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Financial & Managerial Accounting
Found in: Page 840
Financial & Managerial Accounting

Financial & Managerial Accounting

Book edition 7th
Author(s) John J Wild, Ken W. Shaw, Barbara Chiappetta
Pages 1096 pages
ISBN 9781259726705

Short Answer


Henna Co. produces and sells two products, T and O. It manufactures these products in separate factories and markets them through different channels. They have no shared costs. This year, the company sold 50,000 units of each product. Sales and costs for each product follow.

Product T

Product O

Sales

$2,000,000

$2,000,000

Variable cost

1,600,000

250,000

Contribution margin

400,000

1,750,000

Fixed costs

125,000

1,475,000

Income before taxes

275,000

275,000

Income taxes (32% rate)

88,000

88,000

Net income

$187,000

$187,000

Required

1. Compute the break-even point in dollar sales for each product. (Round the answer to whole dollars.)

2. Assume that the company expects sales of each product to decline to 30,000 units next year with no change in unit selling price. Prepare forecasted financial results for next year following the format of the contribution margin income statement as just shown with columns for each of the two products (assume a 32% tax rate). Also, assume that any loss before taxes yields a 32% tax benefit.

3. Assume that the company expects sales of each product to increase to 60,000 units next year with no change in unit selling price. Prepare forecasted financial results for next year following the format of the contribution margin income statement shown with columns for each of the two products (assume a 32% tax rate).

Analysis Component

4. If sales greatly decrease, which product would experience a greater loss? Explain.

5. Describe some factors that might have created the different cost structures for these two products.

  1. Break-even sales:

Product T: $625,000

Product O: $1,658,714

2. Net income when 30,000 units are sold:

Product T: $78,200

Product O: ($289,000)

3. Net income when 60,000 units are sold:

Product T: $241,400

Product O: $425,000

4. Product O will incur a higher loss due to a decrease in sales volume.

5. Direct material, labor, and production facilities.

See the step by step solution

Step by Step Solution

Step 1: Definition of Fixed Cost

Fixed cost is that cost that is not affected by the level of activity achieved by the business entity. Such cost remains fixed until the capacity is increased by capital expenditure.

Step 2: Break-even point in dollar sales

Product

Contribution

/

Sales

=

Contribution margin ratio

T

$400,000

/

$2,000,000

=

0.20

O

$1,750,000

/

$2,000,000

=

0.875

Product

Fixed cost

/

Contribution margin ratio

=

Break-even sales in dollar

T

$125,000

/

0.20

=

$625,000

O

$1,475,000

/

0.875

=

$1,658,714

Step 3: Forecasted income statement for 30,000 units

Product T

Product O

Sales

$1,200,000

$1,200,000

Variable cost

960,000

150,000

Contribution margin (as per contribution margin ratio)

240,000

1,050,000

Fixed costs

125,000

1,475,000

Income before taxes

115,000

(425,000)

Income taxes (32% rate)

36,800

136,000

Net income

$78,200

($289,000)

Step 4: Forecasted income statement for 60,000 units

Product T

Product O

Sales

$2,400,000

$2,400,000

Variable cost

1,920,000

300,000

Contribution margin (as per contribution margin ratio)

480,000

2,100,000

Fixed costs

125,000

1,475,000

Income before taxes

355,000

625,000

Income taxes (32% rate)

113,600

200,000

Net income

$241,400

$425,000

Step 5: Effect of decrease in sales

Product O will experience a higher loss due to a decrease in sales volume. It has a higher fixed cost that will not be covered by the contribution margin generated through lower sales.

Step 6: Factors affecting the cost structure

  1. Direct material and direct labor are used in the production of both products.
  2. Expenses incurred in respect of the production facilities used for each product. Such as depreciation expenses on equipment and rent expenses for space used.

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