Cost Volume - Profit Analysis

Chapter 25
Cost-Volume-Profit
Analysis
Questions
1.
Cost-volume-profit analysis is used to accomplish the first step in the planning phase for
a business, which involves predicting the volume of activity, costs to be incurred,
revenues to be received, and profits to be earned.
2.
A variable cost is one that varies proportionately with the volume of activity that drives
the cost. Examples in a manufacturing setting include direct materials and direct labour
(when the workers are paid for completed units).
3.
Variable costs per unit stay the same because each unit consumes the same amount of
variable costs within the relevant range of activity. That is, variable costs per unit remain
constant as volume increases.
4.
Fixed costs per unit decrease because the total amount of fixed costs remains the same
while being divided among more units within the relevant fixed cost range of activity.
5.
A step-wise cost remains constant over a limited range of production, after which it
increases by a lump-sum amount, then remains constant over another limited range of
production, and so on. A curvilinear cost gradually changes in a nonlinear relationship to
volume changes.
6.
A CVP analysis for a manufacturing company is greatly simplified by an assumption that

the production and sales volumes are equal.
7.
The first is that individual costs classified as fixed or variable may not behave precisely
in those patterns; some variations of individual components may tend to offset each
other. The second is that management can assume that costs are either fixed or variable
within the relevant range of operations.
8.
By assuming a relevant range, management can more justifiably assume fixed and
variable relationships between costs and volume, and between revenue and volume. The
assumption also limits the alternative strategies to those that call for a volume that falls
within the relevant range.
9.
Estimated line of cost behaviour, high-low method, least-squares regression.
10. A scatter diagram can be used to display past costs and volumes. Then, management
(assisted by the accountant) can attempt to identify the fixed and variable components of
the total cost being graphed.
11. At break-even, profits are zero. Break-even is the point where sales equals fixed plus
variable costs.
12. The line shows the total cost, which equals the sum of the fixed and variable costs at all
volumes within the periods capacity.
Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.
160
Fundamental Accounting Principles, Eleventh Canadian Edition
13. Fixed costs are depicted as a horizontal line on a CVP chart because they remain the
same at all volumes within the relevant range.
14. Company A has a contribution margin ratio of 50% ([$20,000 $10,000] $20,000), and
Company B has a contribution margin ratio of 80% ([$20,000 $4,000] $20,000). Thus,
compared to Company A, Company B will make more profit on each additional dollar of
sales.
15. Margin of safety.
16. The primary variable costs in making hats are cloth, thread, cardboard, and direct labour.
The costs of operating the plant and equipment are fixed because regardless of
production levels these product costs are incurred.
17. A 65% increase in production would be viewed as a substantial increase in production.
When this occurs, the sales and cost structure changes. The sales value, fixed costs,
and variable costs are likely to change as production moves out of the relevant range.
Variable cost per unit may go down, and fixed cost in total is likely to increase due to, for
example, more space needed to manage the increase in production.
Copyright 2005 McGraw-Hill Ryerson Limited. All rights reserved.

Solutions Manual for Chapter 25
161
QUICK STUDY
Quick Study 25-1
Series 1
Series 2
Series 3
Variable cost
Fixed cost
Step-wise cost
Quick Study 25-2

(a) Fixed
(b) Variable
(c) Variable
(d)
(e)
(f)
Fixed
Probably mixed
Variable
Quick Study 25-3

(a) Fixed
(b) Mixed
(c) Variable
Quick Study 25-4
Fixed costs = $3,000

Variable costs =
$8,000 $3,000
= $1.4286
3,500 0

162
Quick Study 25-5

Total cost = $15,000 + $6(9,000 units) = $69,000
Quick Study 25-6
(a) Contribution margin per unit = $50 $30 = $20
(b) Break-even point in units =
$225,000
= 11,250 units
$20
Quick Study 25-7

(a)
Contribution margin ratio =
(b)
Break-even point in dollars =
$50 $30
$50
= 40%
$225,000
= $562,500
40%
Quick Study 25-8

The correct answer is b.
Quick Study 25-9
Before-tax income = $630,000 (1 .40) = $1,050,000
Income taxes = $1,050,000 .40 = $420,000
$225,000 + $630,000 + $420,000 = 63,750 units
$50 $30
Quick Study 25-10
Break-even point in composite units =
$835,120
= 9,825 units
$85
Mixers at break-even point = 3 9,825 = 29,475

163
EXERCISES
Exercise 25-1
1.
2.
3.
4.
5.
6.
f
c
d
a
b
e
Exercise 25-2
Sales
Variable
Cost
$3,000
1,960
960
$4,000
2,800
6,200
Fixed
Cost
$600
840
840
Total
Cost
$3,600
2,800
1,800
Net Income
$400
-04,400
Contribution
Margin
$1,000
840
5,240
Exercise 25-3
Series A
Series B
Series C
Series D
Series E
Curvilinear cost
Mixed cost
Variable cost
Step-wise cost
Fixed cost
Exercise 25-4
a.
b.
1.
2.
3.
4.
5.
Fixed cost
Mixed cost
Step-wise cost
Variable cost
Curvilinear cost
(1)
(2)
(3)
(4)
(5)
3
5
1
4
2

164
Exercise 25-5 (20 minutes)
The cost appears to be a mixed cost.

165
Exercise 25-6
The cost appears to be a step-variable cost.

166

High level of activity
Low level of activity
Change observed
CGS
$235,000
226,000
$ 9,000
Sales
$450,000
420,000
$ 30,000
Variable cost element:

Change in CGS
$9,000
=
= $0.30 per sales dollar
Change in Sales
$30,000
Fixed cost element:
Total cost at the high level of activity
$235,000
Less variable cost element ($0.30 $450,000) 135,000
Fixed cost element
$100,000
High level of activity

Low level of activity
Change observed
Sales
$450,000
420,000
$ 30,000
Selling &
Administration
Expenses
$108,000
106,000
$ 2,000
Variable cost element:

Change in
Expenses
= $2,000 = $0.0667 per sales dollar
Change in Sales
$30,000
Fixed selling and administration expenses:
Total cost at the high level of activity......................
Less variable cost element ($0.0667 $450,000) ...
Fixed selling and administration expenses ............
$108,000
30,015
$ 77,985

167

KEATING COMPANY
Forecasted Income Statement
For Month Ended January 2002
Sales.......................................................................
Variable costs:
Variable cost of goods sold*..............................
Variable selling and administrative expenses**
Total variable costs...............................................
Contribution margin..............................................
Fixed costs:
Cost of goods sold..............................................
Selling and administrative expenses ................
Total fixed costs....................................................
Income before taxes .............................................
Income taxes (35% rate) .......................................
Net income.............................................................
$500,000
$150,000
33,350
$183,350
$316,650
$100,000
77,985
$177,985
$138,665
48,533
$ 90,132
*$0.30 $500,000 = $150,000

**$0.0667 $500,000 = $33,350
a.
b.
c.
d.
Contribution margin per unit = $117.60 $88.20 = $29.40 per unit

Contribution margin ratio = $29.40 $117.60 = 25%
Break-even point in units = $441,000 $29.40 = 15,000 units
Break-even point in dollars = $441,000 25% = $1,764,000
or = 15,000 units $117.60 = $1,764,000
Exercise 25-11
Income
Sales (15,000 $117.60) .........................................
Variable costs (15,000 $88.20) ........................
Contribution margin ...........................................
Fixed costs ..........................................................
Net income ..............................................................
$1,764,000
1,323,000
441,000
441,000
$
0
Sales (in dollars) to break even with increased fixed costs:

Break-even = (original fixed costs + new amount) contribution margin ratio
= ($441,000 + $63,000) 25% = $2,016,000
168
Exercise 25-12
Pre-tax income = After-tax income (1 tax rate)
= $530,000 (1 0.4)
= $530,000 0.6
= $883,333
Income taxes = Pre-tax income tax rate
= $883,333 0.4 = $353,333
a.
Unit sales at target income level
=
=
Fixed
costs
Net
+ Income
income
taxes
Contribution margin
+
$441,000 + $530,000 + $353,333

$29.40
= 45,045 units (rounded)

b.
Dollar sales at target income level =
=
Fixed
costs
Net
+ Income
income
taxes
Contribution ratio
$441,000 + $530,000 + $353,333

25%
= $5,297,332

169
Exercise 25-13
a.
Recall that:
Net income = Sales revenue Variable costs Fixed costs Income taxes.
Given that we are working with pre-tax income, we can ignore income taxes.
Therefore, we can rewrite the above equation as follows:
Desired pre-tax net income = Total contribution margin Fixed costs
Assume desired sales dollars is S.

Therefore,
0.18S = 0.25S - $441,000
(desired pre-tax income is 18% of sales revenues; contribution margin ratio is 25%
of sales revenues)
Therefore, 0.07S = $441,000, and S = $441,000 0.07 = $6,300,000.
Monroe Company must generate sales revenues of $6,300,000 to earn a pre-tax income
equal to 18% of sales.
b.
Desired sales in units = $6,300,000 $117.60 = approximately 53,572 units

170
Exercise 25-14
Sales (60,000 $175)..............................................
Variable costs (60,000 $100)...............................
Contribution margin ...............................................
Fixed costs..............................................................
Net income before taxes ........................................
Income taxes (40% $4,059,000) ..........................
Net income after taxes ...........................................
$10,500,000
6,000,000
4,500,000
441,000
4,059,000
(1,623,600)
$ 2,435,400
Exercise 25-15
(a) Sales = Fixed costs + Variable costs + Pre-tax income
Sales = $600,000 + $375,000 + $150,000
Sales = $1,125,000
(b) Total contribution
Total contribution
= Sales Variable costs

= $1,125,000 $375,000
= $750,000
Unit sales = Total contribution Contribution margin
= $750,000 $75 per unit
= 10,000 units
Exercise 25-16
a.
(i)
(ii)
Sales price =
Sales
units
$12,000,000
= $150 per unit
80,000
Selling price per unit...............................................

Less: contribution margin per unit........................
Variable costs per unit............................................
Total variable costs ($110 80,000 units).............
$ 8,800,000
Sales .........................................................................
Less variable costs .................................................
Less pre-tax income................................................
Fixed costs...............................................................
$12,000,000
(8,800,000)
(2,400,000)
$ 800,000
150
(40)
110

171
Exercise 25-17
(a) Dollar sales = Fixed costs + Target pre-tax income
Contribution rate
= 600,000 + $240,000
75%
= $1,120,000
(b) Sales .......................................................................
Less fixed costs .....................................................
Less pre-tax income ..............................................
Variable costs ........................................................
$1,120,000
(600,000)
(240,000)
$ 280,000
Exercise 25-18
(a) Selling price per composite unit
10 windows @ $70 per unit ..............................................
3 doors @ $450 per unit ...................................................
Selling price per composite unit .....................................
$ 700
1,350
$2,050
(b) Variable costs per composite unit

10 windows @ $40 per unit ..............................................
3 doors @ $290 per unit ...................................................
Variable costs per composite unit ..................................
$ 400
870
$1,270
(c)
Break-even point in composite units =
=
Fixed costs
Contribution margin per composite unit
$975,000
$2,050 $1,270
= 1,250 units
(d) Unit sales of windows and doors at break-even point:
Windows:
Doors:
10 1,250 ..................................
3 1,250...................................
12,500 units
3,750 units

172
PROBLEMS
Problem 25-1A (45 minutes)
Parts 1 & 2
Note to Instructoranswers to Parts 3 and 4 will vary among students because they will
be based on imprecise visual placements of the estimated line of cost behaviour. The
better predictions of total fixed costs will fall in the range between $20,000 and $30,000.
The predicted variable cost per sales dollar should fall between $0.60 and $0.70.
According to a least-squares regression, the following coefficients apply in this case:
Fixed costs = $24,928
Variable cost = $0.665 per sales dollar

173
Problem 25-1A (concluded)

Part 3
Using the scatter diagram and the vertical intercept, a good approximate answer for the
predicted monthly fixed cost is $25,000.
Assessing the variable cost requires determining the slope of the line. The slope can be
estimated by dividing the difference between two costs on the line by the difference
between the two sales levels associated with those costs.
At sales of $200,000, it appears that the total cost will equal approximately $158,000. And,
at sales of $0, the total cost will equal the fixed costs, which are about $25,000. Using
these two data points, we can estimate the variable cost as follows:
Point
1 ................................................................
2 ................................................................
Differences ..................................................
Sales
Total Cost
$200,000
0
$200,000
$158,000
25,000
$133,000
Slope = Difference in Total Cost

Difference in Sales
= $133,000 = $0.665 per sales dollar
$200,000
Part 4
Then, these factors can be used to predict the total costs that will be incurred at sales
levels of $200,000 and $280,000:
Sales Level
$200,000
$280,000
Fixed cost ........................................................
$ 25,000
$ 25,000
186,200
Variable cost ($0.665 sales dollar) .............
133,000
Total cost .........................................................
$158,000
$211,200
Noteaccording to the least-squares estimated line of cost behaviour, the predicted total
costs at these given sales levels would be $157,928 and $211,128. The above approximations are reasonably close to these more precisely determined amounts.

174
Problem 25-2A
Part 1
(a) Contribution margin per unit = $480 $180 = $300
Break-even point in units
(b) Contribution ratio

Break-even point in dollars
Part 2
= Fixed costs Contribution margin per unit

= $300,000 $300
= 1,000 units
= $300 $480 = 62.5%
= Fixed costs Contribution ratio
= $300,000 62.5%
= $480,000

175

Part 3
GROVE COMPANY
Product A Income Statement at Break-Even Point
Sales (1,000 units $480) ....................................................................
Costs:
Fixed costs .................................................................................... $300,000
Variable costs (1,000 units $180) .............................................. 180,000
Net income ............................................................................................
$480,000
480,000
$
0
Part 4
Pre-tax target income
= After-tax target income (1 tax rate)

= $231,000 (1 .3)
= $330,000
Income tax = $330,000 30% = $99,000

Necessary sales level
=
=
=
=
(Fixed costs + Target income + Taxes) Contribution rate

($300,000 + $231,000 + $99,000) 62.5%
$630,000 62.5%
$1,008,000
Part 5
Contribution margin at predicted sales
= Sales Contribution rate

= $1,200,000 62.5%
= $750,000
Pre-tax income = Contribution margin Fixed costs

= $750,000 $300,000
= $450,000
Income taxes
= Pre-tax income Tax rate

= 450,000 30%
= $135,000
After-tax income = Pre-tax income Income taxes

= $450,000 $135,000
= $315,000

176
Problem 25-3A
Part 1
Price per unit ................................ $750,000 15,000
Variable costs per unit ................ $450,000 15,000
Contribution margin per unit ...... $50 $30
Contribution ratio ......................... ($20 $50)
Fixed costs ...................................
Break-even point .......................... $384,000 40%
=
=
=
=
= $50
= $30
$20
40%
$384,000
$960,000
=
=
=
=
=
$15
$35
70%
$504,000
$720,000
Part 2
New variable costs per unit .........
New contribution margin per unit
New contribution ratio .................
New fixed costs ............................
New break-even point ..................
$30 ($30 50%)

$50 $15
$35 $50
$384,000 + $120,000
$504,000 70%
Part 3

177

Part 4
MORGAN COMPANY
For Year Ended December 31, 2005
Sales (15,000 $50) ..............................................................................
Variable costs (15,000 $15) ..............................................................
Contribution margin..............................................................................
Fixed ($384,000 + $120,000) ................................................................
Income before income taxes ...............................................................
Income taxes ($21,000 30%)..............................................................
Net income ............................................................................................
$750,000
225,000
$525,000
504,000
$ 21,000
6,300
$ 14,700
Part 5
Pre-tax target income
= After-tax target income (1 tax rate)

= $147,000 (1 .30)
= $210,000
Income tax = $210,000 30%...............................= $63,000

Necessary sales level
=
=
=
=
(Fixed costs + Target income + Taxes) Contribution rate

($504,000 + $147,000 + $63,000) 70%
$714,000 70%
$1,020,000
Unit sales = $1,020,000 $50 = 20,400 units

MORGAN COMPANY
Sales (20,400 $50) ..............................................................................
Variable (20,400 $15) .........................................................................
Contribution margin..............................................................................
Fixed ......................................................................................................
Income before income taxes.......................................................... ......
Income taxes ($210,000 30%) ...........................................................
Net income ............................................................................................
$1,020,000
306,000
$ 714,000
504,000
$ 210,000
63,000
$ 147,000

178
Problem 25-4A
Part 1
Sales ................................................................
Units sold ........................................................
Selling price per unit ......................................
Variable costs ...................... ...........................
Variable cost per unit .....................................
Contribution margin per unit .........................
Contribution ratio ...........................................
Fixed costs ......................................................
Break-even (fixed costs contribution rate)
Product A
Product B
$800,000
50,000
$ 16.00
$560,000
$ 11.20
$ 4.80
30.0%
$100,000
$333,333
$800,000
50,000
$ 16.00
$100,000
$ 2.00
$ 14.00
87.5%
$560,000
$640,000
Part 2

179
Problem 25-4A, Part 2 (concluded)
Part 3
Income statements, assuming that the sales volume falls to 33,000 units:
Sales ...............................................................
Fixed costs .....................................................
Variable costs .................................................
Total costs ......................................................
Income before taxes ......................................
Income taxes (32%) ........................................
Net income ......................................................
Per Unit
Units
Product A Product B
$16.00
$16.00
33,000
33,000
$528,000
$11.20
$ 2.00
33,000
33,000
$100,000
369,600
$469,600
$ 58,400
(18,688)
$ 39,712
$528,000
$560,000
66,000
$626,000
$ (98,000)
(31,360)
$ (129,360)

180

Part 4
Income statements, assuming that the sales volume increases to 64,000 units:
Sales ...............................................................
Fixed costs .....................................................
Variable costs .................................................
Total costs ......................................................
Income before taxes ......................................
Income taxes (32%) ........................................
Net income ......................................................
Per Unit
Units
Product A
$16.00
$16.00
64,000
64,000
$1,024,000
$11.20
$ 2.00
64,000
64,000
$ 100,000
716,800
$ 816,800
$ 207,200
66,304
$ 140,896
Product B
$1,024,000
$ 560,000
128,000
$ 688,000
$ 336,000
107,520
$ 228,480
Part 5
If sales were to greatly decrease, Product B would suffer the greater loss because it
would lose more contribution per unit than Product A. At zero sales, Product B would
have a loss equal to its fixed costs of $560,000, while Product As loss would be only
$100,000.
Part 6
A factor that could cause Product A to have lower fixed costs might be a labour
arrangement that pays workers for units produced. Another might be that the sales
representatives work totally on commission. Managers may be compensated with a share
of the profits instead of salaries. The fixed costs for Product B may be higher because of
a salary structure that is not based on production or sales. Another factor may be that
assets used in the production of Product A are leased and rent is based on the amount of
usage. Product Bs assets may be owned or under a lease agreement based on time, not
the amount of usage.

181
Problem 25-5A
Part 1
New variable costs:
Materials cost .......................
Direct labour ........................
Overhead variable costs ......
Selling and admin. costs .....
Total variable costs .............
$4.00 (1 60%)
$3.00 (1 40%)
=
=
=
=
=
$1.60
$1.80
$0.40
$0.20
$4.00
=
=
=
=
=
$16.00
$12.00
75%
$300,000
$400,000
=
=
=
=
=
$20.00
$16.00
80%
$300,000
$375,000
Plan 1
Selling price .........................
Contribution margin per unit $16.00 $4.00
Contribution ratio ................ $12.00 $16.00
Total fixed costs ..................
Break-even point (dollars) .. $300,000 75%
Plan 2
Selling price ......................... $16.00 (1 + 25%)
Contribution margin per unit $20.00 $4.00
Contribution ratio ................ $16.00 $20.00
Total fixed costs ...................
Break-even point (dollars) .. $300,000 80%
Part 2

182
Part 3
KIRBY COMPANY
Sales ............................................................
Fixed costs ..................................................
Variable costs ..............................................
Total costs ...................................................
Income before taxes ...................................
Income taxes (30%) .....................................
Net income ...................................................
Per Unit
Units
Plan 1
$16.00
$20.00
35,000
31,500
$560,000
$ 4.00
$ 4.00
35,000
31,500
Plan 2
$630,000
$300,000 $300,000
140,000
126,000
$440,000 $426,000
$120,000 $204,000
61,200
36,000
$ 84,000 $142,800

183
Problem 25-6A
1.
Sales ................................................................
Variable costs:
Cost of sales ............................................... $840,000
Commissions .............................................. 210,000
Contribution margin .......................................
Contribution margin ratio (CMR)
Variable cost ratios

Cost of sales ....................................
Commissions ...................................
CMR = 100% 65%
$14,000
.25
$56,000
60%
5%
65%
= 35%
Fixed costs
Sales manager .............................................................
Three salespeople @ $42,000......................................
Administrative ..............................................................
Fixed costs .......................................................................
CMR ..................................................................................
Estimated break-even point.............................................
3.
1,050,000
$ 350,000
= $ 350,000
$1,400,000
= 25%
Fixed costs ...........................................

CMR ......................................................
Estimated break-even point ................
2.
$1,400,000
Target income before income tax ..................................

Fixed costs .......................................................................
Cost of sales ....................................
Commissions ...................................
CMR = 100% 80% ..............................
$ 84,000
126,000
14,000
$224,000
$224,000
.35
$640,000
$336,000
14,000
$350,000
60%
20%
80%
20%
Target income + fixed costs ...........................................

CMR ..................................................................................
Estimated sales volume ..................................................
$ 350,000
.20
$1,750,000

184

4.
Total costs with agents
x
.80x + $14,000
.15x
x
= Total costs with companys own force

receiving 20% commission
= sales volume
= .65x + $224,000
= $210,000
= $1,400,000
Problem 25-7A
(a) $1,680,000 (560,000 + 700,000 + 140,000 + VSA) = $140,000
Variable selling and administrative expense (VSA)
= $140,000
(b) $1,680,000 (560,000 + 700,000 + 140,000 + FMO) = $140,000

Fixed manufacturing overhead (FMO)
= $140,000
(c) Contribution margin ratio
= $140,000 1,680,000
= 8.33%
At break-even, contribution margin
= Fixed selling and administrative +

Fixed manufacturing overhead
Break-even point
= $1,890,000
Contribution margin = 1,890,000 .083333 = 157,500
157,500
= FSA + 140,000
Fixed selling and administrative
= $17,500
(d) Maximum increased advertising expenditure

= 1,680,000 .25 .083333 = $35,000
The amount that advertising expenditures can be increased and the company be just
as profitable as before is the amount of the increased contribution arising from the
increase in sales. The fixed manufacturing overhead and the fixed selling and
administrative expenses are irrelevant in this case.

185
Problem 25-8A
Part 1
5 units of Red @ $55 per unit
4 units of White @ $85 per unit
2 units of Blue @ $110 per unit
Selling price of a composite unit
5 units of Red @ $40 per unit
4 units of White @ $60 per unit
2 units of Blue @ $80 per unit
Variable cost of a composite unit
Contribution margin of a composite unit
Contribution margin ratio
Break-even point in composite units
Units of Red at break-even point:
Units of White at break-even point:
Units of Blue at break-even point:
= $275
= 340
= 220
= $835
= $200
= 240
= 160
= $600
= $835 $600 = $235
= $235 $835 = 28.14%
= $150,000 28.14% = $533,049
= $150,000 $235 = 639 composite units
639 5 = 3,195 units
639 4 = 2,556 units
639 2 = 1,278 units
Part 2
Under the new plan, there would be no change in selling prices. The fixed costs would
increase by $20,000 to $170,000 per year.
5 units of Red @ ($40 $10) per unit
= $150
4 units of White @ ($60 $20) per unit
= 160
2 units of Blue @ ($80 $10) per unit
= 140
= $450
Contribution margin of a composite unit = $835 $450 = $385
= $385 $835 = 46.11%
= $170,000 46.11% = $368,683
= $170,000 $385 = 442 composite units
Units of Red at break-even point:
442 5 = 2,210 units
Units of White at break-even point:
442 4 = 1,768 units
Units of Blue at break-even point:
442 2 = 884 units
Part 3
When a business invests in capital assets, as in this problem, the risk of doing business
changes. The break-even point decreased, making it easier to make a profit. However, the
commitment of fixed resources is higher, therefore increasing the amount of loss in a
business failure.

186
ALTERNATE PROBLEMS
Problem 25-1B
Parts 1 & 2
Part 3
Using the scatter diagram and the vertical intercept, a good approximate answer for the
predicted monthly fixed cost is $90 and .30 for variable cost.
Part 4
Then, these factors can be used to predict the total costs that will be incurred at sales
levels of $150 and $250.
$250
$150
Fixed cost................................................................
$ 90
$ 90
75
Variable cost ($0.30 sales dollar).......................
45
Total cost.................................................................
$135
$165

187
Problem 25-2B
Part 1
(a) Contribution margin
Break-even point in units
(b) Contribution margin ratio
= $225 $150 = $75

= Fixed costs Contribution margin
= $30,000 $75
= 400 units
= $75 $225 = 33.33%
Break-even point in dollars = Fixed costs Contribution margin ratio

= $30,000 33.33%
= $90,009
Part 2

188
Problem 25-2B (concluded)

Part 3
Sales (400 units @ $225)........................................
Variable costs (400 units @ $150).........................
Contribution margin ...............................................
Fixed costs..............................................................
Net income ..............................................................
$90,000
60,000
30,000
30,000
0
Problem 25-3B
Part 1
Price per unit.................................
Variable costs per unit .................
Contribution margin per unit.......
Contribution margin ratio ............
Fixed costs....................................
Break-even point ..........................
$800,000 50,000
$900,000 50,000
$16 $18
($2 $16)
= $16.00
= $18.00
= $2
= not applicable
= $100,000
Capital will never
break even because
variable cost is
greater than selling
price per unit.
Part 2
New variable costs per unit .........
New contribution margin per unit
New contribution margin ratio ....
New fixed costs ............................
New break-even point ..................
$18 ($18 72.22%)

$16 $5
$11 $16
$100,000 + $200,000
$300,000 68.75%
= $5
= $11
= 68.75%
= $300,000
= $436,364
Part 3
CAPITAL COMPANY
Sales (50,000 $16)................................................
Costs:
Fixed ($100,000 + $200,000) ............................... $300,000
Variable (50,000 $5) .........................................
250,000
Income before income taxes .................................
Income taxes ($250,000 40%) .............................
Net income ..............................................................
$800,000
550,000
250,000
100,000
$150,000

189
Problem 25-3B (continued)

Part 4
Pre-tax target income = After-tax target income (1 tax rate)
= $300,000 (1 0.40)
= $500,000
Income tax
= $500,000 40% = $200,000
Necessary sales level = (Fixed costs + Target income + Taxes) Contribution margin ratio
= ($300,000 + $300,000 + $200,000) 68.75%
= $800,000 68.75%
= $1,163,637
Unit sales = $1,163,637 $16 = 72,728 units
Part 5
CAPITAL COMPANY
For Year Ended December 31,2005
Sales (72,728 $16)....................................................
$1,163,648
Costs:
Fixed....................................................................... $300,000
663,640
Variable (72,728 $5) ........................................... 363,640
Income before income taxes .....................................
$ 500,008
Income taxes ($500,008 40%) .................................
200,003
Net income ..................................................................
$ 300,005
(Net income is greater than $300,000 due to rounding up in units from Part 4.)

190
Problem 25-4B
Part 1
Sales .....................................................................
Units sold .............................................................
Selling price per unit ...........................................
Product L
$3,000,000
120,000
$25
Product M
$3,000,000
120,000
$25
Variable costs ......................................................

Variable cost per unit ..........................................
$1,800,000
$15
$600,000
$5
Contribution margin per unit..............................

Contribution margin ratio ...................................
$10
40%
$20
80%
Fixed costs...........................................................
Break-even (fixed costs
contribution margin ratio)...............................
$ 600,000
$1,800,000
$1,500,000
$2,250,000
Part 2
Income statements, assuming that the sales volume falls to 104,000 units:
Per Unit
Units
Product L
Product M
Sales ................................
$25.00 104,000 $2,600,000
$25.00 104,000
$2,600,000
Variable costs .................
$15.00 104,000
1,560,000
520,000
$5.00 104,000
Contribution margin .......
1,040,000
2,080,000
Fixed costs......................
600,000
1,800,000
Income before taxes.......
440,000
280,000
98,000
Income tax (35%) ............
154,000
Net income ......................
$ 286,000 $ 182,000

191

Part 3
Income statements, assuming that the sales volume increases to 190,000 units:
Per Unit
Units
Product L
Product M
Sales ................................
$25.00 190,000 $4,750,000
$25.00 190,000
$4,750,000
Variable costs .................
$15.00 190,000
2,850,000
950,000
$ 5.00 190,000
Contribution margin .......
1,900,000
3,800,000
Fixed costs ......................
600,000
1,800,000
Income before taxes .......
1,300,000
2,000,000
Income tax (35%) ............
455,000
700,000
Net income ......................
$ 845,000 $1,300,000
Part 4
If sales were to greatly increase, Product M would experience the greater increase in
profit because it would experience a much greater contribution for each additional unit
sold.
Part 5
A factor that could cause Product L to have lower fixed costs might be a labour
arrangement that pays workers for units produced. Another might be that the sales
representatives work totally on commission. Managers may be compensated with a share
of the profits instead of salaries. The fixed costs for Product M may be higher because of
a salary structure that is not based on production or sales. Another factor may be that
assets used in the production of Product L are leased and rent is based on the amount of
usage. Product Ms assets may be owned or under a lease agreement based on time, not
the amount of usage.

192
Problem 25-5B
Part 1
Priced at $25.00 per unit (old plan):
Bulk material cost per unit .................................
Packaging cost per unit ......................................
Total variable costs per unit...............................
Fixed costs per year............................................
Break-even point .................................................
Priced at $20.00 per unit (new plan):
Bulk material cost per unit .................................
Packaging cost per unit ......................................
Total variable costs per unit...............................
Fixed costs per year............................................
Break-even point .................................................
$1,000,000 100,000
$100,000 100,000
$10.00 + $1.00
$25.00 $11.00
$14.00 $25.00
$1,250,000 56%
= $10.00
= $1.00
= $11.00
= $14.00
= 56%
= $1,250,000
= $2,232,143
$10.00 80%
$1.00 125%
$8.00 + $1.25
$20.00 $9.25
$10.75 $20.00
= $8.00
= $1.25
= $9.25
= $10.75
= 53.75%
= $1,250,000
$1,250,000 53.75% = $2,325,581
Part 2
WHITE COMPANY
Sales ................................
Fixed costs......................
Variable costs:
Product ........................
Packaging ....................
Total costs.......................
Income before taxes.......
Income taxes (30%) ........
Net income ......................
Per Unit
$25.00
$20.00
Units
100,000
180,000
$10.00
$ 8.00
$ 1.00
$ 1.25
100,000
180,000
100,000
180,000
Return on sales...............
Old Plan
$2,500,000
$1,250,000
1,000,000
100,000
New Plan
$3,600,000
$1,250,000
1,440,000
$2,350,000
$ 150,000
45,000
$ 105,000
225,000
$2,915,000
$ 685,000
205,500
$ 479,500
4.2%
13.3%

193
Problem 25-6B
Part 1
Sales ................................................................
Variable costs:
Cost of sales ...............................................
Commissions ..............................................
Contribution margin .......................................
Contribution margin ratio (CMR)
$1,960,000
$1,176,000
235,200
$548,800
$1,960,000
= 28%
Fixed costs ...........................................

CMR ......................................................
Estimated break-even point ................
Part 2
a. Variable cost ratios
Cost of sales ....................................
Commissions ...................................
CMR = 100% 64%
$21,100
.28
$75,357
60%
4%
64%
= 36%
b. Fixed costs
Sales manager .............................................................
Three salespeople @ $48,000......................................
Administrative ..............................................................
Fixed costs .......................................................................
CMR ..................................................................................
Estimated break-even point.............................................
c.
1,411,200
$ 548,800
Target income before income tax ..................................

Fixed costs .......................................................................
Cost of sales ....................................
Commissions ...................................
CMR = 100% 75% ..............................
$107,600
144,000
21,100
$272,700
$272,700
.36
$757,500
$468,900
21,100
$490,000
60%
15%
75%
25%
Target income + fixed costs ...................................................

CMR ..................................................................................
Estimated sales volume ..................................................
$ 490,000
.25
$1,960,000

194

d. Total costs with agents
= Total costs with companys own force

receiving 15% commission
x
.75x + $21,100
.11x
= sales volume
= .64x + $272,700
= $251,600
= $2,287,273
Problem 25-7B
(a) $910,000 (280,000 + 350,000 + 70,000 + VSA)
= $182,000
Variable selling and administrative expense (VSA)
= $ 28,000
(b) $910,000 (280,000 + 350,000 + 70,000 + FMO)

Fixed manufacturing overhead (FMO)
= $ 70,000
= $140,000
(c) Contribution margin ratio

= $182,000 910,000
= 20%
At break-even, contribution margin
= Fixed selling and administrative +

Fixed manufacturing overhead
Break-even point
= $1,050,000
Contribution margin = 1,050,000 .2 =
210,000
210,000
= FSA + 140,000
Fixed selling and administrative
= $ 70,000
(d) Maximum increased advertising expenditure
= 910,000 .3 .2 = $54,600
The amount that advertising expenditures can be increased and the company be just
as profitable as before is the amount of the increased contribution arising from the
increase in sales. The fixed manufacturing overhead and the fixed selling and
administrative expenses are irrelevant in this case.

195
Problem 25-8B
Part 1
Break-even analysis assuming new machine is not acquired:
2 units of Product 1 @ $225 per unit
= $ 450
=
750
=
960
Selling price of a composite unit
= $2,160
= $ 240
=
510
=
600
= $1,350
Contribution margin of a composite unit = $2,160 $1,350 = $810

= $810 $2160 = 37.5%
= $793,800 37.5% = $2,116,800

= $793,800 $810 = 980 composite units
Units of Product 1 at break-even point:

980 2 = 1,960 units

980 5 = 4,900 units
980 8 = 7,840 units
Part 2
Break-even analysis assuming purchase of new machine:
Under the new plan, there would be no change in selling prices. The fixed costs would
increase by $81,000 to $874,800 per year.
5 units of Product 2 @ ($102 $18) per unit
8 units of Product 3 @ ($75 $9) per unit
= $ 240
= 420
= 528
= $1,188
Contribution margin of a composite unit

= $2,160 $1,188 = $972

= $972 $2,160 = 45%

= $874,800 45% = $1,944,000

= $874,800 $972 = 900 composite units

900 2 = 1,800 units

900 5 = 4,500 units
900 8 = 7,200 units
Part 3
When a business invests in capital assets, as in this problem, there is a change in the
riskiness of conducting business. The break-even point decreased, making it easier to
make a profit with less sales. However, because of the commitment of higher fixed
resources, the risk of loss from business failure is greater.
196
ANALYTICAL & REVIEW PROBLEMS

A&R Problem 25-1
(a) Break even = Fixed costs contribution margin per unit
SP
VC:
Direct material
Direct labour
Variable overhead
Variable selling
Contribution margin
CAMS
$42.00
$7.00
8.40
4.20
2.80
22.40
$19.60
LIPS
$42.00
$ 7.84
10.08
6.72
2.80
27.44
$14.56
(i) $3,416,000 + $700,000 = 210,000 units

19.60
(ii) $1,848,000 + $700,000 = 175,000 units
14.56
(b) $22.40X + $4,116,000 = $27.44X + $2,548,000

$ 5.04X = $1,568,000
X = 311,111 units

197
A&R Problem 25-2 (20 minutes)
a.
Three relevant ranges are identified; in terms of percentage of physical capacity

utilization, the ranges are OK, KL, and LM. In the three ranges, the total cost has
linear relationship with volume, and fixed costs remain constant in the range.
b. At lower levels of capacity utilization, costs increase rapidly; as efficiency of

operation is reached, costs level off, increasing at a constant lower rate as increases
in volume are experienced; when capacity of facility is approached, the rate of cost
increase increases due to factors such as machine breakdowns, material shortages,
increased waste, etc.

198
A&R Problem 25-3 (10 minutes)

Fixed costs are costs that remain constant, in total, regardless of changes in the level of
activity. These costs are a function of capacity; for example, amortization is a function of
the amount of capital assets. Since these costs are a function of capacity they are viewed
as capacity costs. Variable costs are not affected (per unit of activity) by changes in
volume. They are a function of activity and vary with activity. Hence, variable costs are
viewed as activity costs.
A&R Problem 25-4
1.
Variable costs:
Materials
Direct labour
Factory rent
Total variable costs
Fixed costs:
Factory rent
Factory equipment
Total fixed costs
Total cost
Sales in units
Cost per unit
NIKE
Reebok
100,000
300,000
100,000
340,000
400,000
440,000
30,000
50,000
80,000
480,000
10,000
$48
10,000
60,000
70,000
510,000
10,000
$51
2.
The reason why NIKE is more profitable than Reebok can be explained by the
difference in cost structures for each company. NIKE invested more in capital assets
than Reebok. Thus, the contribution margin for NIKE is greater than for Reebok. As a
result, at sales of 10,000 pairs, the savings in labour more than offsets the $10,000 of
additional investment in capital assets for NIKE.
3.
If sales significantly decline, NIKE will be less profitable. The fixed cost for each
company stays the same, and NIKE has a greater commitment to fixed costs. Thus, a
decrease in total contribution would be greater for NIKE ($12/pair) than for Reebok
($9/pair) in a sales downturn, although sales would have to decrease by more than
75% before Reebok would be more profitable than NIKE.

199

Cost Volume - Profit Analysis

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Chapter 25

A CVP analysis for a manufacturing company is greatly simplified by an assumption that

Estimated line of cost behaviour, high-low method, least-squares regression.

Fundamental Accounting Principles, Eleventh Canadian Edition

Copyright 2005 McGraw-Hill Ryerson Limited. All rights reserved.

Quick Study 25-2

Quick Study 25-3

Fixed costs = $3,000

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Fundamental Accounting Principles, Eleventh Canadian Edition

Quick Study 25-5

Quick Study 25-7

Contribution margin ratio =

Break-even point in dollars =

Quick Study 25-8

Mixers at break-even point = 3 9,825 = 29,475

Copyright 2005 McGraw-Hill Ryerson Limited. All rights reserved.

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Fundamental Accounting Principles, Eleventh Canadian Edition

Exercise 25-5 (20 minutes)

The cost appears to be a mixed cost.

Copyright 2005 McGraw-Hill Ryerson Limited. All rights reserved.

The cost appears to be a step-variable cost.

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Fundamental Accounting Principles, Eleventh Canadian Edition

Exercise 25-7 (15 minutes)

Variable cost element:

High level of activity

Variable cost element:

Copyright 2005 McGraw-Hill Ryerson Limited. All rights reserved.

Exercise 25-9 (20 minutes)

*$0.30 $500,000 = $150,000

Contribution margin per unit = $117.60 $88.20 = $29.40 per unit

Sales (in dollars) to break even with increased fixed costs:

Fundamental Accounting Principles, Eleventh Canadian Edition

$441,000 + $530,000 + $353,333

= 45,045 units (rounded)

$441,000 + $530,000 + $353,333

Copyright 2005 McGraw-Hill Ryerson Limited. All rights reserved.

Assume desired sales dollars is S.

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Fundamental Accounting Principles, Eleventh Canadian Edition

= Sales Variable costs

Selling price per unit...............................................

Total variable costs ($110 80,000 units).............

Copyright 2005 McGraw-Hill Ryerson Limited. All rights reserved.

(b) Variable costs per composite unit

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Fundamental Accounting Principles, Eleventh Canadian Edition

Copyright 2005 McGraw-Hill Ryerson Limited. All rights reserved.

Problem 25-1A (concluded)

Slope = Difference in Total Cost

Copyright 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

Fundamental Accounting Principles, Eleventh Canadian Edition

(b) Contribution ratio

= Fixed costs Contribution margin per unit

Copyright 2005 McGraw-Hill Ryerson Limited. All rights reserved.

Problem 25-2A (concluded)

= After-tax target income (1 tax rate)

Income tax = $330,000 30% = $99,000

(Fixed costs + Target income + Taxes) Contribution rate

= Sales Contribution rate

Pre-tax income = Contribution margin Fixed costs