Question

Viejol Corporation has collected the following information after its first year of sales. Sales were $1,600,000 on 100,000 units, selling expenses $200,000 (40% variable and 60% fixed), direct materials $508,000, direct labor $290,400, administrative expenses $278,000 (20% variable and 80% fixed), and manufacturing overhead $380,000 (70% variable and 30% fixed). Top management has asked you to do a CVP analysis so that it can make plans for the coming year. It has projected that unit sales will increase by 10% next year.

If the company meets its target net income number, by what percentage could its sales fall before it is operating at a loss? That is, what is its margin of safety ratio?

Answer 1

Answer:

Let us do variable income statement for current year:

Contribution margin ratio = Contribution / Sales = 400000 /1600000 = 25%

Break-even point in dollar sales = Fixed cost / Contribution margin ratio = 456400 / 25% = $18,25,600

Next Year:

Next year sales will increase by 10%.

Next year sales = 1600000 * (1 + 10%) = $1,760,000

As the break-even sales is $18,25,600, it will be incurring losses at sale of $1,760,000 if sales price remains same.

Margin of safety = (Sales - Break-even point sales) / Sales = (1760000 - 1825600) / 1760000 = - 3.73%

At projected 10% increase in sales with no increase in sales price, it will operate in loss only and margin of safety is negative.

Current Year $1,600,000 Sales Less, Variable expenses $508,000 Direct material $290,400 Direct labor Variable manufacturing overhead (70%* 380000) $266,000 Variable administrative expense (20% * 278000) $55,600 $80,000 Variable selling expenses (40% * 200000) $1,200,000 $400,000 Total variable expenses Contribution Less, Fixed expenses Fixed manufacturing overhead (30% * 380000) $114,000 $222,400 $120,000 Fixed administrative expense (80% 278000) Fixed selling expenses (60%* 200000) Total fixed expenses Net operating profit (loss) $456,400 ($56,400)