Unit 3 - Individual Project Consider The Following Scenario
Unit3 - Individual Project Consider the following scenario: Andre has
Evaluate Andre's business, Andre’s Hair Styling, focusing on contribution margin per haircut, break-even point, and operating income. The scenario involves five barbers paid fixed wages, fixed expenses, and variable costs per client. Additionally, analyze the impact of a revised compensation structure on profitability metrics.
Paper For Above instruction
Andrew's Hair Styling, operated by Andre with five barbers, provides a practical setting for analyzing key managerial accounting concepts such as contribution margin, break-even analysis, and operational income. This case offers insight into calculating profitability measures under fixed and variable cost assumptions and assessing the implications of changes in compensation strategies.
Contribution Margin per Haircut
The contribution margin (CM) per unit is the difference between the unit selling price and the variable costs associated with the service. In this scenario, the only variable costs are shampoo expenses, at $0.40 per haircut, and the haircut itself, priced at $12. Therefore, the contribution margin per haircut can be expressed as:
CM = Selling Price - Variable Costs
CM = $12 - $0.40 = $11.60
Thus, the contribution margin per haircut is $11.60. This indicates that for each haircut sold, $11.60 contributes toward covering fixed costs and generating profit.
Determining the Annual Break-Even Point
The break-even point is the number of haircuts needed so that total revenues equal total expenses, resulting in zero operating income. Since the barbers' wages are a fixed cost, and fixed expenses are given as $1,750 per month, the annual fixed costs total:
Fixed Costs = $1,750/month × 12 months = $21,000
Variable costs per haircut are $0.40, and total variable costs vary with sales volume. The total fixed costs are thus the main expense that must be recovered:
Break-even volume = Fixed costs / Contribution margin per unit
Break-even volume = $21,000 / $11.60 ≈ 1,810.34
Rounding up, the business must perform approximately 1,811 haircuts annually to break even. This number ensures that revenues precisely cover both fixed and variable expenses without profit or loss.
Operating Income at 20,000 Haircuts
To determine operating income with 20,000 haircuts, total revenue, total variable costs, and fixed costs are calculated:
Total Revenue = 20,000 × $12 = $240,000
Total Variable Costs = 20,000 × $0.40 = $8,000
Total Fixed Costs = $21,000 (from previous calculation)
Contribution Margin Total = Revenue - Variable Costs = $240,000 - $8,000 = $232,000
Operating Income = Contribution Margin Total - Fixed Costs = $232,000 - $21,000 = $211,000
Thus, performing 20,000 haircuts would generate an operating income of $211,000.
Impact of Revised Compensation Structure
Suppose Andre revises the barber compensation to $4 per hour plus $6 per haircut. First, determine the new contribution margin per haircut:
The variable costs per haircut now are solely the $6 paid per haircut, since the $4 per hour is a fixed wage component paid regardless of the number of haircuts.
New contribution margin per haircut = Selling Price - Variable Cost per Haircut
Contribution margin = $12 - $6 = $6
Next, calculate the new break-even point in units:
Fixed costs are the wages paid to the barbers, which remain constant at $9.90/hour × 40 hours/week × 50 weeks × 5 barbers:
Weekly wages per barber = 40 hours × $9.90 = $396
Total wages for 5 barbers = 5 × $396 = $1,980/week
Annual wages = $1,980/week × 50 weeks = $99,000
Fixed costs now include wages and other fixed expenses ($1,750/month × 12 = $21,000):
Total fixed costs = $99,000 + $21,000 = $120,000
Break-even volume = Total Fixed Costs / New Contribution Margin per Haircut
Break-even volume = $120,000 / $6 = 20,000 haircuts
Therefore, under the new compensation model, Andre must perform approximately 20,000 haircuts annually to break even.
The analysis underscores the significant impact that compensation structures have on profitability metrics. Increasing variable compensation per haircut reduces contribution margin, thereby requiring more sales to cover fixed costs. Conversely, fixed wages, being independent of sales volume, can lower the break-even point if properly managed through increased efficiency or sales volume.
References
- Wild, J. J., & Shaw, K. S. (2017). Financial & Managerial Accounting (8th ed.). McGraw-Hill Education.
- Drury, C. (2013). Management and Cost Accounting. Cengage Learning.
- Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2018). Managerial Accounting. McGraw-Hill Education.
- Hilton, R. W., & Platt, D. (2017). Managerial Accounting: Creating Value in a Dynamic Business Environment. McGraw-Hill Education.
- Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2019). Financial & Managerial Accounting. Wiley.
- Anthony, R. N., Hawkins, D. F., & Merchant, K. A. (2014). Accounting: Texts and Cases. McGraw-Hill Education.
- Frame, W., & Pathak, R. (2019). Cost Accounting: A Managerial Emphasis. McGraw-Hill Education.
- Kaplan, R. S., & Cooper, R. (1998). Cost & Effect: Using Integrated Cost Systems to Drive Profitability and Performance. Harvard Business Review Press.
- Subramanian, R., & Subramanian, K. (2018). Principles of Management Accounting. Wiley.