Question

Part A

Indicate whether each of the following costs would be classified as direct materials, direct labour, manufacturing overhead or period cost. (1 Mark each)

Cost of grapes purchased by a winery
Depreciation on pizza ovens of a pizza restaurant
Salary of a plant manager in a computer production facility
Depreciation of computers used in a sales department
Wages of drill-press operators in a manufacturing plant

Part B

Prime Pizza is famous for making Margherita pizzas and delivers pizzas to the suburb on the Lower North Shore of Sydney in New South Wales. The sales price of a pizza is $10. It is estimated that the company will incur a variable cost of $140250 to make and deliver 25500 pizzas. The company’s estimated fixed costs are $74250.

Required: (Show all calculations)

a)     What is Prime Pizza’s contribution margin ratio?

b)    Calculate Prime Pizza’s break-even point in units (pizzas).

c)     Calculate Prime Pizza’s break-even point in sales dollars.

d)    (i) What is Prime Pizza’s margin of safety ratio?

(ii) How can managers of Prime Pizza use this margin of safety ratio information to manage the profitability of the business?

e) How many pizzas must the company sell to earn a target profit of $63000? (Total 20 Marks)

Answer 1

Answer A

Cost of Grapes = Direct Material
Depreciation = Period Cost
Salary of plant manager = manufacturing overhead
Depreciation = Period Cost
Wages = Direct labor

Answer B

a.

Selling Price (A)	$ 10.00
Variable cost per unit (B)	$   5.50
Contribution per unit (C=A-B)	$   4.50
Contribution ratio (C/A)	45%

b and c.

Break even Point (in units) = Fixed Cost / Contribution per unit

Break even Point (in $) = Fixed Cost / Contribution Margin ratio

Break Even Point (in units) (74250 / 4.5)	16,500
Break Even Point (in $) (74250 / 45%)	$ 165,000

d.

Margin of Safety (in units) = Actual sales (in units) - Break even Point (in units)

= 25,500 - 16,500

= 9,000 units

Margin of Safety ratio = 9000/25,500

= 35.29%

The ratio shows how the company is operating above break-even point. the managers should try to increase this ratio as much as possible.

e.

Desired sales (in units) = (Fixed Cost + Profit)/ Contribution per unit

= (74,250+63000)/4.5

= 16,500 units

In case of any doubt or clarification, you're welcome to come back via comments.