Question

A Company sells two types of lawn mower – the fly-mo and the standard. The selling price of the Fly-mo is $188 and variable costs of $152.80. The Standard sells for $180 with the same variable cost.

Fixed costs are $255,840. The company sells the lawn mowers in equal proportions (i.e. in the same ratio).

1. What is break-even point in units (number of lawn mowers)?
2. What is break-even point in sales (in US$)?
3. Create a contribution income statement for break-even point.
4. How much would the variable cost per unit of the Standard have to change before it had the same break-even point as the Fly-mo?
5. How many units need to be sold if only Standards are sold with fixed costs of $316,800 and a profit of $36,800 is required?
6. After installing a more sophisticated costing system Slash & Burn realises that the fixed costs of only selling the Standard are $350,460. If the variable costs of the Standard decreased by 10% and the fixed costs then increase by 10%, what would be the new break-even point for the standard in units?
7. Why is contribution margin a useful tool for management accountants in decision-making situations like price setting and accepting or rejecting special orders?

Answer 1

	Fly Mo	Standard
Selling Price	188	180
Variable Costs	152.8	152.8
Fixed Cost	255840
Ratio of Units Sold	1	1
Contribution Margin	35.2	27.2
Breakeven point (Units)	7268.18	9405.88
Contribution margin ratio	0.19	0.15
Breakeven point (Sales)	1366418.18	1693058.82

Breakeven point (Units) = Fixed cost/ contribution margin

Contribution Margin = Sales - Variable costs

Contribution Margin(Fly Mo) = 188-152.8 = 35.2

Contribution Margin(Standard) = 180-152.8 = 27.2

Breakeven point in sales = Fixed Expenses / Contribution margin ratio

Contribution Margin ratio = [(Sales-Variable Expense)/Sales]*100

Income Statement
	Formula	Fly Mo	Standard
Sales	Selling Price * Breakeven Units	1366418.182	1693058.824
Less:Variable Costs	Variable Costs * Breakeven Units	1110578.182	1437218.824
Contribution Margin		255840	255840
Less: Fixed Costs		255840	255840
Income before Taxes		0	0

	Fly Mo	Standard
Selling Price	188	180
Variable Costs	152.8	146.298
Fixed Cost	255840
Ratio of Units Sold	1	1
Contribution Margin	35.2	33.702
Breakeven point (Units)	7268.18	7591.24
Contribution margin ratio	0.19	0.19
Breakeven point (Sales)	1366418.18	1366423.36

Variable Costs are decresed by 152.8 - 146.298 = 6.502

Profit = Sales - Variable Cost - Fixed Cost

36800 = 180*Units - 152.8*Units - 316800

36800 = 27.2 units - 316800

No. of Standard Units = 13000

	Standard
Selling Price	180
Variable Costs	137.52
Fixed Cost	385506
Contribution Margin	42.48
Breakeven point (Units)	9075.00
Contribution margin ratio	0.24
Breakeven point (Sales)	1633500.00

Variable costs = 152.8 - 10%

Fixed Cost = 350460+10%

Contribution Margin is useful tool because one is able to recover variable costs. Fixed costs were otherwise being spent only without neworder also and can be recovered by regular business. If special orders are received we see the contribution margin. If it increases accept the order and if it doesnt reject the order.

Price setting for special orders is done on the basis of contribution margin.