# explain why the cvp analysis done in requirement 2 is more accurate than the analysi 649642

CVP ANALYSIS, IMPACT OF ACTIVITY BASED COSTING

Salem Electronics currently produces two products: a programmable calculator and a tape recorder. A recent marketing study indicated that consumers would react favorably to a radio with the Salem brand name. Owner Kenneth Booth was interested in the possibility. Before any commitment was made, however, Kenneth wanted to know what the incremental fixed costs would be and how many radios must be sold to cover these costs.

In response, Betty Johnson, the marketing manager, gathered data for the current products to help in projecting overhead costs for the new product. The overhead costs follow. (The high and low production volumes as measured by direct labor hours were used to assess cost behavior.)

 Fixed Variable Materials handling \$ — \$18,000 Power — 22,000 Engineering 100,000 — Machine costs 30,000 80,000 Inspection 40,000 — Setups 60,000 —

The following activity data were also gathered:

 Calculators Recorders Units produced 20,000 20,000 Direct labor hours 10,000 20,000 Machine hours 10,000 10,000 Material moves 120 120 Kilowatt hours 1,000 1,000 Engineering hours 4,000 1,000 Hours of inspection 700 1,400 Number of setups 20 40

Betty was told that a plantwide overhead rate was used to assign overhead costs based on direct labor hours. She was also informed by engineering that if 20,000 radios were produced and sold (her projection based on her marketing study), they would have the same activity data as the recorders (use the same direct labor hours, machine hours, setups, and so on).

Engineering also provided the following additional estimates for the proposed product line:

 Prime costs per unit \$ 18 Depreciation on new equipment 18,000

Upon receiving these estimates, Betty did some quick calculations and became quite excited. With a selling price of \$26 and just \$18,000 of additional fixed costs, only 4,500 units had to be sold to break even. Since Betty was confident that 20,000 units could be sold, she was prepared to strongly recommend the new product line.

Required:

1. Reproduce Betty’s break even calculation using conventional cost assignments. How much additional profit would be expected under this scenario, assuming that 20,000 radios are sold?

2. Use an activity based costing approach, and calculate the break even point and the incremental profit that would be earned on sales of 20,000 units.

3. Explain why the CVP analysis done in Requirement 2 is more accurate than the analysis done in Requirement 1. What recommendation would you make?