Breakeven Calculations

Breakeven Calculations

 

Introduction

Contribution margin is represented by per unit contribution of the dollar in a particular production process. Contribution represents part of sales turnover that is not affected by the variable costs which provides the provision for fixed costs. Contribution provides the basis for breakeven calculations. In management accounting, the cost volume and profit analysis which is represented by the marginal profit that is contributed per unit sale of a product known as the contribution margin can also be adopted in calculating the operating leverage. Low contribution margins are associated with labor intensive industries while capital intensive industries are associated with a higher contribution margins. Contribution margins are different from the gross profit as contribution margin only entail the part of costs that is associated with the fixed costs while the gross profit includes both the fixed costs and the variable costs that are directly associated with the sales turnover. (Hermanson, Edwards, & Invacevich, 2011)

1) A camera company produces and sells cameras, film, and other imaging products. A condensed 2000 income statement (in millions) includes the following:
Sales 20,991
Cost of goods sold 12,028
Gross margin 8,963
Other operating expenses 5,641
Operating income $3,322
Assume that $3.6 million of the cost of goods sold is a fixed cost representing depreciation and other production costs that do not change with the volume of production. In addition, $5 million of the other operating expenses are fixed. Compute the total contribution margin for 2010 and the contribution margin percentage. Explain why the contribution margin differs from the gross margin.

Unit contribution margin is equivalent to sale price (P) minus unit variable cost V i.e.

Unit contribution margin = p-v

Breakeven total sales units = x=FC ÷ unit cm

Breakeven sales in dollars = Price per unit * Break even sales units

(Garrison, Noreen, Brewer, 2009)

Or FC/CM ratio

		Camera Company
	Income Statement for the Year 2000
Sales		20991
Cost of sales		12028
GP		8963
Expenses		5641
NP		3322
Assumptions From the Question 3322 is the NP + 8600 is the Fixed Costs and the total turnover = $20991, VC = $20991 – $8600 – 3322 = $9069.
FC     =	$3.6m + $5m = $8.6m
VC   =    $9069
Contribution Margin = Px – Vx
P = Price
X  =  Number of units
V =   Variable Costs
CM = Sales – Variable costs
CM =  20991 – 9069
CM = $11922
CM % = $11922/20991 * 100%   =   56.79%

 

Gross profit margin is arrived at by deducting the cost of sales (both fixed and variable costs) from the total sales. The operating expenses are only deducted when calculating the Net Profit. While contribution margin is arrived at by deducting the total variable costs from the total sales.

2) Suppose that sales for the camera company were predicted to increase by 10% in 2011 and that the cost behavior was expected to continue in 2011 as it did in 2010. Compute the predicted operating income for 2011. By what percentage did this predicted 2011 operating income exceed the 2010 operating income? What assumptions were necessary to compute the predicted 2011 operating income in question 2?

Camera Company
Income Statement for the Year		2010	2011
Sales		20991	23090.1
Cost of sales		12028	12028
GP		8963	11062.1
Expenses		5641	6547.9
NP		3322	4514.2
The predicted operating income of the year   2011 was $4514.2
The predicted sales in 2011 increased by 35.9% from the   year 2010
Assumptions Made
The increment applied to the sales and variable   Cost only.
The Fixed expenses were not affected Variable Costs increased by 10% i.e. from $9069 to $9975 Variable Costs affected other costs only not the cost of
sales

 

Variable and fixed costs have different effects on the costs or profits of a company. Changes in variable costs lead to significant changes in the profits or losses of the company while Changes in Fixed expenses have less impact on the profits or losses of a company. (Drucker, 1999)

To conclude, a large reduction in fixed costs has less effect on the overall cost structure of a company’s total costs. The same case with the increment in fixed costs. But the changes in the variable costs normally affect very significantly the total costs of a company’s costs. A small change in variable costs or a little increase in variable costs leads to a large increase in total costs as it’s related to each unit.

 

 

References

Hermanson, R.H., Edwards, J.D., & Invacevich, S.D. (2011). Accounting Principles: A Business Perspective. First Global Text Edition, Volume 2 Managerial Accounting, 37-73.

Drucker, F. (1999) Management Challenges of the 21st Century. New York: Harper Business.

Garrison, H., Noreen, E., Brewer, C., (2009) Managerial Accounting. McGraw-Hill Irwin.