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 24.50 Sales commissions 30.50 Total per unit variable costs $ 55.00 Total annual fixed expenses Advertising $ 287,500 Rent 243,000 Salaries 387,500 Total fixed expenses $ 918,000 Required: 1. Calculate the annual breakeven point, both in terms of units and in terms of sales dollars. 2. If Bubba’s sells 38,000 hats, what is its before-tax income or loss? Support your answer by preparing a contribution income statement. 3. If Bubba’s sells 51,000 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 $344,625 annually. What would be the new breakeven point in units? What would be the before-tax income or loss if 38,000 hats are sold with the new salary plan?

Answer 1

SOLUTION

1. Contribution margin per unit = Sales price - Variable cost

=$80 - $55 = $25

Contribution margin ratio = Contribution margin per unit / Sales

= $25 / $80 = 31.25%

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

= $918,000 / $25 = 36,720 units

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

= $918,000 / 31.25% = $2,937,600

2. Contribution income statement-

Particulars	Amount ($)
Sales (38,000*$80)	3,040,000
Less: Variable cost (38,000*$55)	(2,090,000)
Contribution margin	950,000
Less: Fixed costs	(918,000)
Net operating income / (Loss)	32,000

3. Actual sales = 51,000 * $80 = $4,080,000

Margin of safety in units = Actual sales - breakeven sales

= $4,080,000 - $2,937,600 = $1,142,400

Margin of safety ratio = (Actual sales - breakeven sales) / Actual sales

= ($4,080,000 - $2,937,600) / $4,080,000 = 28%

4. New contribution margin per unit = $80 - $24.50 = $55.50

New fixed expenses = $918,000 + $344,625 = $1,262,625

Breakeven point in units = $1,262,625 / $55.50 = 22,750

Contribution income statement-

Particulars	Amount ($)
Sales (38,000*$80)	3,040,000
Less: Variable cost (38,000*$24.50)	(931,000)
Contribution margin	2,109,000
Less: Fixed costs	(1,262,625)
Net operating income / (Loss)	846,375