Question

Suppose that you are working for Amenia Ltd. as a junior management accountant. The previous accounting staff has collected the following data for the company’s last year of operations:

Sales volume (units)	150,000
Sales revenue:	$2,400,000
Direct materials:	$578,000
Direct labour:	$415,000
Manufacturing overhead*:	$540,000
Selling expenses**:	$360,000
Administrative expenses***:	$420,000
Note that:
*70 variable and 30% fixed
**40% variable and 60% fixed
***20% variable and 80% fixed

The managing director has asked that you undertake a cost-volume-profit (CVP) analysis to assist with planning. (Note: Round all calculations to two decimal places.)

Required:

a)​Calculate the breakeven point in units and in dollars for the last year of operations.   

b)​Based on a recent market study, the managing director has set a target profit (net income) of $450 000 for next year. What are the required sales in units and in dollars for the company to achieve this target? (Assume that information of selling price, variable costs per unit, and fixed costs will remain the same as for the last year of operations.)

c)​Assuming that the company meets its target profit (net income) for next year, what will be its margin of safety ratio?

d)​ When consulting with the managing director about the implication of operating leverage measure, he states that the higher the margin of safety, the better the company’s future performance. Do you agree or disagree with his statement? Explain (5marks)

Answer 1

Working Note 1 –

	Total Cost	Total Variable Cost	Total Fixed Cost
Manufacturing Overhead (70 variable and 30% fixed)	$540,000	$378,000	$162,000
Selling Expense (40% variable and 60% fixed)	$360,000	$144,000	$216,000
Administrative Expense (20% variable and 80% fixed)	$420,000	$84,000	$336,000
	$1,320,000	$606,000	$714,000

Contribution Margin Per Unit and in Percentage	Per Unit
Unit Selling Price ($2,400,000 / 150,000 Units) (A)	$16.00
Variable Cost Per Unit
Direct materials ($578,000 / 150,000)	$3.85
Direct labor ($415,000 / 150,000)	$2.77
Variable Overheads including selling and admin ($606,000 / 150,000) (Refer Note 1 above)	$4.04
Total Variable Cost per unit	$10.66
Contribution Margin Per Unit (B)	$5.34
CM Ratio (B/A*100)	33.38%

Part a –

Break Even Point in Units
Total Fixed Costs (Refer note 1)	$714,000
Divide by: Contribution Margin Per Unit (Refer Note 1)	$5.34
Break Even Point in units	133,707.87
	Units
Break Even Point in Dollars
Total Fixed Costs (Refer note 1)	$714,000
CM Ratio	33.38%
Break Even Point in Dollars	$2,139,005.39

Part b –

Required units to achieve target profit
Total Fixed Costs	$714,000
Plus: Desired Profit	$450,000
	$1,164,000
Divide by: Contribution Margin Per Unit	$5.34
Required units to achieve target profit	217,977.53
Required sales in dollars to achieve target profit
Total Fixed Costs	$714,000
Plus: Desired Profit	$450,000
	$1,164,000
Divide by: CM Ratio	33.38%
Required sales in dollars to achieve target profit	$3,487,118.03

Part c –

Margin of Safety Ratio
Total Sales Revenue (From Part b) (A)	$3,487,118.03
Less: Break Even Sales in dollars (Part a)	$2,139,005.39
Margin of Safety in dollars (B)	$1,348,112.64
Margin of Safety Ratio (B/A*100)	38.66%

Part d –

Margin of safety describes the margin over and above break even sales. It is good for the company if margin of safety is higher since the margin over break even sales is higher.

Agree with this statement.

Hope the above calculations, working and explanations are clear to you and help you to understand the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you