Question

CVP Analysis and Variable/Absorption Costing

For this mini-case, you will be tasked with conducting some cost-volume-profit (and related) analysis, and will have an opportunity to practice communicating the results of that analysis in written form. You are always welcome to discuss general course material with classmates and others, but please be sure to complete this mini-case individually. Compile a document (PDF for the final output, please) with your responses and work, and submit it via Canvas by the deadline announced.

Kelly Kneppy owns a company that manufactures and sells camping equipment and outdoor gear. Kelly’s latest creation is the Bear-B-Gone, a tent constructed of Kevlar and reinforced steel mesh that could theoretically protect campers (who hadn’t followed appropriate food storage guidelines) from bear attacks. Kelly believes the Bear-B-Gone offers many of the same desirable features as other tents on the market, and that this extreme safety feature will make it one of the best-selling tents in short order.

Kelly can make the Bear-B-Gone with one of two available technologies. The first is a labor-intensive process, that if chosen will require $720,000 per year in fixed overhead costs, and the following in variable costs of production per unit: direct materials of $45, direct labor of $65, and overhead of $15. The second technology is a more automated (machine-dependent) process, that if chosen will require $1,540,000 per year in fixed overhead costs, and the following in variable costs of production: direct materials of $40 (savings due to less waste in the automated process), direct labor of $5, and overhead of $60. Kelly believes she can sell the tent for $175.

1. What is Kelly’s break-even point in units (and sales dollars) with the labor-intensive production process? What is the break-even point in units (and sales dollars) with the more automated process?

2. Which process is preferred if sales are expected to be 30,000 units? How about at 50,000 units? At what sales level would the two processes yield equivalent profit (round to the nearest whole unit)?

3. Suppose possible sales are expected to range between 30,000 and 50,000 units as noted above, and that production will equal sales (no beginning/ending inventory). Which process has the greater range in profit? Why might this be a factor for Kelly to consider in making her decision?

4. Assume sales were to fall at the midpoint of the projections above, 40,000 units. Following up to the previous question, under which process would you say Kelly’s profit is more sensitive to changes in demand (sales)? Why? Does this make one of the options strictly “better” than the other? Why or why not?

5. Suppose Kelly decided to go with the labor-intensive process. Suppose also that, in the first year of operations, Kelly produces 70,000 tents and sells 55,000. What is the unit product cost of the tents under variable costing? Under absorption costing? Round to two decimal places as needed. If Kelly prepared GAAP-compliant financial statements in order to share with potential investors, would her “over” production make her appear more or less profitable (or no different) as compared to if production had been equal to sales at 55,000 units?

6. What other factors might affect Kelly’s decision to focus on capital- vs. labor-intensive processes? To get you started, consider things from earlier in this class and outside of a strictly managerial accounting realm, such as taxes (or tax credits for certain business operations), product quality, and public perception (using employees vs. automation). To strengthen your response, you might wish to refer to a source or two from business or popular press that illustrates how the factor(s) you’re discussing affected a real organization in a positive or negative manner.

7. Prepare a brief memo to Kelly, outlining your findings. You do not necessarily need to include all of the “numbers” you’ve calculated above, but you should include anything that you think would best convey the most important points of your analysis. Feel free to include components that aren’t part of the formal requirements in items #1-6, if you deem them critical.

Answer 1

Amount in Dollars ($)
No.	Particulars	1st Technology	2nd Technology
1	Fixed Overhead Cost	720000	1540000
2	Direct Material /unit	45	40
3	Direct Labour /unit	65	5
4	Overhead/unit	15	60
5	Selling Price	175
6	Contribution/unit= Selling Price - (Direct Material + Direct labour + Overhead)	50 (175-(45+65+15))	70 (175-(40+5+60))
7	Contribution Ratio= Contrubution per unit/selling price * 100	28.57% (50/175*100)	40% (70/175*100)
8	Break even point (in units) = Fixed Overhead / Contribution per unit	14400 units (720000/50)	22000 units (154000/70)
9	Break even point (in sales) = Fixed Overhead / Contribution Ratio	205704 (720000*28.57/100)	616000 (1540000*40/100)
10	Expected Sales	30000	30000
	Profit A= Expected sales * contribution per unit - Fixed overhead	780000 (30000*50-720000)	560000 (30000*70-1540000)
11	Expected Sales	50000	50000
	Profit B= Expected sales * contribution per unit - Fixed overhead	1780000 (50000*50-720000)	1960000 (50000*70-1540000)
12	Level of sales = (Fixed overhead of 2nd technology - Fixed overhead of 1st technology) / (Contribution per unit of 2nd technology - Contribution per unit of 2nd technology)	41000 units (1540000-720000) / (70-50)
13	Profit = Level of sales * contribution per unit - fixed overhead cost	133000 (41000 * 50) - 720000	133000 (41000 * 70) - 1540000

Profit in Different levels as per table

Levels of sales	1st Technology	2nd Technology
At 30000 units (Calculated in above table)	780000	560000
At 40000 units = Expected sales * contribution per unit - Fixed overhead	1220000 (40000*50-720000)	1260000 (40000*70-1540000)
At 50000 units  (Calculated in above table)	1780000	1960000

If the Sales are at 40000 units 2nd Technology are preferred because of high profit

Level of Sales	Cost Variation	Method
0 - 30000	Fixed cost is Low	Method A is Preferred
> 30000	Variable cost is High	Method B is Preferred

Please comment for any clarification