Question

Break-Even Sales Under Present and Proposed Conditions Battonkill Company, operating at full capacity, sold 105,400 units at a price of $57 per unit during 2014. Its income statement for 2014 is as follows: Sales $6,007,800 Cost of goods sold 2,128,000 Gross profit $3,879,800 Expenses: Selling expenses $1,064,000 Administrative expenses 646,000 Total expenses 1,710,000 Income from operations $2,169,800 The division of costs between fixed and variable is as follows: Fixed Variable Cost of goods sold 40% 60% Selling expenses 50% 50% Administrative expenses 70% 30% Management is considering a plant expansion program that will permit an increase of $456,000 in yearly sales. The expansion will increase fixed costs by $60,800, but will not affect the relationship between sales and variable costs. Required: 1. Determine for 2014 the total fixed costs and the total variable costs. Total fixed costs $ Total variable costs $ 2. Determine for 2014 (a) the unit variable cost and (b) the unit contribution margin. Unit variable cost $ Unit contribution margin $ 3. Compute the break-even sales (units) for 2014. units 4. Compute the break-even sales (units) under the proposed program. units 5. Determine the amount of sales (units) that would be necessary under the proposed program to realize the $2,169,800 of income from operations that was earned in 2014. units 6. Determine the maximum income from operations possible with the expanded plant. $ 7. If the proposal is accepted and sales remain at the 2014 level, what will the income or loss from operations be for 2015? $ SelectIncomeLossItem 10 8. Based on the data given, would you recommend accepting the proposal? In favor of the proposal because of the reduction in break-even point. In favor of the proposal because of the possibility of increasing income from operations. In favor of the proposal because of the increase in break-even point. Reject the proposal because if future sales remain at the 2014 level, the income from operations of will increase. Reject the proposal because the sales necessary to maintain the current income from operations would be below 2014 sales. Choose the correct answer. a,b,c,d,e

Answer 1

Solution

Battonkill Company

1. Determination of the total fixed cost and variable cost for the current year:

Fixed cost –

	Total cost	Proportion	Fixed Cost
Cost of goods sold	$2,128,000	40%	$851,200
Selling Expenses	$1,064,000	50%	$532,000
Administrative expenses	$646,000	70%	$452,200
Total Fixed Cost			$1,835,400

Variable Cost –

	Total cost	Proportion	Variable Cost
Cost of goods sold	$2,128,000	60%	$1,276,800
Selling Expenses	$1,064,000	50%	$532,000
Administrative expenses	$646,000	30%	$193,800
Total Variable Cost			$2,002,600

Total Fixed Cost	$1,835,400
Total Variable Cost	$2,002,600

1. Determination of unit variable cost and unit contribution margin (CM):

Number of units sold in current year = 105,400

Total variable cost = $2,002,600

Unit variable cost = $2,002,600/105,400 = $19

Unit CM = unit selling price – unit variable cost

Unit selling price = $57

CM per unit = $57 - $19 = $38

1. Computation of break-even sales in units for current year:

Break-even sales in units = fixed cost/unit CM

Fixed cost = $1,835,400

Unit CM = $38

Break-even point in units = $1,835,400/$38= 48,300 units

1. Computation of break-even sales in units under the proposed program:

Under the proposed program, fixed cost increase by $60,800.

Hence, the revised fixed cost = $1,835,400 + $60,800 = $1,896,200

No change in sales and variable cost. Hence, CM per unit remains same at $38

Break-even point in units for proposed program = $1,896,200/$38 = 49,900 units

1. Determination of sales (units) needed to earn target net income of $2,169,800 under the proposed program:

Desired sales (units) = (fixed cost + target income)/CM per unit

Fixed cost = $1,896,200

Target income = $2,169,800

CM per unit = $38

Desired sales in units = (1,896,200 + $2,169,800)/38 = 107,000 units

1. Determination of the maximum income possible from the expanded plant:

Sales $6,463,800

Variable costs$2,154,600

Fixed cost$1,896,200

Net Income$2,413,000

Sales = $6,007,800(105,400 x $57) + $456,000 = $6,463,800

Variable cost proportion to sales= 6,007,800/2,002,600 = 33.33%

Variable cost = $6,463,800 x 33.33% = $2,154,600

1. Determination of income or loss if Proposal accepted and sales remain at current level –

Sales remain at current level = $6,007,800

Variable cost $2,002,600

Fixed cost $1,896,200

Net Income$2,109,000

Hence, if the proposal is accepted and sales remain at current level, the net income of the company from operations for the following year would be $2,109,000.

Note: Fixed cost increase by $60,800 if proposal is accepted.

However, since sales are mentioned to remain at current level, the likely increase of $456,000 is not considered for computation of net income in the given situation.

1. Decision – Reject the proposal because if the sales remain at the 2014 level, the income from operations will not increase.

Income from operations at current level (without any expansion) $2,169,800

Income from operations at current level (with expansion$2,109,000

The income from operations at current sales level after expansion is less than the income from operations without expansion. So, if after expansion sales do not increase as expected and remain at current level, the company’s income from operations fall by $60,800 ($2,169,800 - $2,109,000). So, the expansion is not advisable.