Dude Skis is conducting its annual budgeting process, and the cost accountant is called upon to create a profit volume table that shows the amount of profit before taxes that Dude is likely to earn at different unit volume sales levels. The company currently produces 50,000 pairs of skis per year, and this figure is unlikely to decline. He learns that the company can produce an additional 10,000 pairs of skis without incurring any additional overhead costs. However, if the company expands production by an additional 20,000 pairs, it will incur an additional $750,000 in annual overhead expenses, and will likelyalso have to reduce its prices by 10% in order to achieve that volume level. Based on this information, he constructs the following table:
|
Number of Skis Sold |
|||
|
Number of ski pairs |
50,000 |
60,000 |
70,000 |
|
Direct cost per pair of skis |
$210 |
$210 |
$210 |
|
Net sales price per pair sold |
380 |
380 |
342 |
|
Total revenue |
19,000,000 |
22,800,000 |
23,940,000 |
|
Total direct cost |
10,500,000 |
12,600,000 |
14,700,000 |
|
Total period cost |
8,000,000 |
8,000,000 |
8,750,000 |
|
Profit |
$500,000 |
2,200,000 |
$490,000 |
|
Profit % |
3% |
10% |
2% |
The analysis reveals that Dude should certainly make every effort to increase its sales by an additional 10,000 units, since this will result in a significant improvement in its profitability. However, expanding by yet another 10,000 units may be a bad idea, since the company must accept lower per unit prices as well as more overhead. In fact, the additional growth by 20,000 units, when coupled with an increased need for working capital and reduced profitability, may put the company in serious operating difficulties.