7e - Solutions CH06

CHAPTER 6
Cost-Volume-Profit Analysis: Additional Issues
ASSIGNMENT CLASSIFICATION TABLE
Brief A
Learning Objectives Questions Exercises Do It! Exercises Problems
1. Apply basic CVP concepts. 1, 2, 3, 4, 5, 1, 2, 3, 4, 5, 1 1, 2, 3, 4, 5 1A, 2A, 6A

6 6
2. Explain the term sales mix and 7, 8, 9 7, 8, 9, 10 2 6, 7, 8, 9, 10 3A

its effects on break-even sales.
3. Determine sales mix when a 10, 11 11, 12 3 11, 12, 13 4A

company has limited resources.
4. Indicate how operating leverage 12, 13, 14, 13, 14, 15 4 14, 15, 16 5A, 6A
affects profitability. 15, 16
*5. Explain the difference between 17, 18, 19, 16, 17, 18, 17, 18, 19 7A, 8A
absorption costing and variable 20, 21, 22 19
costing.
Copyright © 2015 John Wiley & Sons, Inc. Weygandt, Managerial Accounting, 7/e, Solutions Manual (For Instructor Use Only) 6-1
ASSIGNMENT CHARACTERISTICS TABLE
Problem Difficulty Time

Number Description Level Allotted (min.)
1A Compute break-even point under alternative courses of Moderate 20–30

action.
2A Compute break-even point and margin of safety ratio, and Moderate 20–30
prepare a CVP income statement before and after changes
in business environment.
3A Determine break-even sales under alternative sales Moderate 20–30
strategies and evaluate results.
4A Determine sales mix with limited resources. Simple 10–15
5A Compute degree of operating leverage and evaluate Moderate 20–30
impact of operating leverage on financial results.
6A Determine contribution margin, break-even point, target Moderate 20–30
sales, and degree of operating leverage.
*7A Prepare income statements under absorption costing and Moderate 20–30
variable costing for a company with beginning inventory,
and reconcile differences.
*8A Prepare absorption and variable costing income statements Moderate 20–30
and reconcile differences between absorption and variable
costing income statements when sales level and production
level change. Discuss relative usefulness of absorption
costing versus variable costing.
6-2 Copyright © 2015 John Wiley & Sons, Inc. Weygandt, Managerial Accounting, 7/e, Solutions Manual (For Instructor Use Only)
Copyright © 2015 John Wiley & Sons, Inc.
BLOOM’S TAXONOMY TABLE

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems
Learning Objective Knowledge Comprehension Application Analysis Synthesis Evaluation
*1. Apply basic CVP concepts. Q6-1 Q6-2 BE6-2 DI6-1 E6-5 BE6-1
Q6-3 Q6-4 BE6-3 E6-1 P6-3A P6-1A
Q6-5 BE6-4 E6-2 P6-6A P6-2A
Q6-6 BE6-5 E6-3 P6-6A
Weygandt, Managerial Accounting, 7/e, Solutions Manual
BE6-6 E6-4
*2. Explain the term sales mix and Q6-7 Q6-8 BE6-7 DI6-2 E6-9 E6-6
its effects on break-even sales. Q6-8 Q6-9 BE6-8 E6-6 E6-10 E6-7
BE6-9 E6-7 P6-3A E6-8
BE6-10 E6-8 P6-3A
*3. Determine sales mix when a Q6-11 Q6-10 BE6-11 E6-11 P6-4A E6-11 P6-4A
company has limited resources. BE6-12 E6-12 E6-12
DI6-3 E6-13 E6-13
*4. Understand how operating Q6-12 Q6-14 Q6-16 BE6-15 E6-16 DI6-4 P6-5A
leverage affects profitability. Q6-13 BE6-13 E6-14 P6-5A E6-14 P6-6A
Q6-15 BE6-14 E6-15 P6-6A E6-15
E6-16
**5. Explain the difference between Q6-17 Q6-19 E6-18 E6-18
absorption costing and Q6-18 BE6-16 E6-19 E6-19
variable costing. Q6-19 BE6-17 P6-7A P6-7A
Q6-20 BE6-18 P6-8A P6-8A
Q6-21 BE6-19
Q6-22 E6-17
(For Instructor Use Only)
Broadening Your Perspective BYP6-6 BYP6-3 CD6 BYP6-5 BYP6-2

BYP6-4 BYP6-1 BYP6-8 BYP6-7
BYP6-9
6-3
ANSWERS TO QUESTIONS
1. CVP or cost-volume-profit analysis is the study of the effects of changes in costs and volume on
a company’s profit.
2. Managers use CVP analysis to make decisions involving break-even point, sales required to
reach a target net income, margin of safety, the most profitable sales mix, allocation of limited
resources, and operating leverage.
3. Both types of income statements report the same amount of net income. But the format used to
reach net income differs.
A traditional income statement’s format consists of:
Sales revenue – cost of goods sold = gross profit; Gross profit – selling and administrative expenses =
net income.
A CVP income statement’s format consists of:
Sales revenue – variable expenses = contribution margin; Contribution margin – fixed expenses =
net income.
4. The CVP income statement isolates variable costs from fixed costs while the traditional income
statement does not. The CVP format indicates contribution margin in total and frequently on a per
unit basis as well. This format facilitates calculation of break-even point and target net income.
It also highlights how changes in sales volume or cost structure affect net income.
5. WHEAT COMPANY
CVP Income Statement
Sales .......................................................................................................... $900,000

Variable costs ($500,000 X .75) + ($200,000 X .75).................................. 525,000
Contribution margin ................................................................................... $375,000
6. If the selling price is reduced but variable and fixed costs remain unchanged, the break-even point
will increase.
7. Sales mix is the relative percentage of each product sold when a company sells more than one
product. Sales mix changes the calculation of the break-even point because the fixed costs must
be divided by the weighted-average unit contribution margin.
8. The 150,000-mile tire has a higher unit contribution margin, that is, each tire sold covers a larger
amount of fixed costs. Therefore, if the sales mix shifts away from the 150,000-mile tire to the
50,000-mile tire, the company will have to sell more total tires in order to break-even.
9. If a company has many products, the break-even point is calculated using sales information for
divisions or product lines, rather than individual products. The weighted-average contribution
margin ratio is computed by multiplying the sales mix percentage of each product line by the
contribution margin ratio of each product line, and then summing the results. Total break-even
sales in dollars is then calculated by dividing the company’s total fixed costs by the weighted-
average contribution margin ratio. Finally, to determine the amount of sales generated by each
product line at the break-even point, multiply the total break-even sales by the sales mix percentage
of each product line.
Questions Chapter 6 (Continued)
10. Contribution margin per unit of limited resource is determined by dividing the unit contribution
margin of the product by the number of units of the limited resource required to produce the
product.
11. The theory of constraints is a specific approach used to identify and manage constraints to achieve
the company’s goals. According to this theory, a company must continually identify its constraints
and find ways to reduce or eliminate them, where appropriate. Examples of constraints would be
production bottlenecks or poorly trained workers.
12. Cost structure refers to the relative proportion of fixed costs versus variable costs that a company
incurs. Companies that rely heavily on fixed costs will have higher break-even points.
13. Operating leverage refers to the extent to which a company’s net income reacts to a given change
in sales. A company can increase its operating leverage by increasing its reliance on fixed costs.
14. Typically manual labor is considered a variable cost. Depreciation on factory equipment is a fixed
cost. Therefore, if a company replaces manual labor with automated factory equipment it will
increase its operating leverage, and increase its break-even point.
15. The degree of operating leverage is a measure of a company’s relative operating leverage. It is
calculated by dividing the contribution margin by net income at a particular level of sales.
16. Pine’s degree of operating leverage of 8 versus Fir’s measure of 4 tells us that Pine will
experience twice (8 ÷ 4) the increase (or decrease) in net income for a given increase
(decrease) in sales as Fir.
*17. Under absorption costing, both variable and fixed manufacturing costs are considered to be
product costs. Under variable costing, only variable manufacturing costs are product costs and
fixed manufacturing costs are expensed when incurred.
*18. (a) The rationale for variable costing centers on the purpose of fixed manufacturing costs, which
is to have productive facilities available for use. Since these costs are incurred whether a
company operates at zero or 100% capacity, it is argued that they should be expensed
when they are incurred. Variable costing is useful in product costing internally by management
and it is useful in controlling manufacturing costs.
(b) Variable costing cannot be used for financial reporting purposes because it does not follow
generally accepted accounting principles.
*19. One way to compute the difference is as follows:

Ending inventory X Fixed manufacturing overhead cost per unit
8,500 X $5 = $42,500
Absorption costing will report a $42,500 higher net income than variable costing because a
portion of the fixed manufacturing overhead costs are deferred in inventory.
Questions Chapter 6 (Continued)
*20. If production equals sales in any given period, the net incomes under both methods will be equal.
In this case, there is no increase in the ending inventory. So fixed manufacturing overhead costs
in the current period are not deferred to future periods through the ending inventory.
*21. If production is greater than sales, absorption costing net income will be greater than variable
costing net income. Absorption costing net income is higher because some of the fixed
manufacturing overhead costs will be deferred in the inventory account until the products are
sold.
*22. In the long run, neither method will produce a higher net income amount. Over a long period of
time, sales can never exceed production, nor production exceed sales by significant amounts.
For this reason, over the lifetime of a corporation, variable costing and absorption costing will
tend to yield the same net income amounts.
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 6-1
1. (a) $70 = ($250 – $180)

(b) 28% = ($70 ÷ $250)
2. (c) $300 = ($500 – $200)

(d) 40% = ($200 ÷ $500)
3. (e) $1,100 = ($330 ÷ 30%)

(f) $770 = ($1,100 – $330)
BRIEF EXERCISE 6-2
HAMBY INC.
Income Statement
For the Quarter Ended March 31, 2017
Sales ........................................................................ $2,000,000

Variable expenses
Cost of goods sold ......................................... $760,000
Selling expenses............................................. 95,000
Administrative expenses ............................... 79,000
Total variable expenses.......................... 934,000
Contribution margin ............................................... 1,066,000
Fixed expenses
Cost of goods sold ......................................... 600,000
Selling expenses............................................. 60,000
Administrative expenses ............................... 66,000
Total fixed expenses ............................... 726,000
Net income .............................................................. $ 340,000
BRIEF EXERCISE 6-3
Contribution margin ratio = [($250,000 – $150,000) ÷ $250,000] = 40%

Required sales in dollars = $120,000 ÷ 40% = $300,000
BRIEF EXERCISE 6-4
(a) $400Q = $250Q + $210,000 + $0

$150Q = $210,000
Q = 1,400 units
(b) Unit contribution margin $150, or ($400 – $250)

X = $210,000 ÷ $150
X = 1,400 units
BRIEF EXERCISE 6-5
X = .70X + $210,000 + $60,000

.30X = $270,000
X = $900,000
BRIEF EXERCISE 6-6
Margin of safety = $1,200,000 – $960,000 = $240,000

Margin of safety ratio = $240,000 ÷ $1,200,000 = 20%
BRIEF EXERCISE 6-7

Sales Mix Unit Contribution Weighted-Average Unit
Model Percentage Margin Contribution Margin
A12 60% $15 ($50 – $35) $ 9.00
B22 15% $30 ($100 – $70) 4.50
C124 25% $100 ($400 – $300) 25.00
$38.50
BRIEF EXERCISE 6-8
Total break-even = ($269,500 ÷ $38.50*) = 7,000 units
*Computed in BE 6-7
Sales Units
Units of A12 = .60 X 7,000 = 4,200
Units of B22 = .15 X 7,000 = 1,050
Units of C124 = .25 X 7,000 = 1,750
7,000
BRIEF EXERCISE 6-9

(a) Weighted-average
contribution = (.30 X .20) + (.50 X .30) + ( .20 X .45) = .30
margin ratio
(b) Total break-even

point = ($450,000 ÷ .30) = $1,500,000
in dollars
Birthday $1,500,000 X .30 = $ 450,000

Standard tapered $1,500,000 X .50 = 750,000
Large scented $1,500,000 X .20 = 300,000
$1,500,000
BRIEF EXERCISE 6-10

(a) Sales Mix
Bedroom Division $500,000 ÷ $1,250,000 = .40
Dining Room Division $750,000 ÷ $1,250,000 = .60
(b) Weight-average contribution = $575,000 = .46

margin ratio $1,250,000
OR
Contribution Margin Ratio
Bedroom Division($275,000 ÷ $500,000) = .55
Dining Room Division($300,000 ÷ $750,000) = .40
Weighted-average contribution
margin ratio = (.55 X .40) + (.40 X .60) = .46
BRIEF EXERCISE 6-11
Product A Product B
Unit contribution margin (a) $10.0 $12
Machine hours required (b) 2 3
Contribution margin per unit of limited resource $ 5 $ 4
[(a) ÷ (b)]
BRIEF EXERCISE 6-12
Product 1 Product 2
Unit contribution margin (a) $ 42 $ 32
Machine hours required (b) .15 .10
Contribution margin per unit of limited resource $280 $320
[(a) ÷ (b)]
Product 2 has a higher contribution margin per limited resource, even though
it has a unit lower contribution margin. Given that machine hours are
limited to 2,000 per month, Sage Corporation should produce Product 2.
BRIEF EXERCISE 6-13
Degree of operating
leverage (old) = $200,000 ÷ $40,000 = 5
Degree of operating
leverage (new) = $240,000 ÷ $40,000 = 6
If Sam’s sales change, the resulting change in net income will be 1.2 times
(6 ÷ 5) higher with the new machine than under the old system.
BRIEF EXERCISE 6-14
Break-even point in dollars:
Diggs Co. Doggs Co.

$75,000 ÷ ($120,000 ÷ $200,000) $105,000 ÷ ($150,000 ÷ $200,000)
= $125,000 = $140,000
Doggs Company’s cost structure relies much more heavily on fixed costs
than that of Diggs Co. As result, Doggs has a higher contribution margin
ratio of .75 ($150,000 ÷ $200,000) versus .60 ($120,000 ÷ $200,000), for Diggs
Co. Doggs also has much higher fixed costs to cover. Its break-even point
is therefore higher than that of Diggs Co.
BRIEF EXERCISE 6-15

Degree of operating leverage = Contribution margin ÷ Net income
Montana Corp. 1.6 = Contribution margin ÷ $50,000
Contribution margin = $50,000 X 1.6 = $80,000
APK Co. 5.4 = Contribution margin ÷ $50,000
Contribution margin = $50,000 X 5.4 = $270,000
*BRIEF EXERCISE 6-16
Variable Costing
Direct materials $14,400
Direct labor 25,600
Variable manufacturing overhead 29,400
Total product costs $69,400
Absorption Costing
Direct materials $14,400
Direct labor 25,600
Fixed manufacturing overhead 12,000
Total product costs $81,400
(a) Absorption Costing

....... Direct materials ................................................................. $20
Direct labor ........................................................................ 14
Variable manufacturing overhead ................................... 15
Fixed manufacturing overhead ($128,000 ÷ 8,000) ........ 16
Total manufacturing cost per unit ................................... $65
(b) Variable Costing

Direct materials ............................................... $20
Direct labor ...................................................... 14
Variable manufacturing overhead ................. 15
Total manufacturing cost per unit ................. $49
MEMO
To: Chief financial officer
From: Student
Re: Absorption and variable costing
Under absorption costing, fixed manufacturing overhead is a product cost,

while under variable costing, fixed manufacturing overhead is a period cost
(expensed as incurred).
Since units produced (50,000) exceeded units sold (46,000) last month, income
under absorption costing will be higher than under variable costing. Some
fixed overhead (4,000 units X $4 = $16,000) will be assigned to ending
inventory and therefore not expensed under absorption costing, whereas all
fixed overhead is expensed under variable costing. Therefore, absorption
costing net income will be higher than variable costing net income by
$16,000.
SOLUTIONS TO DO IT! REVIEW EXERCISES
DO IT! 6-1
(a) Break-even point in units is 7,500 units ($150,000 ÷ $20).

Break-even point in sales dollars is $375,000 ($150,000 ÷ .40*).
The margin of safety in dollars is $75,000 ($450,000 – $375,000).
*$20 ÷ $50.
(b) Break-even point in units is 8,333 units (rounded) ($150,000 ÷ $18*).

Break-even point in sales dollars is $400,000 ($150,000 ÷ .375**).
The margin of safety in dollars is $118,400 ($518,400*** – $400,000).
*$50 – (.04 X $50) – 30 = $18.

**$18 ÷ $48 = .375
***9,000 + (.20 X 9,000) = 10,800 units, 10,800 units X $48 = $518,400
The increase in the break-even point from $375,000 to $400,000 indi-

cates that management should not implement the proposed change
while the increase in the margin of safety from $75,000 to $118,400
indicates that management should implement the proposed change.
Since the expected 20% increase in sales volume will result in a con-
tribution margin of $194,400 (10,800 X $18) which is only $14,400 more
than the current amount, management should be cautious before
reducing unit prices.
DO IT! 6-2
(a) The sales mix percentages as a function of units sold is:
Basic Basic Plus Premium

750 ÷ 1,500 = 50% 450 ÷ 1,500 = 30% 300 ÷ 1,500 = 20%
(b) The weighted-average unit contribution margin is:

[.50 X ($250 – $195)] + [.3 X ($400 – $285)] + [.20 X ($800 – $415)] = $139.
(c) The break-even point in units is: $180,700 ÷ $139 = 1,300 units.
DO IT! 6-2 (Continued)
(d) The break-even units to produce for each product are:

Basic: 1,300 units X 50% = 650 units
Basic Plus 1,300 units X 30% = 390 units
Premium: 1,300 units X 20% = 260 units
1,300 units
DO IT! 6-3
(a) The Best binoculars have the highest unit contribution margin. Thus,
ignoring any manufacturing constraints, it would appear that the
company should shift toward production of more Best units.
(b) The contribution margin per unit of limited resource is calculated as:
Good Better Best

Unit contribution margin $40 $150 $420
Limited resource consumed per unit .5 = $80 1.5 = $100 6 = $70
(c) The Better binoculars have the highest contribution margin per unit of
limited resource, even though they do not have the highest unit
contribution margin. Given the resource constraint, any additional
capacity should be used to make Better binoculars.
DO IT! 6-4
(a) Contribution Degree of operating

÷ Net Income =
Margin Leverage
Old $1,400,000 ÷ $400,000 = 3.5
New $2,300,000 ÷ $400,000 = 5.8
The degree of operating leverage measures the company’s sensitivity to

changes in sales. By switching to a cost structure dominated by fixed
costs, the company would significantly increase its operating leverage. As
a result, with a percentage change in sales, its percentage change in net
income would be 1.66 times as much (5.8 + 3.5) under the new structure as
it would under the old.
SOLUTIONS TO EXERCISES
EXERCISE 6-1
(a) 1. Contribution margin per room = $60 – ($8 + $34)

Contribution margin per room = $18
Contribution margin ratio = $18 ÷ $60 = 30%
Fixed costs = $10,600 + $2,400 + $1,500 + $800 = $15,300

Break-even point in rooms = $15,300 ÷ $18 = 850
2. Break-even point in dollars = 850 rooms X $60 per room

= $51,000 per month
OR
Fixed costs ÷ Contribution margin ratio = $15,300 ÷ .30
= $51,000 per month
(b) 1. Margin of safety in dollars:

Planned activity = 50 rooms per day X 30 days
= 1,500 rooms per month
Expected rental revenue = 1,500 rooms X $60 = $90,000

Margin of safety in dollars = $90,000 – $51,000 = $39,000
$39,000 = 43%
2. Margin of safety ratio:
$90,000 (rounded)
EXERCISE 6-2
(a) Contribution margin in dollars: Sales = 4,000 X $30 = $120,000

Variable costs = $120,000 X .75 = 90,000
Contribution margin $ 30,000
Unit contribution margin: $30 – $22.50 ($30 X 75%) = $7.50.

Contribution margin ratio: $7.50 ÷ $30 = 25%.
EXERCISE 6-2 (Continued)
$16,800
(b) Break-even sales in dollars: = $67,200.
25%
$16,800
Break-even sales in units: = 2,240.
$7.50
(c) Margin of safety in dollars: $120,000 – $67,200 = $52,800.

Margin of safety ratio: $52,800 ÷ $120,000 = 44%.
EXERCISE 6-3
Current selling price = $325,000 ÷ 5,000 units

Current selling price = $65
1. Increase selling price to $71.50 ($65 X 110%).

Net income = $357,500* – $210,000 – $75,000 = $72,500.
*($71.50 X 5,000)
2. Reduce variable costs to 58% of sales.

Net income = $325,000 – $188,500** – $75,000 = $61,500.
**($325,000 X .58)
3. Reduce fixed costs to $60,000 ($75,000 – $15,000).

Net income = $325,000 – $210,000 – $60,000 = $55,000.
Alternative 1, increasing unit sales price, will produce the highest net income.
EXERCISE 6-4
$30,000
(a) 1. Contribution margin ratio is: = 62.5%
$48,000
$20,250
Break-even point in dollars = = $32,400
62.5%
$48,000
2. Round-trip ticket price = = $120
400 flights
$32,400
Break-even point in flights = = 270 flights
$120
(b) At the break-even point fixed costs and contribution margin are equal.
Therefore, the contribution margin at the break-even point would be
$20,250.
(c) Fare revenue ($108* X 500**) $54,000

Variable costs ($18,000 X 1.25) 22,500
Contribution margin 31,500
Fixed costs 20,250
Net income $11,250
Yes, the fare decrease should be implemented because net income

increases to $11,250.
*$120 – (.10 X $120)
**400 + 100
EXERCISE 6-5
(a) CAREY COMPANY

For the Year Ended December 31, 2017
Total Per Unit

Sales (60,000 X $26) ....................................... $1,560,000 $26
Variable costs (60,000 X $15) ........................ 900,000 15
Contribution margin (60,000 X $11) .............. 660,000 $11
Fixed costs ...................................................... 500,000
Net income ...................................................... $ 160,000
(b) CAREY COMPANY

Total Per Unit

Sales [(60,000 X 105%) X $24.50*] ................ $1,543,500 $24.50
Variable costs (63,000 X $12.00**) ................ 756,000 12.00
Contribution margin (63,000 X $12.50) ......... 787,500 $12.50
Fixed costs ($500,000 + $100,000) ................ 600,000
Net income...................................................... $ 187,500
*$26.00 – ($3 X 50%) = $24.50.

**$15.00 – ($15 X 20%) = $12.00.
EXERCISE 6-6
Sales Mix Unit contribution Weighted-Average

Percentage Margin Contribution Margin
Lawnmowers 20% $30 $ 6
Weed-trimmers 50% $20 10
Chainsaws 30% $40 12
$28
Total break-even sales in units = $4,200,000 ÷ $28 = 150,000 units

Total Sales Units
Sales Mix Break-even Sales Needed
Percentage in Units Per Product
Lawnmowers 20% X 150,000 = 30,000 units
Weed-trimmers 50% X 150,000 = 75,000 units
Chainsaws 30% X 150,000 = 45,000 units
Total units 150,000 units
EXERCISE 6-7
(a)
Weighted-Average
Sales Mix Contribution Contribution
Percentage Margin Ratio Margin Ratio
Oil changes 70% 20% .14
Brake repair 30% 40% .12
.26
Total break-even sales in dollars = $15,600,000 ÷ .26 = $60,000,000
Total Sales Dollars

Sales Mix Break-even Sales Needed
Percentage in Dollars Per Product
Oil changes 70% X $60,000,000 = $42,000,000
Brake repair 30% X $60,000,000 = 18,000,000
Total sales $60,000,000
(b)
Sales to achieve target net income = ($78,000 + $52,000) ÷ .26 = $500,000
Sales Dollars
Sales Mix Total Needed Per Product
Percentage Sales Needed Per Store
Oil changes 70% X $500,000 = $350,000
Brake repair 30% X $500,000 = 150,000
Total sales $500,000
EXERCISE 6-8
(a)
Weighted-Average
Mail pouches
and small boxes 80% 20% .16
Non-standard
boxes 20% 70% .14
.30
Total Break- Sales Dollars

Sales Mix even Sales Needed
Mail pouches
and small boxes 80% X $40,000,000 = $32,000,000
Non-standard
boxes 20% X $40,000,000 = 8,000,000
(b)
Weighted-Average
Mail pouches
and small boxes 40% 20% .08
Non-standard
boxes 60% 70% .42
.50
Total Break-
Sales Mix even Sales Sales Dollars
Mail pouches
and small boxes 40% X $24,000,000 = $ 9,600,000
Non-standardized
boxes 60% X $24,000,000 = 14,400,000
EXERCISE 6-9
(a) Weighted-average unit

contribution margin = ($40 X .35) + ($20 X .55) + ($60 X .10) = $31
Break-even point in units = $620,000 ÷ $31 = 20,000
(b) Shoes (20,000 X .35) = 7,000 pairs of shoes

Gloves (20,000 X .55) = 11,000 pairs of gloves
Range-finders (20,000 X .10) = 2,000 range-finders
(c) Shoes: 7,000 X $40 = $280,000

Gloves: 11,000 X $20 = 220,000
Range-finders: 2,000 X $60 = 120,000
Total contribution margin 620,000
Fixed costs 620,000
Net income $ 0
EXERCISE 6-10
(a) Sales mix percentage

iPad division: $600,000 ÷ ($600,000 + $400,000) = .60
iPod division: $400,000 ÷ ($600,000 + $400,000) = .40
Contribution margin ratio:

iPad division: $180,000 ÷ $600,000 = .30
iPod division: $140,000 ÷ $400,000 = .35
(b) Weighted-average contribution $320,000

= = .32 OR
margin ratio $1,000,000
Weighted-average contribution
margin ratio = (.60 X .30) + (.40 X .35) = .32
(c) Break-even point in dollars = $120,000 ÷ .32 = $375,000
(d) Sales dollars needed at break-even point for each division

iPad division: $375,000 X .60 = $225,000
iPod division: $375,000 X .40 = $150,000
EXERCISE 6-11
(a) Product
A B C
Unit contribution margin (a) $ 6 $ 2 $ 3
Machine hours required (b) 2 1 2
Contribution margin per unit of limited resource (a) ÷ (b) $3.00 $ 2 $1.50
(b) Product A should be manufactured because it results in the highest

contribution margin per machine hour.
(c) 1. Product
A B C
Machine hours (a) (3,000 ÷ 3) 1,000 1,000 1,000
Contribution margin per unit of limited
resource (b) $ 3 $ 2 $ 1.50
Total contribution margin [(a) X (b)] $3,000 $2,000 $1,500
The total contribution margin = ($3,000 + $2,000 + $1,500) = $6,500.
2. Product A
Machine hours (a) 3,000
Contribution margin per unit of limited resource (b) $ 3
Total contribution margin [(a) X (b)] $9,000
EXERCISE 6-12
(a) Product D: $30 ÷ $10 = 3.0 hours per unit

Product E: $80 ÷ $10 = 8.0 hours per unit
Product F: $35 ÷ $10 = 3.5 hours per unit
(b) Product
D E F
Selling price $200 $ 300 $250
Variable costs 125 160 180
Contribution margin 75 140 70
Direct labor hours per unit ÷ 3.0 ÷ 8.0 ÷ 3.5
Contribution margin per
direct labor hour $ 25 $17.50 $ 20
(c) Product D should be produced because it generates the highest contri-

bution margin per direct labor hour.
Product D
Total direct labor hours available 2,000
Contribution margin per direct labor hour X $25
Total contribution margin $50,000
EXERCISE 6-13
(a) Product
Basic Deluxe
Selling price per unit $40 $ 52
Variable costs per unit 22 24
Unit contribution margin (a) $18 $ 28
Machine hours required (b) .5 .8
Contribution margin per
machine hour (a) ÷ (b) $36 $35
(b) The Basic product should be manufactured because it results in the

higher contribution margin per machine hour.
(c) 1. Basic Deluxe Total

Machine hours allocated 500 500 1,000
X Contribution margin
per machine hour $36 $35
Contribution margin $18,000 $17,500 $35,500
2. Basic Deluxe Total

Machine hours allocated 1,000 –0– 1,000
X Contribution margin
per machine hour $36 $35
Contribution margin $36,000 –0– $36,000
EXERCISE 6-14
(a)
Contribution Net Degree of Operating
Margin ÷ Income = Leverage
Armstrong $260,000 ÷ $100,000 = 2.60
Contador $450,000 ÷ $100,000 = 4.50
Interpretation: Contador has a higher degree of operating leverage. Its

earnings would increase (decrease) by a greater amount than Armstrong if
each experienced an equal increase (decrease) in sales.
(b)
Armstrong Company Contador Company
Sales $550,000** $550,000***
Variable costs 264,000** 55,000***
Contribution margin 286,000** 495,000***
Fixed costs 160,000** 350,000***
Net income $126,000** $145,000***
*$500,000 X 1.1
**$240,000 X 1.1
***$ 50,000 X 1.1
(c) Each company experienced a $50,000 increase in sales. However, be-

cause of Contador’s higher operating leverage, it experienced a $45,000
($145,000 – $100,000) increase in net income while Armstrong experienced
only a $26,000 ($126,000 – $100,000) increase. This is what we would
have expected, since Contador’s degree of operating leverage exceeds
that of Armstrong.
EXERCISE 6-15
(a)
Contribution Degree of
Margin ÷ Net Income = Operating Leverage
Manual system $300,000 ÷ $200,000 = 1.50
Computerized
system $900,000 ÷ $200,000 = 4.50
(b) The computerized system would produce profits that are 3.0 times
(4.50 ÷ 1.50) as much as the manual system. With a $150,000 increase in
sales, net income would increase $30,000 ($230,000 – $200,000)
under the manual system and $90,000 ($290,000 – $200,000) under the
computerized system.
Manual Computerized
System System
Sales $1,650,000 $1,650,000
Variable costs 1,320,000* 660,000**
Contribution margin 330,000 990,000
Fixed costs 100,000 700,000
Net income $ 230,000 $ 290,000
*($1,200,000 ÷ $1,500,000) X $1,650,000

**($600,000 ÷ $1,500,000) X $1,650,000
(c)
(Actual Sales – Break-even Sales) ÷ Actual Sales = Margin of Safety Ratio
Manual system ($1,500,000 – $500,000*) ÷ $1,500,000 = .67
Computerized
system ($1,500,000 – $1,166,667**) ÷ $1,500,000 = .22
*$100,000 ÷ ($300,000 ÷ $1,500,000)

**$700,000 ÷ ($900,000 ÷ $1,500,000)
The manual system could weather the greater decline in sales before
reaching the break-even point. Under the manual system sales could
drop 67% before suffering a loss, while sales under the computerized
system could only decline by 22% before suffering a loss.
EXERCISE 6-16
(a)
Traditional Yams $ 80,000 ÷ $50,000 = 1.60
Auto-Yams $240,000 ÷ $50,000 = 4.80
Auto-Yams, which relies more heavily on fixed costs, has the higher
degree of operating leverage, 4.8 versus 1.60. That means for every
dollar of increase (decrease) in sales, Auto-Yams will generate 3
(4.80 ÷ 1.60) times more (less) in contribution margin and net income.
(b)
Degree of
% Change Operating % Change in
in Sales X Leverage = Net Income
15% decrease:
Traditional Yams (15%) X 1.60 = (24.0%)
Auto-Yams (15%) X 4.80 = (72.0%)
10% increase:
Traditional Yams 10% X 1.60 = 16.0%
Auto-Yams 10% X 4.80 = 48.0%
(c) There are several possible answers that could be given. For example,
if the candied Yams business is fairly stable, Auto-Yams might be the
choice, because they will generate the higher contribution margin and
net income. If, however, sales swing widely from year to year, Traditional
Yams might be chosen because they will provide the more stable
contribution margin and net income. Finally, if the investment banker
is a risk taker, she might choose Auto-Yams in spite of year to year sales
swings.
EXERCISE 6-17
(a)
Unit Cost
Direct materials $ 7.50
Direct labor 3.45
Variable manufacturing overhead 5.80
Manufacturing cost per unit $16.75
(b)
SIREN COMPANY
Income Statement
Variable Costing
Sales (80,000 lures X $25) $2,000,000
Variable cost of goods sold
(80,000 lures X $16.75) $1,340,000
Variable selling and administrative
expenses (80,000 lures X $3.90) 312,000 1,652,000
Contribution margin 348,000
Fixed selling and administrative
expenses 210,100 435,100
Net Income (loss) $ (87,100)
(c)
Unit Cost
Direct materials $ 7.50
Direct labor 3.45
Variable manufacturing overhead 5.80
Fixed manufacturing overhead ($225,000 ÷ 90,000) 2.50
Manufacturing cost per unit $19.25
(d)
SIREN COMPANY
Income Statement
Absorption Costing
Sales (80,000 lures X $25) $2,000,000

Cost of goods sold (80,000 lures X $19.25) 1,540,000
Gross profit 460,000
Variable selling and administrative expenses
(80,000 lures X $3.90) $312,000
Fixed selling and administrative expenses 210,100 522,100
Net Income $ (62,100)
*EXERCISE 6-18
(a)
Direct materials used $ 79,000
Direct labor incurred 30,000
Variable manufacturing costs $130,500
Variable manufacturing cost per unit = $130,500 ÷ 9,000 = $14.50 per unit
Finished goods inventory cost = (9,000 – 8,200 units) X $14.50
= $11,600
(b) Absorption costing would show a higher net income because a portion
of the fixed costs are deferred to future periods. The following computa-
tion indicates that finished goods inventory will be $4,000 higher under
absorption costing which will cause its net income to be $4,000 higher.
Direct materials used $ 79,000
Direct labor incurred 30,000
Total manufacturing costs $175,500
Total manufacturing costs per unit = $175,500 ÷ 9,000 = $19.50 per unit
Finished goods inventory cost = (9,000 – 8,200 units) X $19.50 = $15,600
Inventory (absorption costing) $15,600
Inventory (variable costing) 11,600
$ 4,000
*EXERCISE 6-19
(a)
Utility Expense
Months in Kilowatt Hourly Variable
X X =
a year hours Charge Utilities
12 X 500 X $0.50 = $3,000
Months in Monthly Fixed

X =
a year Fee Utilities
12 X $1,500 = $18,000
*EXERCISE 6-19 (Continued)
Variable Costing
Labor:
Crate builders $43,000
Material:
Wood 54,000
Variable Overhead:
Utilities 3,000
Nails 350
(b)
Absorption Costing
Labor:
Crate builders $ 43,000
Material:
Wood 54,000
Variable overhead:
Utilities 3,000
Nails 350
Fixed overhead:
Utilities 18,000
Rent 21,400
(c) The entire difference in costs between the two methods is due to the
fact that fixed overhead is included as part of manufacturing costs
only under the absorption costing method. This difference amounts to
$39,400 ($18,000 + $21,400).
SOLUTIONS TO PROBLEMS
PROBLEM 6-1A
(a) Sales were $2,000,000 and variable expenses were $1,200,000, which
means contribution margin was $800,000 and CM ratio was .40. Fixed ex-
penses were $1,035,000. Therefore, the break-even point in dollars is:
$1,035,000
= $2,587,500
.40
(b) 1. The effect of this alternative is to increase the selling price per unit
to $31.25 ($25 X 125%). Total sales become $2,500,000 (80,000 X
$31.25). Thus, contribution margin ratio changes to 52%
[($2,500,000 – $1,200,000) ÷ $2,500,000]. The new break-even point
is:
$1,035,000
= $1,990,385 (rounded)
.52
2. The effects of this alternative are: (1) fixed costs decrease by

$160,000, (2) variable costs increase by $100,000 ($2,000,000 X 5%),
(3) total fixed costs become $875,000 ($1,035,000 – $160,000), and
the contribution margin ratio becomes .35 [($2,000,000 – $1,200,000 –
$100,000) ÷ $2,000,000]. The new break-even point is:
$875,000
= $2,500,000
.35
3. The effects of this alternative are: (1) variable and fixed cost of
goods sold become $784,000 each, (2) total variable costs become
$934,000 ($784,000 + $92,000 + $58,000), (3) total fixed costs are
$1,301,000 ($784,000 + $425,000 + $92,000) and the contribution
margin ratio becomes .533 [($2,000,000 – $934,000) ÷ $2,000,000].
The new break-even point is:
$1,301,000
= $2,440,901 (rounded)
.533
Alternative 1 is the recommended course of action using break-even

analysis because it has the lowest break-even point.
PROBLEM 6-2A
(a) (1)
Current Year
Sales $1,500,000
Variable costs
Direct materials 511,000
Direct labor 290,000
Manufacturing overhead ($350,000 X .70) 245,000
Selling expenses ($250,000 X .40) 100,000
Administrative expenses ($270,000 X .20) 54,000
Total variable costs 1,200,000
Current Year Projected Year

Sales $1,500,000 X 1.1 $1,650,000
Variable costs
Direct materials 511,000 X 1.1 562,100
Direct labor 290,000 X 1.1 319,000
Manufacturing overhead 245,000 X 1.1 269,500
Selling expenses 100,000 X 1.1 110,000
Administrative expenses 54,000 X 1.1 59,400
Total variable costs 1,200,000 X 1.1 1,320,000
Contribution margin $ 300,000 X 1.1 $ 330,000
(2)
Fixed Costs Current Year Projected year
Manufacturing overhead ($350,000 X .30) $105,000 $105,000
Selling expenses ($250,000 X .60) 150,000 150,000
Administrative expenses ($270,000 X .80) 216,000 216,000
Total fixed costs $471,000 $471,000
PROBLEM 6-2A (Continued)
(b) Unit selling price = $1,500,000 ÷ 100,000 = $15

Unit variable cost = $1,200,000 ÷ 100,000 = $12
Unit contribution margin = $15 – $12 = $3
Contribution margin ratio = $3 ÷ $15 = .20
Break-even point in units = Fixed costs ÷ Unit contribution margin

157,000 units = $471,000 ÷ $3.00
Break-even point in dollars = Fixed costs ÷ Contribution margin ratio

$2,355,000 = $471,000 ÷ .20
(c) Sales dollars

required for = (Fixed costs + Target net income) ÷ Contribution margin ratio
target net income
$3,355,000 = ($471,000 + $200,000) ÷ .20
(d) Margin of safety = (Expected sales – Break-even sales) ÷ Expected sales

ratio
29.8% = ($3,355,000 – $2,355,000) ÷ $3,355,000
(e) (1)
Current Year
Sales $1,500,000
Variable costs
Direct materials 511,000
Direct labor ($290,000 – $104,000) 186,000
Manufacturing overhead ($350,000 X .30) 105,000
Total variable costs 1,081,000
Fixed cost
Manufacturing overhead ($350,000 X .70) $245,000
Total fixed costs $486,000
(2) Contribution margin ratio = $419,000 ÷ $1,500,000 = .28 (rounded)
(3) Break-even point in dollars = $486,000 ÷ .28 = $1,735,714 (rounded)
The break-even point in dollars declined from $2,355,000 to $1,735,714.

This means that overall the company’s risk has declined because it
doesn’t have to generate as much in sales. The two changes actually
had opposing effects on the break-even point. By changing to a more
commission-based approach to compensate its sales staff the company
reduced its fixed costs, and therefore reduced its break-even point. In
contrast, the purchase of the new equipment increased the company’s
fixed costs (by increasing its equipment depreciation) which would
increase the break-even point.
PROBLEM 6-3A
(a)
Weighted-Average
Percentage X Margin Ratio = Margin Ratio
Appetizers 15% X 50% = .075
Main entrees 50% X 25% = .125
Desserts 10% X 50% = .050
Beverages 25% X 80% = .200
.450
Total sales required

to achieve target net
income = ( $1,053,000 + $117,000 ) ÷ .45 = $2,600,000
Sales Mix Total Sales Sales from

Percentage X Needed = Each Product
Appetizers 15% X $2,600,000 = $ 390,000
Main entrees 50% X $2,600,000 = 1,300,000
Desserts 10% X $2,600,000 = 260,000
Beverages 25% X $2,600,000 = 650,000
$2,600,000
(b)
Weighted-Average
Desserts 10% X 50% = .050
Beverages 40% X 80% = .320
.520
income = ( $1,638,000* + $117,000) ÷ .52 = $ 3,375,000
*$1,053,000 + $585,000
Thus, sales would have to increase by $775,000 ($3,375,000 – $2,600,000) to
achieve the target net income. This increase in sales is driven by the
increase in fixed costs. The sales of each product line would be:
Appetizers 25% X $3,375,000 = $ 843,750
Main entrees 25% X $3,375,000 = 843,750
Desserts 10% X $3,375,000 = 337,500
Beverages 40% X $3,375,000 = 1,350,000
$3,375,000
(c)
Weighted-Average
Desserts 10% X 50% = .050
Beverages 25% X 80% = .200
.375
The weighted-average contribution margin ratio computed in part (a) was
45%. With the contribution margin ratio on entrees falling to 10%, that
average will now be 37.5% as shown previously. Applying this to the new
fixed costs of $1,638,000 and target net income of $117,000 we get:
income = ($1,638,000 + $117,000) ÷ .375 = $ 4,680,000
Appetizers 15% X $4,680,000 = $ 702,000
Main entrees 50% X $4,680,000 = 2,340,000
Desserts 10% X $4,680,000 = 468,000
Beverages 25% X $4,680,000 = 1,170,000
$4,680,000
Relative to parts (a) and (b), the total required sales for (c) would increase.
It appears that the least risky approach would be for Paul to switch to the
new sales mix, but not to incur the additional fixed costs of expanding
operations. If the switch in sales mix appears to be successful, then it may
be appropriate for him to incur the additional fixed costs necessary for
expansion of operations.
PROBLEM 6-4A
(a) Product
Economy Standard Deluxe
Selling price $30 $50 $100
Less: Variable costs 16 20 46
Unit contribution margin $14 $30 $ 54
Ignoring the machine time constraint, the Deluxe product should be produced
because it has the highest unit contribution margin.
(b) Product
Economy Standard Deluxe
Unit contribution margin (a) $14 $ 30 $ 54
Machine hours required (b) .5 .8 1.6
Contribution margin
per limited resource (a)/(b) $28 $37.50 $33.75
(c) If additional machine hours become available, the additional time should
be used to produce the Standard product since it has the highest contri-
bution margin per machine hour.
PROBLEM 6-5A
(a) To determine the break-even point in dollars we must first calculate

the contribution margin ratio for each company.
Contribution Contribution Margin

Margin ÷ Sales = Ratio
Blanc Company $220,000 ÷ $500,000 = .44
Noir Company $320,000 ÷ $500,000 = .64
Fixed Contribution Break-even Point

Costs ÷ Margin Ratio = in Dollars
Blanc Company $170,000 ÷ .44 = $386,364
Noir Company $270,000 ÷ .64 = $421,875
Margin of Safety
(Actual Sales – Break-even Sales) ÷ Actual Sales = Ratio
Blanc Company ($500,000 – $386,364) ÷ $500,000 = .227
Noir Company ($500,000 – $421,875) ÷ $500,000 = .156
(b)
Blanc Company $220,000 ÷ $50,000 = 4.4
Noir Company $320,000 ÷ $50,000 = 6.4
Because Noir Company relies more heavily on fixed costs, it has a higher
degree of operating leverage. This means that its net income will be more
sensitive to changes in sales. For a given change in sales, the change in
net income will be 1.45 (6.4 ÷ 4.4) times higher for Noir Company than for
Blanc Company.
(c)
Blanc Company Noir Company
Sales $600,000* $600,000
Variable costs 336,000** 216,000***
Fixed costs 170,000 270,000
Net income $ 94,000 $114,000
*$500,000 X 1.2
**$280,000 X 1.2
***$180,000 X 1.2
(d)
Blanc Company Noir Company
Sales $400,000* $400,000
Variable costs 224,000** 144,000***
Fixed costs 170,000 270,000
Net income (Loss) $ 6,000 ($ 14,000)
*$500,000 X .80
**$280,000 X .80
***$180,000 X .80
(e) In part (b) the degree of operating leverage of Noir Company was
higher than that of Blanc Company, telling us that the net income of
Noir Company was more sensitive to changes in sales than that of
Blanc Company. In part (c) we see that a 20% increase in sales
increased the net income of Noir Company by $64,000 ($114,000 –
$50,000), while the net income of Blanc Company increased by only
$44,000 ($94,000 – $50,000). However, in part (d) we see that a 20%
decrease in sales resulted in a $64,000 ($50,000 + $14,000) decline in
net income for Noir Company, while Blanc Company’s net income only
declined by $44,000 ($50,000 – $6,000). The increased risk caused by
higher operating leverage is also seen in part (a). Noir Company has a
higher break-even point, and a lower margin of safety ratio than Blanc
Company. Thus, while operating leverage can be very beneficial for a
company that expects its sales to increase, it can also significantly
increase a company’s risk.
PROBLEM 6-6A
(a) Reformat the income statement to CVP format.

All amount are in $000s.
Sales.......................................................... $75,000
Variable costs ($31,500 + $13,500) ......... 45,000
Contribution margin ................................ 30,000
Less: Fixed costs ($8,610 + $10,260) .... 18,870
Operating income .................................... $11,130
Contribution margin ratio = $30,000 ÷ $75,000 = 40%
Break-even point = $18,870 ÷ 40% = $47,175
(b) If a hired workforce replaces sales agents, commissions will be reduced

to 8% of sales, or $6,000; but fixed costs will increase by $7,500.
Sales.......................................................... $75,000
Variable costs ($31,500 + $6,000) ........... 37,500
Less: Fixed costs ($18,870* + $7,500) ... 26,370
Operating income .................................... $11,130
*($8,610 + $10,260)
Contribution margin ratio = $37,500 ÷ $75,000 = 50%
Break-even point = $26,370 ÷ 50% = $52,740
(c) Operating leverage = contribution margin ÷ operating income
(1) Current situation: from part (a)

$30,000 ÷ $11,130 = 2.70
(2) Proposed situation: from part (b)

$37,500 ÷ $11,130 = 3.37
The calculations indicate that at a sales level of $75 million, a percentage

change in sales and contribution margin will result in 2.70 times that
percentage change in operating income if Bonita continues to use sales
agents. If they choose to employ their own, the change in operating
income will be 3.37 times the percentage change in sales.
The higher contribution margin per dollar of sales and higher fixed
costs from Bonita employing their own agents gives them more
operating leverage. This will result in greater benefits (increases in
operating income) if revenues increase, but greater risks (decreases in
operating income) if revenues decline.
(d) The sales level at which operating incomes will be identical is called
the point of indifference. This would be when the cost of the network of
agents (18% of sales) is exactly equal to the cost of paying employees
8% commission along with additional fixed costs of $7.5 million. None
of the other costs is relevant, because they will not change between
alternatives.
Let the sales volume = S

18% X S = (8% X S) + $7,500,000
.18S = .08S + $7,500,000
.10S = $7,500,000
S = $75,000,000
*PROBLEM 6-7A
(a) JACKSON COMPANY

Income Statement
Variable Costing
Sales (3,500 tons X $2,000) .......................... $7,000,000

Inventory, January 1 ............................. $ –0–
Variable cost of goods manufactured
[4,000 tons X ($2,000 X .15)] ............. 1,200,000
Variable cost of goods available
for sale ............................................... 1,200,000
Inventory, December 31
[500 tons X ($2,000 X .15)] ............... 150,000
Variable cost of goods sold ................. 1,050,000
Variable selling expenses
[3,500 tons X ($2,000 X .10)] ............. 700,000 1,750,000
Contribution margin ..................................... 5,250,000
Fixed manufacturing overhead ................... 2,800,000
Fixed administrative expenses .................... 500,000 3,300,000
Net income .................................................... $1,950,000
*PROBLEM 6-7A (Continued)
JACKSON COMPANY
Income Statement
Variable Costing
Sales (4,000 tons X $2,000)............................ $8,000,000

Inventory, January 1 ............................... $ 150,000
Variable cost of goods manufactured
[3,500 tons X ($2,000 X .15)] .............. 1,050,000
Variable cost of goods available
for sale ................................................. 1,200,000
Inventory, December 31 ......................... –0–
Variable cost of goods sold ................... 1,200,000
[4,000 tons X ($2,000 X .10)] .............. 800,000 2,000,000
Contribution margin ....................................... 6,000,000
Fixed manufacturing overhead ..................... 2,800,000
Fixed administrative expenses ..................... 500,000 3,300,000
Net income ...................................................... $2,700,000
(b) JACKSON COMPANY
Income Statement
Absorption Costing
Sales (3,500 tons X $2,000)....................... $7,000,000

Cost of goods sold
Inventory, January 1 .......................... $ –0–
Cost of goods manufactured ............ 4,000,000 (1)
Cost of goods available for sale ...... 4,000,000
Inventory, December 31 .................... 500,000 (2)
Cost of goods sold ............................ 3,500,000
Gross profit ................................................ 3,500,000
[3,500 tons X ($2,000 X .10)] ................. 700,000
Fixed administrative expenses ................ 500,000 1,200,000
Net income ................................................. $2,300,000
(1) 4,000 X [($2,000 X .15) + ($2,800,000 ÷ 4,000)]
(2) 500 X [($2,000 X .15) + ($2,800,000 ÷ 4,000)]
JACKSON COMPANY
Income Statement
Absorption Costing
Sales (4,000 tons X $2,000) ................... $8,000,000

Cost of goods sold
Inventory, January 1 ...................... $ 500,000
Cost of goods manufactured ........ 3,850,000 (1)
Cost of goods available for sale .... 4,350,000
Inventory, December 31................. –0–
Cost of goods sold......................... 4,350,000
Gross profit ............................................ 3,650,000
[4,000 tons X ($2,000 X .10)] .............. 800,000
Fixed administrative expenses ............. 500,000 1,300,000
Net income ............................................. $2,350,000
(1) 3,500 X [($2,000 X .15) + ($2,800,000 ÷ 3,500)]
(c) The variable costing and the absorption costing net income can be
reconciled as follows:
2016 2017
Variable costing net income $1,950,000 $2,700,000
Fixed manufacturing overhead
expensed with variable costing $2,800,000 $2,800,000
Less: Fixed manufacturing overhead
expensed with absorption costing (2,450,000)(1) (3,150,000)(2)
Difference 350,000 (350,000)
Absorption costing net income $2,300,000 $2,350,000
(1)
3, 500 units sold
In 2016, with absorption costing $2,450,000 $2, 800, 000 X of the
4, 000 units produced
fixed manufacturing overhead is expensed as part of cost of goods sold, and $350,000
500 units in inventory
$2,800, 000 X is included in the ending inventory.
4, 000 units produced
(2)
In 2017, with absorption costing $3,150,000 of fixed manufacturing overhead is expensed
as part of cost of goods sold. This includes the fixed manufacturing overhead for 2017 of
$2,800,000 plus $350,000 of fixed manufacturing overhead from 2016 that was included in
the beginning inventory for 2017.
(d) Income parallels sales under variable costing as seen in the increase
in net income in 2017 when 500 additional units were sold. In contrast,
under absorption costing, income parallels production as seen in the
higher net income in 2016 when production exceeded sales by 500
tons.
*PROBLEM 6-8A
(a)
DILITHIUM BATTERIES DIVISION

Income Statement
Absorption Costing
_______________________________________________________________
60,000 90,000
Produced Produced
Sales (60,000 units X $30) $1,800,000 $1,800,000
Cost of goods sold
(60,000 units X $21) 1,260,000 (60,000 X $18) 1,080,000
Gross profit 540,000 720,000
Variable selling and
administrative expenses
(60,000 units x $2) 120,000 120,000
Fixed selling and
administrative expenses 50,000 50,000
Net income $ 370,000 $ 550,000
(b)
DILITHIUM BATTERIES DIVISION

Income Statement
Variable Costing
_______________________________________________________________
60,000 90,000
Produced Produced
Sales (60,000 units X $30) $1,800,000 $1,800,000
(60,000 units X $12) 720,000 720,000
Variable selling and
administrative expenses
(60,000 units X $2) 120,000 120,000
Fixed manufacturing overhead 540,000 540,000
Fixed selling and
administrative expenses 50,000 50,000
Net income $ 370,000 $ 370,000
(c) If the company produces 90,000 units, but only sells 60,000 units,
then 30,000 units will remain in ending inventory. Under absorption
costing these 30,000 units will each include $6 of fixed manufacturing
overhead—a total of $180,000. However, under variable costing, fixed
manufacturing overhead is expensed when incurred. This accounts for
the $180,000 difference ($550,000 – $370,000) in net income. This is
summarized as:
Net income under absorption costing $550,000

Less: Fixed manufacturing overhead included
in ending inventory (30,000 units X $6) 180,000
Net income under variable costing $370,000
(d) Variable costing has a number of advantages over absorption costing

for decision making and evaluation purposes. (1) The use of variable
costing is consistent with cost-volume-profit and incremental analysis.
(2) Net income computed under variable costing is unaffected by
changes in production levels. Note that, under variable costing the
company’s net income is $370,000 no matter what the level of production
is. (3) Net income computed under variable costing is closely tied to
changes in sales levels (not production levels), and therefore provides
a more realistic assessment of the company’s success or failure during
a period. (4) The presentation of fixed and variable cost components
on the face of the variable costing income statement makes it easier to
identify these costs and understand their effect on the business.
Under absorption costing, the allocation of fixed costs to inventory
makes it difficult to evaluate the impact of fixed costs on the
company’s results.
CD 6 CURRENT DESIGNS
(a) Weighted
Average Unit
Contribution
Rotomolded Kayaks Composite Kayaks Margin
+ =
(($950 – $570) X .80) (($2,000 – $1,340) X .20) $436
(b) Break-even Sales = $820,000 ÷ $436 = 1,881 units
Break-even Sales Distribution: Rotomolded Kayaks = 1,881 X 80%

= 1,505 units
Composite Kayaks = 1,881 X 20%
= 376 units
(c) Target Net Income in Units:
Weighted-Average
Rotomolded Kayaks + Composite Kayaks = CM/Unit
($380 X .70) ($660 X .30) $464
Required Sales in Units = ($820,000 + $2,000,000) ÷ $464 = 6,078 units
Required Sales Distribution: Rotomolded Kayaks = 6,078 X 70%

= 4,255 units
Composite Kayaks = 6,078 X 30%
= 1,823 units
(d) CVP Income Statement
Rotomolded Composite
Sales $2,000,000 $1,000,000
Variable Costs 1,200,000* 670,000**
Contribution Margin 800,000 330,000
Fixed Costs 660,000 160,000
Net Income $ 140,000 $ 170,000
*($570 ÷ $950) X $2,000,000 **($1,340 ÷ $2,000) X $1,000,000
CD 6 (Continued)
(e) Degree of Operating Leverage
Rotomolded Kayaks = $800,000 ÷ $140,000 = 5.71

Composite Kayaks = $330,000 ÷ $170,000 = 1.94
At a sales mix of 2/3 to 1/3, the degree of operating leverage is nearly

three times as high for the rotomolded kayaks as it is for the composite
kayaks. This means that the company’s net income will respond more
quickly to a change in the sales of rotomolded kayaks than to composite
kayaks. For example, an increase in sales of the rotomolded kayaks
will increase the company’s net income at a faster rate than an increase
in the sales of the composite kayaks. This result will differ depending
on what sales mix assumption is made.
BYP 6-1 DECISION-MAKING ACROSS THE ORGANIZATION
(a)
Sales (10,000 seats X $500) $5,000,000
Variable costs (10,000 seats X $200) 2,000,000
Contribution margin 3,000,000
Fixed costs 2,000,000
Net income $1,000,000
(b) Contribution margin ratio = $3,000,000 ÷ $5,000,000 = .60
Break-even point in dollars = $2,000,000 ÷ .60 = $3,333,333
Margin of safety ratio = ($5,000,000 – $3,333,333) ÷ $5,000,000 = .333
Degree of operating leverage = $3,000,000 ÷ $1,000,000 = 3.0
(c)
Sales (10,000 seats X $500) $5,000,000
Variable costs (10,000 seats X $ 100) 1,000,000
Contribution margin 4,000,000
Fixed costs 3,000,000
Net income $1,000,000
(d) Contribution margin ratio = $4,000,000 ÷ $5,000,000 = .80
Break-even point in dollars = $3,000,000 ÷ .80 = $3,750,000
Margin of safety ratio = ($5,000,000 – $3,750,000) ÷ $5,000,000 = .25
Degree of operating leverage = $4,000,000 ÷ $1,000,000 = 4.00
(e) By automating its manufacturing process the company will replace some
of its variable costs with fixed costs. This shift toward more fixed costs
will increase its break-even point from $3,333,333 to $3,750,000 and
reduce its margin of safety from 33.3% to 25%. This means that under
the old system sales could fall by 33.3% percent before the company
would operate at a loss, whereas under the automated system they could
only fall by 25%. Both of these findings suggest that the company would
be riskier with the automated system. However, the company’s degree
of operating leverage would increase from 3.0 to 4.00. This means that
with a change in sales, the change in net income would be 1.33 (4 ÷ 3)
times higher under the automated system. This would be good if the
company expects sales to increase, but would be bad if the company’s
sales fall.
BYP 6-2 MANAGERIAL ANALYSIS
(a) The contribution margin ratios under each approach are:
Current approach $500,000/$2,000,000 = .25

Automated approach $1,000,000/$2,000,000 = .50
This means that for every dollar of sales, net income goes up by
25 cents under the current approach, but by $.50 under the automated
approach.
(b) The break-even points in sales dollars under each approach are:
Current approach $380,000/.25 = $1,520,000

Automated approach $800,000/.50 = $1,600,000
This shows that, under the automated approach, the company’s sales
would have to be 5.26% higher just to break-even.
(c) At the current level of sales, the margin of safety ratio under each
approach is:
Current approach ($2,000,000 – $1,520,000)/$2,000,000 = .24
Automated approach ($2,000,000 – $1,600,000)/$2,000,000 = .20
The company has a low margin of safety under either approach. Under
the current approach sales could drop 24% before the company would
be operating at a loss. Under the automated approach the company’s
sales could drop by 20% before it would be operating at a loss.
(d) The degree of operating leverage under each approach at the current
level of sales is:
Current approach $500,000/$120,000 = 4.17

Automated approach $1,000,000/$200,000 = 5.00
This means that for a 10% drop in sales net income would drop by
41.7 percent for the current approach, but 50% for the automated
approach. Recall, however, that at the current level of sales the company
makes considerably more money using the automated approach.
BYP 6-2 (Continued)
(e) In order to solve for the sales level where net income would be equal
under either approach, set the two CVP equations equal to each other
and solve for sales:
Sales – ((1 – .75) X Sales) – $380,000 = Sales – ((1 – .5) X Sales) – $800,000
(.25 X Sales) – $380,000 = (.5 X Sales) – $800,000
(.25 X Sales) = $420,000
Sales = $1,680,000
When sales are equal to $1,680,000 the company would make the same
amount of income under either approach.
Current approach $1,680,000 – [(1 – .25) X $1,680,000] – $380,000 = $40,000

Automated approach $1,680,000 – [(1 – .5) X $1,680,000] – $800,000 = $40,000
(f) Based upon this numeric analysis it would appear that the decision to
purchase the automated system would be a good decision. The
current level of sales far exceeds the break-even point, and, unless
sales were to fall all the way to $1,680,000, the company would be
better off under the automated system. However, there are many
difficult issues that should also be considered. Not-the-least of these
is the decision to lay-off 15 employees, many of whom have likely been
with the company for a long time. Also, the company should carefully
evaluate whether the automated system will be able to attain the same
level of quality as the skilled employees. Perhaps the automated
system would be more appropriate for some of the painting work,
while skilled labor would be more appropriate for other painting work.
BYP 6-3 REAL-WORLD FOCUS
(a)
($ in millions) Soup and
Consumer Pet Infant-Feeding
Products Products Products
Sales $1,031.8 $ 837.3 $ 302.0
Variable costs 610.0 350.0 100.0
Contribution margin $ 421.8 $ 487.3 $ 202.0
Contribution margin $ 421.8 $ 487.3 $ 202.0

÷ Sales 1,031.8 837.3 302.0
Contribution margin ratio 40.9% 58.2% 66.9%
Division sales $1,031.8 $ 837.3 $ 302.0

÷ Total sales 2,171.1 2,171.1 2,171.1
Sales mix percentage 47.5% 38.6% 13.9%
(b)
Weighted-Average
Consumer products 47.5% 40.9% .194
Pet products 38.6% 58.2% .225
Soup and infant-feeding
products 13.9% 66.9% .093
.512
Break-even point
in dollars = $860,300,000 ÷ .512 = $1,680,273,438
Sales Mix Sales from

Percentage X Total Sales = Each Product*
Consumer products 47.5% X $1,680,273,438 = $ 798,129,883
Pet products 38.6% X $1,680,273,438 = 648,585,547
Soup and infant-
feeding products 13.9% X $1,680,273,438 = 233,558,008
Total sales $1,680,273,438
*Sales are rounded
(a) The four primary product lines are FedEx Express (provides express
transportation); FedEx Ground (small package ground delivery); FedEx
Freight (regional, less-than-truckload freight service); and FedEx
Services (Sales, information technology, communications). The key
factors affecting operating results are overall customer demand, the
volumes of shipments transported through networks; the mix of
services purchased by customers; the prices obtained for services;
ability to manage cost structure for capital expenditures and operating
expenses; ability to match operating costs to shifting volumes; and the
timing and amount of fluctuations in fuel prices and our ability to
recover incremental fuel costs through our fuel surcharges.
(b)
FEDEX GROUND
Income Statement
For the Year Ended May 31, 2013
Variable Costing
(In Millions)
____________________________________________________________
Revenues ....................................................... $10,578
Variable costs:
Salaries and employee benefits ............. $1,586
Purchased transportation ....................... 4,191
Fuel ........................................................... 17
Maintenance and repairs ......................... 190
Intercompany charges............................. 1,148 7,132
Fixed costs:
Rentals ...................................................... 331
Depreciation and amortization ............... 434
Other ......................................................... 893 1,658
Net income .................................................... $1,788
Contribution Contribution
Margin ÷ Revenues = Margin Ratio
$3,446 ÷ $10,578 = 32.6%
Contribution Break-even Point

Fixed Costs ÷ Margin Ratio = in Dollars
$1,658 ÷ .326 = $5,085.9 million
BYP 6-4 (Continued)
(c)
(i)
2013 2011
FedEx Express $27,171 ÷ $44,730 = 60.7% $24,581 ÷ $39,661 = 62.0%
FedEx Ground 10,578 ÷ $44,730 = 23.6% 8,485 ÷ $39,661 = 21.4%
FedEx Freight 5,401 ÷ $44,730 = 12.1% 4,911 ÷ $39,661 = 12.4%
FedEx Services 1,580 ÷ $44,730 = 3.5% 1,327 ÷ $39,661 = 4.2%
Total $44,730 $39,661
(ii) 2013 2011

FedEx Express 2.0% 5.0%
FedEx Ground 16.9% 15.6%
FedEx Freight 3.9% (3.6)%
(iii) In part (ii) we see that the FedEx Express’s operating margin declined,
but the other two increased. We also see in part (ii) that FedEx Express
had the lowest operating margin in 2013 (2.0%) while FedEx Ground
had the highest (16.9%). In part (i) we see that the company shifted its
sales mix percentage down in FedEx Express (62.0% to 60.7%) and
FedEx Services but increased its sales mix percentage for FedEx
Ground (21.4% to 23.6%) and FedEx Freight (12.4% to 12.1%). Thus, during
this period two of the company’s divisions became more profitable,
and the company successfully shifted its sales mix so that more of its
revenue came from its more profitable divisions.
(a) Smart Balance relies very heavily on outsourcing. It keeps it employees

and investments in fixed assets to a minimum. As a consequence it
has very low fixed costs.
(b) The company keeps new-product development and marketing in house.
(c) The potential advantage of having very low fixed costs is that the
company has a lower break-even point. It can be profitable at relatively
low volumes of sales and therefore it has less potential for financial
failure.
(d) The potential disadvantage of this approach is that its low fixed costs
means that the company has low operating leverage. If the company’s
sales increase significantly, it would not enjoy the same increase in
profitability as a company that was producing its own goods.
BYP 6-6 COMMUNICATION ACTIVITY
MEMO
To: Bjorn Borg—CEO
From: Student
Re: Best use of limited resources
I share your concern, that, since we are operating at full capacity, we need
to ensure that our product mix maximizes our profitability. The decision of
how to best utilize our limited productive resources is one of the most
important decisions we face. We currently make two different anchors, a
traditional fishing anchor, and a high-end yacht anchor. The unit
contribution margin of the yacht anchor is three times that of the fishing
anchor, thus one might logically assume that we should shift our
production toward producing the yacht anchor. However, this assumption
ignores an element that is critical to the decision. In order to make a proper
decision, we would need to know the contribution margin per unit of limited
resource that each product produces. While the yacht anchor has a very high
contribution margin, it also may consume considerably more productive
resources. I propose that a study be done to determine exactly how much
of the limited productive resource is consumed by one unit of each of the
two anchor types.
In addition, at the same time that this study is being undertaken, I propose
that the marketing department undertake a study of the demand for each
anchor type. This is important so that we don’t produce anchors that we
can’t sell.
Finally, a shift in our product mix would maximize our profitability at our
current level of productive capacity. However, we should also consider a
more long-term solution to our production constraints. Since we have been
operating at, or near full capacity for two years, it would seem appropriate
to undertake a study of whether an acquisition of additional plant equipment
would be appropriate.
*BYP 6-7 ETHICS CASE
(a) The division’s net income increased by $225,000 ($525,000 – $300,000).

This represents a 75% increase over the previous year ($225,000 ÷
$300,000). Thus Brett’s bonus would be 75 X $5,000 = $375,000.
(b) In 2016 the number of units produced and sold were equal. When this
occurs variable costing and absorption costing provide the same
results. Thus, in 2016, net income under variable costing would have
been $300,000. In 2017, units produced exceeded units sold by 5,000
units. However, net income under variable costing is not impacted by
the number of units produced. Since the number of units sold did not
change from 2016 to 2017, and the selling price, variable cost per unit,
and total fixed costs didn’t change, the division’s net income in 2017
would equal its 2016 income of $300,000.
(c) In part (b) it was determined that the division’s net income would have
been $300,000 in 2017 under variable costing. Since this is the same as
2016 net income, Brett would not receive a bonus.
(d) If Brett intentionally overproduced inventory in order to increase his

bonus, then his actions were unethical. Overproduction of inventory
increases the company’s costs related to inventory, such as storage,
handling, waste and theft. Based on the information provided we
can’t actually determine Brett’s motives. He may have believed that
just-in-time inventory was causing the company to lose sales due to
“stock-outs.” If that was the case, there would be options available
to the company other than totally giving up on just-in-time practices. In
order to eliminate any potential conflicts of interest between Brett and
the company, and to ensure that his actions are in the best interest of the
company, the company could begin preparing variable costing income
statements to supplement its absorption costing statements for the
purpose of calculating bonuses. This would eliminate any incentive
Brett might have to over-produce, as well as providing useful information
for other internal management decision making.
BYP 6-8 ALL ABOUT YOU
(a) Using a common equation for CVP analysis,

Sales = Variable Costs + Fixed Costs + Net Income, and substituting the
information provided, and knowing that at break-even, net income = $0,
($26 X 300) = Variable Costs + ($4,000 + $1,460) + $0

$7,800 = Variable Costs + $5,460 + $0
$2,340 = Variable Costs (in total)
or $7.80 (variable costs/member/month) = $2,340 ÷ 300
(b) To find the sales required to reach a target net income, contribution
margin must be calculated.
Contribution Margin = Sales – Variable Costs
Contribution Margin = $7,800 – $2,340
Contribution Margin = $5,460
Unit Contribution Margin = $5,460/300 memberships = $18.20
Contribution Margin Ratio = $5,460/$7,800 = 70%
To compute the sales required to reach a target net income of $3,640.

Required Sales in Units = (Fixed Costs + /Unit Contribution
Target Net Income) Margin
Required Sales in Units = ($5,460 + $3,640)/$18.20

Required Sales in Units = 500 memberships
Required Sales in Dollars = 500 memberships X $26

= $13,000
Using the contribution margin ratio,

Required Sales in Dollars = (Fixed Costs + /Contribution Margin
Target Net Income) Ratio
Required Sales in Dollars = ($5,460 + $3,640)/70%

Required Sales in Dollars = $13,000
(c) Answers will vary. Suggested examples include franchise fees, employee
wages, utilities, supplies, and maintenance.
(d) Answers will vary.
BYP 6-9 CONSIDERING CORPORATE SOCIAL RESPONSIBILITY
Discussion Guide: If reduction of greenhouse gas emissions is a goal, then

one step toward attainment of that goal is to assign a cost to greenhouse-
gas emissions. One approach that is currently being used is the buying and
selling of carbon-emission rights. As companies buy and sell emission rights,
the price of polluting becomes a tangible factor in the formulations that will
be used to make future energy-source decisions. This approach has been
effective in addressing similar issues, such as the reduction of sulfur
emissions. However, as suggested in the “No” response, many believe that,
to be effective and fair, an enforceable international agreement on such an
approach would be necessary. In the United States, companies currently
participate on a voluntary basis; in some other countries, participation is
required. Another factor to consider in these decisions is the timing of
conversion to new technology. A gradual conversion to new technologies
as existing power plants reach the end of their productive lives would be
far less costly than a rapid conversion to new technologies that required
scrapping existing plants before they are fully depreciated. Decisions
about which plants to replace and when to replace them will require careful
cost-benefit analyses.

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CHAPTER 6

Cost-Volume-Profit Analysis: Additional Issues

ASSIGNMENT CLASSIFICATION TABLE

1. Apply basic CVP concepts. 1, 2, 3, 4, 5, 1, 2, 3, 4, 5, 1 1, 2, 3, 4, 5 1A, 2A, 6A

2. Explain the term sales mix and 7, 8, 9 7, 8, 9, 10 2 6, 7, 8, 9, 10 3A

3. Determine sales mix when a 10, 11 11, 12 3 11, 12, 13 4A

Problem Difficulty Time

1A Compute break-even point under alternative courses of Moderate 20–30

BLOOM’S TAXONOMY TABLE

Learning Objective Knowledge Comprehension Application Analysis Synthesis Evaluation

Broadening Your Perspective BYP6-6 BYP6-3 CD6 BYP6-5 BYP6-2

Sales .......................................................................................................... $900,000

*19. One way to compute the difference is as follows:

BRIEF EXERCISE 6-1

1. (a) $70 = ($250 – $180)

2. (c) $300 = ($500 – $200)

3. (e) $1,100 = ($330 ÷ 30%)

BRIEF EXERCISE 6-2

Sales ........................................................................ $2,000,000

BRIEF EXERCISE 6-3

Contribution margin ratio = [($250,000 – $150,000) ÷ $250,000] = 40%

(a) $400Q = $250Q + $210,000 + $0

(b) Unit contribution margin $150, or ($400 – $250)

BRIEF EXERCISE 6-5

X = .70X + $210,000 + $60,000

BRIEF EXERCISE 6-6

Margin of safety = $1,200,000 – $960,000 = $240,000

BRIEF EXERCISE 6-7

BRIEF EXERCISE 6-9

(b) Total break-even

Birthday $1,500,000 X .30 = $ 450,000

BRIEF EXERCISE 6-10

(b) Weight-average contribution = $575,000 = .46

BRIEF EXERCISE 6-12

BRIEF EXERCISE 6-13

Diggs Co. Doggs Co.

BRIEF EXERCISE 6-15

*BRIEF EXERCISE 6-16

*BRIEF EXERCISE 6-17

(a) Absorption Costing

(b) Variable Costing

*BRIEF EXERCISE 6-19

To: Chief financial officer

Re: Absorption and variable costing

Under absorption costing, fixed manufacturing overhead is a product cost,

(a) Break-even point in units is 7,500 units ($150,000 ÷ $20).

(b) Break-even point in units is 8,333 units (rounded) ($150,000 ÷ $18*).

*$50 – (.04 X $50) – 30 = $18.

The increase in the break-even point from $375,000 to $400,000 indi-

(a) The sales mix percentages as a function of units sold is:

Basic Basic Plus Premium

(b) The weighted-average unit contribution margin is:

(d) The break-even units to produce for each product are:

Good Better Best

(a) Contribution Degree of operating

The degree of operating leverage measures the company’s sensitivity to

(a) 1. Contribution margin per room = $60 – ($8 + $34)

Fixed costs = $10,600 + $2,400 + $1,500 + $800 = $15,300

2. Break-even point in dollars = 850 rooms X $60 per room