Before answering the given question, let's look at the confusing issues. A variable cost is one that changes when your order changes, and is usually based on a percentage of what you sell, unlike fixed costs which remain unchanged, even if you do not buy or sell anything (rental or a lease stays the same , insurance on your equipment, for example remains the same and so on). Therefore, you are correct to consider the dealer margin as a variable cost because even if the percentage is fixed perhaps by legislation or contract, (say 5% like this question), the value will change when the amount sold changes, because it is a percentage.

Gross profit and net profit are the before and after tax amounts, and gross profit does not take any sales costs into account. So, in this question, gross profit would be the $9500 which it was sold for less the original cost which included insurance and freight of $4500. You could have even gone one step further back and looked at the cost before insurance and freight in order to find the original cost if the question had allowed. In this case, however, the $4500 is our starting point.

Take care when calculating VAT, which is very different from a post-sales tax. If the product is sold for $9500 including VAT you cannot work out 10% of $9500 because, remember, the VAT is already added to the $9500 which means that $9500 = 110% (in other words, it is the original cost which represents 100% plus the 10% VAT). If the VAT was 12% it would be represented by 112% and so on. So to work out what VAT has been added create an equation.

Let x= the amount before VAT

Therefore, 110% of x = 9500

Therefore, x (which is the pre-VAT amount) = $ 8636, 36 ($ 9500 divided by 110%).

The 5% dealer margin is the percentage that the dealer is allowed to add to the price and is calculated on the pre-VAT amount; so = $ 431, 82 ( 5% of $ 8636, 36).

Therefore, if we start with $ 4500 + $ 431, 82 + $ 863,64 = $ 5795, 46

= $ 3704, 54 net profit (because VAT and the dealer had to be paid).

**The gross profit is $ 5000.**

The cost, insurance and freight of one unit is $4500. The dealer margin is 5%. The retail price is $9500 which is inclusive of a 10% tax.

When one unit is sold, the amount received by the dealer from the buyer is $9500. The dealer has to pay a tax of 10%, which is $950. Of the remaining amount, $9500 - $950 = $8550, the dealer takes a 5% margin. This is $427.5. The amount receivable by the manufacturer is $8550 - $427.5 = $8122.5

The cost of production, transport and insurance is $4500. Subtracting this from the amount received gives 8122.5 - 4500 = $3622.5

As this is profit after tax has been considered, it is **net** profit.

The dealer's margin is a variable cost as it is applicable for each unit that is sold. As the number of units sold increases, a larger amount has to be given out as dealer's margin. This is a dealer's margin calculation for post-sales tax, as in the U.S.

There is a different way to account for VAT that has been included in the selling price, as in the U.K.

For a VAT, the price at which the item is being sold is $9500, this is inclusive of 10% VAT. The actual price of the item is $9500/1.1 VAT = $8636.36.

The dealer cannot take a 5% margin on the amount that has been added to pay for VAT, only on the pre-VAT amount. (This is a little tricky issue as different methods are used in different nations.)

As a result, the margin to be paid to the dealer is $431.82 calculated on cost without VAT.

The **net** profit, then, of the manufacturer is $3704.54.

## We’ll help your grades soar

Start your 48-hour free trial and unlock all the summaries, Q&A, and analyses you need to get better grades now.

- 30,000+ book summaries
- 20% study tools discount
- Ad-free content
- PDF downloads
- 300,000+ answers
- 5-star customer support

Already a member? Log in here.

Are you a teacher? Sign up now