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  • Mar 23, 2008, 11:54 AM
    greatone
    Break-even analysis
    MY QUESTION IS AT THE VERY BOTTOM...

    Royal Essentials, Inc. began operations on January 1, 2008. The company produces a hand and body lotion in an eight-ounce bottle, called Eternal Beauty. The lotion is sold wholesale in 12-bottle cases for $80 per case. There is a selling commission of $16 per case. The January direct materials, direct labor, and factory overhead costs are as follows:


    DIRECT MATERIALS
    Cost Behavior Units per Case Cost per Unit Direct Materials
    Cost per Case
    Cream base Variable 72 ozs. $0.015 $1.08
    Natural Oils Variable 24 ozs. $0.250 $6.00
    Bottle (8 oz.) Variable 12 bottles $0.400 $4.80
    $11.88


    DIRECT LABOR
    Cost Behavior Time per Case Labor Rate per Hour Direct Labor
    Cost per Case
    Mixing Variable 16.80 min $15.00 $4.20
    Filling Variable 4.20 min $12.00 $0.84
    21.00 min $5.04


    FACTORY OVERHEAD
    Cost Behavior Total Cost
    Utilities Mixed $230
    Facility Lease Fixed $9,694
    Equipment Depreciation Fixed $3,600
    Supplies Fixed $600
    $14,124


    Part A - Break-Even Analysis

    The management of Royal Essentials, Inc. wishes to determine the number of cases required to break even per month. The utilities cost, which is part of factory overhead, is a mixed cost. The following information was gathered from the first six months of operation regarding this cost:


    2008 Case Production Utility Total Cost
    January 300 $230
    February 600 $265
    March 1,000 $300
    April 900 $292
    May 750 $275
    June 825 $280


    Instructions:

    1. Determine the fixed and variable portion of the utility cost using the high-low method.


    At High Point At Low Point
    Variable Cost
    Fixed Cost
    Total Cost


    2. Determine the contribution margin per case. Enter your answer in dollars and cents. Round to two decimal places. For example, 89.458 would be entered as 89.46

    Contribution margin per case: $

    3. Determine the fixed costs per month, including the utility fixed cost from part (1). Enter your answer as a whole number. Round to the nearest whole unit. For example, 89.45 would be entered as 89 and 89.56 would be entered as 90.


    Utilities Cost (from part 1)
    Facility Lease
    Equipment Depreciation
    Supplies
    Total Fixed Costs


    4. Determine the break-even number of cases per month.

    cases


    MY QUESTION IS, WHAT IS THE BREAK-EVEN NUMBER OF CASES PER MONTH?
  • Mar 23, 2008, 02:55 PM
    morgaine300
    You can't do the break even until you have the utilities broken down into fixed and variable.

    Here's how hi-low method works. It's easier to understand if you know an answer and can look at it worked backwards. You're always picking out the highest production and the lowest production to make a comparison. You can ignore the rest. So let's just make up two production levels and some costs, using simple numbers.

    The two production levels will be 10 units and 15 units. Fixed costs are $25. Variable costs are $1 per unit.

    10 units = $25 + variable costs
    15 units = $25 + variable costs

    10 units = $25 + (10 units x $1)
    15 units = $25 + (15 units x $1)

    10 units = $25 + $10 = $35 total
    15 units = $25 + $15 = $40 total

    You can see that the $25 doesn't change cause it's fixed. The difference in total costs was caused entirely by the variable costs. It went up $5. But also notice the entire variable costs is not $5. That's only the difference in costs.

    Now, let's go backwards. You cannot see the portion in blue because you don't know that information. That's what you're trying to find out. So everything that follows is actually how you do the high-low. The preceding was just to help show why it works and what's behind it.

    We know the change in units is 5. And we know the change in cost is $5. So you take cost and divide by units: $5/5 units = $1 per unit.

    Since only variable costs can cause that change, that has to be variable. So we now know our variable is $1 per unit. But this still would not tell us what portion of $35 and $40 is the variable.

    So now we can take the variable cost that we know and multiply by units:
    10 units x $1 variable = $10

    Now we know $10 of the $35 (for 10 units) is variable. So $35 - 10 = $25 fixed. Whatever's left over must be fixed.

    You only need to do that last step with one category, but you can prove it to yourself by doing the other one too:
    15 units x $1 variable = $15
    $40 total costs - $15 variable = $25 fixed

    $25 fixed: same number and it "checks."

    High-low can be a little difficult to understand at first, but with some practice is not that difficult.

    Once you have that, you need to add the fixed and variable for the utilities to your other costs. You need to make sure you don't add the entire $230 under the fixed overhead costs.

    Break-even is fixed divided by contribution margin. The contribution margin sales price less variable costs, so it's what is "left over" for each unit after variable costs. You need that in order to cover the fixed costs. By dividing, you're figuring out how many units at that amount it will take in order to just cover the total fixed costs.

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