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Chapter 2: Question 5-4DQ (page 143)

What role does depreciation play in break-even analysis based on accounting flows? Based on cash flows? Which perspective is longer term in nature?

Short Answer

Expert verified

Break even analysis is done by dividing the fixed cost with the contribution per share. Fixed cost includes the depreciation cost when the break even analysis is based on accounting flows. But when the company uses the cash flow basis for break even analysis, depreciation amount should be excluded from the fixed cost.

Accounting flows perspective is longer term in nature because we must consider problems of fixed asset replacement.

Step by step solution

01

Role of depreciation in break even analysis

Depreciation is considered as the fixed cost while computing the break even point based on accounting flows.

02

Role of depreciation while computing break even point based on cash flows

While computing the break even point based on the cash flows, depreciation shall be excluded from the fixed cost. Because, the depreciation of the company is a non-cash transaction. Cash flows perspective is not longer in nature because it does not consider the problem of fixed asset replacement. However, it is considered under accounting flows perspective.

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Most popular questions from this chapter

Given the following information, prepare an income statement for Jonas Brothers Cough Drops.

Selling and administrative expenses

$328,000

Depreciation expenses

195,000

Sales

1,660,000

Interest expenses

129,000

Cost of goods sold

560,000

Taxes

171,000

Lemon Auto Wholesalers had sales of \(1,000,000 last year, and cost of goods sold represented 78 percent of sales. Selling and administrative expenses were 12 percent of sales. Depreciation expense was \)11,000 and interest expense for the year was \(8,000. The firm’s tax rate is 30 percent.

a. Compute earnings after taxes.

b. Assume the firm hires Ms. Carr, an efficiency expert, as a consultant. She suggests that by increasing selling and administrative expenses to 14 percent of sales, sales can be increased to \)1,050,900. The extra sales effort will also reduce cost of goods sold to 74 percent of sales. (There will be a larger markup in prices as a result of more aggressive selling.) Depreciation expense will remain at \(11,000. However, more automobiles will have to be carried in inventory to satisfy customers, and interest expense will go up to \)15,800. The firm’s tax rate will remain at 30 percent. Compute revised earnings after taxes based on Ms. Carr’s suggestions for Lemon Auto Wholesalers. Will her ideas increase or decrease profitability?

Assume the following data for Cable Corporation and Multi-Media Inc.

Capable corporation

Muli-media inc

Net income

\(31,200

\)140,000

Sales

317,000

2,700,000

Total assets

402,000

965,000

Total debts

163,000

542,000

Stockholder’s equity

239,000

423,000

b. Compute the following additional ratios for both firms:

Net income/Sales

Net income/Total assets

Sales/Total assets

Debt/Total assets

The balance sheet for Stud Clothiers is shown below. Sales for the year were \(2,400,000, with 90 percent of sales sold on credit.

Stud Clothier

Balance sheet 20X1

Assets

Liabilities and Equity

Cash

\)60,000

Account payable

\(220,000

Account receivable

240,000

Accrued taxes

30,000

Inventory

350,000

Bonds payable (long term)

150,000

Plant and equipment

410,000

Common stock

80,000

Paid in capital

200,000

Retained earnings

380,000

Total assets

\)1,060,000

Total LIbilities and Equity

$1,060,000

Compute the following:

c. Debt to total assets ratio.

Using the income statement for Times Mirror and Glass Co., compute the following ratios:

The total assets for this company equal \(80,000. Set up the equation for the Du Pont system of ratio analysis, and compute c, d, and e.

c. Profit margin.

Times mirror and glass company

Sales

\)126,000

Less: Cost of goods sold

93,000

Gross profit

\(33,000

Less: selling and administrative expenses

11,000

Lease Expenses

4,000

Operating profit*

\)18,000

Less: Interest expenses

3,000

Earning before taxes

\(15,000

Less: Taxes (30%)

4,500

Earning after taxes

\)10,500

*equal income before interest and taxes
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