This document contains lecture notes on management accounting topics including operating leverage, contribution margin, gross margin, sales mix analysis, break-even analysis, and the impact of income taxes. It provides examples and calculations to illustrate key concepts such as how the degree of operating leverage affects changes in net income from changes in sales volume, how to calculate contribution margin and gross margin, how to determine the break-even point for different sales mixes, and how to account for taxes when setting a target after-tax net income.

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Introduction to Management Accounting
Chapter 2 (Lecture 02)

2. Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall 2 - 2
Operating Leverage
Operating leverage:
a firm’s ratio of fixed costs to variable costs.
Highly leveraged firms have high fixed costs
and low variable costs. A small change in sales
volume = a large change in net income.

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Operating Leverage
Margin of safety = planned unit sales –
break-even sales. How far can sales fall
below the planned level before losses occur?
Low leveraged firms have lower fixed costs
and higher variable costs.
Changes in sales volume will have a
smaller effect on net income.
Degree of
operating leverage = Contribution Margin
Net Income

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Contribution Margin
and Gross Margin
Sales price – Cost of goods sold = Gross margin
Sales price - all variable expenses =
Contribution margin
Per Unit
Selling price $1.50
Variable costs (acquisition cost) 1.20
Contribution margin and
gross margin are equal $ .30
Learning
Objective 6

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Contribution Margin and Gross Margin
Contribution Gross
Margin Margin
Per Unit Per Unit
Sales $1.50 $1.50
Acquisition cost of unit sold 1.20 1.20
Variable commission .12
Total variable expense $1.32
Contribution margin .18
Gross margin $.30
Suppose the firm paid a commission of $.12 per unit sold.

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Nonprofit Application
Suppose a city has a $100,000
lump-sum budget appropriation
to conduct a counseling program.
Variable costs per prescription
are $400 per patient per day.
Fixed costs are $60,000 in the
relevant range of 50 to 150 patients.

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If the city spends the entire budget
appropriation, how many patients
can it serve in a year?
Variable + Fixed
Sales = expenses + expenses
$100,000 = $400N + $60,000
$400N = $100,000 – $60,000
N = $40,000 ÷ $400
N = 100 patients
Nonprofit Application

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Nonprofit Application
If the city cuts the total budget appropriation by
10%, how many Patients can it serve in a year?
Variable + Fixed
Sales = expenses + expenses
$90,000 = $400N + $60,000
$400N = $90,000 – $60,000
N = $30,000 ÷ $400
N = 75 patients
Budget after 10% Cut
$100,000 X (1 - .1) = $90,000

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Sales Mix Analysis
Sales mix is the relative proportions or
combinations of quantities of products
that comprise total sales.
Learning
Objective 7

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Sales Mix Analysis
Ramos Company Example
Sales in units 300,000 75,000 375,000
Sales @ $8 and $5 $2,400,000 $375,000 $2,775,000
Variable expenses
@ $7 and $3 2,100,000 225,000 2,325,000
Contribution margins
@ $1 and $2 $ 300,000 $150,000 $ 450,000
Fixed expenses 180,000
Net income $ 270,000
Wallets
(W)
Key Cases
(K) Total

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Sales Mix Analysis
Wallets Key Cases
300,000 75,000
4 : 1
4K : K
Let K = number of units of K to break even, and
4K = number of units of W to break even.

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Sales Mix Analysis
Break-even point for a constant sales mix
of 4 units of W for every unit of K.
sales – variable – fixed = zero net income
expense expenses
[$8(4K) + $5(K)] – [$7(4K) + $3(K)] – $180,000 = 0
32K + 5K - 28K - 3K - 180,000 = 0
6K = 180,000
K = 30,000
W = 4K = 120,000
30,000K + 120,000W = 150,000 units.
120,000 30,000
Wallets Key Cases
Let K = number of units of K to break even, and
4K = number of units of W to break even.

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Sales Mix Analysis
Income Statement
Sales Revenue (120,000x8 + 30,000x5) $1,110,000
Total variable costs (120,000x7 + 30,000x3) ($930,000)
Contribution margin $180,000
Total fixed costs ($180,000)
Net income Zero
To proof:

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Sales Mix Analysis
If the company sells only key cases:
break-even point = fixed expenses
contribution margin per unit
= $180,000
$2 (5 – 3)
= 90,000 key cases
If the company sells only wallets:
break-even point = fixed expenses
contribution margin per unit
= $180,000
$1 (8 – 7)
= 180,000 wallets

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Sales Mix Analysis
Suppose total sales
were equal to the
budget of 375,000 units.
However, Ramos sold
only 50,000 key cases
And 325,000 wallets.
What is net income?

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Sales Mix Analysis
Ramos Company Example
Sales in units 325,000 50,000 375,000
Sales @ $8 and $5 $2,600,000 $250,000 $2,850,000
Variable expenses
@ $7 and $3 2,275,000 150,000 2,425,000
Contribution margins
@ $1 and $2 $ 325,000 $100,000 $ 425,000
Fixed expenses 180,000
Net income $ 245,000
Wallets
(W)
Key Cases
(K) Total

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Impact of Income Taxes
Suppose that a company earns
$1,440 before taxes and pays
income tax at a rate of 40%.
What is the
after-tax income?
Learning
Objective 8

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Impact of Income Taxes
Target income before taxes = Target after-tax net income
1 – tax rate
Target income before taxes = $ 864 = $1,440
1 – 0.40
Suppose the target net income
after taxes was $864

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Impact of Income Taxes
Target sales - Variable expenses - Fixed expenses
= Target after-tax net income ÷ (1 – tax rate)
$1.50N - $1.20N - $18,000 = $864 ÷ (1 – 0.40)
$.30N = $18,000 + ($864/.6)
$.18N = $10,800 + $864 = $11,664
N = $11,664/$.18
N = 64,800 units

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Impact of Income Taxes
Suppose target net income after taxes was $1,440
$1.50N - $1.20N - $18,000 = $1,440 ÷ (1 – 0.40)
$.30N = $18,000 + ($1,440/.6)
$.18N = $10,800 + $1,440 = $12,240
N = $12,240/$.18
N = 68,000 units