\fAPPLY THE CONCEPTS: Prepare a contribution margin income statement Assume that you are part of the accounting team for Martin Digital. The company has only one product that sells for $40 per unit. Martin estimates total xed costs to be $9,500. Martin estimates direct materials cost of $4.80 per unit, direct labor costs of $6.00 per unit, and variable overhead costs of $1.20 per unit. The CEO would like to see what the gross margin and operating income will be if 500 units are sold in the next period. Prepare a contribution margin income statement. Martin Digital Contribution Margin Income Statement Sales 15:] Less: Variable costs ' J C] Contribution margin V J D Less: Fixed costs V J C] Operating income D Feedback " Check My Work Apply the numbers given in this section to the formal determined in the section above. Total revenues will be equal to the unit sales price times the number of units sold The total variable cost will be equal to the total of all variable unit costs times the number of units sold CVP Analysis and the Break-Even Point in Sales Dollars CVP analySis focuses on selling price, units sold, variable cost per unit, and total fixed costs. Managers can use the contribution margin format to understand the effects of changes in any of these areas. Contribution margin is the amount that is available to pay fixed ' J costs. After those costs are paid, anything remaining from contribution margin becomes operating income V J . A business can determine the level of sales needed to cover all costs by knowing the break-even point. The breakeven point is where operating income is zero ' J . This pomt can be expressed as the breakeeven point in units or the breakeeven point in sales dollars. The followmg formulas are used to calculate the breakeven point in sales dollars: 1. Calculate the contribution margin per unit: Selling Price Variable Cost per Unit Contribution Margin per Unit 2. Determine the contribution margin ratio: Selling Price Total Fixed Costs 3. Compute the break-even paint in sales dollars: Contribution Margin Ratio Feedback " Check My Work ReVIew the statement format and the example from the sections above What happens as the contribution margin approaches zero? APPLY THE CONCEPTS: Calculate the breakeeven point in sales dollars for Martin Digital Further analysis of Martin Digital's fixed costs revealed that the company actually faces annual fixed overhead costs of $9,800 and annual fixed selling and administrative costs of 54,200. Variable cost estimates are correct: direct materials cost, $4.80 per unit; direct labor costs, $6.00 per unit; and variable overhead costs, $1.20 per unit. At this time, the selling price of $40 will not change. Complete the following formulas for the revised fixed costs. Enter the ratio as a percentage. APPLY THE CONCEPTS: Calculate the break-even point in sales dollars for Martin Digital Further analysis of Martin Digital's xed costs revealed that the company actually i'aces annual fixed overhead costs of $9,800 and annual fixed selling and administrative costs of 54,200. Variable cost estimates are correct: direct materials cost, $4.80 per unit; direct labor costs, $6.00 per unit; and variable overhead costs, $1.20 per unit. At this time, the selling price of $40 will not change. Complete the followmg formulas for the rewsed fixed costs. Enter the ratio as a percentage. Contribution Margin Ratio Now complete the formulas for (1) the break-even paint in sales dollars and (2) the units sold at the break-even point. To calculate this, divide the break-even point in sales dollars by the unit selling price. 3 ) Break-Even Point in Sales Dollars Units Sold at Break-Even Point = :] units Assume that the number of units that Martin sold exceeded the break-even point by one (1). How much would operating income be? 5:] What would operating income be if the units sold exceeded the breal-ceven point by ve (5) units? 5:] The CostVolumesProfit Graph The CVP graph shows the retationshxps among cost, volume, and prots. The X- (hortzontat) axis is the total units, and the Y (verticat) axxs is the dollars (sates or costs). The intersection of these two axes, the origin, is where both units and doHars are zero. There are two lines to be plotted on the graph: the sales line and the total costs line. The sales line crosses the Y'aXIS where sales doHars are zero I0] ' J . The stope of any line T5 the variable rate. The slope of the sales line TS equat to the unit selling price ' J Recall that total xed costs do not change ' J regardless of the number of umts sotd, even it zero units are sold. Therefore, the tota' costs Tine witl cross the Yaxis at total fixed costs ' \\/ doHars. As each additxonal unit is sold, the total costs wilt \ crease by the unit variable cost V J . Therefore, the slope of the total costs line is equal to the unit variable cost ' J . The breakeeven pOInt exists at the point where the two lines intersect v V' , Feedhadr " Check My Work Try drawmg the lines described on a piece of paper \ order to gel a visuat handle on the concept. Start with a blank XY axis grid Y [dollars] I | | | | | | | ......................... x (units] APPLY THE CONCEPTS: Create the CVP graph for Martin Digital Review the information and previous calculations for the break-even point in sales dollars for Martin Digital. Choose the graph that correctly represents the CVP graph for Martin Digital. Sales Line Total Cost Line a. Break-even Point Units\fAPPLY THE CONCEPTS: Use the CVP graph to analyze the effects of changes in price and costs Graph the folloWing on your own paper. At the original position, the breal-ceven point in sales dollars is 524,000 at 500 units. The fixed costs are $8,000. Assume the slope of the sales line is equal to the selling price. When the two points of the sales line are at the origin and the breakeven point, you see that the slope of the line is S48, which means that the selling price is $:] . When the two points of the total costs line are at the origin and the breakieven point, you see that the slope of the line is $32.00, which means that the variable cost per unit is $ Leave the break-even pomt (x) at its original position. Use it as a reference pomt to answer the followmg questions. Analyze the scenarios by sliding the p0ints on the lines to get the slope deSIred. Recall that the new break-even point for each scenario exists where the sales and total costs lines intersect. Compare it to the original breakeven p0int (x). (You may want to put the lines back to their original position for each scenario.) Each scenario should be considered independently. 1. The company purchases a fixed asset and increases xed costs by $2,000. Variable costs remain the same, which means that the slope does not change. This will cause the breakeven point to move to the right V J , which means that break-even point in sales dollars increases ' J . 2. A new supplier can provide a product of equal quality at $4.00 per unit less than the current direct materials cost. If the new supplier is used, the slope of the total costs line will be $:] , and the break-even point in sales dollars decreases ' J . 3. Market research shows that a price increase will decrease the number of units sold. A price increase will cause the slope of the sales line to increase ' J . But internal analysis shows that this price increase will cause the breakeven point in sales to shift to the left V J , which means that fewer V J units will need to be sold to break even. Fearlhar-k Martin Digital Contribution Margin Income Statement Sales '- 20,000 \\' LeSS: Variable costs ' J 2,400 3' Contribution margin ' J '. 17,600 X Less: Fixed costs V J 9,500 3/ Operating income '- 8,100 X