2,800 goggles (rounded)

The weighted average contribution margin is needed to factor in the proportion of each product that is sold, along with its selling price. Companies do not sell the same number of each product, and the selling price and variable costs of each product typically differ, resulting in differing contribution margins.
Sales mix percentages = No change, because number of units of each product increased by the same percentage:

Jet: (2,400 × 110%) ÷ [(2,400 + 1,600) × 110%] = 60%

Spirit: (1,600 × 110%) ÷ [(2,400 + 1,600) × 110%] = 40%

Contribution margins per unit = No change, because the sales price, variable cost per unit, and number of units increased by the same percentage:

Jet: Contribution margin ÷ Number of units =

= ($15,318 × 110%) ÷ (2,400 × 110%) = $6.383

Spirit: Contribution margin ÷ Number of units =

= ($13,230 × 110%) ÷ (1,600 × 110%) = $8.269

WACM per unit = $7.138 (from part b) = No change, because the sales mix and the contribution margins per unit of each product are the same.

Break-even point for both products = Total fixed costs ÷ WACM per unit

= ($19,989 × 110%) ÷ $7.138 = 3,080.40 = 3,080 goggles (rounded)

Break-even point for both products without changes (part b) = 2,800 goggles

Break-even point for both products without changes (part d) = 3,080 goggles

The break-even point increased from 2,800 to 3,080, which by itself is not a favorable change. This increase requires that more units be sold before the sale of units begins to generate a positive contribution margin. The increase occurred because there will be no effect on the contribution margin per unit for either product, so no change in total contribution margin per unit will occur, while fixed costs will increase by 10%. However, operating income is expected to increase, because the 10% increase in sales will increase the total contribution margin by $2,855 ($28,548 × 10%), which is greater than the 10% increase in fixed costs of $1,999 ($19,989 × 10%), resulting in a net increase in operating income of $856. Based on the increase in operating income, the company should make the change.

The following operating data was reported by Acer Sports for the month of October, during which 1,000 rackets and 4,000 packs of racquetballs were produced and sold:

	Rackets	Ball Packs	Total
Sales revenue	$40,000	$20,000	$60,000
Variable costs	23,200	11,000	34,200
Contribution margin	$16,800	$ 9,000	25,800
Fixed costs			18,400
Operating income			$ 7,400

Acer Sports has a loan agreement with its bank that enables the company to borrow as needed for working capital purposes. However, the agreement requires that Acer’s degree of operating leverage not exceed 4.0. Acer’s income tax rate is 30%.

Answer the following questions. Use three decimal places for DOL amounts.

Calculate the degree of operating leverage for Acer Sports for October. Explain the lever effect as it relates to the DOL.
The management team estimates that it will experience an 8% decline in sales volume for the months of November and December. Using the answer to part a, determine the expected operating income if the sales decline occurs in November.
Explain to the management team the effects of the sales decline. Will the company be in violation of the loan agreement?
What actions might management take to improve its DOL?

Ans: N/A, LO 1, 4, 5, Bloom: AP, Difficulty: Hard, AACSB: Analytic, Communication, AICPA: PC, Communication, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution

Degree of operating leverage = Contribution margin ÷ Operating income

= $25,800 ÷ $7,400

= 3.486

The DOL is referred to as a lever because it has a multiplier effect on sales. Once the expected change in sales is multiplied by the DOL, the lever effect causes the change in profit to be a multiple of the change in sales.

Percentage decrease in operating income = Percentage decrease in sales × DOL

= 8% × 3.486 = 27.89% decrease in operating income

New operating income = (100% − 27.89%) × $7,400 = $5,336.14 = $5,336

The decline in sales is expected to reduce operating income from $7,400 to $5,336, an unfavorable effect. As a result, the company is expected to be in violation of its loan agreement in November. Its DOL is expected to increase from its October level of 3.486 to 4.448 in November, which exceeds the maximum DOL of 4.0 allowed under the loan agreement.

New DOL = Contribution margin ÷ Operating income

= ($25,800 × (100% − 8%)) ÷ $5,336

= 4.448

The increase in the DOL occurs because a smaller amount of contribution margin is available to cover fixed costs, which results in an increase in the volatility of operating income for each percentage change in sales. Because variable costs declined and fixed costs remained the same, the company now has a larger proportion of fixed costs. The degree of operating leverage measures risk in that the larger the degree of operating leverage, the more swing that will occur in operating income.

To improve the DOL, management can either decrease fixed costs, perhaps by selling some plant assets, or reduce variable costs. Perhaps an advertising campaign could be undertaken, in hopes that the campaign will cause an increase of sales volume that will offset the expected 8% decline in sales. However, since an advertising campaign is a fixed cost, this action will affect the DOL as well.
Mini Baker products mini cupcakes in various flavors. Suzi Wu opened the shop

on January 1 of the current year. The average selling price for each cupcake is $2.50, with some flavors and icings selling for more and some for less. For the first quarter of the current year, the cost of ingredients totaled $28,000; labor to mix, pour, bake, and ice was $35,000; and variable indirect costs, such as supplies, totaled $8,000. The cost of using the baking facility and equipment amounts to $18,000 of fixed product costs each quarter. Selling and administrative costs total $26,000, with 60% variable and 40% fixed. During the first quarter, the company produced and sold 52,000 cupcakes. The income tax rate is 30%. Answer the following questions. Use two decimal places for ratios.

Determine the amount of gross margin for the quarter.
What is the amount of contribution margin for the quarter? What information does this amount provide to Suzi Wu’s bakery? Be specific.
Determine the amount of contribution margin ratio for the quarter. What information does it provide to managers? How does it differ from gross margin?
Suzi Wu hopes to generate an after-tax target profit of $23,000 per quarter. How much sales revenue must Suzi generate to meet this target?
What will happen to the break-even point if the income tax rate increases to 40%?

Ans: N/A, LO 1, 3, and 5, Bloom: AP, Difficulty: Hard, AACSB: Analytic, Communication, AICPA: PC, Communication, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis, Reporting & Control: Cost Accounting.

Solution

a.	Sales (52,000 × $2.50)		$130,000
	Variable product costs ($28,000 + $35,000 + $8,000)	$71,000
	Fixed product costs	18,000	89,000
	Gross margin		$41,000

Contribution margin = Sales revenue – Variable costs (Product and Selling & Admin.)

= $130,000 – $71,000 (part a) – ($26,000 x 60%)

= $43,400

The company has $43,400 to cover fixed costs and to contribute to profit.

Contribution margin ratio = Contribution margin ÷ Sales revenue

= [($130,000 − $71,000 (part a) – ($26,000 × 60%)] ÷ $130,000

= 33.385%

The contribution margin ratio is the amount available out of each sales dollar to cover fixed costs and then contribute to profit. The two margins differ in the costs that are subtracted from sales to arrive at the respective “margin.” The contribution margin is sales less both product and period variable costs, while gross margin is sales less both variable and fixed product costs.

Total fixed costs = $18,000 + (40% × $26,000) = $28,400

Sales dollars to earn target profit =

= [Total fixed costs + {(Target profit ÷ (1 – Tax rate)}] ÷ Contribution margin ratio

= [$28,400 + {($23,000 ÷ (1 – 30%)}] ÷ 33.385%

= $183,487

There will be no change in the break-even point. Because total costs equal total revenue at the break-even point, operating income is zero, and no tax is incurred.
Pate & Murwick, CPAs, employs 22 professional salaried accountants and 3 hourly administrative staff. The amount billed to clients during the current year differs among the different levels of professional staff. The annual billable hours, costs, rates, and professional staff levels are as follows:

	Partners	Managers	Staff	Total
Number of employees	2	6	14	22
Billing rate per hour	$280	$180	$120
Labor cost per hour	$220	$140	$90
Target billable hours per employee	1,800	2,500	2,100

The partners estimate the firm will incur variable overhead amounting to 10% of the professional labor cost and fixed overhead amounting to $8 per billable hour of labor. Total selling and administrative are estimated at $114,000 per year, with 60% of this being fixed. The company’s proportions of professional accountants, as well as the billing rates, labor costs, overhead, and selling and administrative costs, are expected to remain the same throughout the next year. The firm uses billable hours as its output measure.

Determine the total hours that the firm must provide to break-even.
How many total hours must the firm bill for managers to break-even?
Why do service businesses use different measures of output than retail companies when calculating their break-even point?

Ans: N/A, LO 3, 4, 6, Bloom: AN, Difficulty: Hard, AACSB: Analytic, Communication, AICPA: PC, Communication, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Solution

Sales mix—partners: (2 × 1,800) ÷ [(2 × 1,800) + (6 × 2,500) + (14 × 2,100)] = 7.50%

Sales mix—managers: (6 × 2,500) ÷ [(2 × 1,800) + (6 × 2,500) + (14 × 2,100)] = 31.25%

Sales mix—staff (14 × 2,100) ÷ [(2 × 1,800) + (6 × 2,500) + (14 × 2,100)] = 61.25%

Budgeted labor hours = (Number of partners × Number of hours each) + (Number of managers × Number of hours each) + (Number of staff × Number of hours each)

48,000 Budgeted labor hours = (1,800 × 2) + (2,500 × 6) + (2,100 × 14)

Weighted average contribution margin = [(Billable rate, partners – Variable cost, partners) × Sales mix, partners] + [(Billable rate, managers – Variable cost, managers) × Sales mix, managers] + [(Billable rate, staff – Variable cost, staff) × Sales mix, staff]

= [($280 – $220) × 7.5%] + [($180 – $140) × 31.25%] + [($120 – $90) × 61.25%]

= $35.375 per hour of professional services provided plus the variable selling and administrative costs of [$45,600 or (114,000 × 40%)] ÷ 48,000 billable hours = $35.375 + $.95 = $36.325 per hour of professional services provided]

Break-even point in billing hours = Total fixed costs ÷ WACM per billable hour

= [($8 × 48,000) + ($114,000 × 60%)] ÷ 36.325 = 12,454.23

= 12,454 billable hours (rounded)

Number of hours for managers = Total billable hours × Sales mix

= 12,454 × 31.25% = 3,891.88 hours

= 3,892 billable hours (rounded)

Service firms use different measures when calculating their break-even point because they have no tangible products to use as their output measures. They may use number of persons served, number of billable hours, number of nights housed, or number of meals provided, among other measures.

SHORT ANSWER

Briefly describe why break-even analysis is important and what it can tell the management of a business. What information is necessary to calculate the break-even point?

Solution: A break-even analysis is used to determine how much product a firm needs to sell to cover the costs of doing business. Break-even is the point at which a business’s total costs and total revenue are exactly equal. With a break-even analysis, a business can determine at what sales volume the firm will begin to make a profit. The information needed includes sales revenues, or sales price or revenues per unit; variable costs, or variable costs per unit; and total fixed costs.

Ans: N/A, LO 1, Bloom: C, Difficulty: Medium, AACSB: Knowledge, Communication, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Briefly describe the differences between contribution margin and gross margin.

Solution: Gross margin, sometimes referred to as gross profit, is equal to sales revenues minus cost of goods sold, which includes both fixed and variable cost of goods sold. Conversely, contribution margin refers to sales revenues minus variable costs, which include both variable cost of goods sold and variable selling and administrative costs.

Why is the understanding of cost behavior important to break-even analysis?

Solution: It is important to be able to categorize costs into variable and fixed cost elements. The variable cost elements will remain constant on a per unit basis but will change directly and proportionately with a given change in the sales level. On the other hand, fixed costs will stay the same in total regardless of changes in an activity level. So, if a business had no activity in sales, no variable costs would be incurred, but the business would still have to cover the fixed costs. It is important for management to plan accordingly for business activities to cover all costs, both variable and fixed, when making decisions.

Briefly describe what important information the margin of safety can provide to a company’s management team. How is the margin of safety calculated?

Solution: The margin of safety is the amount by which current sales (or budgeted sales) can be reduced before the break-even point is reached. This informs management of the risk of potential loss to which a business is subjected by changes in sales or revenue volume. The concept is useful when a significant proportion of sales are at risk of decline or elimination, as may be the case when a sales contract is coming to an end, or the economy weakens. A minimal margin of safety might trigger action to reduce expenses. The opposite situation may also arise, when the margin of safety is so large that a business is well protected from sales variations and management can consider investments in infrastructure through the increase of fixed costs. To calculate the margin of safety, subtract the current break-even point from current (or budgeted) sales. The margin of safety can be expressed in terms of sale revenue dollars or in terms of units.

Ans: N/A, LO 2, Bloom: C, Difficulty: Medium, AACSB: Knowledge, Communication, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Define the relevant range and explain its importance in CVP analysis.

Solution: The relevant range is the band of activity with a specific relationship between activity levels and the cost being measured, where fixed costs remain fixed and variable costs are constant. This concept is important because for a given company, there is a limit to what can be made/or sold. This upper limit is defined by either the capacity of the facilities or equipment usage (time) or the market demand for the product. For example, a business cannot sell more than what the customers demand, and even if the demand exists, the business cannot sell more than what it can realistically produce given it resources and capabilities.

Ans: N/A, LO 2, Bloom: K, Difficulty: Medium, AACSB: Knowledge, Communication, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

In your own words, explain how a CVP graph can be used to indicate cost behavior, break-even point, and profit/loss situations.

Solution: In preparing a CVP graph, it is important to understand the components of the graph. Dollars (cost/sales) are shown on the vertical or Y-axis and the units are shown on the horizontal or X axis. Lines are then drawn for fixed costs represented by a horizontal straight line, with the total cost line upward sloping starting at the fixed cost line. The area showing between the fixed cost line and the total cost line will represent the variable costs for the business at different levels of activity. The last line included is the revenue (sales) line, which is also upward sloping, but beginning at 0. The point at which the total cost line and the revenue line intersect will represent the break-even point (total revenues = total costs = $0 profit (loss)). The area then above this intersection will reflect profit for the business, whereas the are below the intersection of these two lines will show the net loss situations for the business.

Briefly describe what target (desired) profit is and why calculating it can be important to a business.

Solution: Target profit is the income that the management of a company expects to attain for a designated accounting period. It is a key concept in a corporate budgeting and control system that is often used to drive corrective management actions. Target income is derived with cost-volume-profit analysis through the following calculation: Multiply the expected number of units to be sold by their expected contribution margin (sales revenues less variable costs) to arrive at the total contribution margin for the period. Subtract the total amount of expected fixed cost for the period. The result is the desired/expected operating income level.

Ans: N/A, LO 3, Bloom: C, Difficulty: Medium, AACSB: Knowledge, Communication, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis

Can management easily adjust its computations for breakeven analysis to accommodate assumptions for a target profit and taxes?

Solution: Yes, management can easily adjust its computations for breakeven analysis to accommodate assumptions for a target profit and taxes. Both adjustments are made directly to the numerator in the breakeven formula. For example, for a target profit, one would simply add the target profit to the fixed costs and then divide by the contribution margin to arrive at the breakeven point. To factor in taxes, this target profit would be adjusted by dividing it by 1 – tax rate to arrive at the after-tax target profit, and then added to the fixed costs before dividing by the contribution margin to arrive at the adjusted level to achieve the after-tax profit.

Explain the impact of integrating tax implications into a target profit computation for a business? What impact will this assumption have on the required sales in both sales units and sales dollars?

Solution: The formula for target profit when considering tax implications requires an adjustment to the target profit from an after-tax amount to a pretax amount. This is adjusted by dividing the target or desired profit amount by 1 – tax rate. This will cause the desired profit adjusted for tax implications to increase, which in turn will cause the required sales in both sales units and sales dollars to also increase.

How is cost-volume-profit analysis (CVP) used to calculate target operating income and why is it important to companies?

Solution: CVP analysis using the breakeven equation can be modified to include the computation of required sales to arrive at a desired profit. Although, the computation of the break-even point is useful to management, most companies do not just want to break even (net income = $0) but instead, prefer to make a profit. To plan for this, the business would add the desired or target profit to the fixed costs in the numerator in the initial break-even equation and then, divide by the unit contribution margin to determine the required units to achieve the target profit. In addition, the required sales dollars to achieve a target profit can be computed by dividing the total of fixed costs plus the target profit by the contribution margin ratio or simply multiply the required units to achieve the target profit by the unit selling price.

Briefly describe the concept of the weighted average contribution margin (WACM).

Solution: The weighted average contribution margin is the average amount that a group of products or services contributes to offsetting the fixed costs of a business. The relative sales mix provides the weighting for the contribution margin of each product in the mix. The concept is a key element of break-even analysis, which is used to project profit levels for various levels of sales.

Ans: N/A, LO 4, Bloom: K, Difficulty: Medium, AACSB: Knowledge, Communication, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Explain why a company’s sales mix is important to determining weighted average contribution margin (WACM) when multiple products with different cost structures are being sold. What is a weakness of the WACM method?

Solution: A company’s sales mix is important because it provides the weighting for the

contribution margin of each product in the mix, since different products or services likely have

different contribution margins. Its main weakness is that projections based on the average

contribution margin incorporate the assumption that the same sales mix of product sales and

margins will apply in the future, which is not necessarily the case.

Ans: N/A, LO 4, Bloom: C, Difficulty: Medium, AACSB: Knowledge, Communication, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

If a company increases the selling price of one of its products or services in its sales mix what impact (if any) will this have on the company’s weighted average contribution margin, assuming all else remains the same? If the company adds a new product to the sales mix, or drops a product from its sales mix, will this impact the company’s weighted average contribution margin? Explain.

Solution: If a company increases the selling price of one of its products or services in its sales mix, the company’s weighted average contribution margin will increase given that all else remains the same. If the company adds a new product to the sales mix, or drops a product from its sales mix, this will also impact the company’s weighted average contribution margin based on the percentage affect to the sales mix for not only the new or terminated product, but also based on the impact to the sales mix for the other company products along with the respective contribution margins of the products. In these situations, the weighted average contribution margin could either increase or decrease.

Explain changes in assumptions can change the break-even point, and why a lower break-even point is preferred by a business when using break-even analysis.

Solution: Changes in assumptions such as the unit selling price, unit variable cost, and/or total fixed costs will each affect the break-even point computation for a business. For example, if a business desired to lower its break-even point, it could increase its selling price, and/or lower its unit variable cost and/or lower fixed costs. A lower break-even point in units indicates that the business is covering all costs, both variable and fixed, in a given period, and that after that point, all additional units sold will contribute to operating income at a rate of the unit contribution margin. The lower the break-even point, the sooner the business will begin to earn a profit. If given alternatives for changes, the business will typically prefer the option with the lower break-even point.

Ans: N/A, LO 5, Bloom: C, Difficulty: Medium, AACSB: Knowledge, Communication, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Reporting, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Briefly describe the concept of operating leverage. How can a company’s degree of operating leverage (DOL) be used to help company management in conducting sensitivity analyses? How is the DOL calculated?

Solution: Operating leverage refers to the relative mix of fixed and variable costs in a firm’s

cost structure. If a firm has a relatively high amount of fixed costs, it is said to have a high

degree of operating leverage (DOL). DOL works like a lever, enabling management to quickly

determine the impact of a projected change in sales on operating income by multiplying the

DOL by the percent of revenue increase or decrease. To calculate operating leverage, divide

a firm’s contribution margin (sales revenues minus variable costs) by its net operating

income.

How might the degree of operating leverage be used by a company to help predict profits and losses based on decisions that affect cost structures?

Solution: The degree of operating leverage (DOL) offers insight into the relative mix of fixed costs to variable costs for a company. The DOL serves as a multiplier when evaluating projected changes in sales to determine the effect on operating income. The higher the fixed costs in comparison to the variable costs for a company, the higher the DOL. For example, if the DOL for Company A is 7, with a 10% increase, one can expect a 70% increase in operating income. However, if the change is a 10% decrease, one can expect a 70% decrease in operating income. Now, on the other hand, if Company B has a DOL of 3, with a 10% increase, one can expect a 30% increase in operating income. However, if the change is a 10% decrease, one can expect a 30% decrease in operating income. This facilitates the projection of income impact for changes in sales without having to work each scenario through a CVP income statement to determine the impact of a change in sales on operating income.

Briefly describe the differences between calculating the contribution margin for a service provider and for a manufacturing business.

Solution: The contribution margin for both types of business has the same formula—sales

revenues minus variable costs. Although essentially the formula remains the same, for a

service provider sales revenues are generated from the sales of its services, whereas for a

manufacturing business sales revenues are generated by the sales of its products. The big

difference between these two types of firms is the nature of variable costs for each business

type. Service providers typically have labor expenses as their variable costs. For example, an

accounting firm’s variable costs on an audit engagement will consist of staffing costs. A

manufacturing firm will have variable costs that are product costs, such as the direct

materials, overhead, and labor costs that go into fabricating the product.

Ans: N/A, LO 6, Bloom: K, Difficulty: Medium, AACSB: Knowledge, Communication, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Can CVP analysis be used for service companies and if so, is the methodology the same as that used for manufacturing companies?

Solution: Yes, CVP analysis can be used for service companies, and the methodology is the same as for manufacturing companies. Costs need to be separated into fixed and variable cost categories. Then, contribution margin is computed by deducting the variable cost from the sales. This can be done on a per service basis or in total. Then, just as with manufacturing, the total fixed costs are divided by the unit contribution margin to arrive at the break-even point in units of service and by the contribution margin ratio to determine the break-even point in revenue dollars (or by multiplying the break-even point in units of service by the price per unit of service).

Ans: N/A, LO 6, Bloom: C, Difficulty: Medium, AACSB: Knowledge, Communication, AICPA: FC, Measurement, Analysis, and Interpretation, IMA: Strategy, Planning & Performance: Cost Management and Decision Analysis.

Explain how a nonprofit entities might use CVP analysis to determine a break-even point.

Solution: Nonprofit entities can use CVP analysis, which is similar to for-profit entities, but typically they will start with identifying the cost structure for the organization, separating fixed costs and variable costs, and then setting net income = $0 (break-even), determine the amount of funding needed on a periodic basis to support operations.

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Chapter 4 Cost Volume Profit Analysis

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Number and percentage of questions:

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MULTIPLE CHOICE QUESTIONS

Margin of safety = Current sales level – Break-even sales level

Accent produces reading lamps and sells each for $18 to distributors. Accent’s June income statement follows:

Number of hours for managers = Total billable hours × Sales mix

= 12,454 × 31.25% = 3,891.88 hours

= 3,892 billable hours (rounded)

Service firms use different measures when calculating their break-even point because they have no tangible products to use as their output measures. They may use number of persons served, number of billable hours, number of nights housed, or number of meals provided, among other measures.

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