The overall concept of CM is pretty straightforward- it is how much each unit co
ID: 2730073 • Letter: T
Question
The overall concept of CM is pretty straightforward- it is how much each unit contributes to covering fixed costs and eventually, profit, after variable costs are taken care of. Let’s talk about sales mix. This relates to the mix of products. How do changes in the mix of products impact breakeven? How could a shift in sales mix result in both a higher breakeven point and a lower net income? Use specific examples from a company you know something about. What are the assumptions underlying sales mix and cost volume profit that are potentially misleading?
Explanation / Answer
Answer: if sales mix shifted from high contribution margin products to low contribution margin products. Such a shift would cause the average contribution margin ratio in the company to decline, resulting in less total contribution margin for a given amount of sales. Thus, net operating income would decline. With a lower contribution margin ratio, the break-even point would be higher because more sales would be required to cover the same amount of fixed costs.
Different products have different sales prices, variable expenses and contribution margin. Therefore, any change in proportion in which the products are sold has significant impact on the break-even point. This change is known as ‘change in sales mix’ or ‘shift in sales mix’.
Example:
The NORAN company sells two products; product X and product Y. The information about sales price, variable expenses per unit and total fixed expenses is given below:
The total monthly fixed expenses of the company are $270,000. The company wants to generate a sales revenue of $1,000,000 in the next month. To obtain this goal the company has the following options:
(i). Sell 6,000 units of product X and 7,000 units of product Y.
(ii). Sell 14,000 units of product X and 3,000 units of product Y.
Required:
Solution:
(1). If option (i) is selected:
NORAN Company
Contribution margin income Statement
For the month of ………….
Break-even point = Total fixed expenses / Overall contribution margin ratio
= $270,000/.54*
= $500,000
*540,000/1,000,000
(2). If option (ii) is selected:
NORAN Company
Contribution margin income Statement
For the month of ………….
Break-even point = Total fixed expenses / Overall contribution margin ratio
= $270,000/.46*
= $586,957
*300,000/1,000,000
(3) The better option:
Option (i) is better than option (ii) because it generates more net operating income.
(4). The reason of change in break-even point:
A change in sales mix usually have a strong effect on the break-even point. The break-even point has increased from $500,000 to $586,957 because the shift in sales mix from high margin product (product Y) to low margin product (product X) has dropped the overall contribution margin ratio from 0.54 to 0.46.
A shift in sales mix from high contribution margin product to low contribution margin product increases the dollar sales required to break-even while a shift from low contribution margin product to high contribution margin product reduces the dollar sales required to break-even.
CVP analysis employs the same basic assumptions as in breakeven analysis. The assumptions underlying CVP analysis are:
Product X Product Y Sales price $50 per unit $100 per unit Variable expenses $30 per unit $40 per unitRelated Questions
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