Question

ABC, Inc., produces widgets. The company manufactures three levels of widgets-Economy, Better and Best. Selected information on the widgets is given below.

Economy Better Best

Selling price per widget $45.00 $70.00 $85.00

Variable expense per widget production $23.00 $27.00 $32.00

Selling (5% of selling price) $2.25 $3.50 $5.00

All sales are made through the company’s own retail outlets. The widgets have the following fixed costs.

Per Month

Fixed production costs $130,000

Advertising expense 120,000

Administrative salaries 65,000

Total $315,000

Sales, in units, over the past two months have been as follows:

Economy Better Best Total

April 2,000 1,000 5,000 8,000

May 9,000 1,000 2,000 12,000

Required:

1. Prepare contribution format income statements for April and May. Place the fixed expenses only in the Total column. Do not show percentages for the fixed expenses.

Use the following headings:

Economy Better Best Total

Amount Percent Amount Percent Amount Percent Amount Percent

Sales

Etc…

2. Upon seeing the income statements in (1) above, the president stated, “I can’t believe this! We sold 50% more widgets in May than in April, yet profits went down. It’s obvious that costs are out of control.” What other explanation can you give for the drop in net operating income? (Provide at least a paragraph for your explanation)

3. Compute the widgets break-even point in dollar sales for April.

4. Without doing calculations, explain whether the break-even point would be higher or lower with May’s sales mix than with April’s sales mix.

5. Assume that sales of the Economy widgets increase by $20,000. What would be the effect on net operating income? What would be the effect if the Best widget sales increased by $20,000? Do not prepare income statements; use the incremental analysis approach in determining your answer.

Answer 1

1.		April
		Economy		Better		Best		Total Sales
		Amount	Percentage	Amount	Percentage	Amount	Percentage	Amount	Percentage
Sales Unit		2000		1000		5000
Sales Price		45		70		85
Variable cost per Unit		25.25		30.5		37
Contribution Per Unit		19.75		39.5		48
Total Sales		90000	100%	70000	100%	425000	100%	585000	100%
Less:
Variable Cost		46000	51%	27000	39%	160000	38%	233000	40%
Selling Cost		4500	5%	3500	5%	25000	6%	33000	6%
Contribution		39500	44%	39500	56%	240000	56%	319000	55%
Less:
Fixed Production Cost								130000
Advertising Cost								120000
Administration Cost								65000
Total Fixed Cost								315000
Profit								4000
		May
		Economy		Better		Best		Total Sales
		Amount	Percentage	Amount	Percentage	Amount	Percentage	Amount	Percentage
Sales Unit		9000		1000		2000
Sales Price		45		70		85
Total Sales		405000	100%	70000	100%	170000	100%	645000	100%
Less:
Variable Cost		207000	51%	27000	39%	64000	38%	298000	46%
Selling Cost		20250	5%	3500	5%	10000	6%	33750	5%
Contribution		177750	44%	39500	56%	96000	56%	313250	49%
Less:
Fixed Production Cost								130000
Advertising Cost								120000
Administration Cost								65000
Total Fixed Cost								315000
Profit								-1750
2. Reason for drop on Net profit is the drop in the sales volume of product with Best quality as it generates highest contribution per unit.
Another reason is decrease in the Weighted average contribution per unit in May due to chnge in the sales Mix.
3. Computation of Break-even sales
		April				May
		Sales Unit	Contribution per Unit	Total Contributio			Sales Unit	Contribution per Unit	Total Contributio
	Economy	2000	19.75	39500			9000	19.75	177750
	Better	1000	39.5	39500			1000	39.5	39500
	Best	5000	45	225000			2000	45	90000
	Total	8000		304000			12000		307250
Weighted Average Contribution			=304000/8000	38				=307250/12000	25.60
Weighted Average Sales	=Total Sales/Total Units						=Total Sales/Total Units
	=585000/8000						=564000/12000
	73.13						47
Break-even Sales =	(Fixed Cost/Weighted Avg. Contribution per Unit)*Avaerage Sales price per unit
Break-even Sales April=	=(315000/38)*73.13
	606209.2
Break-even Sales May =	=(315000/25.6)*47
	578320.3
4. Break even point for May would be higher then the break even point of April as the Weighted Average contribution per unit in May is lower then in April.
5. If the Economy Widget Sales increases by 20000
Increase in contribution	8800
Net operating income would increase by 8800.
If the Best Widget Sales increases by 20000
Increase in contribution	11200
Net operating income would increase by 11200.
Note-
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