C-V-P equation.Contribution margin - Essay Example

Week 4 Discussion Questions/Practice/Exercises Discussion questions 9 thru 14 9. What is the basic C-V-P equation What is a more detailed version of this equation The C-V-P equation or the Cost Volume Profit Analysis is a major step in major decisions. It is the model which defines a relationship between the sales price, cost or production, sales volume and other costs of any product. The major purpose of this model and its application is the predictability of future profits and its change based on changes in either volume or any of the components of costs that it takes into account. The basic CVP equation is of the form Profit = Sales(Revenue) - Fixed Costs - Variable costs. Or Sales = Profits + Fixed Costs + Variable Costs. The detailed version of the above equation can be expressed as: Price x Units (to be) sold = Unit Variable cost x units + Fixed Cost + Profits 10. What is the contribution margin, and why is it important for managers to know the contribution margins of their products Contribution margin is the remaining revenue amount after the deduction of variable costs. This provides the gross profitability without the deduction of fixed expenses. Contribution margin = Revenue - Variable costs. It is important for managers to decide if their materials costs and other direct variable costs are too high given the revenue from the product. Keeping aside the fixed costs which have to be borne irrespective of the sales revenue, the remaining costs which are directly proportional to units sold can be minimized to manage cash flows in a better way. They can cut on their variable costs by having a look at the contribution margins of their company and their products. 11 How much will profits increase for every unit sold over the break-even point The contribution of sales to before tax profits, or gross profits, over and above the break even is exactly the contribution margin as there are no fixed costs any more. The amount after the deduction of variable costs from the revenues will be added to the profits. 12. What is the major advantage of using C-V-P graphs CVP graphs help the manager and the reader to have a better figure of the relationship between the profits, sales and volume of sales. CVP graphs also helps in viewing the breakeven points on the graph and provides a better insight into the profit-impact of increased sales or costs. 13. When other factors are constant, what is the effect on profits of an increase in fixed costs Of a decrease in variable costs When we have a increase in the fixed costs, the breakeven point changes. The breakeven point is the point where the profits are zero or the total contribution margin is equal to the fixed costs. It's a no-profit and no-loss position. When the fixed costs increase in the [(Fixed costs) / (contribution margin)] calculation of break-even point, the number of units to break even increases. If there is a decrease in variable costs, the contribution margin increases, given the same price. Due to this, the break even units decrease as the denominator is increasing. 14. What are the limiting assumptions of C-V-P analysis The CVP model assumes that the prices of the units will remain constant and do not change in the entire process. Variable and fixed components can be easily and accurately calculated for units. The determination of fixed and variable costs, in actual conditions, is very difficult. Inventories are available at all times to make sales and that there is no shortage of supply of products to sell. The sales mix remains constant for multi product companies too. Practice 16-3 Linearity of Variable Costs within the Relevant Range The company has assembled the following data about its variable costs: Level of Activity Total Variable Cost 1,000 units $ 25,000 2,000 units 46,000 3,000 units 69,000 4,000 units 92,000 5,000 units 100,000 The company is currently producing 3,300 units. According to these data, what is the relevant range over which the company can assume that the variable cost per unit is constant In this case, the company is producing 3,300 units of its products. The relevant cost range for them is the 4,000 units range as it is above 3,000 units and they are producing more than 3,000 units. The cost range for units from 1,001 to 4,000 will have a constant variable cost of $23 per unit. Practice 16-4 Fixed Costs If the level of activity increases during the month, does the fixed cost per unit increase, decrease, or remain constant If the level of activity increases, the same dollar amount of fixed cost will be divided over a larger number of units and thus result in a lower per unit fixed cost. Still, the total dollar amount of fixed costs will remain constant. Practice 16-7 Mixed Costs The company's president receives a $100,000 base salary and a bonus of 0.5% of sales for the year. How much will the president earn at a sales level of $2,750,000 for the year At a sales level of $2,750,000, the president of the company will earn the following. 0.5% x $2,750,000 = $13,750 The total salary/income for him will be $113,750 Exercise 16-7 Contribution Margin Calculations Jerry Stone owns and operates a small beach shop in a mall on Sanibel Island, Florida. For the last six months, Jerry has had a display of sunglasses in the front window. Largely because of the display, Jerry has sold 100 pairs of sunglasses per month at an average cost of $26 and selling price of $50. The sales volume has doubled since the display was put in the window. One-fourth of Jerry's storage space is occupied by 190 ice coolers. The coolers have not been selling as well as Jerry hoped, but he is convinced that a front window display of coolers would increase sales by 50%. The coolers cost Jerry a total of $2,280 and have been selling at a rate of 100 per month at $28 each. 1. Assuming that cost of goods sold is the only variable cost, compute the contribution margin per unit for sunglasses and ice coolers. Contribution margin for sunglasses = $50 - $26 = $24 per unit Contribution margin for coolers = $28 - $2,280/190 = $12 2. Compute the total contribution margins for both sunglasses and ice coolers assuming window displays and no window displays for both items. Assuming window displays for both, The total contribution margin for sunglasses = 100 x $24 = $2,400 For coolers, total contribution margin = 150 x $12 = $1,800 Assuming no-window displays for both, The total contribution margin for sunglasses = 50 x $24 = $1,200 For coolers, total contribution margin = 100 x $12 = $1,200 3. What are the economic costs associated with keeping the sunglass display in the store window The economic costs or the opportunity costs of keeping the sunglasses in the display are the lost sales of coolers due to their no-window displays. It's the trade-off between keeping the sunglasses in the display as opposed to coolers. To be exact, in our case they are the lost total margin of coolers of $600. 4. What are the economic costs associated with replacing the sunglass display with an ice cooler display With the replacement of sunglasses by coolers, the economic costs are the lost sales of sunglasses. They are $1,200 in our case. The increased revenue from coolers, if overcome the lost sales of sunglasses, it is better to incur these costs. Exercise 22-2 Importance of Manufacturing Overhead Allocation The percentages of product costs comprised by direct materials, direct labor, and manufacturing overhead for three companies are as follows: Company A Company B Company C Direct materials 7% 21% 42% Direct labor 13 42 49 Manufacturing overhead 80 37 9 100% 100% 100% Based on this information, which of these three companies would probably improve its product costing accuracy most by converting to activity-based costing (ABC) Explain your answer By converting to activity-based costing or ABC, company A is likely to improve on its costing accuracy. The major reason for this is the increased overhead in case of company A. the higher the overhead, the better the impact of ABC on the costing structure and accuracy. Exercise 22-3 Product Cost Hierarchy For the following list of costs, indicate by the appropriate letter which category of activities each cost applies to: unit level (U), batch level (B), product line (P), or facility support (F): A Machine fine-tuning adjustment cost (required after the production of each unit) U B Salary of vice president of finance P C Machine inspection cost (required after the completion of each day's production) B D Cost of the external audit firm P E Direct labor U F Product testing cost (performed at the start of each day's production) B G Direct materials U H Factory security cost F I Machine straight-line depreciation cost (Generally, machines are dedicated to producing a particular type of product.) P J Warehousing cost (Each type of product has its own warehouse.) P K Employee training cost (Training is generally specific to different types of products.) P Summary 200 words Based on the above discussion questions, practice and exercises Summarize the learnings from this work and provide a discussion of the application of the material to their professional and/or personal lives. Based on the above questions and the support they provide to decision making for management, we learn the following from these exercises. If the fixed costs are high, the companies have to produce and sell more units in order to break even and enter the profits region. At the same time if the variable costs are high, the contribution margin will be low and thus the break even units will be high. Given a condition for production where there are more than one product, there are trade-offs in all areas of business between their production, sales, resource usage and utilization within and beyond the organizational boundaries. The company must consider the trade-offs it is facing before making any decision for any type of product. In practical life, it is not very easy to estimate the components of total costs. Fixed costs and variable costs are estimates based on past experience and future expectations. They can not be very accurately measured at all times. There must be a reasonable cushion in order to assure a feasible outcome even after the margin of adjustment in their values. Assumption for the models must be carefully looked at and their applicability in the given condition must be carefully analyzed to see if any adjustments need to be made. Read More