Comprehensive Cost-Volume-Profit (CVP) Analysis For Blake Dunn's Business Decisions

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Comprehensive Cost-Volume-Profit (CVP) Analysis for Blake Dunn'sBusiness Decisions3‐34ComprehensiveCVPanalysis(LO1,2,3,5) “I'll never understand this accounting stuff,” Blake Dunnyelled, waving the income statement he had just received from his accountant in the morning mail. “Lastmonth, we sold 1,000 stuffed State University mascots and earned $6,850 in operating income. Thismonth, when we sold 1,500, I thought we'd make $10,275. But this income statement shows an operatingincome of $12,100! How can I ever make plans if I can't predict my income? I'm going to give Janiceone last chance to explain this to me,” he declared as he picked up the phone to call Janice Miller, hisaccountant.“Will you try to explain this operating income thing to me one more time?” Blake asked Janice. “After Isaw last month's income statement, I thought each mascot we sold generated $6.85 in net income; nowthis month, each one generates $8.07! There was no change in the price we paid for each mascot, so Idon't understand how this happened. If I had known I was going to have $12,100 in operating income, Iwould have looked more seriously at adding to our product line.”Taking a deep breath, Janice replied, “Sure, Blake. I'd be happy to explain how you made so much moreoperating income than you were expecting.”Requireda.Assume Janice's role. Explain to Blake why his use of operating income per mascot was in error.b.Using the following income statements, prepare a contribution margin income statement for March.FebruaryMarchSales revenue$25,000$37,500Cost of goods sold10,00015,000Gross profit15,00022,500Rent expense1,5001,500Wages expense3,5005,000Shipping expense1,2501,875Utilities expense750750Advertising expense750875Insurance expense400400Operating income$6,850$12,100c.Blake plans to sell 500 stuffed mascots next month. How much operating income can Blake expect toearn next month if he realizes his planned sales?d.Blake wasn't happy with the projected incomestatement you showed him for a sales level of 500stuffed mascots. He wants to know how many stuffed mascots he will need to sell to earn $3,700 inoperating income. As a safety net, he also wants to know how many stuffed mascots he will need tosell to break even.e.Blake is evaluating two options to increase the number of mascots sold next month. First, he believeshe can increase sales by advertising in the University newspaper. Blake can purchase a package of 12ads over the next month for a total of $1,200. He believes the ads will increase the number of stuffed

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mascots sold from 500 to 960. A second option would be to reduce the selling price. Blake believes a10% decrease in the price will result in 1,000 mascots sold. Which plan should Blake implement? Atwhat level of sales would he be indifferent between the two plans?f.Just after Blake completed an income projection for 1,200 stuffed mascots, his supplier called toinform him of a 20% increase in cost of goods sold, effectiveimmediately. Blake knows that hecannot pass the entire increase on to his customers, but thinks he can pass on half of it while sufferingonly a 5% decrease in units sold. Should Blake respond to the increase in cost of goods sold with anincrease in price?g.Refer back to the original information. Blake has decided to add stadium blankets to his product line.He has found a supplier who will provide the blankets for $32, and he plans to sell them for $55. Allother variable costs currently incurred for selling mascots will be incurred for selling blankets at thesame rate. Additional fixed costs of $350 per month will be incurred. He believes he can sell oneblanket for every three stuffed mascots. How many blankets and stuffed mascots will Blake need tosell each month in order to break even?Answer:a. Explain to Blake why his use of operating income per mascot was in error.Blake's mistake lies in how he is interpreting the operating income per mascot. Operating income is thedifferencebetween sales revenue and all expenses (variable and fixed), not simply the income generated fromeach unit sold. His calculation assumes that the income generated per mascot is static and fixed, but operatingincome depends on both variable costs and fixed costs. In addition, since fixed costs do not change with thenumber of units sold, Blake cannot directly apply operating income per unit sold in this manner to estimatefuture income. Instead, operating income depends on the contribution margin (which includes variable costs)and how fixed costs are distributed.In simpler terms: While the sale of each mascot generates revenue, the costs associated with producing andselling those mascots (both variable and fixed) determine the operating income. Asmore units are sold, theoperating income increases because the fixed costs remain constant, and the contribution from the variablecosts grows, resulting in higher profitability.b. Contribution Margin Income Statement for MarchLet's start by creating a contribution margin income statement for March. The formula for Contribution Marginis:ContributionMargin=SalesRevenue−VariableCosts\text{Contribution Margin} =\text{Sales Revenue}-\text{Variable Costs}For each month, we need to determine the variable costs. We can identify variable costs from the Cost ofGoods Sold (COGS) and other variable expenses such as wages, shipping, and advertising. Fixed costs are thecosts that remain constant irrespective of the number of units sold, such as rent, utilities, and insurance.We’ll calculate the contribution margin as follows:1.Sales Revenue: Given as $37,500.2.Variable Costs: We estimate variable costs by looking at the cost increases for COGS, wages,shipping, and advertising based on the increase in sales from February to March.ItemFebruaryMarchIncrease (March-February)Sales Revenue$25,000$37,500+$12,500COGS$10,000$15,000+$5,000Wages Expense$3,500$5,000+$1,500Shipping Expense$1,250$1,875+$625Advertising Expense$750$875+$125Variable Costs Total (March) = $15,000 (COGS) + $5,000 (Wages) + $1,875 (Shipping) + $875 (Advertising)= $22,750Fixed Costs remain constant:•Rent Expense: $1,500•Utilities Expense: $750•Insurance Expense: $400

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