Break-even analysis
- Contribution margin
- CM = p − v
- Break-even quantity
- QBE = FC/(p − v)
- Target profit
- Q = (FC + profit)/(p − v)
- Profit
- π = (p − v)·Q − FC
- Margin of safety
- (Q − QBE)/Q
Management Accounting: cram pack
Formula sheets, the key method steps for every topic and 4 practice problems, with full solutions at the back.
1Formulas and methods
2Practice problems
1.Break-even analysisMedium
A company sells 3 750 units at €38 each. The variable cost is €18 per unit and fixed costs are €30 000. Find the degree of operating leverage DOL at this sales level.
Q = 3 750p = €38v = €18F = €30 000
DOL =
2.Break-even analysisHard
A company sells 1 800 units at €51 each, with a variable cost of €45 per unit and fixed costs of €7 200. By what percentage %ΔΠ does operating profit change if sales volume rises by 12%?
Q = 1 800p = €51v = €45F = €7 200%ΔQ = +12%
%ΔΠ = %
3.Financial accountingMedium
Under IAS 38, how are research and development costs treated?
- ABoth are always expensed immediately
- BResearch is expensed; development is capitalised only when strict criteria are met
- CResearch is capitalised; development is expensed
- DBoth are always capitalised as intangible assets
4.Financial accountingHard
Under IFRS, how is purchased goodwill treated after acquisition?
- AIt is written off against equity immediately
- BIt is not amortised but tested for impairment at least annually
- CIt is revalued upwards every year
- DIt is amortised over 20 years
3Solutions
1.Break-even analysis
Answer: DOL = 1.667
Operating leverage: fixed costs make profit react more strongly than sales. The degree of operating leverage DOL = contribution margin/operating profit tells you that a 1% change in sales changes profit by DOL %. It is very high just above break-even and falls as sales grow.
Total contribution margin
CM = 3 750·(38 − 18) = €75 000
Operating profit
Π = 75 000 − 30 000 = €45 000
DOL
DOL = 75 000/45 000 = 1.667
Answer
DOL = 1.667
2.Break-even analysis
Answer: %ΔΠ = 36 %
Operating leverage: fixed costs make profit react more strongly than sales. The degree of operating leverage DOL = contribution margin/operating profit tells you that a 1% change in sales changes profit by DOL %. It is very high just above break-even and falls as sales grow.
Contribution margin and profit
CM = 1 800·6 = €10 800
Π = 10 800 − 7 200 = €3 600
DOL
DOL = 10 800/3 600 = 3
Change in profit
%ΔΠ = 3·(+12%) = +36%
Answer
%ΔΠ = +36%
Check: new profit = 2 016·6 − 7 200 = €4 896.00.
3.Financial accounting
Answer: B · Research is expensed; development is capitalised only when strict criteria are met
Why this is the answer
Research costs are always expensed. Development costs are capitalised when, for example, technical feasibility, intention, ability and probable future benefits can be shown.
Answer
B · Research is expensed; development is capitalised only when strict criteria are met
4.Financial accounting
Answer: B · It is not amortised but tested for impairment at least annually
Why this is the answer
Goodwill has an indefinite life under IFRS. It is allocated to cash-generating units and tested for impairment yearly, or more often if there are signs of impairment.
Answer
B · It is not amortised but tested for impairment at least annually
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