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Comprehensive Cost-Volume-Profit (CVP) Analysis For Blake Dunn's Business Decisions

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    Comprehensive Cost - Volume - Profit (CVP) Analysis for Blake Dunn's Business Decisions 3 ‐ 34 Comprehensive CVP analysis (LO 1 , 2 , 3 , 5 ) “I'll never understand this accounting stuff,” Blake Dunn yelled, waving the income statement he had just received from his accountant in the morning mail. “Last month, we sold 1,000 stuffed State University mascots and earned $6,850 in operating income. This month, when we sold 1,500, I thought we'd make $10,275. But this income statement shows an operating income of $12,100! How can I ever make plans if I can't predict my income? I'm going to give Janice one last chance to explain this to me,” he declared as he picked up the phone to call Janice Miller, his acco untant. “Will you try to explain this operating income thing to me one more time?” Blake asked Janice. “After I saw last month's income statement, I thought each mascot we sold generated $6.85 in net income; now this month, each one generates $8.07! There was no change in the price we paid for each mascot, so I don't understand how this happened. If I had known I was going to have $12,100 in operating income, I would have looked more seriously at adding to our product line.” Taking a deep breath, Janice replied, “Sure, Blake. I'd be happy to explain how you made so much more operating income than you were expecting.” Required a. Assume Janice's role. Explain to Blake why his use of operating income per mascot was in error. b. Using the following income statements, prepare a contribution margin income statement for March. February March Sales revenue $25,000 $37,500 Cost of goods sold 10,000 15,000 Gross profit 15,000 22,500 Rent expense 1,500 1,500 Wages expense 3,500 5,000 Shipping expense 1,250 1,875 Utilities expense 750 750 Advertising expense 750 875 Insurance expense 400 400 Operating income $ 6,850 $12,100 c. Blake plans to sell 500 stuffed mascots next month. How much operating income can Blake expect to earn next month if he realizes his planned sales? d. Blake wasn't happy with the projected income statement you showed him for a sales level of 500 stuffed mascots. He wants to know how many stuffed mascots he will need to sell to earn $3,700 in operating income. As a safety net, he also wants to know how many stuffed mascots he will need to sell to break even. e. Blake is evaluating two options to increase the number of mascots sold next month. First, he believes he can increase sales by advertising in the University newspaper. Blake can purchase a package of 12 ads over the next month for a total of $1,200. He believes the ads will increase the number of stuffed

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    mascots sold from 500 to 960. A second option would be to reduce the selling price. Blake believes a 10% decrease in the price will result in 1,000 mascots sold. Which plan should Blake implement? At what level of sales would he be indifferent between the two plans? f. Just after Blake completed an income projection for 1,200 stuffed mascots, his supplier called to inform him of a 20% increase in cost of goods sold, effective immediately. Blake knows that he cannot pass the entire increase on to his customers, but thinks he can pass on half of it while suffering only a 5% decrease in units sold. Should Blake respond to the increase in cost of goods sold with an increase in price? g. Refer back to the original information. Blake has decided to add stadium blankets to his product line. He has found a supplier who will provide the blankets for $32, and he plans to sell them for $55. All other variable costs currently incurred for selling mascots will be incurred for selling blankets at the same rate. Additional fixed costs of $350 per month will be incurred. He believes he can sell one blanket for every three stuffed mascots. How many blankets and stuffed mascots will Blake need to sell e ach month in order to break even? Answer: a. Explain to Blake why his use of operating income per mascot was in error. Blake's mistake lies in how he is interpreting the operating income per mascot. Operating income is the difference between sales revenue and all expenses (variable and fixed), not simply the income generated from each unit sold. His calculation assumes that the income generated per mascot is static and fixed, but operating income depends on both variable costs and fixed costs. In addition, since fixed costs do not change with the number of units sold, Blake cannot directly apply operating income per unit sold in this manner to estimate future income. Instead, operating income depends on the contribution margin (which includes variable costs) and how fixed costs are distributed. In simpler terms: While the sale of each mascot generates revenue, the costs associated with producing and selling those mascots (both variable and fixed) determine the operating income. As more units are sold, the operating income increases because the fixed costs remain constant, and the contribution from the variable costs grows, resulting in higher profitability. b. Contribution Margin Income Statement for March Let's start by creating a contribution margin income statement for March. The formula for Contribution Margin is: Contribution Margin=Sales Revenue−Variable Costs \ text{Contribution Margin} = \ text{Sales Revenue} - \ text{Variable Costs} For each month, we need to determine the variable costs. We can identify variable costs from the Cost of Goods Sold (COGS) and other variable expenses such as wages, shipping, and advertising. Fixed costs are the costs that remain constant irrespective of the number of units sold, such as rent, utilities, and insurance. We’ll calculate the contribution margin as follows: 1. Sales Revenue: Given as $37,500. 2. Variable Costs: We estimate variable costs by looking at the cost increases for COGS, wages, shipping, and advertising based on the increase in sales from February to March. Item February March Increase (March - February) Sales Revenue $25,000 $37,500 +$12,500 COGS $10,000 $15,000 +$5,000 Wages Expense $3,500 $5,000 +$1,500 Shipping Expense $1,250 $1,875 +$625 Advertising Expense $750 $875 +$125 Variable Costs Total (March) = $15,000 (COGS) + $5,000 (Wages) + $1,875 (Shipping) + $875 (Advertising) = $22,750 Fixed Costs remain constant: • Rent Expense: $1,500 • Utilities Expense: $750 • Insurance Expense: $400

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