Andre has asked you to evaluate his business, Andre’s Hair Styling. Andre has five barbers working for him. (Andre is not one of them.) Each barber is paid $9.90 per hour and works a 40-hour week and a 50-week year, regardless of the number of haircuts. Rent and other fixed expenses are $1,750 per month. Hair shampoo used on all clients is .40 per client. Assume that the only service performed is the giving of haircuts (including shampoo), the unit price of which is $12. Andre has asked you to find the following information.
- Find the contribution margin per haircut. Assume that the barbers’ compensation is a fixed cost. Show calculations to support your answer.
- Determine the annual break-even point, in number of haircuts. Support your answer with an appropriate explanation. Show calculations to support your answer.
- What will be the operating income if 20,000 haircuts are performed? Show calculations to support your answer.
- Suppose Andre revises the compensation method. The barbers will receive $4 per hour plus $6 for each haircut. What is the new contribution margin per haircut? What is the annual break-even point (in number of haircuts)? Show calculations to support your answer.
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BELOW IS MORE EXPLANATION HOW THE ASSIGNMENT SHOULD BE HANDLED
AIU Managerial Accounting
In this IP, we have Andre who owns a styling salon. He has 5 barbers who do haircuts at his salon. This problem can be a little confusing, because it states that the only service is a haircut, but it also talks about a shampoo, and says that every customer gets their hair washed. Thus every haircut includes a shampoo, so the shampoo cost is a cost for each customer.
In this problem, we are computing the breakeven point in units, meaning that we want to know the number of haircuts that they must do to breakeven. What is breakeven? Breakeven is the point where expenses and income match. The operating income is 0 meaning that income and expenses are equal to each other.
We have formulas for determining breakeven. First we will determine the contribution margin and we will use this to determine the breakeven. Contribution margin is sales per unit minus the variable cost per unit. Breakeven in units is the total fixed costs divided by the contribution margin.
So in question 1, you are to find the contribution margin. So we go back to what we learned in unit 1 about what is a variable cost. A variable cost is a cost that is incurred each time we have a sale. We will not have this cost unless we have a sale, thus in question 1, we have 1 variable cost. You will subtract this from the sales per unit, and you will get the contribution margin. And that is question 1.
In question 2, we will use this contribution margin to determine breakeven. The first thing we must do is find our total fixed costs. Our fixed costs, you will remember, are the costs that will not change as we increase our sales. They remain the same if we do 1 haircut or 10,000 haircuts. So we have 2 fixed costs in this problem. Now the problem asks for the annual breakeven, so when you find the total fixed costs, you want this as an annual, or yearly, amount. You have monthly rent so you can convert this to annual rent. You have wages per hour, the hours per week, the weeks worked per year, and the number of barbers that work, so you can find the annual wages. You add your annual fixed costs together and divide by the contribution margin from question 1, to get the breakeven. This is breakeven in units, or haircuts, not dollars. We always round breakeven up if we come up with a partial amount, or fraction.
In question 3, you are to find the operating income if we do 20,000 haircuts. Operating income is sales minus expenses. You can find this in 2 ways. The first way is to find the total income for 20,000 haircuts, and then subtract the expenses for these haircuts, which includes the variable and the fixed expenses. The second way is the preferred method for managerial accountants because it can be done more quickly. For this method, you subtract the breakeven point in units that you found in question 1 from the 20,000 units that you expect to do, and you have the number of haircuts over breakeven. You then multiply this by the contribution margin that you found in question 1 and you will have the operating income. This method works because contribution margin is the amount that provides the payment of fixed expenses and profit. When we produce units in excess of breakeven, the entire amount of the contribution margin is profit, thus it increases operating income.
In question 4, Andre decides to pay in a different way. He decides that he will pay an amount per haircut and reduce the wages per hour. So you have to compute the breakeven for this scenario. So you will find a new contribution margin because even though sales stay the same, you now have a new variable cost. The fixed costs will also change since the wages per hour are now changed. This will affect the breakeven point that you are to find in this question.
I hope this helps you understand this very important concept of managerial accounting. Good luck!!