ACCT 2302
Fundamentals of Accounting II
Spring 2011
Lecture 7
Professor Jeff Yu
Review: The Contribution Format Income Statement
Used primarily for
external reporting
Used primarily for Managerial
Decision making
Review: The Contribution Margin Method
Break - even Pointin Units
Fixed Expenses
CM per Unit
Break - even Pointin Sales Dollars
Units sales to attain Target Profit 
Fixed Expenses
CM Ratio
Fixed Expenses  Target Profit
CM Per Unit
Review: The Equation Method
Let B.E.P. in units = X
Sales – Variable Expenses – Fixed Expenses = NOI
Price * X
VC/unit * X
$$$
B.E.P in sales dollars = B.E.P. in Units * Price
$0
CVP Analysis: Changes in Break-even Point
How can a company change its break-even point?
1. If fixed costs change by X%, then break-even point
would also change by X% (assuming everything else
remains constant)
2. An increase or decrease in CM per unit will also change
break-even point.
CVP Analysis: predicting profit
Expected profit (NOI) may change due to:
 a change in fixed expenses
 a change in CM per unit (=price - VC/unit)
 a change in sales volume:
once the break-even point has been reached, NOI will
increase by CM per unit for each additional unit sold.
Two approaches to predict profit using CVP analysis:
1) Income Statement approach
2) Incremental approach
Example
Razor Inc. is currently selling 500 scooters per month. The owner
believes that an increase of $10,000 in the monthly advertising
budget would increase sales of scooters to 540 per month.
Q: Should the increase in advertising be made?
Sales
Current Sales
(500 Scooters)
$
250,000
Less: variable expenses
Contribution margin
$
Less: fixed expenses
Net Operating Income
$
150,000
100,000
80,000
20,000
Proposed
Sales
(540 Scooters)
Margin of Safety
The amount by which sales can drop before losses are incurred.
Margin of Safety in units
= Budgeted or actual units sold – Break-even point in units
Margin of Safety in sales dollars
= Budgeted or actual sales – Break-even point in sales dollars
Margin of Safety percentage
= Margin of Safety in units / Budgeted or actual units sold
= Margin of Safety in sales dollars / Budgeted or actual sales
Example
Coffee Klatch is an espresso stand in a downtown office building.
The price of a cup of coffee is $1.5 and the variable expense per
cup is $0.36. The fixed expense per month is $1,140. Each month
2,000 cups are sold.
Q: (1) What is the margin of safety in cups?
(2) Margin of safety in sales dollars?
(3) Margin of safety percentage?
Operating Leverage
A measure of how sensitive net operating income is to
percentage changes in sales.
Degree of
Operating Leverage
=
Contribution Margin
Net operating income
Thought Question: How will cost structure (relative
proportion of fixed costs) or sales volume
affect the degree of operating leverage?
Example
Actual sales
500 Bikes
Sales
$ 250,000
Less: variable expenses
150,000
Contribution margin
100,000
Less: fixed expenses
80,000
Net income
$
20,000
Q: (1) What is the degree of operating leverage?
(2) If sales increase by 10%, net operating income will
increase by ___%?
Sales Mix and Break-even Analysis
The sales mix is the relative proportions in which a company’s
multiple products are sold. Profits will often be greater if high-margin
items make up a larger proportion of total sales.
For simplicity, we assume sales mix is always CONSTANT, that is,
the relative proportions of each product as a percentage of total
sales do not change as sales volume changes.
Example
Okabee Co. makes two products: A100 & B900.
A100
B900
Total
Sales
$700,000
$300,000
$1,000,000
CM Ratio
60%
70%
?
Q: Based on the current sales mix,
(1) What is its break-even point in total sales dollars?
(2) Prepare a contribution format income statement for Okabee.
(3) If sales increase by $50,000 per month, by how much would you
expect net operating income to increase?
Practice Problem
Description
Scooters
Bicycles
Total sold
Unit
Unit
Number
Selling Variable Contribution of units
Price
Cost
Margin
sold
$
500 $
300
500
1,000
450
250
750
Razor sells scooters and bicycles. Total fixed cost is $95,000.
Q: What is Razor’s breakeven point based on the current sales mix
(for every 1 bicycle sold, 2 scooters are sold)?
For Next Class
 Review for Midterm Exam 1
Homework Problem 1
Acoustic Concepts is currently selling 400 speakers per month;
monthly sales are $100,000. Variable cost per speaker is 60% of
the speaker price. The sales manager feels that a $10,000 increase
in the monthly advertising budget would increase monthly sales by
$30,000.
Q: Should the advertising budget be increased?
Homework Problem 2
In 2008, Voltar Co. sold 20,000 units of a special telephone at $60 each,
variable expenses were $900,000 and fixed expenses were $240,000.
Q:(1) Sales are expected to increase by $400,000 in 2010. If cost
behavior remain unchanged, by how much will NOI increase in 2010?
(2) Compute its margin of safety in dollars and percentages.
(3) Compute its degree of operating leverage at current sales volume.
(4) If sales increase by 8% in 2011, by what % will NOI increase?
(5) If a high-quality speaker is used, annual sales will increase by 20%,
variable cost will increase by $3 per unit, but annual salary of $30,000
paid to one quality inspector can be eliminated. Should the change be
made?
Homework Problem 3
Pittman Co. produces two products, A and B. Product A accounts for
20% of total sales, while B accounts for 80% of sales. Variable
expense ratios are 75% for A and 50% for B. Pittman’s total fixed
cost is $90,000.
Q: Based on the current sales mix,
(1) What is its break-even point in total sales?
(Hint: CM ratio = 1 – variable expense ratio)
(2) Assume the unit price of product B is $24, how many units of B
should Pittman sell to break even?