Question

1.Due to erratic sales of its sole product—a high-capacity battery for laptop computers—PEM, Inc., has been experiencing financial difficulty for some time. The company’s contribution format income statement for the most recent month is given below:

  

Sales (12,700 units × $20 per unit)	$	254,000
Variable expenses		152,400
Contribution margin		101,600
Fixed expenses		113,600
Net operating loss	$	(12,000	)

Required:

1. Compute the company’s CM ratio and its break-even point in unit sales and dollar sales.

2. The president believes that a $6,400 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $86,000 increase in monthly sales. If the president is right, what will be the increase (decrease) in the company’s monthly net operating income?

3. Refer to the original data. The sales manager is convinced that a 10% reduction in the selling price, combined with an increase of $30,000 in the monthly advertising budget, will double unit sales. If the sales manager is right, what will be the revised net operating income (loss)?

4. Refer to the original data. The Marketing Department thinks that a fancy new package for the laptop computer battery would grow sales. The new package would increase packaging costs by 0.50 cents per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,700?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $54,000 each month.

a. Compute the new CM ratio and the new break-even point in unit sales and dollar sales.

b. Assume that the company expects to sell 20,600 units next month. Prepare two contribution format income statements, one assuming that operations are not automated and one assuming that they are. (Show data on a per unit and percentage basis, as well as in total, for each alternative.)

c. Would you recommend that the company automate its operations (Assuming that the company expects to sell 20,600)?

2. Lynch Company manufactures and sells a single product. The following costs were incurred during the company’s first year of operations:

Variable costs per unit:
Manufacturing:
Direct materials	$	12
Direct labor	$	6
Variable manufacturing overhead	$	3
Variable selling and administrative	$	3
Fixed costs per year:
Fixed manufacturing overhead	$	276,000
Fixed selling and administrative	$	186,000

During the year, the company produced 23,000 units and sold 19,000 units. The selling price of the company’s product is $50 per unit.

Required:

1. Assume that the company uses absorption costing:

a. Compute the unit product cost.

b. Prepare an income statement for the year.

2. Assume that the company uses variable costing:

a. Compute the unit product cost.

b. Prepare an income statement for the year.

3. Haas Company manufactures and sells one product. The following information pertains to each of the company’s first three years of operations:

Variable costs per unit:
Manufacturing:
Direct materials	$	26
Direct labor	$	18
Variable manufacturing overhead	$	6
Variable selling and administrative	$	3
Fixed costs per year:
Fixed manufacturing overhead	$	390,000
Fixed selling and administrative expenses	$	150,000

During its first year of operations, Haas produced 60,000 units and sold 60,000 units. During its second year of operations, it produced 75,000 units and sold 50,000 units. In its third year, Haas produced 40,000 units and sold 65,000 units. The selling price of the company’s product is $62 per unit.

Required:

1. Compute the company’s break-even point in unit sales.

2. Assume the company uses variable costing:

a. Compute the unit product cost for Year 1, Year 2, and Year 3.

b. Prepare an income statement for Year 1, Year 2, and Year 3.

3. Assume the company uses absorption costing:

a. Compute the unit product cost for Year 1, Year 2, and Year 3.

b. Prepare an income statement for Year 1, Year 2, and Year 3.

Answer 1

Solution 1-1 :

CM ratio = Contribution margin / Sales = $101,600 / $254,000 = 40%

break-even point in unit sales = Fixed expenses / CM per unit = $113,600 / $8 = 14200 units

Breakeven point in dollar sales = Fixed expenses / CM ratio = $113,600 / 40% = $284,000

Solution 1-2:

increase (decrease) in the company’s monthly net operating income = Increase in contribution margin - Increase in advertising expenses

= ($86,000*40%) - $6,400 = $28,000

Solution 1-3:

New selling price per unit = $20*90% = $18

New CM per unit = $8 - $2 = $6 per unit

New fixed costs =$113,600 + $30,000 = $143,600

New sales volume = 12700*2 = 25400 units

New operating income = Contribution margin - Fixed costs = (25400*$6) - $143,600 = $8,800

Solution 1-4:

New contribution margin per unit = $8 - $0.50 = $7.50 per unit

Target income = $4,700

Nos of units to be sold to attain target profit = (Fixed cost + Net operating income) / CM per unit

= ($113,600 + $4,700) / $7.50 = 15773 units

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