Question

The condensed income statement for the Terri and Jerri partnership for 2010 is as follows.
TERRI AND JERRI COMPANY
Income Statement
For the Year Ended December 31, 2010
Sales (200,000 units)
Cost of goods sold
Gross Profit
Operating expenses
Selling
Administrative
Net Loss
$280,000
160,000
$1,200,000
800,000
400,000
440,000
($40,000)
A cost behavior analysis indicates that 75% of the cost of goods sold are variable, 50% of the selling expenses are variable, and 25% of the administrative expenses are variable.
Instructions: (Round to nearest unit, dollar, and percentage, where necessary.)
(a) Compute the break-even point in total sales dollars and in units for 2010.
(b) Terri has proposed a plan to get the partnership “out of the red” and improve its profitability. She feels that the quality of the product could be substantially improved by spending $0.25 more per unit on better raw materials. The selling price per unit could be increased to only $6.25 because of competitive pressures. Terri estimates that sales volume will increase by 30%. What effect would Terri’s plan have on the profits and the break-even point in dollars of the partnership? (Round the contribution margin ratio to two decimal places.)
(c) Jerri was a marketing major in college. She believes that sales volume can be increased only by intensive advertising and promotional campaigns. She therefore proposed the following plan as an alternative to Terri’s. (1) Increase variable selling expenses to $0.79 per unit, (2) lower the selling price per unit by $0.30, and (3) increase fixed selling expenses by $35,000. Jerri quoted an old marketing research report that said that sales volume would increase by 60% if these changes were made. What effect would Jerri’s plan have on the profits and the break-even point in dollars of the partnership?
(d) Which plan should be accepted? Explain your answer

Answer 1

a)		Variable cost per unit	Fixed Cost
Cost of goods sold	$    800,000.00	$               3.00	$ 200,000.00
Selling	$    280,000.00	$               0.70	$ 140,000.00
Administrative	$    160,000.00	$               0.20	$ 120,000.00
Total		$               3.90	$ 460,000.00
Selling price per Unit	$               6.00
Contribution Margin % = ($6 - $3.90)/$6	35%
BEP Units = Fixed Cost/ SP - VC
BEP Units = $460,000/($6 - $3.90)	219,048	Unit
BEP Dollars = Fixed Cost/ CM % = $460,000/35%	$      1,314,286
b)
Sales volume =  (200,000 X ( 1+ 30%)	260,000.00
New COGS per Unit = $3 + $.25	$               3.25
Income Statement
For the Year Ended December 31, 2010
Sales (260,000 units)		$ 1,625,000.00
Less: Variable  Expenses
Cost of goods sold (260,000 X $3.25)	$    845,000.00
Selling Expenses (260,000 X $.70)	$    182,000.00
Administrative expenses (260,000 X $.20)	$      52,000.00
Total variable expenses		$ 1,079,000.00
Contribution Margin		$    546,000.00
Fixed expenses:
Cost of goods sold	$    200,000.00
Selling Expenses	$    140,000.00
Administrative Expenses	$    120,000.00
Total fixed expenses		$    460,000.00
Net Income		$      86,000.00
Contribution Margin % = $546,000/$1,625,000	34.00%
BEP Dollars = $460,000/34%	$      1,352,941
Profits and the break-even point would both increase
c)
Sales volume =  (200,000 X ( 1+ 60%)	320,000.00
Income Statement
For the Year Ended December 31, 2010
Sales (320,000 units)x ($6.00 – $.30)		$ 1,824,000.00
Less: Variable  Expenses
Cost of goods sold (320,000 X $3.00)	$    960,000.00
Selling Expenses (320,000 X $.79)	$    252,800.00
Administrative expenses (320,000 X $.20)	$      64,000.00
Total variable expenses		$ 1,276,800.00
Contribution Margin		$    547,200.00
Fixed expenses:
Cost of goods sold	$    200,000.00
Selling Expenses ($140,000 + $35,000)	$    175,000.00
Administrative Expenses	$    120,000.00
Total fixed expenses		$    495,000.00
Net Income		$      52,200.00
Contribution Margin % = $546,000/$1,625,000	30.00%
BEP Dollars = $495,000/30%	$      1,650,000
Profits and the break-even point would both increase.
d) Terri’s plan should be accepted. It produces a higher net income anda lower breakeven point than Jerry’s plan