Question

1.  Explain how changes in activity affect CM and Net operating income

2. Interpret a CVP graph which portrays the revenue and cost characteristics of a company's products and operations. Explain how the lines on the graph and the break even point would change if (a) the selling price per unit decreased, (b) fixed cost increased during the entire range of activity portrayed on the graph , and (c) variable cost per unit increased

3. How to use CM ratio to compute changes in CM and Net operating income resulting from changes in sales volume.

4. Explain the effects on CM of changes in variable cost, fixed costs, selling price and volume   

5. Define break even point and how it's computed

6. Determine the level of sales needed to achieve a desired target profit

7. Define Margin of Safety and explain its significance.

8. Define Degree of Operating Leverage at a particular level of sales and explain how it can be used to predict changes in Net operating income

9. Compute the break even point for a multi product company and explain the effects of shifts in the sales mix on CM and the break even point. What assumption is usually made concerning sales mix in CVP analysis. Explain how a shift in the sales mix could result in a higher break even point and a lower net income.

Answer 1

ONLY FIRST 4 PARTS ASNWERED

Ans-1

The factors that impact Contribution margin are -

• Units Sold
• Selling Price
• Variable Cost/Unit

Of above "activity change" if presumed to be Units Sold then the relationship is diretly proportional meaning increase in Units Sold increases Contribution Margin and decrease in Units Sold leads to decrease in Contribution Margin.

The impact on the Net Income is equal to the change in Contribution since the Fixed Costs remain unchanged.Hence Net Iincome too moves directly proportion to change in Contribution margin.

Ans-2

CVP or Cost Volume Profit graph represents graphically the relationship between Sales , Variable and Fixed Costs.In the process also reflecting the profits and break even points.

Below is an illsutrative chart and related data-

CVP Graph

The GREEN flat line shows th fixed Cost.This line shows that at any sales level it will remain constant be it 0 sales or 1000 units

PURPLE Line represents total cost of sales which is Variable plu Fixed.

RED line represents the Sales value

X - axis shows the activity level and Y- axis represents the Values

The point in graph whre the RED and the PURPLE line intersect (circled) is called the BREAKE EVEN POINT.Region beyond this point is profit region.Breakeven pint is Sales volume ini dollars 50000 or 500 units

Ans-2-(a)-Impact of Decrease in Sale price:

A decrese in Sale price pushes the Breakeven point to Sales Value of 75000 or 750 units as can be seen from below

CVP Graph

Ans-2-(b)

Increase in Fixed costs pushes the breakeven point higher.

CVP Graph

Ans-2-(c)

Increase in variable cost leads to increase in Break even point

CVP graph

Ans-3

Contribution margin Ratio = (Sales Price - Variable Cost per Unit)/(Sale Price) expressed as %

When differential Sales Value is multiplied with this ration it gives the additional Contribution generated which is also the differential Net Income generated.

The following illustration shows the same

It is very clear that 50% of (90000 - 80000) or 5000 is the change both at the CM and NI levels

Ans-4

Effects on CM of -

Variable Costs - Increase leads to reduction and decrease leads to increase in CM

Fixed Costs - No Impact

Selling Price - Increase leads to increase and decrease leads to decrease in CM

Sales Volume - Margin % remains unchanged but total contribution increase with higher sales and decreases with decrease in sales