Question

Bubba’s Western Wear is a western hat retailer in Lubbock, Texas. Although Bubba’s carries numerous styles of western hats, each hat has approximately the same price and invoice (purchase) cost, as shown in the following table. Sales personnel receive a commission to encourage them to be more aggressive in their sales efforts. Currently, the Lubbock economy is really humming, and sales growth at Bubba’s has been great. The business is very competitive, however, and Bubba, the owner, has relied on his knowledgeable and courteous staff to attract and retain customers who otherwise might go to other western wear stores. Because of the rapid growth in sales, Bubba is also finding the management of certain aspects of the business more difficult, such as restocking inventory and hiring and training new salespeople.

Sales price	$	80.00
Per unit variable expenses
Purchase cost		36.50
Sales commissions		18.50
Total per unit variable costs	$	55.00
Total annual fixed expenses
Advertising	$	167,500
Rent		183,000
Salaries		293,000
Total fixed expenses	$	643,500

Required:

1. Calculate the annual breakeven point, both in terms of units and in terms of sales dollars.

2. If Bubba’s sells 27,000 hats, what is its before-tax income or loss? Support your answer by preparing a contribution income statement.

3. If Bubba’s sells 39,000 hats, what is its margin of safety (MOS) and MOS ratio?

4. Bubba is considering the elimination of sales commissions completely and increasing salaries by $215,625 annually. What would be the new breakeven point in units? What would be the before-tax income or loss if 27,000 hats are sold with the new salary plan?

Answer 1

1.

Contribution margin per unit = Sales price per unit - Variable expenses per unit

= $80 - $55

= $25

Contribution margin ratio = Contribution margin per unit / Sales price per unit

= $25 / $80

= 0.3125

Breakeven point in units = Fixed expenses / Contribution margin per unit

= $643,500 / $25

= 25,740 units

Breakeven point in sales dollars = Fixed expenses / Contribution margin ratio

= $643,500 / 0.3125

= $2,059,200

2.

Contribution margin format income statement

Sales revenues	$2,160,000 (27,000*$80)
Less : Variable expenses	$1,485,000 (27,000*$55)
Contribution margin	$675,000
Less : Fixed expenses	$643,500
Before tax income	$31,500

3.

Margin of safety = Sales - Breakeven sales

= 39,000 - 25,740

= 13,260

Margin of safety ratio = Margin of safety / Sales

= 13,260 / 39,000

= 0.34

4.

Variable expenses per unit = Purchase cost = $36.5

Fixed expenses = $643,500 + $215,625 = $859,125

Contribution margin per unit = Sales price per unit - Variable expenses per unit

= $80 - $36.5

= $43.5

Breakeven point in units = Fixed expenses / Contribution margin per unit

= $859,125 / $43.5

= 19,750 units

Contribution margin format income statement

Sales revenues	$2,160,000 (27,000*$80)
Less : Variable expenses	$985,500 (27,000*$36.5)
Contribution margin	$1,174,500
Less : Fixed expenses	$859,125
Before tax income	$315,375