 Hello and welcome to this session. This is Professor Farhat in which we compute the break even analysis or the break even point for a segmented operation or for a specific income statement. And we will discuss the common errors that could arise from computing the break even point for a whole segment. Now, in the prior session, we looked at how we compute the break even point for a product. We can do so by computing the break even in dollar amount or the break even in number of units sold. In this session, we're going to be focusing on the dollar amount because we are dealing with income statement data, not unit sold and produced. Therefore, let's start by reviewing how do we compute the break even point? Well, first, you have to compute your contribution margin percentage. And that's taken the contribution margin for this company, which is sales minus variable cost 520 divided by sales. And we have a contribution margin percentage of 52%. The next thing we're going to do is we're going to compute the break even point for the whole company, for this whole company. Well, well, it's 270,000, which is the fixed cost. And notice here what we did with the fixed cost. We have a traceable fixed cost and we have common fixed cost. What I did for the whole company, you combine both. And when you combine traceable fixed cost plus common fixed cost, fixed cost is 270. So you will take 270 divided by the contribution margin percentage that you computed in the prior step. And you will come up with the break even point in sales for the whole company. Simply put, the formula is fixed cost divided by the contribution margin percentage. And that's what we did. Now, what we're going to do is we're going to compute the break even point for each division separately. We have a business division for this company and we have consumer division. So one of our divisions will sell only two businesses and another one will sell to consumers. Whatever we are selling, it doesn't really matter. So let's compute the break even for the business division. Well, we're going to take, notice what we're going to do. We're going to take the fixed cost traceable to the business division, which is 100,000. That's going to be used in the numerator. So this is the numerator and the contribution margin percentage is 52%. And how do we know it's 52% you will take 312 divided by 600,000 divided by 600. And the contribution margin is 52%. Therefore, the break even point, you need to have sales 192 307 192 307. That's the break even point in sales for the business division. Let's compute the consumer division using the same method. 45,000 divided by 52 will give us break even in dollar amount 86 538 86 538. Now we computed the break even for each division separately. Now, let me, let me show you this. And obviously you're going to notice this immediately. The break even for the whole company is 519 230. Now, if we add the break even point for each division separately, let's do that. It's not going to equal. So if we take 192 307 plus 86 538, it's equal together equal 278. If my math is right, 845. And that's the break even for each company separately. Well, hold on a second, but the break even for the whole company is 519 5, 519 230. What is the difference? Obviously, the difference is the 125,000, the fixed cost that's common for the whole company, which we did not use. So if we take 125, if we compute the break even for the 125 separately, so if we take 125 divided by 52.52, 125 divided by 0.52, that's going to give us 240. 243.84, if we take 243.84 plus 278.845 will give us 519 230, which is the break even for the whole company. I just wanted to do the math to show you, obviously, I'm pretty sure most of you already noticed this, that when you do the break even, when you compute the break even for a particular division, because you are using only the traceable fixed cost, when we compute all the division, well, guess what? It's not going to be equal to the break even for the whole company. So what is the issue here? The issue is we have to be very careful in how we compute the business division. We have to be very careful in how we interpret that number, because depending on the traceable cost, what does that mean? It means that we could face some common errors, some common pitfalls. When we misinterpret the break even point for a particular division, within the company, and this is what we need to discuss. What are some of those common errors that we have to be on the lookout for? Before we discuss the common errors, most likely you are a student or a CPA candidate or a CMA candidate. If that's the case, please visit farhatlectures.com where I have additional resources for you. Obviously, if you're watching, it means you are looking for some help, multiple choice lectures through false exercises that's going to help you do better in your accounting courses, as well as professional certification exams, such as the CPA. I don't replace your CPA review course. Please connect with me on LinkedIn, YouTube, Instagram, Facebook, Twitter and Reddit. So let's take a look at some of the common errors. The first one is emission of cost. When we compute the break even point, sometime what we end up happening, not accounting for certain costs that goes into the product. So hold on a second. What happened to it? Does it disappear? It doesn't disappear. We just don't treat it as part of the product cost. Let's think about manufacturing companies use absorption costing. Well, we don't count upstream costs like R&D and product design. Also, we don't count downstream costs like marketing. And those costs could be a substantial amount of the product cost of the company. So we don't, we don't account for them under the product costs. We don't, we treat them as period costs. Therefore, when we perform this computation, we ignore them. Not they go away, we ignore them. Therefore, we, we did as we, we omitted certain important costs. Sometime we might use an appropriate method for the allocating the traceable fixed costs. Remember the traceable fixed cost is the cost that's traceable to that particular division or product or unit. Well, sometime we don't do a proper tracing or if we do tracing, it's, we use the wrong allocation tracing. So that could be a problem. And we will see an example to illustrate this point. So we could be using an appropriate allocation base. For example, we can use selling an administrative based on sales. So what we do is we look at your division and we look at your sales. And the more sales you have, we'll say, the more sales you have, the more selling and administrative we're going to allocate to your division. Well, that's not really correct. There might be no correlation between selling, selling and administrative expenses and sales itself. There might be, but there may not be. So we need to find the proper driver if we are going to do that. And sometime what we do, we arbitrarily allocate those common costs to various division, you would say, let's be fair and let's spread that equally. Well, what would happen if that's the case? Let me show you an example with numbers that illustrate the point. Let's assume this is a restaurant and this is the restaurant, the income statement for the whole restaurant. Contribution margin sales minus variable cost gives us contribution margin minus, you know, minus a traceable fixed cost minus common fixed cost. The restaurant is making 24,000 in profit. Now we, this restaurant, they have, we're going to break it down and to do division, a bar and the restaurant, the food under the bar. This is the sales variable cost, contribution margin minus the traceable cost for the bar and the bar is making $13,000 in profit by itself. We'll do the same thing for the restaurant. Sales minus variable cost, contribution margin for the restaurant minus the traceable fixed cost and restaurant is making $221,000 in profit by itself. Now, obviously, obviously the whole company is making 24. Why? Because we have $210,000 that we did not allocate their common between the bar and the restaurant. Now here's what some companies would do. And this is the, some of the pitfalls that some companies would do. And they will, they will use this break, even analysis or segmented income statement for the wrong division, for the wrong reasons, sorry, not for the wrong division. The question is, how do we allocate this $210,000? And here's what some companies would do. If they're common, keep them common. But here's what some companies would do. Some company would say, well, you know what? To be fair, let's spread them equally. 105 and 105. What would happen if we allocate another 105 to the bar business? If we allocate 105 to the bar business, now we incur a loss. Let it be more specific. Let me show you what would happen. So if we have 13,000 profit and we deduct 105, an additional fixed cost, now it shows that the bar restaurant is incurring a loss of 92,000. Obviously, the restaurant will be able to absorb, will, would still be at a profit, will be able to absorb the 105. But what happened is now we think the bar is not, is not a good business for us and we need to close the bar because it's not a good thing. So that could be a pitfall. Okay. We made a mistake. We shouldn't have done so. And usually the bar have a higher profit margin, but that's beside the point. This is just a fictitious number. Or what we do is we say, okay, let's be reasonable and let's assume this restaurant is a thousand square footages for the sake of illustration. And the bar occupy 300 square footage and the restaurant occupies 700. Oh, we say, okay, we're going to, we're going to try to be rational and we're going to allocate 30% of 210 to the bar. So if we take 210 times 0.3 is 63,000. So we would allocate an additional 63,000. Again, what's going to happen? We're going to end up in a loss. And the question is, what should we do with that bar? Should we close it because it's incurring a loss? Not necessary. But if we go through those allocation, if we misallocate, then we could be in a problem. This is, this is what would happen. So we have, we have to be very careful on how we look at our common fixed cost. How do we treat our common fixed cost and how to use it for business decision? And that's the whole purpose of this. What should you do now? Go to farhatlectures.com and work MCQs through false. 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