Purpose of Assignment The Case Study focuses on CVP (Cost-Volume-Profit), break-even, and margin of safety analyses which allows students to experience working through a business scenario and applying these tools in managerial decision making. Resources Cost-Volume-Profit Analysis Grading Guide Generally Accepted Accounting Principles (GAAP), U.S. Securities and Exchange Commission (SEC) Tutorial help on Excel and Word functions can be found on the Microsoft Office website. There are also additional tutorials via the web offering support for Office products. Scenario: Mary Willis is the advertising manager for Bargain Shoe Store. She is currently working on a major promotional campaign. Her ideas include the installation of a new lighting system and increased display space that will add $24,000 in fixed costs to the $270,000 in fixed costs currently spent. In addition, Mary is proposing a 5% price decrease ($40 to $38) will produce a 20% increase in sales volume (20,000 to 24,000). Variable costs will remain at $24 per pair of shoes. Management is impressed with Mary’s ideas but concerned about the effects these changes will have on the break-even point and the margin of safety. Assignment Steps Complete the following: Compute the current break-even point in units, and compare it to the break-even point in units if Mary’s ideas are used. Compute the margin of safety ratio for current operations and after Mary’s changes are introduced (Round to nearest full percent). Prepare a CVP (Cost-Volume-Profit) income statement for current operations and after Mary’s changes are introduced. Prepare a maximum 700-word informal memo to management addressing Mary’s suggested changes. Explain whether Mary’s changes should be adopted. Why or why not? Analyze the above information (three bullet points above) and use this information to support your suggestion. Show your work in Microsoft Word or Excel. Complete calculations/computations using Microsoft Word or Excel.

Cost-volume-profit analysis

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Part I

Question 1

Break- even point units

Break-even point = fixed cost divided by contribution margin per unit.

Current selling price = $40

Less variable cost = $24

Contribution margin = ($40 – $24) = $16

Fixed cost = $270, 000.00

Current BEP (UNITS) = $270,000/$16 = 16,875

Mary’s proposal

Selling price = $38

Variable cost = $24

Contribution = ($38 – $24) = $14

Fixed cost = $294, 000

BEP (UNITS) = $294,000/$14 = 21,000

BEP Units change will be = (21000 – 16875) = 4125

Question 2

Margin of safety Ratio

Current

Actual sales: units = 20,000

Price per unit = $40

Total = 20,000* 40 = $800,000

Break even sales: units = 16,875

Price per unit = $40

Total = (16, 875 * $40) = $675000

Margin of safety = Actual sales less Break even sales = $800,000 – $675, 000 = $125,000.00

Margin of safety ratio = (Actual sales – break even sales)/actual sales *100 = $125,000/$800,000*100 = 15.625% = 16%

Margin of safety after Mary’s proposal

Actual sales: units = 24, 0000

Price per unit = $38

Total = $38*24000 =$912,000

Break even sales: units = 21,000

Price per unit = $38

Total = $38*21000= $798,000

Margin of safety = $912,000 – $798,000 = $114,000

Margin safety ratio = $114,000/$912,000*100 = 12.50% = 13%

Question 3

Cvp income statement

Current

Sales: Total units = 20,000

Cost per unit = $40

Total = 20000*$40 = $800000

Variable cost: units = 20,000

Cost per unit = $24

Total variable cost = 20,000*$24 = $480,000

Contribution margin = total cost of sales – total variable cost = ($800,000 – $480,000) =$320,000

Net income = contribution margin – fixed cost = ($320,000- $270,000) = 50,000

After Mary’s changes

Sales: total units = 24,000

Cost per unit = $38

Total = 24,000*$38 = $912,000

Variable cost: units = 24,000

Cost per unit = $24

Total = 24,000*24 =$576, 000

Contribution margin = $912,000 – $576,000 = $336,000

Net income = $336,000 -$294,000 = $42,000

Part II

Memorandum

Date: June 09, 2019

To:	Manager
From:	Accounting Department
Subject:	Cost-Volume-Profit Analysis

The advertising manager at bargain shoe store proposes the installation of a new lighting system. She also proposes an increase in the display space which will increase the fixed cost. In addition, Mary also proposes that there should be a reduction in the product’s price as well as an increase in sales volume by 20%. I have reviewed Mary’s proposed idea by conducting a cost-volume-profit analysis to do an estimation of the impacts of Mary’s proposal to the break-even – point as well as the margin of safety for the company. I have also prepared a cost- volume –profit income statement to see the effect of these suggestions on the net income.

The breakeven analysis can be said to be a financial technique widely used by managers in production and accounting to determine a certain point where a company is able to cover all its expenses and start making a profit (Tracy, 2004). The concept is based on categorizing both the variable costs and the fixed costs the two types of cost are compared with the sales revenue to determine sales volume level, the value of sales or production whereby the company makes neither profit nor loss.

According to my calculations above, the current break-even point is at 16, 875 units. If Mary’s suggestions are applied, the breakeven-point increases to 21000 units. Hence, the company is supposed to sell 4125 extra units to break-even. The primary cause of an increase in break-even is due to a decrease in selling price by 2% as well as an increase in fixed cost by $24,000

The margin of safety shows the total amount of sales which are above the breakeven point. Basically, the margin of safety shows the amount by which sales in a company could be reduced before the company gets no profits (Calandro, 2011). In my calculation, the current margin of safety is at 16%. When Mary’s changes are introduced, the margin of safety ratio drops to 13%. This means there is a decrease of 3%.

A CVP income statement only prepared for an organization’s internal use. In a CVP income statement, the expenses are either as a variable or as fixed (Choo & Tan, 2011). The above income statements show that the current net income of the company is higher at $50,000. If Mary’s changes are introduced the net income will decrease to $42,000. It indicates that there will be a decrease of $8,000 in net income if Mary’s changes are introduced.

According to the discussion and the calculations above, Mary’s suggestions should not be implemented because they will result in an increase in break-even point as well as a reduction in the margin of safety. The net income will also decrease by $8000.

References

Calandro, J. J. (2011). The margin of safety principle and corporate strategy. Strategy & Leadership, 39(5), 38-45.

Choo, F., & Tan, K. B. (2011). An Income Statement Teaching Approach for Cost-Volume-Profit (CVP) Analysis by Using a Company’s CVP Model. Journal of Accounting and Finance, 11(4), 23-36.

Tracy, B. (2004, 15 November). Conducting a Break-Even Analysis. Retrieved from Entreprenuer : https://www.entrepreneur.com/article/73782

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To:

Manager

From:

Subject:

Cost-Volume-Profit Analysis

According to the discussion and the calculations above, Mary’s suggestions should not be implemented because they will result in an increase in break-even point as well as a reduction in the margin of safety. The net income will also decrease by $8000.