EXERCISE 1: CVP RELATIONSHIPS

Kelter Company manufactures and sells a specialized cordless telephone high electromagnetic radiation environments.
The company's contribution format income statement for the most recent year is given for below.

TOTAL PER UNIT % OF SALES

Sales (20,000 units) ₱ 1,200,000 ₱ 60 100%
Less: Variable Expense 900,000 45 75%
Contribution Margin ₱ 300,000 ₱ 15 25%
Less: Fixed Expenses 240,000
Net Operating Income ₱ 60,000

Management is anxious to improve the company's profit performance and has asked for an analysis of a number of items.

REQUIRED:
1. Compute the company's CM ratio and variable expenses ratio.
Total Contribution Margin ₱ 300,000 0.25
CM ratio= = =
Total Sales ₱ 1,200,000 or 25%

Variable ₱ 900,000 0.75

= =
Expenses ₱ 1,200,000 or 75%

2. Compute the company's break-even point in both units and peso. Use the equation method.

Sales = Variable Expenses + Fixed Expenses + Profits Sales = Variable Expenses + Fixed Expenses + Profits
P60Q = P45Q +P240,000 + P0 X = 0.75 +P240,000 + P0
15Q = P240,000 0.25X = P240,000
Q = P240,000/P15 X = P240,000/0.25
Q = 16,000 units X = P960,000

3. Assume that sales increase by P400,000 next year. If cost behavior patterns remain unchanged, by how much
determine your will the company's operating income increase? Use the CM ratio to answer.
 PRESENT EXPECTED INCREASE % OF SALES
Sales ₱ 1,200,000 ₱ 1,600,000 ₱ 400,000 100%
Less: Variable Expense 900,000 1,200,000 300,000 75%
Contribution Margin ₱ 300,000 ₱ 400,000 ₱ 100,000 25%
Less: Fixed Expenses 240,000 240,000 0
Net Operating Income ₱ 60,000 160,000 ₱ 100,000

* P1,600,000 expected sales ÷ 60 per unit = 26,666.67 × 45 per unit = P1,200,000

4. Refer to the original data. Assume that next year management wants the company to earn a minimum
profit of P90,000. How many units will have to be sold to meet this target profit?

Fixed Expenses + Target Profit

Unit Sales to Attain the Target Profit =
Unit Contribution Margin
P240,000 + P90,000
0.15
P330,000
= 22,000 units
0.15

5. Refer to the original data. Compute the company's margin of safety in both peso and percentage form.
*IN PESO
Fixed Expenses 240,000
= = ₱ 960,000
CM Ratio 0.25

*IN PERCENTAGE
Sales (at the current volume of 20,000 units) (a) ₱ 1,200,000
Break-even Sales (at 16,000 units) 960,000
Margin of Safety in Peso (b) ₱ 240,000
Margin of Safety as a Percentage of Sales [(b)/(a)] 20%

6. (a) Compute the company's degree of operating leverage at the present level of sales.
 Contribution Margin ₱ 300,000
Degree of Operating Leverage = = = 5
Net Operating Income ₱ 60,000

(b) Assume that through a more intense effort by the sales staff, the company's sales increase by 8% next year. By what
percentage would you expect net operating income to increase? Use the degree of operating leverage to obtain your answer.

PRESENT EXPECTED INCREASE % OF SALES

Sales ₱ 1,200,000 ₱ 1,296,000 ₱ 96,000 100%
Less: Variable Expense 900,000 972,000 72,000 75%
Contribution Margin ₱ 300,000 ₱ 324,000 ₱ 24,000 25%
Less: Fixed Expenses 240,000 240,000 0
Net Operating Income ₱ 60,000 84,000 ₱ 24,000

Contribution Margin ₱ 324,000

Degree of Operating Leverage = = = 3.86
Net Operating Income ₱ 84,000

5 × 8 = 0.4 or 40%

c. Verify your answer to (b) by preparing a new contribution format income statement showing an 8% increase in sales.
Kelter Company
Contribution Income Statement
For the Most Recent Year

PRESENT PER UNIT EXPECTED % OF SALES

Sales ₱ 1,200,000 ₱ 60 ₱ 1,296,000 100%
Less: Variable Expense 900,000 45 972,000 75%
Contribution Margin ₱ 300,000 ₱ 15 ₱ 324,000 25%
Less: Fixed Expenses 240,000 240,000
Net Operating Income ₱ 60,000 84,000
7. In an effort to increase sales and profits, management is considering the use of a higher-quality speaker. The higher-
quality speaker would increase variable costs by P3 per unit, but management could eliminate one quality inspector who
is paid a salary of P30,000 per year. The estimates that the higher-quality speaker would sales manager increase
annual sales by at least 20%.

a. Assuming that changes are made as described above, prepare a projected contribution format income statement for
next year. Show data on a total, per unit, and percentage basis.

TOTAL UNIT % OF SALES

Sales ₱ 1,440,000 ₱ 60 100%
Less: Variable Expense 1,152,000 48 80%
Contribution Margin ₱ 288,000 ₱ 12 20%
Less: Fixed Expenses 210,000
Net Operating Income ₱ 78,000

b. Compute the company's new break-even point in both units and peso of sales. Use the contribution margin method.

₱ 210,000
Break-even point (units) = = 17,500 units
₱ 12

₱ 210,000
Break-even point (peso) = = ₱ 1,050,000
0.20

c. Would you recommend that the changes be made? Why?

Yes, because the net operating income increase by P18,000.