Break-even analysis, contribution margin, and variable costing calculations

¶ … equation to calculating the breakeven point is straightforward, px = vx + FC + profit p is the price per unit, x relates to the number of units, v is the variable costs and FC is the fixed costs. In the case of a break even calculation the profit will be set at zero. To calculate the break even point in unit sales the equation is x = FC/(p-v).

The answers are presented below in table 1, using these equations.

Table 1; Break Even Point

Revenue per item (p)

Less variable costs (v)

Contribution per unit (p-v)

Fixed costs (FC)

$181,980

Break even point (units)

Break even point (sales)

$363,960

Therefore, the break even point is 674 units or sales of $363,960

Brief Exercise 18-10

If the firm requires a profit of $120,051, and it is known there are fixed costs of $170,500, and variable costs are 57%. Knowing that the fixed costs are met out of the contribution margin of p-v, and that this will then provide the calculation, the level of sales needed can be calculating, by taking the FC+ required profits and calculating the total required, so that FC + required profit makes up 43% of the total. Sales required will be $675,700.

Brief Exercise 18-11

The margin of safety, in dollars, is calculated by deducting the break even point from the sales achieved. For example, sales of $1,223,000 less a break even level of $770,490 gives a safety margin of $452.510.

The margin of safety in percentage terms is calculated by taking the margin of safety in dollar terms and dividing it by the total sales and expressing it as a percentage.

$452.510/$1,223,000 = 37%

Exercise 19-17

In variable costing the costs are allocated on actual production, therefore when assessing the allocation of the fixed cost, it is the costs per unit produced, and not the units sold which are used in the calculation. Sales and admin costs are not a manufacturing cost. so are not included.

Table 3; Total manufacturing costs per unit

Variable costs

Direct materials

$8.03

Direct labor

$2.62

Variable manufacturing overheads

$6.15

Variable selling and admin costs

$4.17

Total variable costs

$20.97

Manufacturing overhead

$251,856

Units produced

95,400

Total fixed cost per unit

$2.64

Total manufacturing costs per unit

$23.61

The total manufacturing costs per unit are $23.61.

Brief Exercise 21-1

The static sales budget for Maris Company

Actual

Budget

Difference

Variance

Sales

339,800

318,200

21,600

6.79%

QUESTION: Incremental analysis is considered to be more economical than a comprehensive analysis, while being just as effective. Do you agree or disagree and why?

An incremental analysis is quicker and less complex than a comprehensive analysis. With an incremental analysis there is a calculation of only the additional costs and the additional revenues that are created, so the difference on the bottom line can be assessed. There are some specific advantages; when a firm assesses a potential investment or new product, it is the difference that it will make on the bottom line which may be most important (Bragg, 2012). It may be argued that where the firm is using resources which are already being accounted for (fixed overheads which are not included in incremental costing), and the costs will not increase as a result, that the incremental approach helps to give an overall picture of the change in the firm without complicating the calculations. The process of incremental costing facilitates quick decision making (Bragg, 2013).

There are also some disadvantages. It is possible that incremental costing may give a misleading impression of the actual costs as it does not include overheads (Bragg, 2013). The production of the new good, or the investment being costed, is likely to be using some of the resources in the overheads, so the costing without including these is not accurate. In the short-term this may not be problematic, but in the long-term the distortion of costs may result in inefficient decision making, with profitable goods potentially supplementing less profitable goods. In the short-term incremental costing may be useful, especially where there is a spare capacity or under use of resources, but in the ling term a more accurate method, such as activity-based costing, may be more advisable in giving an assessment of total costs to help with future decision making, especially of opportunity costs are being considered with compare of different products and decision regarding which to continue or discontinue.

Reference

Bragg, Steven M, (2012), Cost Accounting Fundamentals: Essential Concepts and Examples, Accounting Tools