Need to Know 24.

1
P1
A company is considering purchasing equipment costing $75,000. Future annual net cash
flows from this equipment are $30,000, $25,000, $15,000, $10,000, and $5,000. Cash
flows occur uniformly during the year. What is this investment's payback period?

Period Expected Net Cash Flows Cumulative Net Cash Flows

Year 0 ($75,000) ($75,000)
Year 1 30,000 (45,000)
Year 2 25,000 (20,000)
Year 3 15,000 (5,000)
Year 4 10,000 5,000
Year 5 5,000 10,000

Payback between the end of Year 3 and the end of Year 4

Fraction of Year: Absolute Value Cumulative Cash Flows Beginning of Year $5,000
0.5
Expected Net Cash Flows During Year $10,000

Payback = 3.5 years

1
 Need to Know 24.2
P2 The following data relate to a company’s decision on whether to purchase a machine:
Cost $180,000
Salvage value 15,000
Annual after-tax net income 40,000
Assume net cash flows occur uniformly over each year and the company uses straight-line
depreciation. What is the machine's accounting rate of return?

The Accounting Rate of Return (ARR) measures the amount of net income generated
from a capital investment.

Accounting Rate of Return = Annual After-Tax Net Income

Annual Average Investment

Annual After-Tax Net Income

(Cost + Salvage) / 2

$40,000
($180,000 + $15,000) / 2

$40,000
$97,500

41%

2
 Need to Know 24.3
P3
A company can invest in only one of two projects, A or B. Each project requires a $20,000
investment and is expected to generate end-of-period, annual cash flows as follows:

Net Cash Inflows

Year 1 Year 2 Year 3 Total
Project A $12,000 $8,500 $4,000 $24,500
Project B 4,500 8,500 13,000 26,000

Assuming a discount rate of 10%, which project has the higher net present value?

Project A Net Cash PV of $1 at PV of Net

Inflows 10% Cash
Inflows
Year 1 $12,000 0.9091 $10,909
Year 2 8,500 0.8264 7,024
Year 3 4,000 0.7513 3,005
$24,500 $20,939

PV of Net Cash Inflows $20,939

Amount invested (20,000)
Net Present Value – Project A $939

3
 Need to Know 24.3
P3
A company can invest in only one of two projects, A or B. Each project requires a $20,000
investment and is expected to generate end-of-period, annual cash flows as follows:

Net Cash Inflows

Year 1 Year 2 Year 3 Total
Project A $12,000 $8,500 $4,000 $24,500
Project B 4,500 8,500 13,000 26,000

Project B Net Cash PV of $1 at PV of Net

Inflows 10% Cash
Inflows
Year 1 $4,500 0.9091 $4,091
Year 2 8,500 0.8264 7,024
Year 3 13,000 0.7513 9,767
$26,000 $20,882

PV of Net Cash Inflows $20,882 PV of Net Cash Inflows $20,939

Amount invested (20,000) Amount invested (20,000)
Net Present Value – Project B $882 Net Present Value – Project A $939

Project A has the higher net present value.

4
 Need to Know 24.4
P4
A machine costing $58,880 is expected to generate net cash flows of $8,000 per year for each of the next 10 years.
1. Compute the machine’s internal rate of return (IRR).
2. If a company’s hurdle rate is 6.5%, use IRR to determine whether the company should purchase this machine.

Internal rate of return (IRR) is the interest rate at which the net present value cash flows from a project or
investment equal zero.

PV of Net Cash Inflows $58,880

Amount invested (58,880)
Net Present Value $0

PV of Net Cash Inflows = Annual Amount x PV Annuity of $1 factor

$58,880 = $8,000 x PV of Annuity of $1 factor
$58,880
= PV of Annuity of $1 factor
$8,000

7.3600 = PV of Annuity of $1 factor

IRR is approximately 6%.

Since this rate is lower than the 6.5% hurdle rate, the machine should not be purchased.

5
 NEED-TO-KNOW
The media division of a company reports income of $600,000, average invested assets of
$7,500,000, and a target income of 6% of invested assets. Compute the division’s
(a) return on investment and (b) residual income.

Return on Investment (ROI) represents the earnings power of invested assets.

Return on investment = Net Income

Average Invested Assets

$600,000
$7,500,000

8%

A1
 NEED-TO-KNOW
The media division of a company reports income of $600,000, average invested assets of
$7,500,000, and a target income of 6% of invested assets. Compute the division’s
(a) return on investment and (b) residual income.

Residual income is the amount earned above a targeted amount.

Net income $600,000

Target income ($7,500,000 x .06) 450,000
Residual income $150,000

A1
 NEED-TO-KNOW
A division reports sales of $50,000, income of $2,000, and average invested assets of $10,000.
Compute the division’s (a) profit margin, (b) investment turnover, and (c) return on investment.

Profit margin measures the income earned per dollar of sales.

Profit margin = Net Income

Sales

$2,000
$50,000

4%

A2
 Need
NEED-TO-KNOW
to Know (24-2b)
A division reports sales of $50,000, income of $2,000, and average invested assets of $10,000.
Compute the division’s (a) profit margin, (b) investment turnover, and (c) return on investment.

Investment turnover measures how efficiently an investment center generates

sales from its invested assets.

Investment turnover = Sales

Average Invested Assets

$50,000
$10,000

A2
 Need
NEED-TO-KNOW
to Know (24-2c)
A division reports sales of $50,000, income of $2,000, and average invested assets of $10,000.
Compute the division’s (a) profit margin, (b) investment turnover, and (c) return on investment.

Return on Investment (ROI) represents the earnings power of invested assets.

Return on investment = Net Income

Average Invested Assets

$2,000
$10,000

20%

A2
 Need
NEED-TO-KNOW
to Know (24-2d)
A division reports sales of $50,000, income of $2,000, and average invested assets of $10,000.
Compute the division’s (a) profit margin, (b) investment turnover, and (c) return on investment.

Return on Investment (ROI) represents the earnings power of invested assets.

Return on investment = Profit Margin x Investment Turnover

Net Income = Net Income Sales

Average Invested Assets Sales Average Invested Assets

20% = 4% x 5

A2
 NEED-TO-KNOW 21.1

A manufacturing company reports the fixed budget and actual results for the year as shown below. The
company’s fixed budget assumes a selling price of $40 per unit. The fixed budget is based on 20,000 units
of sales, and the actual results are based on 24,000 units of sales. Prepare a flexible budget performance
report for the year.
Fixed Budget Actual Results
(20,000 units) (24,000 units)
Sales $800,000 $972,000
Variable costs 160,000 240,000
Fixed costs 500,000 490,000

Budget assumptions:
Selling price per unit $40.00 ($800,000 divided by 20,000 units)
Variable cost per unit $8.00 ($160,000 divided by 20,000 units)

Budget Assumptions Flexible Budget

(24,000 units)
Sales $40.00 x 24,000 units = $960,000
Variable costs $8.00 x 24,000 units = 192,000
Fixed costs 500,000

P1
12
 NEED-TO-KNOW 21.1

A manufacturing company reports the fixed budget and actual results for the year as shown below. The
company’s fixed budget assumes a selling price of $40 per unit. The fixed budget is based on 20,000 units
of sales, and the actual results are based on 24,000 units of sales. Prepare a flexible budget performance
report for the year.
Fixed Budget Actual Results
(20,000 units) (24,000 units)
Sales $800,000 $972,000
Variable costs 160,000 240,000
Fixed costs 500,000 490,000

Budget Assumptions Flexible Budget

(24,000 units)
Sales $40.00 x 24,000 units = $960,000
Variable costs $8.00 x 24,000 units = 192,000
Fixed costs 500,000

FLEXIBLE BUDGET PERFORMANCE REPORT

Flexible Budget Actual Results
(24,000 units) (24,000 units) Variances
Sales $960,000 $972,000 $12,000 Favorable (F)
Variable costs 192,000 240,000 48,000 Unfavorable (U)
Contribution margin 768,000 732,000 36,000 Unfavorable (U)
Fixed costs 500,000 490,000 10,000 Favorable (F)
Net income 268,000 242,000 26,000 Unfavorable (U)

P1
13
 NEED-TO-KNOW 21.2

A manufacturing company reports the following for one of its products. Compute the direct materials
(a) price variance and (b) quantity variance and indicate whether they are favorable or unfavorable.
Direct materials standard 8 pounds @ $6.00 per pound
Actual direct materials used 83,000 pounds @ $5.80 per pound
Actual finished units produced 10,000
AQ 83,000 lbs.
AP $5.80 per lb.
SQ 80,000 lbs. (10,000 units x 8 lbs. per unit)
SP $6.00 per lb.
Actual Cost Standard Cost
AQ X AP AQ x SP SQ x SP
83,000 x $5.80 83,000 x $6.00 [10,000 x 8] x $6.00
$481,400 $498,000 $480,000

$16,600 Favorable $18,000 Unfavorable

Materials Price Variance Materials Quantity Variance

$1,400 Unfavorable
Total Direct Materials Variance

P2
14
 NEED-TO-KNOW 21.3
The following information is available for York Company.
Actual direct labor cost (6,250 hours @$13.10 per hour) $81,875
Standard direct labor hours per unit 2.0 hours
Standard rate per hour $13.00
Actual production (units) 2,500
Budgeted production (units) 3,000

Compute the direct labor rate and efficiency variances.

SQ (2,500 units x 2 hrs. per unit = 5,000 standard hrs. )

Actual Cost Standard Cost

AQ X AR AQ x SR SQ x SR
6,250 x $13.10 6,250 x $13.00 (2,500 x 2) x $13.00
$81,875 $81,250 $65,000

$625 Unfavorable $16,250 Unfavorable

Labor Rate Variance Labor Efficiency Variance

$16,875 Unfavorable
Total Direct Labor Variance

P2
15
 NEED-TO-KNOW 21.4
A manufacturing company uses standard costs and reports the information below for January. The company
uses machine hours to allocate overhead, and the standard is two machine hours per finished unit.
Predicted activity level 1,500 units
Variable overhead rate $2.50 per machine hour
Fixed overhead budgeted $6,000 per month ($2.00 per machine hour at predicted activity level)
Actual activity level 1,800 units
Actual overhead costs $15,800
Compute the total overhead cost variance, overhead controllable variance, and overhead volume variance
for January. Indicate whether each variance is favorable or unfavorable.

Actual Overhead Flexible Budget Standard Cost

1,800 units SQ x SR
VOH [(1,800 x 2) x $2.50] + FOH $6,000 (1,800 x 2) x $4.50
$15,800 $15,000 $16,200

$800 Unfavorable $1,200 Favorable

Controllable Variance Overhead Volume Variance

$400 Favorable
Total Overhead Variance

SQ 3,600 MHs (1,800 units x 2 MHs per unit = 3,600 standard hrs. )
SR $4.50 per MH (FOH $2.00 + VOH $2.50 = $4.50 per MH)

P3
16
 NEED-TO-KNOW 21.5

A company uses a standard cost accounting system. Prepare the journal entry to record these
direct materials variances:
Direct materials cost actually incurred $73,200
Direct materials quantity variance (favorable) 3,800
Direct materials price variance (unfavorable) 1,300

General Journal Debit Credit

Work in Process Inventory 75,700
Direct Materials Price Variance 1,300
Direct Materials Quantity Variance 3,800
Raw Materials Inventory 73,200

P4
17
 NEED-TO-KNOW 20-1

A manufacturing company predicts sales of 220 units for May and 250 units for June. The company wants
each month’s ending inventory to equal 30% of next month’s predicted unit sales. Beginning inventory for
May is 66 units.
Compute the company’s budgeted production in units for May.

Budgeted ending inventory for May 75 30% of 250 (June’s expected sales)
Plus: Budgeted sales for May 220
Required units of available production 295
Less: Beginning inventory (units) (66)
Total units to be produced 229

P1 15
 NEED-TO-KNOW 20-2

A manufacturing company budgets production of 800 units during June and 900 units during July. Each
unit of finished goods requires 2 pounds of direct materials, at a cost of $8 per pound. The company maintains
an inventory of direct materials equal to 10% of next month’s budgeted production. Beginning direct
materials inventory for June is 160 pounds. Each finished unit requires 1 hour of direct labor at the rate of
$14 per hour.
Compute the budgeted (a) cost of direct materials purchases for June and (b) direct labor cost for June.

Budgeted production (units) 800

Materials requirements per unit (lbs.) 2
Materials needed for production (lbs.) 1,600
Add: Budgeted ending inventory (lbs.) 180 (July production of 900 units x 2 lbs. per unit x 10%)
Total materials requirements (lbs.) 1,780
Less: Beginning inventory (lbs.) (160)
Materials to be purchased (lbs.) 1,620
Material price per pound $8
Total cost of direct materials purchases $12,960

Budgeted production (units) 800

Labor requirements per unit (hrs.) 1
Total direct labor hours needed 800
Labor rate (per hour) $14
Total cost of direct labor $11,200

P1 18
 NEED-TO-KNOW 20-3
A manufacturing company budgets sales of $70,000 during July. It pays sales commissions of 5% of sales
and also pays a sales manager a salary of $3,000 per month. Other monthly costs include depreciation on
office equipment ($500), insurance expense ($200), advertising ($1,000), and office manager salary of
$2,500 per month. For the month of July, compute the total (a) budgeted selling expense and (b) budgeted
general and administrative expense.

Budgeted selling expense Total

Sales commissions ($70,000 x 5%) $3,500
Sales manager's salary 3,000
Advertising expense 1,000
Total budgeted selling expense $7,500

Budgeted general and administrative expense Total

Depreciation on office equipment $500
Insurance expense 200
Office manager's salary 2,500
Total budgeted and administrative expense $3,200

P1 25
 NEED-TO-KNOW 20-4

In preparing monthly budgets for the third quarter, a company budgeted sales of 120 units for July and 140
units for August. Management wants each month’s ending inventory to be 60% of next month’s sales. The
June 30 inventory consists of 50 units, which does not comply with the company's inventory policy. How
many units should be purchased in July?

Next month's budgeted sales (units) 140

Ratio of inventory to future sales 60%
Budgeted ending inventory (units) 84
Add: Budgeted sales (units) 120
Required units of available merchandise 204
Deduct: Beginning inventory (units) (72)
Units to be purchased 132

P4 54
 NEED-TO-KNOW
A manufacturer reports the following data.
Direct materials  $6.00  per unit
Direct labor $14.00  per unit
Overhead costs:
Variable overhead $220,000  per year $220,000 / 20,000 units = $11 per unit
Fixed overhead $680,000  per year $680,000 / 20,000 units = $34 per unit
Expected units produced 20,000  units
1) Compute the total product cost per unit under absorption costing.
2) Compute the total product cost per unit under variable costing.

$6.00 $6.00

$14.00 $14.00

$31.00 per unit

$11.00 $11.00
$65.00 per unit

$34.00 $34.00

P1
19-22
Copyright © 2015 McGraw-Hill Education
 NEED-TO-KNOW
Zbest Manufacturing reports the following costing data for the current year. 20,000 units were produced,
and 14,000 units were sold.
Direct materials per unit $6 per unit
Direct labor per unit $11 per unit
Variable overhead per unit $3 per unit
Fixed overhead for the year $680,000 per year
Sales price $80 per unit
Variable selling and administrative cost per unit $2 per unit
Fixed selling and administrative cost per year $112,000 per year
1. Prepare an income statement for the year using absorption costing.

Product cost per unit using Absorption Costing:

Direct materials per unit $6.00
Direct labor per unit 11.00
Variable overhead per unit 3.00
Fixed overhead per unit ($680,000 / 20,000 units produced) 34.00
Cost per unit $54.00
Zbest Manufacturing
Absorption Costing Income Statement
Sales (14,000 units @ $80 per unit) $1,120,000
Cost of goods sold (14,000 units @ $54 per unit) 756,000
Gross margin 364,000
Selling, general and administrative expenses:
Variable selling and administrative expenses (14,000 x $2) $28,000
Fixed selling and administrative expenses 112,000
Total selling, general and administrative expenses 140,000
Net income (loss) $224,000
P2
19-23
Copyright © 2015 McGraw-Hill Education
 NEED-TO-KNOW
Zbest Manufacturing reports the following costing data for the current year. 20,000 units were produced,
and 14,000 units were sold.
Direct materials per unit $6 per unit
Direct labor per unit $11 per unit
Variable overhead per unit $3 per unit
Fixed overhead for the year $680,000 per year
Sales price $80 per unit
Variable selling and administrative cost per unit $2 per unit
Fixed selling and administrative cost per year $112,000 per year
2. Prepare an income statement for the year using variable costing.
Product cost using Variable Costing:
Direct materials per unit $6.00
Direct labor per unit 11.00
Variable overhead per unit 3.00
Cost per unit $20.00
Zbest Manufacturing
Variable Costing Income Statement
Sales (14,000 units @ $80 per unit) $1,120,000
Less: Variable costs
Variable production costs (14,000 x $20 per unit) $280,000
Variable selling and administrative expenses (14,000 x $2) 28,000
Total variable costs 308,000
Contribution margin 812,000
Less: Fixed expenses
Fixed overhead costs 680,000
Fixed selling and administrative expenses 112,000
Total fixed expenses 792,000
Net income (loss) $20,000
P2
19-24
 NEED-TO-KNOW
Zbest Manufacturing
Absorption Costing Income Statement
Sales (14,000 units @ $80 per unit) $1,120,000
Cost of goods sold (14,000 units @ $54 per unit) 756,000
Gross margin 364,000
Selling, general and administrative expenses:
Variable selling and administrative expenses (14,000 x $2) 28,000
Fixed selling and administrative expenses 112,000
Total selling, general and administrative expenses 140,000
Net income (loss) $224,000

Zbest Manufacturing
Variable Costing Income Statement
Sales (14,000 units @ $80 per unit) $1,120,000
Less: Variable costs
Variable production costs (14,000 x $20 per unit) $280,000
Variable selling and administrative expenses (14,000 x $2) 28,000
Total variable costs 308,000
Contribution margin 812,000
Less: Fixed expenses
Fixed overhead costs 680,000
Fixed selling and administrative expenses 112,000
Total fixed expenses 792,000
Net income (loss) $20,000

Number of units added to inventory 6,000

Fixed overhead per unit ($680,000 / 20,000 units) $34.00
P2
Change in income (Absorption vs. Variable) $204,000
19-25
Copyright © 2015 McGraw-Hill Education
 NEED-TO-KNOW 18-1
Determine whether each of the following is best described as a fixed, variable, mixed, step-wise, or curvilinear
cost as the number of product units changes.

Rubber used to manufacture tennis balls $0.50 per tennis ball Variable cost
Depreciation (straight-line method)
Electricity cost
Supervisory salaries
A salesperson’s commission is 7% for sales of up to $100,000, and
10% of sales for sales above $100,000

$0.50 per tennis ball - Variable

$6,000

$5,000

Total Cost $4,000

$3,000

$2,000

$1,000

$0
0 2,000 4,000 6,000 8,000 10,000
Units Produced

© McGraw-Hill Education 
26
Learning Objective C1: Describe different types of cost behavior in relation to production and sales volume.
 NEED-TO-KNOW 18-1
Determine whether each of the following is best described as a fixed, variable, mixed, step-wise, or curvilinear
cost with respect to product units.

Rubber used to manufacture tennis balls $0.50 per ball Variable cost
Depreciation (straight-line method) $2,000 per month Fixed cost
Electricity cost
Supervisory salaries
A salesperson’s commission is 7% for sales of up to $100,000, and
10% of sales for sales above $100,000

$2,000 per month - Fixed

$2,500

$2,000
Total Cost
$1,500

$1,000

$500

$0
0 2,000 4,000 6,000 8,000 10,000
Units Produced

© McGraw-Hill Education 
27
Learning Objective C1: Describe different types of cost behavior in relation to production and sales volume.
 NEED-TO-KNOW 18-1
Determine whether each of the following is best described as a fixed, variable, mixed, step-wise, or curvilinear
cost with respect to product units.

Rubber used to manufacture tennis balls $0.50 per ball Variable cost
Depreciation (straight-line method) $2,000 per month Fixed cost
Electricity cost $500 + $0.10 per ball Mixed cost
Supervisory salaries
A salesperson’s commission is 7% for sales of up to $100,000, and
10% of sales for sales above $100,000

$500 + $0.10 per unit- Mixed

$1,600
$1,400
$1,200
$1,000
Total Cost

$800
$600
$400
$200
$0
0 2,000 4,000 6,000 8,000 10,000
Units Produced

© McGraw-Hill Education 
28
Learning Objective C1: Describe different types of cost behavior in relation to production and sales volume.
 NEED-TO-KNOW 18-1
Determine whether each of the following is best described as a fixed, variable, mixed, step-wise, or curvilinear
cost with respect to product units.

Rubber used to manufacture tennis balls $0.50 per ball Variable cost
Depreciation (straight-line method) $2,000 per month Fixed cost
Electricity cost $500 + $0.10 per ball Mixed cost
Supervisory salaries 4,000 units per shift $5,000 per mo. per supervisor Fixed *
A salesperson’s commission is 7% for sales of up to $100,000, and
10% of sales for sales above $100,000

$5,000 per supervisor per month - Step-wise

$16,000
$14,000
$12,000
Total Cost $10,000
$8,000
$6,000
$4,000
$2,000
$0
0 2,000 4,000 6,000 8,000 10,000
Units Produced

* If more shifts are added, then supervisory salaries behave like a step-wise cost with respect to the number of shifts.
© McGraw-Hill Education 
29
Learning Objective C1: Describe different types of cost behavior in relation to production and sales volume.
 NEED-TO-KNOW 18-1
Determine whether each of the following is best described as a fixed, variable, mixed, step-wise, or curvilinear
cost with respect to product units.

Rubber used to manufacture tennis balls $0.50 per ball Variable cost
Depreciation (straight-line method) $2,000 per month Fixed cost
Electricity cost $500 + $0.10 per ball Mixed cost
Supervisory salaries 4,000 units per shift $5,000 per mo. per supervisor Step-wise cost
A salesperson’s commission is 7% for sales of up to $100,000, and Curvilinear cost
10% of sales for sales above $100,000

Sales Commissions - Curvilinear

$30,000

$25,000

Total Cost $20,000

$15,000

$10,000

$5,000

$0
$0 $50,000 $100,000 $150,000 $200,000 $250,000 $300,000
Sales $

© McGraw-Hill Education 
30
Learning Objective C1: Describe different types of cost behavior in relation to production and sales volume.
 NEED-TO-KNOW 18-2
Using the information below, use the high-low method to determine the cost equation
(total fixed costs plus variable costs per unit).

Volume Units Total Cost

Level Produced
Lowest 1,600 $9,800
Highest 4,000 17,000

Variable Cost = Cost at high point - Cost at low point ($17,000 - $9,800) $7,200
Units at high point - Units at low point (4,000 - 1,600) 2,400

$3 per unit produced

Fixed Costs (at high point) Total cost = Fixed costs + $3 per unit
$17,000 = Fixed costs + ($3 x 4,000)
$5,000 = Fixed costs

Fixed Costs (at low point) Total cost = Fixed costs + $3 per unit
$9,800 = Fixed costs + ($3 x 1,600)
$5,000 = Fixed costs

Total costs = $5,000 + $3 per unit

© McGraw-Hill Education 
31
Learning Objective P1: Determine cost estimates using the scatter diagram, high-low, and regression methods of estimating costs.
 NEED-TO-KNOW 18-2 SOLUTION

Slope = Variable Cost $3 per unit

y-intercept = Fixed Costs $5,000

Total Cost = $5,000 + $3 per unit

$18,000
$16,000 (4,000 units, $17,000)

$14,000
$12,000
Total Cost

$10,000 (1,600 units, $9,800)

$8,000
$6,000
(0 units, $5,000)
$4,000
$2,000
$0
0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500
Units Produced

© McGraw-Hill Education 
32
Learning Objective P1: Determine cost estimates using the scatter diagram, high-low, and regression methods of estimating costs.
 NEED-TO-KNOW 18-3
Hudson Co. predicts fixed costs of $400,000 for 2017. Its one product sells for $170 per unit, and it incurs
variable costs of $150 per unit. The company predicts total sales of 25,000 units for the next year.

1. Compute the contribution margin per unit. $20 per unit

2. Compute the break-even point (in units).
3. Prepare a contribution margin income statement at the break-even point.

Contribution margin per unit, or unit contribution margin, is the amount by which a
product’s unit selling price exceeds its total variable cost per unit.

Sales $170 per unit

Variable costs 150 per unit
Contribution margin $ 20 per unit

© McGraw-Hill Education  33
Learning Objective P2: Compute the break-even point for a single product company.
 NEED-TO-KNOW 18-3
Hudson Co. predicts fixed costs of $400,000 for 2017. Its one product sells for $170 per unit, and it incurs
variable costs of $150 per unit. The company predicts total sales of 25,000 units for the next year.

1. Compute the contribution margin per unit. $20 per unit

2. Compute the break-even point (in units). 20,000 units
3. Prepare a contribution margin income statement at the break-even point.

Break-even point in units = Fixed costs

Contribution margin per unit

$400,000
$20 per unit

20,000 units to break-even

Units per unit Total

Sales 20,000 $170 $3,400,000
Variable costs 20,000 $150 3,000,000
Contribution margin $20 400,000
Fixed costs 400,000
Net income $0

© McGraw-Hill Education  34
Learning Objective P2: Compute the break-even point for a single product company.
 NEED-TO-KNOW 18-4
A manufacturer predicts fixed costs of $502,000 for the next year. Its one product sells for $180 per unit,
and it incurs variable costs of $126 per unit. Its target income (pretax) is $200,000.
1. Compute the contribution margin ratio. 30%
2. Compute the dollar sales needed to yield the target income.
3. Compute the unit sales needed to yield the target income.

The contribution margin ratio is the percent of a unit’s selling price that exceeds total
unit variable cost.

Contribution margin ratio = Contribution margin per unit

Selling price per unit

$180 - $126 $54

$180 $180

30%

per unit Ratio

Sales $180 100%
Variable costs 126 70%
Contribution margin $54 30%

© McGraw-Hill Education  35
Learning Objective C2: Describe several applications of cost-volume-profit analysis.
 NEED-TO-KNOW 18-4
A manufacturer predicts fixed costs of $502,000 for the next year. Its one product sells for $180 per unit,
and it incurs variable costs of $126 per unit. Its target income (pretax) is $200,000.
1. Compute the contribution margin ratio. 30%
2. Compute the dollar sales needed to yield the target income. $2,340,000
3. Compute the unit sales needed to yield the target income.

Dollar sales to achieve target income = Fixed costs + Pretax Income

Contribution margin ratio

$502,000 + $200,000
.30

$2,340,000

per unit Ratio Total

Sales $180 100% $2,340,000
Variable costs $126 70% 1,638,000
Contribution margin $54 30% 702,000
Fixed costs 502,000
Net income $200,000

© McGraw-Hill Education  36
Learning Objective C2: Describe several applications of cost-volume-profit analysis.
 NEED-TO-KNOW 18-4
A manufacturer predicts fixed costs of $502,000 for the next year. Its one product sells for $180 per unit,
and it incurs variable costs of $126 per unit. Its target income (pretax) is $200,000.
1. Compute the contribution margin ratio. 30%
2. Compute the dollar sales needed to yield the target income. $2,340,000
3. Compute the unit sales needed to yield the target income. 13,000 units (or $2,340,000 / $180)

Units to yield target income = Fixed costs + target (pretax)

Break-even point in units = Fixed costs
income
Contribution margin per unit
Contribution margin per unit

$502,000 + $200,000 $702,000

$180 - $126 $54

13,000 units

Units per unit Total

Sales 13,000 $180 $2,340,000
Variable costs 13,000 $126 1,638,000
Contribution margin $54 702,000
Fixed costs 502,000
Net income $200,000

© McGraw-Hill Education  37
Learning Objective C2: Describe several applications of cost-volume-profit analysis.
 NEED-TO-KNOW 18-4
A manufacturer predicts fixed costs of $502,000 for the next year. Its one product sells for $180 per unit,
and it incurs variable costs of $126 per unit. Its target income (pretax) is $200,000.
1. Compute the contribution margin ratio. 30%
2. Compute the dollar sales needed to yield the target income. $2,340,000
3. Compute the unit sales needed to yield the target income. 13,000 units (or $2,340,000 / $180)
4. Assume break-even sales of 9,296 units. Compute the margin of safety (in dollars) if the company
expects to sell 10,000 units. $126,720

The excess of expected sales over the break-even sales

level is called a company’s margin of safety

Units per unit Total

Expected sales 10,000 $180 $1,800,000
Break-even sales 9,296 $180 1,673,280
Margin of safety $126,720

© McGraw-Hill Education 
Learning Objective C2: Describe several applications of cost-volume-profit analysis.
 NEED-TO-KNOW 18-5
The sales mix of a company’s two products, X and Y, is 2:1. Unit variable costs for both products
are $2, and unit selling prices are $5 for X and $4 for Y. The company has $640,000 of fixed costs.
1. What is the contribution margin per composite unit? $8
2. What is the break-even point in composite units?
3. How many units of X and how many units of Y will be sold at the break-even point?

Selling price per composite unit Units per unit Total

Product X 2 $5 $10
Product Y 1 $4 4
Total 3 $14

Variable cost per composite unit Units per unit Total

Product X 2 $2 $4
Product Y 1 $2 2
Total 3 $6

Contribution margin per composite unit ($14 - $6) $8

© McGraw-Hill Education  39
Learning Objective P4: Compute the break-even point for a multiproduct company.
 NEED-TO-KNOW 18-5
The sales mix of a company’s two products, X and Y, is 2:1. Unit variable costs for both products
are $2, and unit selling prices are $5 for X and $4 for Y. The company has $640,000 of fixed costs.
1. What is the contribution margin per composite unit? $8
2. What is the break-even point in composite units? 80,000 composite units
3. How many units of X and how many units of Y will be sold at the break-even point?

Break-even point in composite units = Fixed costs

Contribution margin per composite unit

$640,000
$8 per composite unit

80,000 composite units to break even

© McGraw-Hill Education  40
Learning Objective P4: Compute the break-even point for a multiproduct company.
 NEED-TO-KNOW 18-5
The sales mix of a company’s two products, X and Y, is 2:1. Unit variable costs for both products
are $2, and unit selling prices are $5 for X and $4 for Y. The company has $640,000 of fixed costs.
1. What is the contribution margin per composite unit? $8
2. What is the break-even point in composite units? 80,000 composite units
3. How many units of X and how many units of Y will be sold at the break-even point?
Units of each product at break-even Total
Product X 80,000 composite units x 2 units per composite unit 160,000
Product Y 80,000 composite units x 1 unit per composite unit 80,000
240,000

Total Sales Units per unit Total

Product X 160,000 $5 $800,000
Product Y 80,000 $4 320,000
Total 240,000 $1,120,000

Total Variable Costs Units per unit Total

Product X 160,000 $2 $320,000
Product Y 80,000 $2 160,000
Total 240,000 $480,000

Composite units per unit Total

Sales 80,000 $14 $1,120,000
Variable costs 80,000 $6 480,000
Contribution margin $8 640,000
Fixed costs 640,000
Net income $0

© McGraw-Hill Education  41
Learning Objective P4: Compute the break-even point for a multiproduct company.
 NEED-TO-KNOW
A manufacturer reports the following budgeted data for its two production departments.
Machining Assembly
Manufacturing overhead costs $600,000 $300,000
Machine hours to be used (MH) 20,000 0
Direct labor hours to be used (DLH) 20,000 5,000
1. What is the company’s single plantwide overhead rate based on direct labor hours?

Total Plant Overhead Costs $900,000 $36 per DLH

Total Direct Labor Hours 25,000 DLH

2. What are the company’s departmental overhead rates if the machining department assigns overhead
based on machine hours and the assembly department assigns overhead based on direct labor hours?

Overhead Costs - Machining Dept. $600,000 $30 per MH

Machine Hours - Machining Dept. 20,000 MH

Overhead Costs - Assembly Dept. $300,000 $60 per DLH

Direct Labor Hours - Assembly Dept. 5,000 DLH

3. Using the departmental overhead rates from part 2, how much overhead should be assigned to a job
that uses 16 machine hours in the machining department and 5 direct labor hours in the assembly
department?

Overhead Costs - Machining Dept. 16 MHs x $30 per MH = $480

Overhead Costs - Assembly Dept. 5 DLHs x $60 per DLH = 300
Total Overhead Cost assigned to Job $780

P2
17-42
 NEED-TO-KNOW
A manufacturer makes two types of snowmobiles, Basic and Deluxe, and reports the following data to be used in applying
activity-based costing. The company budgets production of 6,000 Basic snowmobiles and 2,000 Deluxe snowmobiles.

Activity Cost Pool Activity Cost Driver Cost Assigned to Pool Basic Deluxe
Machine setup Number of setups $150,000 200 setups 300 setups
Materials handling Number of parts 250,000 10 parts per unit 20 parts per unit
Machine depreciation Machine hours (MH) 720,000 1 MH per unit 1.5 MH per unit
$1,120,000

1. Compute overhead activity rates for each cost pool using ABC.
Machine setup costs $150,000 $300.00 per setup
Number of setups (200 + 300) 500 setups

Materials handling costs $250,000 $2.50 per part

Number of parts (6,000 x 10) + (2,000 x 20) 100,000 parts

Depreciation cost $720,000 $80.00 per MH

Number of MHs (6,000 x 1) + (2,000 x 1.5) 9,000 MHs

2. Compute the total amount of overhead cost to be allocated to each of the company’s product lines using ABC.

Activity Cost Pool Activity Pool Rate Basic Deluxe

Machine setup $300 per setup 200 setups x $300 $60,000 300 setups x $300 $90,000
Materials handling $2.50 per part 60,000 parts x $2.50 150,000 40,000 parts x $2.50 100,000
Machine depreciation $80 per MH 6,000 MHs x $80 480,000 3,000 MHs x $80 240,000
Totals $690,000 $430,000

A2
17-43
 NEED-TO-KNOW
A manufacturer makes two types of snowmobiles, Basic and Deluxe, and reports the following data to be used in applying
activity-based costing. The company budgets production of 6,000 Basic snowmobiles and 2,000 Deluxe snowmobiles.
3. Compute the overhead cost per unit for each product line using ABC.

Activity Cost Pool Activity Pool Rate Basic Deluxe

Machine setup $300 per setup 200 setups x $300 $60,000 300 setups x $300 $90,000
Materials handling $2.50 per part 60,000 parts x $2.50 150,000 40,000 parts x $2.50 100,000
Machine depreciation $80 per MH 6,000 MHs x $80 480,000 3,000 MHs x $80 240,000
Totals $690,000 $430,000

Units produced 6,000 2,000

Cost per unit $115/unit $215/unit

A2
17-44
Quick Check 
For the current period, Jones started 15,000 units
and completed 10,000 units, leaving 5,000 units in
process 30 percent complete. How many equivalent
units of production did Jones have for the period?
a. 10,000
b. 11,500
10,000 units + (5,000 units × 0.30)
c. 13,500 = 11,500 equivalent units
d. 15,000