I need help with the following question:
The company's sales manager believes that sales in the Central geographic market could be increased by 15% if monthly advertising were increased by $25,000. Would you recommend the increased advertising? Show computationsto support your answer.
Data is attached.
Exercise 611 Segmented Income Statement
Bovine Company, a wholesale distributor of DVDs, has been experiencing losses for some time, as shown by its most recent monthly contribution format income statement below:
Sales
Variable Expenses
Contribution Margin
Fixed Expenses
Net operating loss
$1,500,000
588,000
912,000
945,000
($33,000)
In an effort to isolate the problem, the president has asked for an income statement segmented by geographic market. Accordingly, the Accounting Department has developed the following data:
Sales
Variable expenses as a percentage of sales
Traceable fixed espenses
Geographic Market
South
Central
North
$400,000
$600,000 $500,000
52%
$240,000
30%
40%
$330,000 $200,000
I attached my notes from the chapter to help with the question.
CostVolumeProfit Relationships
Chapter 6
McGrawHill/Irwin
Copyright 2010 by The McGrawHill Companies, Inc. All rights reserved.
Basics of CostVolumeProfit Analysis
Racing Bicycle Company
Contribution Income Statement
For the Month of June
Sales (500 bicycles)
$
250,000
Less: Variable expenses
150,000
Contribution margin
100,000
Less: Fixed expenses
80,000
Net operating income
$
20,000
CM is used first to cover fixed expenses. Any
remaining CM contributes to net operating income.
62
The Contribution Approach
Sales, variable expenses, and contribution margin can
also be expressed on a per unit basis. If Racing sells an
additional bicycle, $200 additional CM will be generated
to cover fixed expenses and profit.
Racing Bicycle Company
Contribution Income Statement
For the Month of June
T otal
Per Unit
Sales (500 bicycles)
$
250,000
$
500
Less: Variable expenses
150,000
300
Contribution margin
100,000
$
200
Less: Fixed expenses
80,000
Net operating income
$
20,000
63
The Contribution Approach
Each month, RBC must generate at least
$80,000 in total contribution margin to breakeven
(which is the level of sales at which profit is zero).
Racing Bicycle Company
Contribution Income Statement
For the Month of June
T otal
Per Unit
Sales (500 bicycles)
$
250,000
$
500
Less: Variable expenses
150,000
300
Contribution margin
100,000
$
200
Less: Fixed expenses
80,000
Net operating income
$
20,000
64
The Contribution Approach
If RBC sells 400 units in a month, it will be
operating at the breakeven point.
Racing Bicycle Company
Contribution Income Statement
For the Month of June
T otal
Per Unit
Sales (400 bicycles)
$
200,000
$
500
Less: Variable expenses
120,000
300
Contribution margin
80,000
$
200
Less: Fixed expenses
80,000
Net operating income
$

65
The Contribution Approach
If RBC sells one more bike (401 bikes), net
operating income will increase by $200.
Racing Bicycle Company
Contribution Income Statement
For the Month of June
T otal
Per Unit
Sales (401 bicycles)
$
200,500
$
500
Less: Variable expenses
120,300
300
Contribution margin
80,200
$
200
Less: Fixed expenses
80,000
Net operating income
$
200
66
CVP Relationships in Equation Form
When a company has only one product we can further
refine this equation as shown on this slide.
Profit = (Sales Variable expenses) Fixed expenses
Profit
Quantity sold (Q)
Selling price per unit (P)
= Sales (Q P)
Quantity sold (Q)
Variable expenses per unit (V)
= Variable expenses (Q V)
Profit = (P Q V Q) Fixed expenses
67
CVP Relationships in Equation Form
It is often useful to express the simple profit equation in
terms of the unit contribution margin (Unit CM) as follows:
Unit CM = Selling price per unit Variable expenses per unit
Unit CM = P V
Profit = (P Q V Q) Fixed expenses
Profit = (P V) Q Fixed expenses
Profit = Unit CM Q Fixed expenses
68
Preparing the CVP Graph
Profit Area
Profit Area
Dollars
Breakeven point
(400 units or $200,000 in sales)
Loss Area
Loss Area
Units
69
Preparing the CVP Graph
Profit = Unit CM Q Fixed Costs
Profit = Unit CM Q Fixed Costs
$ 60,000
$ 40,000
Prof it
$ 20,000
$0
$20,000
An even simpler form of
the CVP graph is called
the profit graph.
$40,000
$60,000
0
100
200
300
400
Number of bicycles sold
500
600
610
Preparing the CVP Graph
$ 60,000
Breakeven point, where
Breakeven point, where
profit is zero ,, is 400
profit is zero is 400
units sold.
units sold.
$ 40,000
Prof it
$ 20,000
$0
$20,000
$40,000
$60,000
0
100
200
300
400
Number of bicycles sold
500
600
611
Contribution Margin Ratio (CM Ratio)
The CM ratio is calculated by dividing the total
contribution margin by total sales.
Racing Bicycle Company
Contribution Income Statement
For the Month of June
Total
Per Unit
Sales (500 bicycles)
$ 250,000
$ 500
Less: Variable expenses
150,000
300
Contribution margin
100,000
$ 200
Less: Fixed expenses
80,000
Net operating income
$
20,000
CM Ratio
100%
60%
40%
$100,000 $250,000 = 40%
612
The Formula Method
The formula uses the following equation.
Unit sales to attain
Target profit + Fixed expenses
=
the target profit
CM per unit
613
Target Profit Analysis in Terms of Unit Sales
Suppose Racing Bicycle Company wants to
know how many bikes must be sold to earn
a profit of $100,000.
Unit sales to attain
Target profit + Fixed expenses
=
the target profit
CM per unit
$100,000 + $80,000
Unit sales =
$200
Unit sales = 900
614
Formula Method
We can calculate the dollar sales needed to
attain a target profit (net operating profit) of
$100,000 at Racing Bicycle.
Dollar sales to attain
Target profit + Fixed expenses
=
the target profit
CM ratio
$100,000 + $80,000
Dollar sales =
40%
Dollar sales = $450,000
615
Breakeven in Unit Sales:
Equation Method
Profits = Unit CM Q Fixed expenses
Suppose RBC wants to know how many
bikes must be sold to breakeven
(earn a target profit of $0).
$0 = $200 Q + $80,000
Profits are zero at the breakeven point.
Profits
616
Breakeven in Dollar Sales:
Formula Method
Now, lets use the formula method to calculate the
dollar sales at the breakeven point.
Dollar sales to
Fixed expenses
=
break even
CM ratio
$80,000
Dollar sales =
40%
Dollar sales = $200,000
617
The Margin of Safety in Dollars
The margin of safety in dollars is the
excess of budgeted (or actual) sales over
the breakeven volume of sales.
Margin of safety in dollars = Total sales  Breakeven sales
Lets look at Racing Bicycle Company and
determine the margin of safety.
618
Operating Leverage
Operating leverage is a measure of how sensitive net
operating income is to percentage changes in sales.
It is a measure, at any given level of sales, of how a
percentage change in sales volume will affect profits.
Degree of
operating leverage
Contribution margin
= Net operating income
619
Key Assumptions of CVP Analysis
Selling price is constant.
Costs are linear and can be accurately divided
into variable (constant per unit) and fixed
(constant in total) elements.
In multiproduct companies, the sales mix is
constant.
In manufacturing companies, inventories do not
change (units produced = units sold).
620
End of Chapter 6
621
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