Question

BASED COSTING AND PROCESS COSTING

Andre has asked you to evaluate his business, Andre’s Hair Styling. Andre has five barbers working for him. (Andre is not one of them.) Each barber is paid $9.90 per hour and works a 40-hour week and a 50-week year, regardless of the number of haircuts. Rent and other fixed expenses are $1,750 per month. Hair shampoo used on all clients is $0.40 per client. Assume that the only service performed is the giving of haircuts (including shampoo), the unit price of which is $12. Andre has asked you to find the following information.

i) Find the contribution margin per haircut. Assume that the barbers' compensation is a fixed cost. Show calculations to support your answer.

ii) Determine the annual break-even point, in number of haircuts. Support your answer with an appropriate explanation. Show calculations to support your answer.

iii) What will be the operating income if 20,000 haircuts are performed? Show calculations to support your answer.

iv) Suppose Andre revises the compensation method. The barbers will receive $4 per hour plus $6 for each haircut. What is the new contribution margin per haircut? What is the annual break-even point (in number of haircuts)? Show calculations to support your answer.

Using the information provided, provide a memo to Andre explaining the completed analysis and how he should use this information to monitor the operations of the barber shop. The memo should explain the cost associated with the barber shop including their relationships.

Answer 1

Solution:

i) Contribution Magin per unit = Sales price per unit - Variable cost per unit

here, Sales price per haircut = $ 12 and the Variable cost per haircut = $0.40

So, the Contribution Margin per haircut = $ 12 - $ 0.40 = $ 11.6

ii) Break even point as per CVP analysis = Fixed Cost / (Price per unit - Variable cost)

here the Fixed cost includes barbers compensation and Rent & other expensese

which is calculated as Barbers compensation for a year = $ 9.9 per hour X 40hours X 50 weeks X 5 barbers

= $ 99000

Now the total Fixed cost = $ 99000 + $ (1750 X 12) = $ 120000 annual

So, the Annual Break even point = $ 120000/ ( $ 12 - $ 0.40 ) = 10344.82 haircuts

iii) Operating Income = Revenue - Cost of goods sold - oprating expenses

Here Total Revenue at @ 20000 haircuts = $ 12 per haircut X 20000 haircuts = $ 240000

Cost of goods sold (here in this case we can say cost of service ) = $ 0.40 per haircut X 20000 haircuts = $ 4000

the oprating expenses are all those expenses which are incurred for the oprating or genrating such revenue so here all the fixed expenses incured by Andre are operating expenses, i.e. $ 120000

So, Operating Income = $240000 - $ 4000 - $ 120000 = $ 116000

iv) As per revised method, the compensation will be divided into variable and fixed portion: $4 per hour will remain fixed cost as in i) and the $6 per haircut will be variable part.

So, the contribution margin = Sales price per haircut - Variable cost per haircut

$12 - $( 0.40 + 6) = $ 5.6

the break even in this case = Fixed cost / ( Price per unit - Variable cost)

the fixed cost = barbers compensation + rent & other expenses

= ( $ 4 per hour X 40 hour X 50 weeks X 5 ) + ( $ 1750 X 12) = $ 40000 + $ 21000 = $ 61000

Now the Break even point = $ 61000 / ($12 - $0.40 - $6) = 10892.86 haircuts