Dela Cruz, Jumar James

Let’s Check!

I. Questions:
What is the meaning of the term contribution margin?
The contribution margin can be stated on a gross or per-unit basis. It represents the
incremental money generated for each product/unit sold after deducting the variable
portion of the firm's costs.The contribution margin is computed as the selling price per
unit, minus the variable cost per unit. Also known as dollar contribution per unit, the
measure indicates how a particular product contributes to the overall profit of the
company. It provides one way to show the profit potential of a particular product offered
by a company and shows the portion of sales that helps to cover the company's fixed
costs. Any remaining revenue left after covering fixed costs is the profit generated.

What is meant by the term operating leverage?

Operating leverage is a cost-accounting formula that measures the degree to which a
firm or project can increase operating income by increasing revenue. A business that
generates sales with a high gross margin and low variable costs has high
operating leverage. The higher the degree of operating leverage, the greater the
potential danger from forecasting risk, in which a relatively small error in forecasting
sales can be magnified into large errors in cash flow projections
What is meant by margin of safety?
margin of safety, or safety margin, refers to the difference between actual sales
and break-even sales. Managers can utilize the margin of safety to know how much
sales can decrease before the company or a project becomes

II. True or False:

Write “TRUE” if the statement is true otherwise write “FALSE” if the
statements is incorrect.

___False__ 1. Operating leverage determines how income from

operations is to be divided between debt holders and
stockholders.
__False___ 2. Contribution margin is equal to fixed costs minus variable
costs.
 __False___ 3. A lower price for the firm's product will reduce the firm's
breakeven point.
___True__ 4. Linear breakeven analysis and operating leverage are only
valid within a relevant range of production.
__True___ 5. Operating leverage emphasizes the impact of using fixed
assets in the business.

III. Multiple choice

Encircle the letter that correspond to your answer.

1) Cost-volume-profit analysis is a technique available to management to

understand better the interrelationships of several factors that affect a firm's
profit. As with many such techniques, the accountant oversimplifies the real
world by making assumptions. Which of the following is not a major
assumption underlying CVP analysis?
a. All costs incurred by a firm can be separated into their fixed and
variable components.
b. The product selling price per unit is constant at all volume levels.
c. Operating efficiency and employee productivity are constant at all
volume levels.
d. For multi-product situations, the sales mix can vary at all volume
levels.

2) CVP analysis relies on the assumptions that costs are either strictly fixed or
strictly variable. Consistent with these assumptions, as volume decreases
total
a. fixed costs decrease.
b. variable costs remain constant.
c. costs decrease.
d. costs remain constant.

3) Cost-volume-profit relationships that are curvilinear may be analyzed linearly

by considering only
a. fixed and mixed costs.
b. relevant fixed costs.
c. relevant variable costs.
d. a relevant range of volume.

4) The margin of safety would be negative if a company('s)

a. was presently operating at a volume that is below the break-even
point.
 b. present fixed costs were less than its contribution margin.
c. variable costs exceeded its fixed costs.
d. degree of operating leverage is greater than 100.

5) A recent income statement of Fox Corporation reported the following data:

Sales revenue P3,600,000
Variable costs 1,600,000
Fixed costs 1,000,000

If these data are based on the sale of 10,000 units, the break-even point
would be:
a. 2,000 units. c. 3,600 units.
b. 2,778 units. d. 5,000 units.

6) Maxie's budget for the upcoming year revealed the following figures:
Sales revenue P840,000
Contribution margin 504,000
Net income 54,000

If the company's break-even sales total P750,000, Maxie's safety margin

would be:
a. P(90,000). c. P246,000.
b. P90,000. d. P(246,000).

7) An organization's break-even point is 4,000 units at a sales price of P50 per

unit, variable cost of P30 per unit, and total fixed costs of P80,000. If the
company sells 500 additional units, by how much will its profit increase?
a. P25,000 c. P12,000
b. P15,000 d. P10,000

8) O'Dell sells three products: R, S, and T. Budgeted information for the

upcoming accounting period follows.
Product Sales Volume (Units) Selling Price Variable
Cost
R 16,000 $14 $9
S 12,000 10 6
 T 52,000 11 8

The company's weighted-average unit contribution margin is:

a. $3.00. c. $4.00.
b. $3.55. d. $19.35.

9) The following information relates to Day Company: Sales revenue

P12,000,000
Contribution margin 4,800,000
Net income 800,000
Day's operating leverage factor is:
a. 0.167.
b. 0.400.
c. 2.500.
d. 6.000.
Let’s Analyze!

Pullman Company is a small but growing manufacturer of telecommunications

equipment. The company has no sales force of its own; rather, it relies completely
on independent sales agents to market its products. These agents are paid a
commission of 15% of selling price for all items sold.

Maui Soliman, Pullman’s controller, has just prepared the company’s budgeted
income statement for next year. The statement follows:

Pullman Company
Budgeted Income Statement
For the Year Ended December 31
Sales P16,000,000 Manufacturing costs:
 Variable P7,200,000
Fixed overhead 2,340,000 9,540,000
Gross margin 6,460,000
Selling and administrative
costs:
Commissions to agents 2,400,000
Fixed marketing costs* 120,000
Fixed administrative costs 1,800,000 4,320,000

Net operating income 2,140,000

Less fixed interest cost 540,000 Income before income
1,600,000 taxes
Less income tax (30%) 480,000 Net income P1,120,000

*Primarily depreciation on storage facilities

As Maui handed the statement to Kim Viceroy, Pullman’s president, she commented,
“I went ahead and used the agents’ 15% commission rate in completing these
statements, but we’ve just learned that they refuse to handle our products next year
unless we increase the commission rate to 20%.”

“That’s the last straw,” Kim replied angrily. “Those agents have been demanding
more and more, and this time they’ve gone too far. How can they possibly defend a
20% commission rate?”

“They claim that after paying for advertising, travel, and the other costs of promotion,
there’s nothing left over for profit,” replied Maui.

“I say it’s just plain robbery,” retorted Kim. “And I also say it’s time we dumped those
guys and got our own sales force. Can you get your people to work up some cost
figures for us to look at?”

“We’ve already worked them up,” said Maui. “Several companies we know about pay
a 7.5% commission to their own salespeople, along with a small salary. Of course,
we would have to handle all promotion costs, too. We figure our fixed costs would
increase by P2,400,000 per year, but that would be more than offset by the
P3,200,000 (20% x P16,000,000) that we would avoid on agents’ commissions.”
The breakdown of the P2,400,000 cost figure follows:
Salaries:
Sales manager P 100,000
Salespersons 600,000
Travel and entertainment 400,000
Advertising 1,300,000
Total P2,400,000

“Super,” replied Kim. “And I note that the P2,400,000 is just what we’re paying the
agents under the old 15% commission rate.”

“It’s even better than that,” explained Maui. “We can actually save P75,000 a year
because that’s what we’re having to pay the auditing firm now to check out the
agents’ reports. So our overall administrative costs would be less.”

“Pull all of these number together and we’ll show them to the executive committee
tomorrow,” said Kim. “With the approval of the committee, we can move on the
matter immediately.”

Required:
Answer the following questions:

1. What is the breakeven point in pesos for next year assuming that the agents’
commission rate remains unchanged at 15%?

2. What is the breakeven point in pesos for next year assuming that the agents’
commission rate is increased to 20%?
3. What is the breakeven point in pesos for next if the company employs its own
sales force?

4. Assume that Pullman Company decides to continue selling through agents

and pays the 20% commission rate. The volume of sales that would be
required to generate the same net income as contained in the budgeted
income statement for next year would be:

5. The volume of sales at which net income would be equal regardless of

whether Pullman Company sells through agents at a 20% commission rate or
employs its own sales force:
Let’s Check!
ULO B

I. Questions:
1. Distinguish between a cost center, a profit center, and an investment
center?
- Cost Center: This is a unit within the organization wherein the
manager is responsible for minimizing costs or expenses subject to
some output constraints. Example are maintenance department of a
manufacturing company, library section of a school and accounting
department of a trading concern.
- Profit Center: This is a unit or segment within the organization
wherein the manager is responsible for the generation or revenues
and control of cost incurred in the center. Examples are loans and
discounts department of a commercial banks, ladies wear section of
a department store and college department of a university.
- Investment Center: This is a unit or segment within the organization
where the manager is responsible for the control of revenues, costs
and investment made in that center. Examples include corporate
headquarters or division of a large decentralized organization such
as subsidiary companies.
2. Define the term transfer pricing and why are transfer pricing systems
needed?
- Transfer pricing is the value of goods or services transferred by one
segment to another segment within the company, therefore, a
transfer price is an internal price that is charged by one
responsibility center to another responsibility center for goods and
services. The transfer price of interdivisional sales will affect the
selling division’s sales and the buying division’s costs but will not
have any direct effect on the company’s profit. However, the
transfer price policy of the company can have an indirect effect on
company profit by influencing decisions of the division manager.

II. True or False

Write “TRUE” if the statement is true otherwise write “FALSE” if the
statements is incorrect.

__False___ 1. Under a responsibility accounting system, fewer expenses

are charged against managers the higher one moves upward
in an organization
__True__ 2. Responsibility accounting functions most effectively in
decentralized organizations.
 _False____ 3. Return on investment (ROI) encourages managers to
accept all investment decisions that will benefit the
company as a whole when it is used as a measure of
performance.
__True_ 4. Whenever the selling division must give up outside sales
in order to sell internally, it has an opportunity cost that
should be considered in setting the transfer price.
____False_ 5. If transfer prices are to be based on cost, then the costs
should be actual costs rather than standard costs.

III. Multiple choice

Encircle the letter that correspond to your answer.

1) Which of the following statements is correct concerning return on investment

calculations?
a. Margin equals stockholders' equity divided by sales.
b. Return on investment equals margin divided by turnover.
c. Turnover equals return on investment divided by margin.
d. Sales equals turnover divided by margin.

2) Managerial performance can be measured in many different ways including

return on investment (ROI) and residual income. A good reason for using
residual income instead of ROI is:
a. Residual income can be computed without having to measure
operating assets.
b. Managers are more likely to accept projects that’s are beneficial
to the company.
c. ROI does not take into account both turnover and margin.
d. A minimum rate of return does not have to be specified when the
residual income approach is used.

3) Transfer prices
a. reduce employee turnover.
b. are necessary for investment centers.
c. should encourage the kinds of behavior that upper-level
management wants.
d. are not used for departments with high amounts of fixed costs.

4) The following selected data pertain to the belt division of Allen Corp. for last
year:
Sales P500,000
 Average operating assets P200,000
Net operating income P80,000
Turnover 2.5
Minimum required return 20% How
much is the return on investment?
a. 40% c. 16%
b. 20% d. 15%
5) Division A had the following information:
Asset base in Division A P800,000
Net income in Division A P100,000
Operating income margin for Division A 20%
Target ROI 15%
Weighted-average cost of capital 12% What
is EVA for Division A?
a. P120,000 c. P15,000
b. P96,000 d. P4,000

6) Company Y is highly decentralized. Division X, which is operating at capacity,

produces a component that it currently sells in a perfectly competitive market
for P13 per unit. At the current level of production, the fixed cost of producing
this component is P4 per unit and the variable cost is P7 per unit. Division Z
would like to purchase this component from Division X. What would be the
price that Division X should charge Division Z?
a. P 7 c. P 11
b. P 9 d. P 13