Each question refers to the same initial data. Treat each question separately. Ignore income...

Question:

Each question refers to the same initial data. Treat each question separately. Ignore income taxes. Assume no beginning or ending inventories. Calculations and backup should be completed and submitted in Excel. Use proper Contribution Income Statement formatting. Analysis can either be typed into cells in Excel (formatted to be easily legible) or typed into a text box in Excel.

Data for all questions:

Sound Eleven Corporation produces electric guitars. Their "High Volume" style guitars are mainly used for students and guitar players looking for an inexpensive practice guitar. The cost of manufacturing and marketing their guitars, at their normal factory volume of 5,000 "High Volume" guitars per month, is shown in the table below. These guitars sell for $350 each. (Note: Fixed costs are shown on a per-unit basis in the table based on normal volume. However, fixed costs as a total do not change when volume changes, so you will need to determine total fixed costs first.)

       Unit manufacturing costs:
Variable Materials $ 30
Variable Labour $ 40
Variable Overhead $ 25
Fixed Overhead $ 50
Total Unit Manufacturing Costs: $ 145
Unit Marketing Costs:
Variable Marketing Costs $ 45
Fixed Marketing Costs $ 40
Total Unit Marketing Costs: $ 85
Total Unit Costs: $ 230

Question 1: What is the break-even point? A) In units? B) In sales dollars?

Question 2: A nearby music school has offered to purchase 3,000 guitars (one time) if the price was lowered to $300 per guitar. Sound Eleven's maximum capacity is 6,000 units. A) Based on the cost data provided, what would be the impact of the price decrease on sales, costs, and operating income if Sound Eleven accepted this sale? B) Do you think Sound Eleven should accept this sale? Support your decision with evidence and analysis.

Question 3: Research has shown that there is a need for a higher quality guitar on the market. Sound Eleven would be able to produce a higher quality guitar, called the "Turn it Up" on their existing equipment if they upgraded the wood and strings at an additional cost of $25 per guitar. However, they would need a new paint booth to be able to produce the better paint job required for the "Turn it Up" guitar. This would increase fixed overhead costs by $60,000 per month (still based on normal production volume of 5,000 units). Maximum production for both types of guitars together would still be 6,000 units because the majority of the same equipment would be used. The "Turn it Up" guitars would sell for $450 each. A) What would be the break-even point if String Thing only sold "Turn it Up" guitars? B) Create a contribution income statement for a month in which String Thing sold 3,500 "High Volume" guitars, and 2,000 "Turn it Up" guitars. C) Explain, in your own words, the difference between fixed and variable costs and how they impact profitability.

Costs:

Costs can be classified as either fixed, variable or mixed. The fixed and variable component of a mix cost can be separated through high-low method, least squares regression and other related methods. These costs affects the company's profitability.

Answer and Explanation:

Question 1: What is the break-even point?

A) In units?

Variable Materials 30
Variable Labor 40
Variable Overhead 25
Variable Marketing Costs 45
Total Variable Costs per Unit 140


Fixed Overhead 50
Fixed Marketing Costs 40
Total Fixed Cost per Unit 90
Units 5,000
Total Fixed Costs 450,000


Selling Price 350
Total Variable Costs per Unit 140
Contribution Margin per Unit 210


Total Fixed Costs 450,000
Contribution Margin per Unit 210
Break-even Point in Units 2,143


B) In sales dollars?

Selling Price 350
Total Variable Costs per Unit 140
Contribution Margin per Unit 210
Selling Price 350
Contribution Margin Ratio 60%


Total Fixed Costs 450,000
Contribution Margin Ratio 60%
Break-even Point in Dollar Sales 750,000


Question 2:

A) Based on the cost data provided, what would be the impact of the price decrease on sales, costs, and operating income if Sound Eleven accepted this sale?

Original
Sales (5,000*350) 1,750,000
Variable Cost (5,000*140) 700,000
Contribution Margin 1,050,000
Fixed Costs 450,000
Net Income 600,000


With Special Offer
Sales at original Price (3,000*350) 1,050,000
Sales of Special Offer (3,000*300) 900,000
Total Sales 1,950,000
Variable Costs (6,000*140) 840,000
Contribution Margin 1,110,000
Fixed Cost 450,000
Net Income 660,000


Because of the increase is units sold, the total sales and variable costs increase. However, the total contribution margin and net income still increased with the special offer.


B) Do you think Sound Eleven should accept this sale? Support your decision with evidence and analysis.

Based on the computation above, the special offer should be accepted because it will result in higher net income amounting to 60,000. Although the price is lower as compared to the 350 original selling price, no additional cost will be incurred in the said special offer because it can still be accommodated by the firm's capacity.


Question 3: A) What would be the break-even point if String Thing only sold "Turn it Up" guitars?

Total Variable Cost-Original 140
Additional 25
Total variable Cost per Unit-New 165


Original Fixed Cost 450,000
Additional 60,000
New Fixed Cost 510,000


Selling Price 450
Total variable Cost per Unit-New 165
Contribution Margin per Unit 285
Selling Price 450
Contribution Margin Ratio 63%


New Fixed Cost 510,000
Contribution Margin per Unit 285
Break-even in Units 1,790


New Fixed Cost 510,000
Contribution Margin Ratio 63%
Break-even Point in Dollar Sales 805,263.16


B) Create a contribution income statement for a month in which String Thing sold 3,500 "High Volume" guitars, and 2,000 "Turn it Up" guitars.

Sales (3,500*350) 1,225,000
Sales (2,000*450) 900,000
Total Sales 2,125,000
Variable Costs (3,500*140) -490,000
Variable Costs (2,000*165) -330,000
Contribution Margin 1,305,000
Fixed Cost (450,000+60,000) -510,000
Net Income 195,000


C) Explain, in your own words, the difference between fixed and variable costs and how they impact profitability.

Variable Cost is a type of cost which varies as the level of activities change. This means that when level of activities increase, the total variable cost increase and vice versa. However, the per unit variable cost remains the same and is not affected by the level of activities. On the other hand, fixed cost is a cost that remains constant, regardless of the level of activities, considering that the company is operating within its capacity. However, as opposite to per unit variable cost, the fixed cost per unit is inversely proportional to the level of production. This means that when activity level increased, the fixed cost per unit decreases and vice versa. As to profitability, both costs are considered as a deduction to income. However, the fixed cost does not affect the level of activities if company is operating within its capacity, otherwise, additional fixed cost will be incurred.


Learn more about this topic:

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Variable Costing: Method, Formula & Advantages

from Financial Accounting: Help and Review

Chapter 13 / Lesson 5
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