Managerial Accounting

Topics: Variable cost, Management accounting, Costs Pages: 7 (1738 words) Published: June 23, 2013
Case 4-32 Breakeven for individual products in a multiproduct company:
The overall break-even sales can be determined using the CM ratio.
VelcroMetalNylonTotal
Sales165,000 $300,000 $340,000 $805,000 $
Variable expenses125,000 $140,000 $100,000 $365,000 $
Contribution margin40,000 $160,000 $240,000 $440,000 $
Fixed expenses400,000
Net operating income40,000 $

CM ratio =(Contribution margin)/Sales = (440,000)/(805,000) = 0.5466 Break-even point in total sales dollars =(Fixed expenses)/(CM ratios) = (400,000)/(0.5466) = 732,000 $ (Rounded)
What to do with the common fixed cost when computing the break-evens for the individual products. The correct approach is to ignore the common fixed costs. If we include the common fixed costs in calculation, the break-even points will be exaggerated for individual products which may lead managers to drop products that in fact are profitable.

The break-even points for each product can be computed using the contribution margin approach as follows:

VelcroMetalNylon
Unit selling price1.65 $1.50 $0.85 $
Variable cost per unit1.25 $0.70 $0.25 $
Unit contribution margin (a)0.40 $0.80 $0.60 $
Product fixed expenses (b)20,000 $80,000 $60,000 $
Break-even point in units sold (b) ÷ (a)50,000 100,000 100,000

If the company will sell exactly above computed break-even quantities, the company would lose $240,000, the amount of the common fixed cost. This can be verified as below table:

VelcroMetalNylonTotal
Unit sales50,000 100,000 100,000
Sales82,500 $150,000 $85,000 $317,500 $
Variable expenses62,500 $70,000 $25,000 $157,500 $
Contribution margin20,000 $80,000 $60,000 $160,000 $
Fixed expenses400,000 $
Net operating income(-240,000) $

NOTE: Total sales at the individual product break-evens is only $317,500 whereas the total sales at the overall break-even computed in part (1) is $732,000.

In order managers to resolve this deficiency they can allocate the common fixed costs among the products prior computing the break-evens for individual products. The common fixed costs are allocated on the below based on sales.

Allocation of common fixed expenses on the basis of sales revenue:

VelcroMetalNylonTotal
Sales165,000 $300,000 $340,000 $805,000 $
Percentage of total sales20.497%37.267%42.236%100.0%
Allocated common fixed expense*49,193 $89,441 $101,366 $240,000 $ Product fixed expenses20,000 $80,000 $60,000 $160,000 $
Allocated common and
product fixed expenses (a)69,193 $169,441 $161,366 $400,000 $ Unit contribution margin (b)0.40 $0.80 $0.60 $
“Break-even” point in units
sold (a) ÷ (b)172,983 211,801 268,943
*Total common fixed expense × percentage of total sales

From the above table the company the apparent break-evens for Velcro & Metal are higher than their normal annual sales, hence it can be decided to be dropped.

VelcroMetalNylon
Normal annual sales volume100,000200,000400,000
“Break-even” annual sales172,983 211,801 268,943
“Strategic” decisionDropDropRetain

Based on above break-even calculation managers may decide to drop the Velcro & Metal products and concentrate on the company’s core product which is Nylon product.

If the managers drop the Velcro and Metal products, the company would loss $60,000 as below:

VelcroMetalNylonTotal
SalesDroppedDropped340,000 $340,000 $
Variable expenses100,000 $100,000 $
Contribution margin240,000 $240,000 $
Fixed expenses*300,000 $
Net operating income(- 60,000) $
* By dropping the two products, the company reduces its fixed expenses by only $100,000 (=$20,000 + $80,000). Therefore, the total fixed expenses are $300,000 rather than $400,000.

By dropping the two products, the company would go from making a profit of $40,000 to suffering a loss of $60,000. The reason is that the two dropped products were contributing $100,000 toward...
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