CENTURY 21 ACCOUNTING © Thomson/South-Western LESSON 15-3 Decisions That Affect Net Income

CENTURY 21 ACCOUNTING © Thomson/South-Western CALCULATING SALES TO EARN PLANNED NET INCOME Determining the breakeven point provides management with important information about the relationship of sales, variable costs, & fixed costs. Managers also need information that will assist them in achieving planned net income The breakeven analysis can be used to calculate the dollar & unit sales needed to earn a specified amount of planned net income 2 LESSON 15-3

CENTURY 21 ACCOUNTING © Thomson/South-Western 3 LESSON 15-3 Contribution Margin Rate Required Contribution Margin Sales Dollars ÷= $22, ÷ = $150, or 15% Planned Net Income Total Fixed Costs Required Contribution Margin += $21, = $22,500.00$1, CALCULATING SALES TO EARN PLANNED NET INCOME page 455 Calculate the required contribution margin. The sum of total fixed costs & the planned net income is the contribution margin necessary both to cover fixed costs & to earn the planned amount of net income. Shows total sales required to earn $1,500 of net income Calculate the amount of sales dollars by dividing the required contribution margin by the contribution margin rate.

CENTURY 21 ACCOUNTING © Thomson/South-Western 4 LESSON 15-3 EFFECT OF VOLUME CHANGES ON NET INCOME page 456

CENTURY 21 ACCOUNTING © Thomson/South-Western 5 LESSON 15-3 EFFECT OF COST CHANGES AT AVERAGE VOLUME page 457 Management is concerned that the relatively low contribution margin rate makes increasing net income difficult for the company Considering an alternative production method With alternative 2 the contribution margin is higher, but fixed costs also are higher The higher fixed costs cancel the higher contribution margin

CENTURY 21 ACCOUNTING © Thomson/South-Western 6 LESSON 15-3 EFFECT OF COST CHANGES AT ABOVE AVERAGE VOLUME page 458 If the company expects a permanent sales increase, Alternative 2 would be more profitable than Alternative 1

CENTURY 21 ACCOUNTING © Thomson/South-Western 7 LESSON Contribution margin rate, Alternative Contribution margin rate, Alternative 2. EFFECT OF CHANGES IN COSTS ON CONTRIBUTION MARGIN RATE page A logical conclusion is “everything else being equal, the activity with the higher contribution margin rate is more profitable.” If “everything else” is equal, selecting the more profitable choice is simple An effective business looks for the best combination of fixed & variable costs.

CENTURY 21 ACCOUNTING © Thomson/South-Western EFFECT OF CHANGE IN SALES PRICE 8 LESSON 15-3 Setting the sales price of a product is extremely important. If the price is set too high, potential customers will buy from another business If the price is set too low, the company may not earn enough money to cover costs & may suffer a loss Objective is to set sales prices that provide a reasonable amount of net income while keeping prices competitive

CENTURY 21 ACCOUNTING © Thomson/South-Western 9 LESSON 15-3 New Contribution Margin per Unit Contribution Margin Unit Sales Required to Maintain Planned Net Income ÷= $22,500.00÷=45,000 units $0.50 EFFECT OF CHANGE IN SALES PRICE page 459

CENTURY 21 ACCOUNTING © Thomson/South-Western USING BREAKEVEN TO PLAN SALES MIX 10 LESSON 15-3 Businesses that sell two or more products can also use breakeven point calculations to assist managers in planning Relative distribution of sales among various products is called sales mix The sales mix must be calculated to determine the breakeven point for a company that sells more than one product.

CENTURY 21 ACCOUNTING © Thomson/South-Western 11 LESSON 15-3 USING BREAKEVEN TO PLAN SALES MIX page 460 Product Sales÷Net Sales=Sales Mix Television$52,500.00÷$75,000.00=70% VCR$22,500.00÷$75,000.00=30% Calculate the sales mix using information from the income statement. Net sales are divided by the sales amounts for each product. The total product mix must equal 100%

CENTURY 21 ACCOUNTING © Thomson/South-Western 12 LESSON 15-3 USING BREAKEVEN TO PLAN SALES MIX page 460 Contribution Margin Rate Contribution MarginNet Sales ÷=.40 or 40%$30, ÷ $75, = $34,000.00$24, $10, = Required Contribution Margin Total Fixed Costs Planned Net Income +=  Calculate the contribution margin rate by dividing the contribution margin shown on the income statement by net sales  Add total fixed costs & the planned net income to determine the required contribution margin

CENTURY 21 ACCOUNTING © Thomson/South-Western 13 LESSON 15-3 USING BREAKEVEN TO PLAN SALES MIX page 460 $85,000.00$34, ÷.40 or 40% = Total Sales Dollars Required Contribution Margin Contribution Margin Rate ÷=  Multiply the sales mix percentage by the total sales dollars to determine the sales dollars needed for each product.

CENTURY 21 ACCOUNTING © Thomson/South-Western 14 LESSON 15-3 USING BREAKEVEN TO PLAN SALES MIX page 460 Product Sales Dollars Sales Mix Total Sales Dollars ×= Product Unit Sales Product Sales Dollars Unit Sales Price ÷= Television 170 units$59, ÷ $ = 102 units$25, ÷ $ = VCR Television $59, % × $85, = $25, % × $85, = VCR  Divide the product sales dollars by the unit sales price to determine product unit sales. The unit sales prices are found on the income statement.  The product unit sales indicate the number of units of each product that must be sold to achieve the planned net income of $10,000

CENTURY 21 ACCOUNTING © Thomson/South-Western 15 LESSON 15-3 TERM REVIEW sales mix page 462