Managerial Accounting This Scenario Shows the Importance

Managerial Accounting

This scenario shows the importance of variable cost drivers in calculating a breakeven point and conducting effective CVP analysis. In this situation, the company is losing money no matter which scenario with respect to fixed costs is investigated, but there is a solution available for at least the lower fixed cost scenario:

Total variable cost is: (50,000 * 80) + 400,000 = $4,400,000

The average variable cost is: $4,400,000 / 200,000 = $

The average total cost is ($4,400,000 + $1,000,000) / 200,000 = $

Worker Productivity is 200,000 / 50,000 = 4 units per day per worker

If total fixed costs equal $3,000,000 per day the same figures are as follows:

Total variable cost is: (50,000 * 80) + 400,000 = $4,400,000

The average variable cost is: $4,400,000 / 200,000 = $

The average total cost per unit is ($4,400,000 + $3,000,000) / 200,000 = $

Worker Productivity is 200,000 / 50,000 = 4 units per day per worker

In both cases, the price of the output is lower than the average total cost of the output. The firm should not shut down immediately, however, based on the $1,000,000 fixed costs scenario. The point at which the firm should shut down is when variable costs exceed the revenues. In this situation, that is not the case, as revenues are $25 per unit. If the company is able to produce and sell more of these units, it will be able to turn a profit.

At $3,000,000 in fixed costs, the average fixed cost per unit is $15. This implies again that the firm has the opportunity to earn a profit if it can sell enough units to cover the fixed costs. In this case, that would be a significant jump in production, but because the selling price is higher than the average variable cost the firm should not immediately shut down.

Using the first case with $1,000,000 in fixed costs, the firm can break even if it reduces its average variable cost. The revenue is at $5 million, which implies that total variable cost cannot exceed $4 million. Taking away the $400,000, this means that the variable wages would need to be at $3.6 million to break even. This implies 45,000 workers.

The change in worker productivity is as follows: 200,000 / 45,000 = 4.44 units per day, an increase of 0.44 units per day.

The change in workers is not too large. The increase in productivity in this instance is 11%. We do not know anything about the nature of production at this facility, but an 11% increase in productivity does not seem at all unreasonable. The firm should not shut down immediately.

This example highlights the usefulness of breakeven analysis. The company is losing money, but it does not need to be doing so. The point at which the company should shut down is when the revenues do not cover the variables costs -- but even then with productivity improvements they might be able to cover such costs.