CENTURY 21 ACCOUNTING © Thomson/South-Western

LESSON 15-3LESSON 15-3

Decisions That Affect Net Income

CENTURY 21 ACCOUNTING © Thomson/South-Western

CALCULATING SALES TO EARN PLANNED CALCULATING SALES TO EARN PLANNED NET INCOMENET 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

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LESSON 15-3

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3

LESSON 15-3

Contribution Margin Rate

Required Contribution Margin

Sales Dollars÷ =

$22,500.00 ÷ = $150,000.00.15 or 15%

PlannedNet Income

TotalFixed Costs

Required Contribution Margin

+ =

$21,000.00 + = $22,500.00$1,500.00

CALCULATING SALES TO EARN CALCULATING SALES TO EARN PLANNED NET INCOMEPLANNED 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.

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LESSON 15-3

EFFECT OF VOLUME CHANGES EFFECT OF VOLUME CHANGES ON NET INCOMEON NET INCOME page 456

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5

LESSON 15-3

EFFECT OF COST CHANGES AT AVERAGE EFFECT OF COST CHANGES AT AVERAGE VOLUMEVOLUME 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

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LESSON 15-3

EFFECT OF COST CHANGES AT EFFECT OF COST CHANGES AT ABOVE AVERAGE VOLUMEABOVE AVERAGE VOLUME page 458

• If the company expects a permanent sales increase, Alternative 2 would be more profitable than Alternative 1

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LESSON 15-3

1. Contribution margin rate, Alternative 1.

2. Contribution margin rate, Alternative 2.

EFFECT OF CHANGES IN COSTS ON EFFECT OF CHANGES IN COSTS ON CONTRIBUTION MARGIN RATECONTRIBUTION MARGIN RATE page 458

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• 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.

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EFFECT OF CHANGE IN SALES PRICEEFFECT OF CHANGE IN SALES PRICE

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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

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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 PRICEEFFECT OF CHANGE IN SALES PRICE page 459

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USING BREAKEVEN TO PLAN SALES MIXUSING BREAKEVEN TO PLAN SALES MIX

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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.

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LESSON 15-3

USING BREAKEVEN TO USING BREAKEVEN TO PLAN SALES MIXPLAN 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%

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LESSON 15-3

USING BREAKEVEN TO USING BREAKEVEN TO PLAN SALES MIXPLAN SALES MIX page 460

Contribution Margin Rate

Contribution Margin Net Sales÷ =

.40 or 40%$30,000.00 ÷ $75,000.00 =

$34,000.00$24,000.00 + $10,000.00 =

Required Contribution Margin

Total Fixed CostsPlanned 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

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LESSON 15-3

USING BREAKEVEN TO USING BREAKEVEN TO PLAN SALES MIXPLAN SALES MIX page 460

$85,000.00$34,000.00 ÷ .40 or 40% =

Total Sales DollarsRequired

Contribution MarginContribution Margin Rate

÷ =

Multiply the sales mix percentage by the total sales dollars to determine the sales dollars needed for each product.

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LESSON 15-3

USING BREAKEVEN TO USING BREAKEVEN TO PLAN SALES MIXPLAN SALES MIX page 460

Product Sales Dollars

Sales MixTotal Sales

Dollars× =

Product Unit Sales

Product Sales Dollars

Unit Sales Price

÷ =

Television 170 units$59,500.00 ÷ $350.00 =

102 units$25,500.00 ÷ $250.00 =VCR

Television $59,500.0070% × $85,000.00 =

$25,500.0030% × $85,000.00 =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

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LESSON 15-3

TERM REVIEWTERM REVIEW

sales mix

page 462