Question

Island Novelties, Inc., of Palau makes two products—Hawaiian Fantasy and Tahitian Joy. Each product's selling price, variable expense per unit and annual sales volume are as follows:

	Hawaiian Fantasy			Tahitian Joy
Selling price per unit	$	25		$	120
Variable expense per unit	$	15		$	42
Number of units sold annually		14,000			7,500

Fixed expenses total $580,000 per year.

Required:

1. Assuming the sales mix given above, do the following:

a. Prepare a contribution format income statement showing both dollar and percent columns for each product and for the company as a whole.

b. Compute the company's break-even point in dollar sales. Also, compute its margin of safety in dollars and its margin of safety percentage.

2. The company has developed a new product called Samoan Delight that sells for $50 each and that has variable expenses of $40 per unit. If the company can sell 13,000 units of Samoan Delight without incurring any additional fixed expenses:

a. Prepare a revised contribution format income statement that includes Samoan Delight. Assume that sales of the other two products does not change.

b. Compute the company’s revised break-even point in dollar sales. Also, compute its revised margin of safety in dollars and margin of safety percentage.

Answer 1

Solution 1a:

Contribution margin income statement
Particulars	Hawaiian Fantasy		Tahitian Joy		Total
	Amount	%	Amount	%	Amount	%
Sales	$350,000.00	100.00%	$900,000.00	100.00%	$1,250,000.00	100%
Variable Costs	$210,000.00	60.00%	$315,000.00	35.00%	$525,000.00	42%
Contribution margin	$140,000.00	40.00%	$585,000.00	65.00%	$725,000.00	58%
Fixed Expenses					$580,000.00
Net Operating income					$145,000.00

Solution 1b:

Breakeven point in dollar sales = Fixed expenses / Weighted average contribution margin ratio = $580,000 / 58% =$1,000,000

Margin of safety in dollar = Current sales - Breakeven sales = $1,250,000 - $1,000,000 = $250,000

Margin of safety in percentage = (Current sales - Breakeven sales) / Current sales = ($1,250,000 - $1,000,000) / $1,250,000 = 20%

Solution 2a:

Contribution margin income statement
Particulars	Hawaiian Fantasy		Tahitian Joy		Samon Delight		Total
	Amount	%	Amount	%	Amount	%	Amount	%
Sales	$350,000.00	100.00%	$900,000.00	100.00%	$650,000.00	100.00%	$1,900,000.00	100%
Variable Costs	$210,000.00	60.00%	$315,000.00	35.00%	$520,000.00	80.00%	$1,045,000.00	55%
Contribution margin	$140,000.00	40.00%	$585,000.00	65.00%	$130,000.00	20.00%	$855,000.00	45%
Fixed Expenses							$580,000.00
Net Operating income							$275,000.00

Solution 2b:

Revised breakeven point in dollar sales = Fixed expenses / weighted average contribution margin ratio = $580,000 / 45% = $1,288,889

Revised margin of safety in dollar = Current sales - Breakeven sales = $1,900,000 - $1,288,889 = $611,111

Margin of safety percentage = (Current sales - Breakeven sales) / Current sales

= $611,111 / $1,900,000 = 32.16%