Question

E6-22 Computing Target Profit, Preparing Contribution Margin Income Statement, Computing Margin of Safety [LO 6-2, 6-3]

Erin Shelton, Inc., wants to earn a target profit of $880,000 this year. The company’s fixed costs are expected to be $1,160,000 and its variable costs are expected to be 60 percent of sales. Erin Shelton, Inc., earned $780,000 in profit last year.

Required:
1. Calculate break-even sales for Erin Shelton, Inc.


  
2. Prepare a contribution margin income statement on the basis break-even sales. (Do not leave any cells blank, enter a zero wherever required.)



3. Calculate the required sales to meet the target profit of $880,000.



4. Prepare a contribution margin income statement based on sales required to earn a target profit of $880,000.



5. When the company earns $880,000 of net income, what is its margin of safety and margin of safety as a percentage of sales? (Round your "Percentage Sales" answer to 2 decimal places. (i.e. .1234 should be entered as 12.34%.))

Answer 1

1.

Break Even Sales = Total fixed costs / Contribution margin ratio

Break Even Sales = $1,160,000 / 40%

Break Even Sales in Dollars = $2,900,000

2.

Contribution margin income statement
Sales	$ 2,900,000
Less: Variable cost ($2,900,000*60%)	$ 1,740,000
Contribution margin	$ 1,160,000
Less: Fixed expenses	$ 1,160,000
Net operating income	$                   -

3.

Target sales = (Fixed expenses + target profit) / contribution margin ratio

Target sales = ($1,160,000+$880,000) / 40%

Target sales = $5,100,000

4.

Contribution margin income statement
Sales	$ 5,100,000
Less: Variable cost ($5,100,000*60%)	$ 3,060,000
Contribution margin	$ 2,040,000
Less: Fixed expenses	$ 1,160,000
Net operating income	$     880,000

5.

Margin of safety = Actual Sales - Break even point sales in dollars

Margin of safety = $5,100,000 - $2,900,000

Margin of safety = $2,200,000

Margin of safety as percentage of sale = Margin of safety / total sales

Margin of safety as percentage of sale= $2,200,000 / $5,100,000

Margin of safety as percentage of sale = 43.14%

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