Question

2. Cost-Volume-Profit (CVP)                                                                                                               40 points

a. Assignment Question on Cost Volume Profit (CVP)

MMC Nutri Company is a small family fast food restaurant that opened in 2015, serving tropical cuisine to its mainly Afro-American, Asian and African customers. Because of its hot ingredients, few others patronize the food.

This business serves its popular dish Jollof rice, fish or meat stew, and rice flour porridge, as a meal for $9 a serving. Its variable cost per serving is $4.10 and its monthly fixed cost is $4,600 a month. On average, the business sells 60 servings a day, opened every day except Sunday. The highly religious owner takes Sunday off, as a rest day.

During this 2020 year of COVID-19 pandemic, average sales has dropped significantly. In June of this year, the federal government gave a lump sum financial assistance of $10,000 to the business, during a six weeks lockdown. Since then, current sales has dropped by 60% of its pre-COVID level, despite the introduction of take-away opportunity. The business optimistically estimates that sales will slowly increase to a maximum of 80% of pre-COVID level, for the rest of this year.

The owner is considering closing the business, due to uncertainty and depletion of personal savings to finance its operations, and has commissioned you to give advice, based on your knowledge of accounting.

The business is also exploring an available option of a $6,000 investment in machinery that will be used for 5 years and will reduce variable cost by $0.30 a unit. Sales price/unit will not change.

What will be your overall advice to this owner? Justify each option with analysis based on CVP.            

(Points will be awarded for trend of thought and the application of CVP principles. There is no one answer.) 30 points

b. Assignment on Plant-wide Overhead Absorption

Basic Construction Company won a bid to build a gym between January and March 2020. The actual manufacturing overhead for the completed construction was $128,610. On December, 2019, before the start of the construction, the company decided to set an annual overhead rate of $875,000 for all jobs during 2020, to be absorbed by direct labor hours. The actual direct labor hours used for this job was 49,000, and the direct machine hours used was 12,700. The annual direct labor hours estimated for 2020 by the company was 350,000 DLH. Provided there is over or under absorbed overhead, considered not significant, prepare the journal entry to close the manufacturing overhead account, at the end of the contract.                                                                                                                                             10 points

Answer 1

1. Business managers use cost-volume-profit analysis, also known as a break-even analysis, as a way to understand how changes in sales volume, prices and costs will affect profits. Cost refers to fixed and variable costs incurred by the company. Volume refers to the number of products sold. Profit refers to how much money the company makes given the price of the product sold, the volume of products sold and the company's fixed and variable costs.

Types of Costs

Every business has fixed and variable costs. Fixed costs are typically overhead costs incurred, regardless of how many products a company produces or sells. Variable costs change depending on business activity. CVP analysis typically uses variable cost per unitof product produced and sold.

Uses of CVP Analysis

A main reason businesses use CVP analysis is to estimate how changes in selling price, sales volume, variable cost per unit and fixed costs affect profits. A business can also use CVP analysis to analyze existing or new business opportunities to determine a break-even point and potential profitability, including the sales volume required to reach a target profit. Managers can use this information in determining how to price products, how to market products and how to produce products.

CVP Equations

The basic equation for CVP analysis is Profits = Sales - Variable Costs - Fixed Costs. To determine the break-even point for sales of a product(s), this equation becomes (Unit Sales x Price) = (Unit Sales x Unit Variable Cost) + Fixed Expenses. Often the CVP relationship is shown in graphical form so the relationship between sales volume and profit can easily be seen.

Example

A business sells a product for a price of $100. The variable cost per unit is $50. Fixed costs are $10,000. If the business sells one unit, total costs are $10,050, meaning the company has a loss of $9,050 ($10,050 - $100). Using CVP analysis, the breakeven formula for this company is as follows: Revenue (Unit Sales x $100) = variable costs (Unit Sales x $50) + fixed costs ($10,000). The unit sales required to break even is 200. Corporate Finance Institute offers a great expansion of this as applied to various business considerations.

Contribution Margin

In CVP analysis, the contribution margin is the dollar amount remaining after deducting variable expenses from sales revenue, according to the College of San Mateo. The unit contribution margin is the amount that each unit of sold product contributes. In this example, the unit contribution margin is $50 (price of $100 minus variable cost of $50). Once sales have reached the breakeven point, each additional product sold contributes $50 to company profits.

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