Accounting – Break Even | Buy or Sell | Budgeting | Operation Analysis

Question 1

Question 1 – a

In order to prepare contribution margin income statement, the information should be

computed as follow:

- Sales = Quantity Units Sold × Unit Price = 2,000 × $12 = $24,000

- Variable Expenses: Cost of Goods Sold = Quantity Units Sold × buying wooden

frames price + design price = 2,000 × ($3 + $1) = $8,000

- Variable Expenses: Selling and Administrative Cost = Quantity Units Sold × Sales

Commission = 2,000 × $1 = $2,000

- Fixed Expenses: Annual Rent = Monthly Rent × 12 = $300 × 12 = $3,600

Ravi's Frames
Contribution Margin Income Statement
For 1 Year
   
Revenue  
  Sales $ 24,000.00
   
Less: Variable Expenses  
  Cost of Goods Sold $ 8,000.00  
  Selling and Administrative Costs $ 2,000.00 $ 10,000.00
   
Contribution Margin $ 14,000.00
   
Less: Fixed Expenses  
  Rent $ 3,600.00
   
Operating Income $ 10,400.00
       

- Unit Variable Costs = Total Variable Expenses ÷ Quantity Units Sold

$10,000 ÷ 2,000 = $5
 Question 1

- Unit Contribution Margin = Unit Selling Price – Unit Variable Costs

$12 – $5 = $7

- Contribution Margin Ratio = Contribution Margin ÷ Sales

$14,000 ÷ $24,000 = 58.33%

- Variable Margin Ratio = Total Variable Expenses ÷ Sales

$10,000 ÷ $24,000 = 41.67%

Question 1 – b

- Break-even Revenue = Total Fixed Costs ÷ Contribution Margin Ratio

$3,600 ÷ 58.33% = $6,171.43

- Break-even point in units = Break-even Revenue ÷ Sales Unit Price

$6,171.43 ÷ $12 = 514.29 unit => rounded up = 515 units

- Break-even point in units = Total Fixed Costs ÷ Unit Contribution Margin

$3,600 ÷ $7 = 514.29 unit => rounded up = 515 units

- Break-even units with the equation method:

Sales = Variable Expenses + Fixed Expenses + Profit

12Q = $5Q + $3,600 + $0

7Q = $3,600

Q = 515 units

Question 1 – c
 Question 1

- Total Budgeted = 3,000 units

- Total Budgeted = 3,000 × $12 = $36,000

- Margin of Safety = Total Budgeted – Break-even Sales

3,000 – 515 = 2,485 units

2,485 × $12 = $29,820

- Margin of Safety Percentage = Margin of Safety in dollars ÷ Total Budgeted in dollar

$29,820 ÷ $36,000 = 82.83%

Question 1 – d

Steps to draw the Cost-Volume-Profit Graph:

- Naming the axes

o x-axis: quantity units

o y-axis: value in dollar

- Drawing fixed expenses line horizontally and parallel to the x-axis

- Plotting a straight line for total expenses (Fixed + Variable) where it should intersect

where the fixed expense intersects the y-axis

- Plotting a straight line for total sales dollar crossing the origin (0,0)

- The point of intersection for these two lines is the breakeven point

- The area to the left of the breakeven point is the loss area, and the area to the right is

the profit area

Question 1
 Question 2

In order to compare the two options of retaining the current Corsica vehicle or replace it with

a Honda Accord, the following should be calculated first:

- Current Car (Corsica):

o Variable Costs:

 Insurance: $2,000 p.a.

 Fuel Expense: $200 p.m. = $2,400 p.a.

 Repair Cost: $500 p.a.

 Total Variable Costs = 2,000 + 2,400 + 500 = $4,900 p.a.

 Total Variable Costs (4 years) = $4,900 × 4 years = $19,600

o Salvage Value after 4 years = $0

- New Car (Accord):

o Variable Cost:

 Insurance: $210 p.m. = $2,520 p.a.

 Fuel Expense: $800 p.m. = $9,600 p.a.

 Repair / Maintenance Cost: $300 p/quarter = $1,200 p.a.

 Total Variable Costs = 2,520 + 9,600 + 1,200 = $13,320 p.a.

 Total Variable Costs (4 years) = $13,320 × 4 years = $53,280

o Purchase Cost: $7,000

o Other Income:

 SkipTheDishes Driver: $1,200 p.m. = $14,400 p.a. × 4 years = $57,600

 Question 2

o Salvage Value after 4 years = $2,000

o Selling the Older Car (Corsica): $1,000

The Incremental Analysis for 4 years

Net income
Retain Current Replace
  increase / decrease

Variable Costs $ 19,600.00 $ 53,280.00 $ (33,680.00)

Purchase Cost - New Car (Accord) $ - $ 7,000.00 $ (7,000.00)

Other Income (SkipTheDishes) $ - $ (57,600.00) $ 57,600.00

Sale of Older Car (Corsica) $ - $ (1,000.00) $ 1,000.00

Sale of New Car (Accord) $ - $ (2,000.00) $ 2,000.00

Total Costs: $ 19,600.00 $ (320.00) $ 19,920.00

Since there is a $19,920 increase in income, it is recommended to replace the car with a
Honda Accord. Having said that, Sam should consider the monthly working hours of 70
hours that is required to increase his income which could result in affecting his education.
 Question 3

First will look at the performance report based on a static budget made by Kayleigh for the

coming year:

Kayleigh Umbrellas
Static Budget Performance Report
For 1 year
Budgeted Amount Actual Static Budget Static Budget
   
Per Unit (2200 units) (2000 units) Variance
Sales $8.00 $15,400 $16,000 600 u
Less Variable Expenses  
  Total Variable Expenses 5 11,000 10,000 1,000 u
Contribution Margin 3 4,400 6,000 1,600 u
Less Fixed Expenses  
  Total Fixed Expenses Not specified Not specified 0
Operating Income   $4,400 $6,000 $1,600 u

Now will compare the flexible budget performance report for the coming year:

Kayleigh Umbrellas
Flexible Budget Performance Report
For 1 year
Budgeted Amount Actual Flexible Budget Flexible Budget
   
Per Unit (2200 units) (2200 units) Variance
Sales $8.00 $15,400 $17,600 2,200 u

Less Variable Expenses  

  Total Variable Expenses 5 11,000 11,000 0

Contribution Margin 3 4,400 6,600 2,200 u

Less Fixed Expenses  

  Total Fixed Expenses Not specified Not specified 0

Operating Income   $4,400 $6,600 $2,200 u

 Question 3

The comprehensive performance report that includes the sales volume variance will

be as follow:

Kayleigh Umbrellas
Comprehensive Performance Report
For 1 year

Flexible Flexible Sales

Actual Static Budget
    Budget Budget Volume
(2200 units) (2000 units)
Variance (2200 units) Variance

Sales $15,400 2,200 u $17,600 1,600 f $16,000

Less Variable Expenses  

  Total Variable Expenses 11,000 0 11,000 1,000 u 10,000

Contribution Margin 4,400 2,200 u 6,600 600 f 6,000

Less Fixed Expenses  

  Total Fixed Expenses Not specified 0 Not specified 0 Not specified

Operating Income $4,400 $2,200 u $6,600 $600 f $6,000

Total Static-Budget Variance = $1,600 u

The comprehensive performance report depicts a significant difference between actual

sales revenue and the flexible budget (flexible budget variance), which is $2,200

unfavourable: the sales revenue is lower than what Kayleigh expected. These unplanned

deviations from the plan should be investigated to understand the reasons behind lower sales

as it could result from data entry error, offered special price and promotions or fraudulent

behaviour. This difference has caused an unfavourable output in the contribution margin and

the same amount of unfavourable value on operating income. It is suggested that if the reason

behind the lower sales amount is due to sales promotions, Kayleigh could investigate to

reduce the promotion frequency, volume or discount rate while trying to maintain the same
 Question 3

trend of increase in sales quantity. Otherwise, it is advised to make the following year's

budget based on $7 per unit.

Additionally, as per the above reports, it is evident that the variable expenses were

considered $5 per unit in the static and flexible budget, and in actuality, the 2,200 units sold

have ended up having 5$ per unit cost (total $11,000). Therefore, the assumption that the total

variable expenses increase could be due to higher sales volume seems valid. In addition, this

shows that there is no trend in the variable expenses.

Finally, the sales volume variance is $1,600 favourable, which is due to the higher

quantity of items sold, which is a good sign for the business, even though it has a small

contribution to increased operating income. Reduced competition and incorrect or imprecise

forecasting are other probable causes of favourable sales volume variance that Kayleigh

should keep in mind for future budgeting and comparison.

In future, it is also advised to track fixed expenses in order to assure and identify any

variance in fixed costs in detail. In order to do so, store rent, fixed administrative, and fixed

selling expenses should be considered. Furthermore, it is recommended to state the variable

expenses such as direct material (umbrella purchase, design addition), direct labour and

variable marketing expenses (possible per unit commission) separately and assign a per-unit

value to each expense. It would help to identify the source of variance in case of occurrences.
 Question 4

Standard Hours allowed = 2.33

Direct Labour (Standard Hour): 2.33 hours

Direct Labour (Standard Rate): $20 per hour

Standard Cost = $46.60

Option A

Actual Hours of input = Actual hours per worker x number of workers = 2,000 x 6

= 12,000 hours

Actual Rate = $19 per hour

Bonuses = $1,000 x 6 workers = $6,000

Actual Hours of input at Actual Rate = 12,000 hours x $19.00 per hour + $6,000

= $234,000

Actual Hours of input at Standard Rate = 12,000 hours x $20.00 per hour

= $240,000

Labour Rate Variance = $234,000 – $240,000 = $6,000 f

Which means the cost of labor was less expensive than planned

Standard Hours allowed for Actual Output =

Expected number of units x Standard Hours allowed = 5150 units x 2.33 hours

= 11,995.50 hours
 Question 4

Standard Hours allowed for Actual Output at Standard Rate = 11,995.50 hours x $20

= $239,990

Labour Efficiency Variance = $240,000 -$239,990 = $10 u

Which means that the labour efficiency is lower than standard rate but for only $10

Total Flexible Budget Variance = $234,000 – $239,990

= $5,990 f

AH x AR AH x SR SH x SR
Actual Hours of input Actual Hours of input Standard Hours allowed
@ Actual Rate @ Standard Rate @ Standard Rate
12000 hours x $19.00 12000 hours x $20.00 11999.5 hours x $20.00
per hour per hour per hour
+ $6000 bonuses
$234,000 $240,000 $239,990

Labour Labour
Rate Efficiency
Variance Variance
$6,000 f $10 u

Total Flexible Budget

Variance
$5,990 f

Since the flexible budget variance is favourable, Joey could adjust the future cost budget

accordingly.

Now the 1% defect should be calculated:

5150 units x 1% = 52 units

Total defect free products = 5150 – 52 = 5098 units

 Question 4

Therefore, labour cost per defect free unit will be computed as follow:

Actual Hours of input at Actual Rate + bonuses ÷ Total defect free products

= 234,000 ÷ 5098 = $45.90

Productivity:

5,150 units of output x 2.33 standard hour ÷ 12,000 total time to produce output

=~1

Effective Production Ratio: (total output product – defective items) ÷ total output product

= (5,150 units – 52 units) ÷ 5,150 units = 0.99

Efficiency: (total output product x standard hour x effective production ratio) ÷ total time to

produce output

= (5150 x 2.33 x 0.99) ÷ 12000 = 0.99

Option B

Actual Hours of input = Actual hours per worker x number of workers = 2,200 x 6

= 13,200 hours

Actual Rate = $17 per hour

Bonuses year end = $3,000 x 6 workers = $18,000

Performance Bonuses = 6,200 ÷ 100 x $75 = $4,650

 Question 4

Actual Hours of input at Actual Rate = 13,200 hours x $17.00 + $18,000 + $4,650

= $247,050

Actual Hours of input at Standard Rate = 13,200 hours x $20.00 per hour

= $264,000

Labour Rate Variance = $247,050 – $264,000 = $16,950 f

Which means the cost of labor was significantly less expensive than planned

Standard Hours allowed for Actual Output =

Expected number of units x Standard Hours allowed = 6200 units x 2.33 hours

= 14,446 hours

Standard Hours allowed for Actual Output at Standard Rate = 14,446 hours x $20

= $288,920

Labour Efficiency Variance = $264,000 -$288,920 = $24,290 f

Which means that the labour efficiency is significantly higher than standard rate

Total Flexible Budget Variance = $247,050 – $288,920

= $41,870 f
 Question 4

AH x AR AH x SR SH x SR
Actual Hours of input Actual Hours of input Standard Hours allowed
@ Actual Rate @ Standard Rate @ Standard Rate
13200 hours x $17.00 13200 hours x $20.00 14446 hours x $20.00
per hour per hour per hour
+ $22,650 bonuses
$247,050 $264,000 $288,920

Labour Labour
Rate Efficiency
Variance Variance
$16,950 f $24,9200 f

Total Flexible Budget

Variance
$41,870 f

Since the flexible budget variance is favourable, Joey should adjust the future cost budget

accordingly.

Now the 2.5% defect should be calculated:

6200 units x 2.5% = 155 units

Total defect free products = 6200 – 155 = 6045 units

Therefore, labour cost per defect free unit will be computed as follow:

Actual Hours of input at Actual Rate + bonuses ÷ Total defect free products

= 247,050 ÷ 6045 = $40.87

Productivity in option B:

6,200 units of output x 2.33 standard hour ÷ 13,200 total time to produce output

= 1.09
 Question 4

Effective Production Ratio: (total output product – defective items) ÷ total output product

= (6,200 units – 155 units) ÷ 6,200 units = 0.975

Efficiency: (total output product x standard hour x effective production ratio) ÷ total time to

produce output

= (6,200 x 2.33 x 0.975) ÷ 13,200 = 1.07

To summarize the two option:

Description Option A Option B

Labour Rate Variance $6,000 f $16,950 f

Labour Efficiency Variance $10 u $24,290 f

Total Flexible Budget Variance $5,990 f $41,870 f

Defect-free units 5098 units 6045 units

Cost for each unit (defect free) $45.90 $40.87

Productivity rate 1 (100%) 1.09 (109%)

Effective Production Ratio 0.99 (99%) 0.975 (97.5%)

Efficiency Rate 0.99 (99%) 1.07 (107%)

Obviously, option B is a better choice for Joey as with the same number of

employees, the total number of units produced is greater than option A, and the price per unit

is lower than option A. In addition, option A productivity rate is 1, where are option B has a

higher Productivity rate of 1.09, and the efficiency in option A is 0.99, where the efficiency

in option B is 1.07.
 Question 4

However, from the workers' perspective, option A will result in a $39,000 annual

salary per worker ($38,000 total hourly wage + $1000 bonus), which is $19.5 per hour for

their work on average. In Option B, if we consider that all workers work the same amount of

time and the payment of performance bonuses being divided among six workers equally, it

will result in a $41,175 annual salary per worker ($37,400 total hourly wage + $3000 bonus +

$775 performance bonus), which is $18.71 per hour for their work on average. It also means

that they work about 42 hours per week and 200 hours extra in a year in option B and will

receive $2,175 extra, approximately $11 per hour.

It is recommended to adjust the following year's flexible budget plan and standard rate

according to Option B to have a more accurate forecast, expectation, and plan.

Recommendation

Joey may consider the following option, which is an adjustment to option B:

Option C
Hourly wage: $18
Annual hours per worker: 2,200
Expected production: 6,200 units
Expected product defect rate: 1%
Expected performance bonuses: $1 per units
Expected year-end bonuses: $1,000 per worker

Which would yield the following information:

AH x AR AH x SR SH x SR
 Question 4
Actual Hours of input Actual Hours of input Standard Hours allowed
@ Actual Rate @ Standard Rate @ Standard Rate
13200 hours x $18.00 13200 hours x $20.00 14446 hours x $20.00
per hour per hour per hour
+ $12,200 bonuses
$249,800 $264,000 $288,920

Labour Labour
Rate Efficiency
Variance Variance
$14,200 f $24,9200 f

Total Flexible Budget

Variance
$39,120 f

This way, there is a higher incentive to increase the quality and reduce the defect by

workers, which is expected to result in a defect rate of 1%.

Additionally, wage per hour has increased; therefore, the monthly income of workers

will increase from $2877 to $3046 and even though the workers will receive a lower year-end

bonus, the total average hourly salary will increase from $18.71 option B to $18.92

From the company's perspective, they it will be more favourable as in option B,

considering the defective items value, the actual favourable value for the company was

$41,870 – $6,334 = $35,536 where in new option it will be $39,120 – $2,523 = $36,597

Finally, the defect-free cost per unit in option B was $40.87, whereas it will be $40.70

per unit in the new option C.

Description Option A Option B Option C

 Question 4

Labour Rate Variance $6,000 f $16,950 f $14,200 f

Labour Efficiency Variance $10 u $24,290 f $24,920 f

Total Flexible Budget Variance $5,990 f $41,870 f $39,120 f

Defect-free units 5098 units 6045 units 6138 units

Cost for each unit (defect free) $45.90 $40.87 $40.70

Productivity rate 1 (100%) 1.09 (109%) 1.09 (109%)

Effective Production Ratio 0.99 (99%) 0.975 (97.5%) 0.99 (99%)

Efficiency Rate 0.99 (99%) 1.07 (107%) 1.08 (108%)