Selected Exercises in preparation of Question 3 on BA

6601 (Section 9) Compressive Exam

Question 1

The Atkins Company manufactures and sells one product. The sales price, $30 per unit, remains constant regardless of

volume. Last years sales were 15,000 units and operating profits (Profit before tax) were $200,000. Fixed costs depend

on production levels, as the following table showed. Variable cost per unit are 40 percent higher for level 2 (day and

night shift) than for level 1 (day shift only). This is because additional labour costs result primarily from higher wages

required to employ workers for the night shift.

Annual production range (in units) Annual total fixed costs

Level 1 (Day shift) 0 - 20,000 $ 100,000

Level 2 (Day and night shifts) 20,001 - 36,000 (Max capacity) $ 164,000

Atkins expects last years cost structure and selling price not to change in this year. The company is able to sells all unit it

produces.

Required :

1. Compute the contribution margin per unit for last year for day and night shift.

2. Compute the break-even points in units for last year for each of the two production level.

3. Compute the volume in units that will maximise operating profits.

Question 2

The leaded Bottoms Company manufactures kewpie dolls for carnivals and sells them for $2 per kewpie. The variable

costs of manufacturing and selling are $1.00 and $0.25 per kewpie, respectively. The fixed costs are based upon the

following ranges of activity.

Range of Activity Fixed costs

0 - 40,000 kewpies $ 35,000

40,001 - 75,000 kewpies 50,000

75,001 - 125,000 kewpies (maximum capacity) 70,000

During this year Leaded Bottoms produced and sold 45,000 kewpies.

Required :

1. Determine the net income for Lead Bottoms for this year.

2. How many additional units (above the 45,000) would Leaded Bottoms need to sell in order to break- even if the additional units will be sold for only $1.90 ?

3. How many additional units (above the 45,000) would Leaded Bottoms need to sell in order to generate a profit of $6,000 if the additional units will be sold for only $1.90 ?

4. What is the maximum profit that could be earned by Leaded Bottom [disregard (2) and (3)]?

5. Leaded Bottoms wants to produce and sell 85,000 units but does not want to incur any additional fixed costs. The company production supervisor decided to pay double time for labour in order to produce the 10,000 kewpies above the second range of activity. If the labour costs are three-fourths of the variable manufacturing costs, determine the profit that the company should earn.

6. For the next year , it is proposed to add another product line (product Y) whose selling price

would be $ 3 per unit with a variable cost ratio of 60 percent. Total fixed costs for production of

both product X and Y are not subjected to step fixed cost scheme but it is collectively

estimated at $100,000. The sales mix of X : Y would be 7 : 3. The company is subjected to an

income tax level of 30 percent. At what level of sales (in dollar) next year would the company

achieve target profit after tax amount of $14,000 ?

Question 3

Bell Bang Company furnishes the following income statement :

Bell Bang Company

Income Statement

For the first half of the year ended 30 June 20xx

Sales $ 200,000

Less : Cost of goods sold :

Direct materials 30,000

Direct labor 35,000

Factory overhead (of which $22,000 is fixed expense) 37,000 102,000

Gross profit 98,000

Less : Operating expense :

Salaries expense 13,000

Commission expense 20,000

Depreciation expense 5,000

Advertising expense 10,000 48,000

Income before tax 50,000

Less : Income tax expense 20,000

Net income 30,000

Required : Answer which following questions independently

1. Reconstruct the above income statement into contribution margin income statement.

2. For the first half of the year ended 30 June 20xx, compute :

2.1 Contribution margin ratio

2.2 Break-even point in dollars.

2.3 Margin of safety ratio

3. Compute the expected sales volume for the second half of the year ended 31 December 20xx if Bell Bang had projected a loss of $10,000 for the second half of the year, assuming that sale price and fixed expenses remain unchanged.

4. How much additional sales from (3) would Bell Bang need to make in order to break-even if the variable cost of the additional sales is decreased by 20%.

5. How much sales should Bell Bang make for the whole year ending 31 December to generate a net profit after tax of $120,000?

6. If the sales commission in next year are discontinued in exchange for additional annual salaries of $25,000. How much sales would have to make for the next whole year to generate a net profit after tax of $120,000.

Question 4

Mayberry owns and operates a BEAUTIFUL CUT company, a small salon. The only service that is offered is haircuts at a price of $8 a clip. Tip is also another source of the company which average about 15% of the price. The number of hairdressers (in addition to Mayberry) that Mayberry employs depends on the number of estimated haircuts for the year. As long as Mayberry expects fewer than 4,000 cuts in a year, he will operate the shop by himself. In case he estimated the number of haircuts will exceed 4,000 cuts, he will hire additional hairdressers (employees) to meet following yearly demands :

Number of additional employees Expected number of haircuts for year

1 4,001 - 8,000

2 8,001 - 15,000

All hairdressers including Mayberry shares all work equally. For example, if the numbers of haircuts is 12,000 cuts,

Mayberry will hire 2 additional employees and thereby each hairdresser (including Mayberry) will work for 12,000 3 = 4,000 haircuts.

The compensations that Mayberry pay to his individual employee are as follows :

1) Salary amount of $5,000 per year,

2) Commission at the rate of 25% of the price. Payment of commission is made to the employees for his or her services provided to customers.

3) Tip, which average about 15% of the price. Payment of tip is made to the employees for his or her services provided to customers.

As being the owner of the company, Mayberry takes no salary, commission and tip for his work. The other costs of operating the company are $6,000 per year and $2 per haircut.

Required :

1. If the number of haircuts was less than 4,000, determine the number of haircuts that enable the company to reach break-even point.

2. If the number of haircuts is expected to increase to 9,000, what will be the profit (loss) for the company (Mayberrys income)?

Question 5

Marston Corporation manufactures pharmaceutical products that are sold through a net work of independent sales

agents located in the United States and Canada. The agents are currently paid an 18% commission on sales. Marston

used this percentage in preparing the following budgeted income statement for the fiscal year ending 30 June 20xx :

(In thousands)

Sales 26,000

Cost of goods sold :

Variable 11,700

Fixed 2,870 14,570

Gross margin 11,430

Marketing & administrative expenses :

Sales commissions 4,680

Fixed marketing expenses 750

Fixed administrative expenses 1,850 7,280

Operating income 4,150

Interest expenses 650

Net income before taxes 3,500

Income taxes 1,400

Net income 2,100

Since preparing this budgeted income statement, Marston has learned that its agents are demanding an increase in the

commission rate to 23% for the upcoming year. As a result, Marstons president has decided to investigate the

possibility of hiring it own sales staff in place of the network of sales agents and has asked Tom Ross, Marstons

controller, to gather information on the cost associated with this alternative.

Ross estimates that Marston will have to hire eight salespeople to cover the current market area. The annual payroll

cost of each of these employees will average $80,000, including fringe benefit costs. Travel and entertainment cost are

expected to total $600,000 for the year, and the annual cost of sales manager and sales secretary will be $150,000.

In addition to their salary, the eight salespeople will each earn commissions at the rate of 10% on the first $2 million in

sales and 15% on all sales over $2 million. Ross expects that all eight salespeople will exceed the $2 million and that

sales will be at the level originally projected ($26,000,000). Ross believes that Marston should also increase its

marketing budget by $500,000.

Required :

1) Calculate Marston Corporations breakeven point in sales dollars for the fiscal year ending 30 June 20xx if the company hires its own sales force and increase its marketing costs.

2) If Marston Corporation continues to sell through its network of sales agent and pays the higher

commission rate, determine how many percent increase of dollar sales for the fiscal year ending 30 June

20xx would be to generate the same net income as projected in the budgeted income statement

presented above.

Solution to Cost Volume Profit Question

Question 1

1) Day shift

30(15,000) - 15,000VC - 100,000 = 200,000

VC = 10

CMU = P - VC = 30 - 10 = 20

Night shift

VC = 140% 10 = 14

CMU = 30 - 14 = 16

2) Break-even point of production level 1

S - (10/30)S - 100,000 = 0

S = 150,000

Q = 150,000/30 = 5,000

Break-even point of production level 2

Let X = number of units in excess of 20,000 units

30(20,000 + x) [(10)(20,000) + 14x] - 164,000 = 0

x = 19,000

Q + x = 20,000 + 19,000 = 39,000

3)

Q = 20,000 Q = 36,000

Sales 600,000 1,080,000

Total variable expenses 200,000 424,000

Total contribution margin 400,000 656,000

Total fixed expenses 100,000 164,000

Operating profits 300,000 492,000

The volume that will maximise operating profits = 36,000 units

Question 2

1) 2(45,000) - 1.25(45,000) - 50,000 = -16,250

2) Let x = additional units above 45,000 units

[(245,000) +( 1.90x)] [1.25(45,000 + x)] - 50,000 = 0

x = 25,000

Q + x = 45,000 + 25,000 = 70,000 70,000 units is valid for 50,000 fixed expenses

The additional units (above 45,000) would lead bottoms need to sell in order to break even is 25,000 units

3) Let x = additional units above 45,000 units

[(245,000) +( 1.90x)] [1.25(45,000 + x)] - 50,000 = 6,000

x = 34,231

Q + x = 45,000 + 34,231 = 79,231 79,231 units is invalid for 50,000 fixed expenses try at 70,000 fixed

Expenses [(245,000) + (1.90x)] [1.25(45,000 + x)] - 70,000 = 6,000

x = 65,000

Q = 45,000 + 65,000 = 110,000 110,000 units is valid for 70,000 fixed expenses

Therefore, the additional unit (above 45,000) would lead bottoms need to sell in order to generate profit of 6,000 are

65,000 units

4)

Q = 40,000 Q = 75,000 Q = 125,000

Sales 80,000 150,000 250,000

Total variable expenses 50,000 93,750 156,250

Total contribution margin 30,000 56,250 93,750

Total fixed expenses 35,000 50,000 70,000

Operating profits (5,000) 6,250 23,750

5)

Sales (85,000@2) 170,000

Total variable expenses [(75,000@1.25 + 10,000@[1.25+(1*3/4)] 113,750

Total contribution margin 56,250

Total fixed expenses 50,000

Operating profits 6,250

6)

Product X P = 2, VC per unit = 1.25

Product Y P = 3, VC per unit = 3*60% = 1.8

TFC for both products = 100,000

Sales mix X : Y = 7 : 3

Tax rate = 30%

Let Q = the number of composite units sold (X and Y in bundle)

[[(2 1.25)(7/10) + (3 1.8)(3/10)]Q 100,000](1 0.3) = 14,000

Q = 135,594 units

units of product X sold = 135,594(7/10) = 94,916 sales in dollar = (94,916)(2) = 189,832

unit of product Y sold = 135,594(3/10) = 40,678 sales in dollar = (40,678)(3) = 122,034

Total sales = 311,866

Question 3

1)

Bell Bang Company

Income Statement

For the first half of the year ended 30 June 20xx

Sales 200,000

Less : Variable expenses :

Direct materials 30,000

Direct labor 35,000

Variable overhead 15,000

Commission expense 20,000 100,000

Total contribution margin 100,000

Less : Fixed expenses :

Fixed overhead 22,000

Salaries expense 13,000

Depreciation expense 5,000

Advertising expense 10,000 50,000

Income before tax 50,000

Less : Income tax 40% 20,000

Net income 30,000

2) Contribution margin ratio = 100,000 / 200,000 = 0.50

Break-even point in dollar : S - 0.50S - 50,000 = 0

S = 100,000

Margin of safety ratio = (200,000 - 100,000) / 200,000 = 0.50

3) S - 0.50S - 50,000 = -10,000

S = 80,000

4) Let x = additional sales

(80,000 + x) - (40,000 + 0.40x) - 50,000 = 0

x = 16,667

5) Tax rate = 20,000 / 50,000 = 0.4

[S - 0.50S - (50,0002)] (1-0.40) = 120,000

S = 600,000

6) [S - 0.40S - 125,000] (1-0.40) = 120,000

S = 541,667

Question 4

1) S [2/(8 + (8*0.15)]S - 6,000 = 0

S = 7,666.67

Q = 7666.67 / (8 + (8*0.15)) = 834

2)

Hair cut revenue (9,000@8) 72,000

Tip [3,000@(8*0.15)] 3,600

Total revenue 75,600

Variable expenses :

Commission (6,000@2) 12,000

Other operating expense (9,000@2) 18,000 30,000

Total contribution margin 45,600

Fixed expenses :

Salaries (2@5,000) 10,000

Other operating expense 6,000 16,000

Operating profits 29,600

Question 5

Current situation : Sales = 26,000,000

: Total variable expenses = 11,700,000 + 4,680,000 = 16,380,000

: Total fixed expense = 2,870,000 + 750,000 + 1,850,000 + 650,000 = 6,120,000

: Tax rate = 1,400,000 / 3,500,000 = 0.40

New situation ( Increasing commission) : Sales = 26,000,000

: Total variable expense = 11,700,000 + [(23%/18%)*4,680,000]

= 17,680,000

: Total fixed expense = 2,870,000 + 750,000 + 1,850,000 + 650,000

= 6,120,000

: Tax rate = 0.40 (unchanged)

New situation : (Arranging own sale force)

Sales = 26,000,000

Variable expense :

Sales dollar Variable cost ratio (based on sales at 2,600,000)

0 - 2,000,000 [11,700,000 + (26,000,000*10%)]/ 26,000,000 = 0.55

2,000,000 and over [11,700,000 + (26,000,000*15%)]/ 26,000,000 = 0.60

Total fixed expense = 2,870,000 + (750,000 + 500,000) + 1,850,000 + 650,000 + 640,000 + 600,000 + 150,000

= 8,010,000

1) Let S = Sales dollars above $ 2,000,000

(2,000,000 + S) [0.55(2,000,000) + 0.6S] - 8,010,000 = 0

S = 17,775,000

Total sales at breakeven point = 2,000,000 + 17,775,000 = 19,775,000

2) S (17,680,000 / 26,000,000)S - 6,120,000 = 3,500,000

S = 30,062,500

Therefore sales have to increase by (30,062,500 26,000,000)/26,000,000 = 15.625%