1. © 2004 by Nelson, a division of Thomson Canada Limited 1

2. 2 To be strategically successful, managers must assure their organizations are achieving the right combination of volume of products and selling prices that will generate enough revenue to cover all variable and fixed costs. At breakeven, a company experiences neither profits nor losses on its operating activities. However, you want to make profits. Knowing the breakeven level of operations provides a point of reference from which you would be better able to plan for volume goals that should generate income rather than produce losses.

3. © 2004 by Nelson, a division of Thomson Canada Limited 3 How is the breakeven point computed and what does it represent? How can cost-volume-profit (CVP) be used by a company? How do costs, revenues, and contribution margin interact with changes in an activity base (volume)? How are breakeven and profit volume graphs prepared? How does cost-volume-profit (CVP) analysis in single-product and multi-product firms differ? continued

4. © 2004 by Nelson, a division of Thomson Canada Limited 4 What are the underlying assumptions of CVP analysis and how do these assumptions create a short-run managerial perspective? How are the margin of safety and operating leverage concepts used in business? What are cost accumulation and cost presentation approaches to product costing? How do changes in sales and/or production levels affect net income as computed under absorption and variable costing?

5. © 2004 by Nelson, a division of Thomson Canada Limited 5 that level of activity, in units or dollars, at which REVENUES = COSTS R = VC + FCR – VC – FC = 0

6. © 2004 by Nelson, a division of Thomson Canada Limited 6 Relevant range – The company is operating within the relevant range of activity specified in determining the revenue and cost information used in each of the following assumptions. Revenue – Revenue per unit is assumed to remain constant. Variable costs – Variable costs per unit are assumed to remain constant within the relevant range. Variable costs include both variable manufacturing overhead and variable selling and administrative expenses. Fixed costs – Total fixed costs remain constant within the relevant range. Fixed costs include both fixed manufacturing overhead and fixed selling and administrative expenses. Mixed costs – Mixed costs must be separated into their variable and fixed elements before they can be used in CVP analysis. Because these basic assumptions treat selling prices and costs as known and constant, any analysis based on these assumptions is valid only for the short term. Because these basic assumptions treat selling prices and costs as known and constant, any analysis based on these assumptions is valid only for the short term.

7. © 2004 by Nelson, a division of Thomson Canada Limited 7 CM is the selling price per unit minus all variable production, selling and administrative costs per unit. R – VC = CM CM per unit is constant, because both revenue and variable costs per unit have been defined as being constant. Total contribution margin fluctuates in direct proportion to sales volume.

8. © 2004 by Nelson, a division of Thomson Canada Limited 8 Collegiate Rings, Incorporated Income Statement for the year ended June 30 Total per Unit Ratio Sales (3,000 units)$750,000 $ 250 100% Variable Costs: Production$330,000 $110 44% Selling and Administration 15,000 5 2% Total Variable Costs 345,000 $115 46% Contribution Margin 405,000 $135 54% Fixed Costs: Production$ 30,000 4% Selling and Administration 105,000 14% Total Fixed Costs 135,000 18% Income before Income Taxes$270,000 36%

9. © 2004 by Nelson, a division of Thomson Canada Limited 9 Mathematical Approach to CVP Analysis The breakeven equation represents the income statement. It groups costs by behaviour and shows the relationships among revenue, volume, variable cost, fixed cost and profit as follows.

10. © 2004 by Nelson, a division of Thomson Canada Limited 10 R(X) – VC(X) – FC = PBT where R = revenue (selling price per unit) X= number of units to be sold R(X)= total revenue VC= variable cost per unit VC(X)= total variable cost FC= fixed costs PBT= profit before tax

11. © 2004 by Nelson, a division of Thomson Canada Limited 11 At breakeven, P = 0; at breakeven, total CM = FC. For Collegiate Rings, contribution margin is $135 ($250 - $115) and total fixed costs are $135,000. If one ring contributes $135 towards covering fixed costs, how many rings have to be sold to cover the $135,000 fixed costs?

12. © 2004 by Nelson, a division of Thomson Canada Limited 12 If one ring contributes $135, it will take 1,000 rings to cover the $135,000 fixed costs. $135,000 / $135 = 1,000 units Breakeven in dollars: 1,000 x $250.00 = $250,000. Proof:Sales$250,000 Variable costs: Production 110,000 (1,000 x $110) Selling and admin. 5,000 (1,000 x $ 5) Contribution margin 135,000 Fixed Costs 135,000 Profit before tax$ 0

13. © 2004 by Nelson, a division of Thomson Canada Limited 13 Contribution Margin Ratio (CM%) – Contribution margin divided by revenue indicates what proportion of selling price remains after variable costs have been covered. Fixed costs divided by the CM ratio gives the breakeven point in sales dollars. Collegiate Ring's CM ratio is $135/$250 =.54 Breakeven in sales dollars is $135,000 /.54 = $250,000

14. © 2004 by Nelson, a division of Thomson Canada Limited 14 Variable Cost Ratio – the variable cost proportion of each revenue dollar 100% - CM% = VC ratio Collegiate's variable cost ratio is 1.0 -.54 =.46.

15. © 2004 by Nelson, a division of Thomson Canada Limited 15 CVP analysis is the process of examining the relationships among revenues, costs, and profits for a relevant range of activity and for a particular time period. The amount of profit which would be produced under specific conditions can be calculated using the CVP equation. Management can set a desired target profit, then focus on the relationships between that target and specified income statement amounts to find an unknown such as volume.

16. © 2004 by Nelson, a division of Thomson Canada Limited 16 Fixed Amount of Profit Before Tax (PBT) Units: R(X) – VC(X) – FC = PBT CM(X)= FC + PBT X= (FC + PBT) / CM Sales dollars: R(X) = (FC + PBT) / CM%

17. © 2004 by Nelson, a division of Thomson Canada Limited 17 Assume Collegiate wants to generate before tax profit of $270,000. How many rings must they sell? What would be the sales dollars? Fixed Amount of Profit Before Tax

18. © 2004 by Nelson, a division of Thomson Canada Limited 18 Fixed Amount of Profit Before Tax Units: R(X) – VC(X) – FC = PBT CM(X)= FC + PBT $135(X)= $135,000 + $270,000 X= $405,000 / $135 X= 3,000 units Sales dollars: R(X) = (FC + PBT) / CM% R(X)= $135,000 + $270,000 /.54 R(X)= $750,000

19. © 2004 by Nelson, a division of Thomson Canada Limited 19 Fixed Amount of Profit After Tax (PAT) R(X) – VC(X) – FC= PBT (PBT)(TR)= Tax Expense PBT – (PBT)(TR)= PAT PBT(1 - TR)= PAT PBT= PAT / (1-TR) TR = tax rate

20. © 2004 by Nelson, a division of Thomson Canada Limited 20 Fixed Amount of Profit After Tax Units: Desired PAT = $162,000 PBT= PAT / (1-TR) PBT= $162,000 /.6 PBT= $270,000 CM(X)= FC + PBT $135(X)= $405,000 X= $405,000 / $135 X= 3,000 Sales Dollars: Sales= (FC + PBT) / CM ratio = $135,000 + $270,000 /.54 = $750,000 Assume Collegiate's tax rate is 40% Assume Collegiate's tax rate is 40%

21. © 2004 by Nelson, a division of Thomson Canada Limited 21 Variable Amount of Profit Before Tax R(X) – VC(X) – FC = P u BT(X) CM(X) – P u BT(X) = FC X (CM – P u BT)= FC X= FC / (CM – P u BT) P u BT = profit per unit before income tax

22. © 2004 by Nelson, a division of Thomson Canada Limited 22 Variable Amount of Profit Before Tax Assume Collegiate Rings wants to know what level of sales (units and dollars) would would be required to earn 36% before tax profit on sales. How many rings must they sell? What would be the sales dollars?

23. © 2004 by Nelson, a division of Thomson Canada Limited 23 Variable Amount of Profit Before Tax Units: P u BT desired= 36% on sales revenues =.36($250) = $90. R(X) – VC(X) – FC = P u BT(X) CM(X) - P u BT(X) = FC $135(X) – $90(X) = FC X= $135,000 / ($135 - $90) X= $135,000 / $45 X= 3,000 units

24. © 2004 by Nelson, a division of Thomson Canada Limited 24 Variable Amount of Profit Before Tax Sales Dollars: The following relationships exist. PerPercent Unitof Sales Selling price $250100% Variable costs115 46% Variable profit before tax 90 36% Adjusted CM$45 18% Sales dollars= FC / Adjusted CM ratio = $135,000 /.18 = $750,000

25. © 2004 by Nelson, a division of Thomson Canada Limited 25 Variable Amount of Profit After Tax R(X) – VC(X) – FC= P u BT(X) (P u BT)(TR)= Tax Expense P u BT(X) – [(P u BT)(X)] TR = P u AT P u BT(X) [(1 - TR)]= P u AT P u BT(X)= P u AT / (1-TR) R(X) – VC(X) – FC = P u BT(X) CM(X) – P u BT(X)= FC X(CM – P u BT)= FC X= FC / (CM – P u BT) P u BT = fixed amount of profit per unit before tax P u AT = fixed amount of profit per unit after tax

26. © 2004 by Nelson, a division of Thomson Canada Limited 26 Variable Amount of Profit After Tax Assume Collegiate Rings wants to know what level of sales (units and dollars) would be required to earn 21.6% after tax profit on sales. How many rings must they sell? What would be the sales dollars?

27. © 2004 by Nelson, a division of Thomson Canada Limited 27 Variable Amount of Profit After Tax Units: P u AT desired = 21.6% of revenue = 0.216($250) = $54 P u BT(X)= [$54 / (1-.40)](X) = $90(X) CM(X) – P u BT(X)= FC $135(X) – $90(X)= $135,000 $45(X)= $135,000 X= $135,000 / $45 X= 3,000 units

28. © 2004 by Nelson, a division of Thomson Canada Limited 28 Variable Amount of Profit After Tax Sales Dollars: The following relationships exist. PerPercent Unitof Sales Selling price$250100% Variable costs 115 46% Variable profit before tax 90 36% Adjusted CM$ 45 18% Sales dollars= FC / Adjusted CM ratio = $135,000 /.18 = $750,000

29. © 2004 by Nelson, a division of Thomson Canada Limited 29 Used to prepare pro forma statements Used to determine the impact of various sales levels on profits Used to prove accuracy of computations made using the formula approach (Income statements on the next slide prove each of the computations made on the previous slides.)

30. © 2004 by Nelson, a division of Thomson Canada Limited 30 FBT FAT VBT VAT Units 3,000 3,000 3,000 3,000 Sales$750,000$750,000$750,000$750,000 VC 345,000 345,000 345,000 345,000 CM 405,000 405,000 405,000 405,000 FC 135,000 135,000 135,000 135,000 PBT$270,000 270,000$270,000 270,000 Tax 108,000 108,000 PAT$162,000$162,000 % of Sales.36.216 FBT = fixed before tax FAT = fixed after tax VBT = variable before tax VAT = variable after tax

31. © 2004 by Nelson, a division of Thomson Canada Limited 31 Incremental analysis is a technique used in decision analysis that compares alternatives by focusing on the differences in their projected revenues and costs.

32. © 2004 by Nelson, a division of Thomson Canada Limited 32 Sales would be 3,000 units at $250.00, 5,000 units at $200.00, or 5,500 units at $175.00. The sales staff would give up $10,000 base salary (in total) if they could have 4% commission on sales. Currently, commissions are paid at the rate of 2%. Collegiate's direct material cost is $75.00 per ring. The supplier advised Collegiate that the cost of ring materials (metal and stones) will increase by 20% this year unless enough material is purchased to make 5,500 rings. The design of the ring will change next year. The new design requires different metal and stones. Ending inventory of direct material will not be used in next year's production. How will each of the different scenarios affect profits, and what will be the impact of each on BEP?

33. © 2004 by Nelson, a division of Thomson Canada Limited 33 Variable costs of Production excluding direct material = $110 - $75 = $35. New direct material cost = $75 X 1.20 = $90 for A, B, C, and D. New variable cost of Production = $35 + $90 = $125 for A, B, C, and D.

34. © 2004 by Nelson, a division of Thomson Canada Limited 34 The choice that offers the highest profit is combination A. Selling price is not changed. Sales force salary and commission arrangements are not changed. There is one more possibility that should be considered. It may be profitable to purchase enough material to make 5,500 rings.

35. © 2004 by Nelson, a division of Thomson Canada Limited 35 Assumes the quantity of direct materials purchased is sufficient to produce 5,500 rings to avoid the price increase. Direct material is now a fixed cost. Fixed costs do not change in total as volume increases or decreases. Fixed cost per unit increases as volume decreases and decreases as volume increases. The cost of the direct materials, $412,500 (5,500 X $75), is added to fixed costs. Variable cost of production is reduced to $35.00 ($110 - $75).

36. © 2004 by Nelson, a division of Thomson Canada Limited 36 Combination I is the most profitable choice. Other considerations: Collegiate may be able to sell the remaining inventory. Or, given that they do have extra materials, increasing the commission rate to 4% may motivate the sales staff to sell more rings. The difference in profit between I and J is only $10,000. Unit CM is $157.00. They would only have to sell an additional 64 rings to recover the $10,000 difference. They have enough direct materials to produce an additional 500 rings.

37. © 2004 by Nelson, a division of Thomson Canada Limited 37 The breakeven graph is a graphical depiction of the relationships among revenues, variable costs, fixed costs, and profits (or losses).

38. © 2004 by Nelson, a division of Thomson Canada Limited 38 Step 1. Label the x-axis as volume and the y-axis as dollars. Plot the variable cost line as a linear function with a slope equal to the variable cost per unit. Next, plot the revenue line with a slope equal to the unit sales price. The area between the variable cost and revenue lines represents total CM at each level of volume. Volume Dollars Total Variable Cost Line Total Revenue Line Contribution margin area

39. © 2004 by Nelson, a division of Thomson Canada Limited 39 Step 2. To graph total cost add a line parallel to the total variable cost line. The distance between the total and variable cost lines is the amount of fixed cost. The breakeven point is located where the revenue and total cost lines intersect. Volume Dollars Total Variable Cost Line Total Revenue Line Fixed Costs BEP

40. © 2004 by Nelson, a division of Thomson Canada Limited 40 1. CM is created by the excess of revenues over variable costs. If variable costs are greater than revenues, no quantity of volume will allow a profit to be made. 2. Total CM is equal to total fixed cost plus profit or minus loss. Volume Dollars Total Variable Cost Line Total Revenue Line Fixed Costs BEP Profit Loss

41. © 2004 by Nelson, a division of Thomson Canada Limited 41 A profit-volume graph is a graphical presentation of the profit or loss associated with each level of sales.

42. © 2004 by Nelson, a division of Thomson Canada Limited 42 Locate two points: total fixed costs and breakeven point. Total fixed costs are shown on the vertical axis as a negative amount. The breakeven point in units is shown on the horizontal axis (there is no profit or loss at that point). Draw a line that passes through these two points. This line represents total CM, and its slope is determined by the unit CM. 0 +1 Loss Profit No profit is made until unit CM covers the fixed costs. Total Fixed Costs Breakeven Point

43. © 2004 by Nelson, a division of Thomson Canada Limited 43 To perform CVP analysis in a multiproduct company, it is necessary to assume a constant product sales mix or an average CM ratio. constant sales mix – bag or package assumption allows computation of a weighted average CM ratio

44. © 2004 by Nelson, a division of Thomson Canada Limited 44 Collegiate's customers have asked for school sweaters. The VP, Marketing estimates that they will sell two sweaters for every ring sold. The bag has a 2:1 ratio. Collegiate will outsource the sweaters. There is no increase in fixed costs. Variable cost per sweater is $25. The VP plans to sell them for $90.

45. © 2004 by Nelson, a division of Thomson Canada Limited 45 Rings Sweaters Total Number of product per bag12 Revenue $250 $90 (x 2) $430 Variable cost 115 25 (x 2) 165 CM 135 130 $265 CM ratio 61.6 BEP in bags(B) CMB = FC $265B = $135,000 = 510 bags BEP in bags(B) CMB = FC $265B = $135,000 = 510 bags BEP in sales dollars B S = FC / CM ratio B S = $135,000 /.616 B S = $219,156* (510 x $430 = $219,300)* BEP in sales dollars B S = FC / CM ratio B S = $135,000 /.616 B S = $219,156* (510 x $430 = $219,300)* Using original data for rings from slide 8 *rounding BEP =Breakeven Point CMB = Contribution Margin per Bag

46. © 2004 by Nelson, a division of Thomson Canada Limited 46 1. Revenues and variable costs remain constant per unit, and are linear. 2. Total contribution margin is linear within the relevant range and increases proportionally with units sold. 3. Total fixed cost is a constant amount within the relevant range. 4. Mixed costs can be separated into their fixed and variable elements. 5. Sales and production are equal. 6. There will be no capacity additions during the period under consideration. 7. In a multiproduct firm, sales mix will remain constant. 8. Either there is no inflation, or inflation affects all factors equally. 9. Labour productivity, production technology, and market conditions will not change.

47. © 2004 by Nelson, a division of Thomson Canada Limited 47 When making decisions about various business opportunities, managers often consider the company's margin of safety and operating leverage.

48. © 2004 by Nelson, a division of Thomson Canada Limited 48 Margin of Safety – the excess of the estimated or actual sales of a company over its breakeven point; can be calculated in units or sales dollars, or as a percentage

49. © 2004 by Nelson, a division of Thomson Canada Limited 49 Units Estimated units – Breakeven units Sales Dollars Estimated dollars – Breakeven dollars Percentage Margin of safety in units or dollars Estimated sales in units or dollars If fixed costs increase, the margin of safety will decrease as the following example illustrates.

50. © 2004 by Nelson, a division of Thomson Canada Limited 50 Using data from Collegiate Rings, Incorporated: In Units 3,000 – 1,000 = 2,000 units In Sales Dollars $750,000 – $250,000 = $500,000 Percentage 2,000 / 3,000= 66.7% OR $500,000 / $750,000 = 66.7% Using original data from slide 8 – fixed costs are $135,000

51. © 2004 by Nelson, a division of Thomson Canada Limited 51 Operating Leverage – a factor that reflects the relationship of a company's variable and fixed costs; measures the change in profits expected to result from a specified percentage change in sales

52. © 2004 by Nelson, a division of Thomson Canada Limited 52 Degree of operating leverage is a measure of how a percentage change in sales will affect profits. It indicates how sensitive the company is to sales increases and decreases by measuring how a percentage change in sales affects company profits. It is calculated at a specified sales level as CM divided by profit before tax.

53. © 2004 by Nelson, a division of Thomson Canada Limited 53

54. © 2004 by Nelson, a division of Thomson Canada Limited 54 Companies with high variable costs and low fixed costs have a low operating leverage and a relatively low breakeven point. Companies with a low operating leverage can show a profit even when they experience wide swings in volume levels. Companies with high fixed costs and high CM ratios have a high operating leverage. Because fixed costs are high, breakeven point will be high. If prices are set by the market, volume has the primary impact on profit. High sales volumes are required to cover fixed costs, but each unit sold after breakeven produces large profits.

55. © 2004 by Nelson, a division of Thomson Canada Limited 55 Using original data from slide 8 – variable cost per unit is $115.; fixed costs are $135,000

56. © 2004 by Nelson, a division of Thomson Canada Limited 56 Profit increase at 3,300 rings = 310,500 – 270,000 = 40,500, or 15%. Note: the percent increase is equal to the DOL x % increase in sales (1.50 x.10 =.15). The lower the DOL, the lower the impact of a percent increase in sales.

57. © 2004 by Nelson, a division of Thomson Canada Limited 57 Using data from slide 35, scenario G. Variable cost per unit is reduced by $75 (to $40). Direct materials has been reclassified to fixed cost. Cost of direct materials is $412,500 for any volume up to 5,500 rings. Fixed costs are changed to $547,500 ($135,000 + $412,500.

58. © 2004 by Nelson, a division of Thomson Canada Limited 58 Profit increase at 3,300 rings = 145,500 – 82,500 = 63,000, or 76.4%. Note: the percent increase is equal to the DOL x % increase in sales (7.46 x.10 =.764). The higher the DOL, the greater the impact of a percent increase in sales.

59. © 2004 by Nelson, a division of Thomson Canada Limited 59 Absorption costing is a cost accumulation method that treats costs of all manufacturing components (direct materials, direct labour, variable overhead, and fixed overhead) as inventoriable, or product, costs; also known as full costing. An absorption costing income statement separates costs by function. Variable costing is a cost accumulation method that includes only variable production costs (direct materials, direct labour, and variable overhead) as product or inventoriable costs and treats fixed overhead as a period cost; also known as direct costing. A variable costing income statement separates costs by cost behaviour.

60. © 2004 by Nelson, a division of Thomson Canada Limited 60 PRODUCT COSTS Direct Material (DM) Direct Labour (DL) Variable Manufacturing Overhead (VOH) Fixed Manufacturing Overhead (FOH) PRODUCT COSTS Direct Material (DM) Direct Labour (DL) Variable Manufacturing Overhead (VOH) Fixed Manufacturing Overhead (FOH) PERIOD COSTS All Nonmanufacturing Expenses PERIOD COSTS All Nonmanufacturing Expenses Work in Process Work in Process Finished Goods Finished Goods Cost of Goods Sold Cost of Goods Sold Selling and Administrative Expenses, Other Expenses Selling and Administrative Expenses, Other Expenses

61. © 2004 by Nelson, a division of Thomson Canada Limited 61 BALANCE SHEET Assets Current:. Raw Materials Inventory Work in Process Inventory Finished Goods Inventory. BALANCE SHEET Assets Current:. Raw Materials Inventory Work in Process Inventory Finished Goods Inventory. INCOME STATEMENT Revenue Less: Cost of Goods Sold Equals: Gross Margin Less: Operating Expenses Selling Expenses Administrative Expenses Other Expenses Equals: Profit Before Tax INCOME STATEMENT Revenue Less: Cost of Goods Sold Equals: Gross Margin Less: Operating Expenses Selling Expenses Administrative Expenses Other Expenses Equals: Profit Before Tax

62. © 2004 by Nelson, a division of Thomson Canada Limited 62 PRODUCT COSTS Direct Material (DM) Direct Labour (DL) Variable Manufacturing Overhead (VOH) PRODUCT COSTS Direct Material (DM) Direct Labour (DL) Variable Manufacturing Overhead (VOH) PERIOD COSTS Variable Nonmanufacturing Expenses Fixed Manufacturing Overhead Fixed Nonmanufacturing Expenses PERIOD COSTS Variable Nonmanufacturing Expenses Fixed Manufacturing Overhead Fixed Nonmanufacturing Expenses Work in Process Work in Process Finished Goods Finished Goods Cost of Goods Sold Cost of Goods Sold Variable and Fixed Nonmanufacturing Expenses, Fixed Manufacturing Overhead Variable and Fixed Nonmanufacturing Expenses, Fixed Manufacturing Overhead

63. © 2004 by Nelson, a division of Thomson Canada Limited 63 BALANCE SHEET Assets Current:. Raw Materials Inventory Work in Process Inventory Finished Goods Inventory. BALANCE SHEET Assets Current:. Raw Materials Inventory Work in Process Inventory Finished Goods Inventory. INCOME STATEMENT Revenue Less: Variable Cost of Goods Sold Equals: Product CM Less: Variable Non- manufacturing expenses Equals: Contribution Margin Less: Total Fixed Expenses Equals: Profit Before Tax INCOME STATEMENT Revenue Less: Variable Cost of Goods Sold Equals: Product CM Less: Variable Non- manufacturing expenses Equals: Contribution Margin Less: Total Fixed Expenses Equals: Profit Before Tax

64. © 2004 by Nelson, a division of Thomson Canada Limited 64 IF the number of units produced > than the number of units sold, then NI under variable costing < than NI under absorption costing. If the number of units produced < than the number of units sold, then NI under variable costing > than NI under absorption costing.

65. © 2004 by Nelson, a division of Thomson Canada Limited 65 Net Income (Absorption Costing) - Net Income (Variable Costing) = Inventory X Fixed Overhead Rate

66. © 2004 by Nelson, a division of Thomson Canada Limited 66 Let’s compare absorption and variable costing.

67. © 2004 by Nelson, a division of Thomson Canada Limited 67 Newman Manufacturing Company incurs the following costs to produce 2,000 units of inventory. Cost NumberTotal Inventory Costs per Unit of Units Cost Variable manufacturing costs $ 9.00 x 2,000 = $18,000 Fixed manufacturing costs 12,000 Total (Absorption) Product Cost $30,000 What happens to costs if Newman increases production?

68. © 2004 by Nelson, a division of Thomson Canada Limited 68 Units produced2,000 3,000 4,000 Inventory Costs: Total Fixed Overhead (a) $12,000$12,000 $12,000 Number of Units (b)2,000 3,000 4,000 Fixed Overhead per unit (a / b) $ 6.00 $ 4.00 $ 3.00 Variable manufacturing costs 9.00 9.00 9.00 Absorption Product Cost per Unit $ 15.00 $ 13.00 $ 12.00 Compute profit before tax at the three levels of production if Newman sells 2,000 units.

69. © 2004 by Nelson, a division of Thomson Canada Limited 69 Units produced2,000 3,000 4,000 Sales @ $20 x 2,000 units $40,000 $40,000 $40,000 Cost of goods sold $15 x 2,000 30,000 $13 x 2,000 26,000 $12 x 2,000 24,000 Gross Margin $10,000 $14,000 $16,000

70. © 2004 by Nelson, a division of Thomson Canada Limited 70 Units produced2,000 3,000 4,000 Sales @ $20 x 2,000 units $40,000 $40,000 $40,000 Variable cost of goods sold $9.00 x 2,000 $ 18,000$18,000 $18,000 Contribution Margin 22,000 22,000 22,000 Fixed Overhead 12,000 12,000 12,000 Profit Before Tax $10,000 $10,000 $10,000 Profit is not affected by production increases.

71. © 2004 by Nelson, a division of Thomson Canada Limited 71 1) Under variable costing, income is correlated with sales and not influenced by production 2) Under absorption costing, income is affected by production as well as sales 3) Income is the same when production = sales 4) Production > sales, income is under absorption costing 5) Sales > production, income under variable costing Difference due to inventory levels