The Natural Water Company is a processor of mineral water. Sales are made principally in litre bottles to grocery stores throughout the country.

The company’s income statements for the past year and the coming year are being analyzed by top management.

Consider each requirement independently.
Unless otherwise stated, assume that all unit costs of inputs such as material and labour are unchanged. Also, assume that efficiency is unchanged—that is, the labour and quantity of material consumed per unit of output are unchanged.
Unless otherwise stated, assume that there are no changes in fixed costs.

1. The president has just returned from a management conference at a local university, where he heard an accounting professor criticize conventional income statements. The professor had asserted that knowledge of cost-behaviour patterns was of key importance in determining managerial strategies. The president now feels that the income statement should be recast to harmonize with cost-volume-profit analysis—
that is, the statement should have three major sections: sales, variable costs, and fixed costs. Using the 2006 data, prepare such a statement, showing the contribution margin as well as operating income.
2. Comment on the changes in each item in the 2007 income statement.
What are the most likely causes for each increase? For example, have selling prices been changed for 2007? How do sales commissions fluctuate in relation to units sold or in relation to dollar sales?
3. The president is unimpressed with the 2007 budget: “We need to take a fresh look in order to begin moving toward profitable operations.
Let’s tear up the 2007 budget, concentrate on 2006 results, and prepare a new comparative 2007 budget under each of the following assumptions:

a. A 5 percent average price cut will increase unit sales by 20 percent.

b. A 5 percent average price increase will decrease unit sales by 10 percent.

c. A sales commission rate of 10 percent and a 3.33 percent price increase will boost unit sales by 10 percent.”
Prepare the budgets for 2007, using a contribution-margin format and three columns. Assume that there are no changes in fixed costs.
4. The advertising manager maintains that the advertising budget should be increased by $130,000 and that prices should be increased by 10 percent. Resulting unit sales will soar by 25 percent. What would be the expected operating income under such circumstances?
5. Anearby distillery has offered to buy 300,000 litres in 2007 if the unit price is low enough. The Natural Water Company would not have to incur sales commissions or shipping costs on this special order, and regular business would be undisturbed. Assuming that 2007’s regular operations will be exactly like 2006’s, what unit price should be quoted in order for the Natural Water Company to earn an operating income of $10,000 in 2007?
6. The company chemist wants to add a special ingredient, an exotic flavouring that will add $0.03 per litre to the mineral water. Assuming no other changes in cost behaviour, how many units must be sold to earn an operating income of $10,000 in 2007?

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Sales 1,500,000 litres in 2006 Cost of goods sold: Direct materials Direct labour Factory overhead: Variable Fixed Gross margin Selling expenses: Variable: FOR THE YEAR 2006 JUST ENDED FOR THE YEAR 2007 TENTATIVE BUDGET $1,000,000 $900,000 $450,000 $495,000 90,000 99,000 18,000 19,800 50,000 608,000 50,000 $292,000 663,800 $ 336,200 Sales commissions (based on dollar sales) $ 45,000 Shipping and other 90,000 $ 50,000 99,000 Fixed: Salaries, advertising, etc. 110,000 138,000 Administrative expenses: Variable 12,000 13,200 Fixed 40,000 297,000 40,000 340,200 Operating income $ (5,000) $ (4,000)