Exercise 1:

1. What is the monthly break-even point in unit sales and in dollar sales?
Total fixed expenses $216,000
- Break-even in units = = = 12,000 units
Contribution Margin per Uni $18

- Break-even in dollar sales = Break-even in units × Selling price per unit = 12,000 × $30 =
$360,000

2. Without resorting to computations, what is the total contribution margin at the

break-even point?
At break-even, the income is zero.

Profit = (Sales – Variable Cost) – Fixed Cost

=> 0 = Contribution Margin – Fixed Cost

=> Fixed Cost = Contribution Margin = $216,000

3. How many units would have to be sold each month to attain a target proit of
$90,000? Verify your answer by preparing a contribution format income statement
at the target sales level.
Target profit = $90,000
Fixed expenses + Target profit $216,000 + $90,000
Unit sales to target profit = = = 17,000 units.
Contribution Margin per Uni 18

Contribution Format Income Statement

Sales (17,000 × $30) $510,000

Variable expenses (17,000 × $12) 204,000

Contribution Margin (17,000 × $18) 306,000

Fixed expenses 216,000

Net Operating Income $90,000

 4. Refer to the original data. Compute the company’s margin of safety in dollar and
percentage terms.
Margin of safety in dollars = Total Sales - Break-even Sales in dollar = $450,000 - $360,000 =
$90,000
Margin of safety in dollars $90,000
Percentage of Margin of safety = ×100 = ×100 = 20%
Actual sales $450,000

5. What is the company’s CM ratio? If the company can sell more units, thereby
increasing sales by $50,000 per month, and there is no change in fixed expenses, by
how much would you expect monthly net operating income to increase?
The Contribution Margin is the difference between your business’s Sales and Variable Expenses
for a period. Following that, the Contribution Margin Ratio is calculated by divided Contribution
Margin by Sales. Moreover, the Contribution Margin (CM) ratio indicates the company's ability to
generate profit from each dollar of sales, assuming fixed costs remain constant. A higher CM ratio
means that a greater portion of sales revenue contributes to covering fixed costs and generating
profit.
Sales−Variable Expenses
Contribution Margin ratio =
Sales

Sales−Variable Expenses $450,000−$180,000

- CM ratio = = = 0.6 = 60%
Sales $450,000

- Change in Net Operating income = Change in Sales × Contribution Margin Ratio = $50,000 ×
60% = $30,000

Exercise 2:

1. Determine the unit product cost under:

a. Absorption costing:
$315,000
Average fixed manufacturing overhead = = $18 per unit
$17,500

Total unit product cost = Direct labor + Direct materials + Manufacturing Overhead (Fixed MO
+ Variable MO) = $7 + $10 + $5 + $18 = $40 per unit

b. Variable costing:

Total unit product cost = Direct labor + Direct materials + Manufacturing Overhead (Variable
MO)= $7 + $10 + $5 = $22 per unit.
 2. Prepare variable costing income statements for July and August.
Sales:
 July: 15,000 × $60 = $900,000
 August: 20,000 × $60 = $1,200,000
Variable COGS:
 July: 15,000 × $22 = $330,000
 August: 20,000 × $22 = $440,000
Variable S&A:
 July: 15,000 × $3 = $45,000
 August: 20,000 × $3 = $60,000

Variable Costing Contribution Format Income Statement

July August
Sales $900,000 $1,200,000
Less: Variable Expenses
Variable COGS $330,000 $440,000
Variable S&A 45,000 60,000
Total Variable Expenses 375,000 500,000
Contribution margin 525,000 700,000
Less: Fixed Expenses
Fixed MO 315,000 315,000
Fixed S&A 245,000 245,000
Total Fixed Expenses 560,000 560,000
Net Operating Income (loss) ($35,000) $140,000
3. Reconcile the variable costing and absorption costing net operating incomes.
Change in inventory for July = Units produced - Units sold = 17,500 - 15,000 = 2,500 units

=> Fixed MO deferred in inventories

Reconciliation of Variable Costing and Absorption Costing Net Operating Incomes for July
July
Variable costing net operating income (loss) ($35,000)
Add: Fixed manufacturing overhead deferred in inventory (2,500 × $18) 45,000
Absorption costing net operating income $10,000
Change in inventory for August = Units produced - Units sold = 17,500 - 20,000 = - 2,500 units

=> Fixed MO released from inventories

Reconciliation of Variable Costing and Absorption Costing Net Operating Incomes for August
August
Variable costing net operating income $140,000
Deduct: Fixed manufacturing overhead released from inventory (2,500 × $18) 45,000
Absorption costing net operating income $95,000

4. Memo for the President:

To: President, Denton Company

From: Group 1
Subject: Explanation of Net Operating Income Discrepancy

Dear President,

Your concern about between the break-even point calculation and the income statement is totally
understandable. There are some differences due to the difference between two methods: Variable
Costing and Absorption Costing.

Under absorption costing, some fixed manufacturing costs were deferred in inventory rather than
being fully expensed. Since 2,500 units were added to inventory in July, a portion of the fixed
costs ($45,000) was not included in expenses, which artificially increased net income. This
resulted in an absorption net income of $10,000, despite the fact that the company had not reached
the 16,000-unit break-even sales volume.

In contrast, under variable costing, all fixed costs are expensed immediately, leading to a net loss
of $35,000 in July.

To sum up, the net operating income calculated by Absorption Costing is higher than by using
Variable Costing when the unit produced is greater than the unit sold.

Best regard,

Group 1.
Exercise 3:

1. The first-stage allocations of overhead costs to the activity cost pools.

- Wages and Salaries ($300,000)

 Supporting Direct Labor: $300,000 × 40% = $120,000

 Order Processing: $300,000 × 30% = $90,000
 Customer Support: $300,000 × 20% = $60,000
 Other: $300,000 × 10% = $30,000

- Other Overhead Cost ($100,000)

 Supporting Direct Labor: $100,000 × 30% = $30,000

 Order Processing: $100,000 × 10% = $10,000
 Customer Support: $100,000 × 20% = $20,000
 Other: $100,000 × 40% = $40,000

Activity Cost Pools

Supporting Order Customer
Other Total
Direct Labor Processing Support
Wages and Salaries $120,000 $90,000 $60,000 $30,000 $300,000
Other Overhead Cost 30,000 10,000 20,000 40,000 100,000
Total $150,000 $100,000 $80,000 $70,000 $400,000

2. Compute the activity rates for the activity cost pools.

Computation of Activity Rates

Activity Rate
Total Cost Total Activity (𝑎)
Activity Cost Pools
(a) (b) (𝑏)

Supporting Direct Labor $150,000 20,000 DLHs $7.5 per direct labor-hours
Order Processing 100,000 400 orders $250 per order
Customer Support 80,000 200 customers $400 per customer
Other 70,000 Not applicable Not applicable
Total $400,000
 3. Calculate the total overhead costs for the order from Shenzhen Enterprises
including customer support costs.
- “During the year, Advanced Products completed one order for a new customer, Shenzhen
Enterprises. This customer did not order any other products during the year.”

=> Order Processing: 1 Activity and Customer Support: 1 Acitivity

- Direct labor - hours = 10 units × 2 DLHs per unit = 20 direct labor-hours

Overhead Cost for the ShenZhen Enterprises

Activity Cost Pools Activity Rate Activity ABC Cost
Supporting direct labor $7.5 20 $150
Order processing 250 1 250
Customer support 400 1 400
Total $800

4. Calculate the customer margin for Shenzhen Enterprises.

 Total Revenue = $300 × 10 = $3,000
 Direct Labor = $50 × 10 = $500
 Direct Materials = $180 × 10 = $1,800

Customer Margin Calculation

Sales $3,000
Deduct: Direct Costs
Direct Labor $500
Direct Materials 1,800
Supporting direct labor 150
Order processing 250
Customer support 400 3,100
Total Customer Margin ($100)