QUESTION [WORKING EXAMPLE]

Knysna Limited manufactures a single product. Sales are very unpredictable with the result that a profit is made
in some months and a loss is incurred in other months. The company's income statement for April 2021 is as
follows:

Sales (13 500 x R20) 270 000

Variable costs 189 000
Contribution 81 000
Less: Fixed costs 90 000
Net loss (9 000)

YOU ARE REQUIRED TO:

1. Calculate the organisation's contribution margin and break-even point (both in units and value); (5)

2. Determine the effect on the organisation's monthly net income or loss if an R8 000 per month increase in
advertising costs, combined with an additional work effort on the part of the sales staff, leads to an increase
of R70 000 in monthly sales; (3)

3. Prepare an income statement if a 10% decrease in the selling price combines with an increase of R35 000
in advertising costs will cause the number of units sold to double; (5)

4. Calculate how many units per month have to be sold to show a profit of R4 500 under the following
circumstances:

The company's advertising agency is of the opinion that new packaging will increase sales. This new
packaging will increase costs by R0,6 per unit, (3)

5. (a) Calculate the new contribution margin and break-even value if the company, by automating certain
activities, can halve variable costs while fixed costs increase by R118 000 per month; (4)

(b) Prepare two income statements for April 2021, one in the event that the activities are not automated,
and the other in the event that activities are automated (you may assume that 20 000 units will be
sold); (4)

(c) Discuss (with reasons) whether or not you will recommend automation; (4)

(d) Calculate the number of units sold where profit will be the same for automation and non-automation;
(4)

6. Calculate the selling price per unit under the following conditions:

A large distributor offered to purchase 5 000 units on a special price basis. Variable selling costs of R2 can
be avoided on this order. Knysna Limited requires an R11 000 profit for the month and normal sales of
13 500 units will not be affected. (3)
35
QUESTION 1 [SUGGESTED SOLUTION]

1. The contribution margin (CM) is 30%.

Per
Total unit Percentage

Sales (13 500 units) R270 000 R20 100%

Less: Variable expenditure 189 000 14 70
Contribution margin R 81 000 R6 30% (1)

Break-even point is:

Sales = Variable expenditure = fixed expenditure + profit

R20X = 14X + R90 000 + 0
R 6X = R90 000
X = 15 000 units (2)

15 000 units x R20 = R300 000 sales. (2)

5

π Alternative solution:

Fixed expenditure R90 000 = 15 000 units

CM per unit R6

Fixed expenditure R90 000 = R300 000 sales

CM ratio 0.30

2. Incremental contribution margin:

R70 000 increased sales x 30% CM ratio R21 000 (1)

Less: Increased fixed costs
Increased advertising costs 8 000 (1)
Increase in monthly net income R13 000 3

As the company currently shows a loss of R9 000 per month, the acceptance of the changes will change
the loss into a profit of R4 000 per month.

π Alternatively:

Sales = 270 000 + 70 000 = 340 000

∴ Contribution = 340 000 x 30% = 102 000
Fixed costs (90 000 + 8 000) = 98 000
Profit 4 000

3. Sales (27 000 units x R18*) R486 000 (2)

Less: Variable expenditure (27 000 x R14**) 378 000 (1)
Contribution margin 108 000
Less: Fixed costs (R90 000 + R35 000) 125 000 (1)
Net loss (R17 000) (1)
5

* R20 - (R20 x .10) = R18

** 189 000 ÷ 13 500 = R14

4. Sales = Variable costs + fixed costs + profit (1)

R20X = R14.60 X* + R90 000 + R4 500
 ∴ R5.4X = R94 500
∴ X = 17 500 units (2)
3

* R14 + R0.60 = R14.60

π Alternative solution:

Fixed costs + expected net income

CM per unit

= R94 500
R5.40*

= R17 500 units

** R6.00 - R0.60 = R5.40

5. (a) The new CM ratio would be:

Per unit %
Sales R20 100%
Less: Variable costs 7 35%
Contribution margin R13 65% (2)

The new break-even value:

Fixed costs = R208 000 = R320 000 sales (2)

CM ratio 0.65 (4)

(b) Comparative income statements

Not automated Automated

Total Per % Total Per %
unit unit

Sales (20 000 units) R400 000 R20 100 R400 000 R20 100
Less: Variable costs 280 000 14 70 140 000 7 35
Contribution margin 120 000 R 6 30 260 000 R13 65
Less: Fixed costs 90 000 208 000
R 30 000 (2) R52 000 (2)
(4)

(c) The decision on the company's automation depends on the risk that the company is prepared to
accept, and largely depends on the expectations regarding future sales. (1)

The suggested changes will increase the company's fixed costs and break-even point.
(1)

However, the changes will increase the company's CM ratio from 30% to 65%. (1)

The higher CM means that once the break-even point has been achieved, profit will increase more
quickly than is currently the case. (1)

For example, if 20 000 units are sold next month, the higher CM ratio will generate R22 000 more
profit than if no changes were accepted. (1)

The greatest risk regarding automation is that future sales may revert back to current levels (only 13
500 units per month) and as a result losses will be even greater than is currently the case as a result
of the company's increased fixed costs. (1)
 (Note that the question states that the company's sales fluctuate from month to month).

To summarise, the suggested changes will help the company if sales continue to increase in future
months; BUT the changes will be detrimental to the company if sales decrease to ± current levels.
(1)
Any 4: 4

(d) The point where there will be no difference regarding units sold, in other words where profit under
both alternatives will be the same is:

Total income will be the same; therefore only costs have to be considered:

Let X = point of no difference in units sold

Profit = Profit

R6X - 90 000 = R13X - R208 000 (2)

∴ R7X = R118 000

∴ X = 16 857 units (2)

4

If more than 16 857 units are sold, the amended plan will yield the highest profit; BUT if less than 16
857 units are sold, the current plan will yield the greatest profits.

6. Variable costs relating to new sales = R60 000 (1)

[5 000 units x (R14 - R2)]
Current net loss 9 000 (1)
Required net income 11 000 (1)
Total selling price R80 000 3

R80 000 ÷ 5 000 units = R16 per unit.

TOTAL: 35