Chapter 8 Cost-Volume-Profit Analysis Answers to Review Questions

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CHAPTER 8 Cost-Volume-Profit Analysis
ANSWERS TO REVIEW QUESTIONS
8-1 a. In the contribution-margin approach, the break-even point in units is calculated using the following formula: Break-even point = fixed expenses unit contribution margin

b. In the equation approach, the following profit equation is used: sales volume ⎞ ⎛ unit variable sales volume ⎞ ⎛ unit fixed ⎜ ⎟ −⎜ ⎟ − ⎜ sales price × ⎟ ⎜ expense × ⎟ expenses = 0 in units ⎠ ⎝ in units ⎠ ⎝

This equation is solved for the sales volume in units. c. In the graphical approach, sales revenue and total expenses are graphed. The break-even point occurs at the intersection of the total revenue and total expense lines. 8-2 The term unit contribution margin refers to the contribution that each unit of sales makes toward covering fixed expenses and earning a profit. The unit contribution margin is defined as the sales price minus the unit variable expense. In addition to the break-even point, a CVP graph shows the impact on total expenses, total revenue, and profit when sales volume changes. The graph shows the sales volume required to earn a particular target net profit. The firm's profit and loss areas are also indicated on a CVP graph. The safety margin is the amount by which budgeted sales revenue exceeds breakeven sales revenue. An increase in the fixed expenses of any enterprise will increase its break-even point. In a travel agency, more clients must be served before the fixed expenses are covered by the agency's service fees. A decrease in the variable expense per pound of oysters results in an increase in the contribution margin per pound. This will reduce the company's break-even sales volume. © 2005 The McGraw-Hill Companies, Inc.

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McGraw-Hill/Irwin Managerial Accounting, 6/e

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The president is correct. A price increase results in a higher unit contribution margin. An increase in the unit contribution margin causes the break-even point to decline. The financial vice president's reasoning is flawed. Even though the break-even point will be lower, the price increase will not necessarily reduce the likelihood of a loss. Customers will probably be less likely to buy the product at a higher price. Thus, the firm may be less likely to meet the lower break-even point (at a high price) than the higher break-even point (at a low price).

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When the sales price and unit variable cost increase by the same amount, the unit contribution margin remains unchanged. Therefore, the firm's break-even point remains the same. The fixed annual donation will offset some of the museum's fixed expenses. The reduction in net fixed expenses will reduce the museum's break-even point. A profit-volume graph shows the profit to be earned at each level of sales volume. The most important assumptions of a cost-volume-profit analysis are as follows: (a) The behavior of total revenue is linear (straight line) over the relevant range. This behavior implies that the price of the product or service will not change as sales volume varies within the relevant range. (b) The behavior of total expenses is linear (straight line) over the relevant range. This behavior implies the following more specific assumptions: (1) Expenses can be categorized as fixed, variable, or semivariable. (2) Efficiency and productivity are constant. (c) In multiproduct organizations, the sales mix remains constant over the relevant range. (d) In manufacturing firms, the inventory levels at the beginning and end of the period are the same.

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Operating managers frequently prefer the contribution income statement because it separates fixed and variable costs. This format makes cost-volume-profit relationships more readily discernible.

McGraw-Hill/Irwin 8-2

© 2005 The McGraw-Hill Companies, Inc.
Solutions Manual

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The gross margin is defined as sales revenue minus all variable and fixed manufacturing expenses. The total contribution...
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