BU121 Midterm Exam-AID

Agenda

• Cost Volume Profit Explained– CVP Major Problem

• Balance Sheet Explained• Income Statement Explained• Combined Problem

CVP Introduction

– Break-Even Analysis is at the heart of every business decision

• Revenues = Expenses!

– You can include profit goals or work with sensitivity to find different outcomes when changing the price or volume.

Cost Volume Profit Relationship

Fixed Costs

Variable Costs

Break-Even

Loss

Revenues

Profit

CVP Methods

1. Contribution Margin Approach - Used with Per Item Data

2. Contribution Rate Approach - Normally used with “whole figure”.

3. Algebraically - Can be used both with Per Item Data or Total Figure Data

#1 - C. Rate/Total Figure Data

1. Solve for Breakeven Sales

Physical Building Rent - $100,000

Commission on Sales - $25,000

Machinery and Equipment Cost - $75,000

Per-Item Piecework Wages - $50,0000

Fixtures - $25,000 Revenues - $400,000

Materials - Cloth - $10,000

Materials - Wood - $60,000

#1 - C. Rate/Total Figure Data

1. B.E.P.(Sales)= (Fixed Costs)/1 - Contribution Rate

= (FC)/[1 - (VC)/(Sales)]

(100 + 75 + 25)

1 - (50 + 25 + 60 + 10) / (400)

#1 - C. Rate/Total Figure Data

(100 + 75 + 25)

1 - (50 + 25 + 60 + 10) / (400)

Equal to: $313,725 Therefore - After this point in sales = Profitable

#1 - C. Rate/Algebraically

Same Question Format: Except given a Break-Even Sales, Fixed Costs, and Revenue Variable Costs = ?

(500,000)

1 - (X) / (700,000) = $583,333

#1 - C. Rate/Algebraically

500,000 = 1 - (X) / (700,000)

583,333(X)/700,000 = 0.858 - 1

X = (0.142*700,000)

Variable Costs = 100,000

#2 - C. Margin/Unit Data Problem

1. Solve for Breakeven Sales

Physical Building Rent - $100,000

Commission on Sales -$5/units

Machinery and Equipment Cost - $75,000

Materials - Wood - $10/unit

Fixtures - $25,000 Selling Price Per Unit - $30

Materials - Cloth - $5/unit

#2 - C. Margin/Per Unit Data

Contribution Margin = Price - Variable Costs

Break-Even (units) = FC

PRICE - VC

#2 - C. Margin/Per Unit Data

BEP(UNITS) = (100 + 75 + 25)

30 - (5+ 5 + 10)

(X) = (200)

30 - (20)= 20 UNITS TO BREAK EVEN

#2 - C. Margin/Algebraically

Sales = Fixed Costs + Varaible Costs

Selling Price * X = Fixed Costs + Variable Costs *(X)

SP * (X) = FC + VC * (X)

#2 - C. Margin/Algebraically

30 * (X) = (100 + 75 + 25) +

(5 + 5 + 10) * (X)

30 * (X) = (200) + (20) * (X)

10*(X) = 200

X = 20 UNITSBoth are the same approach! Just different ways of getting there. Important to recognize what type of question you are working with - Total or Unit

Sensitivity with Volume and Prices

Lower Prices to Increase Volume ?Raise Prices but Lose Customers?

EVALUATE CHANGE IN MARGIN

versus

CHANGE IN SALES

Sensitivity with Volume and Prices

Selling Price Per Unit = $10Variable Costs = $5Current Sales = 100 units

Increase selling price by $3 but lose 8 customers:

Gain = $3 * 92 (Additional Margin for Existing Customers)

Loss = $5 * 8 Customers (Former Cont. from Lost Customers)

= $276 - $40 => $236 GAIN

Balance Sheet Equations

• A = L + O/E- when one side increases the other

also increasesA = Current + Fixed + OtherL = Current + Long TermO/E = Depends on ownership type

Current Assets• Current Assets are listed in order of declining

liquidity– Cash, Marketable Securities, Accounts Receivable,

Inventories, Supplies, Prepaid• Marketable Securities: temporary investments made with

cash that would otherwise be idle • Prepaid: any asset you hold that is paid for but has not yet

been used.– Ex. Prepaid Rent is rent for a future month that you’ve

already paid

Current Assets Problems

1. You purchased a 12 month insurance plan for $12,000 on June 1st 2007. Your year end is on Dec 31. What is the value of your prepaid insurance at at Dec 31, 2008?

2. You’re A/R on Dec 31, 2007 is $20,000. Your Sales in 2008 was $150,000 and you collected $160,000. What is you’re A/R as at Dec 31, 2008?

Fixed Assets

• Any asset that you expect to hold for more than a year– i.e. Land, Buildings, Equipment

• Fixed Assets are listed in order of declining life expectancy

• Have to include Amortization when calculating the worth of a Fixed Asset

Amortization

• Amortization: How much an asset is worth on a per year basisAmort. = (Cost - Salvage Value)/Life Expectancy

• Accumulated Amortization: Amortization of an asset for given # of years# of Years x Amort. = A.A.

Asset Value = Purchase Price - A.A

Amortization Problem

• You just purchased a truck for $24,000. You figure it’ll last for 5 years and at the end of 5 years you’ll be able to sell it for $4,000. What is the value of the truck on the balance sheet after 4 years?

Other Assets

• These are any assets that don’t fall under Current or Capital.

• Investments: Securities of one company owned by another for reasons other than the temporary use of excess cash

• Goodwill: the difference b/w Purchase Price and the actual value of the assets – A subjective number

Other Assets Questions

1. You’ve just bought 50% of the shares in Company A with money that was earmarked to purchase new company trucks. Is this considered a marketable security or an investment on the balance sheet?

2. You’ve just purchased Company B for $140,000. The company’s total assets amount to $78,000. What is the goodwill for Company B valued at?

Liabilities

• No required format for listing liabilities• CL are those expected to be paid back within one

year– Accounts Payable, Wages Payable, Current Portion of Long-

Term Debt, Interest, Dividends Payable• LTL are any liabilities that will not be paid back in full

within a year– List Examples

Liabilities Problems1. You recently borrowed $120,000 @ 15% with the

principle to be paid back in equal installments over 8 years (interest based on remaining principle). What is the Current & Long-term liabilities associated with loan at the end of the the 3rd year?

2. You pay wages on the last day of each month but your year end is in the middle of a month. What would your wages payable be if you incurred $17,000 in wages per month?

Owners Equity

- Calculation of O/E is different for different types of ownership.

1. SP: Old Capital + Investments + Profits - Withdrawals

2. P: same as above, but do separately for each partner

3. C: separate Common Stock, Preferred Stock, and Retained Earnings- RE: Old RE + Net Profit - Dividends Paid

Owner’s Equity Problem1. Archie Andrews made $7,500 net profit in 2008. He

invested $5,000 for a new Flat Screen TV and took out $9,000 to help pay for student loans. His capital in the previous period was $6,000. What is his owners equity?

2. Company A made a net profit of $250,000 and paid dividends of $.50/share. What is there current retained earnings if their retained earnings were $70,000 the previous period? What would the owners equity section of the balance sheet look like if the company has 100,000 common shares @ $12/share.

Balance Sheet Wrap-Up

• Know The Basic Equation• Need to learn what falls under A, L, O/E• Proper Title: “at at Dec 31…”• Don’t forget to order Assets properly!• The day after you create a balance sheet

everything has changed.

Income Statement Basic Formula

Net Sales- Cost of Goods Sold= Gross Profit- Operating Expenses= Net Income from Operations+/- Other Revenue/(Expenses= Net Income Before Taxes

Gross vs. Net

• Gross = before subtracting the necessary expenses and allowances

• Net = after subtracting the necessary expenses and allowances

Ex. Net Sales = $25,000Sales Returns = $2,000Gross Sales = ?

Income Statement For Service

RevenueGross Sales xxxx Less: Sales Returns xxx Less: Sales Discounts xxx xxxNet Sales xxxxExpenses

Operating Expenses Selling & Distributive xxx General & Admin xxx Total Operating Expenses xxxx

Cost of Good Sold

• COGS goes under the revenue section in a merchandising business.

• Net Sales - COGS = Gross ProfitBeginning Inventory

+ Net Purchases*+ Freight In= Cost of Goods Available For Sale- Ending Inventory= Cost of Goods Sold

COGS Problem

Beginning Inventory = $15,000Ending Inventory = ?COGAS = ?COGS = $28,000Net Purchases = $20,000Freight in = 5% of Net Purchases

Income Statement Wrap-Up• Always Create 1st!

– So you have “taxes payable” & “net profit” for the Balance Sheet

• Remember the Income Statement looks at what’s earned/incurred in a period NOT what you’ve actually received or paid.

• Proper Title: “For the Year Ended…”• Simple Math! Ensure you know format and you’ll be

fine.

Income Statement: Potentially Tricky Problems

1. You sold 100 items @ $20/each. You’ve only collected half the money; what are sales for this period?

2. Wages paid during the month of Oct. were $2,000. On Sept. 30 the Wages Payable account on the B.S. was $1,000; on Oct. 31 it was $500. What was the wage expense in October?

Balance vs. Income Statement• Balance Sheet as “snap-shot”.

– The accounts in the following period depends on the preceding period.

– Accounts “change”, they don’t “happen”• Ex. A/R in 2009 is determined by calculating if A/R in 2008 rose or

fell. NOT how many A/R occurred in 2009.– You care about what was actually spent or collected, not

what happened in totality• Ex. You might have received $12,000 in inventory, but you might

have only paid $10,000. Accounts Payable = +$2,000; Cash = -$10,000; Inventory = +12,000

Balance Sheet vs. Income Statement

• Income Statement as “overview of a period”.– Revenues and Expenses “happen” they don’t “change”

• Ex. 2009 Sales is how much you sold in 2009, not how much more you sold vs. 2008.

– You care about what was incurred, not what was spent or collected

• Ex. Wage Expense depends on the # of hours worked, not how much money you’ve given to employees

Combined Problems

Remember…

• Don’t forget headings on Income Statement and Balance Sheet (easy marks)

• You can prepare an Income Statement and Balance Sheet at the same time but you MUST finish your Income Statement first because you require the Net Income in order to calculate your Retained Earnings

Combined Problem

Serbello Sweet Treats• You have recently been employed by the Serbello sisters, co-

owners of Serbello Sweet Treats Inc. (a chocolate and candy manufacturer) to act as an accountant for their operations. Your first task is to draw up financial statements: Income Statement and Balance Sheet for the fiscal year ended September 30, 2008.

• As a start, the sisters have provided you with the following closing account balances and some additional information listed on the next slide

Account Balances

Gross Sales 855,000 Inventory, Sept. 30 2008 (market)4,000 Supplies 600 Retained Earnings, Oct. 1, 2007 14,500 Advertising Expense 22,000 Sales Returns and Allowances 2,100 Cash 97,893 Gross Purchases 235,000 Inventory, Sept. 30 2008 (cost) 3,500 Freight-In 1,500Inventory, Oct.1 2007(market) 6,300 Common Stock 15,000 Inventory, Oct.1, 2007 (cost) 5,000 Accounts Receivable 112,790Wage Expense – Selling 70% 150,000 Purchase Discounts 4,000 Admin. 30% Office Supplies Expense 2,200

Set up Statements

• Fill in an Income Statement and Balance Sheet with the information that you are given

• Remember to leave space in order to add in additional accounts and expenses

• Suggest writing this section in pencil in case you make a mistake!

Additional Information

1. Serbello Sweet Treats has a fiscal year end date of Sept. 30, 2008.

What does this mean? - This is the date that you will use to label both

your balance sheet and your income statement. All calculations relating to time passed will extend backwards from this date.

Additional Information

2. A warehouse was purchased on Oct. 1, 2006 to store goods for resale. Price of the warehouse was $214,000. It is assumed to have a useful life of 12 years, and it is assumed that at the end of its useful life the warehouse can be sold for $48,000.

What does this mean?- Cost of the warehouse will appear on the Balance Sheet under Capital Assets, Building $214,000- Calculate depreciation expense:= $214,000-$48,000/12 = $13,833 DEPRECIATION EXPENSE (this will appear on the INCOME STATEMENT) = $13,833 x 2 years (time sisters have had the warehouse)= $27,66 ACCUMULATED DEPRECIATION (this will appear on the BALANCE SHEET and be subtracted from the original cost of the warehouse) Building: $214,000Less: Accumulated Amortization: $27,666

Additional Information

3. On Oct. 1, 2006 an insurance policy was taken out on the warehouse at a premium of $2,700/year. It has since been renewed at the same rate on August 31 of each year.

What does this mean?- It is now Sept. 30, 2008 meaning that the insurance policy

applies from Oct. 1, 2007 – Sept. 30, 2008. This will appear as INSURANCE EXPENSE on the INCOME STATEMENT

- This transaction will also appear as PREPAID INSURANCE under the Current Assets section of the BALANCE SHEET. The policy was renewed on August 31 for 12 months, with 1 month used at year end.

- $2,700 INSURANCE EXPENSE Income Statement- $2,475 PREPAD EXPENSE Balance Sheet

Additional Information

4. Serbello Sweet Treats rents its store and office space and pays $4,000/month in rent; 35% of the space is used as office space, and the remainder for selling purposes.

What does this mean? - Total rent each month is $4,000- Total rent each year is $4,000 x 12 months = $48,000 - 35% of the total amount ($48,000x 35% = $16,800) will be

allocated to Office Space and appear as RENT EXPENSE under the General &Admin. section of the INCOME STATEMENT

- 65% of the total amount ($48,000 x 65% = $31,200) will be allocated to Selling Space and appear as RENT EXPENSE under the Selling & Distribution section of the INCOME STATEMENT

5. A cotton candy machine was purchased on Oct. 1, 2006 for $2,000. This machine has a useful life of 5 years but will have no residual value remaining at the end of its life.

What does this mean?- The machine was purchased 2 years ago *Remember to pay attention to the

dates given*- Cost of the machine will appear on the Balance Sheet under Capital Assets,

Cotton Candy Machine $2,000- Calculate depreciation expense:= $2,000-$0/5 years= $400 DEPRECIATION EXPENSE (this will appear on the INCOME STATEMENT) = $400 x 2 years (time sisters have had the machine)= $800 ACCUMULATED DEPRECIATION (this will appear on the BALANCE SHEET and

be subtracted from the original cost of the cotton candy machine) Equipment: Cotton Candy Machine: $2,000Less: Accumulated Amortization: $800

Additional Information

6. To pay for the cotton candy machine, a note was obtained bearing 5% interest per year. The terms of the note are: the principal with interest is to be paid in 4 equal instalments, with the first payment being made on Sept. 30, 2007. The interest is calculated on the loan balance before the instalment payment is made.

What does this mean? (Balance Sheet Accounts) - Principal = $2,000 - 4 Equal Installments = $2,000/4 = $500/year- Made one payment of $500 in 2007 - One payment of $500 was made today. That means that

$1000 is still owing - $500 is due within one year, this will appear as a CURRENT

LIABILITY on the BALANCE SHEET - $500 is due within two years, this will appear as a LONG TERM

LIABILITY on the BALANCE SHEET

What does this mean? (Interest Payments)- Interest expense incurred in 2008 was on a principal balance

of $1,500 (amount before payment). The interest expense is 5% of $1,500 = $75

- INTEREST EXPENSE OTHER EXPENSES/REVENUE

- Note that this will be a negative number on the income statement.

Additional Information

7. In order to attract investors Serbello Sweet Treats maintains a dividend rate of 14% on net income after tax. Dividends are declared at year end.

What does this mean? - Since dividends are a function of Net Income

this value will be calculated after we finish the Income Statement.

- Dividends $$$ Owner’s Equity- Dividends Payable $$$ Current Liability

Additional Information

8.On June 1, 2008 Serbello Sweet Treats purchased 200 shares of Hahn Hot Chocolate Inc. to make use of otherwise idle cash. On the date purchased the stock was selling for $32/share, however on Sept. 30, 2008 the stocks’ price had risen to $45/share

What does this mean?- Use the lower value (cost/market) x number of shares that

you hold in Hahn’s Hot Chocolate = $32/share x 200 shares = $6,400

$6,400 MARKETABLE SECURITIES Current Assets

Additional Information

9.On August 1, 2008, a dividend of $5/share was declared and paid on Hahn’s Hot Chocolate.

What does this mean? - Based on the previous information we know that Serbello

Sweet Treats owns 200 shares of Hahn’s Hot Chocolate - $5 dividend x 200 shares = $1,000 received in dividends

- Dividend Income OTHER EXPENSES/REVENUE

Additional Information

10. Serbello Sweet Treats Inc. tax rate is 30%. Taxes have not yet been paid at year end.

Net Income =

Back to Part 7

7. In order to attract investors Serbello Sweet Treats maintains a dividend rate of 14% on net income after tax. Dividends are declared at year end.

• Remember we needed NET INCOME in order to complete this calculation…

Check Your Work

• If you have done everything correctly, your Income Statement and Balance Sheet should look like this…