Case study 16-13
Bill French
CHAPTER 16
G R O U P
5
Introduction
Bill French was a Staff Accountant in Duo-Products Group.
• He used to report directly to his boss, Wes Davidson(Controller).
• He wanted to do use Break-even analysis for the planning procedures,
which was first of its kind for the Duo-Products Group.
• Basically what French had done was to determine the level at which the
company must operate in order to break even.
• As he put it,
1. The company must be able at least to sell a sufficient volume of goods
so that it will cover all the variable costs of producing and selling the
goods.
2. Further, it will not make a profit unless it covers the fixed costs as well.
3. The level of operation at which total costs are just covered is the breakeven
volume.
4. This should be the lower limit in the planning
Accounting
Records
The accounting records had provided the following information that
French used in constructing his chart:
1. Plant Capacity-2 million units per year.
2. Past year’s level of operations- 1.5 million units.
3. Average unit selling price- $7.20.
4. Total fixed costs- $2,970,000.
5. Average unit variable costs- $4.50.
Question 1
What are the assumptions implicit in Bill
French's determination of his company's
break-even point?
Answer
1.There is just one break even point for the
firm
2.Sales mix will remain constant
3.Level of fixed and variable costs has been
assumed to be unchanged
4.Sales prices will remain constant
Question 2
On the basis of French's revised information,
what does next year look like:
a. What is the break-even point?
2(a). Assumption for next year
Product A reduces to 400,000 units
Product C increase to 950,000 units
(500,000+200,000+250,000)
Fixed cost per year increase to $720,000($60,000 x 12
months and the difference charged to Product C only
Fixed cost for Product C = $450,000 + $720,000 =
$1,170,000.
Selling price for Product C increase to $4.80.
Formula
Variable cost to sales : Total Variable cost
Sales revenue
Utilization of capacity : Sales volume
Sales at full capacity
Break-even point operation : Fixed Cost
Contribution/unit
The break-even point for next year
Question 2
b. What level of operations must be
achieved to pay the extra dividend, ignoring
union demands?
2(b). To pay extra dividend
Last year
Profit = $900,000 (divided evenly between government & company $450,000:$450,000)
Dividend paid = $300,000
This year
Dividend to be paid = $300,000 + 50% extra = 300,000 + 150,000 = $450,000
Profit retained = $150,000
Profit (after tax) needed by company = 450,000 + 150,000 = $600,000
Profit (before tax) targeted = $600,000 + $600,000 because the profit will be divided
evenly between gov. and co,
Level of operation must be achieved
The profit before tax must be $1,200,000 in order to meet the dividend of
$450,000 and retained profit of $150,000., therefore it is considered as fixed
cost.
Question 2
C. What level of operations must be
achieved to meet the union demands,
ignoring bonus dividends?
2(c). To meet the union demands
Increase 10% in variable cost
Total variable cost = $5,925,000 + 10% = $6,517,500
Variable cost per unit = $6,517,500/1,750,000 units = $3.72
Contribution per unit = Selling price - variable cost per unit = 6.95 - 3.72 = 3.23
Dividend maintains as $300,000
Profit to be retain is still $150,000
Level of operation must be achieved
Question 2
d. What level of operations must be
achieved to meet both dividends and
expected union requirements?
2(d). To meet the union demands and
expectation dividend
Increase 10% in variable cost
Total variable cost = $5,925,000 + 10% = $6,517,500
Variable cost per unit = $6,517,500 / 1,750,000 units = $ 3.72
Contribution per unit = Selling price - variable cost per unit = 6.95 - 3.72 = 3.23
Dividend : $450,000
Profit to be retained is still $150,000
Level of operation must be achieved
Question 3
Can the break-even analysis help the
company to decide whether to alter the
existing product emphasis? What can the
company afford to invest for additional "C"
capacity?
Breakeven Analysis:
Help the company decide to alter
the existing product because it will
allow the company to identify which
product generates the highest profit.
Question 4
Calculate each of the three products breakeven points using the data in Exhibit 3. Why
is the sum of these three volumes not equal
to the 1,100,000 units aggregate break-even
volume?
Sum of the three products A + B + C = 1,181,143 units
Not equal to 1,100,000 because = Fixed Cost
This is because, if the product are calculated individually where
it ignores the effect of the product mix there is a diffrent in
total amount of BEP
This is where the production of each product is different in values
and units that contribute to the fixed costs
In this product mix, the higher the contribution margin in a
product will help to cover the fixed costs of the less efficient
product because they share the same fixed costs.
Question 5
Is this type of analysis of any value? For
what can it be used?
CVP analysis:
Is a simplified technique for a decision-making process
Gives the insight to the company on the needs to make
the right choices and avoid costly mistakes
Provides management with a comprehensive overview
of the effects on revenue and costs of all kinds of shortterm financial changes
By understanding the break-even point concept it
enables the company to take a number of strategic
decision
It can be used
To help understand and formulate the relationship
between cost (fixed and variable), output, profit.
To determine the most profitable product or service
To identify what sales volumes that need to be achieved
and sales goals that need to meet by the marketing or
sales department
To assist in establishing prices of products or services
To assist in analyzing how the mix of products affects profit
To set sales target and/or price to generate profits.
To find out which product are performing well and which
are leading to losses
Conclusion
Cost Volume Profit (CVP) Analysis and Break Even Analysis is
the critical factor in profit planning
As an important part for the company of short-term decision
making in a business