Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 53

Extensions of the CVP Model—Multiple Products and Taxes

Assume that Limitless Labs, Inc., offers three basic drug-testing services for professional athletes. Here are its prices and costs:

	?Price per Unit	?Variable Cost per Unit	?Units Sold per Year
Basic	$ 500	$ 120	850
Retest	800	400	100
Vital	4,000	2,800	50

Variable costs include the labor costs of the medical technicians at the lab. Fixed costs of $390,000 per year include building and equipment costs and the costs of administration. A basic “unit” is a routine drug test administered. A retest is given if there is concern about the results of the first test, particularly if the test indicates that the athlete has taken drugs that are on the banned drug list. Retests are not done by the laboratory that performed the basic test. A “vital” test is the laboratory’s code for a high-profile case. This might be a test of a famous athlete and/ or a test that might be challenged in court. The laboratory does extra work and uses expensive expert technicians to ensure the accuracy of vital drug tests. Limitless Labs is subject to a 40 percent tax rate.

Required

a. Given the above information, how much will Limitless Labs earn each year after taxes?

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b. Assuming the above sales mix is the same at the break-even point, at what sales revenue does Limitless Labs break even?

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c. At what sales revenue will the company earn $180,000 per year after taxes assuming the above sales mix?

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d. Limitless Labs is considering becoming more specialized in retests and vital cases. What would be the company’s break-even revenues per year if the number of retests increased to 400 per year and the number of vital tests increased to 200 per year, while the number of basic tests dropped to 100 per year? With this change in product mix, the company would increase fixed costs to $420,000 per year. What would be the effect of this change in product mix on Limitless Labs’s earnings after taxes per year? If the laboratory’s managers seek to maximize the company’s after-tax earnings, would this change be a good idea?

Step 1 of 14

a.

Prepare the income statement of LL Labs to find out the amount of profit they earn each year after taxes.

LL Labs Income statement
Particulars	Amount	Amount
Sales revenue
Basic (850 units × $500 per unit)	$ 425,000
Retest (100 units × $800 per unit)	$ 80,000
Vital (50 units × $4,000 per unit)	$ 200,000	$ 705,000
Less: Variable costs
Basic (850 units × $120 per unit)	$ 102,000
Retest (100 units × $400 per unit)	$ 40,000
Vital (50 units × $2,800 per unit)	$ 140,000	$ 282,000
Contribution margin		$ 423,000
Less: Fixed costs		$ 390,000
Profit before tax		$ 33,000
Less: Income tax ($33,000 × .4)		$ 13,200
Profit after tax		$ 19,800

The company is earning an after tax profit of per year.