Question

This year Burchard Company sold 27,000 units of its only product for $19.60 per unit. Manufacturing and selling the product required $112,000 of fixed manufacturing costs and $172,000 of fixed selling and administrative costs. Its per unit variable costs follow. Material $ 3.20 Direct labor (paid on the basis of completed units) 2.20 Variable overhead costs 0.32 Variable selling and administrative costs 0.12 Next year the company will use new material, which will reduce material costs by 60% and direct labor costs by 40% and will not affect product quality or marketability. Management is considering an increase in the unit selling price to reduce the number of units sold because the factory’s output is nearing its annual output capacity of 32,000 units. Two plans are being considered. Under plan 1, the company will keep the selling price at the current level and sell the same volume as last year. This plan will increase income because of the reduced costs from using the new material. Under plan 2, the company will increase the selling price by 25%. This plan will decrease unit sales volume by 10%. Under both plans 1 and 2, the total fixed costs and the variable costs per unit for overhead and for selling and administrative costs will remain the same.

Answer 1

Burchard Company

Analysis of Plan 1:

Financial data and calculations under Plan 1:

Sales volume                     27,000 units

Unit Selling price                          $19.60

Variable costs –

Direct materials                 $1.28 (reduced $3.20 by 60%)

Direct labor                       $1.32   (reduced $2.20 by 40%)

Variable overhead cost     $0.32

Variable S&A costs          $0.12

Total variable cost             $3.04

Unit Contribution Margin $16.56

Total contribution margin $447,120 ($16.56 x 27,000 units)

Fixed costs –

Manufacturing overhead   $112,000

S&A overhead                  $172,000

Total fixed costs                           $284,000

Net operating income                    $163,120

CM ratio = (16.56/$19.60) x 100 = 84.50%

BEP in dollars = $284,000/84.5% = $336,135

BEP in units = $284,000/$16.56 = 17,149

Analysis of Plan 2:

Sales volume                     24,300 units (reduced 27,000 by 10%)

Unit selling price                           $24.50 (increased $19.60 by 25%)

Variable costs:

Direct materials                 $1.28 (reduced $3.20 by 60%)

Direct labor                       $1.32   (reduced $2.20 by 40%)

Variable overhead cost     $0.32

Variable S&A costs          $0.12

Total variable cost             $3.04

Unit Contribution Margin $21.46

Total CM                                       $521,478 ($21.46 x 24,300)

Fixed costs –

Manufacturing overhead   $112,000

S&A overhead cost           $172,000

Total fixed cost                             $284,000

Net operating income                    $237,478

CM ratio    = ($21.46/$24.50) x 100 =87.59%

BEP in dollars = $284,000/87.59% = $324,238

BEP in units = $284,000/$21.46 = 13,234

Hence, Plan 2 results in higher net operating income of $237,478 as compared to the net operating income of $163,120 under Plan 1.