## Hard Practice Test

1. Once the volume of sales is higher than the break-even point

a. the contribution margin ratio increases
b. the contribution margin per unit increases
c. total fixed cost per unit will not change
d. total contribution margin will be higher than fixed costs

D. Use the formula: Sales – VC = CM – FC = Profit. When sales go higher than break-even the profit becomes positive and the contribution margin will be higher than fixed costs since the fixed costs do not increase with volume increases. The contribution margin per unit and ratio do not change with volume because the cost per unit remains the same

2. When a company’s profits do not change as volume changes, it has

a. no fixed costs
b. no variable costs
c. a sales price equal to variable costs
d. fixed costs equal to variable costs

C. Use the formula: Sales – VC = CM – FC = Profit. When the sales price equals variable costs than there will be no contribution margin. This will hold true as volume changes. Fixed costs do not change with volume changes, therefore, profit will not change either. The contribution margin being 0 is the key.

3. A management team that prefers to have a low operating leverage means that the company most likely

a. expects a strong increase in sales volume
b. expects a decrease in sales volume
c. is very unprofitable
d. has very high fixed costs

B. The operating leverage indicates how much profits will change as sales change. A company will want to have a low operating leverage when sales are decreasing, because the decrease will lower profits by a lower amount than a high operating leverage. Contribution margin is what most affects the operating leverage, not fixed costs. Operating leverage is not a direct indicator of whether the firm is profitable.

4. When variable costs decrease and all other factors do not change

a. the number of units necessary to be profitable increases
b. the number of units necessary to be profitable decreases
c. the number of units necessary to be profitable does not change
d. none of the above

B. When variable costs decrease the contribution margin per unit will increase. When you have a higher contribution margin you will need fewer units to be profitable.

5. What must you consider when doing cost volume profit analysis when the company has four different products with four different contribution margin ratios?

a. the per unit contribution margin of each product only
b. that fixed costs will change as the mix changes within the relevant range
c. that the sales mix will impact profitability
d. that as sales increase the variable costs will decrease

C. The sales mix will impact profits when the company has different products with different contribution margin ratios. You can not only consider the profits individually when doing an analysis for the entire company. As sales increase, variable costs will increase, not decrease.

6. Two companies have a break-even point of 2,000 units. One company has lower fixed costs and higher variable costs than the other company. How will a 10% increase in units sold affect the two companies?

a. the two company’s profits will increase by the same percentage
b. the company with the higher variable cost will be more profitable
c. the company with the higher variable cost will be less profitable
d. can’t determine without additional information

C. The higher variable cost will give a lower contribution margin ratio and lower contribution dollars from the same increase in sales. Less contribution margin dollars will lead to lower profits.

7. Operating leverage is related to

a. sales and variable costs only
b. sales and fixed costs only
c. sales and fixed costs and variable costs
d. variable costs and contribution margin dollars

C. Operating leverage works because fixed costs remain constant and as the contribution margin ratio remains constant and sales increase, the company will earn more profits. The formula is CM / Income and income includes all costs.

8. Contribution margin is calculated as

a. one less the variable cost as a percentage of sales
b. sales per unit less variable costs per unit
c. sales less fixed costs less income
d. all of the above

D. You can calculate the contribution margin in all of the following ways because Sales – VC = CM – FC = Income

9. The break-even point in sales dollars can be calculated using:

a. sales revenue as a percentage of income
b. contribution margin as a percentage of income
c. contribution margin as a percentage of sales
d. fixed costs as a percentage of sales

C. Break-even in sales dollars is calculated as Fixed Costs / CM % and the CM % is calculated as CM / Sales, therefore it is a percentage of sales

10. As the contribution margin percentage increases, the sales dollars required to break-even will

a. decrease
b. increase
c, remain the same
d. can’t tell unless you know what the contribution margin is currently

A. The contribution margin percentage is the percentage of every sales dollar that is available to cover fixed costs and when fixed costs are covered is profit. As the percentage increases, less sales will give the same amount of profit.

11. You know the following:

Sales                \$200,000           Operating Income  \$24,000
Fixed Costs     \$ 40,000             Units sold 200

Determine:

a. Contribution margin per unit and contribution margin ratio
b. Break – even in units and sales dollars
c. Units and sales dollars sold to have before tax profit of \$50,000
d. Operating leverage
e. The expected income if sales increase 10%
f. How many sales dollars are required to give a \$0 profit if variable costs
increase by 10%?

You have to do the income statement and plug to find total variable costs:

You cannot do cost volume profit analysis without knowing variable costs and the contribution margin.

 Sales \$200,000 Variable costs \$136,000 2nd plug working up 2nd plug working up \$ 64,000 1st plug working up Fixed costs \$ 40,000 Operating Income \$ 24,000

1st – Identify the sales price as \$1000 per unit  (\$200,000 / 200 units given)

2nd – Identify the variable costs as \$680 per unit:  (\$136,000 / 200 units given)

3rd – Contribution margin per unit is \$1000 sales – \$680 variable cost = \$320 per unit

4th –  Contribution margin ratio is   \$320 CM / \$1000 sales =  32% or .32

5th – Total fixed costs are  \$40,000

You should follow these 5 steps first for all problems.

a. The CM is \$320 per unit and the CM ratio % is 32%

b.  The break-even formula is

Total Fixed Costs  = units sold to B/E
CM per unit

\$40,000    =  125 units to get B/E
\$320 per unit

b. The break-even formula is

Total Fixed Costs  = sales \$ sold to B/E
CM %

\$40,000   =  \$125,000 to get B/E
.32

For c., add the desired profit to the break-even formula:

c. The formula is

Total Fixed Costs + Desired Profit   = units sold
CM per unit

\$40,000 + \$50,000    =  281.25 to earn \$50,000
\$320 per unit

c. The formula is

Total Fixed Costs + Profit =  sales \$ sold
CM %

\$40,000 + \$50,000    =  \$281,250 to earn \$50,000
.32

d. The operating leverage formula is

Contribution Margin
Income

64,000 / 24,000 = 2.667 factor

e. To get the % income is expected to increase is sales increase do the following:

Sales % increase                             10%
x  operating leverage factor            2.667
= % income will increase                26.67%

Use the % income will increase to determine the income if sales go up 10%

Current Income                                \$24,000
x % income will increase                 .2667

+ current income                              \$24,000
= income if sales + 20%                  \$30,401

f. A zero profit is just another way of saying break-even. Use the break-even formula with the new contribution margin after the 10% increase in variable costs.

Sales                                      \$200,000
New variable costs               \$149,600  (\$136,000 x 1.1)
New Contribution margin    \$ 50,400
New CM ratio                          25.2%  (\$50,400 / \$200,000)

Fixed Costs               \$40,000    =  \$158.730
CM ratio                       .252

to break-even if variable costs increase

12. The company had sales of \$1,000,000 and units sales of 50,000 and incurred the following costs:

 Rent at the manufacturing plant \$89,000 Utilities at the manufacturing plant \$32,000 General business insurance \$12,000 Direct Materials \$288,000 Plant manager’s salary \$56,000 Direct labor \$156,000 Glue used to put together every product \$6,000 Total advertising paid at a weekly rate \$28,000 Sales commissions \$10,000 Salesman travel that is planned each year \$39,000 Executive and administrative salaries \$162,000

Determine:
a. Contribution margin per unit and contribution margin ratio
b. Break – even in units and sales dollars
c. Operating leverage and expected income if sales increase 10%

You have to do a contribution margin income statement which requires you to determine which costs are variable costs and which are fixed costs

`         Sales                                                                         \$1,000,000`
```         Less variable costs:
Utilities at the manufacturing plant                           \$ 32,000
Direct materials                                                        \$288,000
Direct labor                                                               \$156,000
Glue used to put together every product                   \$ 6,000
Sales commissions                                                   \$ 10,000
Total variable costs                                            \$492,000```
`         Contribution Margin                                                    \$508,000`
```         Less fixed costs:
Rent at the manufacturing plant                                \$ 89,000
Plant manager’s salary                                              \$ 56,000
Total advertising paid at a weekly rate                    \$ 28,000
Salesman travel that is planned each year              \$ 39,000
Total fixed costs                                                  \$386,000```
`         Operating Income                                                        \$122,000`

Then:

1st – Identify the sales price as \$20 per unit (\$1,000,000 / 50,000 units)

2nd – Identify the variable costs as \$9.84 per unit:  (\$492,000 / 50,000 units)

3rd – Contribution margin per unit is \$20 sales – \$9.84 variable cost = \$10.16 per unit

4th –  Contribution margin ratio is  \$10.16 CM / \$20 sales =  50.8% or .508

5th – Total fixed costs are  \$386,000 You should follow these 5 steps first for all problems.

a. The CM is \$10.16 per unit and the CM ratio % is 50.8%

b.

\$386,000    =  37,993  to get B/E
\$10.16 per unit      units

b.

\$386,000    =  \$759,843 to get B/E
.508

c.

508,000 / 122,000 = 4.164 factor

e. To get the % income is expected to increase if sales increase do the following:

Sales % increase                             10%
x  operating leverage factor            4.164
= % income will increase                41.64%

Use the % income will increase to determine the income if sales go up 10%

Current Income                                \$122,000
x % income will increase                 .4164

+ current income                              \$122,000
= income if sales + 20%                  \$172,801

` `

13. A company makes and sells 2 different product. Out of 8 products sold, the company normally sells 3 of product Y and 5 of product Z. Y sells for \$1000 and Z sells for \$500. Variable costs for Y are \$ 400 per unit and for Z are \$100 per unit.
Total fixed costs are \$2,000,000 per year. Considering the current sales mix, calculate the following:

1. The total company break-even point in units
2. The total company break-even point in sales dollars
3. Unit sales required to earn \$500,000 in operating income

```                                                             Y                   Z
1.      Sales                                     \$1,000             \$500
- Variable Cost                          400                100
= CM                                        \$ 600             \$400
units sold                  (3/8) .375     (5/8) .625          average CM
Average CM                        \$ 225             \$250    = \$475 per product```
`                  FC / CM per unit = \$2,000,000 / \$475 = 4,211 units`

2. Weighted average sales price is:

```                                     Y                   Z
Sales            \$1,000           \$500
%                 .375              .625
\$375     +     \$312.50 = \$687.50```
`         W.A. CM / W.A. Sales = \$475 / \$687.50 = .6909`
`         Fixed cost / CM % = \$2,000,000 / .6909 = \$2,894,775`

3. Fixed cost + profit / CM per unit

```         \$2,000,000 + \$500,000 / \$475 = 5,263
```