Reference no: EM132645202

Soft Towel Ltd. manufactures towels for department stores and residential hotels. It has three major product lines: bath sheets, bath towels and hand towels. The following income statement was prepared by product line. (Ignore income taxes.)

Bath sheets Bath towels Hand towels Total
Sales (in pcs) 2 000 500 500 3 000
Sales revenue  $1 000 $400. $200 $1 600
Variable manufacturing costs:    
Direct material $330 $160 $100 $590
Direct labour 90 40 20 150
Manufacturing overhead. 108 48. 24 180
Total cost of goods sold $528. $248. $144. $920
Gross margin $472. $152. $56. $680
Operating expenses:    
Selling expenses:    
Advertising. $50 $30 $20 $100
Commissions 50 40 20. 110
Salaries and on-costs 30 20 10. 60
Total selling expenses. $130 $90 $50 $270
General and administrative expenses:    
Licences          $50 $20 $15 $85
Salaries and on-costs   60 25 15 100
Total general and administrative expenses$110 $45. $30. $185
Total operating expenses $240 $135 $80 $455
Operating profit before taxes. $232. $17 ($24) $225

Other data:
· Cost of goods sold. The company's inventories of raw materials, work in process and finished products do not vary significantly from year to year. (The inventories on 30 June were essentially identical to those on 30 June in the previous year.)

Manufacturing overhead was applied to products at 120 per cent of direct labour dollars. The manufacturing overhead costs for the year ended 30 June were as follows:

Indirect labour and supplies (variable). $ 15000
Employee on-costs for indirect labour (variable). 30000
Supervisory salaries and on-costs 35000
Plant occupancy costs 100000
Total $180000

There was no overapplied or underapplied overhead at year-end.

· Advertising. The company has been unable to determine any direct causal relationship between the level of sales volume and the level of advertising expenditures. However, because management believe that advertising is necessary, an annual advertising program is implemented for each product line. Each product line is advertised independently of the others.

· Commissions. Sales commissions are paid to the sales force at the rate of 5 per cent on the bath sheets and 10 per cent on the hand towels and bath towels.

· Licences. Various licences are required for each product line. These are renewed annually for each product line.

· Salaries and on-costs. Sales and administrative personnel devote time and effort to all product lines. Their salaries and wages are allocated on the basis of management's estimates of time spent on each product line.

Required:
1. The accountant of Soft Towel Ltd has recommended that the company do a cost volume profit analysis of its operations. As a first step, the accountant has requested that you prepare a revised income statement that employs a contribution margin format, which will be useful in CVP analysis. The statement should show the contribution margin for each product line and the operating profit before taxes for the company as a whole, taking into account the sales mix.

2. Use the data in your contribution statement to:
a. Calculate a separate break-even point for each of the three product lines taking into account the sales mix.
b. Calculate a single break-even point for the company.
c. Explain which of the answers in parts (a) and (b) are the most useful for the company.

3. The accountant of Soft Towel is going to prepare a report to present to the other members of top management, explaining cost volume profit analysis. Identify and explain the following points, which the accountant should include in the report:
a. Advantages that CVP analysis can provide to the company.
b. Difficulties the company could experience in the calculations involved in CVP analysis.
c. Dangers that management should be aware of in using the information derived from the CVP analysis.