Converting Full- Absorption Costing Income Statements to CVP Analysis: Pralina Products Company is a regional firm that has three major product lines cereals, breakfast bars, and dog food. The income statement for the year ended April 30, Year 4, is shown below; the statement was prepared by product line using full- absorption costing. Explanatory data related to the items presented in the income statement follow.

Other data:

1. Costs of sales. The company's inventories of direct materials and finished products do not vary significantly from year to year. The inventories at April 30. Year 4, were essentially identical to those at April 30. Year 3. Factory overhead was applied to products at 120 percent of direct labor- dollars. The factory overhead costs for the Year 4 fiscal year were as follows:

There was no overapplied or underapplied overhead at year-end.

2. Advertising. The company has been unable to determine any direct causal relationship between the level of sales volume and the level of advertising expenditures. However, because management believes advertising is necessary. an annual advertising program is implemented for each product line. Each product line is advertised independent of the others.

3. Commissions. Sales commissions are paid to the sales force at the rates of 5 percent on the cereals and 10 percent on the breakfast bars and dog food.

4. Licenses. Various licenses are required for each product line. These are renewed annually for each product line.

5. Salaries and related benefits. Sales, and general and administrative personnel devote time and effort to all product lines. Their salaries and wages are allocated on the basis of management's estimates of time spent on each product line.

Required:

a. The controller of Pralina Products Company has recommended that the company do a CVP analysis of its operations. As a first step, the controller has requested that you prepare a revised income statement for Pralina Products Company that employs a product contribution margin format that will be useful in CVP analysis. The statement should show the profit contribution for each product line and the operating profit before taxes for the company as a whole.

b. The controller of Pralina Products Company is going to prepare a report, which he will present to the other members of top management, explaining CVP analysis. Identify and explain the following points that the controller should include in the report.

(1) The advantages that CVP analysis can provide to a company.

(2) The difficulties Pralina Products Company could experience in the calculations involved in CVP analysis.

(3) The dangers that Pralina Products Company should be aware of in using the information derived from the CVP analysis.

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Total 3,000 $1,600 590 150 180 920 680 8g 8 $(24) g**8 &&8 } 25 *3 88 8& 3 8 38 8 Sales in pounds Revenue from sales Cost of sales: Direct materials Direct labor Factory overhead Total cost of sales Gross margin Operating costs: PRALINA PRODUCTS COMPANY Income Statement For the Year Ended April 30, Year 4 (in thousands) Cereals 2,000 $1,000 Breakfast Bars 500 40 Selling costs: Advertising Commissions Salaries and related benefits Total selling expenses General and administrative costs: Licenses Salaries and related benefits Total general and administrative costs Total operating costs Operating profit before taxes