Gross Profit Analysis

Gross profit is the difference between the cost of goods sold and sales. Since the proximity of the actual to the budgeted or standard gross profit figure is highly desirable, a careful analysis of unexpected changes in gross profit is useful to a company's management. These changes are the result of one or a combination of the following. Changes in sales prices of the products. Changes in volume sold. a. Changes in number of physical units sold. b. Changes in the types of products sold, often called the product mix or sales mix. Changes in cost.

Procedures for analyzing gross profit

Two types of procedures: 1. Gross Profit Analysis Based on the Previous Year's Figures. 2. Gross Profit Analysis Based on Budgets and Standard Costs.

Gross Profit Analysis Based on the Previous Year's Figures.

As the basis for illustrating the gross profit analysis using the previous year's figures, the following gross profit section of a company's operating statements for 2011 and 2012 are presented

2011 Sales (net) Cost of goods sold $120,000 $100,000 ---------$20,000 =======

2012 $140,000 $110,000 --------$30,000 =======

Changes +$20,000 +$10,000 ---------+$10,000 =======

Gross profit

Contd

In comparison with 2011, sales in 2012 increased $20,000 and costs increased $10,000, resulting in increase in gross profit of $10,000. Additional data taken from various records indicate that the sales and the cost of goods sold figure can be broken down as follows:
2011 Sales Product X Y Quantity 8,000 Units 7,000 Units UnitPrice $5.00 $4.00 Total $40,000 $28,000 Unit Cost $4.000 $3.500 2011 Cost of goods sold Total $32,000 $24,500

20,000 Units

$2.60

$52,000
---------$1,20,000 =======

$2.175

$43,500
---------$1,00,000 =======

Contd
2012 Sales 2012 Cost of goods sold

Product X Y Z

Quantity 10,000 Units 4,000 Units 20,000 Units

UnitPrice $6.60 $3.50 $3.00

Total $66,000 $14,000 $60,000 -------140,000 ======

Unit Cost $4.00 3.50 2.80

Total $40,000 $14,000 $56,000 ------110,000 =====

Contd..
In analyzing the gross profit of the company, the sales and cost of 2011 are accepted as the basis (or standard) for all comparisons. A sales price variance and a sales volume variance are computed first., followed by the computation of a cost price variance and a cost volume variance. The sales volume variance and cost volume variance are analyzed further as a third step, which result in the computation of a sales mix variance and a final sales volume variance.

Contd..
Calculation of sales price and sales volume variance: The sales price and sales volume variances from the above data are calculated as follows:

Actual 2012 sales Actual 2012 sales at 2011 price: X: 10,000 units @ $5.00 Y: 4,000 units @ $4.00 Z: 20,000 units @ $2.60

$140,000 $50,000 $16,000 $52,000 -------

Favorable sales price variance Actual 2012 sales at 2011 price Total 2011 sales (used as standard) Unfavorable sales volume variance

$118,000 ------$22,000 ======= $118,000 $120,000 -----$2,000 ======

contd
Calculation of Cost Price and Cost Volume Variance:
The cost price and and cost volume variances are calculated as follows.

Actual 2012 cost of goods sold Actual 2012 sales at 2011 cost: X: 10,000 units @ $4.000 Y: 4,000 units @ $3.500 Z: 20,000 units @ $2.175 $40,000 $14,000 $43,500 ---------

$110,000

Unfavorable cost price variance Actual 2012 sales at 2011 cost Cost of goods sold in 2011 used as standard Favorable cost volume variance

$97,500 --------$12,500 ======== $97,500 $100,000 --------$2,500 ========

Contd.
The result of the preceding computations might explain the reason for the $10,000 increase in gross profit.
Favorable sales price variance Favorable volume variance (net) consisting of: Favorable cost volume variance Less unfavorable sales volume variance Net favorable volume variance $22,000 $2,500 $2,000 -------$500 -------$22,500 $12,500 ------10,000 =====

Less unfavorable cost price variance Increase in gross profit

Contd

Calculation of the sales mix and final sales volume variance:

The net $500 favorable volume variance is a composite of the sales volume and cost volume variance. It should be further analyzed to determine the more significant sales mix and final sales volume variances. To accomplish this analysis, one additional figure must be determinedthe average gross profit on the units sold in the base (or standard) year. The computations is:
Total gross profit Total number of units sold = $20,000 35,000 = $0.5714

Contd.

The $0.5714 average gross profit per unit sold in 2011 is multiplied by the total number of units sold in 2012 (34,000 units). The resulting $19,427 is the total gross profit that would have been achieved in 2012 if all units had been sold at 2011s average gross profit per unit.

The sales mix and final sales volume variance can now be calculated:

Contd..
Actual 2012 sales at 2011 sales price Actual 2012 sales at 2011 cost $118,000 $ 97,500 ------------Difference 2012 sales at 2011 average gross profit Favorable sales mix variance 2012 sales at 2011 average gross profit Total 2011 sales (used as standard) Cost of goods sold in 2011 (used as standard) $120,000 100,000 --------Unfavorable final sales volume variance 20,000 --------$573 $20,500 $19,427 --------$ 1,073 ====== $19,427

Contd

Recapitulations of Variances: The variances identified in the preceding calculations are

summarized below:
Gains Gain due to increased sales price Loss due to increased cost Gain due to shift in sales mix Loss due to decrease in units sold $1073 $573 $22,000 $12,500 Losses

--------Total Less $23073 $13073 --------Net increase in gross profit $10,000 =======

--------$13073